DEST - Destination Maternity

[clutch]

Seems like the market will probably just "value" this company the same the day before the acquisition closes as the day after.  In other words, there might be a significant discount to KAZI after the ADR listing.  If you are buying for the merger-arb spread, I am not sure when you think this discount will close or why?

 

My feeling is that the current spread will shrink enough to warrant a decent return from this point (even if the spread does not completely close). I've been tracking the spread and it has varied between 25 and 50+% in the past couple of weeks. Currently the spread is at ~47%. Even if the spread closes by half, and there is still 20+% spread, you are getting a pretty good return.

 

However, all this assumes that the merger will go through and KAZI won't tank...

[Hielko]

Seems like the market will probably just "value" this company the same the day before the acquisition closes as the day after.  In other words, there might be a significant discount to KAZI after the ADR listing.  If you are buying for the merger-arb spread, I am not sure when you think this discount will close or why?

Most ADRs trade with an near zero spread because usually you can simply convert ADRs to underlying shares (Also French ADRs). It's not always possible, and perhaps a part of the spread reflects this uncertainty, and perhaps it will not be possible directly after the completion of the merger, but don't think it's that likely that a huge spread will persist after the merger.

[oddballstocks]

Seems like the market will probably just "value" this company the same the day before the acquisition closes as the day after.  In other words, there might be a significant discount to KAZI after the ADR listing.  If you are buying for the merger-arb spread, I am not sure when you think this discount will close or why?

Most ADRs trade with an near zero spread because usually you can simply convert ADRs to underlying shares (Also French ADRs). It's not always possible, and perhaps a part of the spread reflects this uncertainty, and perhaps it will not be possible directly after the completion of the merger, but don't think it's that likely that a huge spread will persist after the merger.

 

Correct, and investors can do the conversion themselves if they want.  If you buy DEST shares and receive the ADR you can request the underlying shares for a small fee.  Then re-sell those same shares back on the primary market.  This involves 2-3 phone calls, it isn't complicated and isn't that expensive.  I was quoted at $.05 per share to do this type of transaction a few years ago.  I was told that if I purchased a significant number of shares that they'd give me a price break to $.03 per share.

 

This is a fascinating special situation, I'm looking into it here. 

 

To whomever commented about KAZI financials.  If you look at their site in French they have an investor page.  Then they have links to recent documents.  The language to get to these is all in French.  But bizarrely the financials themselves are in English.

[writser]

Seems like the market will probably just "value" this company the same the day before the acquisition closes as the day after.  In other words, there might be a significant discount to KAZI after the ADR listing.  If you are buying for the merger-arb spread, I am not sure when you think this discount will close or why?

 

As mentioned by others: because the depository bank can convert ADR's into common shares and vice versa. An ADR is just a wrapper for US investors around a foreign common share. This was probably the easiest way for Orchestra Premaman to list their shares in the US.

 

Correct, and investors can do the conversion themselves if they want.  If you buy DEST shares and receive the ADR you can request the underlying shares for a small fee.  Then re-sell those same shares back on the primary market.  This involves 2-3 phone calls, it isn't complicated and isn't that expensive.  I was quoted at $.05 per share to do this type of transaction a few years ago.  I was told that if I purchased a significant number of shares that they'd give me a price break to $.03 per share.

 

I don't think it is always that easy. The liquid ADR's (for example, see a list of shares supported by IB here) can easily be converted. But for many other ADR's I think there's a minimum value ($1m or something) and I'm not sure all brokers would support it (they probably support it for the large names because they can pool the requests). And if they don't, good luck calling BNY Mellon to try and convert your fifty ADR's. But the details are irrelevant anyway. If a big player can convert the ADR's into normal stock then that should keep prices more or less in sync. And even if the ADR's trade at a few percentage points discount to KAZI the trade would still be great at current prices.

 

The $1m question is not: "what will happen with the ADR discount" but "at what price will KAZI trade after the merger." (apart from, of course: "will the merger succeed"). KAZI has low turnover, low free float and cannot be shorted. A lot of new shares held by former DEST holders will flood the market. One could argue that shares of the acquirer are currently mispriced, not the shares of the target. My best guess is that the truth is somewhere in the middle. I haven't done any advanced valuation work on the combined entity.

 

If I'm wrong the Saudi prince will hopefully bail me out!  :P

[NeverLoseMoney]

I'd think holders of KAZI should also be interested in selling their stock post-merger and picking up the ADR instead, if it is trading at a huge discount. Perhaps they are hesitant to do this now. That could put selling pressure on KAZI and create demand for the ADR. The ADR should be pretty accessible to French / European KAZI holders, I would think.

[writser]

Somebody messaged me that he/she thought the spread was way too wide and wondered what we are missing and what my biggest concerns are. I'll post my reply here to encourage further discussion (or ridicule of my ideas).

 

I have no special insights. My main worries with this deal:

 

1) That as an outsider I am misjudging the chances of this deal getting cancelled or restructured. I can see no signs that point in that direction but maybe I am missing something.

2) That KAZI is trading at an elevated level because it cannot be shorted and has a low free float. Meaning that KAZI (and thus the ADR) collapses after the deal.

 

Imho it is dangerous to think: "the spread is 32%, something must be wrong". While discounted deals are often hairy, with such a thought process you have to be careful that you don't end up buying the same deal at a 5% discount (because the discount looks reasonable) but refuse to buy it at a 32% discount (because something must be wrong). It's a trap I have fallen into before. If you can't find what is wrong with your thesis the large discount is a good thing, not a bad thing. Frankly I don't expect to capture the full spread when buying DEST now. KAZI will probably drop after deal completion but even if it drops 30% you are still pocketing a profit. As I said before, the truth is probably somewhere in the middle. My assumption is that the spread is made up of several components, let's say:

 

a: discount rate.

b: uncertainty about deal completion.

c: US investors not liking receiving an ADR in a small French company.

d: investors wanting an extra premium because they currently hate the retail space.

e: investors expect KAZI to drop so they want an extra margin of safety.

 

My reasoning is that I expect to lose some money on point e but the bet is still profitable because of a, b, c and d. This is not an 'arb' because you cannot capture profits beforehand and I think that is one of the reasons an opportunity exists in the first place. It's not a fundamental value play but a bet that investors dislike the uncertainty inherent in owning DEST and that that depressed the stock price too much. A similar situation (where the acquirer could not be shorted) last year was AFCO/FPI. Current similar situations (only for PA's) are ADGE/TGEN or one of the many microcap bank mergers. These plays are volatile but I think they are +EV.

 

The weak point of my analysis is that it is mostly psychological mumbo-jumbo. I sized accordingly. A more sensible investor should probably do a valuation of combined entity as well to see if the current KAZI price makes any sense but I'm very lazy (and I give the market some credits for being approximately right most of the time).

[awindenberger]

Another great example of a merger that had a massive spread at one point was the TSLA/SCTY deal last summer/fall. Many people didn't expect it to be completed, and SCTY was at one point trading with a 30% discount. I bought in at that point, although I was concerned TSLA would tank to eliminate much of the gains. In the end they actually went up and I pocketed 50% (of course had I held til now that would have been 100%)

[JayGatsby]

To whomever commented about KAZI financials.  If you look at their site in French they have an investor page.  Then they have links to recent documents.  The language to get to these is all in French.  But bizarrely the financials themselves are in English.

Thanks. I could only find the revenue, but it looked solidly good enough. I opened a small position in DEST.

[whistlerbumps]

At the end of the day, if this works out you get the KAZI ADR... Based on the numbers I have seen KAZI looks overlevered and non FCF generative.  So why would I want to get the ADR?  I understand the arb if you can put it on but don't understand why people are interested in just being long the merged entity.

 

[NBL0303]

To those that have been following this, what have the companies said about the timeline for closing this?  I realize that is largely contingent on the shareholder vote and everything, but just curious has management discussed a timeline for closing?

[writser]

Initial press release from last December:

The parties currently expect the transaction to close mid-2017.

 

From the latest conference call (about a month ago):

Now before I wrap up, I again want to reiterate that we believe we are positioning our company well for long-term success and a major part of this positioning relates to our merger with Orchestra-Prémaman. We've been busy working diligently with Orchestra on preparation of its stock registration statement with the SEC and related documents. And we believe we are on track for closing in our third fiscal quarter.

[clutch]

The spread has become so ridiculous now that I bought more shares today...  ???

[Guest roark33]

Everyone keeps talking about the spread, but like the above poster mentioned, no one mentions what the combined entity should be worth.  The liquidity of DEST probably reflects the value of the combined company much more than the KAZI shares, which are highly illiquid and probably impossible to short.

[clutch]

Everyone keeps talking about the spread, but like the above poster mentioned, no one mentions what the combined entity should be worth.  The liquidity of DEST probably reflects the value of the combined company much more than the KAZI shares, which are highly illiquid and probably impossible to short.

 

Following this logic, are KAZI shares then significantly overvalued?

[Guest roark33]

That would be my conclusion.....

[writser]

They probably are overvalued. But, as Roark pointed out:

The liquidity of DEST probably reflects the value of the combined company much more than the KAZI shares [..]

 

Key question is: how much more? Average daily turnover in KAZI is 130k euro. Average daily turnover in DEST is 160k usd (these are sloppy calculations but they are ballpark correct). Should we completely ignore the KAZI price action? Look at it as a free option. Even if you blend KAZI/DEST prices as 10%/90% your IRR would be great. As I said a few times before, the truth is probably somewhere in the middle. I'm sure KAZI will crater after the merger but your cost basis is currently 6.30 euro, 20% below the 52 week low. I'm betting that that is a profitable  buy but I understand that that is not everybodies cup of tea.

 

One could try to value the combined entity but I am to lazy / incompetent to do so thoroughly. From what I can see the merger makes sense so I'm giving the market some credit and say the the price range of the combined entity is somewhere between the current DEST price and the current KAZI price. We'll see where it ends up exactly. I don't have much more to add. The spread is still ridiculous, there is no news, this trade could fail spectacularly and I don't recommend going all-in. I'm fine with holding and waiting.

[Hielko]

Everyone keeps talking about the spread, but like the above poster mentioned, no one mentions what the combined entity should be worth.  The liquidity of DEST probably reflects the value of the combined company much more than the KAZI shares, which are highly illiquid and probably impossible to short.

 

Following this logic, are KAZI shares then significantly overvalued?

I think it's a bit weird to think that the market is right on DEST and just totally wrong on KAZI, just because the first one has higher trade volumes. KAZI is the stock with a way higher market cap, will be the biggest part of the combined company post merger, has stronger fundamentals (growing revenue, decent earnings) and it's trading at normal PE multiple of 10x. That shouldn't be too hard to value.

 

DEST is the company with the more troubling financials (declining revenue and negative operating earnings) that is a lot tougher to value. Assuming that the market is right on this one just because for some reason people like buying and selling this stock at prices I can't explain is a bit of a stretch to me.

 

I wouldn't be surprised if KAZI would drop post merger, not because it's now not correctly valued, but just because there are probably a lot of arbs who want to get out after deal completion and they will not care a whole lot about the price.

 

But guess we will see how this will turn out.

[Hielko]

PS. Just taking the numbers from google finance, but approx average daily trade value of KAZI is $228K USD and DEST is $222K USD. So practically identical. DEST trades more shares, but a single share is obviously a lot less valuable.

[Guest roark33]

have you guys ever tried to short KAZI?  That's the main question.....

[clutch]

have you guys ever tried to short KAZI?  That's the main question.....

 

Well, that could end really badly if the deal fails... and It would have also not worked well for the past couple of weeks as the spread got bigger.

[Guest roark33]

I am just wondering if it is possible, as I haven't tried. 

[Hielko]

I am just wondering if it is possible, as I haven't tried.

My broker doesn't have shares available for borrow.

[constala]

On borrow: IB used to have some KAZI shares to borrow a few months ago, but not any more.

 

On liquidity, price discovery and market efficiency: traded volumes on DEST and KAZI are now equivalent; KAZI free float is comparable to DEST Market Cap; some stock lending existed on KAZI; so I would say both prices are not totally disconnected from market forces. Clearly, it was not always so: before its capital raise in September 2016 at EUR 15.65 , KAZI float was non-existent, 1.93% at one point, so the past price range (8-23) needs to be taken with a pinch of salt.

For DEST price action, interesting to observe that the high short interest (>16%) in 2016 receded to less than 2.5% now. 

Since October, price correlation is very high. Both stocks are down 40%. Recent rebound of KAZI following the Saudi partnership.

 

On merger failure odds: seem extremely low. Especially if you read this update. KAZI has been working hand-in-hand with DEST since months and key French executives are already on the American ground, opening shops, "corners" in DEST shops, and recruiting, and revamping the retail website. Looks like both parties behave as if the merger had already closed.

www.philly.com/philly/hp/news_top/European-Invasion-at-KOP-Mall-French-kids-retailer-Orchestra-is-the-latest.html

 

On the jockey, Pierre Mestre: reading about his track, his visions, the many pitfalls he escaped, he appears to be one of the best and most experienced French retail entrepreneurs. I would not bet against him. 21 years of profitable growth. In 2000, he had 18 shops and a Turnover of EUR 12 million. Now he sells 90 million units in 580 shops, and note he still guides to a Turnover of 1 bln in 2019/2020 without DEST. I would say he proved masterfully how to integrate new businesses: he acquired no less than 10 in 15 years! He realizes the DEST potential, synergies and hidden assets (1 million names of pregnant women every year...), he has growing scale (and modern logistics, and powerful purchasing bureaux in the low-cost regions) to be competitive on price. He has already identified the levers at hand (Costco-style membership fee model, cross-selling, internet growth, childcare products higher margins etc..).

 

On metrics of merged entity: Turnover of merged entity in 2020: above $1.5 bln, forward Ebitda  guidance>$100m. Implied Market Cap: less than $150m.  Combined Net debt less than $180m. Not overly expensive for a profitable growth story.

 

 

 

[clutch]

The spread getting significantly narrower past couple of days (with no apparent reason...).

 

It seems like the best way to make money with this one is to trade in/out when the spread gets big/small.

[awindenberger]

The spread getting significantly narrower past couple of days (with no apparent reason...).

 

It seems like the best way to make money with this one is to trade in/out when the spread gets big/small.

 

I believe this is the reason: https://seekingalpha.com/article/4075581-destination-maternity-merger-spread-believe

 

Article was published yesterday to SA Pro users, which likely explains the run up. Then today to all users. I'd been planning to put together one myself over the weekend and got busy. DEST Q1 earnings come out Friday I believe. That should be interesting.