For some time now, value investors have been lamenting that their portfolios are full of bargain-priced businesses that are ignored by investors chasing the latest technology offering. So it was a vindication of sorts when two Canadian value stocks, Dorel Industries Inc. (DII.B-TSX) and Rocky Mountain Dealerships Inc. (RME-TSX), were the subject of takeover offers within minutes of each other on Monday morning. Strictly speaking, these are not takeover offers, but going-private transactions and the potential buyers include current management. This presents a problem: Minority investors are effectively negotiating with groups that have in-depth knowledge of the recovery potential facing the companies – not exactly a level playing field. Shareholders normally expect management to maximize company value, but when management is the buyer, the motivation is reversed.
This would not be an issue if the proposals offered a generous exit price, but my initial impression is that the offering prices are underwhelming at a time when both businesses appear to be in the early stages of a recovery. If minority shareholders accept the offer, they may be leaving a lot of upside on the table.
In the case of Dorel, the offer of $14.50 for all of the shares is almost exactly the level of recent book value per share and represented a tiny premium to the previous day’s closing stock price. Depending on your entry point, this is either a coup or a disaster. The stock traded as low as $1.25 six months ago and as high as $40 as recently as December, 2016.
I mentioned Dorel in passing in an article I wrote for Report on Business in July as a possible beneficiary of the upsurge in cycling caused by the COVID-19 pandemic but was lukewarm on the stock, even though I own one of their Cannondale bikes. Only one-third of revenues came from cycling products, and the balance sheet was quite leveraged. At the time, the stock was trading at half of book value, so management may feel that one-times-book is generous. At the time of writing, Dorel stock trades at a premium to the offer price, so some investors are clearly hoping for an improvement. The presence of multiple-voting shares means that the Schwartz family controls 60.2 per cent of the votes. I suggest that subordinate voting shareholders wishing for a bidding war, while technically possible, might want to study the Cogeco takeover saga and the response by the controlling family before getting too excited about a better price.
The situation at Rocky Mountain Dealerships, which I own, has more potential upside. The company is Canada’s largest agriculture-equipment dealer, with branches throughout Alberta, Saskatchewan and Manitoba.
The offer by the management group is $7 in cash, which was a 27-per-cent premium to the recent stock price of $5.50. More important, in my view, is the fact that book value per share at the end of September was $9.74, while tangible book value was only a little lower at $8.66. As recently as 2017-18, the company generated an earning power of $1 a share, which represents a return on equity (book value) of about 10 per cent and paid a dividend of 48 cents. Although the company has since struggled with the downturn in exports of agricultural commodities, which caused farmers to hold off on new equipment purchases, the balance sheet has been downsized through inventory reductions and the financial leverage dramatically reduced. Earnings per share for the nine months to Sept. 30 are already 25 cents, so a recovery is at hand.
Earlier this year, Strongco Corp., a TSX-listed small-cap heavy-equipment distributor, was sold to a European competitor for $3.15 a share, representing a 36-per-cent premium to the latest published book value and an 80-per-cent premium to the average 60-day trading price. Although the end markets are not the same, the industry dynamics are similar to Rocky Mountain Dealerships, and Strongco had a more volatile recent history, which would have dampened the enthusiasm of the buyer. A premium to the book value of Rocky Mountain Dealerships is not an unreasonable expectation on the part of minority shareholders.
How likely is this to happen? Well, unlike the situation at Dorel Industries, there are no multiple-voting shares here, and the management group proposing the buyout holds only 13.3 per cent of the shares outstanding. All the minority shareholders have to do is to say no until a better offer materializes. Failing that, we may be better off simply to hold the stock for the long haul – the preferred habitat of true value investors.
Robert Tattersall, CFA, is co-founder of the Saxon family of mutual funds and the retired chief investment officer of Mackenzie Investments.
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