Prem Watsa, chairman and CEO of Fairfax FinancialCharla Jones/The Globe and Mail
The hunt for undervalued companies led two of Canada's richest and most famed investors to funeral home operator Arbor Memorial Services Inc. Now, a dispute between them could derail a $375-million plan to take the company private.
On one side is Stephen Jarislowsky's firm, Jarislowsky Fraser Ltd., which says the bid of $32 a share is too low. On the other is Prem Watsa's Fairfax Financial Holdings Ltd., which is helping to finance the proposed buyout of Arbor by the Scanlan family, which already controls the company, in hopes of finally banking some profits on a holding that has done well on paper but is very difficult to sell in the open market.
Jarislowsky Fraser will not support the deal at $32, said Helen Beck, the firm's lead manager for Canadian equities. "The timing is a bit opportunistic," she said in an interview, in part because the company's spending has been elevated of late so profit appears depressed.
The Fairfax group, which includes another large money manager, JC Clark Ltd., counters that there is no more money to raise the bid, because banks won't lend any more. They say this may be the only chance that minority shareholders have to get their money out for a very long time.
Jarislowsky owns enough shares to raise a credible threat of blocking the deal, if it can convince other shareholders to also hold out for more. But if the transaction were to fail, Arbor's stock could fall back toward the low $20s, where it traded before the bid.
At the heart of the issue is one of the conundrums of value investing. Prospecting for cheap stocks can lead to companies such as Arbor that sell for less than their underlying value, in large part because they trade so rarely. But just how do you get out of a big stake in a company that might trade a few thousand shares in a busy a week, as Arbor does? Often, the answer is to patiently wait for a takeover from a rival who will pay up.
Except, in this case, the Scanlan family says it has no intention of selling Arbor to anyone else. Ever, if possible. "I know forever is a hard word to use, but that would be my goal," David Scanlan, chairman of the family holding company and Toronto-based Arbor, said in an interview.
The family has looked at taking Arbor private in the past, but could not find the money, he said. That changed this year when Fairfax decided it wanted out. Mr. Watsa himself got in touch, and the parties crafted a plan. Fairfax enlisted JC Clark to help. The two shareholders are not taking all their cash up front, instead allowing the Scanlans to buy them out over time. Without that, "it would be very tough" for the family to do the deal, Mr. Scanlan said.
Fairfax would rather have all cash but there is no other way, so Fairfax and JC Clark are both taking back shares in the proposed private company, including preferred stock that pays a below-market rate, said Paul Rivett, vice-president of operations. That also means "this stretches the balance sheet of the company to the breaking point," Mr. Rivett said.
Colin Stewart, head of JC Clark, echoed that, saying there is simply no more cash available to raise the bid. "Why would anyone in their right mind take on uneconomic pref shares if there was more leverage available?" he wondered.
What do the people entrusted with protecting the interests of minority shareholders have to say? The special committee of Arbor's board is recommending the takeover, based in part on a valuation opinion from TD Securities. But there is also controversy about that.
The $32 price is at the bottom end of a valuation range of $32 to $38 a share calculated by TD. However, that range was calculated based on what investors would pay in an "open and unrestricted market," with no allowance for the fact that the stock is illiquid and the controlling shareholder has no intention of selling.
TD did not use a leveraged buyout analysis, even though it admits that "the arrangement is similar to a traditional leveraged buyout transaction and that a strategic combination is not reasonably possible" because of the family's stance on selling. Based on an LBO analysis, TD estimates the value range at $28.37 to $35 – which puts the current bid smack in the middle.
Both the Fairfax side and the Jarislowsky side can make the case that they are standing up for smaller shareholders, Jarislowsky by holding out for more cash and Fairfax for having come up with a takeover where otherwise there would be none. Investors will just have to decide who to trust, and whether there is really a little more money to be had at the risk of getting nothing at all.
Whatever happens at the deadline on Nov. 16, Mr. Scanlan and his family expect to keep running Arbor.
"We have three generations working in the family business," he said. "The business since it was public has always been controlled by my family. We have a lot of sweat equity in it. We are very committed to the business."