By Alex Gavrish, Etalon Investment Research; author of Wall Street Back To Basics

 

Stock price action leaves investors paralyzed

The ongoing takeover battle between Jos. A. Bank Clothiers Inc (NASDAQ:JOSB) and The Men’s Wearhouse, Inc. (NYSE:MW) left many investors puzzled and somehow paralyzed as to what action to take, if any. Since the start of the process, once Jos. A. Bank Clothiers Inc (NASDAQ:JOSB) presented its offer, the market reacted positively and supported the merger. As the bidding war went on, the shares of both companies continued to climb higher, which is unusual. The perceived benefits of combining the two companies, lack of debt on the balance sheets, and most importantly value that could be created due to potential cost savings and operational synergies ignited investor interest. At the same time, some market participants were perplexed with regards to what action to take and which company’s stock to buy to profit from the developments. One can learn an interesting investment lesson from Ricky Sandler, manager of the hedge fund firm Eminence Capital.

Transaction overview

On October 9th 2013, Jos. A Bank disclosed an offer to acquire Men’s Wearhouse for $48 per share. The offer price represented a premium of 36% to The Men’s Wearhouse, Inc. (NYSE:MW) previous day closing price and valued it at about x8.3 EV/EBITDA (based on FY 2012 results). According to Jos. A Bank’s plan to finance the deal, the combined entity would be valued at an EV/EBITDA of x7.3 (based on FY 2012 results and using Jos. A Bank’s October 9th closing price of $44.33 per share). This does not include any cost savings and synergy benefits of combining the two businesses. The same day Men’s Wearhouse promptly rejected the offer as inadequate.

In its letter to Men’s Wearhouse, Jos. A Bank cited an interesting fact: that there is a significant overlap in the shareholder composition of the two companies. The transaction can therefore provide unique benefits to shareholders of Men’s Wearhouse, as they will receive a premium for their shares and at the same time will remain shareholders of the merged entity by being also shareholders of Jos. A. Bank Clothiers Inc (NASDAQ:JOSB). The day the transaction was announced, The Men’s Wearhouse, Inc. (NYSE:MW) shares traded on a very high volume – approximately 32% of shares outstanding, which provided possibility that with a significant change of shareholders Men’s Wearhouse might be under pressure to enter into discussions regarding the merger.

Eminence Capital position

On November 7th 2013, Eminence Capital, a hedge fund firm managed by Ricky Sandler, disclosed a 9.8% stake in Men’s Wearhouse. Eminence Capital sent a letter to the Men’s Wearhouse board of directors expressing their disappointment with Men’s Wearhouse’s response to the proposal and expressed an opinion that Men’s Wearhouse’s boards of directors should evaluate all strategic alternatives available as well as enter into a dialogue with Jos. A. Bank regarding a possible combination. In a presentation the fund published on November 20th 2013, Eminence disclosed that it also owned a 1.4 million shares position in Jos. A Bank, or approximately 5% of shares outstanding, valued at $70 million as of November 18th, 2013. The total value of Eminence Capital’s position was therefore split 75% and 25% between The Men’s Wearhouse, Inc. (NYSE:MW) and Jos. A. Bank Clothiers Inc (NASDAQ:JOSB) shares. Such structuring is interesting, given the fact that possible merger is highly beneficial to both companies.

Current valuation

On November 26th 2013, Men’s Wearhouse turned the tables on Jos. A. Bank Clothiers Inc (NASDAQ:JOSB) and submitted a proposal to acquire Jos. A Bank for $55 per share in cash.  Jos. A Bank reported quarterly results on December 5th 2013 and three weeks later rejected Men’s Wearhouse proposal as it undervalues the company. The proposed price of $55 per share values Jos. A Bank at an EV/EBITDA multiple of x7.4 (based on FY 2012 results). The Men’s Wearhouse, Inc. (NYSE:MW), in turn, is currently valued at an EV/EBITDA of about x9.1 (based on FY 2012 results). Applying a conservative estimate of the increase in combined EBITDA by 20%, the merged company (based on current market prices) is trading at an EV/EBITDA multiple of x7, leaving enough upside potential in place even after the latest round of bidding. By learning from Eminence Capital and taking a position in both equities, for example in a 50/50 proportion, one can still make a sound investment decision while leaving room for potential surprises if the offer price for Jos. A. Bank Clothiers Inc (NASDAQ:JOSB) shares will be increased in the short-term.

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