Open Letter to the Board of Talbots, Inc. by Hedge Fund Kinnaras Capital Management.
VIA EMAIL TO TALBOTS INVESTOR RELATIONS
December 9, 2011
Marjorie L. Brown, John W. Gleeson, Andrew H. Madsen, Susan M. Swain, Tsutomu Kajita, Motoya Okada, Yoshiro Sano, Isa Tsuruta
c/o Mr. Gary M. Pfeiffer,
Chairman of the Board
The Tablots, Inc.
One Talbots Drive
Hingham, MA 02043
Dear Mr. Pfeiffer,
Kinnaras Capital Management LLC ("Kinnaras") is adviser to a number of entities and affiliates which own shares in The Talbots, Inc ("TLB" or the "Company"). The purpose of this communication is to remind the Board of Directors ("Board") of its fiduciary responsibility to shareholders given its track record of shareholder disregard. Sycamore Partners ("SP"), a significant shareholder, has offered to acquire TLB for $3/share. While this offer seems low, it is where a discussion can start with SP as well as other prospective parties. Given reports that the Board squandered a prior opportunity to secure a higher price for TLB shareholders in August 2011[url=#_ftn1][/url], I am writing to urge you to use your current advisor Perella Weinberg to fully shop the Company.
A quick review of the bios of each Board member illustrates that many on the Board may simply be too taxed with duties that distract them from looking out for the best interests of TLB shareholders. For example, a quick review of your bio shows that while you serve as Chairman of the Board, Chairman of the Compensation Committee, and are a member of the Corporate Governance & Nominating Committee you also have numerous Board duties at Quest Diagnostics and Internap Network Services. These are all significant responsibilities which detract from the singular focus needed to address TLB's challenging situation.
It also appears that the Board and management team have little confidence in TLB given the paltry number of shares owned by insiders. A quick review of the Company's proxy shows that the vast majority of insider ownership is due to option grants and awards, basically equity skimmed off the backs of TLB shareholders.
When one combines the number of responsibilities Board members have aside from watching out for TLB shareholders' best interests along with the lack of monetary "skin in the game" by TLB insiders, it's hardly surprising that the Board has overlooked a number of executive and strategic failures. The following summarizes the performance of the Board and Ms. Trudy Sullivan since her appointment as CEO in 2007:
- TLB shares were valued over $22 on August 1, 2007 when Ms. Sullivan was appointed. Since that period, shares never reached that level again and prior to SP's release of it unsolicited offer, shares closed at $1.56, representing a 93% decline in value since Ms. Sullivan's appointment.
- Since 2007, sales have declined by roughly 40% while gross margins have dropped from 35% to an expected 28%-29% for the current fiscal year.
- Since 2007, operating expenses have deleveraged due to sales and gross margin deterioration, accounting for 34% of sales when in 2007 operating expenses were just 29% of sales.
- Despite the pitiful operating results and commensurate evaporation of shareholder value, the Board saw fit to award Ms. Sullivan $15.2MM in 2007, $2.5MM in 2008, $3.0MM in 2009, and $6.3MM in 2010.
- TLB removed its chief designer in mid 2011 but did not secure a replacement heading into the critical holiday season. As a fashion retailer, one would think that this would have been a top priority.
- SP approached the Board with an offer to acquire TLB in August 2011[url=#_ftn2][/url]. When this was reported, shares traded over $4.25 or 41% above the current offer price. In response to the positive price performance at the time, the Board instead enacted a poison pill to protect Ms. Sullivan.
- Despite enacting a poison pill to protect insiders, the Board has now decided to remove Ms. Sullivan as CEO once it is able to locate a suitable replacement. Upon her termination, Ms. Sullivan will receive cash severance of $5,000,000 along with a target "bonus" of $1,500,000, a pro rata annual "bonus" for the fiscal year in which the "retirement" occurs, continued health care benefits for two years following her termination date, accelerated vesting under the Company’s Supplemental Executive Retirement Plan, accelerated vesting of stock options, and 24 months of continued vesting of restricted stock.
- While rewarding Ms. Sullivan for atrocious performance, TLB will implement a $50MM expense savings program. If there are considerable layoffs associated with this program, one would wonder how much employee morale would suffer given Ms. Sullivan's vulgar payout while a number of TLB employees are released because of her failings.
TLB currently has $105MM in net debt excluding $40MM in payables financing with sourcing agent Li & Fung, significant inventories that are aggressively discounted in the current holiday season, and aggressive capital expenditures. It is possible that TLB's working capital will not cycle through to significantly delever its balance sheet during this critical quarter yet the Board is willing to dole out a $5MM cash severance to the CEO that led TLB into this situation. That alone is a disgrace.
Highlighting the failings of the Board and shameful compensation for management is important for current shareholders but the main purpose of the above points is to present unassailable evidence that the Board and management of TLB have unconditionally failed shareholders and the best possible opportunity to preserve and enhance value from here is to seek a sale. There is significant brand value in TLB but execution risk is high largely due to Ms. Sullivan's failures from both a strategic and execution perspective.
Ms. Sullivan's performance as an engaged CEO has severely crippled TLB so her performance as a lameduck CEO could be unfathomable to TLB shareholders. With no permanent CEO on the horizon, a lameduck CEO set to reap undeserved millions while employees are cut loose and demoralized, no chief designer, and no major turnaround strategy, a sale would be in the best interest of shareholders. A number of sellside analysts value TLB at $3 due to SP's offer. However, this $3 target is the lowest valuation - a floor - with one suggested target price of $4 by Oppenheimer & Co. and most recently a valuation range of $7-11 by Lazard Capital.
TLB SELLSIDE ANALYST RECOMMENDATIONS[url=#_ftn3][/url]:
|Oppenheimer & Co.||Quintilian||$4.00||12/7/11|
|Lazard Capital||Davis||$7.00 - $11.00||12/8/11|
What the Board must recognize is that the current disarray with executive management and fashion strategy coupled with a highly competitive retail environment and challenging financing conditions present an environment that requires speed from an execution standpoint that is best conducted by motivated financial or strategic buyers. Anchoring to prior historical prices before Ms. Sullivan tanked the Company will not serve the best interests of shareholders. Further, given TLB's current struggles, the Board would either have to quickly select a new CEO and dangle another hefty payday off the backs of shareholders with no guarantees for valuation improvement or take significant time in its search as TLB continues to struggle and still provide a questionable compensation package to lure a talented executive to TLB.
As an investor that has spent significant time evaluating operationally and financially challenged companies, the most sensible valuation for TLB to a private buyer would be $4.50-$5.00 per share. TLB's poor operations and the challenges in the high yield market would most likely limit a financial buyer to ABL financing, reducing the overall buyout capacity a financial sponsor could bring to the deal. In addition, TLB's current and near term (2012) performance do not support a higher valuation from a financial buyer although a strategic could pay more due to potential cost synergies.
I hope you recognize that the time to attempt a turnaround with the current Board has passed. There is value to the Talbot's brand along with other Company-owned assets but any valuation based on the prospect of significantly improving operations carries far too much execution risk to expect a reasonable buyer to pay close to share prices TLB commanded in prior years. In fact, delaying a sale process only presents the chance for impairment of the Talbot's brand as fundamental operating challenges continue to persist.
SP's offer presents the Board with a chance to start to remedy its history of belligerence towards shareholders and I hope that the Board seizes upon this opportunity. While my affiliates own a small portion of TLB shares, I have sufficient motivation and means to work with current shareholders as well as introduce TLB to larger potential investors and financial and legal advisors with the sole intent of maximizing value for all shareholders.
 Source: Bloomberg
About the author:
Amit Chokshi is the founder and owner of Kinnaras and affiliated companies and is responsible for security analysis, selection, portfolio management, and Firm operations. Prior to founding Kinnaras, he worked as an associate at the Royal Bank of Scotland ("RBS") in the firm's Corporate Advisory Services group, which provided corporate finance and mergers and acquisition ("M&A") services to the firm's clients with a particular emphasis on private equity firms. Amit also worked at Morgan Stanley and received a B.S. in Finance from Bryant University and an MBA from Emory University. In addition to passing the NASD Series 7, 63, and 65 exams, Amit is also a CFA Charterholder and on the Board of the Stamford CFA Society. Amit has appeared on Bloomberg Radio and has also been quoted in various publications regarding Firm-specific holdings.