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Talbots ($TLB) arbitrage opportunity

December 11, 2011 | About:
whopper investments

whopper investments

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Talbots (TLB) may be the perfect example of why it’s so hard to invest in retailers. If you had looked at any point in the past few years, you probably would have seen a retailer in the midst of a turnaround where success would result in huge upside and failure would probably result in a buyout at around the price you were looking at. Check out this write up over at value investors club. It was written exactly one year ago when the stock was at ~$8.50, and if you read it you were probably at least intrigued by the huge possible upside. I was- I looked at the stock at least three different times when it was at $11, than at $8, and finally in the $4-5 range.

Of course, if you had invested at any of those spots, you’d be down huge today. The company bumbled through one initiative after another under the current management, burned through hundreds of millions of dollars in cash, and eventually brought itself to today’s situation- a looming liquidity crunch, missing management in key spots (like creative officer), and basically on the verge of failure.

Which brings us to today’s situation- with the company undergoing a weak holiday season and slowly burning through its cash, Sycamore Partners, a newly formed private equity firmed, offered $3 per share for the company, a huge premium to the previous closing price of ~$1.60. If the deal goes through and Sycamore can turn the company around, it’ll likely turn out to be the bargain of the century, as Sycamore would be paying the lowest price to sales ratio for a retail company in history.

All of which brings us the today’s investment opportunity. The company is trading at a huge spread to the proposed take out price (currently $2.80, or about a 7% spread). On its own, this would be interesting, but what makes it more interesting is Sycamore specifically states in their buyout offer that they could be willing to raise their offer with proper due diligence.

What makes this so interesting is it seems the only rational course for Talbots is to sell themselves. They’re liquidity starved and have several key management vacancies. They’ve tried several turnarounds in the past few years, and the type of turnaround they need to undergo clearly can’t be accomplished be this management team and likely needs to be done by a private company, not a public one. Now that Sycamore has put them into play, Talbots likely needs to hold an auction and quickly sell the company off. The $3 share price would likely serve as a floor, because even if a company could buy them in the low $4 range and successfully turn them around, their IRR would likely be over 50% in three-four years.

Unfortuantely, that may be the “rational choice” but this board has proved time and again they really don’t care about making the rational choice (check out this letter for a great recap of just how bad they’ve been). Thankfully, the management was the big reason I stayed away from the company in my initial look, and they ended up saving me a nice 60% or so loss!

The other worry is shareholders hold out because they anchor on how much higher TLB’s price was one or two years ago and dismiss this offer as a lowball. TLB’s largest shareholder, owning ~12%, has already come out and said he won’t support the $3 offer and refused to disclose a price he would.While the offer may be much lower than what they were worth two years ago, the business is now worth significantly less.

Ultimately, I think this is a pretty interesting situation. If the board makes the right decision and holds an auction, you could be looking at a a IRR of 60-70% on an investment that last three-six months. Not bad at all. The company has a full range of options traded that could be interesting – the May $3, for instance, trade for ~$0.45 per contract, and could easily triple if the company ran a full auction or Sycamore raised its bid a bit. Selling the May $3 puts would be interesting if you see this deal going through.

I am avoiding the situation, purely because I don’t see how I could possibly have an edge here, and there is some risk of permanent capital loss. But it is a very interesting situation that I wanted to point out.

PS- there were two fabulous articles discussing TLB on valueslant and gurufocus that I’d recommend reading if you’re interested in TLB.

Disclosure- Interested, but currently no position


Rating: 3.8/5 (13 votes)

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