Buy This Undervalued Company Before It Goes Private
Shaun is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
American Greetings (UNKNOWN: AM.DL), the second largest greeting cards company in America, is currently attempting to go private by the founding Weiss family, with a current offer of $17.50 per share. This offer is roughly a 6% premium over today's price. I believe that the company is undervalued, and that there is a good chance of the going private offer being successful. In addition, looking through the company financials, the company appears to be undervalued even at the going private premium, with a 3.6% dividend to stabilize the stock’s price in the short term should something go wrong with the going private transaction.
A look at the risks: Overblown fear over restructuring Carlton Cards, and the threat of eCards:
The stock has been beaten down by fears of losing market share and margin to “eCards” sent through the internet. While I suspect that eCards will eat a small amount into American Greetings profits, I largely think the damage has already been done. As anyone who has given or received an eCard can tell you, the experience of getting an electronic card is very different and less personal than receiving a physical, paper card. While some companies are doing very interesting things in regards to personalizing gifts given over the internet (see, for example, internet startup delightfully.com) I don't think giving someone a card can be replicated or replaced through the internet.
Adding another level of uncertainty to American Greetings is the recent acquisition of Carlton cards. Carlton cards was bleeding money before American greetings acquired it. American Greetings has been massively reorganizing Carlton, closing about half of Carlton's 700 stores, and tightening up accounting and store best practices. Growing through acquisition should send off alarm bells in investors, as there is always the fear of Peter Gramm's “De-worse-ification,” but the Carlton cards acquisition appears to be very synergistic. The storefronts of Carlton's stores provide a sales space for American Greetings other products, and the Carlton business is very well within management’s core competencies. This acquisition has had American greetings showing a temporary loss for much of 2012, but management appears to have things under control and the company will again see profits for 2013.
On the downside, American Greetings much smaller than its main competitor, Hallmark. Hallmark pulls in a little over 4 billion in gross profits each year, dwarfing American Greetings 1.7 billion per year. The card business is largely Hallmark and American Greetings in America; the next largest competitor, CSS Industries, only pulls in a gross revenue of around 300 million per year.
Why I think this is a good opportunity for risk arbitrage:
Greeting cards are obviously not a growth industry. But the market is not rationally pricing the income the company can make. The company itself reports a book value of around $20.35 per share, which makes the current $17.50 per share buyout offer (raised from 17.18) a bit of a slap in the face to long term investors. But to folks looking for arbitrage opportunities, this is a good deal. Either the going private transaction is successful, and risk arbiters make a quick 6% on their money, or the going transaction fails, and investors have an undervalued stock buoyed by a dividend of 3.6%.
I think the going private deal will be successful. The Weiss family has over 51% of the controlling interest in the company through their class B shares, and the Weiss family appears to be making good steps in securing funding for this buyout from Bank of America, Macquarie Capital Inc., KeyBank, and PNC bank. Minority shareholders do appear to be mounting lawsuits in reaction to the low price that the Weiss's are offering, but I expect that these efforts would only result in raising the go private offer closer to book value, rather than scuttling the deal all together.
A comparison with other going private transactions:
The market seems to be disagreeing with me regarding American Greetings chances of going private, in that the gap between the stock price and the offered price by the Weiss family has refused to shrink to the levels of other companies being bought out. Let's look at two of these deals getting a lot of press coverage recently.
The threats to Dell's (NASDAQ: DELL) road to going private has been widely publicized. In contrast to American greetings, which is a good 6% or so below the current buyout offer, Dell is currently trading *above* the offered $13.65 per share to shareholders, as the market hopes that minority shareholders will be successful in negotiating better terms for their shares if Dell goes private. This equates to shareholders realizing a potential loss if the deal goes as currently planned. In addition, the group taking American Greetings private have a majority of voting rights, while Dell's group does not. If Dell's deal does not go through, I expect deep short term losses to Dell shareholders as the market grapples with the question of the computer manufacturer's future prospects in a tablet driven market. In contrast, American Greetings' business is still strong, even if the going private transaction does not occur. Right now, I think American Greetings is the safer risk arbitrage play.
Another buyout offer getting a lot of press is from Berkshire Hathaway's acquisition of Heinz(NYSE: HNZ). Heinz currently has a very small gap between stock price and buyout price, around half of a percent or so. This is in spite of some legal action attempting to stop the buyout under its present terms and to take Heinz directors to court. While these legal attempts will probably not bear fruit, Heinz does not look like a sufficiently profitable risk arbitrage play considering the slight risk and time period involved.
The advantages to writing options as opposed to simple stock ownership:
If you want to invest in this risk arbitrage play, consider writing options. The stock is currently trading at around $16.50, which would give you about 6% profit on an investment. But October 2013 put options (at a strike price of 17.5) can currently be written for around $1.6, basically giving you the dividend for the next year up front, which would increase the potential profits from the risk arbitrage play to around 9%-10% of your risked capital. Likewise, if you want to buy stock and write calls, October 17.5 calls can be written for around .30, which adds another 1.5% or so of gains to your risk arbitrage play. If you go the covered call route, you can enjoy the dividend if the deal takes longer than expected, while if you write the puts, you cannot. While the added income these options make is tempting, if the going private offer moves above $17.50 per share due to legal pressure from minority shareholders, you will miss out on those gains.
Cards are boring, but a 5-9% yield in a few months isn't.
The market as a whole currently looks a bit overpriced to me. This makes arbitrage opportunities like the one offered by American Greetings an excellent market neutral play. American Greetings being successful in their bid to go private is largely independent of the overall market. Due to the undervalued nature of the stock, I don't see much danger of a giant loss of capital. Either investors make a quick profit, or they are a part owner in an undervalued company with a proven record of cash generation and long history of a dividend. I predict that American Greetings will outperform the S&P 500 over the next three months, and can provide an important hedging function in a portfolio.
Flyingwhale is short July 2013 17.5 puts on American Greetings. The Motley Fool recommends H.J. Heinz Company. The Motley Fool owns shares of American Greetings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!