Lakewood Capital Submits Letter to Chairman of Securitas Direct
21/11/2007 08:03
PR Newswire
NEW YORK, November 21 /PRNewswire/ --
Lakewood Capital Management, LP yesterday sent the following letter to
Ulf Mattsson, Chairman of the Board of Securitas Direct:
November 20, 2007
Ulf Mattsson
Chairman of the Board
Securitas Direct AB
Kalendegatan 26, Box 4519
SE-203 20 Malmo
Sweden
Dear Mr. Mattsson,
As you may know, funds affiliated with Lakewood Capital Management, LP
("Lakewood") own 4,000,000 series B shares of Securitas Direct AB ("Securitas
Direct" or the "Company"), which represent approximately 1.1% of the total
outstanding shares.
I am writing to inform you that we will not be tendering our shares in
the recently announced offer from ESML Intressenter AB ("ESML" or the
"Offeror"), and I would like to share with you why we believe the current
offer is not in the best interest of Securitas Direct's shareholders. We have
acquired our position in the Company earlier this year, and we have a
long-term, patient view towards our investment in the Company. Securitas
Direct has been our fund's largest holding for some time, and we have spent
considerable effort analyzing and valuing the business.
We believe Securitas Direct is an extraordinary business with strong
management, leading market shares, high returns on capital, predictable and
recurring cash flows, and significant growth opportunities. We firmly believe
the company is worth substantially more than the SEK 26 per share offer from
ESML. In our view, the value of the Company today is conservatively between
SEK 35 and SEK 50 per share based on assumptions which are below management's
publicly-stated targets, as I will discuss further below.
Our view of value is substantiated by the level of financing the Offeror
was able to attain and significant recent insider share purchases, including
those by the CEO which he publicly stated were financed by the sale of his
home. We believe the offer at these levels is an opportunistic attempt by the
Company's two largest shareholders and their financial backers to capture the
vast upside we see in the Company for themselves.
We urge you not to recommend the current offer to shareholders and
instead explore the following options for maximizing shareholder value: (1)
negotiate an offer price from ESML that more fairly represents the value of
the Company, (2) solicit superior offers from other strategic and financial
buyers, and (3) if a deal cannot be completed, pursue a leveraged
recapitalization of the Company to allow public shareholders to participate
in the same upside that the Offeror sees in an appropriately capitalized
Securitas Direct.
THOUGHTS ON VALUE
Since the spin-off of Securitas Direct in September 2006, we believe the
public market has had some difficulty in properly valuing the Company's
shares. Lakewood believes the market has been overly focused on reported
earnings despite the fact that earnings are heavily distorted by the
conservative expensing of customer acquisition costs. In fact, as you know,
the quicker the Company grows and arguably the more value the Company creates
for its shareholders, the lower the reported earnings will become due to the
burden of the customer acquisition costs -- thereby rendering meaningless
traditional valuation metrics such as P/E and Enterprise Value / EBIT
multiples. As a starting point, we believe EBIT must be adjusted for growth
acquisition costs (i.e., expensed acquisition costs necessary to grow the
customer portfolio net of the churn rate). This "steady-state" EBIT
("Adjusted EBIT") is likely to be approximately SEK 1.1 billion in 2008 by
our estimates. The current offer of SEK 26 per share only values the Company
at 8.7x this Adjusted EBIT, a bargain for what we consider a company with
tremendous growth potential at extremely attractive unlevered, after-tax
returns on capital of almost 20%.
After only one year as a public company, we believe investors and
analysts are only beginning to understand the true value of the shares. We
are patient shareholders and we believe that in a reasonable time, the shares
will reflect the underlying economic value of the Company.
Lakewood has valued the Company under two different methodologies: (1) a
discounted cash flow analysis and (2) a leveraged buyout analysis. Please
note that we have not used a comparable company analysis as we believe there
are no standalone public companies that are comparable to Securitas Direct
and the understatement of reported earnings makes such analysis useless.
While I have summarized our assumptions and conclusions below, we have
separately shared the full detail of our analysis with you and your advisor
SEB Enskilda last week via email, as you know. As I recently learned that you
have hired JP Morgan as an additional advisor, I would ask that you share the
detailed analysis with them as well.
Please note the following analysis is based on public information,
discussions with management and our own industry research.
Discounted Cash Flow Analysis
In conducting our discounted cash flow analysis, we have used the
following key assumptions, which we believe are conservative and below
management's publicly stated targets:
i) Customer Growth: 14% average growth over the next three years
(2008-2010), 13% average growth over the next five years (2008-2012)
and 10% average growth over the next ten years (2008-2017) -- which
are levels below both the current growth rate and management's
publicly stated target of at least 20%. Long-term rates of customer
growth at levels we have assumed (or higher) are supported by the
Company's significant market share of new customer additions in a
rapidly growing market due to increased penetration of security
alarms in Europe from a relatively low level.
ii) Payback Period on New Customers: 4.1 years, which is consistent with
current levels and longer than management's stated target of less
than 4.0 years.
iii) Customer Churn: Approximately 7% over the next several years (which
is higher than management's stated target of less than 6%) and
gradually drifting towards a long-term rate of 10% based on a
ten-year customer life (shorter than the ten- to eleven-year average
life disclosed by management).
iv) Pricing/Cost Inflation: 2% annual increase in revenue and operating
costs per customer, consistent with a normal long-term level of
inflation.
v) Discount Rate: 9% weighted average cost of capital, which we believe
is particularly conservative in light of the stability and
predictability of the Company's cash flows and is supported by the
significant level of debt the Offeror has been able to secure.
Based on these assumptions, our discounted cash flow analysis yields a
current value for the shares of SEK 50.
To give you an appreciation for the sensitivities to the analysis, if we
assume that customer growth averages only 10% over the next five years (and
the rate of growth declines steadily from there), our fair value estimate is
still SEK 44 per share. Separately, if customer churn increases to 8% over
the next several years, our fair value estimate is SEK 46 per share. If
pricing pressure forces the Company to only price to 1% long-term growth
instead of the 2% we have assumed, the fair value estimate declines to SEK 39
per share. Finally, increasing our discount rate to 10% lowers the fair value
estimate to SEK 40 per share.
While we believe our estimate of SEK 50 per share is conservative, you
can see through the sensitivities that it is difficult to argue that the fair
value of the shares is much less than SEK 40 per share based on this
analysis.
Leveraged Buyout Analysis
We have also valued the Company by determining what a financial buyer
could pay for the Company under the following assumptions:
i) Operating Case: Same as in the discounted cash flow analysis above.
ii) Leverage: SEK 5.5 billion, equivalent to the financing package the
Offeror has secured (we have used a 7.5% blended rate of interest
which we believe is reasonable).
iii) Fees: 3% financing fees (calculated on debt levels) and 1% advisory
fees (calculated on total deal value).
iv) Holding Period and Exit Multiple: We have assumed a five-year
holding period and an 11x Adjusted EBIT exit multiple, which
we think is a conservative exit valuation either through the public
markets or a strategic sale (please note our discounted cash flow
analysis indicates the fair value of the business is 13x Adjusted
EBIT in five years, so we believe this is a quite conservative exit
valuation).
Based on these assumptions, we believe the Offeror will earn a greater
than 30% annually-compounded rate of return at the current offer price of SEK
26 per share. We believe a fair leveraged return for a financial buyer should
be around 15-18% over a five-year holding period, which would indicate a fair
price per share of SEK 35 to SEK 38. To give you an idea of the
sensitivities, if the exit multiple falls to 10x Adjusted EBIT, a buyer can
still earn a 15% five-year return at a price per share of SEK 35.
Furthermore, if the exit multiple is 12x Adjusted EBIT (which we believe is a
more reasonable estimate of value at that time), a buyer can earn 15% returns
by paying SEK 40 per share today. Finally, even if our Adjusted EBIT estimate
in five years is too high by 10%, we still believe a buyer can earn 15%
returns at a price of SEK 35 per share.
In summary, our leveraged buyout analysis indicates a buyer can pay SEK
35 to SEK 40 per share and still generate an attractive return under what we
believe are quite conservative assumptions.
LEVERAGED RECAPITALIZATION
If a deal cannot be consummated at an attractive price to shareholders,
we believe Securitas Direct's future as a public company is bright. Many
shareholders have expressed the view that the Company is overcapitalized and
can support significant debt levels. We had assumed that the only reason the
Company was not more appropriately leveraged was due to what we figured was
an aversion to debt by the Company's two largest shareholders. However, this
offer makes it plainly clear that these shareholders are quite comfortable
with meaningful leverage on the business. We now can definitively say that
they are in agreement with us and many other shareholders with regard to the
appropriate capital structure, and if Securitas Direct continues as a public
company, we urge you and the Board to immediately pursue a significant
leveraging of the balance sheet which can finance sizeable share repurchases
and/or a special dividend.
We believe the amount of debt secured by the Offeror is a comfortable
level of leverage for the business with Adjusted EBIT / interest expense
levels of 2.6x in 2008 and 2.9x in 2009 by our estimate (with the ratios
steadily improving thereafter). This transaction would maximize public
company value by lowering the Company's cost of capital and providing public
shareholders with the opportunity to either reap the types of returns that I
described in the leveraged buyout analysis above and/or receive cash from
their investment.
CONCLUSION
While we are not opposed to the concept of a sale transaction, we believe
the current offer dramatically understates the value of the Company. We are
supportive, long-term shareholders and we believe the potential upside in the
shares is considerable. If a fair transaction cannot be consummated, we are
particularly excited about the future for Securitas Direct as a more
appropriately capitalized public company.
I would be happy to discuss this with you further by phone at
+1-212-584-2211 or in person.
Sincerely,
Anthony T. Bozza
Managing Partner
Lakewood Capital Management, LP
ABOUT LAKEWOOD CAPITAL MANAGEMENT
Lakewood Capital Management, LP is a private investment firm based in New
York. The firm employs a long-term fundamental approach to investing with a
strict emphasis on capital preservation.
Michael Antonacci, Chief Financial Officer, Lakewood Capital Management, LP, +1-212-584-2213, mantonacci@lakewoodlp.com