RE:Oaktree letterAlphaseeker1984 wrote: OAKTREE SENDS LETTER TO BOARDS OF DIRECTORS OF TEMBEC AND RAYONIER
Investment funds managed by Oaktree Capital Management, L.P. which own 19.9% of the common stock of Tembec, Inc. and have been significant long-term shareholders and bondholders, today sent a letter to the Boards of Directors of Tembec and Rayonier Advanced Materials alerting them of Oaktree’s intention to vote against Rayonier’s proposed acquisition of Tembec at the upcoming special meeting of shareholders on July 27, 2017.
The full text of the letter can be found below.
| Oaktree Capital Management, L.P. 333 S. Grand Avenue, 28th floor Los Angeles, California 90071 |
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| July 14, 2017 |
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| Tembec Inc. Directors: |
| Mr. James Continenza |
| Mr. James Lopez |
| Mr. Francis Scricco |
| Mr. James Chapman |
| Mr. David Steuart |
| Mr. Lorie Wasiberg |
| Mr. Jacques Leduc |
| Mr. Pierre Gignac |
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| Rayonier Advanced Materials Directors: |
| Mr. Paul Boynton |
| Mr. C. David Brown, II |
| Mr. Thomas Morgan |
| Mr. Ronald Townsend |
| Ms. Lisa Palumbo |
| Mr. DeLyle Bloomquist |
| Mr. James Kirsch |
| Mr. Mark Gaumond |
| Mr. Charles Adair |
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| c/o Mr. Patrick Lebel |
| Vice President, General Counsel & Secretary |
| Tembec Inc. |
| 800 Rene-Levesque Boulevard |
| Suite 1050 |
| Montreal, QC H3B 1X9 |
| Canada |
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| Investment Funds Managed by Oaktree Capital Management Will Vote “Against” Rayonier’s Proposed Acquisition of Tembec and Believe Offer Price Must Be Increased to Reflect Fair Value |
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| - Oaktree recognizes the strategic merit of the combination, yet Tembec shareholders are not receiving fair consideration for the value created by the combination
- Transaction is of unique strategic value to Rayonier, giving it a generational opportunity to reposition its business away from the secularly-declining acetate market, reduce customer concentration, and improve geographic diversification. In the absence of this transaction, Rayonier faces a challenging future
- Benefits are not sufficiently shared with Tembec shareholders due to an inadequate multiple of 2017 consensus EBITDA of 5.0x pre-synergies and 3.9x post-synergies (and as low as 2.9x when including the present value of Tembec’s substantial deferred tax assets). Comparable businesses and competitors of Tembec trade in the range of 6.6x - 9.9x EBITDA
- Tembec could generate more shareholder value as a stand-alone entity. On its own, it is poised to produce as much as C$0.85 per share of after-tax free cash flow in the twelve months ending September 2017, representing a 20% stand-alone free cash flow yield at Rayonier’s offer price – an attractive yield for a company with strong growth prospects in its core specialty cellulose ethers business and that is delevering rapidly
- In the week post-announcement, Rayonier’s share price increased 31%1, representing US$213 million of value for Rayonier common and preferred equity holders. Rayonier shareholders can expect to lose much of this increase if the transaction fails
- Tembec’s prior announcement of support for the transaction from a large shareholder, Fairfax Financial, which owned approximately 19.9% of Tembec at the time of the transaction announcement, is now creating market confusion as filings indicate Fairfax has sold all of its Tembec shares and appears to have no remaining economic interest in Tembec, while possibly retaining the ability to vote for the transaction |
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| Directors of Tembec Inc. and Rayonier Advanced Materials: |
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| As you are aware, funds managed by Oaktree Capital Management own 19.9% of Tembec’s common stock and have been a significant and supportive shareholder and bondholder for several years. Oaktree is a leading global alternative investment management firm formed in 1995 with over US$100 billion in assets under management. We write today to express our concerns – which we believe are shared by numerous other Tembec shareholders – regarding the proposed acquisition by Rayonier Advanced Materials. Although we appreciate the strategic rationale of a Rayonier-Tembec combination, we believe Rayonier’s current offer significantly undervalues Tembec. If the offer is not increased, we believe Tembec shareholders would be better off if Tembec remains independent. Following the release of Tembec’s management information circular we engaged in a dialogue with Tembec’s special committee and subsequently contacted Rayonier’s management team (CEO Paul Boynton, CFO Frank Ruperto, and VP of Investor Relations Mickey Walsh) to express our concerns about the proposed transaction. Given the lack of a constructive response in our discussion with Rayonier we now feel compelled to publicly share our views with our fellow shareholders in advance of the Special Meeting on July 27, 2017. As we have communicated to you, we believe Rayonier’s offer provides Rayonier’s shareholders with the vast majority of the value created through the transaction. This is evidenced by Rayonier’s share price increase of 31% following the announcement of the transaction2, which represented approximately US$213 million of implied value creation across Rayonier’s common and preferred equity. |
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| The Transaction is of Unique Strategic Value to Rayonier |
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| By acquiring Tembec, Rayonier is capitalizing on a generational opportunity to reduce its dependence on the deteriorating acetate market, transform itself into a well-balanced global specialty cellulose supplier, and reposition its business for long-term sustainability. The price offered to Tembec shareholders does not fully recognize these benefits, nor does it appropriately compensate Tembec shareholders for the increased risk associated with combining with Rayonier. First, Rayonier’s business is overwhelmingly focused on the acetate specialty cellulose market (63% of revenue in 2016)3, which primarily serves the secularly-declining cigarette-filter end market – a market that is projected to continue to decline at low-single digits annually4. In contrast, Tembec’s most valuable assets are its Temiscaming, Canada and Tartas, France specialty cellulose facilities, which give it the leading global position in the broadly-diversified ethers end market – which is projected to grow at low-single digits annually over the coming years5. Following the deal announcement, Bank of America Merrill Lynch upgraded Rayonier6 after having previously been persistently neutral to negative on the company, writing: |
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“The acquisition [of Tembec] improves RYAM’s position in [specialty cellulose], reducing its exposure to acetate and giving it a better position in the healthier ethers market. Acetate continues to be challenged by weak demand (particularly for cigarettes), and prices have declined each of the last four years with potential to be down again in 2018. As for ethers, the market is healthy as growth has improved with the economy and prices are now rising.”7 |
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| Second, the proposed deal reduces Rayonier’s significant customer concentration. Stand-alone Rayonier’s top three customers represented 56% of 2016 sales, which will decline to 24% of the pro forma company’s 2016 sales8. As seen in 2014, when Rayonier lost customer Celanese Acetate (14% of 2013 sales), concentration poses a significant risk, particularly in light of the fact that each of Rayonier’s top three customers’ contracts are expiring over 2018 and 2019. Reducing this risk through the Tembec acquisition should on its own auger a structurally higher valuation multiple for Rayonier going forward. Third, following the U.S. dollar’s significant appreciation over the last several years, Rayonier’s U.S.-based production footprint has become increasingly high-cost relative to its global competitors. Acquiring Tembec’s Canadian and French assets positions Rayonier lower on the global cost curve and offers greater geographic diversification. Without this transaction, Rayonier faces the prospect of long-term secular decline and increased risk and volatility. Accordingly, we believe a more equitable sharing of the transaction synergies and the combined company’s future prospects is warranted, appropriate, and necessary. |
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| Multiples, Synergies, and Tax Assets Support a Higher Price |
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| Considering these major and unique strategic benefits to Rayonier, as well as the fact that there are so few established specialty cellulose assets that can come to market (as most are tightly held by well-capitalized long-term holders), we believe that Rayonier’s proposal significantly undervalues Tembec. Royal Bank of Canada’s research analyst Paul Quinn wrote: “Attractive purchase multiple for a unique asset,”9 which we think is an understatement. The announced EBITDA multiples of 6.3x last twelve month (“LTM”) EBITDA pre-synergies and 4.6x LTM EBITDA post-synergies10 already undervalue Tembec’s highly-strategic specialty cellulose assets. Moreover, this price fails to reflect key information. Importantly, the twelve month period ended March 31, 2017 only incorporates one quarter of Tembec’s announced specialty cellulose price and volume increases for calendar-year 2017. These multiples also don’t account for abnormally high stock-based compensation in the LTM period. Given that the 2017 price and volume increases have already been contractually negotiated and implemented, we believe Tembec shareholders should instead look to sell-side consensus EBITDA estimates of C$206 million11 for the fiscal year (“FY”) ending September 30, 2017 (which still only includes three quarters of the specialty cellulose price increases and yet is 20% higher than the March LTM figure). Using FY 2017 estimates, the transaction multiples fall to 5.0x EBITDA pre-synergies and 3.9x post-synergies. Moreover, Tembec has highly valuable unrecognized deferred tax assets, noted in Tembec’s 2016 annual report at C$598 million, which under Canadian tax law will largely transfer to Rayonier. Oaktree estimates that on a present value basis these tax assets could be worth as much as C$250 million or C$2.50 per Tembec share, and will potentially enable Rayonier to substantially reduce its effective tax rate by borrowing at its U.S. entities and shifting taxable income to Canada where it can avoid paying taxes for the next 15 - 20 years12. We believe Tembec shareholders are receiving no value in Rayonier’s proposal for this enormous benefit. Incorporating the present value of Tembec’s tax assets, we believe the true post-synergy multiples decline to bargain-basement levels of 3.5x LTM and 2.9x 2017 EBITDA. This valuation looks exceptionally unfair to Tembec shareholders when compared to the market value of Tembec’s primary competitor in the ethers market, Borregaard, which is currently trading at 9.9x LTM EBITDA and 9.3x estimated 2017 EBITDA13. The proposed transaction valuation also looks depressed compared to Tembec’s 5-year average trading multiple of 6.9x EBITDA14, Rayonier’s 5-year average trading multiple of 6.6x EBITDA15, and precedent industry transactions such as Georgia Pacific’s 2013 purchase of Buckeye Technologies for 7.8x EBITDA16. |
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| Stand-alone Tembec Will Generate More Value for Tembec Shareholders |
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| We believe this proposed consideration is inadequate and that Tembec shareholders would generate far more value for its shareholders on a stand-alone basis. While we believe an appropriately valued transaction with Rayonier is the right outcome for Tembec, it is illuminating to evaluate the currently proposed valuation against Tembec’s standalone value. In the absence of this deal, using the consensus 2017 EBITDA forecasts discussed above, we estimate that stand-alone Tembec can generate approximately C$0.85 of after-tax free cash flow per share17 for the year ending September 30, 2017, placing the current deal price at approximately a 20% free cash flow yield18. We believe this is a very attractive valuation for a company that is expected to delever to below 3x EBITDA19 by September and possesses attractive longer-term growth prospects in its core specialty cellulose ethers market.20 Rayonier’s management argues that stand-alone Tembec entails risk due to its exposure to commodity-oriented high yield pulp, newsprint, and lumber businesses. However, this argument does not reflect the fact that approximately 78% of Tembec’s LTM EBITDA21 (and an even larger percentage of its value) is generated by its specialty cellulose and coated bleached board assets, both of which we believe are well-positioned for stability and growth in the coming years. Both of these markets are consolidated with high barriers-to-entry, and largely stable, growing demand. In particular, industry analysts expect continued price and volume increases in the ethers market over the coming years as described earlier. Even if Tembec’s share price were to decrease in the near-term as a result of terminating the Rayonier transaction, we believe that the company’s fundamental value and its free cash flow generation will result in greater value than the current offer over the intermediate-term. |
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| Stand-alone Rayonier’s Prospects Are Challenged |
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| Stand-alone Rayonier, on the other hand, has a significantly more difficult outlook. The company is facing a declining core acetate market, a high-cost position on the global cost curve, and expiring contracts with each of its top three customers (representing 56% of 2016 sales) over 2018 and 2019. It is no wonder that they have sought to acquire Tembec. Considering Rayonier’s EBITDA has already declined 44% from 2012 to 201622 despite escalating cost-cutting efforts, Rayonier’s directors and shareholders must ask themselves: do they really want to risk losing such a transformative and accretive acquisition? Rayonier’s current and prospective shareholders have long held concerns over how Rayonier would allocate the substantial cash proceeds of its preferred equity issuance. If the Tembec transaction falls through, we believe that Rayonier will not only decline to its pre-announcement price (down 16% from current), but may decline below that level due to the re-establishment of the capital allocation fears, yet with an even further-reduced set of potential strategic options. We believe Tembec shareholders are being asked to take on significant new risk by rolling into a combined company with the challenges described above. If we are not compensated fairly, we believe Tembec offers a better risk-adjusted return profile as an independent company. |
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| Tembec Has Created Confusion in the Marketplace Regarding Shareholder Support for the Transaction |
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| On May 25, 2017, Tembec announced the support of then 19.99% shareholder Fairfax Financial Holdings Limited for the announced transaction. In light of this expressed support, the market was surprised to see Fairfax dispose of its entire Tembec position over the following weeks, culminating with large block trades of the majority of its position on June 19, the record date for the upcoming meeting. Either Fairfax does not in fact support the transaction and has voted with its feet, or it has retained the voting rights to the disposed-of shares and intends to vote them in support of the transaction, despite having no economic interest in them. Given the regulatory and governance concerns with “empty voting”, Tembec needs to clarify this issue immediately. |
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| Rayonier Must Improve its Offer |
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| For the aforementioned reasons, Oaktree will be voting all of our shares, representing 19.9% of the vote, against the proposed transaction, significantly reducing the likelihood of the transaction closing as currently structured. Oaktree also continues to consider other avenues for achieving fair value such as dissent and appraisal rights or making representations at the fairness hearing for the plan of arrangement. We note that a dissent at this level will give Rayonier the right to walk away from the transaction. However, Rayonier has a variety of levers available to it to improve its offer for Tembec: increase the cash consideration, increase the share consideration through a higher exchange ratio, reduce the cap on stock election, or some combination of these options. As one example, we believe that Rayonier could easily increase its relatively modest leverage of 3.1x pro forma EBITDA at close23 to something closer to 3.5x in order to improve the cash component of the consideration with limited impact to the credit profile of the business. Any such increase in leverage at close could be rapidly repaid through the significant free cash flow accretion of the transaction (likely within twelve months)24. As discussed in our recent conversation with Rayonier, Oaktree would welcome the opportunity to engage in a constructive dialogue with the Rayonier and Tembec’s boards in order to work towards a win-win for all parties and a transaction we can support. |
Wow!
Can you spell G A M E C H A N G E R!
I wish I didn't sell my entire position of TMB now. My original plan was to hedge some risk and only sell half my TMB position, but feel kinda duped by management and Fairfax that they were in support and the deal was pretty much a lock.
I mentioned in a previous post that I had some cash set aside to buy back into TMB if deal didn't go through.... time to buy some shares on Monday.
I believed TMB was under valued and a steal at $4.05 per share, and so did a lot on this board. Apparently Oak Tree feels the same too.....
This letter will change a lot of things on shareholder sentiment that's for sure.
Good Luck All!
And I look forward to the educated dialogue of the investors on this board.
FI4