Brencourt Advisors Dissatisfied with Vertrue (VTRU) Takeover Offer; Says Stock Worth Much More
In a 13D filing after the close Frday on Vertrue Inc. (Nasdaq: VTRU), Brencourt Advisors disclosed a 9.5% stake and a letter to the company expressing their dissatisfaction with the current offer price by the One Equity Partners consortium and their intention to vote against the merger offer.
In the letter, Brencourt said the current $48.50 offer price is too low. The firm sees a fair value for the stock above $60.
The firm said the Board should reconsider its recommendation of the One Equity offer and also encourages the Board to re-visit a leveraged recapitalization of the Vertrue's balance sheet and to use those proceeds to fund a special dividend to shareholders.
A Copy of the Letter:
Dear Gary,
Brencourt Advisors, LLC ("Brencourt") is one of the largest shareholders of Vertrue Incorporated ("Vertrue" or the "Company"). We are writing to inform you of our dissatisfaction with the current offer price by the One Equity Partners consortium ("One Equity" or the "Sponsors") and our intention to vote against the merger offer. We believe that the current offer significantly undervalues the strong growth that Vertrue is experiencing and is a sub-optimal alternative to other strategies that deliver superior shareholder value.
THE CURRENT OFFER IS TOO LOW
Brencourt's position is that the current $48.50 offer price is too low. In examining the materials the Board reviewed in support of this bid, namely the Jefferies Broadview ("Jefferies") analysis set forth in the Company's preliminary proxy statement on file with the SEC, we believe that there were major flaws in Jefferies methodology which undervalued Vertrue's shares.
For example, Jefferies calculated a weighted average cost of capital ("WACC")that was too low. Jefferies estimated that Vertrue's WACC was 16.5%, comprised of a 17.8% cost of equity and a 9.25% cost of debt. We fail to see how Jefferies could have arrived at these numbers. Aside from the fact that Jefferies used a7.8% market risk premium (versus a market standard 5%), we believe the 2.3%"Size Premium" for the cost of equity is ridiculous. Using Jefferies' beta of1.4x, we believe the cost of equity should be 11.7%. Jefferies calculated the cost of debt based on the coupon of the Company's publicly issued debt. However,prior to the $48.50 offer, Vertrue's 9.25% senior notes were yielding 7%. Using this correct cost of debt (7%) would result in a WACC of 10.2%. Based on MANAGEMENT'S OWN PROJECTIONS, this more realistic WACC would imply an equity value over $60, A 25% PREMIUM TO THE CURRENT OFFER. If one were to apply 10.2%WACC to Jefferies' "NPV Sensitivity" chart, fair value for our shares would be above $70.
TABLE
We believe that the other valuation methods employed by Jefferies were flawed as well. While Jefferies correctly pointed out that there are no other truly comparable public companies to Vertrue, they drew incorrect inferences from theSOLE precedent transaction in the universe: Apollo's purchase of Cendant Corp'sMarketing Services Division ("Affinion"). First, that transaction occurred in July 2005, NEARLY 2 YEARS AGO. Since then, valuations have gone up for nearly every company, especially for less understood business models like Vertrue.Second, Jefferies did not adjust for certain one-time items that raised the Affinion acquisition multiple from 6.25x to 7.1x (please see the debt prospectus for the transaction).
In similar fashion, Jefferies does not properly calculate the acquisition multiple implicit in the Vertrue transaction. Jefferies reports that $48.50represents 8.9x TTM EBITDA, ostensibly a fair multiple, especially with respect to the Affinion transaction. However, this methodology ignores timing differences in marketing spend that have artificially depressed TTM EBITDA,thereby raising the transaction multiple. As you yourself stated on the 2Q07(December quarter) conference call, "I want to point out that it's important to note when comparing our performance to last fiscal year, our year-over-year results reflect both a strong first half in fiscal '06 and an increased marketing investment in the first half of fiscal '07". The results for the March2007 quarter demonstrate your point. In that quarter, adjusted EBITDA rose to$25.4 from $18.4 million in 3Q06.(1) Thus, based on management's projected June2007 EBITDA, the implied transaction multiple would only be 7.2x.
Furthermore, Jefferies does not accord Vertrue the premium multiple that it deserves vis-a-vis the Affinion acquisition. Vertrue, through its established online platform and Management Service segment, has better growth prospects than Affinion. A company with higher growth deserves a higher multiple. Therefore,the 7.2x multiple used to arrive at a $48.50 price is not quite the "gift" that the Jefferies analysis suggests. In fact, based on management's projected high teens EBITDA growth, Vertrue should trade in the 10-13x range. Even if we discounted that valuation to a 9x multiple, we still arrive at a fair value for the stock above $60.
We also find fault with the IRR returns of this transaction. If one were to take management's projections and use the same entry/exit multiples, One Equity will realize a mid 40% IRR over a 5-year horizon. This analysis includes all fees and expenses and does not consider One Equity re-levering at various stages of the investment to take dividends out of the Company. Although we understand that new buyers need an adequate return to compensate them for long-term risk, mid 40% is far higher than the 15-20% IRRs that private equity sponsors typically accept incurrent markets. At even a 30% IRR, the implied share price would be above $58,20% HIGHER than the current offer.
Finally, we take issue with Jefferies analysis that this offer is fair because it represents a 20% premium to the pre-NY Post article price of $40.12. While we do not believe that the premium offered to shareholders has any relevance to the ACTUAL value of our shares, we regard Jefferies analysis as incomplete. Nowhere does Jefferies account for the technical selling caused by Vertrue's converts that are struck at $40.37. Historically, the stock price has been capped by convert holders who hedge their stock exposure above that strike price.Likewise, Jefferies does not mention that the Company raised its guidance on January 24, 2007, THE SAME DAY that the NY Post reported the company was up for sale. We fail to see how Jefferies could not attribute any of the appreciation in the stock to that. Therefore, based on the $43.82 closing price on January24th, this transaction represents a mere 10.8% premium. How is that fair to shareholders based on Jefferies analysis?
ALTERNATIVES
We believe that there are other ways to increase shareholder value other than by accepting a low ball bid for the company. We believe that the Board should reconsider its recommendation of the One Equity offer in the light of the points we make above and the existence of alternative, value-enhancing transactions. In particular, we encourage the Board to re-visit a leveraged recapitalization of the Vertrue's balance sheet and to use those proceeds to fund a special dividend to shareholders.
We understand the Board's reluctance to approach the debt markets considering the Company's experience in 2004. However, much has changed in the market since then. Affinion's experience in the debt markets is a directly relevant example for Vertrue. At the end of 2005, Affinion launched a bond offering to partially fund the acquisition by Apollo. In similar fashion to Vertrue's 2004 offering,Affinion found that the capital markets were not receptive to its offering and consequently, the underwriting banks were forced to hold a large portion of the issue in a bridge facility. In order to move this bridge facility off their balance sheets, the underwriting banks educated the investment community on Affinion's business model to create demand for a new bond issue. In April 2006,the bond issue was placed as 11.5% subordinated debt.
Over the next several months, Affinion met expectations and that same debt appreciated substantially. Today, that 11.5% subordinated issue yields 8.8%despite Affinion being levered 5.2X. Furthermore, in January 2007, Affinionre-levered its balance sheet to 6.4X and used the $350 million of proceeds to buy back preferred debt and dividend to Apollo an amount in excess of Apollo's initial equity investment.
We believe Vertrue should draw upon Affinion's experience for the benefit of its own shareholders. Based on current market conditions and management's projections, Vertrue could issue debt to fund at least a $30 dividend while still maintaining a healthy balance sheet with significant free cash flow. We assess that based on a price to earnings ratio between 12.5 and 13.5x, the proforma stock price, including the special dividend, would be 25-35% higher than the $48.50 offer. We further suggest that if market conditions one year from now are similar and management meets expectations, Vertrue could issue more debt to fund ANOTHER special dividend to shareholders, while allowing current shareholders to maintain their ownership in the Company. We would note that given the size of One Equity's financing package, the Sponsor's bankers believe that this leveraged strategy for Vertrue is entirely feasible.
Looking at the proposed 1st lien / 2nd lien financing structure One Equity will use for its transaction, we hypothesize that one year from now One Equity will be in a position to take advantage of the cheap call protection of its debt and re-lever the Company, and dividend most, if not all, of its equity investment to itself. Clearly, we don't need a private equity company to do what we as shareholders can do for ourselves.
At this point, I would like to note that Brencourt remains a strong supporter of the Company, its management and its prospects. However we strongly urge the Board of Directors to re-consider its endorsement of the current $48.50 offer.We do not believe that the proposed transaction adequately compensates us for our shares. Otherwise we remain prepared to further defend alternative means that deliver greater shareholder value.
Sincerely,
William L. Collins
Chief Executive Officer
Brencourt Advisors LLC
In the letter, Brencourt said the current $48.50 offer price is too low. The firm sees a fair value for the stock above $60.
The firm said the Board should reconsider its recommendation of the One Equity offer and also encourages the Board to re-visit a leveraged recapitalization of the Vertrue's balance sheet and to use those proceeds to fund a special dividend to shareholders.
A Copy of the Letter:
Dear Gary,
Brencourt Advisors, LLC ("Brencourt") is one of the largest shareholders of Vertrue Incorporated ("Vertrue" or the "Company"). We are writing to inform you of our dissatisfaction with the current offer price by the One Equity Partners consortium ("One Equity" or the "Sponsors") and our intention to vote against the merger offer. We believe that the current offer significantly undervalues the strong growth that Vertrue is experiencing and is a sub-optimal alternative to other strategies that deliver superior shareholder value.
THE CURRENT OFFER IS TOO LOW
Brencourt's position is that the current $48.50 offer price is too low. In examining the materials the Board reviewed in support of this bid, namely the Jefferies Broadview ("Jefferies") analysis set forth in the Company's preliminary proxy statement on file with the SEC, we believe that there were major flaws in Jefferies methodology which undervalued Vertrue's shares.
For example, Jefferies calculated a weighted average cost of capital ("WACC")that was too low. Jefferies estimated that Vertrue's WACC was 16.5%, comprised of a 17.8% cost of equity and a 9.25% cost of debt. We fail to see how Jefferies could have arrived at these numbers. Aside from the fact that Jefferies used a7.8% market risk premium (versus a market standard 5%), we believe the 2.3%"Size Premium" for the cost of equity is ridiculous. Using Jefferies' beta of1.4x, we believe the cost of equity should be 11.7%. Jefferies calculated the cost of debt based on the coupon of the Company's publicly issued debt. However,prior to the $48.50 offer, Vertrue's 9.25% senior notes were yielding 7%. Using this correct cost of debt (7%) would result in a WACC of 10.2%. Based on MANAGEMENT'S OWN PROJECTIONS, this more realistic WACC would imply an equity value over $60, A 25% PREMIUM TO THE CURRENT OFFER. If one were to apply 10.2%WACC to Jefferies' "NPV Sensitivity" chart, fair value for our shares would be above $70.
TABLE
We believe that the other valuation methods employed by Jefferies were flawed as well. While Jefferies correctly pointed out that there are no other truly comparable public companies to Vertrue, they drew incorrect inferences from theSOLE precedent transaction in the universe: Apollo's purchase of Cendant Corp'sMarketing Services Division ("Affinion"). First, that transaction occurred in July 2005, NEARLY 2 YEARS AGO. Since then, valuations have gone up for nearly every company, especially for less understood business models like Vertrue.Second, Jefferies did not adjust for certain one-time items that raised the Affinion acquisition multiple from 6.25x to 7.1x (please see the debt prospectus for the transaction).
In similar fashion, Jefferies does not properly calculate the acquisition multiple implicit in the Vertrue transaction. Jefferies reports that $48.50represents 8.9x TTM EBITDA, ostensibly a fair multiple, especially with respect to the Affinion transaction. However, this methodology ignores timing differences in marketing spend that have artificially depressed TTM EBITDA,thereby raising the transaction multiple. As you yourself stated on the 2Q07(December quarter) conference call, "I want to point out that it's important to note when comparing our performance to last fiscal year, our year-over-year results reflect both a strong first half in fiscal '06 and an increased marketing investment in the first half of fiscal '07". The results for the March2007 quarter demonstrate your point. In that quarter, adjusted EBITDA rose to$25.4 from $18.4 million in 3Q06.(1) Thus, based on management's projected June2007 EBITDA, the implied transaction multiple would only be 7.2x.
Furthermore, Jefferies does not accord Vertrue the premium multiple that it deserves vis-a-vis the Affinion acquisition. Vertrue, through its established online platform and Management Service segment, has better growth prospects than Affinion. A company with higher growth deserves a higher multiple. Therefore,the 7.2x multiple used to arrive at a $48.50 price is not quite the "gift" that the Jefferies analysis suggests. In fact, based on management's projected high teens EBITDA growth, Vertrue should trade in the 10-13x range. Even if we discounted that valuation to a 9x multiple, we still arrive at a fair value for the stock above $60.
We also find fault with the IRR returns of this transaction. If one were to take management's projections and use the same entry/exit multiples, One Equity will realize a mid 40% IRR over a 5-year horizon. This analysis includes all fees and expenses and does not consider One Equity re-levering at various stages of the investment to take dividends out of the Company. Although we understand that new buyers need an adequate return to compensate them for long-term risk, mid 40% is far higher than the 15-20% IRRs that private equity sponsors typically accept incurrent markets. At even a 30% IRR, the implied share price would be above $58,20% HIGHER than the current offer.
Finally, we take issue with Jefferies analysis that this offer is fair because it represents a 20% premium to the pre-NY Post article price of $40.12. While we do not believe that the premium offered to shareholders has any relevance to the ACTUAL value of our shares, we regard Jefferies analysis as incomplete. Nowhere does Jefferies account for the technical selling caused by Vertrue's converts that are struck at $40.37. Historically, the stock price has been capped by convert holders who hedge their stock exposure above that strike price.Likewise, Jefferies does not mention that the Company raised its guidance on January 24, 2007, THE SAME DAY that the NY Post reported the company was up for sale. We fail to see how Jefferies could not attribute any of the appreciation in the stock to that. Therefore, based on the $43.82 closing price on January24th, this transaction represents a mere 10.8% premium. How is that fair to shareholders based on Jefferies analysis?
ALTERNATIVES
We believe that there are other ways to increase shareholder value other than by accepting a low ball bid for the company. We believe that the Board should reconsider its recommendation of the One Equity offer in the light of the points we make above and the existence of alternative, value-enhancing transactions. In particular, we encourage the Board to re-visit a leveraged recapitalization of the Vertrue's balance sheet and to use those proceeds to fund a special dividend to shareholders.
We understand the Board's reluctance to approach the debt markets considering the Company's experience in 2004. However, much has changed in the market since then. Affinion's experience in the debt markets is a directly relevant example for Vertrue. At the end of 2005, Affinion launched a bond offering to partially fund the acquisition by Apollo. In similar fashion to Vertrue's 2004 offering,Affinion found that the capital markets were not receptive to its offering and consequently, the underwriting banks were forced to hold a large portion of the issue in a bridge facility. In order to move this bridge facility off their balance sheets, the underwriting banks educated the investment community on Affinion's business model to create demand for a new bond issue. In April 2006,the bond issue was placed as 11.5% subordinated debt.
Over the next several months, Affinion met expectations and that same debt appreciated substantially. Today, that 11.5% subordinated issue yields 8.8%despite Affinion being levered 5.2X. Furthermore, in January 2007, Affinionre-levered its balance sheet to 6.4X and used the $350 million of proceeds to buy back preferred debt and dividend to Apollo an amount in excess of Apollo's initial equity investment.
We believe Vertrue should draw upon Affinion's experience for the benefit of its own shareholders. Based on current market conditions and management's projections, Vertrue could issue debt to fund at least a $30 dividend while still maintaining a healthy balance sheet with significant free cash flow. We assess that based on a price to earnings ratio between 12.5 and 13.5x, the proforma stock price, including the special dividend, would be 25-35% higher than the $48.50 offer. We further suggest that if market conditions one year from now are similar and management meets expectations, Vertrue could issue more debt to fund ANOTHER special dividend to shareholders, while allowing current shareholders to maintain their ownership in the Company. We would note that given the size of One Equity's financing package, the Sponsor's bankers believe that this leveraged strategy for Vertrue is entirely feasible.
Looking at the proposed 1st lien / 2nd lien financing structure One Equity will use for its transaction, we hypothesize that one year from now One Equity will be in a position to take advantage of the cheap call protection of its debt and re-lever the Company, and dividend most, if not all, of its equity investment to itself. Clearly, we don't need a private equity company to do what we as shareholders can do for ourselves.
At this point, I would like to note that Brencourt remains a strong supporter of the Company, its management and its prospects. However we strongly urge the Board of Directors to re-consider its endorsement of the current $48.50 offer.We do not believe that the proposed transaction adequately compensates us for our shares. Otherwise we remain prepared to further defend alternative means that deliver greater shareholder value.
Sincerely,
William L. Collins
Chief Executive Officer
Brencourt Advisors LLC
Labels: Brencourt Advisors, Vertrue, VTRU
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