The big corporate merger news on Wall Street today is that Cabela’s (CAB) is being bought out by / merged with Bass Pro Shops at a price of $65.50 per share in cash for a valuation of $4.5. billion. Given that Cabela’s earns profits of $3 per share, you might wonder: What gives with the 21.8x earnings valuation? Given that most mergers of mature/maturing businesses take place in the range of 30-40x earnings, and given that there is usually a premium of 37% attached to the typical corporate takeover, you would be wise to ask why Cabela’s is only getting bought out for a 19% premium compared to recent trading.
Are Cabela’s shareholders getting a bum deal here? In short: Absolutely not.
The longer answer is that Cabela’s has loaded itself up with so much debt that Cabela’s exiting shareholders should be absolutely ecstatic that they are able to secure any meaningful premium at all.
I covered this before when I discussed the failure at The Sports Authority and other sporty big box retailers, but there is a difference between companies that suffer from “a failure of a business model” and companies that suffer from “a failure of business terms.”
If you own a large piece of real estate that can sell sports goods with zero debt on the balance sheet, you can do very well for yourself and spend your days providing for your family, living the American dream, and investing $10,000+ per month into stocks and bonds in an effort to diversify. A well-funded, privately-owned sports store is a quiet way to work yourself onto those penta-millionaire lists by the end of your lifetime.
The problem occurs when you start introducing debt, rent, and leverage (e.g. loans to secure inventory) into the mix. Most recreational outlets occupy large amounts of retail space, and this translates into high rental payments (the amount of square feet compared to overall foot traffic is one of the major drawbacks of this business model.) If you have to borrow heavily to run your store, you will find yourself in trouble because the interest payments on the debt are high because of the season nature of the business, your profits are cyclical for that very same cyclical reason, and the monthly rent payments for a large amount of space can serve as a high fixed hurdle that can be tough to cross at the low point of the business cycle and send you into a downward spiral as you have to borrow at ever-more punitive interest rates to keep the business operations running.
You might look at the ten-year record of earnings growth at Cabela’s and think that the business is absolutely phenomenal. After all, it was making $1.10 per share at the end of 2005 and is earning $3.00 per share now. That is an earnings per share growth rate of 11%. It sounds like Bass Pro Shop’s is getting away with a heist.
But the catch is that all of that earnings growth was funded with debt. Cabela’s had $376 million in debt at the end of 2005. Now? It has $4.4 billion. The balance sheet has been so obliterated that I would automatically disqualify it from investment consideration because it couldn’t survive the bad times. The stock went from $28 in 2007 to $4 in 2008, and the company is far, far more leveraged now than it was back then. Cabela’s shareholders may not know it, and they will go to their graves with the memory of the sweet $66.50 per share buyout, but the Cabela’s business was managed in such a way that it was destined for the corporate graveyard the next time a 1973 or 2009 type of economic shows up.
It is almost comical how leveraged Cabela’s permitted itself to become. It is earning $200 million per share in profit while carrying $4.4 billion in debt. Every dollar in profit was carrying $22 in debt. That is so fiscally irresponsible it is unbelievable. In 2008, Cabela’s managed to earn a profit of $77 million during the worst of the recession, and if it had a clean balance sheet, it would be able to survive just fine under those conditions.
But if 2017 saw a similar recession, Cabela’s shareholders would find themselves in the position of staring down massive dilution or possible bankruptcy if no new equity holders showed. It’s a terrible way to run a business–years and years of boom times don’t mean squat if “Chapter 11 bankruptcy” is an iteration that shows up somewhere in the sequence (it doesn’t matter how pretty your compounding numbers look for years on end if you have to add a zero multiplier at some point.)
And the most embarrassing thing of all? Most of the debt covenants were somewhat short term. Of the $4.4 billion that Cabela’s borrowed, only $300 million was due after the year 2022. This means that if Cabela’s maintained its independence, it would spend the next five years refinancing its enormous debt load at increasingly higher rates.
There is a reason why Cabela’s hasn’t been able to grow its earnings the last few years. After posting $3.13 per share in 2013 profits, the business has held steady since then with its current earnings figure of $3.00 per share. It is not a coincidence that this period occurs alongside the debt position on the balance sheet increasing ten fold.
That growth from 2005 through 2013 specifically–from $1.10 to $3.13—was fueled by monster-sized debt offerings. A few of the chickens came home these past three years, as the debt burden proved so stifling that Cabela’s had to divert some cash flows to maintenance (the double whammy of the leverage kick ending while also having to start making debt payments meant that the business growth froze instantly.)
It’s a shame that the business decided to over-leverage itself to the point of peril because it is a business model that I would love to study, analyze, and talk about a long-term ownership business. But the balance sheet is such a disaster that it has a preclusive effect on my analysis–as a threshold matter, I can’t even analyze the stock as a long-term investment knowing the ease with which a doomsday scenario could materialize.
The Cabela family, which collectively own 26% of the stock, will collect a cool $1.1 billion from this deal. My view is that they are getting out at the top. Cabela’s has become so over-leveraged in recent years that a spike in interest rates or a modest recession would send earnings flailing and the stock price spinning. This 19% premium is mammon from Springfield, Missouri, and the exiting Cabela’s shareholders should happily trade in their ownership slices for $66.50 in cold, hard cash because it lets them say good riddance to a debt burden that was one of the biggest ticking debt bombs in large-cap corporate America.
Originally posted 2016-10-03 21:50:36.