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NEW YORK, Sept. 6 /PRNewswire/ -- Elliott Associates, L.P., and its sister fund, Elliott International, L.P., today announced that the funds filed a Schedule 13D with the Securities and Exchange Commission disclosing an 8% percent ownership position in the common stock of ShopKo Stores, Inc. , and that the funds have sent the following letter to the Board of Directors of ShopKo:
September 6, 2005
The Board of Directors
c/o ShopKo Stores, Inc.
700 Pilgrim Way
Green Bay, Wisconsin 54304
Dear Members of the Board of Directors:
I write to you on behalf of Elliott Associates, L.P. and Elliott International, L.P. ("Elliott"), which collectively own approximately 8% of the common stock of ShopKo Stores, Inc. (the "Company" or "ShopKo"). Elliott strongly disagrees with the Board's decision to sell the Company to a subsidiary of Goldner Hawn Johnson & Morrison ("Goldner Hawn") for $24 per share ("Goldner Hawn Transaction"), as we believe the standalone value of ShopKo to be significantly higher.
Elliott is not alone in this view. Recently, another large institutional shareholder of the Company, holding approximately a 6% stake, publicly opposed the deal. And just last week, Institutional Shareholder Services ("ISS"), the world's leading proxy voting advisory group, recommended its clients vote against the current deal.
In addition, ShopKo's stock has, for all but a few days, consistently traded above the $24 offer since the sale was announced on April 8th. And this was true even before the institutional investor (referred to above) and ISS went public with their opposition to the current deal. This may be viewed as the judgment of the market as a whole that the deal is underpriced.
The general view that the deal is not fully priced is not surprising, given the fact that the Goldner Hawn offer that was accepted by ShopKo was only at a 4.2% premium to the then existing market price. We believe that this is significantly below premia that shareholders of other retailers have received in acquisition transactions.
What is surprising to us is that the Special Committee would consider an acquisition such as this -- where
- the purchaser is supplying only $30 million of equity ($1 per share),
or approximately 3% of the purchase price;
- the Company's former Chairman (relinquishing his chairmanship position
at the time the deal was signed) and still current director, Mr. Jack
Eugster, is going to own approximately 10% of the company for $3
- your fellow board member, Mr. Richard Zona, has invested his own money
into an affiliate of Goldner Hawn (this affiliate being ShopKo's new
owner) and has been serving on the affiliate's strategic advisory
- certain other members of ShopKo's management are going to own a portion
of the post-transaction company at the same valuation(3)
-- to be the mechanism by which to maximize shareholder value.
In fact, in reviewing the Company's filings with the Securities and Exchange Commission ("SEC"), it appears to us that, even after paying out $90 million in transaction and closing fees, Goldner Hawn is able to borrow $27 per share for its $24 per share acquisition.(4) Put another way, absent the temporary dividend prohibition covenant (which the banks could always waive if presented with an attractive fee payment), Goldner Hawn, Mr. Eugster and the other management participants in the deal would be able to recoup their entire equity investment and then pay themselves an additional $108 million dividend immediately upon closing of the deal! Furthermore, according to Goldner Hawn's own admission, some undisclosed portion of the estimated $90 million fees will be paid to Goldner Hawn itself.(3) Our math regarding these figures is shown in the following table:
Sources $MM Uses $MM
Equity from Goldner Hawn (1) 27 Equity at $24.00 (6) 736
Equity from Jack Eugster
(former Chairman) (1) 3 Net Debt (7) 241
Secured Real Estate
Financing (5) 700 Transaction Fees (8) 90
Term Loan (Back Bay) (5) 65 Total Uses 1,066
Senior Debt (Bank
of America) (5) 271
Total Sources 1,066
Additional borrowing capacity
under borrowing base (A) 138 total
Repayment of equity invested availability less
by Goldner Hawn and Mr. Eugster (30) the $271 used above
Potential return to sponsors
on deal closing 108
Note A. The Senior Debt from Bank of America is calculated off of a
Borrowing Base formula similar to the Company's current Amended Secured
Credit Facility. At the end of Q105, the Company had a total of $409
million of total availability under its Amended Secured Credit Facility.
Assuming the same calculation, $409 million less the $271 million assumed
in "Sources" above, leaves $138 million of additional borrowing
We question the effectiveness of the Company's sale process. The decision not to explore strategic buyer interest and to provide a very limited group of private equity investors with only publicly available information in the early round created a situation that lacked any meaningful competitive dynamics.(9) Perhaps this is explained in part by the obvious conflicts of interest, with your former chairman and certain members of your current management participating in what appears to be an incredibly rich deal for them from our point of view. We believe that the Company should publicly identify those members of management who are participating in the transaction, so investors can evaluate the extent of the conflicts of interest.
Furthermore, we are disappointed with the treatment of the termination fee in the merger agreement, particularly the breadth of situations to which it can be applied. Not only is the $27 million termination fee equal in size to Goldner Hawn's entire equity investment, but it also applies to a recapitalization of the Company under a number of scenarios. This has the effect of drastically inhibiting shareholder, management or interloper ability to suggest or consider any alternative to the Goldner Hawn Transaction as such an action could result in a payment of $27 million even after a shareholder vote defeats the proposed acquisition.
Given that most of the financing in the Goldner Hawn Transaction is backed by the Company's real estate and the importance of the real estate valuation in considering the method by which to maximize shareholder value, we are disappointed that the Board did not consider engaging its own appraisal to make a fully informed decision. According to the Goldner Hawn letter, the lender (Bank of America) has received appraisals for the "real estate subject to financing" of approximately $880 million.(3) We ask the Company to disclose whether there is any real estate that is not subject to financing and what is that real estate. These appraisals do not necessarily represent the lender's own assessment of the valuation of the real estate supporting the loan. There are reasons to believe that the lender's own assessment of the real estate is considerably higher than $880 million. This is supported by the fact that the lending commitment was not contingent on the appraisals commissioned by the lender meeting any particular LTV number; in addition, the alternative lending commitment issued by Bank of America assumes collateral value of $935 million.
We believe the proposed acquisition by Goldner Hawn at $24 per share significantly undervalues the Company. To illustrate, Elliott has performed an asset valuation of ShopKo based on the Company's recent SEC filings and the presentation by the Company's financial advisor to the Special Committee. Our analysis, which assumes no "in the money" value for store leases, yields an asset valuation of approximately $32 per share.
Asset value ($MM) Per share ($) (10)
Tangible book value (11) 637 20.58
Adjusted tangible asset value 821 26.53
based on BofA real estate
Prescription files (13) 129-151 4.17-4.88
Continued deferral of
tax liability (14) 44 1.42
Asset Value 994-1,016 32.12-32.83
We have also valued the Company in a recapitalization (for illustrative purposes only) based on a review of the management's five-year base case business plan.(15) If, for example, ShopKo would have effected a recapitalization using leverage similar to the Goldner Hawn Transaction and paid a $23 special dividend, we estimate the future free cash flows of the business would be as shown in our analysis in the following table:
Fiscal Year Ending on or About January 31,
($ in million, except per share)
2006 2007 2008 2009 2010
Store Revenues 3,256 3,293 3,288 3,300 3,346
EBITDA(15) 191 172 167 190 193
Amortization (15) 84 89 91 85 79
Package (73) (73) (73) (73) (73)
Pre-Tax Earnings 34 10 3 32 41
Net Income (after
38.5%) (16) 21 6 2 20 25
Amortization (15) 84 89 91 85 79
Change in Working
Capital (15) 17 13 9 11 1
Capital Expenditures (15)(B) (67) (59) (61) (58) (42)
Free Cash Flow 55 49 41 58 63
Free Cash Flow Per Share $1.78 $1.59 $1.33 $1.87 $2.05
Free Cash Flow (excluding
working capital) 38 36 32 47 62
Free Cash Flow Per Share
(excluding working capital) $1.23 $1.17 $1.04 $1.52 $2.02
Note B. The capital expenditures assumed here make no adjustment for
management's reduction of capital spending in 2005 from the $67 million
figure above to the $35 million figure mentioned in the August 18th
release.(7) Doing so would increase Free Cash Flow by $32 million in FY
2006, or approximately $1 per share.
The foregoing table illustrates that the Company is expected to generate annual free cash flow in the range of $41 million to $63 million between fiscal years 2006 and 2010. Given the total equity investment of $30 million in the Goldner Hawn Transaction, the new ShopKo owners are expected to generate at least 137% annual return on their investment during the forecasted period.(17) Given these spectacular expected returns, it is no surprise to us why Goldner Hawn has been so persistent in trying to acquire ShopKo since late 2003.
In its justification for selling the Company at $24 per share, the Special Committee has expressed reservations with respect to the achievability of the management's financial projections. I would note that those projections are quite recent, having been done only in March of this year and Elliott is not aware of any material changes to the business since then. In addition, as noted above, the former Chairman of ShopKo and certain members of management are personally investing their own money and will own at least 10% of the Company upon closing of the transaction. Finally, ShopKo's current management has indicated that they will continue working for the new owners.
So as to be clear, Elliott is not proposing at this time that the Company do a recapitalization if the shareholders vote down the current deal. Furthermore, our reading of the public letters, 13D filings and preliminary proxy ("Filings") by John A. Levin & Co. ("Levin") to the Company's board and the shareholders is that nowhere in those Filings has Levin proposed a recapitalization either, despite your assertion that Levin "believe[s] that the Company should do a leveraged recapitalization."(18) Our interpretation of the Levin Filings is that they introduce the concept of recapitalization merely as an illustration to show that ShopKo's stock would trade higher than $24 if the Company obtained financing similar to Goldner Hawn's and declared a $23 per share dividend (something with which we wholeheartedly agree). Should Goldner Hawn assert that either Elliott's letter, 13D filing or Levin's Filings would entitle it to a recoupment of Expenses or a payment of Termination Fee (as those terms are defined in the merger agreement) in case of termination of the merger agreement, we would strongly disagree with that view.(19) In this respect, Elliott reserves all its options if the Company's board authorizes payment of Expenses and/or Termination Fee to Goldner Hawn under these circumstances. We would expect the Company to act in this matter in a manner consistent with the fiduciary duty that is owed to the shareholders of ShopKo.
For the reasons explained above, Elliott cannot support the Goldner Hawn Transaction and intends to vote against it. We hope that other shareholders will come to similar conclusion. Elliott intends to consider all courses of action to maximize the value of its investment.
Finally, I wish to sincerely thank the Company's management and its employees for the hard work they have done and continue to do in operating ShopKo. Should you have any questions, feel free to contact me at 212-506- 2999.
Very truly yours,
1. From page 63 of the Definitive Proxy Statement filed August 9, 2005.
2. From page 67 of the Definitive Proxy Statement filed August 9, 2005.
3. As disclosed in letter from Goldner Hawn to Co-Chairmen of ShopKo's
board, attached as Exhibit 99.1 to ShopKo's 8-K filed August 30,
4. Bank of America is willing to lend a total of approximately $1,174
million. This is comprised of a $700 million secured real estate
financing, a $65 million term loan from Back Bay and a portion of the
$640 million of Senior Debt. The portion of the $640 million of
Senior Debt that is available is based on a borrowing base
calculation (see Note A to the first table in this letter for an
explanation of the calculation), which results in availability of
$409 million. This sums to a total figure of $1,174 million.
Subtracting current net debt of $241 million and fees of $90 million
leaves a total of $844 million, or $27.27 per share.
5. From the Commitment Letters filed in Schedule 13E-3 Transaction
Statement filed June 13, 2005 as well as the Definitive Proxy
Statement filed August 9, 2005 on pages 63-66.
6. From the cover page of the Definitive Proxy Statement filed August 9,
7. From ShopKo second quarter results ending July 30, 2005, filed August
8. From page 76 of the Definitive Proxy Statement filed August 9, 2005.
9. From page 5 of the M&A Insight report on ShopKo by Institutional
Shareholders Services, dated August 30, 2005.
10. From the share count given in the Definitive Proxy Statement filed
August 9, 2005 on the cover, adjusted for restricted shares and
outstanding options (using the treasury method) as disclosed in the
Merrill Lynch Discussion Materials to the Special Committee on April
7, 2005, Exhibit (c)(9), in Schedule 13E-3 Transaction Statement
filed June 13, 2005.
11. From Consolidated Condensed Balance Sheet, intangible assets
subtracted from shareholders equity, ShopKo second quarter results
ending July 30, 2005, filed August 18, 2005.
12. From page Consolidated Condensed Balance Sheet, intangible assets
subtracted from shareholders equity assuming property value of $880
million, ShopKo second quarter results ending July 30, 2005, filed
August 18, 2005.
13. From page 26 of the Merrill Lynch Discussion Materials to the Special
Committee on April 7, 2005, Exhibit (c)(9), in Schedule 13E-3
Transaction Statement filed June 13, 2005.
14. From page 59, Note E to Consolidated Financial Statement, Form 10-K,
filed April 1, 2005.
15. From the March 2005 Projections - Base Case, on page 87 of the
Definitive Proxy Statement filed on August 9, 2005.
16. From the First Quarter 2005 Earnings Conference Call held
May 19, 2005.
17. Annual return of 137% is calculated by dividing $41 million of
estimated free cash flow in FY2008 with $30 million total equity
investment in the Goldner Hawn Transaction.
18. From the August 1, 2005 response by the Special Committee to the July
21, 2005 letter sent by John A. Levin & Co., Inc. to the Special
Committee, filed as Schedule 14A on August 2, 2005.
19. Reference to the Agreement and Plan of Merger filed as Exhibit 2.1 to
the 8-K filed on April 8, 2005.
About Elliott Associates, L.P.
Elliott Associates, L.P. and its sister fund, Elliott International, L.P. have more than $5.2 billion of capital under management as of July 1, 2005. Founded in 1977, Elliott Associates is one of the oldest hedge funds under continuous management. The Elliott funds' investors include large institutions, high-net-worth individuals and families, and employees of the firm.
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