J. Alexander’s (JAX) – Merger Arbitrage – 10%+ Upside

Current price: $10.7

Acquisition Offer: $11.75

Upside: 10%+

Expiration Date: TBD

Buyout Offer

 

This idea was published by Rangeley Capital. I find it intriguing and would recommend reading their full post. Below I am sharing the core thesis with some additional thoughts.

On the 8th of April restaurant chain JAX received unsolicited and non-binding offer from Ancora Advisors (8.6% shareholder) at $11.75/share in cash. Their letter reads more as a proxy fight statement with a number of accusations of management's missteps and conflicts of interest rather than an acquisition proposal. This was most likely intentional as it is not clear whether Ancora really wants to acquire JAX or whether this is just a way to put the company in play. Ancora's proposal quickly received support from another activist Marathon Partner's (6.6% shareholder) only to be outright rejected by the board arguing that the offer undervalues the company - although just a year ago the same board agreed to a merger with 99 Restaurants at $11/share valuation in all stock deal (voted down by shareholders).

A week later Ancora issued another letter refuting company's claims and then couple days ago launched a symbolic proxy fight encouraging shareholders to withhold their votes from reelecting 2 of the directors in the upcoming annual meeting (these directors will still be elected anyway as there are no other nominees, also one of them is the largest 11.3% shareholder in the company).

So that is the brief timeline leading to today. Shares currently trade at pre-announcement levels, albeit in the meantime somewhat negative / neutral quarterly results were released. The spread likely exists as Ancora's words/actions do not indicate it has strong intentions to proceed with its own bid.

But the story is still very fresh and the play here is based on the following assumptions:

No. 1) JAX sale (solicited or unsolicited) is likely to attract a number of interested parties. This assumptions is backed by historical interest in the company. In 2012 when JAX was taken private by Fidelity National Financial (FNF) the sale process received multiple bids and FNF was forced to raise its offer couple of times (later in 2015 FNF spun-off JAX back to public markets). J. Alexander's small size, stable financials, real estate ownership and low financial leverage coupled with unscaled and mismanaged operations are likely to be attractive for both private equity and larger restaurant operators.

No.2) JAX shareholders will either force management to sell the company or shareholders will force management change. Company's execs are clearly entrenched, have conflicting interests and are enriching themselves at the expenses of shareholders. 3 out of 4 top execs named in the 2012 annual report are still running the company today, they survived through FNF buyout as well as subsequent spin-off. So forcing their hand might prove difficult especially keeping in mind that one of the directors is the largest shareholder (11.2% ownership). However, when a year ago board recommended value destructive merger with 99 Restaurants, JAX independent shareholders rejected it, albeit only by a narrow margin. Also back in 2012 company's sale process coincided with the proxy fight by activist Privet, which potentially caused management to finalize the sale process faster facing the risk that Privet will force board change. With 15% of shareholders already vocally pushing for the sale and accusing management of value destruction, gathering the required majority does not seem like a stretch.

No.3) And the last and probably the most important assumption is that JAX is undervalued, which gives the upside to current prices as well as confidence in holding the stock until the situation gets resolved one way or another. In the initial letter Ancora outlines undervaluation relative to peers - JAX trades at 6.1x 2018 EV/EBITDA vs 10x for the peer group median despite comparable margins and lack of leverage (see table below). On top of that company owns 37 out of their 46 restaurants, which based on Rangeley's estimates is another $50m in value (but margins would somewhat deteriorate if properties are sold and leased-back).

Peer comparison

Probably the main reason for undervaluation relative to peers is that JAX spends most/all of the generated EBITDA on capex (growth and maintenance) and these incremental investments failed to generate any additional returns to shareholders despite steady growth in revenues and same store sales. This problem is partially due to lack scale and partially due to mismanagement, both of which would be addressed by selling the company.

NOPAT

All in all, given large valuation discount relative to peers, stable financial performance as well as incremental value of the real estate I feel comfortable holding JAX stock while waiting to see how assumptions No.1 and No.2 play out. As for timeline, the nearest event will be shareholder meeting on the 20th of June where shareholders will signal their trust with the board. I do not expect too much from this, but if high percentage of votes are withheld indicating support for the activists, then Ancora might push for the full board overhaul. Any other bids are unlikely to surface till the meeting or before board begins dialogue with Ancora.

22 COMMENTS

  1. lngtrminvestor1

    Any view on why JAX’s EBITDA margins trail their peers, especially since they own so much of their real estate?

    1. dt

      Why do you say that EBITDA margins trail the peers?

      JAX’s margins seem to be rather in line with peer average (as per table copied in the write-up) or even slightly above the other two lower scale restaurants (Del Frisco’s, Chuy’s). Somewhat lower profitability compared to larger players might be due to lack of scale.

  2. dt

    Del Frisco Restaurant Group is getting acquired at 10x-11x forward adjusted EBITDA (as per 2019 company guidance). This compares to 6x multiple for JAX (also using 2019 adjusted EBITDA guidance). Using EV/Revenue multiple difference in valuation is evident as well – 1.4x for Del Frisco and 0.65 for JAX.

    Del Frisco is slightly bigger (76 restaurants vs 46 for JAX), but have similar average check size ($32-$34). However, Del Frisco does not own any of its restaurants (additional $50m of value for JAX) so there does not seem any evident reasons why JAX should be valued so much below its peer.

  3. lngtrminvestor1

    This thing just can’t find a bid.

    I’ll respond to my own question– apologies, I am not smart on this space re: margin structure between lower scale and upper scale operators– but it looks like based on guidance given in 1Q management is expecting EBITDA margins of ~11% which puts it more in line with the broader group referenced in the write-up.

    Additionally, I saw that Black Knight had been receiving 3% of Adj. EBITDA for a consulting agreement that was canceled in Nov. ’18 which also could explain some of the margin under-performance.

  4. Vinn

    Hi dt, regarding the full board overhaul option, on which timeline could this happen at its earliest?
    Does Ancora have to wait a year for the next shareholder meeting or can they initiate this process earlier if they wanted to?

    1. dt

      To be fair, I do not know the answer to this. JAX bylaws seem to indicate that only BoD, Chaiman or CEO can call special meeting – indicating that Ancora would need to wait another year for the regular annual meeting to overhaul the board. However, I am not a proxy fight expert and do not know whether there are some ways around it or some other circumstances upon which activist shareholders can initiate vote on the board.

      https://investor.jalexandersholdings.com/sites/jalexanders.investorhq.businesswire.com/files/doc_library/file/Form_of_Amended_and_Restated_Bylaws.pdf.

      Also, the way Ancora is playing this so far (did not offer its slate of directors for this meeting) seems like signaling to the rest of the world than JAX is in play and that shareholders would be supportive of company sale even if it is at only slight premium to current prices.

    1. dt

      A real positive is management’s announcement that they are expanding strategic review process (I think this is also the reason behind recent 10% share price run up):

      Our Board is fully committed to maximizing shareholder value and believes that expanding our ongoing strategic review process is in the best interests of our shareholders. Recent transactions for companies in the upscale casual dining segment make this potential path more attractive now

      https://investor.jalexandersholdings.com/press-release/j-alexanders-holdings-inc-announces-expansion-review-strategic-alternatives-maximize-s

      On a somewhat negative side, Q2 results have showed further revenue growth deceleration and margin pressure. Management expects H2’19 to be better, but still lowered the guidance for the year.

      https://investor.jalexandersholdings.com/press-release/j-alexanders-holdings-inc-reports-results-second-quarter-ended-june-30-2019

      JAX still trades at 6xEBITDA vs close to 10xEBITDA for competitors.

  5. Ilja

    5.5% holder Marathon Partners has announced their support with the decision of expanded strategic review, but has also raised some concerns over the board’s competency, no formation of special committee, cessation of quarterly conference calls and separate investor calls etc. and also stated that: “Marathon Partners will continue to monitor the Issuer closely and may expand upon its concerns in the near future.”.

    So its probably good that JAX board has this increased pressure now, which may discourage them from some value destructive decisions in the near future.

    Marathon Partners, however, has been slowly decreasing their stake for a few months now.

    https://www.sec.gov/Archives/edgar/data/1353311/000092189519002201/sc13da608009005_08132019.htm

  6. Zulu Investment Partnership

    Is there anything wrong with Jax today? We have already closed out our position in this at the merger price offer, only to find that the spread has widen back to our original buying position once again.

  7. Zulu Investment Partnership

    I believe Jeffrey trimmed their holdings but this was announced in Q2 and they only reduced their holdings by 6.7%. They likely trimmed when the stock was close to the acquisition price offer. Very strange to see such a huge down on a stock with virtually no significant news.

  8. Zulu Investor

    Any updates on this one? This has become basically ~$4 a share and I’m not sure if the original $11.75 thesis still stands given the current environment, although I don’t expect a new or revised acquisition price to be something ridiculously low like $5. They might revise an offer (if there is one) to something like $9. The company didn’t offer a guidance for 2020.

    1. Ilja

      No updates were made about the strategic review for 7 months, while currently due to COVID-19 most of the restaurants are closed. In the current situation any chance of acquisition is very unlikely to say the least. Therefore, the idea is closed with 63% loss in 10 months.

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