Dorel Industries (DII-B.TO) – Large Division Sale + Expected Tender Offer – 50% Upside

Current Price: C$20.97

Target Price: C$30+

Upside: 50%

Expiration Date: Q1/Q2 2022

Press release

This idea was shared by Value9.

 

Dorel Industries is listed in Canada but also has a relatively liquid OTC listing with ticker DIIBF.

Dorel Industries is a rather well-known Canadian micro-cap name, which over the years got abandoned by investors due to frustration over multiple overhangs. These include lackluster M&A performance, fears over secular business declines, the U.S. / China trade war and tariffs, and more recently, management siding with a PE firm to rip-off minority shareholders through a lowball takeover offer. However, the recently announced unexpected sale of Sports division (a third of revenues and earnings) at more than 2x of the pre-announcement market cap has been a major gamechanger and has proven two things – that the market was significantly undervaluing DII and its subsidiaries and that management is still able to create significant value for all shareholders. These cash proceeds will be used to reduce debt and to return capital to shareholders. More details will be unveiled at the time of the closing, expected in Q1 2022, but it seems that half of the market cap could be distributed to shareholders. The stock is already up 100% since the announcement, however, the long-ignorant market seems slow to catch up – pro forma for the pending sale cash on the balance sheet will exceed the current market cap and the remaining two segments are significantly undervalued trading at 3x EBITDA before corporate overheads. This is definitely too low – even with conservative valuation assumptions, we see at least 35%-60% upside from the current prices.

Sports division sale was announced on the 11th of October for US$810m. Net proceeds are expected at US$735m. The buyer is Pon Holdings, a major Dutch transportation conglomerate with 7.3bn EUR annual turnover. Pon should be already well familiarised with the U.S. market (most of DII sales) after their acquisition of Santa Cruz bikes in 2015. The transaction is not subject to financing and we don’t expect any surprises from the buyer. The risk of termination is low.

Pon Holdings comment:

Dorel Sports really is complementary to Pon Bike and that’s why this is such a logical step. Together we can further cater the ever-growing demand for quality and electric bikes, whether it’s for urban use, leisure or sports.

DII comments regarding use of the proceeds:

Dorel expects to use the net proceeds from the sale of approximately US $735 million (subject to closing adjustments) to reduce indebtedness, return capital to shareholders and for general corporate purposes. […] While we may retain some capital from the sale of Dorel Sports for potential reinvestment opportunities, we currently intend to reduce financial leverage and return capital to shareholders.

A bonus to the thesis is the potential sale of the remaining two businesses. Although the press release stated that they won’t “be pursuing” that for now, it is worth noting that the Schwartz brothers (and other family members in senior positions) are not exactly young – around 70, so it only makes sense to think that further division sales are in the cards here.

 

Short business background

A detailed historical business background on Dorel Industries can be found here and here. Short summary/more recent background is provided below.

Dorel Industries was founded over 50 years ago by the Schwartz family. The company is the result of a merger between Leo Schwartz’s juvenile business and his son’s Martin Schwatz’s furniture business in the 90s. The business continued to grow organically and through acquisitions – completing 26 transactions between 1988 and 2019. In 2004 Dorel also entered the bicycle business – the segment currently being sold.

The company has a dual share class structure, both of which trade on TSX – Class A (10 votes) and Class B (1 vote), 96%+ of A shares are owned by the founder family, who also are still running the business, giving them control of around 60% of the votes and 12%+ economic power. Other major shareholders are Fidelity – 13% of total shares (through B class) and Letko – 10.5% of total shares (through B class).

Financials are reported in USD.

Currently, Dorel operates 3 business segments:

  • Dorel Sports – manufactures bikes, jogging strollers, scooters, and bike accessories. Sells to mass merchants (cheaper bikes) and independent bike dealers (premium products). Best known brands are Schwinn, Mongoose, Cannondale, Caloi, GT, etc. The division has been a major beneficiary of the pandemic with revenues going up +15% in 2020 and the momentum continuing into 2021 with sales up 13% YoY in H1.
  • Dorel Home – one of the largest furniture suppliers for homes & offices in NA. Products include mattresses, futons, sofa’s, dining room/bedroom furniture, and baby cribs. The company is also the second-largest ready to assemble furniture manufacturer in the U.S. Over the years, the division has grown mostly through e-commerce channels (Amazon, etc.), which generates 60% of the division revenues. Dorel Home has been a beneficiary of the COVID and housing boom with revenues going up 11% YoY in 2020, but the momentum is subsiding and H1’21 revenue was up only +1.6% YoY with Q2 revenues -9% YoY.
  • Dorel Juvenile – manufactures and supplies kids accessories and other products – infant car seats, strollers, high chairs, health/safety aids, etc. In NA sells low price products to mass merchants, in Europe – mid/high price to specialized juvenile chains. Also has operations in LATAM and Asia. The most popular brands are Safety 1, Quinny, Maxi-Cosi, Tiny Love, Cosco, Bebe Comfort, Infanti, etc. The Juvenile segment was negatively impacted by COVID – revenues down 11% YoY in 2020, but the momentum is now rebounding and H1’21 showed revenues +13% YoY.

Each segment historically generated about a third of total company revenues with Juvenille recently dropping to 28% of the total due to pandemic impact.

Dorel’s financial performance was negatively impacted by an accelerated international M&A spree and new debt issues in 2012-2014. Nevertheless, till 2018 the stock traded at much more reasonable adj. EBITDA multiples in the range of 7x-8x. The share price decline in 2018 coincided with the U.S. – China trade war fears and tariffs impacting Dorel’s operations – the company has a factory with two manufacturing facilities in China and is also sourcing some of its products from Asia. On top of that, Dorel made a strange move to record massive impairments to the Juvenile and Sports divisions on the grounds of declining Dorel share price. These resulted in paper operating losses of nearly $0.5bn in 2018 (vs $53m profit in 2017). After further tariffs were announced in 2019, the stock just kept rolling down, finishing 2019 in the range of C$6/share price vs C$31+ in 2017. Looking back, the market’s reaction seems significantly overblown – the company managed to offset the negative tariff impact by raising prices, sales / gross margins remained stable and the impact on profitability was limited.

 

Takeover attempt

Dorel’s Sports/Home divisions’ sales went up during COVID, however, this positive performance had only a limited impact on Dorel’s share price (vs 2019 levels). Hence, in Nov’20 management has decided to side with a PE firm Cerberus and take the company private at C$14.50/share. Buyers were forced to increase the bid a few times to $16/share. In December, they even released a circular trying to justify the lowball offer. The circular outlines valuation (prepared by TD Securities) of each of Dorel’s divisions and suggests the company is worth between C$14.22 – C$23.54/share. However, this valuation model included many adjustments and “normalizations” as explained in the rejection letter of the second-largest shareholder Letko. Letko noted that without those artificial adjustments, the company would be worth C$56+/share (another extreme).

In the valuation model, the Sports segment is valued at US$290m-US$383m and after only 9 months the same segment was sold at US$810m. It is reasonable to guess that the valuations of other divisions have also been artificially depressed to justify management’s takeover.

Finally, in February, one day before the shareholder meeting, management pulled the plug and terminated the offer after “discussions between Dorel and many of its shareholders and review by Dorel of proxy votes submitted prior to the deadline”.

 

Value of the remaining businesses

The simplest and likely the most conservative way to value the company pro-forma for the sale of the sports division would be to take the Juvenile and Home segment’s valuation provided above in the Dec’20 circular and add the current sale proceeds of the Sports business on top of that. Net pre-tax proceeds are US$735m. Assuming 15% tax on the whole amount (likely to be much lower), we get $625m in after-tax proceeds. The model below also deducts capitalized overheads (figures also from circular) – these are expected to be lower going forward as the business is now smaller.

Keep in mind that this is a very conservative/undercut valuation, as management / TD Securities were motivated to make the C$16/share price look as appealing as possible. The combined adj. EBITDA used in the management takeover circular for Home and Juvenile segments is US$90m, whereas H1’21 is adj. EBITDA run-rate is higher than that (TTM figures look even better due to strong H2’20):

IFRS lease adjustment requires assumptions, which we base on the divisional split of depreciation as well as the percentage of depreciation accounted by right of use assets.

Aside from the various adjustments used, Letko also argued that 7-9x adj. EBITDA multiple used in the Dec circular is too low and should be closer to 11x. This could be true in the takeover scenario if management decides to sell the remaining businesses too – the Dorel Sports division was acquired precisely at 11x EBITDA (not adjusted), provided in the circular.

 

Risks

  • The sports segment sale might not close, however, the credibility of the buyer (Pon Holdings) and no financing condition indicates that this risk is minor.
  • Together with the announcement of Sports division sale, the company kind of ‘reduced outlook’ for the two remaining businesses due to supply chain issues and increased shipping costs. The previous ‘outlook’ was for H2’21 to be better than H1’21 (on which we based run-rate figures) and in line with H2’20. No further details were provided. Worth noting that the highlighted issues are industry-wide and are said to be ‘near-term’ – if there is any financial impact costs should normalize when the global shipping and other supply chain stresses subside.

As in many industries, the uncertainty of supply remains a key concern for Dorel’s Home and Juvenile businesses. The demand for container freight continues to push up costs and is hindering Dorel’s ability to meet continuing strong consumer demand for its products. In addition, the effect of the COVID-19 pandemic in various parts of the world and labour availability for Dorel and its stakeholders are factors with which Dorel is contending. Dorel’s ability to successfully manage these issues with its vendor and retailer partners will be vital to its ability to deliver in the future. In the Home and Juvenile segments, inflation and a highly stressed supply chain are forcing Dorel to reduce its outlook from that in its August 6, 2021 press release.

14 COMMENTS

  1. Ilja

    Thanks for sharing this, Value9. It is interesting that they won’t pursue further sales for now and will focus on improving the operating performance of Home and Juvenile segments. In this sense, the thesis here could be something similar to the Laureate Education situation = large dividend + remaining divisions sold when earnings normalize.

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  2. ijw

    Withholding taxes on dividend might be an issue for non-Canadians. They kill a significant part of upside here at 25%.

    Also the remainco seems kind of mediocre? Juvenile adjusted EBIT has fallen by about 75% in the past few years, even before Covid. With declining revenue.

    And Home business has also seen declining gross margins in 2019 already, despite growing revenue. Where revenue is up in 2019 and 2020 over a few years ago, but adjusted EBIT is down.

    By my calculation, current valuation prices in that remainco trades at 12x after tax adjusted 2020 earnings (assuming no corporate overhead), if you are non-Canadian. Which isn’t all that cheap?

  3. value9

    At the moment it is not clear what kind of capital return (if any) the company might announce – might be dividends, tender, or simply an open market buyback program. So I think it is too early to speculate how withholding taxes on dividends might impact.

    As for the regarding the remaining segments, if you look at historical numbers, Sports division did not look like a star asset either. From 2015 to 2019 sales declined at a similar/faster rate than Juvenile (Home consistently went up) and cash generation was in line with Juvenile/lower than Home. Yes, it did receive a strong benefit from COVID, however, the tailwinds will likely be temporary and should normalize soon (how many bikes can people buy? – the industry itself was going sideways pre-COVID with fears of looming secular decline). Yet, they’ve now managed to sell the division at a very healthy multiple. Juvenile and Home segments have proved to be rather stable, cash generative businesses. Pressure on margins was mostly from the tariff issues, but that has stabilized and the impact was partly offset by price increases. Earnings might be a bit lumpy YoY, but overall adj. EBITDA of both segments grew nicely from 2016 to 2020. Once the current supply chain problems are resolved, I think things should normalize pretty quickly. So overall, I think you’re painting way too dark picture here. Juvenile and Home are not the star assets, but at the current price, they don’t need to be. Especially given where the Sports segment was just sold.

  4. dt

    The announcement regarding tender or any other form of capital return is only expected after the sale of Sport’s division closes. Per management’s comment in the latest press release:

    We will provide further details of the use of net proceeds once the deal closes, which is expected before the end of the first quarter next year.

    As for Q3’21 results couple of things worth noting:
    – Continued supply chain having pressure on revenues (as products can not get delivered on time) and margins (as higher shipping costs take time to pass on to consumers). Similar things were noted in Q2 results but had a more pronounced financial effect this quarter and casued management to lower the expectations for the remainder of the year.
    – One time charge of US$62m related to unfavourable Luxemburg tax rulling. On cash basis this is US$45m or C$1.5/share (relates to case in 2015). This is obviously cash out from the balance sheet and reduces the upside by the equivalent amount.

    On the outlook management noted:

    Despite Dorel Home’s disappointing third quarter due to cost and supply challenges, we are currently in a favourable inventory
    position and we experienced upticks in demand in both September and October. Fourth quarter earnings from operations are
    expected to improve from the third quarter, but given the higher costs we are experiencing, earnings from operations will not
    reach last year’s levels. Our gross margins will remain under pressure in the short term as we continue to implement strategic
    price increases to offset higher costs.

    Dorel Juvenile’s business is performing well in the Americas where sales and earnings are improving. However, the
    challenges in Europe persist. A large share of our supply is from ports where getting product on carriers is a constant challenge
    and often at exorbitant prices. While previously we expected this to be a short term issue, it is now a continuing reality. We
    are reducing our container backlog but this will take time and is at a higher cost. In addition, passing on higher costs to our
    customers will only begin to materially impact our earnings in 2022. As such in the fourth quarter, the gains in other markets
    are going to be offset by losses in Europe and we now expect the quarter to be approximately breakeven

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  5. workingmason

    Do you know how the management is defining “net proceeds of $735m” (as in “net proceeds from the sale of approximately US $735 million (subject to closing adjustments))”? How do you bridge from $810m to 735m net? Sure there are some legal and advisory fees, but $75m or more than 9% of transaction value seems pretty high. What makes you think that $735m is pre tax and not after tax?
    Thanks!

    1. value9

      Most of the time the net amount reflects the net proceeds to the company, not shareholders. Maybe the fees are a bit high, but if you think $735m is after-tax, aren’t the taxes a bit low then. I think Dorel doesn’t have NOLs anymore. Anyways, we’ve conservatively assumed that it is pre-tax, but if it’s not then all the better.

  6. value9

    FYI, I have closed my position in Dorel at $28 – my target, adjusted for the $1.5/share tax ruling, was reached.

    I know, these price targets were based on management’s valuation models during the previous takeover attempt and were supposed to be very conservative. But recent Q3 results were pretty bad – supply chain issues are continuing and both of the remaining segments reported disappointing margins (especially Dorel Home). In other words, I think the remaining segments might be close to fully valued at current levels.

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