Merger Arb / Higher Offer: 15%-40% Upside (at $2.62)
This arb trades at 15% spread and the bidder noted: “we are prepared to increase our proposed price”. That got my attention. On top of that, the downside to pre-announcement trading prices seems to be quite limited.
Destination XL Group, a retailer specializing in big and tall men’s apparel, received a non-binding $3/share proposal from its largest shareholder, Fund 1 Investments, which holds a 21% stake through stock and swaps. Management has acknowledged the offer and is in the process of reviewing it.
After digging a bit deeper into this setup, I think the current offer is likely to be rejected as undervaluing. So, it will all come down to Fund 1’s willingness to raise the bid. I don’t have a strong opinion on the likelihood of that happening, but in any case, the downside seems limited, making this arb quite an interesting play at current prices. My research on both sides of the coin is presented below.
The company is expected to release its annual Holiday Trading update with the revised guidance soon, maybe even today (these updates came out on Jan 8-9 for the last two years). So to avoid any negative surprises, it might be worth holding off bets on this arbitrage until we get this update out of the way.
Now onto the setup. Let’s start with the positives:
- Fund 1 Investments, the bidder, has been a major shareholder of DXLG since 2022 and should have a clear understanding what it’s buying. The fund specializes in apparel and consumer discretionary sectors, and holds stakes in several other retailers, including DXLG’s closest peer, CURV. In its proposal letter, Fund 1 emphasized that it has invested significant internal resources into researching the big and tall retailing industry.
- Financing isn’t a concern – Fund 1 stated it has sufficient equity capital to fund the proposal but prefers a mix of equity and debt. Either way, the deal won’t be contingent on financing.
- The buyout offer appears opportunistically timed at historical lows. Fund 1 would likely be getting a very good deal at $3/share. While the share price chart doesn’t reflect these dynamics, DXLG’s enterprise value sits at just $100m – matching the COVID lows (see historical performance/valuation chart below). Since then, the company has issued some additional shares and significantly strengthened its balance sheet.
- There seems to be enough headroom for an improved bid. The current offer values DXLG at just 6.1x EBITDA (2024 guidance). Its closest peer CURV, a plus-sized women’s apparel retailer, trades at 8.3x 2024 EBITDA (the multiple would be slightly lower at 7.2x if we exclude CURV’s share price run-up after the offer for DXLG). Both companies have similar margins and historical growth trajectories. CURV is slightly larger and more leveraged, whereas DXLG holds a net cash position. While the business dynamics between women’s and men’s apparel might differ, the valuation gap seems wide enough. At 8x EBITDA, DXLG would fetch $3.7/share or 40% upside from the current price.
- Major shareholders might be open to selling. AWM Investment Company (17% stake), acquired its shares during COVID lows at a cost basis of $0.50-$0.70/share. AWM is a special situations hedge fund that focuses on undervalued opportunities or companies with potential for privatization or acquisition. Another shareholder, Wolf Hill Capital Management (5.8% stake), sold 25% of its position in Q3 2024 at around $3/share, suggesting it might be inclined to exit fully.
- Fund 1’s cost basis is $4.30/share, significantly above the current offer. Most of the position was acquired at the end of 2023, before the last year’s decline. However, the fund has been purchasing swaps throughout 2024 (as seen here, here, and here), with strike prices closer to the current levels.
- The offer hasn’t been rejected by the board yet, which I take as a positive sign that the bid is being seriously considered. Management owns 14% of the company. While executives receive substantial salaries (the CEO got $4m in 2023), Fund 1 stated it intends to retain key employees and to ensure they’re appropriately compensated.
My two key concerns with this setup are (1) whether Fund 1 Investments’ offer is genuine or if they made it just to put the company in play or get a board seat, and (2) whether the parties can reach a mutually acceptable transaction price. Unfortunately, I do not have answers to either of these questions and can only share the bits and pieces from my research.
Fund 1 is a relatively new vehicle with fillings starting only at the end of 2022. It seems to be a newly formed entity for managing Pleasant Lake Partners LLC, the vehicle of Jonathan Lennon since 2015. Total AUM stands at c. $1bn, so this would be a sizeable acquisition for the fund. But more importantly, it would be its first full acquisition. So far the Jonathan Lennon has focused on taking minority positions in public companies and has run a few activist campaigns, either pushing for a sale or settling for a board seat. Pleasant Lake Partners had previously made two proposals to buy Magnachip – in 2016 and 2024, but nothing has materialized out of those.
The intro wording of the proposal letter also comes off as a bit odd. The entire first paragraph is dedicated to praising the management and DXLG’s potential, and ends with an emphasis that Destination XL “can generate significant free cash flow into the foreseeable future.” That’s a strange way to kick off an opportunistic lowball takeover offer. Then it goes on to underscore the credibility of Fund 1 in consumer/retail sectors and highlights its participation in “notable ~€6.4 billion take-private of Hong Kong-listed retailer, L’Occitane International”. However, it doesn’t explain what the exact role of Fund 1 was in this transaction or how L’Occitane deal is relevant for the offer at hand (the transaction was done by Blackstone and there’s no mention of Fund 1 in L’Occitane takeover documents). Such vague statements come off as quite promotional.
It’s also unusual that this supposedly-friendly offer was made public instead of being privately discussed with DXLG’s management, especially when the letter notes “the time we have spent speaking with you, members of Board of Directors of Destination XL”. From my limited experience, negotiations at this stage are typically kept private unless the offer comes from management, a parent company, or another party where a conflict of interests might arise (e.g., MLP buyouts). That’s clearly not the issue here.
But even leaving these concerns aside and assuming Fund 1 has every intention to fully acquire DXLG, can the parties reach a mutually acceptable buyout price?
I’ve already mentioned several arguments why the current offer seems too low. There are two more to add:
- DXLG was trading at $3.50-$4/share just six months ago, until weak Q2 and then Q3 earnings came out in July and November;
- Recently the company has been buying back stock quite aggressively, repurchasing 6.6% of its shares during Q3 2024 at an average price of $2.80/share ($10m total spent on buybacks during the quarter). Previously DXLG had spent $24.5m to repurchase 5.4m shares (average of $4.53/share) during FY2023 and $12.7m to repurchase 2.9m shares (average of $4.38/share) during FY2022.
To win over management and shareholders, the buyout offer will likely need a significant bump. My guess is that the offer might need to be raised by at least 20%-30%.
The good news is that Fund 1 has already hinted at the possibility of higher bid, but only if “after completing further due diligence we become aware of some component or aspect of the business and its prospects that provides evidence of additional value”.
DXLG is a non-growing retailer that has historically has always traded in the 5-6x EBITDA range. A bump to $3.5-$4/share, would imply a 7.4x-8.8x EBITDA multiple, and would increase the deal value to $160-$180m, which would be quite sizeable for a fund with $1bn in AUM.
So there is a real risk that Fund 1 might not be willing to up the bid and/or that management might demand too high of an increase.
Business background
Destination XL Group operates 285 stores and an e-commerce platform focused on big and tall (3XL+) men’s apparel. They have several in-house brands and also carry popular names like Hugo Boss, Champion, Adidas, and Lacoste. What sets them apart is that their clothes are designed specifically for plus-sized customers, not just scaled up versions of standard sizes. DXLG offers the widest assortment in this niche, with 80% of its inventory being exclusive – either proprietary brands or developed through exclusive collaborations.
The business is stable, though not growing. It experienced a significant COVID-period boost, but the performance seems to have fully normalized over the last year. The online channel accounts for 31% of sales.
For more on the business background, check out these VIC pitches from 2021 and 2024.
Historical performance table is provided below. Fiscal year ends around January 31.
This offer smells like the Highwire offer for SGRP and Landon offer for TBNK, promotional;
namely, public market investors eager to project an image that they can acquire/operate a private company too, while having no such proven experiences/capacity at all.
Can consider shorting it if stock price rises near $3.
How does that help them make money? Can they later on say they were close to acquiring a company worth >$100M and then try to lure other investors to invest in them? I don’t get how it benefits them to pretend to acquire someone they are unlikely to acquire. Or is it one of those long shots where if a bank gives them funding, sweet, if not nothing lost?
DXLG reported holiday sales results, updated 2024 guidance, and announced it would release full-year results on March 20, 2025.
– Holiday sales totaled $94.7m, down from $102.4m in 2023.
– Fiscal 2024 guidance was slightly reduced, with projected total sales now at $467m-$470m (previously $470m) and an adjusted EBITDA margin of 4.2%-4.5% (previously 4.5%).
– CEO Harvey Kanter attributed the decline to cautious consumer spending and a late Thanksgiving but noted improvement during Black Friday and Cyber Monday promotions.
– There doesn’t seem to be any comment on the non-binding offer. Spread stands at 17-18%.
https://www.bamsec.com/filing/95017025004556?cik=813298
New filing from Fund 1 Investments – on January 17, the buyer entered into a confidentiality and non-disclosure agreement with DXLG to discuss a potential transaction. This agreement includes a standstill provision. The spread to the $3/share offer has narrowed from 15% to 8%.
https://www.bamsec.com/filing/92189525000132?cik=813298
In the previous open letter Fund 1 states that they can execute a definitive agreement within 45 days. But the confidentiality agreement asks for an eight month stand-still. Interesting.
“From the date that we are able to enter into an appropriate confidentiality agreement and commence due diligence, we would anticipate the completion of all due diligence and execution of the definitive purchase agreement within 45 days.”
“The Confidentiality Agreement includes customary standstill provisions, including but not limited to restrictions on the Reporting Person acquiring additional equity securities of the Issuer, effective for eight months from the date of the Confidentiality Agreement or until the earlier termination of the Confidentiality Agreement in accordance with its terms.”
Thanks for spotting this. The significantly longer period might be indicative of contingencies where the buyout negotiations break and Fund1 needs to be restricted from acquiring additional shares in DXLG in order not to mount additional pressure on the company.
Shares traded up to 3,05$ on apparently no news?
Yesterday’s price action was strange. The stock jumped 10% on no news (and on a down day for S&P) and is now trading 3% above the takeover offer. Trading volume wasn’t irregular.
No idea what’s happening – maybe there has been an info leak on a higher offer incoming? Yesterday’s volume was too low to think someone is pumping the stock.
Even if there’s some probability of a higher offer, at 3% premium to the $3/share offer the risk/reward is more attractive for a short.
Fund 1 being a major shareholder of DXLG since 2022, I doubt they can now suddenly discover some “additional value” from “some component or aspect of the business” that it was not aware of. DXLG is not a complex biz with hidden IPs or secret technology.
So if Fund 1 raises the offer by 10%, the loss for a short is just 7%, but the profit is substantial if the deal breaks and stock price comes back down to $2.2.
“Our Proposal is based entirely on publicly available information. If after completing further due diligence we become aware of some component or aspect of the business and its prospects that provides evidence of additional value, we are prepared to increase our proposed price to reflect this new information.”
The write-up shows upside of 15-40% from $2.62, or $3 to $3.67 (which is way higher than 10% increase). I’m just pointing this differnce out. As usual, I myself have no clue.
@dt’s 40% ($3.7/share) scenario assumes 8x EBITDA (comparable to CURV). I don’t think Fund 1 is willing to pay 8X.
Agree, the risk/reward at $3.1 was very different from what it was at $2.62, especially with vacuum of information of where the negotiations are going.
Some online article mentioned a “Strategics Vehicle” raised by Fund 1 for this purpose. However, all of them seem to originate from the same unknown source, have similar wordings (with minor editing) and were published around the same time
“Fund 1 has 37% compounded returns since its inception in 2017, according to people familiar with the matter. Fund 1 is starting a Strategics Vehicle that will take controlling or non-controlling private stakes in companies, similar to its L’Occitane deal.”
I came across similar quotes during my research. While I couldn’t verify their 37% returns, the “strategic vehicle” seemed reasonable. DXLG also emphasized their involvement in the L’Occitane deal when announcing the non-binding offer to DXLG.
Spread is back to write-up levels (now 14%).
Was really thinking that the stock trading up $3.10 was the precursor to an imminent revised higher Fund 1 offer. Guess not…
Funny how market psychology works – when a stock moves up, everyone assumes it means something big (like a higher bid), and selling feels hard. Then, when it drops below previous levels, everything suddenly feels gloomy, and buying more seems just as hard. Spread’s at 20% now.
The spread has widened further to approximately 27%. There haven’t been any significant updates so far, but the upcoming Q4/FY earnings, scheduled for March 20, might provide more insight.
From the comments it doesn’t seem like the risk component here has changed. Is this even more attractive at 2.2’s?
Just entering the convo, might have missed something.
Yes, the spread has doubled from the write-up levels (32% now vs. 15% previously). However, the downside probably isn’t zero, even though the stock is back/close to pre-announcement prices.
DXLG’s holiday sales update in mid-January were not great (November down 12%) and management was forced to engage in ‘strategic promotions’ to soften the decline. The results were called as “mostly in line” with expectations, but they still trimmed the full-year guidance, although only very slightly.
So the downside might be below the pre-offer price of $2.2/share.
My key concern is whether Fund 1 Investments’ offer is genuine one or whether it was made just to put the company in play. As I noted in the write-up, the wording of the offer was a bit strange.
Spreads of 30% usually mean the offer is not happening, so might be that the market knows more than I do.
Spread has once again doubled and now stands at 66%. The market seems to believe there is basically no chance the offer will go through. Let’s see what the March 20 earnings will tell.
Thanks for update Jimo, following up on DT’s comment – all else equal, is downside now close to mitigated completely? I guess the underlying question is, is all else equal at this point?
Tough call. The downside seems small now, but the chance of the deal actually happening is probably super tiny too. Unless the market’s totally got this wrong, which I’d find hard to believe, especially with all the other concerns going on
I’m down 31% on this holding. Is there any chance for recovery or is it time to cut my losses? Thanks
It seems pretty clear that the market does not believe this deal is happening. The deal thesis seems cooked, so if one continues to hold it requires a shift to some sort of value proposition. Personally, I always seem to get in trouble when I buy for one reason and then change the rationale to justify continuing to hold.
They suspended guidance for 2025. Definitely a challenging market for retail in general, but then you also need to factor in the market’s view of GLP-1’s for their target demographic. A fair chunk of the earnings call and questions talked about that. There was no mention* on the call of the deal, not even in the analyst questions.
*that’s based on my somewhat distracted listening. Will need to check the transcript to be sure that is correct.
Results were weak. The worst part was that management decided not to give 2025 guidance, which pretty much signals a quick turnaround isn’t happening. FY24 numbers came in at the low end of adjusted guidance, and at current levels, the stock is trading at like 2–3x adjusted EBITDA. But… FCF has dried up, the outlook is murky, and there are some real headwinds coming for the business.
The only real hope is that Fund 1, being a retail specialist, sees some long-term value here. But the market clearly isn’t buying into that scenario.
If you read through the call, it seems the company has no clear strategy on what to do:
– Management acknowledged that GLP-1 usage is a big issue, but they were not able (or did not want) to quantify it.
– All newly opened stores are underperforming, but management still plans to open 7 further stores in 2025.
– Revamp of the website is actually one of their key pillars that should drive growth going forward. The other pillars are mostly reward program, targeted promotion and etc orientated. No game changers.
– And then were was even this – sounds pretty desperate:
“Perhaps the most exciting steps we will be deploying will be focused on making it easier to enjoy the shopping experience, ultimately using Gen AI to enable this.”
We can forget about Fund 1 offer. That one is off the table.
Half of the market cap is in cash and so far the company is operating above breakeven. But it is not clear if there will be any cash generated during 2025. And despite calling themselves debt free, DXLG actually has burden of $220m in lease payments over the next 7 years. Newly opened stores might increase this figure further. If the business is cashflow positive, these can kind of be ignored. But with sharp and continuous declines in revenues, these lease liabilities might become problematic quite soon.
My initial assessment that “the downside seems limited” was very much off.
I’m down 64% on this. I guess there’s no hope of recovering much but it’s a painful loss to take.