Description

HDG NA

Situation Overview:

Hunter Douglas is the #1 worldwide operator in the Windows Blinds/Shades segment. HDG NA is an interesting and timely situation today and continues to be our largest position post the December agreement between HDG and the founding family/84% shareholder to go private at €64. The stock is currently trading at €66 but we think there is meaningful upside from here. We do not think shareholders will agree to the buyout and expect the founding family to significantly raise the bid in order to effectuate the transaction.  The official offering memorandum will come out in a couple of weeks, would expect a bump to happen then or in the proceeding couple of months. 

HDG has always been a quirky stock; the business is worldwide, its trades in Amsterdam, it is incorporated in Curacao and reports in USD. It is 84% owned by the Sonnenberg family that runs it, so there is little liquidity. For obvious reasons there have not been a natural shareholder base other than the die-hard value investors. But it is a high-quality business with significant barriers to entry, high returns on invested capital, no leverage and operating results that are in the process of exploding higher. 

HDG was trading in the low €50’s in December (it was our largest position then as well) when the Sonnenberg family bid €64 to take the whole thing private. HDG’s stock had not rerated despite the improvement in the business;  given the recent resurgence of value investing in the subsequent 3 months (Russell value up more than 30% since then), my guess is that it would have by now.

HDG had results in the first half of the year that reflected the shutdown, but has seen revenue spring back quickly over the last couple of quarters. They have also cut costs aggressivel and we would expect them to grow EBITDA 20%+ in 2021 and have slower, but positive growth from there.

On 2021 numbers, we believe HDG is trading at a 15.8% forward FCF yield for an unlevered stock with near-term goal of 20% RONAE. That is an insane valuation. The best comp for this business was from 2018 (in a worse) market when Golden Gate Capital sold Springs Window (an inferior competitor) to AEA for 11x unadjusted EBITDA. This deal is slated to occur at 4.6x 2021 EBITDA (including lease liability payments in EBITDA). This is a business that has been trending from low to mid-teens on a RONAE basis, with an explicit medium goal from the CFO of 20% (which I think they hit this year). 

At 11x 2021 EBITDA, HDG would be worth €160 per share. If we are incorrect on the exact EBITDA trajectory/multiple, it would be quibbling between €125-180 per share in fair value; there is no argument that in a clean transaction that this could trade for something with a double-digit stock price.  That €160 per share equal equals around 15x FCF, which is an undemanding multiple for a stock of this quality and no leverage (especially in this interest rate environment).

Company Background/Current Operating Environment:

Focused Compounding put out an 88-page report in 2017 on Hunter Douglas. It gives a lot of the history and description of business. That combined with their annual report should give you good background. I will use this section to briefly describe why after numerous diligence calls I came away thinking this was a great business. 

https://focusedcompounding.com/wp-content/uploads/2017/05/Hunter-Douglas-1.pdf

Hunter Douglas is #1 operator in the Windows Blinds/Shades segment, having rolled up a big chunk of the industry in what is now an oligopolistic industry with HDG as the clear leader. Blinds/Shades are a good business because it a consolidated, scale business that is  difficult to undercut with lower-cost international supply. The high-end business is a custom business with quick turnaround, you go to a specialty blinds store, they come out and measure your house and you order shades/blinds through them. They send the order to Hunter Douglas who fulfills the order quickly and ships back-the whole process takes a couple of weeks. It does not really work to do it from Asia with ship times. It is also hard as a startup competitor to manufacture in a way that is cost competitive domestically (given scale advantages; there is nobody really to outsource manufacturing to). 

Other important barriers to entry for HDG are brand recognition, supplier relationships and R&D spend. On brand recognition, Hunter Douglas has by far the best brand recognition at the high end, and they have budget brands as well for Lowe’s and HD. On the R&D side, because they are so much larger than upstarts they are constantly investing in more R&D and staying ahead of the curve on new products. Before doing the work, I honestly didn’t think there was likely much innovation in this business, but I was incorrect on that assumption. Similar to what we have seen in other businesses recently, there appears to be increasing (not diminishing) returns to scale in this business. 

Each of the competitive advantages might not sound impenetrable, but it has ended up with a business with HDG having huge market share followed by Springs and in a distant third Norman (which does primarily shutters). I did a lot of diligence calls on the space and did not come away with any significant competitive threats. It is not impossible to compete obviously, but HDG over the last couple of decades has consolidated the industry significantly and ROIC is starting to show an inflection point.

In terms of the current operating environment, HDG initially got hit very hard as both retail stores closed and people did not want anybody in their house to measure windows. HDG started to bounce back in the back half of the year while also making permanent cost cuts. As the housing boom continues, we expect revenue to grow organically strongly (with some inorganic growth flowing through as well) and margins to expand in 2021. This is the perfect operating environment for HDG to excel, making the timing of the proposed buyout particularly frustrating. 

Upside/Scenarios:

Hopefully if you have taken a couple of minutes to look at the financials you agree by now that is cheap and would trade for a lot more if it were not a controlled business. But as my informed reader would note, it clearly is. So how does this actually play out from here?

The company is making the argument that because it is incorporated in Curacao and governed by Curacao law, that the only squeeze out rules that apply are in Curacao. Those squeeze-out rules in are set at a 90% threshold and count both the common and preferred stock. Under that test the Sonnenberg family doesn’t need any shareholders to voluntarily participate in this buyout; it can just go straight to squeeze-out because it has over 90%. 

Lawyers in Amsterdam have told us this is incorrect; because HDG’s primary listing is on the Euronext Amsterdam exchange, it needs to get 95% of the common shares (preferred shares do not count in Amsterdam squeeze-out rules) in order to go private and delist from the exchange. We believe that is the correct interpretation. And we do not think they have the votes to meet the Amsterdam requirement. If you are start poking around and reaching out to involved parties, I think you will come to the same conclusion. 

As it relates to the squeeze-out, if we get that far, any scenario where the Sonnenberg’s attempt to take this company private with little to no shareholder support would set them up for a very difficult squeeze out hearing. With valuation, business trends and independent stock votes all suggesting strongly that the price is too low, we think it will be hard for HDG to squeeze-out at €64.  In Amsterdam, if 90% of independent shareholder vote to approve a deal, then the valuation is assumed to be fair; in all other scenarios there is an actual analysis on fair value done. It is hard to handicap where the price would go in a squeeze-out fight, but we are fairly confident 64

There has been one public letter written by a large shareholder and I would guess more communication in private. The stock has not traded below deal price in two months, so any shareholder who wanted to sell at €64 has gotten their chance by now. I believe there is no appetite among the shareholder base to willingly sell at this price.

Here are the scenarios.

1. I am wrong and the company only needs 90% of common/pfd and it already has it; commences squeeze-out procedure which will be contested. All independent valuation would point to a significantly higher price, but TBD on the outcome.

2. I am correct and the company needs 95% of common equity to squeeze out but I am wrong on shareholders' conviction and they get the 11% of outside shareholders to tender their shares. If you are holding at this point, same upside/risk of the squeeze out process.

3. Company ups bid to something shareholders will more broadly accept; unclear on what that is but a 10-15% bump is not going to get it done. Think would need to be at something closer to 85 to be able to start gaining traction. If it goes this direction, would expect it to happen in the next few weeks.

4. Company pulls the offer and this trades freely again. That is actually probably my preferred scenario; I have laid out the upside and business quality and would be happy to hold for long term. Although they will probably try this again in 5 years.  I obviously don’t know where this would trade in the short run. There are no good comps to track; Russell Value is up 30% over the time period. I think that is a pretty good proxy for the share performance and that would take you to a stock price slightly higher than where we are trading (and would still be buying stock at less than half of fair value). 

If the company has reasons to want to be private (which it presumably does), the idea that they are going to get too cute with the final 16% they don’t own doesn’t make a lot of sense. The founder is 87 and we have heard there were estate planning reasons why they wanted to go private; I haven’t been able to confirm what those would be. While it is hard to handicap the likelihoods of the various outcomes, we would expect them to up the bid.

With minimal downside to a worst case scenario, and a ton of upside in a various other scenarios, this is one of the best risk/rewards we have seen in a long time. 

Financials:

Risks:

• Squeeze out is successful at current price offered- Downside of 3%

• Squeeze-out in Curacao takes a long time/energy and large opportunity cost.

• Sonnenberg family walks away from the bid-I do not really see that as a risk, more an opportunity but stock could trade down in near term.

Catalyst

Upped offer

Squeeze-out

Pulled offer