Description

I am recommending buying PSGLQ because I believe it will benefit from an overbid in the current 363 bankruptcy auction being conducted. 

Company Overview:

Performance Sports Group (PSGLQ) designs, manufactures, and distributes performance sports equipment, related apparel, and accessories for ice hockey, roller hockey, lacrosse, baseball, and softball primarily in the United States, Canada, and Europe.  The company offers its products under the brand names of Bauer (hockey), Mission (hockey), Maverik (lacrosse), Cascade (lacrosse), Inaria (soccer uniforms), Combat (baseball and softball), and Easton (baseball and softball).  Performance Sports Group Ltd. was founded in 1927 and is headquartered in Exeter, New Hampshire. 

Bauer holds the #1 market position in ice hockey equipment with approximately 56% overall market share.  Mission and Bauer combined have the #1 market share position in roller hockey equipment at approximately 70%.  Easton is one of the strongest brands in baseball and softball, and holds a significant market share in diamond sports in North America, with an approximately 19% market share. Through the Maverik brand, the Company offers a full line of gloves, heads, shafts and protective equipment for lacrosse, as well as a women’s specific line of product, for players of all ages. Cascade has been a pioneer in head protection since 1986 and is the #1 brand in lacrosse head protection with 90% market share.

Situation Overview:

The Company acquired Easton in 2014 primarily funded by a $450mm syndicated term loan.  The Company has remained current on the term loan, but was in default because it is unable to file its FYE May 31, 2016 financial statements.  The Company’s accounting is under internal investigation and by U.S. and Canadian regulators.    The Company was able to successfully negotiate a forbearance with its lenders through October 28^th, but filed for bankruptcy on October 31^st after it was still unable to file its financials.

At the time of the filing, 17% holder Sagard Capital and Fairfax Financial Holdings announced a $575mm stalking horse bid for the Company.  Brookfield an approximately 13% shareholder was also rumored to be interested in bidding and / or providing a DIP.  The bidding procedures allows for a longer than normal auction period (January 9^th auction date) and a relatively low incremental bid ($7.5mm), so it appears that the bidding procedures have been set to ensure a robust auction.  The Company’s CRO says it did not conduct a full marketing process pre-bankruptcy.  Notably, the Stalking Horse bidders are also providing a DIP loan that fully refinances the term loan, putting significant capital at risk, while waiting for the auction to finalize.  Finally, it is important to note that Sagard has a board seat and is likely highly informed about the Company’s accounting issues and value.     

The Company currently has $489mm of secured debt and $40mm of trade.  I believe the current bid provides some equity value, but likely below the current market capitalization.  That said, I believe an overbid is very likely as discussed in the valuation section below.

Valuation:

I am primarily valuing the Company based on precedent transactions and comparable publicly traded companies.  The most recent Company financial data we have is from Q3 2016 (December 2015).  On a constant currency and adjusting for some large, unusual bad debt expense related to the bankruptcy of Sports Authority, EBITDA was $93.9mm.  Revenue was $602mm.  In addition to EBITDA multiples, I am also using revenue multiples to sanity check the valuation given the accounting issues.

Below are precedent sporting goods transactions that suggest the Company is worth a high single digit EBITDA multiple and a 1.1x to 1.5x revenue multiple.  Note the Company’s EBITDA margins (~15%) are best in class with only Bushnell and Company owned Cascade having higher margins.

Using comparable publicly traded companies, I arrive at a similar conclusion.  Note that the Company historically traded in the high single digit / low double digit EBITDA multiple range.  The lowest average multiple the Company traded at over the past five years was ~7.25 implying 60%+ upside from the current bid.

So how confident can we be in EBITDA?  Note that the Company’s cash taxes paid has been fairly consistent with its GAAP tax provisions indicating that GAAP and tax EBITDA are close, and thus that the Company isn’t trying to present a rosier GAAP picture than it is presenting to the IRS.

I would also point to the fact that Sagard being on the board and putting significant capital at risk through the DIP financing as a mitigant to this risk. 

However, OCF has consistently been below net income by approximately 30% over the past several years.

Conclusion:

If EBITDA is overstated by 30%, then the stalking horse bid looks like it is in fair value range (implies ~10x multiple when EBITDA is reduced by 30%).  However, that would put the transaction value at 1.0x revenue, which is definitely on the low end of the range of precedents.  I am using the stalking horse bid as my low case.

In my mid case presented below, I assume an EBITDA multiple on the low end of the comps and precedents, but in line with the average revenue multiple of the precedents. 

In my high case, I assume an average EBITDA multiple of the comps and precedents. 

As you can see, the stalking horse bid causes you to lose 50% of your money, but you can make 3x – 6x your money from outcomes that appear somewhat probably.  Even if you believe the high case isn’t possible, the current stock price is implying a 12.5% chance of reaching the mid case, which seems very low to me.    

Catalyst

conclusion of 363 BK process in January