Description

I originally wrote up this idea in December of 2003. TSC’s management is in the process of trying to take the company private at $4.60 per share in cash. At the time of my initial write-up the going private proposal was $3.25 in cash and $1.25 in a 4.5% amortizing note. Although the offer has improved it is still well below fair value. In my earlier write-up I support a valuation in the range of $7.00 to $9.00 per share. Interested readers who are not familiar with TSC should refer to my earlier post for any discussion regarding valuation. For the purposes of this write-up I would like to focus on issues other than the valuation.

On August 17, 2004 a preliminary proxy was filed by Merlin Partners. The experienced shareholder activist Phillip Goldstein has been retained by Merlin to help with the proxy solicitation. The purpose of the proxy is to get the MBO deal voted down while simultaneously getting control of the board.

This is a unique opportunity to replace five of six board members at one shareholder’s meeting. Historically, TSC’s board of directors has been divided into three classes serving staggered terms, with each class consisting of one-third of the entire board of directors, and standing for re-election for a three-year period. However, because Stephan has not had an annual meeting of stockholders since September 1, 2000, all classes of directors (for differing staggered time periods) are being elected at this annual meeting.

In Ancora Capital’s (Ancora and Merlin Partners are essentially one and the same) 13D filing on August 16, 2004 the following was set forth:

“We expect the newly elected Board to consider some or all of the following means to realize shareholder value, including, but not limited to: (i) payment of a sizable cash distribution to shareholders; (ii) an increase in the quarterly dividend rate;(iii) repurchase of the Company's common stock in the open market; (iv) a tender offer by the Company to acquire common stock at a premium to the current price; (v) an analysis of all strategic options, including status quo, sale of certain real estate and/or brands, sale of the Company and consolidation of operations; and (vi) renegotiation of certain management contracts on more favorable terms for the Company.”

If the alternative slate of directors is elected, I expect efforts to effectuate the following:

1. A special dividend in the amount of $2.50 to $4.00 per share (as set forth in Ancora’s 13-D). Given the amount of cash on the balance sheet and borrowing capacity this should easy to accomplish.
2. The monetization of real estate assets netting $3 to $4 million dollars or approximately $0.70 per share (using $3.5 million pre-tax proceeds on a fully diluted basis).
3. Reductions in operating expenses of $500,000 to $1,000,000 per year (approximately $0.10 to $0.20 pre-tax per fully diluted share) as a result of renegotiated management contracts and/or other cost savings initiatives.

Again, I don’t want to focus on valuation here, please read my last post if you desire more details.

The real issue now is whether or not the alternative slate of directors will be elected and the MBO deal voted down. Management and the directors have about 31.5% (approximately 1,500,000 shares) of the votes after the exercise of in the money options. The fully diluted share count should be approximately 4,760,000 shares. A simple majority is needed to block the MBO. Therefore, 2,380,000 votes against the deal should defeat the MBO proposal. Ancora Capital, Richard L. Scott and David Knott collectively own 1,142,701 shares. There are other large shareholders who can be identified that control enough shares to bring the tally to approximately 1,750,000 shares or about 37%.

If Merlin Partners can get these large shareholders to vote with them there will be approximately 1,500,000 shares/votes up for grabs of which only 630,000 are needed to change the board and vote down the buyout. That’s 42% of the remaining votes.

On August 6, 2004 TSC filed their third preliminary proxy. The filing of Merlin’s proxy on August 17, 2004 will likely delay the filing of a definitive proxy by TSC as new disclosures will have to be incorporated in the proxy document.

As more time passes it becomes more likely that Merlin will prevail. TSC has traded at a premium to the MBO price since June 2, 2004. Effectively every share traded since then will likely be voting with Merlin. Current shareholders inclined to vote for the MBO deal are better off selling their shares in the market.

Catalyst

A successful proxy fight replacing five of the six board members with independent, shareholder friendly directors.

A $2.50 to $4.00 per share one time dividend

Renegotiation of management contracts

Monetization of real estate assets.