Major Investor Views the $24 Per Share Offer as Substantially
Undervaluing ShopKo NEW YORK, Sept. 6 /PRNewswire/ -- Elliott
Associates, L.P., and its sister fund, Elliott International, L.P.,
today announced that the funds filed a Schedule 13D with the
Securities and Exchange Commission disclosing an 8% percent
ownership position in the common stock of ShopKo Stores, Inc.
(NYSE:SKO), and that the funds have sent the following letter to
the Board of Directors of ShopKo: September 6, 2005 The Board of
Directors c/o ShopKo Stores, Inc. 700 Pilgrim Way Green Bay,
Wisconsin 54304 Dear Members of the Board of Directors: I write to
you on behalf of Elliott Associates, L.P. and Elliott
International, L.P. ("Elliott"), which collectively own
approximately 8% of the common stock of ShopKo Stores, Inc. (the
"Company" or "ShopKo"). Elliott strongly disagrees with the Board's
decision to sell the Company to a subsidiary of Goldner Hawn
Johnson & Morrison ("Goldner Hawn") for $24 per share ("Goldner
Hawn Transaction"), as we believe the standalone value of ShopKo to
be significantly higher. Elliott is not alone in this view.
Recently, another large institutional shareholder of the Company,
holding approximately a 6% stake, publicly opposed the deal. And
just last week, Institutional Shareholder Services ("ISS"), the
world's leading proxy voting advisory group, recommended its
clients vote against the current deal. In addition, ShopKo's stock
has, for all but a few days, consistently traded above the $24
offer since the sale was announced on April 8th. And this was true
even before the institutional investor (referred to above) and ISS
went public with their opposition to the current deal. This may be
viewed as the judgment of the market as a whole that the deal is
underpriced. The general view that the deal is not fully priced is
not surprising, given the fact that the Goldner Hawn offer that was
accepted by ShopKo was only at a 4.2% premium to the then existing
market price. We believe that this is significantly below premia
that shareholders of other retailers have received in acquisition
transactions. What is surprising to us is that the Special
Committee would consider an acquisition such as this -- where - the
purchaser is supplying only $30 million of equity ($1 per share),
or approximately 3% of the purchase price; - the Company's former
Chairman (relinquishing his chairmanship position at the time the
deal was signed) and still current director, Mr. Jack Eugster, is
going to own approximately 10% of the company for $3 million;(1) -
your fellow board member, Mr. Richard Zona, has invested his own
money into an affiliate of Goldner Hawn (this affiliate being
ShopKo's new owner) and has been serving on the affiliate's
strategic advisory board;(2) and - certain other members of
ShopKo's management are going to own a portion of the
post-transaction company at the same valuation(3) -- to be the
mechanism by which to maximize shareholder value. In fact, in
reviewing the Company's filings with the Securities and Exchange
Commission ("SEC"), it appears to us that, even after paying out
$90 million in transaction and closing fees, Goldner Hawn is able
to borrow $27 per share for its $24 per share acquisition.(4) Put
another way, absent the temporary dividend prohibition covenant
(which the banks could always waive if presented with an attractive
fee payment), Goldner Hawn, Mr. Eugster and the other management
participants in the deal would be able to recoup their entire
equity investment and then pay themselves an additional $108
million dividend immediately upon closing of the deal! Furthermore,
according to Goldner Hawn's own admission, some undisclosed portion
of the estimated $90 million fees will be paid to Goldner Hawn
itself.(3) Our math regarding these figures is shown in the
following table: Sources $MM Uses $MM Equity from Goldner Hawn (1)
27 Equity at $24.00 (6) 736 Equity from Jack Eugster (former
Chairman) (1) 3 Net Debt (7) 241 Secured Real Estate Financing (5)
700 Transaction Fees (8) 90 Term Loan (Back Bay) (5) 65 Total Uses
1,066 Senior Debt (Bank of America) (5) 271 Total Sources 1,066
Comments Additional borrowing capacity under borrowing base (A) 138
total Repayment of equity invested availability less by Goldner
Hawn and Mr. Eugster (30) the $271 used above Potential return to
sponsors on deal closing 108 Note A. The Senior Debt from Bank of
America is calculated off of a Borrowing Base formula similar to
the Company's current Amended Secured Credit Facility. At the end
of Q105, the Company had a total of $409 million of total
availability under its Amended Secured Credit Facility. Assuming
the same calculation, $409 million less the $271 million assumed in
"Sources" above, leaves $138 million of additional borrowing
availability. We question the effectiveness of the Company's sale
process. The decision not to explore strategic buyer interest and
to provide a very limited group of private equity investors with
only publicly available information in the early round created a
situation that lacked any meaningful competitive dynamics.(9)
Perhaps this is explained in part by the obvious conflicts of
interest, with your former chairman and certain members of your
current management participating in what appears to be an
incredibly rich deal for them from our point of view. We believe
that the Company should publicly identify those members of
management who are participating in the transaction, so investors
can evaluate the extent of the conflicts of interest. Furthermore,
we are disappointed with the treatment of the termination fee in
the merger agreement, particularly the breadth of situations to
which it can be applied. Not only is the $27 million termination
fee equal in size to Goldner Hawn's entire equity investment, but
it also applies to a recapitalization of the Company under a number
of scenarios. This has the effect of drastically inhibiting
shareholder, management or interloper ability to suggest or
consider any alternative to the Goldner Hawn Transaction as such an
action could result in a payment of $27 million even after a
shareholder vote defeats the proposed acquisition. Given that most
of the financing in the Goldner Hawn Transaction is backed by the
Company's real estate and the importance of the real estate
valuation in considering the method by which to maximize
shareholder value, we are disappointed that the Board did not
consider engaging its own appraisal to make a fully informed
decision. According to the Goldner Hawn letter, the lender (Bank of
America) has received appraisals for the "real estate subject to
financing" of approximately $880 million.(3) We ask the Company to
disclose whether there is any real estate that is not subject to
financing and what is that real estate. These appraisals do not
necessarily represent the lender's own assessment of the valuation
of the real estate supporting the loan. There are reasons to
believe that the lender's own assessment of the real estate is
considerably higher than $880 million. This is supported by the
fact that the lending commitment was not contingent on the
appraisals commissioned by the lender meeting any particular LTV
number; in addition, the alternative lending commitment issued by
Bank of America assumes collateral value of $935 million. We
believe the proposed acquisition by Goldner Hawn at $24 per share
significantly undervalues the Company. To illustrate, Elliott has
performed an asset valuation of ShopKo based on the Company's
recent SEC filings and the presentation by the Company's financial
advisor to the Special Committee. Our analysis, which assumes no
"in the money" value for store leases, yields an asset valuation of
approximately $32 per share. Asset value ($MM) Per share ($) (10)
Tangible book value (11) 637 20.58 Adjusted tangible asset value
821 26.53 based on BofA real estate appraisal (12) Prescription
files (13) 129-151 4.17-4.88 Continued deferral of tax liability
(14) 44 1.42 Asset Value 994-1,016 32.12-32.83 We have also valued
the Company in a recapitalization (for illustrative purposes only)
based on a review of the management's five-year base case business
plan.(15) If, for example, ShopKo would have effected a
recapitalization using leverage similar to the Goldner Hawn
Transaction and paid a $23 special dividend, we estimate the future
free cash flows of the business would be as shown in our analysis
in the following table: Fiscal Year Ending on or About January 31,
($ in million, except per share) 2006 2007 2008 2009 2010 Store
Revenues 3,256 3,293 3,288 3,300 3,346 EBITDA(15) 191 172 167 190
193 Depreciation & Amortization (15) 84 89 91 85 79 Estimated
Interest Expense with Goldner Loan Package (73) (73) (73) (73) (73)
Pre-Tax Earnings 34 10 3 32 41 Net Income (after taxes at 38.5%)
(16) 21 6 2 20 25 Depreciation & Amortization (15) 84 89 91 85
79 Change in Working Capital (15) 17 13 9 11 1 Capital Expenditures
(15)(B) (67) (59) (61) (58) (42) Free Cash Flow 55 49 41 58 63 Free
Cash Flow Per Share $1.78 $1.59 $1.33 $1.87 $2.05 Free Cash Flow
(excluding working capital) 38 36 32 47 62 Free Cash Flow Per Share
(excluding working capital) $1.23 $1.17 $1.04 $1.52 $2.02 Note B.
The capital expenditures assumed here make no adjustment for
management's reduction of capital spending in 2005 from the $67
million figure above to the $35 million figure mentioned in the
August 18th release.(7) Doing so would increase Free Cash Flow by
$32 million in FY 2006, or approximately $1 per share. The
foregoing table illustrates that the Company is expected to
generate annual free cash flow in the range of $41 million to $63
million between fiscal years 2006 and 2010. Given the total equity
investment of $30 million in the Goldner Hawn Transaction, the new
ShopKo owners are expected to generate at least 137% annual return
on their investment during the forecasted period.(17) Given these
spectacular expected returns, it is no surprise to us why Goldner
Hawn has been so persistent in trying to acquire ShopKo since late
2003. In its justification for selling the Company at $24 per
share, the Special Committee has expressed reservations with
respect to the achievability of the management's financial
projections. I would note that those projections are quite recent,
having been done only in March of this year and Elliott is not
aware of any material changes to the business since then. In
addition, as noted above, the former Chairman of ShopKo and certain
members of management are personally investing their own money and
will own at least 10% of the Company upon closing of the
transaction. Finally, ShopKo's current management has indicated
that they will continue working for the new owners. So as to be
clear, Elliott is not proposing at this time that the Company do a
recapitalization if the shareholders vote down the current deal.
Furthermore, our reading of the public letters, 13D filings and
preliminary proxy ("Filings") by John A. Levin & Co. ("Levin")
to the Company's board and the shareholders is that nowhere in
those Filings has Levin proposed a recapitalization either, despite
your assertion that Levin "believe[s] that the Company should do a
leveraged recapitalization."(18) Our interpretation of the Levin
Filings is that they introduce the concept of recapitalization
merely as an illustration to show that ShopKo's stock would trade
higher than $24 if the Company obtained financing similar to
Goldner Hawn's and declared a $23 per share dividend (something
with which we wholeheartedly agree). Should Goldner Hawn assert
that either Elliott's letter, 13D filing or Levin's Filings would
entitle it to a recoupment of Expenses or a payment of Termination
Fee (as those terms are defined in the merger agreement) in case of
termination of the merger agreement, we would strongly disagree
with that view.(19) In this respect, Elliott reserves all its
options if the Company's board authorizes payment of Expenses
and/or Termination Fee to Goldner Hawn under these circumstances.
We would expect the Company to act in this matter in a manner
consistent with the fiduciary duty that is owed to the shareholders
of ShopKo. For the reasons explained above, Elliott cannot support
the Goldner Hawn Transaction and intends to vote against it. We
hope that other shareholders will come to similar conclusion.
Elliott intends to consider all courses of action to maximize the
value of its investment. Finally, I wish to sincerely thank the
Company's management and its employees for the hard work they have
done and continue to do in operating ShopKo. Should you have any
questions, feel free to contact me at 212-506- 2999. Very truly
yours, Ivan Krsticevic Portfolio Manager Notes: 1. From page 63 of
the Definitive Proxy Statement filed August 9, 2005. 2. From page
67 of the Definitive Proxy Statement filed August 9, 2005. 3. As
disclosed in letter from Goldner Hawn to Co-Chairmen of ShopKo's
board, attached as Exhibit 99.1 to ShopKo's 8-K filed August 30,
2005. 4. Bank of America is willing to lend a total of
approximately $1,174 million. This is comprised of a $700 million
secured real estate financing, a $65 million term loan from Back
Bay and a portion of the $640 million of Senior Debt. The portion
of the $640 million of Senior Debt that is available is based on a
borrowing base calculation (see Note A to the first table in this
letter for an explanation of the calculation), which results in
availability of $409 million. This sums to a total figure of $1,174
million. Subtracting current net debt of $241 million and fees of
$90 million leaves a total of $844 million, or $27.27 per share. 5.
From the Commitment Letters filed in Schedule 13E-3 Transaction
Statement filed June 13, 2005 as well as the Definitive Proxy
Statement filed August 9, 2005 on pages 63-66. 6. From the cover
page of the Definitive Proxy Statement filed August 9, 2005. 7.
From ShopKo second quarter results ending July 30, 2005, filed
August 18, 2005. 8. From page 76 of the Definitive Proxy Statement
filed August 9, 2005. 9. From page 5 of the M&A Insight report
on ShopKo by Institutional Shareholders Services, dated August 30,
2005. 10. From the share count given in the Definitive Proxy
Statement filed August 9, 2005 on the cover, adjusted for
restricted shares and outstanding options (using the treasury
method) as disclosed in the Merrill Lynch Discussion Materials to
the Special Committee on April 7, 2005, Exhibit (c)(9), in Schedule
13E-3 Transaction Statement filed June 13, 2005. 11. From
Consolidated Condensed Balance Sheet, intangible assets subtracted
from shareholders equity, ShopKo second quarter results ending July
30, 2005, filed August 18, 2005. 12. From page Consolidated
Condensed Balance Sheet, intangible assets subtracted from
shareholders equity assuming property value of $880 million, ShopKo
second quarter results ending July 30, 2005, filed August 18, 2005.
13. From page 26 of the Merrill Lynch Discussion Materials to the
Special Committee on April 7, 2005, Exhibit (c)(9), in Schedule
13E-3 Transaction Statement filed June 13, 2005. 14. From page 59,
Note E to Consolidated Financial Statement, Form 10-K, filed April
1, 2005. 15. From the March 2005 Projections - Base Case, on page
87 of the Definitive Proxy Statement filed on August 9, 2005. 16.
From the First Quarter 2005 Earnings Conference Call held May 19,
2005. 17. Annual return of 137% is calculated by dividing $41
million of estimated free cash flow in FY2008 with $30 million
total equity investment in the Goldner Hawn Transaction. 18. From
the August 1, 2005 response by the Special Committee to the July
21, 2005 letter sent by John A. Levin & Co., Inc. to the
Special Committee, filed as Schedule 14A on August 2, 2005. 19.
Reference to the Agreement and Plan of Merger filed as Exhibit 2.1
to the 8-K filed on April 8, 2005. About Elliott Associates, L.P.
Elliott Associates, L.P. and its sister fund, Elliott
International, L.P. have more than $5.2 billion of capital under
management as of July 1, 2005. Founded in 1977, Elliott Associates
is one of the oldest hedge funds under continuous management. The
Elliott funds' investors include large institutions, high-net-worth
individuals and families, and employees of the firm. For More
Information Contact: Scott Tagliarino (212) 506-2999 (917) 922-2364
(cell) DATASOURCE: Elliott International, L.P. CONTACT: Scott
Tagliarino, +1-212-506-2999, or cell, +1-917-922-2364
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Shopko Stores (NYSE:SKO)
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Shopko Stores (NYSE:SKO)
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