Rational Investment Group Delivers Letter to the Special Committee of Tree Island Steel
Outlines two crucial steps for the Special Committee to take in order to ensure that minority shareholders' interests are protected
Demonstrates that when properly valued, Tree Island is conservatively worth $4.49 per share, a 99% premium to the price of the non-binding proposal to minority shareholders
BOSTON, July 23, 2019 /CNW/ - Rational Investment Group, LP, a long-term shareholder of Tree Island Steel Ltd. (TSX: TSL), today announced that it has delivered a letter to the Special Committee of the company's Board of Directors related to the non-binding proposal to take the company private at $2.25 per share. The full text of the body of the letter follows below. To access the entire letter including appendices, please click here.
July 23, 2019
Members of the Special Committee of the Board of Directors (the "Special Committee")
c/o Michael Fitch, Chairman of the Special Committee
Tree Island Steel Ltd.
Delivered Via Email
Dear Special Committee Members:
We understand that you are currently evaluating the non-binding proposal by The Futura Corporation and Arbutus Distributors Ltd. (collectively the "Majority Shareholders") to privatize Tree Island Steel Ltd. ("Tree Island" or the "Company") at $2.25 per share (the "Insider Offer"). In doing so, we trust that you will take seriously your duty of care and your obligation to protect the interests of minority shareholders under Multilateral Instrument 61-101 ("MI 61-101"). We urge you to take the following steps to ensure that minority shareholders receive fair value for their investment:
- Have PwC prepare or obtain an appraisal of Tree Island's owned real estate, and
- Ensure that PwC's valuation of the Company incorporates the imminent and material benefits to be realized from the recent removal of the Section 232 steel tariffs and the recently commissioned ATT mesh machine at the Etiwanda facility.
As board members of the Company, we trust that you are aware of Tree Island's significant real estate value as well as the substantial incremental profits that will be realized from the removal of the tariffs and from the new mesh machine. We fully expect that you will factor them into your assessment of Tree Island's valuation and of the fairness of the Insider Offer. As this letter demonstrates, once these factors are taken into account, Tree Island is conservatively worth $4.49 per share, a 99% premium to the price of the Insider Offer.
By way of background, Rational Investment Group, LP has been a shareholder of Tree Island since 2010. We are long-term, patient investors who seek to back talented management teams and boards as they create value for all shareholders. We believe that Tree Island shares trade at a significant discount to their intrinsic value and offer substantial upside potential at current prices. If we are to be deprived of the opportunity to participate in this upside due a takeover of the Company, then we, and indeed all minority shareholders, have a right to be adequately compensated by receiving a fair price for our shares. By valuing minority shareholders' investment at half of fair value, the Insider Offer is clearly inadequate in our view.
We understand that the Majority Shareholders have indicated that they will not entertain a transaction involving the sale of Tree Island to a party other than themselves. While this restricts your ability to conduct a broad sale process to maximize shareholder value, it does not compel you to accept or recommend an offer that is clearly unfair to minority shareholders. Instead, you should negotiate a better price or recommend that the Insider Offer be rejected.
Tree Island's Real Estate Alone is Worth More than the Insider Offer
As you no doubt are aware, Tree Island's owned real estate is incredibly valuable relative to its current market cap and enterprise value. The Company owns the 400,000 square foot, 38 acre Richmond facility in Metro Vancouver and the 134,000 square foot, 16 acre Etiwanda facility in the Inland Empire area of Greater Los Angeles. Based on our research, including discussions with numerous analysts and brokers in both regions, we estimate that Tree Island's owned real estate is worth approximately $83 million. In a sale-leaseback scenario, we estimate proceeds net of transaction costs and taxes of $72 million or $2.49 per share.
Our valuation is included in Appendix A. We note that this is not merely a theoretical exercise; both regions' industrial property markets are booming, with industrial vacancy rates of just 2% in Richmond and Inland Empire West (where the Etiwanda facility is located). There would be a healthy appetite for sale-leaseback transactions at both sites that would provide Tree Island with the security of maintaining a long-term presence at the plants. We would be happy to share some of the insights that we have gleaned regarding Richmond and Etiwanda if that would be helpful.
At $2.25 per share, the Insider Offer doesn't even cover the value of Tree Island's real estate and values its profitable core business at less than zero. Therefore, we fail to see how the Insider Offer can be viewed as being anywhere close to fair value. We urge you to have PwC prepare or otherwise obtain an appraisal of Tree Island's owned real estate.
The Rest of the Business is Also Valuable, and Poised for Significant Growth
Tree Island is poised to benefit from two material operational catalysts. First, we estimate that the Section 232 tariffs have cost the Company $3 million in lost EBITDA in the past year. Further, we estimate that the new mesh machine will generate incremental EBITDA of more than $2 million annually through cost savings alone while adding 30,000 tons of production capacity. Over time, this increased capacity is capable of generating millions of dollars in additional EBITDA per year, creating a multi-year runway for profitable growth. However, for conservatism, we will assume a benefit of just $3 million in total.
Cumulatively, we estimate that the tariff removal and the new mesh machine will produce $8 million in incremental EBITDA. This represents impressive growth of 68% over trailing EBITDA of $11.7 million. If Tree Island were to remain public, its stock would be handsomely rewarded by the market for this growth. Clearly, Tree Island's trailing results are not representative of its true earning power in light of the impact of the tariff removal and the contribution of the new mesh machine. We trust that you will ensure that management will inform PwC of these critical developments and their material positive impact on Tree Island's future results.
Of note, we expect that Tree Island's upcoming Q2 results, to be reported on July 31, will be poor due to the lingering effects of the tariffs, which were still in place for much of the quarter. Likewise, the new mesh machine was just commissioned earlier this year, and realizing the benefits of a major capital investment like this takes time. We expect that by the second half of 2019, the Company's reported results will begin to reflect the benefits of these developments, and by 2020 the benefits will be apparent on an annual basis, leading to significant growth. To reiterate, we know that Q2 will be weak and urge you not to allow this transitory weakness to be used as a pretext for justifying a "take-under" of Tree Island at a fire sale price.
We value Tree Island's business excluding its real estate based on estimated normalized free cash flow. Our adjustments include the deduction of additional rent expense as we are valuing the real estate separately. Using a modest multiple of just eight times normalized free cash flow, the rest of Tree Island's business is worth $2.00 per share. Please see Appendix A for a detailed calculation. Adding up the values of the real estate and the rest of the business, we arrive at a fair value of $4.49 per share for Tree Island – double the Insider Offer.
Important Additional Thoughts
Between May 2018 and May 2019, The Futura Corporation – one of the Majority Shareholders – purchased 259,900 shares of Tree Island on the open market at an average price of $2.90 per share, 29% above the price of the Insider Offer. This includes 136,000 shares bought last May and June at an average of $3.31 per share and as high as $3.50 per share, or 47% and 56% above the Insider Offer, respectively. Further, these purchases occurred after the tariffs were announced or in force but before their removal was announced on May 17, 2019, so Tree Island's fundamentals are actually stronger today than when these purchases took place.
We note that Futura is Tree Island's largest shareholder and is controlled by the Company's Chairman. In our view, it speaks volumes about the unfairness of the Insider Offer that one of the Majority Shareholders, a highly informed insider, considered Tree Island an attractive investment at prices that were 29% higher on average and as much as 56% higher than the price that this insider is now offering for the entire company.
Lastly, we would like to address the reasons provided by the Majority Shareholders in their June 27 press release for why they believe the Insider Offer would be "in the best interests of the Company and its shareholders." In Appendix B, we offer some questions for you to consider as you evaluate each of these assertions.
In conclusion, it is incumbent on you, in discharging your duty of care and your obligation to protect minority shareholders under MI 61-101, to ensure that PwC's valuation of Tree Island includes an assessment of the market value of its real estate as well as the impact of the tariff removal and the new mesh machine in Etiwanda. Once the Company is properly valued, it is clear that the Insider Offer does not even come close to providing fair value to minority shareholders. Therefore, we urge you to either negotiate a fair price or to recommend that the Insider Offer be rejected.
Sincerely,
Guy Gottfried
Managing Partner
To access the entire letter including appendices, please click here.
SOURCE Rational Investment Group, LP
Guy Gottfried, tel.: 617-319-3282, email: [email protected]
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