Well, here's the letter I sent to Sasamat's Board. I hope to get a response.
To the Board of Directors of Sasamat Capital Corporation:
Re: Going Private Transaction
I write to you as a shareholder of Sasamat Capital Corporation (the “Company”). This letter serves as my objection to the currently proposed offer, as set out in the Proxy Circular as of April 25, 2006, as it fails to fully account for the fair value of MFC Industrial. Having reviewed the Valuation and Fairness Opinion, several times, it’s evident that the framework of the analysis is incomplete, both misrepresenting and disregarding data necessary for a complete and accurate assessment. There are many aspects to this impaired analysis I find troubling, the most egregious of which are: the benchmarking of MFC Industrial against a peer group that does not serve as an appropriate comparable; the omission of relevant ratios to further support and justify the conclusions reached in the analysis; and the failure to acknowledge MFC Industrial as a publicly traded company with an established market valuation. Had a thorough and accurate analysis been conducted, appropriately addressing the aforementioned, a valuation well in excess of the $72mm would have resulted, thereby significantly increasing the proposed transaction price for the Company’s shares.
To start with, the 2005 peer group is misrepresented as it doesn’t account for those companies represented in the 2004 analysis with market caps over $100mm. Faulty reasoning on the part of the analyst is used to support this benchmark alteration as he believes the value of MFC Industrial is better represented by companies with valuations under $100mm. Clearly, there is no justification for this as who’s to say that such an adjustment is even merited? Had the complete peer group from 2004 been used to support the 2005 analysis, the average Price to Book and Price to Sales ratios, would have increased to 2.2 times book and .84 times sales, respectively, vs. the adjusted average ratios used in the analysis of 1.39 times book and .69 times sales. This re-adjustment back to the 2004 peer group is relevant as the increase in average multiples supports an overall higher valuation for MFC Industrial. However, adjusting for this difference only partly resolves the issues surrounding the peer group analysis and its impact on the Company’s valuation.
The analyst’s outright omission of KHD’s analysis, which identifies a relevant peer group multiple of 4 to 5 times book value or .85 to 1.2 times sales, is impossible to understand. KHD, as you’re well aware, wants to own 100% of MFC Industrial. This will enable it to fully consolidate MFC Industrial’s financials without having to account for minority interest, which in turn will help support the valuation it believes is justified based on its own peer group analysis. In applying KHD’s analysis to the valuation of MFC Industrial, a market value ranging from $290mm to $440mm would result depending on the ratio, and multiples applied to each ratio, used, as compared to the analyst’s current valuation of $72mm. Such a discrepancy in valuations is without merit and indicates a flawed assessment on the part of the analyst. This is further supported by MFC Industrial’s operational performance over the last several years.
To suggest that a below average multiple should be applied to MFC Industrial is to imply that the Company is of below average quality, which would be a complete misrepresentation. With revenue growth and profitability margins ranking within the top quartile of its peer group, MFC Industrial is far from average and should therefore be valued accordingly. The analyst’s fair value assessment of a 10% - 30% discount to book value, which the analyst reasons as being sensible based on the cyclical nature of the industrial and engineering services industry, is unwarranted as this would apply only under the worst of circumstances and only to the bottom quartile of companies within the relevant peer group. This clearly does not represent MFC Industrial as it has been able to grow its revenues (in dollars) from $109mm in 2003 to $341mm in 2005, which equates to a 78.9% CAGR, while its EBT (earnings before taxes) has increased from $.755mm in 2003 to $26.1mm in 2005, representing a 487.9% CAGR. At such levels of performance a much higher valuation for the Company is justified.
Another point of contention I have with the analysis, is the analyst’s emphasis on the Price to Book ratio for deriving value. While the analyst does incorporate the Price to Sales ratio into his analysis, it is not used to attribute any value to MFC. Had the analyst’s average Price to Sales ratio been utilized, a value of $235mm would have resulted as opposed to the value deemed appropriate by the incomplete analysis. This discrepancy in value can be further demonstrated by extending the analysis to include two additional valuation approaches. They are MV/EBT (market value/earnings before taxes) and the carve-out value approach as it is commonly known.
In applying the MV/EBT ratio to two of MFC Industrial’s direct competitors, Andritz AG and FLSmidth, the multiples at which they trade are 10.8x and 20.6x EBT, respectively. This compares to MFC Industrial’s valuation multiple of 2.8x EBT. There is no justification for this valuation discrepancy, considering MFC Industrial, on all fronts, has outperformed Andritz AG and, as a percentage of sales, is more profitable than FLSmidth.
In applying the carve-out method, I isolated the market value of KHD’s ownership interest in MFC Industrial by extracting from KHD’s holdings all income producing assets, leaving MFC to be valued independently by the market. In so doing, I removed the value of the cash on KHD’s balance sheet of $168mm and the value of KHD’s mining royalty asset, which I aggressively valued at $100mm (it is very unlikely that this asset is worth even close to this amount). The result, based on an April 21, 2006 market value of $411mm ($27.09 price/share X 15.2mm shares), just prior to the release of the Circular, is a valuation for MFC of $143mm, reflecting a multiple of 6.8x EBT (this multiple would be higher if I adjusted down the valuation used for KHD’s mining asset).
As you can see, both approaches provide further confirmation for higher valuations, which is further supported by MFC Industrial’s Frankfurt listed share price representing a market capitalization of $155mm (in dollars). Such a valuation, albeit low due to the illiquidity of the stock, further represents the degree of omission and error on the part of the analyst, as the public market status of MFC Industrial was never disclosed in the analysis. This, I believe, is the final omission that completely discredits the entire valuation analysis. By excluding such pertinent information, one can only conclude that the analysis is both misleading and entirely inaccurate.
Having said all this, the $3.15 proposed transaction price, which values the Company at $24.5mm, is blatantly inaccurate. With its 35% interest in MFC Industrial valued at between $70mm to $115mm, the per share transaction price should be between $9 and $15. Anything less would be inappropriate.
As directors, you must act in the best interest of the shareholders of the Company. This offer does not meet those interests. To ensure that you obtain the best price possible for the Company’s shares, I think it’s most appropriate that I come and visit with the board to ensure that everyone involved in the process clearly understands the problems associated with the fairness opinion and how we might come to a resolution on value. I’ve spoken, and have the support, of many large shareholders who will be voting “no” on this transaction. |
