Scion Asset Management, run by Michael Burry of "The Big Short," is really upping his activism. After engaging with Gamestop (NYSE:GME) recently, he has also sent a letter to the board of directors of Tailored Brands Inc. (NYSE:TLRD). Burry is getting on the board's case because of the sale of its corporate apparel business.
Burry, who owns 4.7% through Scion, thinks the board should consider buybacks because the stock is near a 25-year low, and there is money coming in through the $60 million sale of its corporate apparel division.
Burry also subtly reminded the board of its duties to shareholders when selling segments:
"Thank you for the information on the sale of Corporate Apparel for $62 million in total consideration, and we appreciate the improved guidance for the quarter. We hope the negotiations with a buyout group led by Tailored's own executives were conducted at arm's length, and that the price received is a true representation of the value of that $235.4 million sales division. Any information you can share regarding the financing of the transaction would be helpful to shareholders."
It also sounds like he may have some lingering doubts regarding the sale price, given the level of sales and the acquiring party. But Burry stopped short of any allegations and merely politely asked for more information to be released.
Burry's key message throughout the letter was that the board should prioritize buybacks (emphasis mine):
"We reiterate that share buybacks are the most efficient manner in which to reward long-term shareholders when the share price is heavily discounted. The stock currently trades at an earnings yield greater than 20% and at a free cash flow yield much greater than that. A $50 million share buyback at the current 1994 vintage stock prices could retire about 20% of the outstanding shares."
Investors intuitively understand how attractive buybacks are when a company is deeply undervalued vis-a-vis other capital allocation options. To executives and board members, this isn't always as obvious.
Tailored Brands has been prioritizing debt reduction, and that's understandable because it has a market cap of $250 million with over $2 billion in debt. Its Ebitda exceeds $300 million and free cash flow exceeds $200 million. You have to be certain Ebitda will hold up if you want to do anything but reduce debt. Burry appears to be confident in that respect: "Scion views Tailored Brands as a resilient business that has experienced substantial same store sales declines in the past and recovered," he said.
It is a difficult sell to get a board to prioritize buybacks in a situation like this, so Burry contrasted it to the dividend allocation policy (emphasis mine):
"If Tailored feels that it absolutely must use funds from the sale of Corporate Apparel to pay down debt, then we wonder why Tailored continues to pay over $36 million a year toward the dividend."
He has a point because the dividend puts the yield around 14%. If the board thinks that is sustainable, an obviously better use of capital would be buybacks. Boards are often loath to cut dividends. It puts pressure on the share price, as dividend investors exit the company in response. In this case, there seems to be wiggle room to cut the dividend by about two-thirds and still be considered a company with a good dividend.
"We recommend the Board of Directors prioritize a substantial buyback along with continued aggressive debt reduction. If necessary, the dividend should be eliminated or reduced in order to facilitate these more urgent and timely allocations of capital."
Odds aren't high that the board will kill the dividend in response (read near zero). But it is possible they will study the differences in shareholder value creation between options. If they do they might reduce the dividend in order to enable buybacks.
There is also a slim chance the lump sum of the sale of the corporate apparel business will be used in buybacks. If proceeds are used in the most accretive manner, it is easier to justify the sale of the segment even at a less-than-optimal price.
My assessment is that Burry has slight odds of big success here. His letter is not particularly aggressive or persuasive compared to a typical letter by Carl Icahn or Starboard Value or a specialized activist. He's also putting forward a rather big ask because of the company's debt situation and board's general reluctance to mess with the dividend. If you ask me, this saga isn't over yet.
Disclosure: No positions.
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This article first appeared on GuruFocus.
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