Why don't long term investors behave that way?

Spitfire portfolio company Univar Solutions, Inc. (NYSE: UNVR) was recently sold to Apollo in an all-cash transaction valued at $36.15 per share.? The deal was struck at a premium of 17% relative to the undisturbed closing price on November 25, 2022, the day Univar first disclosed it had received a preliminary indication of interest from Brenntag SE, a European strategic acquiror.?

We initiated our position in Univar in March 2020, during the Covid-induced market crash, as we liked the Company’s leading domestic market position in chemicals distribution and assessed that the Company would remain profitable and free cash flow positive even in a severe downturn.? We had been following Univar for some time, and first looked at the Company after it came public in 2015 and again in 2018 after it announced the acquisition of Nexeo Solutions, Inc.? Since then, management, led by CEO David Jukes, successfully completed the Nexeo integration; sold its plastics distribution business; grew the share of revenue from specialty chemicals; increased margins; and paid down debt.? The Company’s return on invested capital also increased from less than 10% in 2016 to over 20% in 2022.

In late May, in response to the customary litigation surrounding such transactions, the Company made certain supplemental disclosures to the Company’s merger proxy, including additional financial projections prepared by management, approved by the Board of Directors, and provided to Apollo.? We have summarized the Univar Standalone Projections below, which were prepared by management assuming that the Company maintained its independence and included the pro forma impact of two acquisitions announced in the first quarter.

Univar Standalone Projections ($ in millions).

Based on these assumptions, and using a 9.0x terminal EBITDA multiple, below that of the comparable transactions selected by Company’s financial advisors, we estimate that standalone Univar could have achieved a 5-year exit stock price of over $75 per share, a compound return of 19% from the take-private price.? This equity return is well above the equity discount rates of 11.5% to 12.5% used by the Company’s financial advisors.? We illustrate the drivers of potential value accretion below.

Based on management’s projections, staying public was a no-brainer.

CEO David Jukes shared his perspective prior to the shareholder vote: “As a private company, and with Apollo’s support, we expect to have even more flexibility to explore new opportunities and to make additional investments to accelerate Univar Solutions’ growth.? In Apollo, we believe we have found an ideal partner, and we are looking forward to working with their team to take our business to new heights.”? “We have a real competitive moat with our asset footprint in a re-industrializing North America, which means we have great growth opportunities here.? No one has a better set of continuous assets for inorganic and organic chemistries in North American than we do.”?

Following completion of the transaction, he stated: “I couldn’t be more pleased to be in such an advantaged position due to our broad product offering and enhanced presence in target growth end markets, award winning customer experience, leading digital tools, and expanded suite of service capabilities.”

Does this sound like a man selling at the top?

In June, shareholders of Univar overwhelmingly voted in favor of adopting the merger agreement, with over 93% of votes cast in support of the deal.? Votes in favor included that of the California State Teachers Retirement System (“CalSTRs”), the second largest pension fund in the U.S., established in 1913 to provide retirement benefits to California’s public-school teachers.? This caused us some bewilderment.? Why would a purportedly long-term investor choose to sell their shares under such circumstances, requiring them to find a suitable alternative investment, with comparable risk/reward characteristics?? Why would a pension manager sell an asset, led by a proven management team, with a better than reasonable chance of exceeding its target equity return by over two times?

While CalSTRs was obviously not the only “long-term” investor to approve the Univar buyout, we note that CalSTRs is also a limited partner in Apollo Investment Fund X, L.P., one of the Apollo affiliates participating in the Univar buyout.? As such, CalSTRs effectively transferred its investment in Univar from a low-fee, transparent and liquid market into one which is high-fee, opaque and illiquid.? Going forward, CalSTRs’ members will cede 20% of their future profits to Apollo.? By selling, CalSTRs also facilitated the transfer of ownership to an owner focused on maximizing value over a three- to five-year period, a much shorter time frame than CalSTRs’ investment horizon.? Why does this happen?? Is it because the largest pension funds outsource their fiduciary obligations to Company’s boards of directors?? Have they also outsourced their governance responsibilities to third-party proxy advisors?? Does their team have the tools to assess whether the deal is a good one for their members?? Do their short-term incentives motivate them to try and beat the market over short time periods?? Either way, CalSTRs members do not get the rewards they would otherwise enjoy.

While we are disappointed to cede our future upside to Apollo’s limited partners, we are grateful for management’s hard work over the course of our investment.? This transaction represents the 21st take private of a Spitfire portfolio company.

Note: Net debt is based on pro forma CYE 2022 net debt of $2,238mm minus annual levered free cash flow, which assumes $100mm in annual interest expense.

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