Bare Escentuals, Inc. (NASD: BARE) management could experience a bit of a shake-up after Sandler Capital Management took a 5% stake in the company and demanded changes in a
Schedule 13D filing with the SEC. In a letter, the activist hedge fund outlined several changes that it would like to see made, including a share buyback and an exploration of strategic alternatives.
Here is a complete copy of the letter:
Ladies and Gentlemen:
Today, Sandler Capital Management and related persons (“Sandler Capital” or “we”) will file a Schedule 13D with the United States Securities and Exchange Commission indicating that we beneficially own in the aggregate over 5% of the outstanding common stock of Bare Escentuals, Inc. (the “Company”). Sandler Capital, a Registered Investment Advisor since 1988, is an alternative asset management firm managing both hedge funds and private equity funds. Sandler Capital currently manages approximately $850 million in assets including approximately $500 million within our hedge fund portfolios.
We are writing to you to express our concern regarding what we believe to be a great disconnect between the value of the Company and its brand, on the one hand, and the price at which the Company’s Common Stock currently trades, on the other hand. Since the Company’s initial public offering on September 28, 2006 at a price of $22.00 per share, the market price of the Company’s Common Stock has fallen approximately 60%.(1) During the same period, the S&P 500 Index was down approximately 25% and the Russell 2000 Index was down approximately 20%. During the same period, the stock price of two of the Company’s peers, L’Oreal SA (“L’Oreal”) and The Estée Lauder Companies Inc. (“Estée Lauder”), fell approximately 26% and 10%, respectively. The Company’s underperformance relative to the overall market and to its peers is similar on a trailing two year basis. In addition, based on analysts’ current consensus earnings estimates for both calendar years 2009 and 2010, the Company is currently trading at substantial discount to Estée Lauder and L’Oreal. Compared to Estée Lauder, the Common Stock is trading at nearly a 60% discount on 2009 estimates and close to a 50% discount on 2010 estimates. Compared to L’Oreal, the Common Stock is trading at over a 40% discount to both 2009 and 2010 estimates. We note that although Estée Lauder and L’Oreal have net debt to EBITDA profiles that are similar to the Company’s, the Company has far superior return on assets. The current disconnect between “Wall Street’s” perception of the Company as compared to the cosmetic industry’s perception of the Company is vast and in our opinion is being perpetuated by the actions and inactions of the Company’s board and management.
We would like to engage the Company’s board and management in an active dialogue to offer suggestions that we believe will enhance the value of the Company’s Common Stock. We respectfully remind the board of directors, including affiliates of Berkshire Partners LLC (“Berkshire”), and Ms. Leslie A. Blodgett, of their duties to act in the best interests of all of the Company’s shareholders and we believe that the Company needs to alter its mindset in order to do so. A brief outline of some broad suggestions is included below.
- Improve communication efforts with the investment community: We believe that part of the value destruction that has taken place has been due to the Company’s lack of communication with the public investment community. Rather than shy away from “Wall Street,” we believe now is the time to communicate in a clear manner and attend various marketing events and non-deal road shows. In addition, we believe the Company and board should better communicate to investors anticipated large distributions of the Company’s Common Stock, particularly by inside private equity owners. Specifically, we cite the recent August 4, 2009, unannounced, haphazard distribution by Berkshire of just over 4 million shares of Common Stock. This distribution was done without an underwritten offering and without a road-show. We find this most disturbing because Berkshire has two seats on the Company’s board, including the Chairman, giving them a fiduciary duty to act in the best interest of all shareholders. We believe that this type of haphazard distribution of Common Stock skews upwards the volatility of the Common Stock, sharply depresses its price, and needlessly raises its beta. These factors result in depressed earnings multiples. In our opinion, an underwritten public offering of such Common Stock would have produced a more desirable outcome than the arbitrary stock distribution that occurred. We cite the foregoing as a key example of the board and management not acting in shareholders’ best interests and the inherent conflict imposed on the Chairman of the board.
- Utilize the strength of the balance sheet for buying back stock: The Company’s balance sheet continues to strengthen and net debt to EBITDA now stands well below 1x. With the continued free cash flow, supported by return on assets in the 40% range, we believe the board should authorize a share buy back program, as permitted by covenants contained within the Company’s credit agreements. Any such buy back at current valuations would be highly accretive to earnings. For example, according to our calculations, repurchasing Common Stock using this year’s estimated free cash flow would be very accretive to even conservative forward 12 month earnings per share estimates. If “Wall Street” will not recognize the value of the Company as evidenced by per share market price remaining at current levels, we believe the board should take advantage of the disconnect by authorizing the Company to buy back its Common Stock.
- Explore strategic alternatives and sale of the Company: We believe that the Company’s powerful brand, unique distribution strategies, including a growing boutique footprint, and burgeoning push into international markets, would be an attractive fit for a number of multi-national cosmetic companies. If the disconnect continues, we would urge the Company’s board to form a special committee of the independent directors to actively seek strategic alternatives for the Company in order to maximize shareholder value.
We would appreciate and look forward to discussing these issues with you and with senior management in a cordial and productive manner. Given the urgency of these matters, we suggest that this occur as soon as possible.
Very truly yours,
Andrew Sandler
Managing Director
Sandler Capital Management