ShopKo LBO Hits Opposition

The $1.1 billion leveraged buyout of ShopKo(SKO), a Wisconsin-based discount retailer, by private equity firm Goldner Hawn is facing headwinds.

Hedge Fund Elliott Associates, an 8% ShopKo owner, sent a letter this week to the company's board opposing the $24-a-share takeout price, which it said "significantly undervalues the company."

Another hedge fund, John A. Levin & Co., which owns a 6% ShopKo stake, also publicly criticized Goldner's offer as too low. Proxy adviser Institutional Shareholder Services has recommended that shareholders vote against the buyout.

ShopKo Stores operates general merchandise and drug store outlets through two chains in the U.S., ShopKo and Pamida. Its stock currently costs $25.35 a share and has generally traded above the $24 price since the sale was announced April 8.

The deal's opponents say ShopKo is doing a poor job valuing its real estate holdings, an asset that is being used to back financing for the takeover that is being extended by Bank of America.

The funds, whose opposition to the deal is not concerted, have separately performed asset valuations, and both say the stock is worth about $32 a share, or 33% above the offer price. Elliott estimates that the company will generate annual free cash flow of $41 million to $63 million between next year and 2010.

In its filing, John A. Levin says the process for negotiating and approving the transaction was flawed because of conflicts of interest.

"For example, the company's chairman at the start of this process, [Jack] Eugster, was offered the opportunity to acquire 10% of the equity in this transaction at its apparent attractive valuation, unlike the shareholders," Levin said. "Moreover, Mr. Eugster's pay package could result in payments to him that have the effect of reimbursing him for his entire out-of-pocket cost associated with his equity investment in the merger."