Is the Cabela's Inc and Bass Pro Shops Merger Doomed to Failure?

In this segment fromIndustry Focus: Consumer Goods, host Vincent Shen is joined by contributor Daniel Kline as they update investors on the state of the the $4.5 billion merger between privately-held Bass Pro Shops andCabelas(NYSE: CAB)as the companies grapple with challenges that may ultimately scuttle the entire deal.

From additional inquiries from regulators to a weak quarter of results, here is what investors need to know.

A full transcript follows the video.

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This podcast was recorded on Feb. 24, 2017.

Vincent Shen: I think it would be appropriate for us to give an update on a story that you and I actually covered last year regarding the now-struggling merger between the outdoors outfitters Bass Pro Shop and Cabela's. After that, we'll look at the telecom industry, and if we have a little bit of time, I want to riff a little bit about the growing importance of delivery to retailers across a wide variety of sectors.

But first, for the Bass Pro and Cabela's story, the deal between these two companies was first announced last October. It was months after Cabela's management team had announced to the investor community that it would be pursuing "strategic alternatives, which is basically CEO-speak for, "We're struggling, we're at a little bit of a loss for what to do, and we're considering something drastic, maybe a sale, restructuring, management change, what have you." So, Bass Pro, which is privately held, they offered to buy out their competitor for about $65.50 per share, which comes out to a $4.5 billion deal. That would give the combined entity a pretty substantial network of about 180 stores and 40,000 employees. And these stores are special.

Daniel Kline: Massive. And unlike a lot of competing retail chains, this isn't Lowe'sandHome Depotwhere they're always across the street from each other. These are two companies that, because the stores are such destinations, with things like archery ranges and fishing holes inside the stores --

Shen: Wildlife museums within the stores.

Kline: Yeah, and restaurants, generally, these are very geographically spread out. So, there was a lot of supply chain logic. And besides marketing and all the other logic you can put into combining them, there was a lot of geographic reason for combining these two chains. But a lot has changed, which I think you want to talk about.

Shen: Sure. Keep in mind, the stock was trading at about $55 immediately before the deal announcement. It jumped about 15% to over $63 after the news came out, which makes sense. The offer price was around $65.50. Usually, when you have a deal like this, the company being acquired, their shares will approach parity with the offer price, right?

Kline: Usually a little bit below.

Shen: So this is very common with these deals involving publicly traded companies. But there's a big caveat in that what started off as really promising, what you mentioned in terms of them having very complementary geographic footprints with some overlap, but overall not too much --

Kline: This wasn't going to be a merger where you saw a lot of closures. You might see some upper management cash out and leave, but you weren't going to see widespread layoffs, and while I've never worked at these companies, culturally, everything I've read is that these are places that were pretty compatible. But, the merger is running into problems for sort of the same reason -- and there's a couple reasons, but one of them is sort of what happened with Office DepotandStaples.

There's regulatory concerns because they are the two major players in this space. And there have been some other small bankruptcies of lesser players. The reason I think this is silly, and we've talked about this, is the competition isn't Cabela's versus Bass Pro Shop, or even Cabela's and Bass Pro Shop versus [Dick's Sporting Goods]. It's any physical retailer versus the internet. You can buy a fishing rod on Amazon. You can buy a lot of the things you can buy in the stores, maybe not a handgun, but you can buy a lot of stuff online. So keeping physical retail strong would make sense to me, but I don't think regulators have quite caught up to the logic that we're in a full bore retail crisis in this country.

Shen: And the thing with the regulators, too, is it's kind of murky. Just two days before the new year on December 30th, Cabela's announced that the FTC had issued a request for additional information regarding the deal. This is not a coffin nail by any means, right?

Kline: No.

Shen: But investors often interpret it that way, so that shaved a few dollars off the stock. And then, in terms of the other roadblocks that you mentioned, we have another part of the transaction which is, Cabela's has their branded credit card operation. That was supposed to go to Capital One Financialin a separate side deal.

Kline: A necessary side deal.

Shen: Yeah, exactly. On that end, regulatory approvals have similarly been difficult to lock down. And the agreement with Capital One overall might actually be falling apart in that it put in an application to acquire the credit card business with the Office of the Comptroller of the Currency, but they're running into some snags where, when that application will come through or whether it's going to be denied is uncertain. They're running into issues with a money laundering probe that's happening at Capital One right now, which would essentially prevent them from refiling in time. There's a deadline in October that the companies need to meet. All these things are essentially coming together to mess up this other side deal as well.

And then, to top things off, last week or earlier this month, Cabela's released its fourth-quarter results, and they were rather discouraging. For the quarter, revenue down 5% year over year. This is what you mentioned, in terms of the retail store versus the online store, specifically, their retail stores were down 4.3%, whereas their online catalog business declined over 12%, very bad sign for a long-term strategy. Their comparable store sales were down 6.5%.

Kline: It's especially troubling when you consider that part of the reason they have these destination event stores is actually to drive digital sales. I might take my kid and look and lay in a lot of sleeping bags and play with stuff and buy some fudge at Cabela's and do all the different things. But later on, I'm going to sit down and order some hiking boots that I tried on online. That's how it's supposed to work. So, if they're losing 12% digital sales, the overall sales market demand for these products did not go away, it means that Amazon or Dick's or someone else is taking this business.

Shen: Absolutely. Going more into detail on the financial results that they reported, the profit margins also shrunk from 2015, net income was down 22%, despite revenue for the year being up 3%. Not surprisingly, that shaved more off the stock, it's trading at $46 right now.

Kline: Those fourth quarter numbers are bad by retailers not doing well standards. People are flipping out when companies are reporting 2% down. So when you're starting to see 4% to 5%, and 12% digitally when most people are growing 8% to 9%, and some even more than that, those are not good numbers.

Shen: And I will add, as if it wasn't enough, all these things coming up, all these roadblocks, we have one more story on the side, a competitive dynamic, really, with Gander Mountain. Very much operates in this space, outdoors equipment, think firearms, hunting, archery, things that you mentioned. They are also in the midst of filing for bankruptcy. They really went through a very rapid store expansion in the past five years. I think it opened around 50 locations in that time, maybe got a little bit ahead of themselves, and as a result, they're going through the bankruptcy filing process. But I think that might hurt the Cabela's-Bass Pro deal, because people can point to this and say, "The competitive environment has now weakened even more." But I think, overall, it shows us that this is a pretty tough space to be in. We saw a lot of athletic retailers go belly up in the past year with Sports Authority, City Sports, Eastern Mountain Sports, among many others. It's a tough deal.

Kline: If physical retail, especially physical retail on this size -- these aren't mall locations. These are stand-alone malls, more or less. If these are going to survive, we have to have different rules for them. And while you might not want to see the only two direct competitors in the space combine, there's enough other options to buy this stuff. They don't have a monopoly. And they don't have the cheapest cost structure when competing with digital-only plays. So it's very hard to see why this would be denied. And what I see happening is, the Capital One deal is going to delay it. There's going to be absolute problems on hitting the deadlines, and they're going to have to renegotiate the price. And even if they break up, much like I think with Staples and Office Depot, at some point, whether its regulatory concerns or the companies not being able to agree, the market is going to force this. We don't need two giant outdoor retailers competing for, maybe not customers so much as volume discounts and other things. You're not going to drive three hours out of your way to go to Bass Pro if there's a Cabela's a half hour from you. But, realistically, this has to happen. It just might not happen by the October deadline.

Shen: Yeah. And I will say, I'll mention again, Cabela shares are trading at right around $46 now. Remember that offer price around $65. There's now a lot of uncertainty priced into the stock, and maybe that original optimistic closing date they have for mid-2017 isn't going to happen. But I think everybody, Capital One included, is working hard to try and get this to go through.

Kline: I think it's worth noting overall in retail that this is a good time to go private. If you're a publicly traded company and you're not showing quarter-over-quarter comparable sales growth, even if you're eking out better margins and doing well by a lot of methods, people tend to punish you. So this is not a growth time. This is not an easy retail market. It's really about being like J.C. Penneyand very carefully managing your costs so you can trim your loss down, and doing all the things that, at a private company, people would applaud you for surviving.

As a public company, you're going to have to close stores that are breakeven, instead of waiting out and seeing the landscape, and mirroring what you're doing to what the demand is. I don't think we know where demand is going to shake out. Buying a fishing rod online may be a bad experience for people. And three years from now when they need a new one, maybe we'll go to a physical store where they can actually handle one.

Daniel Kline has no position in any stocks mentioned. Vincent Shen has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends Home Depot. The Motley Fool has a disclosure policy.