SPB - Spectrum Brands

[walkie518]

After seeing some recent interest in the LUK/JEF thread, I wanted a quick refresh on Spectrum after the HRG deal.

 

SPG has 53.4m shs out trading at $68/sh or $3.63B mcap

 

The battery and light division is set to be sold by year end for $2B.  It looks like gains are going to be largely sheltered by HRG's NOL (reminiscent of the old LUK playbook).

 

The remaining company should have about $3B of sales. 

 

Debt is fairly high at $5.1B, unless someone can correct me, it's unclear how much of the $2B goes to debt and buyback.  Last presentation shows EBITDA of $366m and Adj EBITDA at $602m--costs mostly due to the HRG deal along with some other one-off items.  While I don't tend to trust this kind of accounting, provided there is nothing hiding in a line item, the only item I would probably add back is the stock comp.

 

In a rising rate env, I'm not sure how they intend to lower cost of debt unless the goal is to shrink the debt load materially.  Currently, SPB is paying 7%.  Without changing cost of debt or bettering the business, this could yield a $140m improvement to the bottom line.

 

Further on this line of thinking, if it all goes to pay back debt and 2019 EBITDA looks like Adj EBITDA, we might see a CPG company generating $740m of EBITDA.  Pull out interest expense and comp, and we find a company generating close to $500m of owner's earnings trading at a $3.6B mcap.

 

Where am I going wrong here?  Did I miss something in between the filings and merger?

[Broeb22]

You’re mostly correct. SPB plans to use the 3.7B proceeds from its GBA business plus internally generated cash to get to about 1x Net Debt to EBITDA. I was just doing the math today, and I believe pro forma SPB will generate 550 MM FCF when the after tax interest expense accrues to equity holders. I get to about a 15% FCF yield if David Maura can get the operational issues fixed that caused them to whiff on guidance this year.

 

I really like being in a business with very little debt, substantial cash generation, and a seasoned capital allocator at the helm who is prepared to either buy back stock or wait for acquisition multiples to come back to Earth.

[walkie518]

You’re mostly correct. SPB plans to use the 3.7B proceeds from its GBA business plus internally generated cash to get to about 1x Net Debt to EBITDA. I was just doing the math today, and I believe pro forma SPB will generate 550 MM FCF when the after tax interest expense accrues to equity holders. I get to about a 15% FCF yield if David Maura can get the operational issues fixed that caused them to whiff on guidance this year.

 

I really like being in a business with very little debt, substantial cash generation, and a seasoned capital allocator at the helm who is prepared to either buy back stock or wait for acquisition multiples to come back to Earth.

Do you know why 1x is the number?  Any idea what the plan might be at 1x?  That doesn't seem like a business they want to grow but to ...

[Broeb22]

Maura’s first conference calls is one of my favorite calls that I’ve heard any CEO give for a variety of reasons. Highly recommend.

 

In that call, he addresses the question of why he wants to get to 1x EBITDA. In short, he talks about how valuations are sky high today, so it is a better time to be selling than buying. He sounds sort of like a market timer, but I generally agree that there will be better values in the future. I imagine if the stock stays where it is today, he won’t be afraid to buy back a full 1x EBITDA, or about $700MM (about 20% of the equity). If he’s generating $550 million a year in cash, he can probably buyback $500 million annually without losing sleep.

 

Unrelated, this episode kind of reminds me of the Bill Anders chapter in the Outsiders, when he sold off a big piece of the General Dynamics.

 

The other point I would note about SPB relative to other CPG companies is ownership. Look at EPC’s DEF14A and then compare to SPB’s. I chose EPC because they are similar size companies. EPC’s biggest shareholders are Vanguard and Blackrock, who collectively own 24% of the company. SPB until recently had no major institutional holders above 5% because of HRG Group’s control.

 

[walkie518]

Maura’s first conference calls is one of my favorite calls that I’ve heard any CEO give for a variety of reasons. Highly recommend.

 

In that call, he addresses the question of why he wants to get to 1x EBITDA. In short, he talks about how valuations are sky high today, so it is a better time to be selling than buying. He sounds sort of like a market timer, but I generally agree that there will be better values in the future. I imagine if the stock stays where it is today, he won’t be afraid to buy back a full 1x EBITDA, or about $700MM (about 20% of the equity). If he’s generating $550 million a year in cash, he can probably buyback $500 million annually without losing sleep.

 

Unrelated, this episode kind of reminds me of the Bill Anders chapter in the Outsiders, when he sold off a big piece of the General Dynamics.

 

The other point I would note about SPB relative to other CPG companies is ownership. Look at EPC’s DEF14A and then compare to SPB’s. I chose EPC because they are similar size companies. EPC’s biggest shareholders are Vanguard and Blackrock, who collectively own 24% of the company. SPB until recently had no major institutional holders above 5% because of HRG Group’s control.

 

Your last point is very interesting. 

 

The $1B buyback is material considering it is to occur over a 3 yr period.  Typically, it's silly to time a buyback, but in this case and at these prices, it gives a lot of comfort. My guess is that they buyback before entering an index?

 

[kab60]

Agree it looks interesting. Last two calls read like Outsiders/value porn. Couple of things.

 

Mr. Moura has been on HRGs board for ages. Why didn't he act before? Isn't he partly to blame for the mess? Is he aligned with shareholders?

 

How do you think of margins in a recession?

 

Will tariff war make appliances a tough sell?

 

Any risk battery sale doesn't go through?

 

 

[Broeb22]

Agree it looks interesting. Last two calls read like Outsiders/value porn. Couple of things.

 

Mr. Moura has been on HRGs board for ages. Why didn't he act before? Isn't he partly to blame for the mess? Is he aligned with shareholders?

  Maura actually resigned from HRG on 12/1/2016, so close to 2 years ago. Technically yes he is to blame for some of this because he was Chairman during the last few years, but if you were Chairman of the Board, how involved would you be in underwriting distribution and production consolidation moves? I'm sure they were conversations, but what seems clear now is the prior CEO had bad info. Maura said on one of the recent calls he had to re-underwrite the distribution center changes they are doing, meaning the prior CEO really underestimated the costs. He owns about $20 million in stock, relative to total comp of $11 million, which included $9 million in stock awards in the most recent proxy.

 

 

How do you think of margins in a recession?

I honestly don't know. We really need to look product by product to understand how they respond. Most of their brands I would describe as more discretionary than most consumer staple companies. Still, if youre getting a low-teens FCF yield at peak margins, are you really gonna be upset if you only have a 10% FCF yield in a recession. Still WAY cheaper than almost anything out there.

 

Home and Garden - Spectracide and Hot Shot bug exterminator, Cutter insect repellent, etc. - Bug spray is pretty mandatory if you want to spend time outside in some regions, and depending on how allergic you are, bee/bug sprays are not exactly discretionary. But they are also just a nuisance, so not something I would be most worried about addressing if I just lost my job.

Companion Animal - Pet Grooming, Stain Removers, Fish Food/Cleaner - If you have a pet, there are probably ways to groom them without SPB's products, so could substitute to a more difficult grooming, stain removal, cleaning solution.

Global Auto - Armor All, etc. - Armor All products can probably easily be replaced with dish soap and water, so in a Depression-like scenario you could see sales fall here as people substitute away

Hardware & Home Improvement - Locks - This is tied to home sales transactions in some sense which would decline in a recession, and perhaps the level of restraining orders (which is arguably counter cyclical) :)

 

 

 

Will tariff war make appliances a tough sell?

I don't know if tariffs are causing appliances tough to sell, but I think given the silence they have clearly not received the interest they expected, so I personally haircut their stated $3.7BN gross proceeds.

 

 

Any risk battery sale doesn't go through?

 

I think its low. Hart-Scott-Rodino already happened in US, so now they are waiting on European approval. Europe seems to be generally less-pro M&A, but private label batteries have larger share in Europe relative to brands. I saw this analysis in a Merrill research report earlier this year, and my impression was branded market share (even pro-forma for acquisition should not worry regulatKwiksetors. But we'll have to see. Losing the battery sale would difficult to overcome because Energizer is maybe the only company other than Berkshire's Duracell brand which can extract enough synergies to justify the multiple ENR is paying. 

 

 

[kab60]

Much appreciated. The low ownership stake is a negative, but perhaps he starts putting his money were his mouth is, when the story is more clear (and he's clear of inside information regarding divestments). Understand the attraction in getting debt down, but if they do sell both segments for some 3.7b and stock is down here, it'd be nice if they'd lever up a turn of ebitda and buy back aggressively

That would be real Outsiderish but also quiet balsy and not really necessary. Very interesting case, thanks a bunch.

[walkie518]

stock has taken a beating along with the rest of the market alongside some very company specific issues... this is looking really cheap here and might be worth catching a falling knife?

[kab60]

I always like a falling knife, so I jumped in after having done some very superficial research. They generate a ton of cash even with a lot of operational issues, and they just promoted the #1 operations guy to COO the other day (relying on CEO's comments) so he'll oversee all divisions. On top of that you get what sounds like a really thoughtful capital allocator with skin in the game as well as a couple of short term catalysts in pendings sales of divisions. The negative - and that's a potential big negative - is if the pending sales somehow gets blocked or they fetch a poor price for their other asset that is on sale.

[kab60]

Sooo, that took a bit of a twist. Keeping appliances business, selling autocare biz to Energizer instead while getting less for battery business. I understand why the market pukes a bit, but it was obvious appliances was a tough sell. Most important thing is to derisk the case via debt paydown, and if this was the best way so be it.

[ander]

So you think SPB is left with the junk - got rid of the good?

 

(I don't know the business well. I've done more work on NWL and think that's turning the corner operationally and they've made progress on divestitures - but always looking to trade up if this is the better long-term opportunity).

[kab60]

So you think SPB is left with the junk - got rid of the good?

 

(I don't know the business well. I've done more work on NWL and think that's turning the corner operationally and they've made progress on divestitures - but always looking to trade up if this is the better long-term opportunity).

Yeah, something like that. But I don't think it is all that bad. The most important thing is getting leverage down, and the price seems fair. It was obvious the sale of appliances was not going as planned, so I prefer this over them just scrapping it since it could otherwise get ugly in a downturn. Now any existential threats should be gone and they can clean up the balance sheet and improve operations.

[walkie518]

this is an unfortunate turn of events and certainly muddies the chain of catalysts for Jefferies...

 

maybe it's still really cheap but a failure of this magnitude likely defers a deal for another year or two?

 

[kab60]

this is an unfortunate turn of events and certainly muddies the chain of catalysts for Jefferies...

 

maybe it's still really cheap but a failure of this magnitude likely defers a deal for another year or two?

What deal? Appliances or a sale of the whole company? Between these two sales and free cash flow the balance sheet should look pretty pristine in a year if they go through, but I think those odds are pretty good.

[walkie518]

this is an unfortunate turn of events and certainly muddies the chain of catalysts for Jefferies...

 

maybe it's still really cheap but a failure of this magnitude likely defers a deal for another year or two?

What deal? Appliances or a sale of the whole company? Between these two sales and free cash flow the balance sheet should look pretty pristine in a year if they go through, but I think those odds are pretty good.

maybe I misunderstood

 

the battery deal is now being proposed $200m less b/c of the EC's concerns

 

the new deal is w/energizer for another $1.25B...this implies $3.25B of proceeds across the two deals, most of which is cash...correct?

 

[kab60]

this is an unfortunate turn of events and certainly muddies the chain of catalysts for Jefferies...

 

maybe it's still really cheap but a failure of this magnitude likely defers a deal for another year or two?

What deal? Appliances or a sale of the whole company? Between these two sales and free cash flow the balance sheet should look pretty pristine in a year if they go through, but I think those odds are pretty good.

maybe I misunderstood

 

the battery deal is now being proposed $200m less b/c of the EC's concerns

 

the new deal is w/energizer for another $1.25B...this implies $3.25B of proceeds across the two deals, most of which is cash...correct?

Yes, basically. Energizer will have to dispose of Varta, and if the price is lower than expected, Spectrum are on the hook for upto 200m. So 3,25b is best case and some 300m is paid in equity, but I still think both are good deals.

[walkie518]

this is an unfortunate turn of events and certainly muddies the chain of catalysts for Jefferies...

 

maybe it's still really cheap but a failure of this magnitude likely defers a deal for another year or two?

What deal? Appliances or a sale of the whole company? Between these two sales and free cash flow the balance sheet should look pretty pristine in a year if they go through, but I think those odds are pretty good.

maybe I misunderstood

 

the battery deal is now being proposed $200m less b/c of the EC's concerns

 

the new deal is w/energizer for another $1.25B...this implies $3.25B of proceeds across the two deals, most of which is cash...correct?

Yes, basically. Energizer will have to dispose of Varta, and if the price is lower than expected, Spectrum are on the hook for upto 200m. So 3,25b is best case and some 300m is paid in equity, but I still think both are good deals.

 

ok, then what's not to like and why is the stock down 10%?

 

what are we or the market missing? 

 

could the thinking be that the deal gets cut back much further from $200m since this is the initial expectation?

[kab60]

this is an unfortunate turn of events and certainly muddies the chain of catalysts for Jefferies...

 

maybe it's still really cheap but a failure of this magnitude likely defers a deal for another year or two?

What deal? Appliances or a sale of the whole company? Between these two sales and free cash flow the balance sheet should look pretty pristine in a year if they go through, but I think those odds are pretty good.

maybe I misunderstood

 

the battery deal is now being proposed $200m less b/c of the EC's concerns

 

the new deal is w/energizer for another $1.25B...this implies $3.25B of proceeds across the two deals, most of which is cash...correct?

Yes, basically. Energizer will have to dispose of Varta, and if the price is lower than expected, Spectrum are on the hook for upto 200m. So 3,25b is best case and some 300m is paid in equity, but I still think both are good deals.

 

ok, then what's not to like and why is the stock down 10%?

 

what are we or the market missing? 

 

could the thinking be that the deal gets cut back much further from $200m since this is the initial expectation?

The EC wants Varta divested -which hurts Energizer, so Spectrum are chipping in to get the deal done. The deal is good for both parties but obviously less so due to the EC. Anyway, that's up to a 200m, but if Varta fetches a full price it could be zero (unlikely). But it can't be more.

 

Appliances was initially expected to fetch 1,7b so it will take roughly one year extra of free cash flow to get leverage to where they targeted (which was very low).

 

So I think the price drop is pretty fair based on the math above and where it traded yesterday, but on the other hand a very real risk seems to be gone (them only getting one deal done), and they should be a whole different place in one year.

[kab60]

The more I think about it, the more I like this move. Sure, selling appliances for 1,7b would have been sweet, but a tad more than 11xEbitda for GAC seems pretty great and some 15-16x for batteries is still very, very good. It means they're under no pressure now and can do another deal later if it's favorable or just work on optimizing ops.

[ander]

With the new composition of business what are you guys viewing as upside / downside?

[kab60]

With the new composition of business what are you guys viewing as upside / downside?

Hard to peg an exact number on it since disposals like the above can be very accretitive to equity when done at a higher multiple than the public equity trades at, and there might be others done.

 

If management doesn't waste FCF, I tend to think of my return as FCF plus growth (hard to run the numbers since appliances isn't guided for, will see after earnings next week, but a large margin to a 10 year treasury)

 

And then there's a possible rerating due to a derisked balance sheet.

 

Downside is pretty ugly and would involve a large equity market crash where Energizer walks. Very unlikely (batteries should close in beginning of 2019, GAC in Q2), but that would be a gargantuan blow.

 

 

[ander]

Thanks. I’ll revisit after earnings.

[kab60]

Thanks. I’ll revisit after earnings.

Good timing. Pretty ugly set of results.

[ander]

Thanks for your thoughts on this one. I wonder how much is kitchen-sinking / conservative outlook just going forward.