Description

Executive Summary

Through two recently announced strategic transactions, Cott Corporation (COT) is transforming itself into a pure-play water solutions provider.  This transformation will (i) increase COT’s revenue growth, (ii) improve the Company’s EBITDA margins, (iii) be accretive to COT’s earnings and (iv) lower the Company’s leverage.  The combination of these benefits should drive COT’s valuation multiple, and hence share price, higher.  An increase in COT’s EV/EBITDA valuation multiple from ~10.0x to 12.5x translates into a share price of $20, ~30% upside from current levels.

Please note that COT was last written up on VIC on 2/17/16 by AtlanticD.  Additional information can be found in that write-up.

Company Description

In its current form COT is a water, coffee, tea, extracts and filtration service company.  COT has a leading volume-based national presence in the North American and European home and office delivery industry for bottled water, and a leader in custom coffee roasting, iced tea blending, and extract solutions for the US foodservice industry.  The Company operates through three reporting segments:

·         Route Based Services (~77% of Revenues, ~90% of Adj. EBITDA) – This segment provides bottled water, coffee and water filtration services to customers in North America, Europe, and Israel.  Its products include bottle water, coffee, brewed tea, water dispensers, coffee and tea brewers and filtration equipment.  Route Based Services has a national route truck distribution infrastructure covering over 90% of the US population.  In 2016 COT further consolidated its leading position in North America by acquiring Aquaterra, Canada’s oldest and largest home and office water delivery business with over 50% market share in Canada.

·         Coffee, Tea and Extract Services (~23% of Revenues, ~10% of Adj. EBITDA) – This segment, which is composed of S&D Coffee and Tea, provides premium coffee roasting and customized coffee, tea and extract solutions to customers in the United States.  The segment’s products include fresh brewed coffee or tea, specialty coffee, liquid coffee or tea concentrate, single cup coffee, cold brewed coffee, iced blend coffee or tea beverages, tea, blended teas, hot tea, sparkling tea, and coffee or tea extract solutions.

·         All Other (NA% of Revenues, NA% of Adj. EBITDA) – Functionally, this is really no longer a true operating segment as it used to consist of Cott Beverages LLC which COT divested in 1Q19.  While COT still reports the segment, it’s composed of corporate expenses, certain general and administrative costs, and other miscellaneous expenses.

Investment Thesis

COT’s stock price should be driven upwards by its transformation into a pure-play water solutions provider.  This transformation will take place through the closure of two recently announced transactions:

·         Acquisition of Primo Water Corporation (Ticker: PRMW) - On 01/13/20 COT announced a definitive agreement to purchase PRMW for $14.00/share.  Each share of PRMW common stock will be exchanged for $5.04 in cash and 0.6549 shares of COT, or at the election of PRMW’s shareholders, for $14.00 in cash or 1.0229 shares of COT, subject to proration.  COT will pay ~$216mm in cash to PRMW shareholders and issue ~26.8mm shares of new COT shares to PRMW stockholders.  COT has obtained financing commitments of up to $400mm from Deutsche Bank to support the payment of the acquisition price and the refinancing of PRMW’s debt.  The transaction values PRMW at ~$775mm.  COT management projects the acquisition will yield $35mm in annual run-rate cost synergies in 3 years, resulting in a post synergy acquisition multiple of 8.4x 2020E adjusted EBITDA (see pg. 25 of the acquisition presentation found on COT’s website for the calculation of the transaction multiple).  The transaction is expected to close in 1Q20.  PRMW is a leading provider of water dispensers, purified bottled water, and self-service refill drinking water in the US and Canada.  PRMW has a comparable growth rate to COT’s Route-Based Services business and should have higher EBITDA margins post-synergies.

·         Divestiture of S&D Coffee and Tea Business - On 01/31/20 COT announced a definitive agreement to sell its S&D Coffee and Tea business to Westrock Coffee Company for C$405mm in cash.  The transaction is expected to close in 1Q20.  Through this transaction, COT is eliminating its Coffee, Tea and Extract Services segment which has slower growth and lower margins than COT’s Route Based Services segment.

These strategic transactions have the following impacts on COT’s business:

o  Transforms COT into a Pure-Play Water Solutions Provider – By divesting of the S&D Coffee and Tea business, COT will become a pure-play water solutions provider.  The S&D Coffee and Tea business is really a “manufacturing” business which roasts coffee beans (~600,000 lbs/day), blends tea (~120,000 lbs/day) and produces extracts and ingredients which compliment coffees and teas.  After the divestiture, COT’s business model will become essentially only “service oriented”.  Specifically, COT will be predominantly focused on delivering bottled water and coffee to homes and offices.  The acquisition of PRMW further extends this water services business.

o   Improves COT’s Growth Profile – Legacy COT’s revenue growth has been ~4% annually, PRMW’s revenue growth has been ~7% annually, and S&D Coffee and Tea's revenue growth has been essentially flat.  By acquiring PRMW and divesting S&D Coffee and Tea, COT’s revenue growth profile should increase from ~4% to ~6%.

o   Increases COT’s EBITDA Margins – Legacy COT’s EBITDA margins have been ~13%, PRMW’s EBITDA margins have been ~17%, and S&D Coffee and Tea's EBITDA margins have been ~7%.  By acquiring PRMW and divesting S&D Coffee and Tea, COT’s EBITDA margins should increase from 13% to 18% after including cost synergies from the integration of PRMW.

o   Reduces COT’s Leverage – Prior to the transactions, COT’s LTM adj. EBITDA was $313.1mm and its net debt balance was ~$1.2bn, equating to a net debt/EBITDA ratio of 3.8x.  Pro forma for the transactions and including synergies, COT will have a net debt balance of ~$1.3bn and LTM EBITDA of $358.5mm, equating to a net debt/EBITDA ratio of 3.6x. 

Financials

Below is a summary version of my financial model for COT.  The model projects that both the S&D Coffee and Tea business divestiture and the PRMW acquisition close on 03/31/20.  Also, the model projects that COT steadily captures the following run-rate synergies from the integration of PRMW: $7.5mm in 2020E, $25.0mm in 2021E and $35.0mm in 2022E (as depicted by COT management on Pg. 16 of the 01/13/20 PRMW acquisition presentation found on the Company’s website).  The model projects that COT reaches the $35mm synergy run-rate by 4Q22.

Valuation and Risk/Reward Profile

Based on the projections above and pro forma for the balance sheet and share count adjustments for the acquisition of PRMW and divestiture of S&D Coffee and Tea, COT is currently trading at ~10.3x 2021E EBITDA.  This is in-line with how COT has traded on a 1-year forward EV/EBITDA basis.  However, given the financial impacts that the acquisition of PRMW and divestiture of S&D Coffee and Tea will have on the Company (better growth, higher margins and lower leverage), it’s reasonable to argue that COT deserves a re-rating to a higher valuation multiple.

Unfortunately, there are not directly comparable publicly-traded comps to COT’s pro forma business.  COT’s biggest competitor in water delivery services is Nestle S.A (Ticker: NESN SW), but it is a small part of an extremely large company.  Considering COT is essentially a “water-as-a-service” company, one comp is AquaVenture Holdings (Ticker: WAAS).  It’s not a perfect comp as ~50% of their business, known as Quench, is similar to COT’s while 50% of their business, known as Seven Seas Water, is focused on producing clean water through desalinization.  Based on consensus estimates, WAAS currently trades at 13.0x 2021E EBITDA.  Other companies which are service-oriented are ServiceMaster Global (Ticker: SERV) and Aramark (Ticker: ARMK).  Based on consensus estimates, these companies trade at 13.9x and 10.6x 2021E EBITDA, respectively (ARMK has a September FY end).  The average 2021E EV/EBITDA multiple for WAAS, SERV and ARMK is 12.5x.

The risk/reward profile for COT appears very favorable.  If COT begins capturing synergies from the PRMW acquisition, generates $367.7mm in EBITDA in 2021 (as shown in the model above), and it’s EV/EBITDA valuation multiple re-rates to 12.5x, the average of some of its service-oriented competitors (WAAS, SERV, ARMK), COT share price would reach $20, ~30% upside from current levels.

In the event that COT does NOT capture any synergies from the acquisition of PRMW and its EV/EBITDA valuation multiple only re-rates to 11.5x, that equates to an $18/share stock, ~16% upside from current levels.

If, for whatever reason, business for both COT and PRMW deteriorated such that 2021 EBITDA for the pro forma entity was only $350mm and COT’s EV/EBITDA valuation multiple compressed to 9.5x, that equates to a $12.50/share stock price, ~19% downside from current levels.  While possible, this last scenario appears unlikely given the stability of both COT’s and PRMW’s business.

Based on the above, the risk/reward profile for COT stock appears skewed to the upside.

Catalyst

Completion of the divestiture of the S&D Coffee and Tea business and the acquisition of Primo Water Corp (PRMW), both of which are expected to be completed by the end of 1Q20.

Subsequent re-rating of COT's EV/EBITDA valuation multiple.