|Shares Out. (in M):||491||P/E||18.6||18.6|
|Market Cap (in $M):||27,000||P/FCF||25||25|
|Net Debt (in $M):||10,720||EBIT||2,300||2,300|
|Borrow Cost:||General Collateral|
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Below is an update of an idea that we wrote up two years ago - short Newell Rubbermaid (now Newell Brands). The thesis at that time involved the company using accounting shenangians and hyperinflation in Venezuelan to hit both "core" and actual numbers. In that write-up, we did speculate that management might make a large acquisition concurrent with its shift away from using overvalued FX rates in Venezuela. This is indeed what happened, as the company announced the acquistion of Jarden at the end of '15. This occured at the same time Newell finally made the decision to deconsolidate Venezuela.
Vigo 34 did an excellent job of explaining the situational dynamics behind the NWL/JAH merger. I would refer any reader to that write up for further background.
Having previously observed shenanigans at NWL (and believing Vigo's assertions of shenangians at Jarden), we have studied the acquisiton accounting closely. This has led us to post Newell a second time as the new information heightens our conviction around the underlying weakness in the business despite management's impressive efforts to prove otherwise.
Newell Brands Stock Price Trajectory Largely Supported by “Spring-Loading” of Acquired Assets
91% of Newell’s net upward stock price movement after closing the Jarden deal can be explained by two single-day pops (the reporting of Q2’16 and Q1’17), which were largely due to substantial beats on “core growth” (organic growth)
It can be shown quantitatively that both of these core growth beats were largely – if not entirely – driven by the “spring-loading” of recently acquired assets
In Q2’16, spring-loading at least tripled the legacy Jarden asset’s core growth rate
In Q1’17, the Jostens business was spring-loaded into the comp base to such an extent that even though it only accounted for ~5% of total Newell Brands revenue, it contributed one-third of total consolidated core growth
Our analysis shows that Newell is not growing at the above-peer-average growth rates as widely perceived; rather, the legacy Newell business is poised to be exposed as an asset in decline. When this negative core growth becomes clear, we expect Newell to rerate to ~10x adj. EPS (similar to other declining consumer names like Hanesbrands). As such, we see 50% downside in our base case.
“It’s false precision to say that I can say it’s going to be 2.5% ....” – CEO Mike Polk on the Q4’16 earnings call, giving guidance for Q1’17 core growth
Q1’17 reported core growth: 2.5%
Newell appears to be using egregious levels of financial manipulation to meet its stated goals. Since this spring-loading tool is most effectively used around the time of large acquisitions (and when these acquisitions enter the comp base), Newell is running out of “help” for its perceived top line trajectory.
In December 2015, Newell Rubbermaid’s announcement that it would acquire Jarden Corp was met with widespread surprise. This surprise, coupled with concerns about the size and complexity of the deal, as well as the at-best-mediocre quality of many of Jarden’s rolled-up assets, caused Newell’s stock to tumble 25%. In the following months, Newell’s highly promotional CEO laid out ambitious promises and painted a rosy long-term picture for the combined entity. The stock eventually came to receive almost unanimous bullishness from the sell-side.
Since the date of the deal closing on April 15th, 2016, Newell’s stock price has increased by $9.45. Two single-day moves in the stock price (the reporting of Q2’16 and Q1’17) have accounted for a combined $8.61 of stock price move, or 91% of the total.
The dominant driver of these two single-day moves was reported core growth that significantly surprised to the upside. For large companies like Newell, differences in core growth of ± 100 bps can make all the difference for a quarter. However, using simple math and very minimal assumptions, it can be proven that much of this core growth was achieved by “spring-loading” recently acquired assets into the comp base. This degree of spring-loading is at best disingenuous (i.e. not calling out unusual one-time core growth contributors), and at worst highly deceptive.
What Is Spring-Loading?
Acquisitions create confusing periods of discontinuity. For example, during the period of time between when a deal is announced and when it is closed, there is typically a less-than-usual amount of information available about the performance of the acquisition target. Let’s call this the “off-the-clock period.”
For this example, let’s say that a deal was closed (and thus consolidated) on the 15th day of a quarter, or 1/6th of the way through. So we’ll divide the quarter into sixths. In the year-ago period, we’ll assume the business was plugging along, and 1/6th of the “X” in quarterly sales were generated in each 1/6th of the time period. In the current quarter being reported, let’s make an extreme example and assume that the management team of the acquisition target maximally spring-loads by pushing 100% of the sales from the first 15 days (the “off-the-clock” period) into the start of the “on-the-clock” period.
Officially, core growth is only calculated with respect to the “on-the-clock” period in the current quarter versus the precisely comparable period in the prior year quarter, as illustrated above. Core growth would then be calculated as: [6/6th X] / [5/6th X] = 20% core growth. However, the more accurate representation of what is really going on in the business can be seen by looking at “true” core growth for the full quarter: [6/6th X] / [6/6th X] = 0% core growth. Thus given a 15-day window, this tool for manipulation has the ability to swing core sales growth for the acquired entity by as much as 20 percentage points – obviously a massive number.
** For those who want to learn more about spring-loading, we suggest reading the published materials about Tyco International’s use of this form of financial manipulation.
Now let’s leave the theoretical, and return to the reality at Newell. As mentioned previously, the stock price pops following the reporting of Q2’16 and Q1’17 have basically salvaged what would otherwise have been significant underperformance post the closing of the Jarden deal.
The Jarden deal was closed on April 15th, 15 days into Q2’16. Since the deal was announced in December 2015, there was a four-month period of being “off-the-clock” (to varying degrees). When Newell reported its Q1’16 in April, there was very minimal commentary about Jarden’s Q1 except that Jarden core growth was “about 2%” for the quarter. Not until five months later (on 9/9/16, a Friday afternoon), did Newell publish an 8-K that showed GAAP numbers for Jarden’s Q1’16. This press release seemed to get zero attention from the sell-side.
Interestingly, on the second-to-last page of this 8-K, Newell provided Jarden sales figures for the period from 1/1/16 - 4/15/16. Simply subtracting off the reported Jarden Q1 gives the sales number for the 15 days in the missing “off-the-clock” period. Thus the following picture can be pieced together, with a relatively high degree of precision:
This math shows that the impact of spring-loading in Q2’16 was – at least – to triple the legacy Jarden asset’s core growth, from 1.6% to 4.8%.
Interestingly, really the only needle-moving assumption made in the numbers above is that Waddington contributed $23M of sales in the first 15 days of the quarter (aggregating to $200M in full quarter sales for Q2’16, which is then stripped out to arrive at core sales). Management has said that Waddington was expected to contribute $800M for the full year 2016, and that the business was “not very seasonal.” Since Waddington makes a lot of disposable plates and cutlery – of the kind typically used at barbecues and garden parties, etc. – to the extent that Waddington is somewhat seasonal, Q2 is almost certainly an above-average sales quarter. If the estimated revenue contribution from Waddington in Q2’16 was increased from $200M to $220M, true full quarter core sales growth would drop from 1.6% to 0.6%. Thus the assumptions above should be quite conservative.
For the consolidated Newell Brands in Q2’16, this spring-loading of the legacy Jarden asset had the effect of boosting overall core growth by (at least) 130 bps, which made the difference between the company beating and missing core sales growth expectations.
Q1’17 made use of a slightly different spring-loading scenario. Two of the three largest deals that Jarden had ever done – Waddington and Jostens – were closed in the 5 months leading up to the announcement of Jarden’s acquisition by Newell. Thus in Q1’16 (an “off-the-clock” period for Jarden), the Waddington and Jostens assets within Jarden were doubly “off-the-clock,” because at that point they hadn’t entered the comp base. So Newell’s loose comment on its Q1’16 earnings call that Jarden saw core sales growth of “about 2%” in the quarter did not include contributions from Waddington and Jostens.
But before we talk about spring-loaded Jarden acquisitions, let’s first delve into how the legacy Newell business performed on a core growth basis. Page 27 of the Q1’17 10-Q gives the necessary information:
“ The increase in net sales for the three months ended March 31, 2017 is primarily due to the Jarden Acquisition (approximately 158%), partially offset by the divestitures of the Tools and Décor businesses (the "Divestitures") (approximately 10%). Foreign currency impacts on a period- over- period basis were not material.”
As shown below, these numbers can be combined using some very straightforward math to show that the legacy Newell business actually saw negative core growth for the quarter:
Even though the 10-Q said that FX impacts were “not material,” to be conservative we still add back a revenue-weighted FX headwind, as based on the total FX number given in the press release’s consolidated core growth table. Furthermore, in addition to announcing the Jarden acquisition in December 2015, Newell had also acquired Elmer’s Products two months earlier in October; today Elmer’s is benefitting from a widespread children’s fad (i.e. using Elmer’s glue to make “slime”). Like all children’s fads, this surge in popularity will have a very limited life.
Elmer’s generated $46M of sales in Q1’16. Thus assuming Elmer’s grew 20% in Q1’17 (a conservative assumption, given the backdrop), that would imply that the rest of legacy Newell actually saw a core sales decline of (1.1%).
So if the legacy Newell business is comping negative, where did the growth come from to get to +2.5% consolidated core growth? Here’s where the spring-loading comes in. Just four days before reporting Q1’17, Newell announced that it had changed its segment reporting. The new segments – “Live,” “Learn,” “Work,” and “Play” – were re-jiggered in a way that essentially broke sell-side models. For example, the new “Live” segment includes fractional pieces of four different legacy segments.
The one legacy Jarden business that we do have good visibility into (despite the segment re-jiggering) is Jostens. In terms of the legacy Jarden businesses, the new “Learn” segment includes only Jostens and “<1%” of the legacy Jarden Branded Consumables segment. So within a rounding error, when we talk about legacy Jarden in the Learn segment, we’re just talking about Jostens.
From page 28 of the 10-Q: “The Learn segment generated net sales of $569 million, an increase of 47.9 percent compared with $385 million in the prior year. The increase in net sales for the three months ended March 31, 2017 is primarily due to the Jarden Acquisition (approximately 44%).”
So here again, we can use straightforward math to back into Jostens revenue numbers for Q1’16 and Q1’17:
This 15% growth of Jostens was thus a very outsized contributor to both the Learn segment (the best-performing segment in the quarter) and to the consolidated business overall. Even though Jostens represented only ~5% of total Newell Brands revenue for the quarter, the $21M it contributed to core growth represented approximately one-third of total consolidated core growth.
So is Jostens really growing that fast? Prior to its acquisition by Jarden, Jostens was a PE-owned company with public debt, so the company filed financials with the SEC. As shown below, Jostens’ Q1’14 and Q1’15 revenue was within ± 0.5% of the Q1’17 revenue figure – it was Q1’16 (the “off-the-clock” quarter) that was an outlier to the downside. The 13% decline in Q1’16 would not have been a drag on Jarden’s “about 2%” core growth in that quarter, since Jostens had not yet been included in the comp base at that point.
This “Learn” segment provides a unique level of visibility because of the cleanliness of the segment breakdown on the legacy Jarden side, and the fact that quarterly financials were reported for Jostens prior to its acquisition. It cannot be proven as cleanly that Waddington was also spring-loaded into the comp base, although similar math using some basic assumptions shows that this was almost certainly the case. In fact, we believe that absent the spring-loading of Jostens and Waddington, the rest of the legacy Jarden business was very likely experiencing negative core growth as well.
This level of financial manipulation appears to be egregious. Although Newell management suggested on their recent earnings call that “the comps are tough in Q2” (effectively lowering expectations), we’ve proven above that Jarden is actually lapping a substantially less difficult comp than what is widely perceived. After Q2’17 is completed, Newell will have finished lapping all of the noise associated with the Jarden acquisition, and this level of financial manipulation cannot be readily repeated. Thus we expect that the next several quarters will begin to expose the business’s negative topline trends/structural challenges.
Appendix / Additional Red Flags:
At CAGNY on 2/24/17, Newell increased its long-term synergy guidance from $0.5B to $1.0B by 2021 (while also increasing the costs associated with achieving these synergies from $0.5B to $1.0B in the Q1’17 10-Q footnotes). Newell expects $300M of synergies in 2017, which can be largely attributed to the elimination of exorbitant executive salaries at Jarden and relatively simple headcount reductions. These actions were always viewed as the low-hanging fruit in the acquisition. We see little evidence of any significant progress in adjusting the underlying cost structure, and we continue to expect the full integration effort to be exceptionally complex.
Note: SG&A was lower than analyst estimates in Q1’17 simply because Jarden’s Q1’16 SG&A was artificially inflated due to the payout of Jarden executive bonuses related to the Newell deal. (This dynamic is similar to the spring-loading concept discussed above for revenue.) An adjusted P&L for Jarden’s Q1’16 has never been given.
On 3/21/17, Martin Franklin disclosed in a Form 4 that he disposed of a large percentage of the Newell stock that he had kept following the deal, pursuant to a “collaring” arrangement he entered into in Q2’16. Collaring a position is generally seen as a bearish indicator.
Note: Recall that Martin Franklin promoted the merits of the Newell/Jarden deal on the 12/14/16 merger call by stating, “I personally intend to keep half of my current after-tax Jarden ownership in the company post-closing. I believe this will result in my being the largest individual shareholder in the company.” At the time, his economic interest was ~$600M (~7M Jarden shares as well as a golden parachute worth ~$180M).
Furthermore, businesses like Yankee Candle, which sell candles primarily on racks in traditional brick and mortar retail chains (and tend to be an impulse purchase that’s levered to foot traffic – i.e., Yankee Candle is extremely exposed to the secular headwinds in the industry), are a lower percentage of total sales in Q1 due to seasonality. Thus the full impact of these secular challenges was muted in Q1.
The majority of the EPS beat in Q1’17 came from a lower-than-expected share count and tax rate. However, the share count was not a function of repurchases, but rather the impact of an appraisal lawsuit by former Jarden holders (and as a result of the lawsuit, there’s a minimum $650M liability that’s not currently part of the share count or net debt calculation). Additionally, earnings beats driven by lower-than-expected tax rates can be red flags of overly-aggressive tax accounting.
As we move further away from the anniversary of the acquisition, core sales will become increasingfly hard to game. Ultimately, the underlying structural weaknesses in the business will reveal themselves.
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