|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|
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: