Description

Thesis:

Newell’s recent announcement that it will be acquiring Jarden at ~$60 per share ($21 in cash and .862 shares of Newell), a ~25% premium to where Jarden was trading prior to the deal leaking out, creates a compelling opportunity to short a very overvalued company (NWL), who’s levering up to acquire an even more overvalued company (JAH).  More importantly, this transaction is occurring on the eve of both companies being exposed for what they truly are (i.e., no growth/slowly declining, low ROIC businesses, whose shareholders have been the beneficiaries of nothing more than charismatic and promotional CEO’s rather than real operating performance/value creation). We should note that Martin Franklin’s convoluted public comments indicate he will be keeping less than 25% of his holdings (effectively the deal premium) post close—a very telling indication.

We see 50% downside to our base case, valuing NWL at 8.5x proforma 2017E EBITDA (and generously giving them credit for $200mm of synergies by 2017, which we are highly dubious of – more below), or $20 per share, and envision a downside scenario where NWL is ultimately a single digit stock.   We expect the market will re-rate NWL in the ensuing quarters following the deal closing, as the deteriorating operating performance and lack of organic growth become increasingly clear (as the combination of financial leverage in excess of 5x EBITDA, large exposure to emerging markets, sheer size of the consolidated entity, complexity of the integration, and the Jarden asset outside Franklin’s hands, will make it extremely difficult for Mike Polk at NWL to continue to hide what’s actually happening underneath the hood at these two entities).  Furthermore, as market participants continue to digest the Jarden acquisition, we expect the “management valuation premium” assigned to NWL has the potential to erode extremely fast, and thus, we see potential for our thesis to play out in the very near-term – said differently, we believe that NWL’s announcement to acquire Jarden may have been its “Sunedison to acquire Vivint” moment.

• To the extent that there’s logic to the acquisition, perhaps there’s a “culture fit”, as both CEO’s appear to share a similar talent of employing aggressive accounting and creative definitions of non-GAAP company specifics metrics such as “core growth” to create the illusion that they are managing dramatically better businesses than is fundamental reality.  However, although their ability to “promote” their stocks has resulted in remarkable share performance at each entity over the last several years (largely driven by multiple expansion), their underlying operating performances have been wholly unimpressive – in fact, we’d argue there has been little (to no) value creation at either company whatsoever (which is very likely the reason the transaction is occurring in the first place – i.e., both parties are willing/motivated sellers of their equity).

• In other words, we believe that Michael Polk at NWL was desperate to do a deal and use his overvalued equity to buy something to dilute/mask the true underlying fundamentals of his business before they became apparent (likely commensurate with the deconsolidation of Venezuela, potentially at year-end, which has been the main driver of growth simply because of hyperinflation).  Meanwhile, Jarden’s operating performance was showing signs of weakness and Martin Franklin was issuing equity hand over fist to make increasing large acquisitions in what we believe was an effort to hide what was actually happening at his business – He received a stroke of good luck when NWL showed up, as he was able to use Michael Polk’s desperation to stuff NWL and exit Jarden at the exact top.

Newell Rubbermaid:

We think Hamilton1757 did an excellent job laying out the bear case for NWL (on a standalone basis) in his thesis posted on 6/18/15, so we’d point readers to his analysis for more specifics re: NWL.  However, we’d note that we view NWL’s decision to acquire Jarden as confirmatory not only of Hamilton1757’s thesis (i.e., that appearance of progress re: NWL’s restructuring program has been nothing more than illusion, created by accounting shenanigans and Venezuelan hyperinflation, both of which are coming to an end), but also that Mike Polk is a “bad actor”, and knew/knows exactly what he was doing.  

• We believe that a quick scan of the cash flow statement sheds light on the true operating performance at NWL, where we see no signs of progress whatsoever.  As an aside, we find it remarkable that Mike Polk has been able to drive a 200% return for his shareholders simply by driving a re-rating of NWL’s stock from 7x EBITDA (where NWL ALWAYS traded prior to Mike Polk’s arrival) to in excess of 13x when it’s so easy to look at the GAAP financial statements and get a true picture of the fundamental state of the business.  We are not surprised by the lack of growth/progress at NWL, given their underlying end-markets and large exposure to big box retailers (who demand annual price concessions) as well the fact that there are several elements of NWL’s business that are very clearly in secular decline (for instance, the writing category, which represents half the operating income is subject to the same structural issues that have depressed the multiples of every other office product company).  Importantly, the below analysis does not even attempt to strip out the Venezuelan impact (which will contribute $55mm of FCF in ’15 per the recent proxy), which has not only helped to distort NWL’s definition of “core growth” and margins, but also the cash flow statement.  Without the Venezuelan impact, cash earnings growth would be even more tepid (likely negative, during Mike Polk’s tenure).

• Also, it’s worth pointing out that on page 126 of the proxy NWL is projecting 2015 FCF(CFO – capex) of $236.1mm, which they state is artificially depressed by $70mm of voluntary pension contributions and $60mm of tax on the asset sale.  Ignoring the fact that they keep A/R when the make an asset sale (and liquidate it, thus juicing CFO), NWL will do $366.1mm of “normalized” FCF this year, or $1.37 per share (which notably, includes a quarter of the Elmer’s acquisition as well as the company’s late 2014 acquisitions of Ignite, bubba brands, and Baby Jogger for a total of $~$600mm).  To keep an apples to apples analysis, adding back ~$150mm for working capital and subtracting ~$30mm of stock comp to NWL’s projected FCF, I arrive at $486.1mm of cash earnings in 2015, or $1.82 per share -- lower than it was back in 2010 (Venezuela wasn’t contributing much/anything back then), despite a number of acquisitions, refinancing of debt at lower rates, and a cyclical upcycle!).

• We’d also point out that NWL is not a true staples business – EBITDA dropped 20% during the Great Recession.  As such, we see a tremendous amount of downside for the business on a standalone basis during a down cycle.  

• Furthermore, we find it comical that NWL has recently resorted to reporting constant currency “core sales” to exclude the impact of changes in foreign currency.  As a result, Latin America is the primary driver of “core sales growth” with core sales growth of 30.8%!  I’m sorry, Mike, but when you are dealing with emerging economies that are experiencing rampant inflation, that is anything but CORE growth.

Jarden:

Meanwhile, we find Jarden even more nefarious.  Jarden is the ORIGINAL Valeant (i.e., a serial acquirer of mediocre -- to below average -- businesses) with a history of low-quality earnings and questionable corporate governance.  In fact, prior to becoming a darling of the street during the past several years, as market participants desperate for growth flocked to “roll-up stories” (and, partly thanks to Bill Ackman, who presented Jarden as a case study in “value-creation” at Ira Sohn titled “45x”), Jarden was the target of the short community.

http://www.marketwatch.com/story/why-bear-bets-against-jarden

• Somehow, despite its stock getting cut in half during 2007 on the back of these short reports (and ultimately bottoming in the low-single digits during the financial crisis), Martin Franklin managed to wiggle out of these accusations and keep his scheme alive (clearly the Fed’s ZIRP policy helped him out quite a bit).  During the last several years, he has continued to make acquisitions of a massive hodgepodge of consumer products companies (using his perpetually overvalued equity to make them accretive – his value proposition has been nothing more than his ability to sell stock at massively inflated prices – i.e., the very definition of a ponzi scheme) - today Jarden generates ~$10n of topline & ~$1.5bn of fwd EBITDA.  The street seems to have forgotten Jarden’s sketchy past, which also included things like “related party transactions”, where Franklin created businesses outside of Jarden and then monetized them by selling them to Jarden, and today Franklin is viewed as a “value-creator” / tremendous capital allocator.

• In fact, we believe a relatively simple analysis of Jarden’s historical financials suggests that Martin Franklin has created absolutely no economic value whatsoever during his 15-years with Jarden.  The collection of business Franklin has cobbled together offer no-growth (and never have), and in fact, are currently declining.  

• We believe that Jarden has been manipulating its “core growth” by making small acquisitions and then deeming them “complimentary to the core business and insignificant” and as such, treating them as “core, organic growth”.  Therefore, it has been buying “core growth” and masking it in its “acquisition capex” creating the illusion of actual growth, and thus helping Jarden command a higher earnings multiple than it deserves.  It’s then used its overvalued equity as a source of cheap currency to continue the charade.

• For those looking to dissect Jarden in a more granular way, I’d point you to 2012 (which I find an interesting case study, as Jarden made $286mm of acquisitions that year and I don’t believe accounted for any of them as “significant”, after making zero in 2011).  However, I’ve excluded my more detailed attempt to strip out the insignificant acquisitions at Jarden (as the analysis contains a number of assumptions), and believe the more simple data point below is perhaps even more telling.

• We believe the easiest way to look at Jarden is like this:  Jarden spent ~$3.2bn of capital from 2009 – mid-‘2014 on acquisitions in excess of maintenance capex at core Jarden (note: I’m only assuming $250mm of acquisition capex in ’14, as they only had the assets for half the year and I’m also assuming 2009 capex is maintenance capex for “core Jarden”).  Meanwhile EBIT improved from $462mm in 2009 to $835mm in ’14, or a total of $373mm.  At a 35% tax rate, Jarden increased NOPAT $242mm.  So, Jarden got a ~7.5% unlevered cash on cash return over that time period during a cyclical rebound!  Hardly an impressive ROIC and certainly not a reason to pay 13.7x EBITDA for the stock.

The lack of any real organic growth (stripping out the cyclical rebound) makes sense given the low multiples they paid for the assets they acquired.   Again, we see absolutely no evidence whatsoever that Jarden has improved these businesses.  As such, the only reasonable explanation for Jarden trading at 13x EBITDA was Martin Franklin’s ability to simultaneously sell stock at 13x and acquire assets at 8x (which is no longer viable in NWL’s hands).  With that in mind, we believe Jarden is worth exactly what Martin Franklin has been paying for these business, or 8x-9x EBITDA, on $1.5 billion in '16 EBITDA, or $12-$13 billion in stand-alone value (frankly, we think that’s generous, as Martin Franklin was the highest bidder in all of the deals thanks to his “funny money”, so was likely overpaying for the assets.  We also believe these businesses have been starved for capex, making the original multiple paid for the assets even more questionable).  

Recent Red Flags at Jarden:

Starting in July, Martin Franklin has gone on an acquisition/equity selling binge, seemingly funneling equity out the door as fast as humanly possible.

• On July 31st, the company acquired Waddington Group for $1.35bn, or 9.2x EV/EBITDA.  Jarden issued 18.4mm shares at $54, or ~$1bn of equity to help finance the acquisition.

• On November 2nd, the company acquired Visant Corporation, the holding company of Jostens from KKR & aPriori Partners for approximately $1.5 billion, or 7.6x EV/EBITDA.  Jarden issued 11.5mm shares at $49, or $563mm of equity to help finance the transaction (Interestingly, Martin Franklin purchased this asset while he was in negotiations with NWL per the recent proxy – why not buy something at 7.6x that you know you can flip to NWL a month later at 13.7x?!  We find it comical that Martin Franklin bought ~$3bn of assets at ~8x that he flipped to NWL a few months later at 13.7x – now THAT is value creation).

• Notably, the two aforementioned acquisitions are the 2nd and 3rd largest deals Jarden has ever done (only Yankee Candle at $1.8bn was larger in 2013).  Furthermore, Jostens is a business that’s very clearly in secular decline (40-50% of their business is yearbook sales) and topline has been degrading ~2-3% a year for the past decade or so.

• Note:  I can’t help but think that there’s something rotten happening in Jarden’s core business (more on that below) that Martin Franklin was hoping to disguise with two large acquisitions (not to mention two “insignificant” tuck-in acquisitions during the first 9-months of 2015 as well).  At a minimum, it appears he doesn’t think Jarden is worth anywhere near ~$53-54, let alone the $60 he sold the entire company for to NWL.

• Martin Franklin also personally sold 200k shares of stock on August 19th at $54.90 and 200k shares at $53.77 on May 18th (while this isn’t a crazy amount relative to his holdings, ~6% of his total shares, and he has historically been a serial seller of his stock, we still think it’s a notable data point).

• Jarden reported weak Q3 results on 10/29, with one analyst noting that the guide-down was the first he could remember in a decade of covering Jarden.

• Jarden’s 2016 EPS guide implies zero “core” EPS growth yoy.

• After stripping out recent acquisitions, topline is currently comping negative at Jarden (and weakness appeared to accelerate in Q3).

• Jarden’s stock was already starting to come under pressure dropping 20% from mid-summer prior to the deal being announced.

The Deal:

On December 14th, NWL announced that it was buying Jarden for ~$60 per share ($39 in stock based on the NWL share price of $48 and $21 in cash), or ~13.7x EBITDA – the deal is expected to close in Q2 ’16.

Newell is massively overpaying for Jarden while taking on a tremendous amount of risk for very little upside:

• As mentioned above, amazingly, Martin Franklin was able to buy two assets over the prior 5-months for $2.85bn, or 8.3x EBITDA, and then flip them to NWL at 13.7x EBITDA.  The only conceivable reason that Jarden traded at the multiple it did was Franklin’s ability to continue to orchestrate the Ponzi scheme by buying assets at 8x and immediately having them rerate to 13x.  Given our view that NWL won’t be able to continue to do that (the leverage and size of the entity will preclude them from doing so), NWL has effectively paid a premium on top of a premium.  

• Despite claiming that he’s a huge believer in the deal, Martin Franklin said on the call “I personally intend to keep half of my current after-tax Jarden ownership in the company post-closing”.  Hmm, I’m not sure if he’s referring to whatever stock he is left with after the cash component of the takeout price, or relative to his pre-deal holdings (and I don’t know what his tax basis is  - I’m guessing low), but he is very clearly selling a lot of stock commensurate with the deal.

• Excluding synergies, NWL will be levered 5-5.5x following the deal and 4.5x including $500mm of proforma synergies, which they expect to be more heavily weighted to years 2-4 of the integration.  Even being generous and giving them credit for a couple hundred million of synergies, this thing will still be 5x levered, severely limiting their financial wherewithal.

• Given our view of Jarden, we are highly skeptical re: the synergies on this deal, as this is going to be one complicated integration.  

• This deal is expected to take NWL’s revenue from ~$6bn to $16bn, the number of plants will grow from 40+ to 120+, while broadening its geographic footprint.  Furthermore,  Jarden is a massive roll-up with 120+ brands that they’ve acquired primarily from private equity over the years and runs completely decentralized (it’s basically a portfolio of companies) and there’s little to no corporate at Jarden.  

• So to recap, first these businesses were held by private equity for years, who then used Jarden and their “funny money” equity as an exit, and then Martin Franklin ran them for cash at Jarden (where we can’t imagine he didn’t anything but continue to run them bare bones to keep his capital markets fueled roll-up story alive) – we can’t even fathom the amount of deferred capex, etc. in this collection of business. We find it amusing that NWL pointed out “container shipping rates” as the first item of potential synergies when pressed on the merger call, as we can’t fathom how that even remotely moves the needle.  We also find their strategic deal rationale (that comes out during a conversation with management) as ridiculous – as they’ve taken to suggesting that the “sneaky part of the acquisition” is that Jarden is like NWL was 4-years ago, and “they are going to turn it around and reinvest in marketing to drive organic growth”.  In fact, we believe NWL mgmt is essentially acknowledging that Jarden was massively underinvested in, was/is not comping positively, and they are effectively suggesting that there’s going to be a significant cost to driving improvement at Jarden (not to mention that there aren’t many, or perhaps any, “real synergies”).  Finally, we’d note that given the actual operating performance at NWL, we do not think they have any credibility whatsoever in turning around struggling businesses (and question their reason for paying 13.7x EBITDA for the right to do so).  Our guess is that Jarden was the only company willing to take NWL’s overvalued equity as currency for a deal and Mike Polk was so desperate for additional one-off restructuring line items and a large business to dilute Venezuela that he was played for a fool by the more market savvy, Franklin.

• Lastly, this integration not only involves integrating “core” Jarden, but also the two $1.5bn deals Jarden did in the 5-months preceding the Jarden deal as well as Newell’s $600mm purchase of Elmer’s in early October ’15.  

Catalyst

Catalysts:

• Continued earnings deterioration at both entities

• Ponzi schemes break down when they get too big