Description

Sealed Air (NYSE:  SEE) is a strong, geographically diversified business with a dominant market share, maintains a relatively large R&D program (2x of that of its packaging peers), and commands pricing power.  It also is diversified across both packaging and cleaning/sanitation industries.  The stock is a moderately non-cyclical investment with more than one-half of its business in the food and cleaning industries.  The stock is trading at relative low multiples of depressed levels of earnings and free cash flow.  SEE’s competitive advantages stem from its scale, deep design expertise, and its elevated ability to solve customer problems. 

When the stock was in the mid-$20s in the first quarter of 2011, SEE made the announcement that it had come to terms to purchase Diversey, a cleaning and sanitization company, from the Johnson family of SC Johnson & Son and from Clayton, Dubilier and Rice.  SEE made several strategic errors in this purchase: 1) synergies appear rather limited with the core business, 2) the timing was poor, as Diversey has more than 50% of its business in Europe and the Euro began to fall apart soon after acquisition announcement, and 3) the Company dilly-dallied in issuing debt and therefore received a much higher coupon on the debt used to finance the deal. 

Since then, the stock has been trashed by investors for the following reasons:

• Acquisition synergies appear limited.
• The CFO quit.
• The debt level is huge and limits any kind of financial flexibility.
• The Company has rather high exposure to the Euro as a result of the acquisition, and, for a time, the stock traded with a high correlation to the Euro.
• The acquisition makes it seem like growth opportunities in the core business are lower than expected.
• Davis Advisors owned more than 20% of the stock pre-Diversey, and they have been aggressive in selling their shares since the announcement.
• The deal involved the sale of SEE stock plus cash, and both SC Johnson & Son and Clayton, Dubilier and Rice have sold all of their shares, which added to the selling pressure.

In 2013, the acquisition synergies, debt paydown, results from restructurings, and a potential lift from the emergence of W.R. Grace from bankruptcy should all provide tailwinds to the stock, offset by material macro uncertainty with SEE’s European businesses and currency overhang.  I find SEE to be an attractive investment, and a near-double from current prices is not out of reach.

Between the Q2 2012 earnings call and the Q3 2012 earnings call, two material events transpired that impacted investors’ view on SEE.  First, the Company announced that long-standing CEO Bill Hickey would retire in March of 2013.  He has already handed off the role as President of SEE to the incoming CEO, Jerome Peribere.  Hickey will remain on the Board of Directors subsequent to his retirement as a Director. 

Peribere, 58, is a 35-year veteran of Dow Chemical (NYSE:  DOW).  Most recently, Peribere was the CEO of Dow Advanced Materials, a $12 billion global materials business.  As part of this role, Peribere led the integration of Rohm and Haas within Dow Chemical.  Peribere started his career at Dow Chemical selling Ethafoam, a product that SEE acquired from Dow Chemical in the last decade.  In my view, Peribere seems like a reasonable CEO choice, and my discussions with various SEE people at the PackExpo trade show in Chicago demonstrated material support for Peribere as CEO.  I met Peribere in person several weeks ago, and he most certainly seems like the right guy for the job.  He is going light a fire under SEE employees like they have not seen in many years.  

Second, SEE announced several weeks ago that the Company entered into a definitive agreement to sell the Japanese Diversey assets to The Carlyle Group for $377 million (likely to be about $300 million after transaction costs).  The valuation on these assets is roughly 1.2x sales and 8.5-9.5x EBITDA, which I believe to be an attractive price given that Diversey Japan’s growth prospects were “slow to none.”  As a frame of reference, Diversey was purchased by SEE at 1.4x revenues.  Diversey Japan represents ~10% of the Diversey operations and had the lowest profitability among its four operating geographies in 2011.  The cash was used to pay down debt. 

 A short discussion on W.R. Grace is necessary here.  About 15 years ago, SEE purchased the Cryovac assets from W.R. Grace.  Cryovac represents SEE’s food packaging businesses.  As part of the negotiations, SEE obtained an indemnification from W.R. Grace on Cryovac’s asbestos liabilities.  However, subsequent to the acquisition, W.R. Grace went bankrupt, and the courts threw out the indemnification and the liability fell on SEE’s shoulders.  As a result, the Company has a long-standing liability that has been agreed upon and already reserved, but the bankruptcy proceedings are not yet done and may not be for awhile.  Today, this liability stands at $866 million plus 20 million shares of SEE stock. 

With EBITDA under pressure and a higher debt load, net debt/EBITDA remains at an uncomfortable 4.9x and times interest coverage is 5.2x.  While the Company has some near term debt maturities, the estimated 12/31/12 liquidity of the business is ~$1.7 billion, which was, in part, bolstered by the sale of the Diversey Japan business.  SEE should be well prepared should the W.R. Grace case settle.  In the final analysis, should SEE decide not to rollover its debt maturities into new debt issues, the Company should be able to make it for many years without needing to tap the debt markets.  Thus, it does not seem that liquidity is an issue.  Of course, it certainly would be nice for the Company to have the financial flexibility to buy back stock and/or boost the dividend in times like this.

The four primary risks for SEE investors are the following:  1) currency, 2) macro uncertainty, 3) acquisition integration, and 4) raw material spikes.  Management seems to have the last two risks under reasonable control so far.  Price hikes seem to be addressing the input cost inflation that the Company should be facing in 2012.  Given the improved outlook on cost synergies, it seems that acquisition integration is moving along as planned.  Having Jerome Peribere spearheading the acquisition integration certainly seems to be a plus as well.  The Company clearly cannot control macro uncertainty and currency, and these risks remain front and center for now.

Right now, profitability remains under pressure due 1) Euro weakness, 2) acquisition charges, and 3) under performance at Diversey.  Diversey is operating at very low levels of profitability even ex-charges.  As a result, looking at this stock on a sum-of-the-parts basis seems appropriate, and EV/Sales multiples make sense given the depressed profitability. 

Packaging peer Pactiv was taken out a couple of years ago at an EV/Sales multiple of 1.63x, and Pactiv is a lower quality company as compared to SEE.  Diversey’s primary competitor, Ecolab, trades at 2.3x EV/Sales.  Certainly, Ecolab has outperformed Diversey for years, but much of that has to do with U.S. exposure (which is highly profitable), and Diversey essentially has no operating assets in the United States. 

If you discount these multiples by 25%, a sum-of-the-parts analysis calculates a valuation north of $30.  While the Company has a lot of hurdles to improve profitability, these valuation assumptions are far from stretched.  If the Company’s legacy assets return to historic averages and the Diversey assets are able to get profit margins halfway between where they currently are and where Ecolab is, the stock should be a terrific investment.  Given the significant operating and financial leverage involved in the business, slight improvements in the business should result in big EPS gains, and sell-side expectations for improvement remain subdued.

Catalyst