Description

It seems strange to potentially like a stock better AFTER it goes up 17% in a day, however, that could arguably be the case for Spectrum Brands.  Spectrum is clearly not a high momentum / “new era” stock, however we believe the equity represents a traditional value investment and an attractive risk/reward.

What Happened?

Today the company announced the sale of its Hardware & Home Improvement (HHI) business to ASSA ABLOY for $4.3 billion ($3.5 billion net of estimated taxes and fees).  The business includes well known consumer brands such as Kwikset, Baldwin, Pfister, and National Hardware.   HHI is ~75% exposed to the repair & remodel space and 25% to new builds. SPB purchased the business in December 2012 for ~$1.4B and has since doubled the segment EBITDA.  The current transaction values HHI at over 14x estimated fiscal 2021 EBITDA.  Coming into today, SPB shares traded hands at $79 per share, or ~$3.4 billion.  In other words, the company was able to sell one division (albeit the largest) for more than the entire equity value of the business.  

Use of Proceeds

Spectrum Brands had a fairly high amount of leverage at $2.7 billion prior to the transaction.  One primary use of the net proceeds will be to reduce gross leverage to 2.5x RemainCo EBITDA.  Note that the new target leverage range of 2x-2.5x is below prior targets of 3x-4x.  Management hopes to reduce/eliminate the valuation drag associated with higher leverage.   Pro Forma EBITDA of RemainCo is $386 million per management, suggesting that gross debt will be around $950-$1 billion.   Furthermore, it implies that the company will have ~$1.7 billion of residual capital available to deploy (see below).  This represents 42% of the market capitalization at today’s closing price.

Additional priorities for the residual capital will be to invest in the business, repurchase shares, and pursue strategic M&A.   The dividend will be maintained on a per share basis despite the lower revenue/cash flow base; however, it will not be a priority to alter near-term.  

RemainCo

The surviving Spectrum Brands will be a more concentrated and simplified consumer staples company.  88% of new company revenue will come from 15 Brands broken down into three divisions.  More of the business will also be tied to consumables (all of Home & Garden, 2/3rds of Global Pet).

• Global Pet Care (46% LTM EBITDA)

• Key Brands:  Iams, Eukanuba, SmartBones, DreamBone, Marineland, Healthy Hide, 8in1, Tetra

• Revenue up 29% and EBITDA up 102% in the past two years

• Home & Garden (29% LTM EBITDA)

• Key Brands: Cutter, Spectracide, Hot Shot

• Revenue up 21% and EBITDA up 23% in the past two years

• Household & Personal Care (25% LTM EBITDA)

• Key Brands: Black & Decker, Remington, George Foreman, Russell Hobbs

• Revenue up 18% and EBITDA up 19% in the past two years

Management plans to focus its attention on growing the core businesses (Pet, Home & Garden) both organically and inorganically.  They explicitly also continue to evaluate strategic options for the HPC business.  HPC is actually the largest segment as a share of revenue on a pro forma basis, however, it carries the lowest margin at just 9% on an LTM basis.  

In terms of the valuation following today’s appreciation, RemainCo trades at an 8.1x EV / LTM EBITDA multiple.  We believe this is too cheap.

Target Valuation

While choosing the appropriate valuation multiple to apply is obviously always subject to debate, we use a comparable company analysis by division (e.g. SMG, NWL, et al) to triangulate what we believe to be a reasonable/fair price.  HPC deserves the lowest multiple while we believe Pet and H&G deserve higher multiples.  On a blended basis we apply 12x to RemainCo in order to achieve a price objective of $128 per share.  

Importantly, this does not include ANY potential positive returns on capital from either acquiring shares at a depressed valuation, accretive M&A, and/or a potential sale of the HPC business for an attractive multiple.  These are obviously path-dependent and subject to management’s discretion so they cannot be taken as a given, however, management is determined to create value for shareholders.   As a simple exercise, if management were to use ~½ of the cash to acquire shares around the current price and then the shares were to re-rate higher it would lead to greater upside for current equity investors on the reduced float.  

Management

David Maura has been the company’s CEO since early 2018.  He also served as the non-Executive Chairman of the Board since 2011.  As he transforms Spectrum Brands, he is intently focused on creating shareholder value in the process.  Below are a couple key quotes which we believe very candidly demonstrate his intentions:

• “The reality is we have worked tirelessly over the last three years to turn our operating performance around, and not only just stabilize the business, but through our GP program, really drive tremendous growth in sales and earnings.”

• “In my opinion and the board's opinion, our share price has remained materially undervalued. I've been saying that on conference calls for quite some time now, and we simply decided, look, it's time to unlock some value, and we demonstrated that, I think, today. And I think, look, even right now, I think the intrinsic value of this company is materially higher.”

• “I'm a large shareholder personally, and I don't like selling assets. I prefer to buy and build and add value to them. But it's my fiduciary obligation to maximize shareholder value in addition to try to run the business better.”

• [Regarding] “HPC, we're going to continue to invest in that business. But there's no question that I'm looking to unlock further value with HPC. But we're going to take our time and we're going to be judicious. And when the right thing comes around, we'll let you know about it.”

• “And at these levels, I'm going to be pretty aggressive in buying back shares.”

• “Look, just because we got a lot of cash coming over the transom doesn't mean we're going to go just buy everything in sight. We're going to continue to be very disciplined acquirers. We need to see synergy. It's got to fit with what we're doing. It's got to enhance what we're doing. And I prefer to be able to buy the multiple down because it's plug-and-play...We're clearly open for business for bigger targets, and particularly Pet, Home & Garden. But, look, we're going to take our time, and we're going to make sure we get it right. Our capital allocation is super important. And so, I don't think you should think we're going to be in any rush to deploy the cash, and that's why we're going to bring our debt down and materially cut the interest expense, and we're going to sit very, very liquid.”

Risks

• Poor Capital Allocation

• Inflation

• Deal falls apart ($350 million breakup fee)

Catalyst

• Aggressive share repurchase activity
• Accretive M&A
• Additional value additive divestments