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formatted PDF version: https://www.dropbox.com/s/xft6ibf6ozg7b76/FREE_5.12.2021.pdf?dl=0

We recommend purchasing the shares of Whole Earth Brands (FREE) for ~ 94% upside (to $26/share) by year-end 2023 (~28% IRR).  FREE was previously written up by milehigh in August 2020.  The prior writeup was thoughtful and well-timed.  The stock has climbed to around the original writeup’s price target, but we believe that the stock remains excellent value and underappreciated despite expensive valuations in the public markets at large.  Since last summer, the company has recently executed two compelling acquisitions, giving more clarity on its strategy, and we have gotten to know management much better.    

Our above target is not overly aggressive – we assume that this asset will ultimately trade to a 6% free cash flow yield.  This is arguably conservative since many consumer staples companies trade well above 20x free cash flow.  Expectations are not high and we expect that this will be a beat-and-raise story over the next few years.  The addressable market for sweeteners and natural baking mixes is $30 billion and many of the company’s brands are underpenetrated.    

Whole Earth Brands sells plant-based sweeteners, flavor enhancers, and other food products through a number of well-known brands such as Whole Earth, Wholesome, Swerve, Pure Via, Equal, and Canderel.  It is the largest provider of plant-based sweeteners in the world and has a distribution network with a presence in over 100 countries.  

FREE had a rough debut as a busted SPAC, has shares which are not highly liquid, and the team and company have limited history in the public markets.  Moreover, the company does not jump out on a valuation screen based on messy historical financials.  As the story plays out, acquiring shares at current prices will prove to be a unique opportunity to own a high-quality asset in a secular growth industry with relatively low risk and a solid management team.  The management team is very talented and led by CEO Albert Manzone and CFO Andy Rusie.  

The current setup reminds me of our investment in Nomad Foods (also once a SPAC) in 2017 when it was trading around $13.  In 2017, NOMD was still cheap but had recovered from trading incredibly poorly in 2016.  Whole Earth Brands Chairman Irwin Simon is similar to NOMD sponsor Martin Franklin in some ways -- some people like him, others do not, but he’s generally been successful.  Nonetheless, I feel Martin is more talented than Irwin and more in the weeds operationally.  Both CEOs are European men in their mid to late 50s with strong backgrounds -- Stefan and Albert had long, successful runs at ABInBev and Pepsi, respectively.  Both have assembled strong operational teams below them.  Based on the time we have spent with Stefan and Albert, we believe Albert is the better fit for FREE given that the opportunity is more global and FREE is in a space with more growth potential.  Stefan is a solid CEO, but Albert is the more strategic and flexible thinker.        

Healthier for you?

One of our earlier diligence points was to investigate the validity of the “better for you” claim.  We read various studies and spoke to two health experts, including an endocrinologist at Stanford.  After looking at a number of the company’s key ingredients such as stevia, monk fruit, erythritol, and allulose, we came to the conclusion that company’s claims are true.  

Take erythritol (C4-H10-O4), for instance, which is a sugar alcohol used extensively by the company’s legacy operations, as well as by Swerve.  Erythritol has been used in foods in Japan since 1990 and was approved in the U.S. in 2001.  It occurs naturally in small amounts in certain fruits such as watermelons, pears, and grapes.  It is also in mushrooms and fermented foods (wine, sake, beer, soy sauce, cheese).  Academic studies have been done examining the plasma and urine kinetics of erythritol and the effect of erythritol on plasma glucose and insulin levels.  In these studies, 30% of the ingested erythritol is excreted unchanged in urine after 3 hours, and 80% was excreted in a 24-hour period.  Average plasma glucose and insulin levels measured for up to 3 hours after ingestion, were unchanged.  So essentially erythritol is absorbed into the small intestine from where it heads to the bloodstream before the body excretes it in the urine.  It is not metabolized by the human body.  Erythritol is far less likely to cause GI response compared to other sugar alcohols such as xylitol.  1 teaspoon of sugar equivalent has about 4g of erythritol.  35g of erythritol, which is a lot, has been shown to be very well tolerated.  GI issues do not typically show up until one hits 50g.  But even 25g of xylitol causes issues.    

Strong management team

The CEO Albert Manzone strives to hold the company and its managers to the same high standards he is used to from working at larger multinational consumer companies.  Albert started his career as a marketing manager at Philip Morris International.  He ended up being a senior manager in the Italy division (about $1 billion in profits at the time) where he successfully launched a number of new products and increased market share.  He spent 3 years at McKinsey, primarily focused on the Wal-Mart account.  He then spent over 10 years as a senior manager at Pepsi.  We spoke to former colleagues there and he was an excellent manager and strategic thinker and his last post at Pepsi was running the Shelf Stable Juices (Tropicana, Dole, Ocean Spray, etc.) in North America.  He then ran Wrigley Europe ($2 billion in sales) and upon the sale of Wrigley to Mars he spent time as a senior manager at Novartis and then Oettinger Davidoff.  He has been part of Whole Earth Brands (previously Flavors Holdings) since 2016.  

I go through his resume in detail because it’s unusual for a company as small as FREE (run-rating at $500 million of sales) to have someone of Albert’s caliber as CEO.  He has a long track record of success and people enjoy working for him.  Albert aims to take this company to $1+ billion of sales through organic growth and M&A.  The last few businesses Albert has run in prior jobs have been around $1-$2 billion in sales.           

CFO Andy Rusie joined the company in December 2019.  He started his career as an accountant at E&Y, and then had roles of increasing responsibility at Bristol Myers Squibb and then Mead Johnson and Abbott in Asia and the U.S.  At Mead Johnson, he rose to VP Global Financial Planning & Operations overseeing hundreds of finance professionals.  Prior to Whole Earth Brands, he was VP Corporate Finance & Strategy at Mauser Packaging.  We had many conversations with Andy during our diligence and one of our concerns was his ability to handle a levered balance sheet.  Andy dealt with a levered balance sheet at Mauser (BWY CORP on Bloomberg, private company with public debt yielding 8%) and we came away comfortable with his background and abilities.  He has an excellent handle on the numbers, covenants, downside modeling, the various segments, and also the opportunities the company has.  He also has a lot of consumer good experience and has played a key role in analyzing prospective targets.  He is not new to cost optimization, and has a great handle on cost and synergy potential.  This is a very unique opportunity for Andy as it’s his first public company CFO role; he is incredibly focused and determined to make this work.  In assessing Andy, we spoke to a senior executive at Mead Johnson as well as Mauser.    

We spoke to a few more senior managers.  For instance, we spoke at length with Olivier Bouret, Head of Supply Chain.  Prior to Whole Earth Brands, he was at Kraft Foods for 20 years and then at Mondelez for another 5 years.  We had brief conversations with two of his direct reports that worked for him in Zurich where he headed product supply & logistics for the European chocolate business.  The color we got is that Olivier is very smart (studied mechanical engineering in college), knows how to scale businesses, and is one of the best in the industry.  Olivier has run very complicated businesses (thousands of SKUs, dozens of facilities, managing and proposing investments when needed) very successfully.  He has won numerous industry awards, and thinks in terms of return on capital, risk/reward, etc.  Olivier is excited about the cost and purchasing synergies that the company will be able to achieve now that it is a much larger business given the two deals they have closed.          

Irwin Simon, the founder and former CEO of Hain Celestial, is the Chairman of the board.  We see the quality of management as a more relevant driver than Irwin’s involvement, and through conversations we have learned that it has not been easy for Irwin to let someone else run the show, despite the fact that Irwin is plenty busy as CEO and Chairman of Aphria ($5B mcap).  Irwin has a big ego.  However, Albert’s age, tenure, and ability allow Albert to set the vision and drive the company forward.  I foresee Albert in this role for many years.  Where Irwin does add value is in sourcing M&A, however now that Whole Earth Brands is well-known at least to industry participants, Albert and Andy are getting plenty of calls.  Albert has a wide network in the U.S. and Europe and is very connected (for example, he’s a trustee of Northwestern University, along with the Kellogg CEO and the heads of many PE firms).  Irwin’s main focus is Aphria, so I expect him to let Albert execute while occasionally helping source deals through his extensive network built over the years at Hain Celestial.  We have not spoken to Irwin directly, but we have spoken to a handful of people who know him well through Hain Celestial and Aphria.     

Segments

The company has two reporting segments, Branded CPG and Flavors & Ingredients.    

Branded CPG segment (80% of run-rate revenues due to M&A, 64% of 2020 sales)

Branded CPG consists of the original/legacy Merisant division combined with the recent two acquisitions, and is primarily focused on zero-calorie, low-calorie, natural, no-sugar added, and plant-based products.  Products in this segment are sold both under the company’s flagship brands and also under local and private label brands.  Global flagship brands include Whole Earth, Pure Via, Swerve, Wholesome, Canderel, and Equal.  Formulations are typically tweaked to meet local preferences, and key ingredients include stevia, monk fruit, erythritol, aspartame, sucralose, and saccharine.          

Whole Earth is a global brand of natural, low-calorie sweetener which is primarily sold in North America, Australia, and New Zealand.  Pure Via is a global brand of all-natural, low-calorie sweetener which is primarily sold in Western Europe and North America.  Canderel is a global brand of low-calorie sweetener that is primarily sold in EMEA.  It is the leading sugar-free sweetener in many of its key markets such as France, Belgium, the U.K., and South Africa.  Equal is a global brand of low-calorie sweetener that is primarily sold in North America, Asia Pacific, South Africa, and Latin America.  It is the leading sugar-free sweetener in many key markets such as Australia, New Zealand, and Thailand, and is a top-five sugar-free sweetener in the U.S.  

Swerve was recently acquired and is a rapidly growing manufacturer and marketer of a portfolio of zero sugar, keto-friendly, and plant-based sweeteners and baking mixes.  Wholesome is another recent acquisition and is the #1 organic sweetener brand in North America.  Specifically, it is the U.S. leader in organic, plant-based and fair-trade certified sweeteners, including sugar, honey, agave, nectar, allulose, and other liquid sweetener products.  Wholesome holds a 76% share in the organic granulated sugar segment of the organic and natural channel.  

The company also sells some adjacent products under its flagship brands to address growing demand for various categories.  For instance, the company sells chocolate, jams, granola, and cereal bars.    The company also utilizes several local brands in specific countries.  

Flavors & Ingredients segment (20% of run-rate revenues, 36% of 2020 sales) 

This segment is the legacy Mafco Worldwide division.  This is a global b2b operation which manufacturers and supplies licorice derivative and extract products, primarily serving beverage, confectionery, cosmetic, food, nutritional, pharmaceutical, personal care, and tobacco end markets.  This segment is very cash generative, requires little investment, has over 60% market share, but is also expected to have modest (low single digit) growth long-term.  This segment, while non-core, is better than many think and somewhat misunderstood.  For instance, two research analysts we spoke to mentioned that F&I had an inexplicably weak 2019/2020, but in addition to the pandemic there was a significant one-time impact due to a regulatory change in the tobacco industry in Europe which led to a customer loss.     

We believe that management will eventually monetize this asset.  While management has not publicly stated that it has plans to sell the F&I segment, Albert likely realizes there is some irony in claiming to be a “better-for-you” type of company but then selling a substantial volume of this segment’s sales into the tobacco market.  Also, this is a not a branded CPG type of asset and is inconsistent with the larger vision.  And there are not many synergies between the divisions. Management was somewhat constrained under prior ownership – the company did not have public stock as currency and substantial capital was upstreamed from the predecessor company to the parent company.  Now that the company has gone public and executed two deals, management is focused on integrating Swerve and Wholesome.  We believe that once the integration is complete, F&I will potentially be sold and that capital will be redeployed in an accretive fashion.  The additional scale from F&I was helpful during the de-SPAC’ing process.  F&I has a new leadership team in place and the segment continues to innovate, with 50 new products recently launched under the Magna brand serving consumer packaged goods, OTC healthcare, and personal care products.  The company has also launched a manufacturing footprint optimization project in F&I.                 

Recent results

The company reported Q4 2020 earnings about 7 weeks ago.  The company reported a solid quarter and raised its long-term growth outlook and margin guidance.  Swerve was acquired on November 10, 2020.  

Excluding Swerve, Branded CPG organic revenue growth was 14.5% in Q4 (12.0% constant currency).  The segment benefitted from strong growth in North America retail and e-commerce channels, partially offset by foodservice channel weakness associated with the pandemic.  For the year, CPG had organic revenue growth of 4.5%.  

The F&I segment was down 13.9% in Q4.  This was driven by the timing of orders within 2020 (ordering more in Q3 vs Q4; Q3 was up 9%) as well as the pandemic.  For 2020, F&I was down 7.9%, due to lower international tobacco revenues and the covid-19 impact.  Core F&I growth in 2020 excluding these items was 2.2%.        

Adjusted gross margins were up slightly to 41.8%, and were 42.0% for the year.  Consolidated adjusted EBITDA was $14 million, translating into 18% EBITDA margins.  For 2020, adjusted EBITDA was $54.5 million, or 19.8%.      

Pro forma numbers and long-term algorithm

For full-year 2021, the company guided to the following: pro forma organic growth of 3-5%, adjusted EBITDA organic growth of 3-5%, adjusted EBITDA margin of 17%, capex of $10-$12 million, and a 23% tax rate.  This translates into $493 to $505 million of revenues and $82 to $85 million of adjusted EBITDA. 

The 3-5 year guidance is as follows: MSD net product revenue growth, MSD to HSD adjusted EBITDA growth, 34-36% gross margin, 17-19% EBITDA margin, capex at 1.5% of product revenues, and a 23% tax rate.  

The MSD guidance is reasonable in light of natural growing HSD, legacy products like Equal and Canderel growing LSD, F&I flat to positive.  Upside to this would be from significant ACV increases, international expansion, and continued growth in e-commerce which is rapidly growing and 10+% of revenues.        

2023 run-rate & valuation target

We model the company achieving $105 million of run-rate EBITDA by year end 2023.  This is at the high end of the guidance range.  After $9 million of capex, interest, and taxes, one arrives at about $60 million of FCF to equity.  The implied equity value at a 6% yield is slightly above $1 billion, corresponding to $26 per share.  This does not assume any benefit from incremental M&A.  Given the company’s ability to integrate assets and Albert’s stated goal of $1 billion of revenues, M&A upside is very likely.  The M&A pipeline is extensive and the company is playing below the radar of the larger food companies.  The M&A focus is on North America where the consumer base has the desire and the discretionary income to allocate money to functional benefits.  The M&A effort will not be focused on incubating unproven brands; the focus is on acquiring brands which are unique products, already have built a following and are proven, and can immediately benefit from FREE’s scale and customer relationships.         

Swerve

The company closed on the Swerve (founded in 2001) transaction in November 2020.  It paid $80 million, or 9.5x 2020 synergized adjusted EBITDA of $8.4 million.  The cost synergies are estimated to be $2.75 million and achieved by 2022.  Swerve is the fastest growing shelf-stable sweetener brand across conventional grocery, growing at a CAGR of 150% since 2016.  Swerve has grown off a small base but the growth has been impressive.  Please refer to the slide directly below.  

Swerve is made from ingredients found in select fruits and starchy root vegetables and contains no artificial ingredients, preservatives, or flavors.  It is zero-calorie non-glycemic, and safe for those with diabetes since it has no effect on blood glucose or insulin levels.  Unlike many other natural sweeteners, it has no bitter aftertaste and measures just like sugar, cup for cup.  It’s also the only sugar replacement of its kind that browns like sugar and caramelizes just like sugar.  There are 44 calories in a cup of granular Swerve, so one pound of Swerve would have 88 calories versus over 1,500 calories in a pound of sugar.      

In a few years, Swerve can be a $100 million revenue business with $20 million of EBITDA.  This will not happen by 2023, but considering that Swerve is #1 in the U.S. in its category, still has a long runway for growth in the U.S., and has essentially no presence outside the U.S., the long-term potential is very large.  Whole Earth Brands plans to accelerate growth with entry into new categories, new product development, and new distribution.  Swerve is currently sold in the natural channels, certain grocery stores, Wal-Marts, Targets, etc., but Whole Earth Brands can help gain access to club stores as well as accelerate its online sales.             

Swerve opens up a large addressable market for the company as half of the total global sugar volume is used in baking.  Swerve can be many multiples of its current size given that Whole Earth Brands has distribution in 100+ countries and Swerve has no presence internationally.

Wholesome

Wholesome closed on February 8, 2021 and is the company’s second acquisition.  It is a transformational deal (2020 sales modestly shy of $200 million and EBITDA of $23 million) which is immediately accretive.  The lower margin profile is due to Wholesome having a private label business.  Wholesome is the U.S. leader in organic and plant-base sweeteners including sugar, honey, agave, nectar, allulose, and other liquid sweeteners.  Wholesome has a 76% share in the organic granulated sugar segment of the natural channel and 32.5% share of organic sweeteners in the natural channel.  Wholesome has a unique position in the supply chain as it is the largest importer of organic sugar in the U.S. with approximately one-third of U.S. volumes.  The company will use this competitive advantage to increase distribution of its other products, and potentially manage the whole aisle for customers.         

Like the Swerve deal, the Wholesome transaction is attractive and accretive day one.  The initial price of $180 million represents 7.8x 2020E Adjusted EBITDA, not including revenue synergies (1) expected to be realized across the North American customer base and (2) from launching Wholesome products across the company’s global footprint.  Cost savings will be achieved over 2 years.  The Wholesome deal significantly increases the size of the company’s North American supply chain, so there are significant potential facility and purchasing (ingredients, for example) savings.

Wholesome management is excellent and joining the company.   The company will pay a $55 million earnout (taking the total consideration to 8.2x 2021E EBITDA) if Wholesome hits its 2021 targets.  Assuming the earnout is achieved, this implies 25% EBITDA growth for Wholesome.             

Distribution

Earlier I mentioned that many of the company’s brands are underpenetrated.  This includes the two recent deals which only have a U.S. presence, but also the Whole Earth brand of products.  The chart below applies only to the U.S.   

We have spoken to some key U.S. retailers and ACV expansion is underway.  Internationally, Equal and Canderel are massive brands with ACV of 90%.            

Risks

Leverage: I am not overly concerned about leverage.  The Wholesome deal was financed with cash on hand and a new credit facility.  Pro forma leverage is now 4.5x, and will eventually come down to the target of 3x through debt paydown and organic growth.  But all levered M&A stories should be closely monitored.  

M&A and integration:  The Wholesome deal was a large transaction.  Any M&A missteps will be costly.  The team is keen to do deals and Irwin Simon has made mistakes in the past.  The Swerve and Wholesome deals were privately negotiated, non-auction deals and sourced through Irwin’s network.       

Catalyst

Catalysts 

As the team executes, integrates assets, and establishes public market credibility, this relatively unknown company will start to be seen as an organic growth story in a category with an attractive runway.  

Management increasing the ACV of its brands in the U.S.  This is a higher-margin category for retailers, and the company plans to come to market in a consolidated and strategic fashion to grow shelf-space and even manage the category for customers.  International expansion.    

Ramping the ecommerce opportunities in Swerve and Wholesome.  

Continued M&A.  

Sale of Flavors & Ingredients segments and then redeploying this capital to drive M&A on the branded side.  

Eventual acquisition by a strategic or private equity.  The LBO math works at an acquisition price far in excess of today’s stock price.