Description

Whole Earth Brands (FREE)

Short

$3.96

In June 2023, Whole Earth’s largest shareholder, Martin Franklin, made a non-binding all cash offer to acquire the company for $4 per share, which at the time was a 28% premium to the then current share price (and 42% premium to the 3 month average). Since the offer was made 7 months ago, Whole Earth’s business has deteriorated, and it is on track to miss guidance for 2023 and also underperform its long term guidance. In addition, debt has ballooned significantly and is currently sitting at 5.4x TTM EBITDA. Further, recent acquisitions were funded by floating rate bank debt when interest rates were much lower. This has meant that cash flow has been diverted from debt paydown to service higher interest rate payments.

Simply put, the company is in trouble. There have been two long write ups of this name on VIC and the general thesis was that the business would grow revenues, improve margins and generate free cash flow to quickly de-leverage the balance sheet and increase shareholder value. That has not happened and the stock is down over 60% since the De-SPAC transaction. We believe that without this non-binding $4 offer from Martin Franklin, the stock would be down significantly more.

As a short, the set up here is quite interesting. The downside if the acquisition moves from non-binding to binding and actually closes at $4 is only 1% from today’s price of $3.96. Yet, if the deal breaks or the business continues to deteriorate, the upside is quite significant. Consider how the market would react if the largest shareholder (and well known investor) decides not to purchase this highly levered, fairly illiquid, micro-cap business after making an offer only 7 months ago? It would start to think that the decline was terminal and begin to shoot first and ask questions later. There is no doubt in my mind that the stock would get crushed.  

At the time of the offer, Martin Franklin wrote the following:

We wish to proceed to a transaction swiftly in order to minimize disruption to the Company’s business. We are willing to dedicate meaningful resources to this project and would expect a similar level of commitment from the Company. We are prepared to enter into a customary non-disclosure agreement with the Company, so that we can complete our due diligence and negotiate all definitive documentation within 90 days from the date of this letter. We expect our due diligence to include primarily a financial and legal review of the business. This proposal is an expression of interest in a potential transaction, is subject to due diligence and is non-binding.

Despite Martin Franklin having de-facto control of the company with 21% of shares (his son was CEO until he resigned shortly after the offer due to conflict of interest) and a strong interest in closing the deal quickly, nothing has happened for 7 months and counting. The question is why?

Here is what a fellow VIC member wrote about Martin Franklin regarding another investment: “What I learned from the ESI experience is that MF [Martin Franklin] is a dreamer. He envisions futures that may or may not be realistic.”

I agree with this assessment. Seven months ago, Martin Franklin saw a future that was not realistic and now reality has intruded on that vision. Even if the company turns around the business, the balance sheet will still be a problem. Management has stated their target for financial leverage to be 3.0. Given consensus estimates for free cash flow and EBITDA, it would take nearly 3 more years to get leverage down to that target.

Martin Franklin is now in a bit of a pickle. He owns approximately $34 million worth of Whole Earth which would be down significantly if he pulls out of the deal, but also doesn’t want to increase his investment by a factor of 20x. So he’s decided to sit on the ball, hoping the business will turn around. The only saving grace from his perspective is that he didn’t sign a binding agreement.  

Obviously, we are not privy to any internal discussions and both Franklin and the company have been completely radio silent on the acquisition for many months now. However, given the time that has elapsed and deterioration of the business, we think there is a significant chance that this deal will break. Even if the business somehow turns around, the levered balance sheet and $4 acquisition price puts a ceiling on the short exposure risk.

In conclusion, it is only with a hint of irony that we note that for a company that sells plant-based artificial sweeteners the stock price is being artificially held up by a non-binding buyout offer that seems unlikely to come to fruition.

Catalyst

Martin Franklin walking away from the $4 offer

Business further deteriorating