Spectrum Brands ($SPB) — Initiation (10/9/21)

Price: $96 Market Cap: $4.1bn Valuation: 8x EBITDA Category: General

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If you zoom in on the last few months of that 5-year chart you’ll see a recent pop from ~$80 to $95+ per share. Spectrum Brands ($SPB) announced they’re selling their home & hardware business for $4.3bn; a 14x EBITDA multiple. The entire market cap of Spectrum is $4.6bn.

Management deserves some credit in being disciplined with M&A — from 2012-2017 they spent $3.85bn on acquisitions… Once the home & hardware (HHI) sale closes, they’ll have sold $7.9bn worth of businesses during 2018-2022 and still have $385m in annual EBITDA.

The pro-forma business will be split between Global Pet Care products (GPC) such as dog food, treats, and cleaners; Home and Garden (H&G) which makes pest and weed killers; and Home & Personal Care (HPC) which sells kitchen appliances like toasters and personal care items like hair dryers.

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As of Q2, net debt is about $2.6bn. With net proceeds of $3.5bn from the HHI sale, that brings it to a net cash position of about $900m. There are 42.5m shares outstanding x $96/share makes it $4.1bn market cap. Easy math says it’s a $3.2bn EV with $385m EBITDA = ~8x multiple.

Segment revenue and EBITDA

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I do have some hesitations with this business…

Because of the high level of buying / selling businesses, there have been significant charges for restructuring and transaction costs… easy to spot in the chart above. These totaled $354m from 2018-3Q21 ($100m per year on average). Throw in another ~$160m on average for interest expense and it’s no wonder they’ve struggled to generate meaningful cash flow lately ($516m in operating cash flow from 2018-3Q21). I’m hopeful the divestiture and leverage reset should allow for improved cash flow. It’s worth keeping an eye on restructuring and transaction costs to make sure they don’t keep eating away at earnings.

Fortunately, we’re given some tools to take a stab at a pro-forma EPS / FCF estimate…

Segment reconciliation

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The only real assumptions I’ve made are for 2.25x gross leverage (~$870m debt) at 5% interest and a 25% cash tax rate. All other data points were given to us in the segment reconciliation from the investor deck. Working capital could obviously be a factor here too.

Pro-forma EPS / free cash flow

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These seem to be growing businesses as well — revenue for these carved out segments were $2.4bn in 2018 and ~$3bn over the last 12 months. (Though they did just close on a $300m acquisition for the Home & Garden segment in the last quarter.)

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There are plenty of good comps out there with varying degrees of brand portfolio quality. (I don’t consider large competitors like $KMB and $PG to be “quality” businesses; despite their lofty multiples.) On the whole, consumer brand conglomerates are trading at ~10x EBITDA and 16x earnings. Makes sense given the perceived stability of these staples-like businesses.

Comps analysis

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One approach would be to simply use a 10x EBITDA multiple on the pro-forma business ($386m), this would net a $112 share price (17% upside).

Alternatively, management has made it clear they intend to deploy cash up to the 2-2.5x gross leverage level ($770-960m) which means they’ll have $1.7-1.9bn available for M&A, repurchases, dividends, etc. This makes it much harder to come up with a single-point estimate of value. But what I like about it is the defensive nature in the current market. Having nearly half your market cap available for immediate deployment is quite attractive when your shares are cheap and you feel like the market is poised for some challenges.

The M&A call had some great tidbits alluding to future plans. As a starter, it sounds as though the appliances and personal care division may be up for sale; makes sense given the inconsistent performance and low margins (just look at where $HBB is trading). There were several instances where CEO David Maura mentioned the value of the GPC/H&G segments without referencing HPC — asked about a sale, he said “there's no question that I'm looking to unlock further value with HPC.

This was the comment I found most revealing:

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Ultimately, I think Spectrum will close the deal and begin buying back shares. At the same time, I expect they’ll “hold back” some cash for potentially larger deals ($500m-1bn+). It’s apparent they want to add revenue via inorganic growth. The aggressiveness factor could be way higher if they intend to sell the HPC business as well…

I see FCF close to $5-6/share valued at 16x makes the core business worth $88/share. Tack on “deployable” cash of $1.7-1.9bn ($42/share) to stay within the 2-2.5x leverage target and you have roughly $130/share in upside (+35% from here).

A sale of HPC could get me more interested as would fading of the transaction/restructuring costs over time…