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PJ Kurzweil on Spectrum Brands $SPB (podcast 117)
PJ Kurzweil, founder of PJ's SMID Cap Ideas, comes on the podcast to discuss his write up on Spectrum Brands (SPB). Spectrum is currently in the process of selling their HHI business, and whether that deal goes through or not PJ thinks the stock is too cheap given the quality of their brands / businesses. You can find PJ’s first podcast appearance on BC here and my notes on SPB here.
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Alright. Hello, and welcome to Yet Another Value Podcast. I'm your host Andrew Walker. If you like this podcast, it would mean a lot if you could follow it, rate it review it wherever you're listening, subscribing, whatever. With me today, I'm happy to have on for the second time, my friend PJ Kurzweil. PJ, how's it going?
PJ Kurzweil: It's going well, thanks for having me on again.
Andrew: Hey, thanks for coming back on, and thanks for doing it so quickly. Let me start this podcast the way I do every podcast. First, a disclaimer to remind everyone that nothing on this podcast investing advice, please do your own research consultant, financial advisor, all that type of stuff. But we're going to talk about a stock idea here today, but it's not investing advice. Then the second way I start my podcast is a pitch for you, my guests, people would go listen to your first podcast to hear the original pitch but look, you're a sharp guy. I know the first podcast got really nice reviews. I had people coming up to be like BC trading for seven times earnings and earnings are gonna grow like it's a pretty interesting story with share buybacks. We've got another one of those today.
So with that all out the way, let me just pitch it over to you. The company we're going to talk about is Spectrum Brands, the ticker is SPB, and I'll turn it over to you. What is SPB and why are they so interesting?
PJ: Thanks, Andrew. Yeah, so as you said ticker SPB, a $3.2 billion market cap company. Just giving you a little history here, the company was founded in the early 1900s as a small battery company and IPO'd as rail back in 1997, which will tell you that it still maintained its battery heritage until a few years ago. The company did some subsequent acquisitions in the early 2000s in the home and garden space, the global pet care space, and in the home and personal care space before rebranding in 2005 to Spectrum Brands.
The playbook here historically has been to acquire consumer staples and durable brands, mostly us focused except for the home personal cares a little bit more of a global business. But in any case, they want to leverage the channel relationships to boost distribution across geographies or retail channels, and obviously leverage centralized infrastructure for back office and marketing and things as such. The company did pick up some leverage, ran into some trouble in the global financial crisis, filing for bankruptcy in Feb of '09 when they missed an interest payment. There was a debt for equity swap, which is how HRG got involved, which David Moore was an analyst for at the time.
Andrew: I remember those days. You might dive into the history, I remember Jeffrey's at his stake, HRG. I remember all the drama.
PJ: Yeah. Those are interesting details over time but thinking about the business today, and while we're talking about it, Spectrum is undergoing a significant transformation moving from what we'd say is a bloated platform company to a much more focused home garden and pet business. As I'm sure we'll get into a lot of discussions on, they are selling their hardware and home improvement business to Assa Abloy, ticker SSAB, which will bring them to a net cash position and curve a lot of management's comments, allow them to buy back a lot of stock. They're also in the process of separating their least desirable business, their home and personal care business, a lot of which is a contract manufacturer in China. Bottom line, lots of hard catalysts here but also an meaningful improvement in the business and financial profile of that company when you think about it on a go-forward basis.
Andrew: Perfect, perfect. I want to dive into a bunch of different things there. I've already sent you my list of questions. People can see it in the show notes that I posted before we get started. But I guess my first question is always look, we're gonna go into a lot of stuff, but this is Spectrum Brands. It's a company that's been around for a while. As we mentioned, look, Jeffrey's had a stake in it, HRG had a stake in it. It's a lot of personal brands, people know this company. So my first question to you is because the company has been very clear that they want to buy back stock, what are you guys seeing that the market is kind of missing and thinking the stock is cheap, the stock is an alpha opportunity?
PJ: Yeah, no, that's always a question I try to answer when we first get to looking at an opportunity. I think there are a few different pieces. I think the bigger picture, the home and garden and global pet business do have some very interesting tailwinds that don't just make it a COVID winner, but maybe a COVID accelerant or an accelerant because of COVID. We can talk about those trends in that business. People have some questions about the HHI business, hardware in home improvement business and whether it will get sold, I think we can certainly discuss that. I don't have an excellent anti trust argument but there's certain pieces we can point to feel more confident about that. That's a huge game changer from the balance sheet, especially with the business currently having it in discontinued ops, but not giving it credit for an EV.
I think people probably don't give him as much credit for getting rid of HPC home and personal care, I think that will be margin creative, that will be gross to creative. I think this business will be a smaller business. But a more focused business that will get better coverage on the buy side and sell side you're not going to have to straddle building products and consumer products. I do think there's a good chance this business will go after Central Garden and Pet, which is more of a down-the-line feature. And I think investors probably underrate this company's desire to buy back stock.
Andrew: Yep. That all makes total sense to me. I guess the first place we should start is the HHI sale because my Bloomberg is refusing to update currently, but if I've got my numbers right, at about $80 per share, a little over 3 billion market cap, somewhere between three and three and a half billion, it's got about three to three and a half billion of debt and they're selling HHI for three and a half billion. So we're talking about half, a little more than half of the enterprise value-- sorry, they're selling HHI for more than three and a half billion, but three and a half billion is the net after-tax after fees and everything. So we'll just say three and a half billion. So this is more than 50% of enterprise value. Obviously, that's a huge meaningful number so I just want to start there. HHI, what is it, what's the multiple they're selling it for. and why is the market worried that this deal might not happen?
PJ: Great. So HHI hardware and home improvement was a business that was acquired from Stanley Black and Decker back in 2012 for about 7.4 times EBITDA, 69% roughly of the business is in the lock set.
Andrew: PJ, just real quick, because I think it is important when people think about this management team in the company's history, you said 7.9 times EBITDA but could you also put a $1 figure on what they acquired it for?
PJ: 1.4 billion or 7.4 times EBITDA on a trailing basis back in 2012. So 1.4 billion, yeah. Roughly high 60% of business is lock set, which is really what Assa Abloy the acquirer is interested in. The rest is faucets, their Pfister's brand, plumbing rather, and their hardware business, which is door hinges, things like that. So the blocks at businesses really sold under the Kwikset brand. It's also sold under the Baldwin and Wiser brands. They're a really strong player in the mid-tier residential home market in terms of 75% exposed to repair and remodel, 25% exposed to new construction. They primarily sell through the DIY channel. We're about 40% DIY, Home Depot and Lowe's and the rest they sell through builders. And really, the goal here is that people will continue to need locks over time, it's a durable good, but there's a real opportunity to move towards electromechanical locks, smart locks, locks that can unlock using different verification features, and also even have a business that can be rekeyed on its own when the Kwikset businesses can rekey a key in 15 minutes. Go ahead.
No, I was just gonna say look, I remember looking at this in 2018 or 2019 and be like, oh, that's silly. But then if you ever go to an Airbnb and they've got those electronic locks, so you're not like searching for the key in the dark of night or something like that is what this business dude does, right? These electronic locks, all sorts of different locks, and once you experienced like, instead of having to take out your key and do it... Once you experienced the, hey, just tap a couple of buttons and get in like, it really is a difference. There is a little scale here. I mean, I don't think it's the greatest business in the history of the world, but you can start talking to yourself, hey, at the right multiple, this is a business that should grow at least GDP growth, there's probably replacement cycle. Anyway, I'm ranting a little but just wanted to add that because I do remember looking at that and thinking that.
Yeah, it's a high teens margin business. EBITDA was mostly within the 250 to 260 range after a bumped when they bought it. Last year was a blowout year whether it's a stimulus or people staying at home building homes, home offices, whatever it might be. So Assa Abloy, their behemoth are listed on the Swedish Stock Exchange. They are 75% commercial, 25% residential focus. I think they own the HIV brand. They do a lot of different things but they've always wanted to enter into the US residential market. But Slash, I guess you pronounce it that way in Kwikset, which is Allegion and Spectrum really have a stranglehold there and Assa Abloy just doesn't have the connections through the home builder channel or through the DIY channel, which is why they were meant to acquire it. They are acquiring it at 14 times EBITDA back on September 8th, 2021 it was announced. They believe they can synergize it down to 10 times EBITDA, which would be reasonable compared to their 12x multiple. It's the biggest deal they've ever done. This is like a $22 billion market cap company, I think when you look at it in US terms, this does not have a huge impact on their balance sheet.
Andrew: And then, I think there's a regulatory angle, and then there's just a price angle here, right? To use a top example, this buyer is not Elon Musk. Oh, like we paid 14 last year, and now it's worth eight, we want to get the heck out of here will do. But there is a real regulatory angle here. So why don't we talk about regulatory concerns, and then I think they'll bleed into a discussion around multiple because I do think people say in September or October, multiples are a lot lower now, like, what's kind of the downside? But let's start with regulatory.
PJ: Great. So unfortunately, we don't have a ton of information. I'm not a lawyer, I did consult a lawyer for certain general matters in terms of the process. But I didn't find an analog in terms of a similar type case nor that, you know. If your bet here is purely will the case be denied on an antitrust basis, maybe you want to wait to see. I'm totally open to that in the thesis. But in any case, the timeline that we kind of map out is that they announced the merger in early September. The first request is basically satisfied when the companies submit documentation to the regulators. Again, we don't know in the US if it's the DOJ or the FTC, and this business is predominantly us. So we'll just focus on the US regulatory situation. DHSR period obviously expires after 30 days, the companies still indicate the merger is not close so we know that there was a second request. We understand that the DOJ and or FTC had been extremely thorough and how they analyze these cases. So they probably gave them a lot of things to look at, in terms of giving them additional documentation.
Companies can take anywhere from four to six months, maybe less, maybe more to satisfy the second request. I wouldn't say the burden is on the buyer, both sides have to contribute materials, but obviously, Assa Abloy is pushing this along. So that second request would have been satisfied by our timeline in March or April. At that juncture, the regulators may or may not have entered into a timing agreement, which basically gives them more than three days to kind of review everything. And so that kind of puts us in the July-August timeframe. Okay, great, and the merger draft date is December 8, 2022.
So in terms of anti-trust, most of what I share is been discussed by the company but basically, Assa Abloy does not have a real material presence in the US residential lockset market. They do have the M-tech brand and a Yale brand, but definitely not in the mechanical lock business. That's not a big part of their business. Now in the US SmartLock business, they do have the Yale brand and the August brand. HHI has the Kwikset brand and if you kind of sum those up based on a consultant report that Assa Abloy provide in a press release, I believe it's somewhere in the mid-30s In terms of market concentration for consumer global share in the SmartLock business.
So the SmartLock business is probably where it gets interesting. In the merger agreement, maybe it was poor drafting, but they agreed to do any and all remedies for antitrust subject to certain carve-outs that were obviously not disclosed to us. So would they be willing to sell the August business? Would they be willing to sell the Yale business? Will US regulatory body will fire them to divest in any case? Again, Allegion also plays in the Smart Lock business. So those are the general variables. Go ahead.
Andrew: To me, just like 30%, you say they have mid-30s market shares, smart locks, and like mid-30s is generally when having been exposed to antitrust. Mid-30 is actually anything higher than 25%. It's when your ear starts to pick up like, oh, maybe this is a concern. But at the same time, like it's smart locks, you know, like, it's tough to, for me to argue that there's tons of lock-in or that it wouldn't be easy to switch to any of the other 65% if these guys--
PJ: Are you in there? I'm sorry, you cut out for a second. Go ahead.
Andrew: It's just hard for me to imagine like smart locks, like there's not competition, that it'd be a very narrow definition say, oh, these guys have 35% of the market share. So all of a sudden your smart locks are going to be costing like $1,000 per door, you can go with old locks, they're 65% of it. It strikes me as a little bit far-fetched that this is a real antitrust issue.
PJ: Right. So just to be clear, Assa is about 20, and then I think Kwikset is I don't know 14-15, 12 so that's how you get to 32. Yeah, look, Assa Abloy, this business is about technology and innovation. Spectrum Brands is just probably not the player to really innovate the way Assa Abloy can. So you're basically replacing, I guess in the SmartLock business, you should at the end of the day get better products for the consumer.
Andrew: I think that covers HSR nicely. So let's talk about valuation because they're selling this for 4.1, 4.2, or something. Net after taxes will be 3.5 to SPB and I think the big downside is that anyone who looks at this for one second is gonna say, hey, Andrew, you just told me how their proceeds from HGH are going to be more than 50% of the EV. If this deal falls through, then all of a sudden, like the EV, it's not, and they agreed to sell it in September at 14 times, EBITDA multiples are way down there. So how do you think through the downside and what HHI would be worth if this was bought for some reason?
PJ: Okay, well, first, the break fee of $350 million dollars, it's about 8% of proceeds or 8% rather of the purchase price compared to usually 4-6% that you would see. And that's triggered even if the deal falls apart because of antitrust remedy requirements that are too onerous are subject to the carve outs. So that should give you some confidence that Assa Abloy feels as though they can close the deal.
Look, I think in Assa Abloy's merger call which everyone should read, I mean, Spectrum had a call, Assa Abloy had a call. They do briefly highlight that this was a two-round process and that it was a competitive process. And if you take a step back, you think about it. This is a business that has like 40% market share, it is concentrated on the customer side so you can't just be a small guy and just pop up here. So there's definitely some scarcity value here. I would think there were other strategics that may have sniffed at it, whether it's Fortune brands or other companies, maybe a Masco. And I think there would be private equity interest. Through anecdotal conversations, I think the company has acknowledged at some point that this has been a business that has gotten inbound interest over the years.
So in terms of how do you value that, there are not a lot of precedent transactions for us to look at of scale. Allegiant trades at roughly 13 times EBITDA and I think I argue in the write-up, it's a better business. But if you give accounts, some control premium, you can probably shake out around 10 and a half times EBITDA and it's not killing anybody granted it's on a higher, a pretty good EBITDA base of 307 but that's roughly a 25% haircut and that to me finger in the air kind of makes sense.
Andrew: So if I'm doing the math right in my head like HHA, I think I've got them at... called 300 million of EBITDA. Is that right, about 300? And so they're selling it for 14 times or so. You're saying, hey, in a downside scenario where the strikes, it's 10 times, so that would be net $1.2 billion loss, but that would be offset by two things. A, you get the 350 million break fee, and B, you're burning about $600 million of proceeds in terms of just kind of taxes, transaction expenses, everything. Obviously, some of those sticks if the deal falls through, but if you're talking the difference between keeping this business and valued at 10 times and selling it at 14 times if you're talking to differences called 700 million. Yeah, that's not great. We'd obviously rather sell it but it's obviously not the end of the world, right? It's not, I hate to bring back Twitter, but it's not Twitter where you agreed to sell for 54. And given what the markets have done since then, it's probably worth 20 or 25. on the open market. So there's this mammoth difference.
PJ: Yeah, I would say a couple of other things. Look, if they have to do another deal, they're going to be more deal fees. Right. But I think that's probably offset slightly by the fact that they're NLL utilization. They say they're gonna burn them all up with this deal. It's possible that with a smaller deal, they'd be maybe more fully covered on a tax perspective. But yeah, and there's also the question as to whether Spectrum Brands would even sell it for 10 and a half times, but I think they've made the case that this business is not a platform for scaling up. It's a durable business, it's a good business, but it's just not fitting into the rest of their platform. And so I think 10 to half times might be, you know, the high end of the range of people would give it for still part of the company as a sum of parts. But I think for control premia, scarcity value, I think it makes some sense.
Andrew: Perfect, perfect. Alright, so that covers, you know, I think the issue that anyone who studies this is going to be the first scary thing and like the answer is, hey, hopefully, the sales go sale goes through. But if it doesn't go through, it might not be that scary. So let's talk about the other pieces of SPB. So the two big pieces here, there's an HPC, which they're looking to sell their consumer brands, but then the two pieces that are going to really drive this going forward are the pets and the gardening side. So let's just talk about them. You know, how big are these? What products do they sell? Why are these nice businesses?
PJ: Yeah, and I just want to say one more thing about HHI. I think you all should listen to Andrew's podcast from last week he hosted with Jeremy Oh, there are some who just think that you can walk away from a merger, and maybe Elon Musk things [crosstalk]. You know, I don't think there are any surprises in the HHI business where someone's going to say after they do a ton more diligence that there's a material adverse effect or change. So anyone who kind of thinks that this deal is just not going to happen because Assa Abloy has buyer's remorse, hey, it's a strategic asset to Assa Abloy but it generally doesn't work that way. Even as a non-lawyer, I think I can say that with some degree of confidence.
Andrew: Yeah, look, buyer's remorse, there have been plenty of people in history who've signed deals and been like, oh, this is awful. But if you can just get away from deals without anything other than hey, I've got some buyer's remorse, I think I overpaid. Like one of my arguments for Twitter is Delaware law stops working every contract you sign in two weeks later, you say, I kind of wish I didn't sign that. I'm just gonna walk away now. Like, and as you said, this is a real buyer. There are real synergies here. They're trying to get through. There's a very tight merger contract, which is generally what happens after you have, as you said, a two-round process. The seller gets a very seller-friendly contract because other people are willing to pay it. So yeah, I 100% agree.
PJ: All right, so we can cover HPC and then we can talk about really what I consider the remain co-businesses. Great. So home and personal care, really began with Remington in the early 2000s, which I think is somewhere between 400 and $500 million of sales that's sort of a haircare product, personal grooming brand. Not top tier, but it plays globally. They then did a Russell Hobbs merger, they acquired that for roughly 675 million it was stock for stock merger that Russell Hobbs better known in the UK but they got the licensing rights for Black and Decker to make toasters and things like that. They got the George Foreman brand is a pretty big brand.
Andrew: I remember that. Yeah, I forgot that they have the George Foreman brand is doing well. Like I remember in the 90s, everybody had the George Foreman and there were the ads and you lose weight because it was like grill out the grease and everything. Is that still around? I'm not sure how that's held up in kind of the digital age.
PJ: I mean, look, people still need to cook food. It's not like their avatars can eat food for them. I didn't mean that [inaudible]. I think they're actually innovating making a smokeless grill. I know my girlfriend cooks food in your apartment, and the smoke alarm always goes off, and I have to turn it off. But hopefully, that's an interesting piece of innovation.
Andrew: PJ is a tall guy so you could reach up and press that New York City smoke alarm when it's all the way up there.
PJ: Exactly, exactly. So the business today is I think it's roughly 60-40 kitchenware and home sort of personal care. Look, the business is predominantly contract manufactured in China. That's what's kind of made it a little challenging for them. There's been tariffs in 2019. There's inflation, there's particularly freight inflation. It's generally a high single digit, low double digits business. I comment in the write-up that it's really gone from 15% margins to like 8% margins. There should be a bounce back in the second half of the year as they get price. These guys, I think 32% or so is sold for Walmart and Amazon but there's private label competition here. I mean, these gizmos have 6 to 9 years of average life and they're not the most sophisticated devices.
So they recently did the Tristar acquisition, that's another 325 acquisition price. Basically, Tristar has like I don't know if it's power Excel, Emeril Lagasse, and other throwbacks, his equipment, and I think copper technology. But they also have a direct-to-consumer studio. They can sell stuff on TV, which is another channel. Critically, this gets his business to around a $1.7 billion revenue business and roughly $140 million EBITDA run rate, something that can stand alone.
So that's the overview of HPC. They haven't scaled it beyond the Russell Hobbs deal, and just the very recent Tristar deal. There was a rumor that there was inbound interest actually in 2018, that they were going to sell it. They did a very smart thing and get guidance for that sale, the timing, and the proceeds, which end up falling through whether it was tariffs or just not getting the price they want. There was a rumor last year that CVC was going to try to merge it with Con Air in a JV structure, which is kind of why you hear JV rumors today. And ultimately, it's the lowest quality business, in my view and I think in the view of many people. So just having the scale to divest it, I don't think you can IPO it just given the markets, but given the opportunity to sell it or spin it, I think those are really the paths forward for that business.
Andrew: That makes total sense. And then so you know, in your write-up, you've got, hey, this can sell for about 10 times, EBITDA which to me most consumer brands, the 10 times is about, right. But you do serve anything, and I think we'll talk about this with the pets and home and garden in a second. But, you know, you start looking at and you say, Okay, well, the whole company is trading for nine times, EBITDA, this is their worst segment, like 10 times EBITDA. Yes, I get it, but it does start to stretch and I would say, oh, like earnings have declined. I'm just looking at their year-over-year number, like, from 76 million in the first half of 2021 to 38 million in the first half of 2022. We'll talk inflation all this in a second but I just look at all that and say, oh, you know, PJ thinks they can get a billion for this. That'd be a pretty aggressive multiple on trailing numbers, just given how much earnings decline in the first half. And it doesn't seem like that great a business people have known it's been for sale for years, like, is that really reasonable?
PJ: So a few things, maybe first, on the earnings power, inflation is a big factor, definitely ocean freight, those have spiked and kind of persisted. This is also a business that you know, is impacted by resins metals. So I really think in Barclay's conference right after the deal management admitted that HHI and HPC are really most exposed to inflationary forces. The way I tried to think about it is that the business is underearning just given tariffs inflation. As such, I don't assume tariffs reverse but the company has said a few times I really this business should be a low double digits business. We often know that there's buyers and sellers multiple there'll be the with the sellers excited to sell it and with the buyers saying it's getting at and so really, I tried to reverse engineer that. I put the sort of details in the write-up. But I think in the bear case, they sell it, they buy it for five and a half times buyers multiple. And I think it's six and a half times the buyers multiple and then I think maybe an eight and a half times buyers multiple. So I think that's important to highlight the-- excuse me, the base case is seven and a half times buyers multiple, but really, it's the delta in the margins. Anecdotally, it sounds like there could be a lot of cost synergies from someone else picking it up. So that's kind of the way I've thought about the sale there.
Andrew: Consumer brands tend to be some of the highest cost synergies because you mentioned Con Air, you own the Con Air brands, you go and buy the George Foreman brands like you can basically fire everyone in the finance departments. All of a sudden, you had one relationship manager at both sides who was managing the Walmart relationship. Guess what? You can merge that, you can pack everything in the same boxes, merge distribution centers to send it to Walmart. Like you've just got so much duplicative costs because you guys are doing the exact same thing. It does tend to be one of the highest.
Let me ask you on inflation. I was gonna ask this later, but I might as well now. HHI, HPC has been through the hardest hit by inflation. And the company is called out multiple times, like I've got a quote out there that says, hey, are our continuing operations are going to be like three or 400 million of EBITDA this year but that's after we had $400 million in costs headwinds from inflation in the first half of the year. So my question on inflation, we've talked about how it's hit the company in the past, but the company has said, hey, we've taken price increases and by q4, especially those price increases will have flown through and will be offsetting a lot of inflation.
I do wonder, like, I've wondered this for a lot of business, price increases tend to be kind of sticky, and if we got into a situation where they're fiscal 2023 or just calendar year 2023, whatever you want to call it, ocean freight has come way down, metals have come back to kind of where they were a year ago. Could you be in a scenario where all of a sudden these guys are printing margins way above what they normally do, just because these inflation things that kind of spikes have come back, and they already took the price, and they kind of look and say, hey, we don't need to give all that up instantly, it takes a while? Is that a possibility or am I kind of dreaming?
PJ: I think conceptually, it makes sense. I'll say I haven't been a buyer for one of the customers in terms of the retailers to really be able to speak to the mechanics there, but we see that in commodities and other businesses. Look, admittedly, Walmart announced two months ago or a little more than a month ago that year-over-year inventory rose 15 billion, and they kind of wish they didn't buy to 20% of that or 3 billion. That's across all products. So, if inflation comes down, but the consumer is weaker, will the players want to, will the customers that Spectrum faces want to get charged lower prices? I think there's some understanding between the retailer and the consumer product company as far as how temporary or how permanent some of these price increases should be. So I hear you, I think it makes good sense, but I can't speak confidently that there won't be some reversion as well.
Andrew: That actually dives nicely. So I think that covers personal products. Let me talk, let's go to pets and home and garden. We'll talk about each of the individual segments but your discussion on Walmart made me think of the high-level bear case for these. It's hey, Walmart and Target if I remember correctly, they said the right inventory is still moving really quickly, right? Like Target had this thing where they said, hey, our luggage is just flying off the shelves because people want to travel, people want to go have experiences. What we're having issues moving is a lot of the home self that we stocked up in 2021 and people already bought that they don't need anymore and they want to go experience.
So my question on home and garden and pets would be both seem to have great tailwinds but especially home and garden because Penny's sitting behind me. I was checking my day to see Penny, my dogs behind me like once you buy a pet like that's a unit pet, you're not gonna get rid of that, you're gonna keep buying food products, whatever for it. But home and garden, I do wonder if this was a massive COVID beneficiary. And if we're looking at 2021 earnings, are we kind of missing the forest or the trees because 2023 maybe people don't care as much as to their garden. Maybe people are traveling, they're not as much at home care. Was this too much of a COVID beneficiary pull forward? And I do think back to... you mentioned in your write-up, ScottsMiracle-Gro, which has seen their stock come down a lot, part of that is marijuana drip and there's other stuff. But part of it is people were buying fertilizer like crazy a year ago and maybe they're not buying quite so much this year.
PJ: Yeah. I saw your question when you sent it to me just before the interview, I pulled up a ScottsMiracle-Gro presentation, and actually the one area where they have seen an increase in point of sale has been in the control space, which is the weed killer. So, and obviously, Spectrum competes there with their spectracide business. So a lot to unpack with home and garden. It's a very seasonal business, a very weather-dependent business. Look, Central Garden and Pets had risks recently that it was, I don't know if it was a horrific May or just a horrific weather start to this quarter, I think. But a good week in May can more than make up for it. It's more on season, it's warmer out there more insects, there's more weeds, etc.
So I think 20 and 21 probably had some really good weather. I think 21 saw some restocking. So I think 22's up on a tough comp. In terms of the future of gardening, I mean, look, I think it's a hobby, it's outdoor living, I think some people view those as positive secular trends. There's movement from blue to red states, going from cooler environments to warmer environments. And in fairness to Spectrum, they're actually focused on a pretty narrow area really focusing on pest control, 39% is weed control, and then a smaller amount in cleaning and personal repellents. So I find that that is probably a little less subject to sort of large bounces, people want to grow new things. But I think there are some secular trends that probably keep this growing better than the 1 to 2%. You know, I mentioned ScottsMiracle-Gro took up their guidance, long term two to 4%. Obviously, they've had some issues this year, to what you were saying. So that's kind of how I think about it.
Andrew: I did have one question. You mentioned this earlier, and it's in your write-up that I think it was millennials are actually a little more likely than boomers to I'll just say invest in their lawn, right? Like they do a little bit more lawn care. It's not like millennials are 7x more likely or something. But it is, they are more likely and that would be a tailwind just as you think about boomers continue to age up, millennials continuing to buy. And look, maybe it's my New York centric lifestyle or maybe it's just... but I was a little surprised by that just because I feel like, again, maybe I'm interpreting the stories too much like the American dream was such a thing in the 60s and 70s. I feel like now it's a lot more people rent or maybe they're willing to move a little more, so they don't kind of put that same TLC in their yards. Do you think that there's real legs to the millennials are more likely to invest into their kind of home, and that's a long-term tailwind for these guys to ScottsMiracle-Gro 2-4%, or is maybe that there's a misinterpretation of the data there?
PJ: Well, I think there's some good data that says the millennial homeownership has grown. You know, homeownership, I think, predominantly single-family housing. There is a notion of de-urbanization to a small extent. I don't know if it's going to offset the longer-term trend of urbanization, but that has both positive implications for global pets. People who rent in apartments may not be able to have a pet, but if you can have one you have a home. Likewise, when you have a home, you have some sort of lawn that you want to take care of. Another piece of data I didn't mention that came from Central Garden and Pet was there's actually 18 million new gardeners in 2020. So that's that. I mean, I think gardening is largely viewed as an older person's sport, so to say.
Andrew: That's kind of where I was driving at, yeah.
PJ: Yeah, I think it's been encouraging that millennials have kind of stepped up and taken more care of their gardens. I think again, it is a concept of outdoor living, which I think is become a bigger factor in COVID I think people get to spend more time at home because of work from home and I think people want to be outside to interact with friends and do things and so I think it is a really fair I think between global pet and home and garden. I think the secular story is probably a little stronger for global pet. Home and garden will also benefit long term from global warming in my view, just given the increased number of insects you'll have over time and more rain and during warmer weather would help with weed control but all that was mentioned in the write-up but that's more or less how I think about it.
Andrew: Let's talk global pet and I want to be cognizant of time, but there's some good brands here, right? Like I oh no, they only have your times if I remember correctly, but Nature's Miracle which I was laughing at the front page of their investor website is nature miracle stain and odor remover for pets is somebody spraying it. And I'm certainly familiar with that product from when Penny was a puppy. But there are good brands here. Let's just talk about when I say global pet, like the things that popped to mind would be something like Purina. They're good brands here, but they don't have like the Purina or the Blue Buffalo brand or self like they're really top brands. So can you talk to me just a little bit about how good their brands are? What are the competitive moats in global pet care?
PJ: Yeah, I would say first, competitive moats. They aren't as robust as they are in home and garden, we didn't really talk but in home and garden, there's the EPA and that kind of help with structurally higher margins. And they're usually only a few key players in the categories, SC Johnson, lesser extent Central Garden and Pet. Now, look, dog food is a competitive business and it's typically dominated by bigger players like General Mills, or Buffalo Blue, as you said. So I think that's probably why they don't play in that space and to the degree to which they played in that space with the European transaction. It just didn't work out well for them. So really, they are focused on the dog treat space, Dream Bone, a few others that I'll pull up in a second. They play in, like you said, the dog or pet cleanup space with Nature's Miracle, which is a real brand. And they play in Furminator, which is a dog grooming and so there's 70% companion pet, which means dog and cat 3% fish, they also own the Tetra brand, which is a pretty dominant business in the fish business as well as in the fish tank business.
So there is a real private label place in global pet. I think interestingly, Central Garden and Pet said that during the crisis, people actually went more for brands than for private labels. I don't know if it's just trusting that the manufacturing process is better and pet COVID or whatever it might be. That's interesting. Yeah, yeah. So that was kind of a big, that was kind of an interesting data point. And look, a private label is a real player, and Central Garden and Pet do make a private label but I do think people want to give their dogs treats. These are all really consumable things. And there's the humanization of pets. There's the proliferation of more pets. I think someone said 57% of existing pet owners actually got a second pet which might be hard in your apartment, Andrew, but people have done that.
Andrew: It's not the apartment that's the whole back. It's the wife that's the whole back for the second pet.
PJ: Exactly. So lower barriers to entry, but still high teen margins. I think Spectrum as a whole likes to play in certain niches where they have a good position. I will know General Mills bought Tyson's business, which was a sizable but not massive business and SPB said it was rumored to have gone in the high teens.
Andrew: Actually, why don't we just cover home and gardens at a competitive edge as well. So we just did pets, and I'm with you once you get a dog, there is some barriers to entry here. Once you get a dog and you start giving the treats like they do play a lot of treats, the nice thing is that's really renewable. And you tend to want to give your dog the same thing because if you've ever switched kibble brands and all of a sudden your dog has diarrhea or something like that is awful. So you know these tends to be a very, very sticky product similar to if you chew gum, you tend to stick with the same thing. Let's go over to home and garden, you mentioned briefly but I think this is kind of the crown jewel business, nice long term tailwinds, nice regulatory moat. Why don't we just cover that real quick?
PJ: Yeah, there's a two-year EPA registration process, you know, these are chemicals that are in these products, whether it's on your lawn or for killing insects inside your house or other pests. So really, that's the barrier to entry. It's not easy, it takes a while and it's not that easy to get into. So I haven't seen a huge amount of private labels in that space. There may be some but I think really, you know, it's generally dominated by really a few select players. So I haven't really seen precedent transactions in that space. I don't mention any in my write-up. But I did see Green Garden was acquired by Central Garden and Pet that's more seeds on the herb side and vegetable and flower. Central Garden pet didn't disclose that multiple for the $532 million transaction, but they said it was in the teens. So I think, insect repellent business, pest control, I think there would be an appeal from a cash flow business doesn't require a lot of CapEx, but it's really the EPA that probably keeps people you know, out of that business.
Andrew: Makes total sense. So let's talk valuation real quick. So in your write-up, you say hey, look, I think the stock is trading for maybe seven times, let's call it 2023 EBITDA10 times 2023, un-levered cash flow, which are really attractive multiples, right? Like, we've talked about how they're selling HHI. But I would think GPC would be worth the probably 12 plus multiple on if you put it for sale, we talked about how you thought HPC is worth 10. We talked about home and garden would probably be worth 12-14, it depends on the environment and everything. But the whole company, bottom line, whole company trading for what you think is seven times forward. And we just talked about how the sum of the parts are worth almost double that EBITDA multiple.
So, my two questions there are like 2023 earnings are going to be a lot higher than trailing earnings because trailing are in some impacted by inflation? So how do you see the path to getting there and then be like, why that multiple discrepancies? Like what kind of closes it? Why do you think you're right, and the markets wrong? I know, that's a lot to toss out to you in one.
PJ: No, no, no, look, I think in the write-up, we're talking three different scenarios where the multiples vary, and the financials vary. I'm happy to unpack it here. So basically, first to kind of restate it. The seven times EBITDA for remain CO is assuming that HHI sells for 10 and a half. Yep, times EBITDA if it sells for 3.5 million remain CO is like sub six times EBITDA. Now the point of comparison between the EBITDA and the un-levered, free cash the un-levered, free cash refers to 2024 Or is where we see less restructuring expenses, which really has been part of the Achilles heel of Spectrum. I see them stepping down next year to 20 million, although it really depends on whether the transaction closes before their fiscal year which begins at 9:30 or 10:1 rather. But really, you also see a huge per share, jump because of all the buybacks, which you know, doesn't really impact the EBITDA. So I used un-levered free cash because this business can be effectively net cash. And I think you want to, you want to give it credit for that. So, look at some of the competitors, I looked at Central garden and pet. And they traded like 20 times EV un-levered, free cash. It's a little bit of a quirky type multiple. So I only really mentioned it in the one-pager. But that's it is one way to kind of see the cash flow relative to how big the company is.
Andrew: Unrelated question, I actually do want to come back to Central Garden and Pet and it's top of my mind, and I want to make sure I got it in because it was actually one of the questions I really had when, when looking at this, the company historically has spent about 2% of revenue on advertising, and they said, hey, maybe that was too low, we're gonna take it out to 2.5% over time. And I didn't comp at anything or anything so maybe I'm just being a fool throwing the question out, but it did strike me both home and garden and pets. Those are very much brands like you build that brand loyalty. And I did think like 2.5% on advertising, even that does seem small for a kind of consumer brand. Are they under-investing in advertising or am I kind of missing something on that side?
PJ: No, it's a great question. And it's one that I still have, historically, they spend around 1%. Now they're moving it closer to 2. I think normal consumer packaging brands may spend more than double that. So I think maybe it just comes down to the spaces they play and the recognition of the brands they have and whether you know, I don't see insecticide commercials. I mean, I used to see roundup commercials but some of these products just maybe generically don't require as much advertising. Similarly, with global pet, I think you made a really good point that you want to give your pet consistent food or treats or things just because the pet it will be agreeable with the pet so I haven't been able to speak with the company I did reach out that would have been one of the questions on wanting to focus on.
Andrew: Yeah, no, it's just, advertising is an expense. It's a pretty sure line, but it just didn't strike me as these are pretty sticky, you get a pretty nice multiple, it just seemed low just in a vacuum. You mentioned Central Garden and Pet a few times and I have not looked at them in a while. I do think I remember that. It's got a super-voting structure. But I think I remember that there was someone from Liberty Media on the board, which is why I looked at it, but that company trades it's in the name right Central Garden and patented that's going to be a pretty nice comp for the pets in the Garden Market for SPB that company trades for I'm just looking at Bloomberg 10 times EBITDA, you mentioned the un-levered free cash flow number, but when I look at that trading at 10 times EBITDA and I look at Spectrum Brands trading at if HHI goes through Whew, maybe nine times, trailing EBITDA we've talked about how the trailing EBITDA has been impacted by inflation. But Central Garden should be running through some of the same issues I don't see that big of multiple discrepancies.
So, two questions for you here is Spectrum Brands remaining businesses, are these just better businesses than Central Garden? Do you think Central Garden is getting maybe a control multiple discount or and long term? It sounds like you think these two businesses might kind of be meant for each other.
PJ: Yeah, so look, I'm not an expert on Central Garden and Pet but I certainly studied it in the context of Spectrum. Like I think Central Garden and Pet was just pick their pet business. First. They do focus on quote, unquote, a little more durable stuff like dog toys, their nylon bone brand, they also do dog pads, they do warming things for pets. And they also focus a bit more on birch seed. I don't have the breakdown between aquatics and companion pet, but I'm sure it's similar to Spectrum. But I think that their margins are lower, in part because they do private label. But I think even before that, if you look at some earlier reports, I think you would see that.
So I think on the pet side, I think Spectrum would definitely skew to have more consumables. I think they have more recognizable brands. In terms of the garden side, look, I think Central Garden and Pet has some exposure to controls, there'll be a, you know, it's, I think more of a distant third versus SC Johnson and Spectrum. But they also do have a grass seed business, a fertilizer business. So it's actually a complementary business to what Spectrum has. So I do think there's a control premium discount. I think the company does have some leverage, but again, it trades at 10 times EBITDA. I do think that if you slapped on that multiple to the remaining businesses of Spectrum and assume that they got the base case of 3 billion really or 3.1 billion of proceeds from HHI stock would be worth [inaudible].
Andrew: And as you said, Central Garden, probably a worse business, like just you mentioned the private label that they do. But also, if you're selling dog toys, those are generally one-time purchases, it depends on how quickly your dog's going through the tube and stuff. But those are one-time purchases that are going to have a lot less loyalty, than something like dog treats, dog food, all that type of stuff, which is more heavily where the SPBs businesses are. So you said it, it trades for 10 times EBITDA slap that on to SPB and you get a really nice number, but then you adjust for the control premium, the voting control discount that Central Garden would get plus the fact that it seems like SPBs businesses are probably a little bit better. So you could say CNET's 10 is SPB's 12 which gets you a nice place. Spectrum brands, their pet business. I've got Penny. I'm a dog lover obviously so I tend to focus on Nature's Garden, all that type of stuff but if I remember correctly, their aquatics business, which I don't think about because I don't think about fish a lot but they've got GloFish, Tetra, Merlene. I mean, I think these are like the best aquatic businesses out there. Am I misremembering that?
PJ: No, Tetra is a leader in food and leader in I think tank-related equipment filtration, that used to be a bigger part of their business. Again, fish tanks are not as is a much more durable good. GloFish, I believe is actually the ability to create fish that glow in the dark, which is pretty cool. But yes, I think they are really the leader in the aquatic space, which is really not really a growth business. I think we highlight that the number of fish pet fish is not grown over a pretty long period of time when compared to other pets. But yes, I would say it's bigger. It's a nice business, but it is they are the player.
Andrew: And I think there's a little bit of... that was going to be one of my questions. I do think fish at best have like kind of sold out and at worst, they're probably in decline because people just they've got a lot of other things, you've got a lot of Fortnite to wash it. There's no time to take care of a fish. But you know that that is a pretty stable business. And I do think there's engineering components to it, right? Like if you go to a family and you say hey, you're getting your fish a fish for your kid. Do you want the name brand filtration system? Or do you want the knockoff? You know, generally knockoffs are just as good as name brands. But this is keeping the fish alive right like you might have to explain to your kid while you're flushing the fish down the toilet two weeks earlier, if you get the knock-off like that's no bueno, man. That's no bueno. So I do think there's engineering components, obviously distribution all that but I would not be surprised if these are pretty nice, pretty Modi businesses and as we've talked about the multiple, they're not really getting credit for it.
I think we've walked through the majority of my questions. Oh, last question, we got to talk capital allocation. Everyone who listens to this podcast knows my second question is generally like, why isn't the company buying back stock if they're so cheap? I think the company is buying back stock here. But I've been really impressed by how they've talked about capital allocation. So I'll stop ranting. I'll let you talk about capital allocation, m&a here, buybacks, all that type of stuff.
PJ: I just want to go back to Central Garden and Pet. I do think one of the questions you asked is, why would it be a good fit for Spectrum? I do think they do complement each other in the sense that the fertilizer part the wild-bird seed for Central Garden and Pet in their garden business. And again, on the dog side, we've highlighted certain complementary businesses. It's worth noting that David Moore as part of HRG, did bid for Central Garden Pet back in 2014. And so once interested, always interested, I think that that is a real consideration plus this chairman with the majority controls 81. So I think those are two additional pieces that highlight.
The question of capital allocation. Look, I remember when you asked me about Brunswick, you were surprised by the pathetic insider ownership. No offense to Brunswick. Here, look, they bought back a lot of stock, they bought back a lot of stock after they sold Energizer and Global Auto Care. They've been more cautious in terms of buying back stock now, to a lesser degree only because really, they know that the downside here is they get the $350 million break fee, and they probably figure, let's get closer to the deal and let's have more certainty, and then we'll make it happen. So you can read all the quotes in the write-up, and you'll see how aggressive they feel about it.
Insider ownership, David Moore owns a lot of stock, I'd say almost one and a half percent of the company on a beneficial basis. So a lot of his wealth is here. I don't know what other outside interests he has. But he has also bought stock. And he's acquired stock through grants. So capital allocation, I think is one of the most interesting aspects here, I say that they can buy anywhere from 700 million to 1.2 billion worth of stock. In the bulk case, obviously, they're buying stock at a higher price and a bear case, they're buying stock at a much lower price, or maybe not too far from where it is today. And that's really what juices the per-share earnings and free cash. And really, it will be a big shift to go from today four times levered to going net cash, which is unheard of in the space, from what I can tell. Yeah, and then you're going to back up the truck for buying stock, because frankly, m&a in the pet and home and garden space is just really expensive.
Andrew: That's one of the things that's so interesting hear. You've said through this podcast, you've been consistent in saying your base case is that HHI doesn't go through, it's worth 3.1 billion in some form or fashion, that's your base case. But it's so funny that I hear you're being conservative everything but the base case should probably be they have a signed contract to get 3.5 billion in proceeds. Once they do that, as you said, like they have net cash on the balance sheet which you do not find consumed stable consumer brands with net cash on the balance sheet for very good reasons. They are stable consumer brands, private equity, would love to lever them up, and just run that thing. And I think they're gonna they said, hey, our long term target, it's two or two and a half times that leverage, I think you can get there really quickly by taking $400 million of EBITDA or 300 million, whatever number you want to say, bring it to 602 times two that buys you 20% of the company. So you could just do a big tender right off the bat, you could just get really aggressive with an ASR, but that the math works and creates a really interesting out year free cash flow per share number, as you said, if the deal goes through, and they buy back 1015 20% of shares at anywhere close to these prices.
Alright, I think we've hit all my questions, but I always want to turn it over to you. Anything we didn't hit that you wish we had hit, anything that we kind of glanced over that you think we should have hit a little harder?
PJ: I think we've covered a lot of things. I would say tactically if someone's looking to trade this stock, look, if the deal doesn't go through the stock will go up before it will go down before it goes up. So that's just how trading happens and obviously, they have to secure another buyer. If it's a PE buyer, there shouldn't really be any time issues there in terms of how long that will take but I want to just caveat everything with that with you.
Andrew: Everything's risk reward, right? But yes, if this deal doesn't go, if the HHI deal doesn't go through the stock probably goes down the next day, but that's because there was an event that path 50% chance that the stock that the deal went through, 50% chance that the deal didn't go through. But the fact is as you've walked through, even if the deal doesn't go through, slapping conservative multiple on HHI, they get the 350 million and break for a season, right? Like the stock still looks very cheap and yet sucks. They can't buy back 20% of shares tomorrow, but like, that doesn't change that the math still works even if HHI is worth two and a half billion, not the 4 billion, they're gonna sell it for something.
PJ: Yeah, I think the only things I would highlight, we got some questions on Twitter, I think I tried to address them as quickly as I could. Look, in terms of pricing power, these guys in the year we're anticipating taking down 70-80 % of inflation, inflation has stepped up from their previous guidance because of ocean freight. But that said in their recent call, they said they'd gotten 98% of their price increases approved by their channel partners. And so I think that speaks to their ability to get some price on their products. As you said, Andrew, they've claimed that they've replaced 400 million of inflation over the past 18 months, roughly with price.
So look, I don't know if 2023 itself is set up for an amazing year. In terms of the excuse me, 2022, rather, just as you said, Andrew, a lot of inflation. In terms of global pet, it's not a seasonal business, but there was a lot of issues shipping from Vietnam and Cambodia, their rawhides and so now they feel they have the right product, they're good to go. Tristar will benefit HPC as well, pricing in the back half of the year. Home and garden, we'll see where the weather shakes out but obviously, this quarter is the big moneymaker. Q1 is their least interesting quarter.
So if someone really wants to trade earnings, I think you'll see in recent analysts' reports that people are kind of taking down numbers for this quarter, just given the de-stock we've talked about just given the questions about weather. I think it's helpful. Obviously, the stock may trade a little down on that. But I think it's helpful for expectations going into the call where some people think that they may take down guidance. I don't have a strong view on that. But yeah, I think the management team has gotten a lot better with communication. I think they've executed well in their productivity program, which I can't say I'm an expert on. But anytime we were able to raise the net benefit from 100 to 200 million, I think you're doing something right. And I think everything they're saying makes a good deal of sense. And Randy Lewis, an interesting guy sounds like a real operator. David Moore is a good portfolio manager. As we said, buying a business seven and a half times EBITDA, selling a business at now 14 times EBITDA. I think he's learned a few lessons. I don't know him personally, but I think he's doing the right thing.
Andrew: Not only did they buy the business, but they grew it a lot at 10 and so 14 but they grew a lot in the midterm, which that's really where you get the true magic of they bought it for a little over a billion and they're selling it for a little over four, that's where you get the true magic. Now, look, all that makes sense. I mean, the environment is scary but the thing to me with both BC and these obviously different drivers different all that but to me, it's you found companies that hey, right now people are worried about cycle people are worried about inflation, but these are fundamentally good businesses with fundamentally some type of moat like yes, they're not Apple, but they have moats. They should have competitive advantages. And if you're willing to look past the next two to three weeks, two to three months if you're willing to look two years out to win the cycle fully normalizes like you're buying for BC, you're buying it for six or seven times EPS for this, you're buying it for seven times EBITDA which good consumer brands do not go for seven times EBITDA and with both of them you've got a line manage hopefully aligned management teams who have shown that they will buy back a lot of stock when companies are cheap. So yeah, I don't know if you want to add anything to that if you agree if I put the words in your mouth.
PJ: Yeah, I think insider ownership is a little better here. I do think SPB management can sometimes be a little promotional. But I do think it often lines up with the activities they want to do. Just to other things. I want to know if your house is doing this today, if you take HPC you add up how much they paid for Tristar and how much they paid for Russell Hobbs. That's about a billion dollars. And then you're getting Remington which I say is a four to $500 million business seeming it has average margins, you're getting a you know $40 million EBIT da business quote unquote, for free if you assume that what they paid for it was worth today maybe your group Russell House is worth less because of margins. But that's just another way to kind of back into $800 billion worth for HPC. Yes, I think I think we covered a lot of bases.
Andrew: Perfect. Well, PJ, look, I'll include a link here-- PJ, I love what he does, where he does a full write up, and then he publishes a one-pager. So if you just want the summary, go check the one-pager out. If you want the full write-up, you can check that out. I'll include links to both of them in the show notes and then you've obviously got the full podcast that discusses all the different issues. PJ, thanks so much for coming on, and looking forward to having you on for part three hopefully in the not too distant future.
PJ: Good. Andrew, one last thing. I know I mentioned quarterly earnings. I think the reason to be in the stock now though is I do believe whether it's Assa Abloy's call on a week from or this past a week from this past Tuesday or in Spectrum's call, there will be some updates, whether it's providing HPCs, carve out financials, which I think is a precedent to them, being able to sell it or spin it, or whether it's an update on HHI. I think that's where investors are gonna be focused on.
Andrew: Perfect, perfect. All right, well, hey, thanks again, PJ and we'll chat soon.
PJ: Take care.