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Bill Ackman Gets His Way: Fortune Brands (FO) Splits into 3 Companies

Geoff Gannon

Geoff Gannon

410 followers
Fortune Brands (FO) board of directors just approved a plan to split the company into 3 parts. The home and security business – which includes brands such as Moen and Master Lock – will be spun off to shareholders tax-free. The golf business – which includes brands such as Titleist and FootJoy – will either be spun off to shareholders or sold to another company. And the liquor business – which includes brands such as Jim Bean and Maker’s Mark – will stay on as the rump public company.

At least one company has approached Fortune about buying the liquor business. The golf business is expected to attract interest from both Asian sporting goods companies and private equity. Both statements come from unnamed sources.

A couple news reports mentioned Diageo (DEO) as a possible buyer of Fortune’s liquor business. However, this seems to be based on Diageo’s past comments – they’d like to buy a bourbon brand. None of the reports I read said Diageo’s name was mentioned by people who actually know what Diageo and Fortune are thinking. So the Diageo connection – however plausible – is probably coming from analysts and reporters rather than people in the know.

Again, Fortune has definitely decided to spin-off its home and security business to shareholders. It is still waffling over whether to sell or spin-off the golf business. And the core liquor business will remain public – at least until someone like Diageo, Pernod Ricard, or Bacardi make an offer.

When told the news – Fortune’s biggest shareholder, Bill Ackman, said:

“That’s phenomenal news. We think the long-term value of each of the three businesses will be materially higher if they are separate…That is going to create a lot more shareholder value over the long-term.”

Note how he said the long-term. Fortune has been mulling this breakup decision for 4 years. According to the Wall Street Journal: “(Fortune) was already deep ‘into the home stretch’ of pursuing a breakeup of the company when (Ackman) disclosed (his) investment.”

Fortune was undervalued when Ackman bought in. There was definitely a big conglomerate discount. Now…

Not so much.

Fortune’s Vital Signs

1. Z-Score: 2.92

2. F-Score: 5

3. FCF Margin: 8.30%

4. Return on Capital: 18.20%

5. FCF Margin Variation: 0.21

6. Return on Capital Variation: 0.50

7. Price/10-Year Real FCF: 14.92

8. EV/10-Year Real EBIT: 13.93

9. Price/NCAV: NMF

10. Price/Tangible Book: NMF

Fortune has a good chunk of debt on its book. Nothing a free cash flow spewing consumer brands company can’t handle – but it’s there and it counts.

The free cash flow margin you see – 8.2% – accurate, but obviously varies by business. You can bet the booze business generates more cash than 8 cents per dollar of sales.

The return on capital – which is EBIT divided by tangible assets employed in the business – is understated because of write-offs. The amortization of past acquisitions skews this number. Fortune has had a particularly bad time with goodwill write-downs.

The super low free cash flow margin variation coefficient of 0.21 tells the real story. Fortune is a very reliable business. Free cash flow is stable. If anything – its too stable.

Real FCF Per Share
2009 $4.65
2008 $4.25
2007 $4.73
2006 $4.99
2005 $4.18
2004 $4.09
2003 $4.56
2002 $4.63
2001 $3.46
2000 $1.99


Fortune is a free cash flow geyser that anybody would love to own. It’s also a conglomerate. And a public company. So – it’s always looking for sales growth. As a result, Fortune spends a lot of free cash trying to buy growth and mostly failing. The result is a consistent free cash flow generator that doesn’t get much respect in the stock market.

If you cut Fortune up and spread it around, each buyer can manage each business for cash flow. Sales growth – especially quarter to quarter and year to year – isn’t real important to a 100% owner. And there might be some benefit in pairing one liquor business with another, one sporting goods business with another, one home improvement business with another. It probably makes more sense for someone like Masco (MAS) to own Moen than for a company that makes most is money from alcohol.

But there’s only so much rejiggering can do. Finding strategic buyers is the best bet. Fortune shareholders will get a nice premium on the sum of their parts if companies like Diageo really do come in and bid.

A lot of the money that’s going to be made in this stock has already been made. Fortune’s stock is up 42% this year. A stock price rise alone doesn’t mean much. A really cheap stock can double and still be cheap. But Fortune was never some super cheap Ben Graham bargain. Fortune was a great collection of brands selling at a conglomerate discount.

At least that’s what analysts call it. I’d call it more of a capital allocation discount. Conglomerates like Danaher (DHR), United Technologies (UTX), 3M (MMM), and Berkshire Hathaway (BRK.B) don’t sell at discounts. Bad capital allocation – whether done by a niche business or a corporate hydra – leads to discounts.

Complexity can lead to discounts. Sometimes. But combine complexity with cash squandering and you get a low stock price every time.

There’s no conglomerate discount built into Fortune’s stock price anymore. It trades for 15 times its 10-year average real free cash flow. That’s basically 15 times normal earning power for a business that isn’t growing real fast. But it’s a high quality, high reliability business. And it operates in industries where other companies – who also produce plenty of free cash – would love to own these brands.

Whatever additional profits Fortune shareholders get from this point on are going to have to come from better run spin offs. Or – more likely – from premiums paid by strategic buyers for each of the three pieces. The profits from buying a cheap stock are gone. There’s no more valuation adjustment needed. If Fortune was broken up into 3 separate public companies – it could easily sell for the same price it does today.

There’s no financial alchemy here. You need to find buyers. Or what Fortune shareholders have now – $61 a share – is all they’re going to get.

Fortune is fairly valued today.

But it sounds like their might be some buyers willing to pay a bit more than fair value to make a permanent investment in these rare brands.


About the author:

Geoff Gannon
Geoff Gannon


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