Great returns can be made by investing in turnaround situations. However, high returns are often accompanied by high risks. Thus, investors should limit the downside risks in turnaround investing. One turnaround situation that has high upside with limited downside is Newell Brands Inc. (NWL, Financial).
After the acquisition of Jarden Corp., Newell accumulated a huge amount of debt and saw declining operating performance. The stock price suffered, reaching its lowest level in five years. However, there is a lot of hope that Newell Brands will turn around with the help of activist investors Starboard Value and Carl Icahn (Trades, Portfolio).
Declining operating performance
Newell Brands, the owner of many famous brands, including Parker, Paper Mate, Elmer’s, Oster and Yankee Candle, operates in 100 countries. In order to increase economies of scale and expand globally, the company spent as much as $13.22 billion to acquire Jarden in 2016.
After closing the deal, Newell Brands expected to unlock $500 million in cost savings and synergies in four years. It also expected the earnings before interest, taxes, depreciation and amortization margin to be more than 20% and produce more than $3 billion in annual adjusted Ebitda. As it has been more than two years since the acquisition closed, it seems Newell Brands needs to do a whole lot more in order to enhance its operational efficiency.
Newell's Ebitda spiked after acquiring Jarden but then began to decline. Trailing 12-month Ebitda only reached around $2 billion. In the first quarter 2018, sales were down 7.6%, partly due to Toy ‘R’ Us' bankruptcy, resulting in diluted earnings of only 0.11%, a nearly 92% decline from the first quarter of last year. Because of the sluggish first-quarter results, Newell revised its expectations for the full year downward at the lower end of the annual guidance range, with $2.65 earnings per sahre and $1.15 billion in operating cash flow. The company’s shareholders have suffered. In less than two years, Newell's share price has underperformed the S&P 500 by as much as 64%.
A lot of value can be unlocked by operating more efficiently
Fortunately, Newell has decided to save itself, announcing an accelerated transformation plan. As part of the plan, the company will divest eight non-core industrial and consumer businesses, which represents 35% of the total company’s revenue. With $10 billion in after-tax proceeds from the divestitures, the company will use 45% to pay back debt and 55% to return cash to shareholders via share repurchases.
In addition, activist shareholders Starboard Value and Icahn have reached an agreement with the company to replace 75% of the board with their own representatives in order to drive the needed change. According to Starboard Value, the divestitures can unlock value right away, but in order to drive long-term value creation, it will also need to focus on operational improvement. The fund identified four areas which can be improved on to generate incremental Ebitda of $585 million to $966 million.
The four areas are selling, general and administrative costs, procurement, logistics and working capital improvement. For selling, general and administrative costs, Newell Brands should reduce redundant executives and vice presidents that total 500, cut the number of IT and support staff and reduce unnecessary costs in travel nad entertainment. For procurement, it needs to establish well-structured low-cost country source and make-versus-buy strategy, and reexamine the current decentralized sourcing strategy, which prevents the company from leveraging the best processes.
Indeed, Newell Brands should move manufacturing to a low-cost country, rather than stay in mostly high-cost countries. In addition, similar products are made in multiple countries, not concentrating in one location, resulting in higher costs. Thus, it drives up the cost of goods sold (COGS). The peer average COGS is 51% while Newell Brands’ COGS is more than 65%.
Source: Starboard Value presentation
For Logistics, Newell Brands will integrate Newell Rubbermaid’s and Jarden’s warehousing network for better cost efficiencies, reassess the increasing costs of Multiple Transportation Management Systems and increase the collaboration with major retailers to simplify the distribution process. For working capital, the company will reduce inventory levels and days sales outstanding to improve cash conversion cycle.
Starboard Value expects the company will generate incremental EBITDA of at least $399 million in SG&A, $137 million in procurement and $49 million in logistics. Thus, the cost savings will be at least $585 million. With the average EBITDA multiple of 10 times, the enterprise value would be $28.95 billion, and the equity value $19.65 billion.
Source: Starboard Value presentation
At least 50% upside
With the involvement of activist investors Starboard Value and Icahn, Newell Brands can turn around and unlock a lot of value for its shareholders. Its share price should be $40.50 per share (low case) to $55.73 per share (high case), delivering at least 50% upside for current shareholders.
