Monday, October 02, 2006

Why I bought Alberto-Culver

Alberto-Culver can be divided into two lines of business—consumer products and beauty salon supply distribution. As it turns out, Alberto plans to split into two separate companies by spinning off Sally Beauty Supply and Beauty Systems Group, the distribution segment. The remaining company, New Alberto-Culver, will continue selling Alberto VO5, TRESemmĂ©, Consort and Nexxus hair products, St. Ives skin care products, Mrs. Dash, Molly McButter, Static Guard, and a few other random products.

Spinoffs tend to be a good place to find exceptional value. In You Can Be a Stock Market Genius, Joel Greenblatt suggests "certain characteristics [that] point to an exceptional spinoff opportunity: a. Institutions don't want the spinoff (and not because of the investment merits). b. Insiders want the spinoff. c. A previously hidden investment opportunity is uncovered be the spinoff transaction (e.g., a cheap stock, a great business, a leveraged risk/reward situation)." I believe Alberto-Culver possesses all three characteristics.

The transaction is a bit complicated, but the results are fairly straightforward: each share of pre-spinoff Alberto-Culver will be converted into a share of New Alberto, a share of New Sally and $25 cash. A private equity fund (Clayton, Dubilier & Rice Fund VII), will own 47.5% of New Sally, which will issue $1.85 billion in debt to pay for the dividend. So how does Alberto meet the criteria?

  1. I don't think institutions want any part of the spinoff. Half of the value of the spinoff is a dividend, and who doesn't like cash? Well, institutions don't like like large dividends because they are taxable events and need to be reinvested. New Alberto will have a significantly less interesting growth story without Sally and will be compared to Proctor & Gamble and Unilever. New Sally is the worst of all: high debt, single-digit stock price, not part of the S&P 500 (so must be sold by index funds), competes against Wal-Mart, Target and drug stores (but not really), and who wants to say they invested in a company called "Sally"? (To be honest, the whole thing seems a bit "feminine", doesn't it?) One other problem is the stench of failure since an attempt to spin/merge Sally into Regis Corporation, which runs a chain of salons, when sour earlier this year.
  2. Insiders will continue to be part of both surviving companies acting more or less in their current capacities. The family of Leonard H. Lavin, Alberto-Culver's founder, will continue to own a significant percentage of both companies and have agreed not to sell for at least a year in order to keep the tax-free status of the spinoff. CD&R has a history of guiding spinoffs to successful operations, such as Lexmark from IBM and Hertz from Ford. The only thing missing is option or restricted stock grants to increase insiders ownership.
  3. Generally a vertically integrated company has tremendous advantages because they have control over every step from manufacture to the final customer sale (think Starbucks). But Alberto-Culver is not integrated with Sally Beauty Shops or Beauty Systems Group, because only a fraction of New Sally's sales are Alberto products. Sally can't give, for instance, TRESemmé products preferential treatment, because Clairol, Revlon, Conair and L'Oreal would be displeased and might pull their products. Also, Sally must limit advertisement since it competes with stores that carry Alberto products. Rather than being an asset to the other, each company is a potential liability.
I had a bunch of other great insights, but managed to corrupt this post. I'm sure I'll get around to posting them later.

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