Monday, November 13, 2006

Sally Beauty (when issued)

Alberto-Culver shareholders approved the Sally spin-off on Friday and as of today Sally shares are being bought and sold on the "when issued" market. Since there is also a market for both new Alberto and old Alberto, it's now possible to find out what the market says about the breakup math: $25 (cash) + $7.50 (Sally) + $17.85 (Alberto) = $51.35

But it is still possible to buy old Alberto for around $50, so there is still time to take advantage of a market inefficiency. (Basically, index funds that track the S&P 500 need to sell Alberto before the index drops Alberto and replaces it with some other company.) Although I have a little more cash to invest, I'm holding back for when Sally Beauty trades on the open market and after I have received the $25 dividend. I still think Sally conservatively is worth 30% more than $7.50. I suspect that when the company releases financials, the conservative value will be even higher.

Many salons in the US resemble malls in the way they operate. Each beautician rents a "chair" from the salon and keeps any profit they earn above that. Besides the basic services like washing, cutting and styling hair, salons are also an outlet for high end hair and beauty products. These are products that you can't buy at Wal-Mart or drug stores, because the makers of those products (e.g. Paul Mitchell) are aiming for a "Professional" market. As a result, there is a distribution problem—how do manufacturers get their products into the hands of beauticians?

Enter Sally Beauty Supply and Beauty Systems Group. BSG sells only to beauty professionals and Sally sells both to the general public and (under the Sally ProCard program) to professionals. Wal-Mart, Target and drug stores are more or less locked out of Sally's market pretty much by definition. On the other end of the spectrum, it's difficult to imagine another company building or buying a distribution network that competes with Sally.

The one exception is Regis, which is consolidating the salon industry through expansion and acquisitions. As you might recall, Alberto's original plan was to spinoff Sally and merge it with Regis. That plan failed in large part because Regis suffered some operational setbacks that made the merger unlikely to succeed. Ultimately, however, product sales are likely to be merely a sideline in Regis's business. (Humberto Barreto wrote an interesting paper that uses the salon business as a modern example of Ricardian Rent Theory.)

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