Monday, October 23, 2006

Why I bought more Alberto-Culver

On Friday, "Prudential Equity Group analyst downgraded her rating on" Alberto-Culver. According to the AP, her reasons were "that both Alberto Culver and the new Sally Beauty Holdings face deal-related risk, and that tax obligations from the $25 special dividend may not be known until 2008." As a result, shares of Alberto-Culver dropped from $51.25 to $49.94 that day.

To address the second issue, depending on New Sally's earnings, the special dividend might be taxed as a dividend, tax-free return of capital, taxable capital gain, or a combination of the above. The dividend must be reported this tax year (assuming the proposal passes), but the final determination of how it is taxed might not be made until after New Sally's first year in operation at the end of 2007. For most people, the accounting is going to be ugly. But since I hold Alberto-Culver in my IRA, the taxes are an interesting side-note.

The other issue ("deal-related risk") is more of a concern. Without access to the complete report, it is difficult to know what that phrase represents, but I'd imagine it is a reference to the costs and difficulty of splitting a company in half. Until they have been separate for a few quarters, investors can't be sure of the extent of "one-time-charges" on or both of the new companies may incur. On the other hand, it seems to me the businesses have been more or less independent for years and ought to be up to speed quickly.

Considering why I bought shares originally, Prudential's downgrade is actually a positive sign for me. In particular, this is further evidence for point "a. Institutions don't want the spinoff (and not because of the investment merits)." The deal is complicated and it will be a few quarters, if not years, before everything settles down. Until then, institutions may not be comfortable owning shares in a company that is largely unpredictable.

In the meantime, the downgrade and resulting price drop gave me an opportunity to roll the cash I received from two going-private transactions into Alberto-Culver stock. It seems like the great value investors have a simple capital allocation strategy that I'm trying to emulate. When you have capital and an investment idea, allocate the capital to the idea.

Tuesday, October 17, 2006

Alberto-Culver breakup value

Alberto-Culver shareholders are being asked to vote on a spin-off of the company's salon products distribution business (Sally Beauty) in November. Current owners will receive one share of New Alberto, one share of 52.5% of New Sally and $25 per Alberto-Culver share. The other 47.5% of New Sally will go to a private equity fund (Clayton, Dubilier & Rice Fund VII) in exchange for $575 million, which works out to about $6.73 a share. In order to pay the special $25 dividend, New Sally will take on $1.85 billion of new debt.

Based on the current market value of Alberto-Culver and the implied purchase price of New Sally, here is a chart showing the valuation of each piece compared to some competitors:

                  Price/share Price/Sales Price/Earnings EV/EBIT
ACV               51.30       1.35        24.03          14.06 
New Alberto       19.57       1.39        25.70          17.89 
New Sally          6.73       0.50        37.21          13.68 
Cash              25.00    

Procter & Gamble  62.05       2.89        22.69          17.16 
Colgate-Palmolive 60.09       2.72        22.96          16.46 

Personal & Household Prods.   2.6         25.64 
Consumer/Non-Cyclical         2.4         22.1 
Regis             38.20       0.72        15.95          10.93 
CVS               31.25       0.69        20.96          15.56 
Walgreen          44.34       0.94        25.53          16.05 
Longs Drug        44.50       0.36        22.60          11.97 
Retail (Drugs)                0.72        24 

On this basis, New Alberto is not valued dramatically differently than current Alberto or other personal products companies. New Sally, however, looks cheap according to its P/S since it is closer related to drug stores and Regis (the salon company that tried to buy Sally last spring). Retailers, as middlemen, must carefully control profit margins in order to remain competitive, unlike consumer product companies that can nurture a brand to higher margins. The P/E ratio is less telling for Sally because it will take on so much debt. EV/EBIT, which removes the effect of leverage, puts Sally in the middle of the retail pack.

Now, let's look at how the pieces could be evaluated after the spin-off. I set New Alberto's price based on the P/E ratio of Consumer/Non-Cyclical companies and used the P/S ratio of drug retailers for New Sally's price.

                  Price/share Price/Sales Price/Earnings EV/EBIT
ACV               51.60       1.36        24.17          14.14 
New Alberto       16.83       1.20        22.10          15.38 
New Sally          9.76       0.72        38.56          13.87 
Cash              25.00

This isn't too far from the market value of Alberto-Culver, so the investment thesis is that the spin-off will allow both companies to operate more efficiently and will reveal the true value of the underlying businesses.

First, all fundamental data I've used is based on 2005 figures since only 9 months are available for 2006. So far, 2006 seems to be a fine year for the combined companies. EPS for the last 12 months is $2.37 versus $2.09 in the previous 12 months. I expect the initial financial statements from both companies will suggest a higher price per share as well.

Second, New Alberto will be debt-free and able to focus on building its portfolio of brands. The salon distribution business was a distraction and didn't provide any operating advantages since few of Alberto's products where sold in Sally stores or through Beauty Systems Group. Dumping debt on New Sally could allow New Alberto to pursue acquisitions like it recently made with Nexxus and St. Ives.

Third, CD&R has tremendous motivation to increase the post-spin-off value of New Sally. The private equity investment company has successfully invested in spin-off companies such as Lexmark and Hertz and only profits if the price of the highly leveraged stock appreciates significantly. It's helpful to view Sally as an LBO or the stub stock of a recapitalization.

Fourth, New Sally should be able to expand into new markets and increase current-store sales through advertising. Alberto's salon product distribution business has been hampered in the past because the parent company is a competitor with other vendors and predominately distributes through other retailers. Once free of the consumer products business, Sally should be able to promote itself more aggressively.

I see a purchase of pre-spin-off Alberto as a low risk opportunity to participate in CD&R's investment. Depending on how the market values New Alberto and New Sally, purchasing one or the other could be an even more rewarding investment.

Thursday, October 12, 2006

HyperFeed Technologies "perilous financial decline"

Talk about honest. HyperFeed Technologies, which has been trading between 60 cents and $1.05 over the last three months, announced a merger with Exegy Incorporated that will cash out shareholders at $1 a share. In the SEC filing, the company decided this was the best course of action "because of the Company’s perilous financial decline". I think I'll pass on this one.

Thursday, October 05, 2006

Advanced Nutraceuticals cashed out

Well, I don't think anyone could be as pleased as I was to lose a half-million dollars. My shares of Advanced Nutraceuticals were cashed out on Oct. 5 at $4 a share. On an anualized basis, it was 144.12% and one day short of beating Major Automotive, which was 144.21% annualized, as my best investment.

I was thinking about the comparsion with the S&P 500 and it occured to me that Berkshire Hathaway might be a reasonable benchmark to strive for:

Date      S&P 500  Delta    IRA    Delta  BRK A
12/31/02* -11.37%  42.32%  30.95%  30.18%  0.76%
12/31/03   26.38%  -1.49%  24.89%   9.08% 15.81%
12/31/04    8.99%  -2.16%   6.84%   2.49%  4.34%
12/31/05    3.00%   3.23%   6.23%   5.42%  0.81%
10/05/06    8.41%  20.51%  28.92%  17.21% 11.71%
Total Gain 36.31% 102.96% 139.27% 102.16% 37.11%
Annualized  7.49%  15.07%  22.57%  14.93%  7.64%

* First reporting date is 06/23/02
In a little over four years, I've managed to outperform both the S&P 500 and Berkshire, which astounded me. I can't imagine that will continue for the next four years however, because Berkshire is tremendously undervalued. Starting this year, some of my performance will be based on the performance of Berkshire thanks to the share I own. Also, it isn't a fair fight since Mr. Buffett and friends must allocate billions of dollars and can't invest in tiny companies like Advanced Nutraceuticals or even tinyer opportunities like going-private transactions.

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, TRESemm√©, 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.