Sally is a Beauty of a Spinoff
Members of Fat Pitch Financials Contributor’s Corner have been following my investment in the recent Alberto-Culver Co. (ACV) spinoff, Sally Beauty Holdings (SBH). If you haven’t heard, Alberto-Culver, the beauty and hair care products company that makes VO5, TRESemme, St. Ives, and more, gave their shareholders one share in the newly spun off Sally Beauty, for each share of ACV they owned. The new Sally Beauty is one of the largest beauty supply distributors in the world. The deal was completed after the market closed on November 16th.
I started following this spinoff opportunity on November 14, 2006. Right after I researched the details of this opportunity, I got that tingling feeling in my head that I too could be a stock market genius. I wouldn’t be surprised to hear that Joel Greenblatt, the master of spinoff investing, also bought into this opportunity.
Let me list the details about why I got so excited by this spinoff:
- Institutions don’t want it. I discovered that Sally Beauty would not be added to the S&P Composite 1500 index. This means that index funds will have to dump the shares of Sally Beauty that they receive and thus depress the market price of this stock.
- Insiders want it. It looks like the new management of Sally Beauty will be highly motivated to boost the value of this stock since they will be receiving generous stock option grants.
- A previously hidden investment opportunity is uncovered by the spinoff transaction. Because Alberto-Culver produced many of the products that Sally Holdings distributed, other beauty and hair care product manufacturers that would potentially use Sally Beauty to distribute their products were concerned about potential conflicts of interest. This spinoff frees up Sally Beauty and allows it to now more fully compete to expand their distribution of a wider range of products from a larger base of manufacturers. This seems like a great move to me. I still remember when Wal-Mart spun off their food distributor and Warren Buffett snatched it up. (Hmm… Maybe he’ll be interested in snatching up Sally Beauty as well. One can only dream.)
- Leverage! Sally Beauty will also be loaded up with debt ($1.85 billion) and thus be highly leveraged, which is a good thing for spinoffs according to Greenblatt. This leverage will act to turbo charge returns to shareholders if the company is able to generate returns greater than their costs of capital. Based on the numbers I’ve seen for Sally Holdings, I don’t think this will be a problem.
- Margin of Safety. Based on my real rough calculations of future earnings for Sally Holdings, I estimate that the intrinsic value of SBH shares is about $10.
These five factors made Sally Beauty a fat pitch. Even though it is not the first spinoff I’ve invested in, it is the first to be added to the Special Situations Real Money Port. I added 300 shares of Sally Beauty Holdings at $7.42 a share to the Special Situations Real Money Port on last Friday, November 17, 2006. Sally Beauty Holdings closed today (Nov. 21, 2006) at $8.75. I’m already up 18 percent in less than a week on this stock.
That boost has raised the performance of the Special Situation Real Money Port. Based on today’s closing value for my son’s Coverdell ESA account ($7,574.02), it has earned a 15.9% annualized rate of return since inception (Oct. 19, 2004) and 19.5% annualized rate of return year to date. You can get timely information on the special situation opportunities I’m researching and my latest transactions over in Contributor’s Corner.
Full Disclosure: My family owns shares in SBH, even beyond those held in the Special Situations Real Money Port.
13 thoughts on “Sally is a Beauty of a Spinoff”
Interesting analysis. I’m curious as to why you view leverage/loads of debt as a bonus.
I don’t normally view leverage as a bonus. It increases risk and diverts earners away from shareholders. However, Joel Greenblatt makes some good arguements why leverage (low cost leverage) is a good thing for new spinoffs.
If you look at a spinoff as an IPO with a lot of new growth potential, the owners of the company equally enjoy the future growth in earnings. With a highly leveraged spinoff, debt holders only earn their fixed interest rate and the all the rest of the earnings get funneled into the equity holders.
Let’s look at an example of a $1 billion company where debt covers 80 percent of the enterprise value of a company and stock makes up the remaining 20 percent. If the company grows by 20 percent in value as a result of the spinoff restructuring, then the company is now worth $1.2 billion.
Debt holders are paid 10% for their capital, which is $80 million, that leaves $120 million for shareholders. $120 million divided by the original $200 million that shareholders invested give a 60 percent return!
I’m a bit tired right now, so I might have goofed up this explanation. The concept basically comes down to that if you are confident something is going to grow in value, investing in it with leverage will compound your returns. That’s how real estate investors make so much money off of relatively slow appreciating real estate assets.
Great response George!
I failed to take into account the brand new independence of this business, and was thinking in terms of established businesses.
Also, this is the same situation as with WU. When they were spun-off, they were laden with about $3bil in debt if I recall as well.
Thanks for the follow-up, sir. Have a great holiday!
I am glad to see another individual investor who found SBH as attractive as I have. I’ve been watching this one for some time now.
One point to add to your analysis is that this spinoff is essentially a LEVERAGED BUYOUT in which YOU can invest. A private equity firm (CD&R) owns 47.5% of Sally Beauty and has representation on the Board.
I have written an analysis of this attractive spinoff over at my site, http://www.thinkintrinsic.com. I’ve also linked to your report because I think everyone can benefit from.
So, here’s the link to the (free) Sally Beauty Holdings report at TI:
You talk about a price of $10 based on your calculations. Where are your calculations? I mean, I see absolutely no numbers relating earnings, sales, anything to the market cap of the stock. I hate to disparage but your analysis is based completely on subjective numbers. Do you really know what you are doing here?
Also, debt is good if the price paid for it is reasonable. I think a big reason for Greenblatt’s postive stand on debt was that it increased the selling pressure from the big institutions. This stock has done nothing but go up since spun off so I’m not sure that’s the case here.
I think the stock has gone up because even if investors liked both ACV and SBH pre-spinoff, it wasn’t in their best interest to buy before the dividend. Consider that most mutual funds (in my opinion) wouldn’t want that $25 dividend. Furthermore, some international investors (think Bermuda, Cayman, etc) don’t pay capital gains taxes, but pay a 30% withholding tax. So they probably waited until after the dividend. I dont think this is the only reason SBH jumped early on.
It’s a good company, simply put. It has many more opportunities now that it is spunoff. That’s the reason it jumped. I’m skeptical of the $10 valuation. Seems a little arbitrary. But I do like the company as I discussed at http://www.thinkintrinsic.com/companies/s/SBH
You should be sceptical of my $10 intrinsic valuation since it was literally calculated on a napkin (or maybe a sticky note) while I was at work. I’m an amateur investor, so you should assume I don’t know what I’m doing. I encourage you to challenge my own estimate by posting your own calculation of intrinsic value here in the comments section.
Sally Beauty hit $10 during the day today. I guess I’m not the only one that thinks this stock is worth $10. Now I have to determine if it is time to sell, or if Sally Beauty could be worth even more than $10. I was somewhat confident of my $10 estimate, but I’m not so sure I can be confident with a higher valuation without at least seeing at least one more quarters worth of data.
I have not been paying attention to this as much as I should have as I have been very sick the past week. Correct me if I’m wrong but wasn’t the 1.8 billion in debt used to pay the $25/share dividend? If this is the case I don’t see how the debt is doing anything for shareholders of SBH who purchased SBH after the split.
How will the loss of the distribution rights to L’oreal products affect Sally Beauty Holdings
This is a bit off topic. What are your thoughts on ACV? I believe ACV is in a better position to market its products after the spin off (e.g., a good catalyst). ACV seems to be a good value, good moat (high end products, strong brand recognition), and management is making good moves. Managements return of the investor’s $ via the $25 divident is a good sign. Management resists the “institutional imperative” (as Buffett might say). I also read that they are selling the corporate jet (another good sign that they are careful with shareholders’ money). They are also cutting their work force by 2%. According to S&P (which only views ACV as a “hold”), they expect ACV to announce in late January a regular quaterly divident. This is another catalyst. A regular divident should bring in a bunch of new investors.
I started looking at ACV after reading your blog. I don’t own it — still researching.