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Fortune Brands Inc.
Ticker: FO
Andrew D. Jones, CFA
October 21, 2010

Price Target: $82 (37% upside plus 1.2% dividend yield)

Business Overview

Fortune Brands is a conglomerate comprising three divisions: spirits, golf products, and home and security products. The company offers various distilled spirits, including bourbon, tequila, Canadian whiskey, scotch whiskey, and cognacs under the Jim Beam (#1 bourbon), Maker’s Mark (#1 super-premium bourbon), Sauza (#2 tequila), Canadian Club, Laphroaig (#1 single Islay malt Scotch whiskey), and Courvoisier names. It also provides rum, sherries, port, gin, whiskey, and bitters under the Teacher’s, Cruzan, Harveys, Cockburn’s, Larios, Whiskey DYC, and Kuemmerling names. In fiscal 2009, the spirits division reported $485 million in operating profit on $2,500 million in sales. The spirits division accounts for about two-thirds of Fortune's profit.

The home and security division includes MasterBrand cabinets, Moen faucets, Therma-Tru doors, Simonton windows, and the MasterLock and Waterloo product lines. In fiscal 2009, the home and security division reported $87 million in operating profit on $3,000 in sales.

Fortune Brands manufactures and markets golf balls under the Titleist and Pinnacle brands, golf clubs under the Titleist and Cobra brands, golf shoes and gloves under the FootJoy brand, as well as golf bags, golf outerwear, and accessories. In fiscal 2009, the golf division reported $25 million in operating profit on $1,200 in sales.

Fortune offers its products primarily in the United States, Canada, the United Kingdom, Spain, Germany, France, Australia, Japan, China, South Korea, and Mexico. The company was founded in 1904 and is based in Deerfield, Illinois.

Investment Thesis

Fortune Brands is a seemingly odd mish-mash of companies, and the market value likely reflects this oddity. After all, Bourbon, shower heads, and golf clubs are not exactly synergistic businesses. Meanwhile, sales in all three divisions have suffered during the economic downturn, particularly home products. It seems logical that as the economy recovers, Fortune's various business will recover in line. What also seems logical, though somewhat uncertain, is that Fortune Brands would benefit from selling off some of their businesses and focusing on a more streamlined company.

Enter Bill Ackman and Pershing Square Capital Management. The company has been working with activist investor William Ackman over the past several months on a plan to break off the individual pieces in order to unlock value in the shares. The current plan involves spinning off the Home and Security division and selling the Golf division, leaving a stand-alone Spirits business. First-round bids for the Golf business are due this Friday, and estimates range up to $1 billion, a number that I agree with. Meanwhile, there are reports that private equity firms have been sniffing around the Home and Security business, a development that could increase its value.

I analyzed the cash flows of the three divisions to determine what the value of each business is as a stand-alone entity going forward (click to enlarge):



As you can see, I believe sales of Spirits and Home and Security products will be relatively strong going forward, as the US and World economies continue to recover. Meanwhile, even with relatively paltry sales growth, I believe the Golf business is worth at least $1 billion.

After combining the value of the individual businesses and adjusting for debt and cash on the balance sheet, I arrive at a sum-of-the-parts value of $82 per share. This represents 37% upside from current levels, plus a dividend yield of 1.2%, or a total return of 48% since I first wrote about the stock.

The current plan from Fortune calls for the spirits division to continue as a stand-alone entity. However, I think that Diageo in particular has kicked the tires on buying the spirits business, and will continue to do so. After all, Diageo has a huge hole in their portfolio without a strong bourbon brand, and FO happens to have the #1 bourbon (Jim Beam) and #1super-premium bourbon (Maker's Mark). So what would happen to the value of the stock if Diageo paid up for the Spirits division?

I looked at some recent transactions in the spirits business to see what a reasonable price would be for Diageo to pay. In 2006, Belvedere was sold for 22.8x trailing EBITDA, while in 2008, the Swedish government sold Absolut for 21.5x trailing EBITDA. Assuming that valuations have come down slightly, if the Spirits division was taken out at 18x trailing EBITDA, the sahres could be worth $85. At 20x trailing EBITDA, they could be worth as much as $94 (click to enlarge):



Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Fortune Brands: Unlocking Value Through Spin-Offs