I started out looking at Jarden Corporation (JAH) as a potential long investment. In the end I decided not to invest because of the staggering number of red flags that the company's financials revealed. I simply could never get comfortable with their financials. Below is a summary of the red flags / issues / questions raised.
Company Description - JAH is global consumer products company with over 100 brands and a presence in over 100 countries. The company ranks 371 on the Fortune 500. It is highly acquisitive and has completed numerous acquisitions in the last decade.
JAH is highly acquisitive having completed at least twelve major applications in the last decade. Acquisition accounting is generally a minefield for investors and offers management a variety of ways in which to boost performance and hide problems. JAH management's accounting policies and public statements seem designed to hide the impact of the acquisitions on JAH's financial statements.
Hiding True Free Cashflows: Management frequently points to its free cash flow generation and growth as a measure of its successful strategy. Management claims it has grown cash flow by a CAGR of 19% since 2002 and has generated $1.4b in free cash flow in the last five years (Pg 60 of this Investor Presentation).
Management however calculates free cash flow as a cash flow from operations less capex. They completely ignores the cost of the acquisitions. For a serial acquirer like JAH, a truer comparison would be to calculate free cash flow as cash flow from operations less capex less cash outflow for acquisitions. Using this measure the table below shows management has been materially overstating the true extent of free cash flow generation.
(click to enlarge)
(all financials from CapIQ; note March 31 2012 is for twelve months ended March 31, 2012)
Despite management's claim of generating $1.4b in free cash-flows in the last five years, the truth is that management has actually used $350m in cash when one performs a more apple-to-apples comparison.
Management is taking advantage of acquisition accounting to try and fool investors. It is inheriting operating inflows in an acquisition and trying to project an image of running operations well and "exploiting synergies." Because operating inflows are above the cash flow from operations line and acquisition costs are in the cash flow from investing section, management is able to use this trick. This acquisition accounting trick is described in the book "Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports" by Howard Schilit and Jeremy Perler.
Another highly questionable management practice is to hide the true cost of acquisitions related earn-out payments by combining earn-out payments with the cash used in acquisitions. Through the 2007 10-K management used to provide separate disclosure. Maybe its just a coincidence that as soon as the economy tanked, management reduced disclosure. These payments do not flow through the cash-flow from operations or income statement thus depressing the true operating expenses / cash-flows of the acquired businesses and leads to an overstated operating cash-flow number.
Goodwill and Acquisition Related Costs: On earnings calls, JAH management frequently provides positive outlook for the business. Management has said that business is "strong" and touts its ability as a "disciplined" acquirer (see for example the 2008 or 2011 earning calls). Despite management's assertion of being a disciplined acquirer and business being strong, there seem to be a few red flags suggesting that management's claims should not be taken at face value.
First and most importantly the company has taken a staggering number of goodwill impairment and other one-time charges. As shown in the table below these charges total over $800m in the 2007 - 2011 time frame.
The company's current market cap is $3.3b. ~25% of its market cap in one-time charges in the last five years! This certainly makes me question the claim that management is a disciplined acquirer and that these acquisitions have been successful.
Second, and quite surprisingly, on conference calls management still claims these goodwill impairment charges are one time and won't be repeated. For example in 2q2010 management said they do not anticipate further charges for goodwill in 2010. Yet in 3q2010 there was an additional 0.7 million in impairment charges. In 4q2010 one-time charges totaled over $25 million. Even for the year ended 2011, the company pre-announced charges of $75m to $85m before revealing $110m in one-time charges when the 10k was filed. For 2012, Management said on the call announcing Q4 2011 results that it anticipates another $35m in reorganization charges.
Third, Management has been sued previously for announcing rosy prospects for a company they acquired that didn't achieve announced projections. In 2006, a class action lawsuit was filed by shareholders after management made overly optimistic statements about a company it acquired in an alleged scheme to improve management compensation. The company underperformed and management had to settle with plaintiffs in 2009. The company's insurance bore the cost of the settlement displaying an instance where promotional management used the corporation as a shield. One would think a management team that had to settle a lawsuit for making rosy projections would be more careful in the future.
Misleading Metrics: On calls, Management reports earnings, EBITDA, EPS, and Gross Profits excluding these "one-time" charges. In fact, as shown above, the goodwill and restructuring charges are far from one-time. They seem to occur annually and in large amounts. By reporting earnings excluding these charges, management is focusing analysts and investors away from true business performance of JAH. Even more egregiously, the company's compensation committee excludes not only these charges but even more charges in determining management compensation (see the DEF14A filing with the SEC for the years 2008 - 2012). The table below compares the GAAP EPS to the earnings used for management compensation purposes.
For the year 2008, the DEF 14A filing does not provide the management compensation EPS as the target EPS was not met. None the less, the committee decided that management should receive its equity compensation as part of the discretionary bonus. Thus, even when management does not meet its manipulated lower EPS target - management continues to get rewarded. These arrangements are disclosed in the SEC filings so are not illegal but by putting this information in the footnotes management is able to deceive a majority of investors.
According to ThomsonOne, JAH has a ROIC and ROA of 1-5% for each of the last 5 years. Instead of concentrating on improving operational performance, Management seems to have found another way to continue improving EPS. To improve per share earnings and meet EPS targets, management lowered the bar by announcing a $500m buyback tender offer earlier this year. The tender offer at announcement, was projected to reduce the number of shares outstanding by 18%. The lower number of shares outstanding enables management to more easily meet EPS targets. In the end, the share count was reduced by 13.2%.
Also, if management compensation EPS (with the reduced share count) reaches $4.50 by 2014, management will begin to receive an additional $40m in performance based equity grants, with the Chairman alone netting $32m. Management seems to be transferring corporate assets to management's personal fortunes in a legal manner. 2011 management compensation EPS assuming an 13% reduction in share count would be $3.96, materially changing the improvement needed to achieve the $4.50 target. Wonder why the compensation committee did not increase target EPS to adjust for reduced share count? As an aside, its also worth pointing out that in 2009, the board paid cash in lieu of restricted shares to the Chairman and the CEO because the company did not have the shares necessary to hand out under its incentive plan.
This tender offer is even more suspect given that it is being funded by debt, as well as, a suspension of the dividend. Furthermore, the original offer price $30-$33 per share was revised to $32-$36. Along with the revised higher price, management also announced that they would be tendering at least 10% and up to 15% of their shares into the tender. This is a major red flag. Management is tendering over 500,000 shares into the announced buyback after claiming to be frustrated by the market continuing to undervalue the company on the earnings call. Management continues to sell shares based on a review of recent Form 4 filings. If Management is willing to sell shares at $35 why should investors buy at $40? At an investor conference last week, the CEO talked about possibly doing another buy-back next year! I guess they really want to get EPS above $4.50.
In addition to the points noted above, the company has a host of other red flags.
- As discussed in the 10-K and the proxy filing, Management has engaged in related party transactions, and has pledged their shares as collateral with their brokers. Both these are red flags for us.
- In my opinion there is an unhealthy focus on the company's position in the Fortune 500 and on the company's stock price. The CEO said last week at the investor conference "We think there are two types of company's - one that is talked about and one that isn't. We are the type that wants to be talked about." I like to see management focused on the business not on becoming a Wall Street Rock-Star or on its position in the Fortune 500. Larger than life CEO's and management seem to fall back to Earth pretty regularly.
- The company has met or exceeded Wall Street Estimates every quarter since at least the quarter ended June 2010 and annual estimates every year since December 2007. Few companies can consistently outperform expectations while earning such a low ROIC. Managements extensive use of financial engineering is probably a function of this desire to meet targets and takes focus away from true business performance.
- Goodwill and Intangible assets make up $2.9b of the $7b in total assets. Thus, we can continue to expect write-downs and impairments on previous acquisitions.
- Debt has exploded on the balance sheet from $480m to $3.5b in the last decade.
In the end all the issues mentioned above prevented me from getting comfortable and buying the shares. In fact, by the end of my analysis I was wondering if I should be shorting this Wall Street Darling.
For Shorts though, it helps to have a catalyst. I am just not sure what the catalyst is for this stock to begin falling. Hence I have no position.