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Fledgling fund manager, running an incubator fund based on the east coast. Value oriented, heavy emphasis on quantitative analysis. So far, so good. Shoot me a message if you want to chat about ideas.
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  • Un-Wrap a Holiday Gift With Sealed Air Corporation

    I have always been a fan of companies with products driven by relatively inelastic demand – though of course - at the right price.  Sealed Air (NYSE:SEE) produces simple, necessary products, many of which fit the razor/razorblade model.  It does so on scale that prevents rapid diminution of its competitive advantage.  It has a relatively diversified customer base.  And – for the moment – it is cheap.  The core Sealed Air company manufactures and sells packaging and packaging equipment systems worldwide.   Sealed Air recently acquired Diversey company (October 2011) which is discussed below, and which should create profitable synergies over time.

    Sealed Air – Core Business:  There are 3 major segments of the company - the Food Packaging segment, Food Solutions segment, and the Protective Packaging segment.  Sealed Air began with the invention of Bubble Wrap, which remains its best known product, but now accounts for less than 10% of the company's sales. The company now sells protective mail envelopes, foam packaging, shrink wrap, and flexible food packaging.   Further, it sells not only the packaging but sells or leases the equipment to package the product.  Sealed Air also provides service to the machinery and supplies the packaging on a continuous basis. Once a consumer buys or leases a Sealed Air packaging machine they are generally a locked-in revenue stream for the life of the machinery or lease, as they continually order packaging and service from Sealed Air.  The company generates about half its sales in North America and is expanding in international markets. The business is well established in Western Europe and is growing in Mexico, China, and Eastern Europe.  The packaging business is likely to grow only at the rate of population growth plus inflation in developed markets and accordingly international growth will become the primary driver of earnings growth in the future.

    Sealed Air – Diversey Purchase:  Sealed Air purchased Diversey Corp. for roughly $4.3 Billion in October. This purchase price looks high to me as they paid 10x EBITDA for Diversey. Diversey is primarily a sanitation and cleaning company with broad international sales. Approximately 50% of sales of Diversey products come from Europe, the Middle East, and Africa; 20% from both North America and Asia; and 10% from Latin America. Diversey services six core end markets including building management, food and beverage production, Food Service, retail, and lodging.  Basically they sell commercial / industrial cleaning supplies and services.

    Valuation and Assorted Numbers:

    Valuation – Recent Price Near $17

    Is Now:

    Should Be:

    Price – Should Rise to:

    Potential Gain:

    Current P/E

    12.2

    15

    $21.16

    23%

    P/E on 2012 Earnings

    9.2

    15

    $28.04

    63%

    P/E on 2013 Earnings

    8

    15

    $32.25

    88%

    P/E on 2013 Earnings if merger goes well

    5.7

    15

    $45.06

    162%

    5 Year Avg P/E (for comparison to above)

    16.7

     

     

     

    Price/Revenue

    .6

    1.0 (5yr Avg)

    $28.55

    66%

    Enterprise Value/EBIT 2011

    6.5

    8

    $21.17

    23%

    Enterprise Value/EBIT 2012

    4.9

    8

    $28.08

    64%

    Dividend Yield

    3%

    2%

    $28.55

    66%

     

     

     

     

     

    Total Debt

    4 Billion

     

    EBITDA/Yr

    600 Million

    5 yr expected profit growth

    7 - 9%

     

    Dividend Payment/Yr

    250 Million

     

    Why This May Be a Good Investment:

    Its products are simple.  They will not become obsolete in two years like so many tech products.  Inventory doesn’t rapidly lose value.  Products don’t carry the liability risks of vehicles, pharmaceuticals, etc.  They don’t require mass marketing as do other products such as clothing, cell phones, computers, TV’s and other consumer goods. 

    Competitive advantage.  The company’s products require manufacturing equipment and chemical feed products for production.  No small player is likely going to enter the market and compete given the high start-up costs and the price advantage SEE has due to its scale and relationships with suppliers.  The sanitation business does have a competitor with larger market share though.

    Sustained demand.  As long as population grows, demand for packaging products should grow.  The company’s products are important to domestic and international transport of all types of products.  From the 2008 revenue peak of 4.84 Billion, to the trough of the financial crisis at 4.24 Billion, revenue only declined 12.4%.  This is a solid performance in the worst recession in recent decades, and revenue has again nearly reached the peak and is approximately 4.8 Billion.  The fact that the company has grown revenues despite a weak environment speaks to the strength of the business model.  Diversey has a similarly sustainable product line in my opinion but has not executed as well as should be expected in recent years.

    Insider buying.   Officers and Directors have been buying meaningful amounts since August 2011 at prices ranging from $16 – $20.   Glenview Capital is also a major holder, they bought $300 million worth this year – it is an excellent hedge fund.

    Most importantly, it is cheap.  I used four probability weighted scenarios to come up with an expected value for the company at roughly 12 months out.  I had a zero case, bad case, base case, and best case and assigned probabilities of 5%, 30%, 40%, and 25% respectively for the sum of 100%.  The zero case assumes bankruptcy.  I assigned 5% (more than I usually do) because of the acquisition and the debt which the company has taken on from Diversey.  For the bad case I assumed a drop in earnings of 10% and a cut of the dividend by half.  For the base case I assumed a stable dividend and a small increase in earnings.  For the best case I assumed the acquisition and integration of the companies goes smoothly and Diversey’s earnings immediately drop to the bottom line with quickly implemented cost savings.  I used conservative multiples of 6,12, and 15 for the bad, base, and best cases.  Bottom line, at a price of $17 per share the shares look cheap and the probability weighted expected return is 29%, meaning a rise from $17 per share to $22+ per share.  Realistically, I think it will do even better, probably more like $26 share.

    Risks:

    Rising input costs.  Commodity input costs are a significant factor for the combined Sealed Air/Diversey.  Should input costs rise significantly it will compress margins.  In the weak global economy, I’m not sure they could pass on those additional costs to the consumer. 

    Another recession.  Sealed Air took less than a 13% earnings hit peak to trough during the financial crisis and ensuing recession.  This compares favorably with a roughly 21% fall in earnings for the broader S&P 500 index.  I don’t have data on the impact on Diversey during that period.  Either way, a global recession, perhaps driven by the European sovereign debt crisis, would have a significant impact on the combined company, as Diversey derives roughly half of its business from European customers.  Further, the increased debt load post-acquisition could become a problem if cash flow was significantly depressed. 

    Debt load. The combined company has approximately $4 Billion in debt.  Trailing annual EBITDA for Sealed Air alone was roughly $600 Million, plus an additional roughly $50 Million for Diversey.  Though there is a $250 million dividend payment to maintain, the company looks sufficiently able to pay down debt, and there are no significant near term maturities.

    Poor integration of Diversey. Mergers and acquisitions scare me.  If Sealed Air is unable to integrate Diversey effectively, merge corporate cultures, create cost savings through scale, and to create other synergies through complimentary products, then all manner of shortfalls through uncontrolled costs, falling margins, and management distraction may occur.  The company must execute well as they did not buy Diversey cheaply enough to afford mistakes.

    Multiple compression. Market volatility, and macroeconomic uncertainty, have kept multiples largely compressed recently, perhaps 2 or 3 points shy of fair market multiples in a more stable environment.  Should uncertainty increase, or the uncertainty be resolved unfavorably with the probability of another recession visibly and significantly increased, then Price to Earnings, Book, Sales and other valuation multiples in the market will likely decrease, meaning falling or stagnant share prices.  Not good for the near term, perhaps an even better buying opportunity for the long-term.

    How I Traded It:

    Stock only. It looks cheap around $17.

    Sell put options. Sell July 17.5 strike Puts above $2 per contract.  This provides a net cost, should you be executed, of current stock price $17 - $2 per share (excluding commissions), or $15  Should the contract expire worthless, you will pocket $200 per contract, or a 11.4% return for roughly 7 months of exposure.  This equates to an annualized return of 19.6%. 



    Disclosure: I am long SEE.

    Additional disclosure: I am also short long-dated put options on SEE.
    Dec 23 10:49 AM | Link | Comment!
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