Mario Gabelli And The Concept Of Private Market Value
I first learned about the concept of private market value from Chapter 10 " Mario Gabelli - Discovering and Unlocking the Private Market Value" of Bruce Greenwald's book "From Graham To Buffett And Beyond." The book refers to private market value as a modern variant of net-net or a "value metric that is less easily uncovered than net-net but no less discriminating in its ability to identify underpriced securities," and also quotes Gabelli's definition of private market value as "the value an informed industrialist would pay to purchase assets with similar characteristics."
Mario Gabelli's concept of private market value has three differentiating factors, according to the book. Firstly, private market value emphasizes the fact that industrial buyers will pay a premium for control and public market investors can earn this control premium by buying stocks trading at significant discounts to their private market values. Secondly, private market value sets itself apart from other conventional GAAP-based valuation methods such as P/E by either focusing on operating metrics (e.g. number of hotel rooms, subscribers, the acreage in timber etc) or uncovering the value hidden within multi-business conglomerates, valuable real estate carried at historical cost and accounting mirages obscuring true profitability. Thirdly, Mario Gabelli is looking for catalysts which will propel the company's share price towards its private market value; these include company-specific catalysts like a change in management and environmental catalysts such as changes to the political, social, and economic environments.
Interestingly, Marty Whitman of Third Avenue also makes reference to private market value using different terminology. In his book "Modern Security Analysis," Whitman writes about resource conversion (activities including but not limited to massive asset redeployments, mergers and acquisitions, liability restructurings, changes of control, spinoffs, and liquidations), a process where market participants attempt to arbitrage between the public market ("one measuring the prices at which outsiders trade common stocks in the open market") and the private market ("the other reflecting the value of businesses").
Marty Whitman also cautions against investing in resource conversion opportunities where management and insiders are not motivated to undertake corporate actions to narrow the gap between the company's share price and its private market value. He highlighted shark repellents like poison pills, staggered elections for members of boards of directors, and supermajority voting provisions that will minimize the possibility of resource conversion via a change of control.
For myself, private market value is appealing as a valuation metric, considering that it is derived from comparable transaction valuation multiples based on deals done by informed buyers and sellers. This is in stark contrast to current comparable listed peer valuation multiples and discounted cash flow. Comparable peer multiples can vary significantly depending on current market sentiment towards specific industries, markets and stocks; and I like former Third Avenue Chief Investment Officer Curtis Jensen's quote on discounted cash flow below which sums up my thoughts on this particular valuation metric.
Discounted cash flow to us is sort of like the Hubble telescope - you turn it a fraction of an inch and you're in a different galaxy. There are just so many variables in this kind of analysis - that's not for us.
In a separate article, I wrote about Tobias Carlisle's favored valuation metric, enterprise value-to-operating income, which he aptly refers to as the Acquirer's Multiple. Private market buyers evaluate enterprise value as their purchase price rather than market capitalization since they are buying the business in its entirety and have the option to optimize the capital structure once they gain control; while operating income is similarly independent of capital structure consideration facilitating the comparison of companies on a like-for-like basis.
Potential Private Market Value Stock Idea
My potential private market value stock idea, Edgewell Personal Care (NYSE:EPC) (originally the subject of my February 2016 stock idea for subscribers), happens to be a Mario Gabelli/GAMCO Investors (NYSE:GBL) portfolio holding. Mario Gabelli added 74,415 shares (average purchase price of $90.55) and 187,520 shares (average purchase price of $81.04)of Edgewell in Q3 2015 and Q4 2015 respectively, following the split of the former Energizer Holdings' (NYSE:ENR) branded consumer products business and battery business in July 2015.
Edgewell, a manufacturer and marketer of branded consumer products in the global shaving, sun care, feminine care and infant care categories, is a defensive, wide-moat stock boasting market-leading positions for its brands, non-discretionary customer demand and prodigious free cash flow generation. It offers investors downside protection in an uncertain 2016 by virtue of resilient revenues (a function of non-discretionary demand & market leadership) and the potential of being acquired by larger players (which offers a valuation floor).
Edgewell's brands are among the top three players in all the categories/market segments they compete in. Its wet shave brands comprising Schick razors and blades and Edge and Skintimate shaving creams are only second to Gillette globally. The Company's sun-care brands such as Banana Boat and Hawaiian Tropic are ranked number 1 in U.S., Mexico & Australia, while its infant care products sold under the Playtex and Diaper Genie brand names are also the market leaders in U.S. & Canada. Edgewell's feminine-care brands Playtex and Stayfree are ranked second and third in U.S & Canada respectively. Edgewell's scale also enables it to spread R&D expenses over a larger revenue base, suggesting it can spend more on R&D (vis-a-vis its smaller peers), yet keep its R&D-to-sales ratio comparable. (2014 R&D spend = 2.7% of Net sales) Most of Edgewell's products are "need-to-have", rather than "good-to-have." Shaving is a regular routine for most men (except those who choose to keep their facial hair). Also these personal care products are a small proportion of a consumer' monthly budget and they are less likely to be cut (as compared to discretionary purchases) in difficult times. Edgewell's free cash flow conversion rate (defined as Free cash Flow / Net Operating Profit After Tax) averaged 115% for the past five years. Edgewell has delivered 10-year revenue and operating profit CAGRs of 11.6% and 21.8% respectively.
Edgewell's history is that of building a company from scratch through M&A, starting with the shaving business (acquisition of Schick Wilkinson Sword in 2003) and the addition of Hawaiian Tropic, Playtex, and Banana Boat in 2008; Edge and Skintimates in 2010; and o.b., Carefree and Stayfree in 2014. Acquisitions is a key growth driver for Edgewell, allowing it to expand its existing product portfolio which is highly accretive to earnings. Edgewell can simply add new products from acquired personal care companies to its existing distribution network & channels and generate more revenues while expanding profit margins by spreading SG&A expenses over a larger revenue base. More importantly, as an independent company following the spin-off, Edgewell can dedicate resources towards M&A activities, as evidenced by its decision not to pay dividends.
Besides inorganic growth, Edgewell is engaging in systematic cost reduction to meet its target of a 50 basis points expansion in operating margin every year. It is shifting away from legacy, battery go-to-market approach to third-party distribution in certain markets, thereby removing some of the fixed costs. Edgewell is also closing down certain manufacturing facilities in Connecticut & Germany and shifting production to low cost countries like Mexico and China. Headcount in 10 shave cartridge assembly cells was reduced by over 500, with automation projects averaging less than 2 year paybacks. Another example is the plant consolidation in Femcare and closing Montreal Plant which is scheduled to be completed by early 2017. This will result in the relocation of 24 production lines, the decommissioning of 36 production lines, and an estimated $20-25 million in annualized run rate savings.
Edgewell's current share price of $80.98 is below its share price of approximately $100 at the time of spin-off.
Edgewell currently trades at 12.6 times FY2017 (year ended September) forward EV/EBITDA. Reckitt Benckiser's (OTCPK:RBGLY) acquisition of SSL International in 2010 was done at 18 times EV/EBITDA, while Unilever (NYSE:UN) bought hair and skin products specialist Alberto-Culver in 2011 at 14.4 times EV/EBITDA. Earnings growth and multiple expansion in line with comparable transactions should provide valuation upside for the stock.
As a special bonus for my subscribers, they will get access to bonus stock ideas of two companies trading at a discount to their respective private market values.
Piggybacking Mario Gabelli
Mario Gabelli's significant (defined as a 0.1% or more impact on dollar value of portfolio) new purchases or additions in the fourth quarter of 2015, included Comcast Corporation (NASDAQ:CMCSA), Airgas (NYSE:ARG), Keurig Green Mountain (NASDAQ:GMCR) and BioMed Realty Trust (NYSE:BMR) excluding Edgewell. Of the four stocks, Gabelli has publicly commented on Airgas.
In a November 18, 2015 tweet, Mario Gabelli said "Airgas....in deal to be bght by Air Liquide @$143 cash per share......may have to shed ops in some Mkts." Gabelli's Merger and Arbitrage fund "The Gabelli ABC Fund" also mentioned Airgas in its Q4 2015 shareholder commentary.
Airgas is a Wayne, Pennsylvania based producer and supplier of industrial and specialty gases. The company agreed to a $13 billion ($143 per share) cash merger with European competitor Air Liquide SA on November 17, 2015. The deal is subject to a majority vote by Airgas shareholders. Closing is expected in the second quarter of 2016, pending antitrust approval in the U.S. as well as clearance by the Committee on Foreign Investment in the United States.
My subscribers will get access to the full list of Mario Gabelli's new buys, additions and his estimated average purchase price for these positions in the most recent quarter.
Note: Subscribers to my Asia/U.S. Deep-Value Wide-Moat Stocks exclusive research service get full access to the list of deep-value & wide moat investment candidates and value traps, including "Magic Formula" stocks, wide moat compounders, hidden champions, high quality businesses, net-nets, net cash stocks, low P/B stocks and sum-of-the-parts discounts.
Disclosure: I am/we are long EPC.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.