Stanley: Great Deal For Craftsman

| About: Stanley Black (SWK)
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Summary

Stanley's paid $900M for rights to Craftsman brand outside of Sears retail channels.

Stanley has tremendous opportunity to improve Craftsman margins and sales growth.

The deal looks good compared to other comparable transactions.

Stanley Black & Decker (NYSE:SWK) announced an agreement to buy the Craftsman brand for $900M from Sears Holdings (NASDAQ:SHLD) back in January of this year. The deal is a bit complicated. SWK gets the rights to develop, manufacture, and sell Craftsman tools in non-Sears outlets. Sears gets to sell Craftsman in their own stores from now until the end of time. Stanley paid Sears an upfront fee of $525M at closing and will pay a fee of $250M at year three. Stanley will also make varying annual payments to Sears based from now until 2023 based on sales outside the Sears retail channel. I have seen some conflicting information about how long the payments continue but the official transcript from the Stanley conference call on the Craftsman acquisition makes it clear the payments stop after 2023. All told the net present value of all of the payments adds up to around $900M.

We think this is a great deal for Stanley and makes up for the company likely overpaying for the acquisition of Newell's tool business. Given that studies show that 70% of all mergers and acquisitions fail to meet their financial objections the onus is on us (and of course Stanley's management) to prove why we think the deal will be good for shareholders.

SWK's Opportunity 1. Quality Improvements

SWK's history with the word quality is a bit sketchy. While the company certainly has some higher end professional brands like DeWalt, Mac, and Proto things haven't always been great in the quality department. Historically, a significant amount of manufacturing operations for the DeWalt brand were overseas and quality went downhill. Starting in 2013 Stanley moved final assembly of many DeWalt products back to the US. Quality has improved over the years and the brand seems to be growing popularity.

The Craftsman brand used to be synonymous with good quality at an affordable price. Nowadays things seem to have gone downhill. Not only has my personal experience with Craftsman been disappointing but it seems to have slipped in quality according to other's opinions as well. Just take a look at various construction, DIY, and automotive/garage forums and see what other people are saying. According to many people Craftsman tools rank amongst the lowest in quality.

Stanley has a huge opportunity to reinvigorate a brand that a cash strapped Sears looks to have stopped investing in. If Stanley can do to the Craftsman brand what it did to turn around DeWalt then it made a great deal.

2. Vertical Integration

On the financial side of things Stanley also has a huge opportunity. Sears is not and never was a tool manufacturer. The actual production of Craftsman tools was always outsourced to a third party. By contrast Stanley actually manufactures its own line of tools. Cutting out the intermediary should allow Stanley to boost margins. Indeed based on the projections from Stanley's presentation it looks like the operating margins for the Craftsman brand in non-Sears retail channels are around 7.5% to 11.5% compared to over 14% for Stanley so there is ample room for margin expansion.

It's unclear how quickly this may happen. The benefits of vertical integration may be offset by the royalty payments Stanley is making to Sears for the first 15 years of the deal but at some point there will be substantial profits for shareholders just due to the fact that Craftsman will now be vertically integrated.

3. Growth

The biggest opportunity for Craftsman is a whole new world of growth. It's no secret that Sears was and is strapped for cash. It's questionable how much Sears invested in the Craftsman brand and it's also worth wondering how many third party retailers wanted to carry a line of tools from a store that might go bankrupt or a line of tools that might soon be sold to another company.

Stanley is projecting $100M of additional revenue growth for the brand over the next decade. It might seem aggressive at first but we think it is doable especially when you look at all the opportunities available.

Let's start with the biggest. The second largest e-commerce retailer in America is Wal-Mart (NYSE:WMT). Guess whose products don't appear on Walmart.com? Craftsman. Guess what store doesn't really have their own private label brand of tools either? Wal-Mart. If Stanley can get Craftsman carried by Wal-Mart, especially online, it could be a huge win.

The Craftsman Professional line of automotive tools seems to be an exception to Craftsman's dubious quality as of late. Many mechanics seem to give them positive reviews, especially for DIY types looking for a higher end tool that isn't as expensive as Snap-On or Matco. Stanley already has it's Mac tools which are sold to professionals via the tool truck model. We think there could be an opportunity for some Craftsman Professional products to make their way into Stanley's existing distribution system. Sure, there would definitely be the cannibalization of some sales but a broader product line-up and more price points could still drive higher top line growth.

Another area of opportunity is the lawn and garden market. What brands come to mind when you think "lawn and garden"? Probably not DeWalt. Black & Decker, maybe. One of Craftsman's greatest areas of strength is the lawn and garden market. The brand provides Stanley a great opportunity to round out its portfolio. Stanley is already strong in the construction market with a full range of brands covering most price points. It was a bit weak in the automotive market with just Mac and Proto at the high end and Stanley as an afterthought at the middle or low end (depending on your view). Craftsman has the strongest line-up where Stanley was the weakest and there should be great synergies in product development in the future.

Comparables

Based on comparable deals it looks like Stanley got a good deal on Craftsman. The table below shows the multiple paid for tool companies on two previous deals as well as the current market multiples of several tool companies.

Company/Transaction

Date

Price/Sales

EBITDA Multiple

SWK purchase of NWL tools unit

2016

2.6x

13.0x*

Bain Capital purchase of Apex

2013

1.0x

Snap-On

Current price

2.8x

10.9x

Techtronic Industries

Current price

1.5x

12.2x

Makita

Current price

2.6x

12.3x

Stanley Black & Decker

Current price

1.7x

12.6x

*Becomes 8.3x EBITDA if Stanley's $85M immediate cost synergies estimate is true.

Craftsman generated about $1.9B in sales in 2016 with about $200M worth of sales coming from non-Sears channels. Stanley paid approximately .47 times sales for Craftsman. However, that number is a bit misleading since Stanley is only buying the non-Sears retail channel portion of the business (for the first 15 years). If you just consider the portion of the business, Stanley gets immediately it's paying 4.5x sales.

In the very long term this goes from a good deal to a great deal for Stanley. It's highly likely that Sears is going bankrupt and there will be no more Kmart or Sears stores. Can anyone come up with a plausible situation in which Sears or Kmart somehow survives as a brick and mortar, mall based retailer? It has one of the weakest financial positions of all mall based department stores in retail niche that is overbuilt. When that happens Stanley will have complete control over the distribution of the Craftsman brand. Retailers who previously may have been loath to carry Craftsman products because of potential competition with Sears will no longer have anything to worry about.

In fact, if you are a Stanley shareholder I'd be rooting for a Sears bankruptcy sooner rather than later. Sure, Stanley will likely end up with about $5M to $10M per year of legacy warranty costs. Legally, Stanley is not on the hook but it would be brand suicide to cease honoring Craftsman's lifetime guarantee and Stanley's management alluded on the conference call that they would continue to honor it. But Stanley would then assume complete control over the brand and the sooner Craftsman would have a greater appeal to other retailers.

In short the Craftsman deal strengthens Stanley's brand portfolio and offers the company a huge runway for future growth.

Disclosure: I am/we are long SWK.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.