Sometimes, when a company finds itself struggling to make progress in its given market, the answer is to acquire another business that is able to navigate those rough waters. This is the conclusion that Edgewell Personal Care Company (EPC) recently came to. After years of struggling, Edgewell and its management team decided that perhaps the best path forward for the firm, as it strives to create and grow shareholder value, is to buy up care company Harry’s. In the $1.37 billion acquisition, Edgewell is receiving a fast-growing business with strong brand recognition, but the price being paid for the firm is far from immaterial.
A look at the transaction
According to the press release issued by Edgewell, the company has struck a deal whereby it will acquire personal care company Harry’s in exchange for $1.37 billion. The transaction in question will consist largely of cash, worth $1.085 billion. The rest of the deal, $285 million, will be in the form of Edgewell shares. As a result of this transaction, the investors in Harry’s will end up owning 11% of the combined firm. This is, by all accounts, a significant move by Edgewell, the maker of Schick, when you consider that the company’s entire market cap, following a 15.8% decline in response to this development, is only $1.82 billion.
Clearly, the market is not too enthusiastic over Edgewell’s decision. To see why, we need only look at the sales of both firms. Last year, revenue generated by Edgewell totaled $2.23 billion. This year, on the other hand (no significant public data is offered for last year), Harry’s will generate sales of around $325 million. This is a significant disparity in terms of sales alone, but it becomes clear precisely why this exists when you consider the performance of both firms over an extended period of time.
As you can see in the graph above, revenue generated by Edgewell has been declining rather steadily, declining every single year since at least 2014 when it totaled $2.61 billion. In short, over that time frame, the company has lost more than the total revenue that should be generated by Harry’s this year. Not only that, but as you can see, both net income and operating cash flow figures (mostly the former) have been incredibly volatile in recent years.
Unfortunately, because Harry’s is a private company, we can only see what little has been disclosed through this announcement. That said, what is out there is impressive to say the least. Even though sales will only be about $325 million this year, it’s important to keep in mind that the company was founded in 2013. That’s quite an impressive growth rate, and since 2016, the company’s growth rate has averaged 30% per annum. By combining together, the two businesses will also achieve attractive brand recognition, with both combined having a significant number of top products across different parts of the CPG industry segment.
The growth achieved by Harry’s is noteworthy because the industry in which it operates is not known for attractive growth itself. As you can see in the image below, management at Edgewell believes that, combined, the two firms will see growth in the mid-single digits. This compares favorably against the 2.5% annualized growth rate seen in the CPG segment for the 2018 through 2020 time frame forecasted. Not only that, but management believes that gross margins will also be higher than the industry average of 44%. Together, both firms will also own over 2,900 global patents, plus will have pending applications for more than 450 others.
The secret behind Harry’s growth, besides quality products, appears to be a significant emphasis on new-age marketing and distribution. By 2015, the company had already reached 1 million DTC (direct to consumer) customers. In 2016, it landed itself in Target (TGT), and in 2018, the year after its DTC launch in the UK, it got its products inside Walmart Inc. (WMT). As you can see in the image below, there are multiple reasons why Edgewell believes that the company’s disruptive approach to growth has paid off and it’s likely that as the two firms combine, Edgewell will try to capitalize on these methods.
Assuming all goes according to plan, Edgewell has high hopes for its purchase of Harry’s. In addition to the brand’s strong growth prospects, management believes that it can generate annual run-rate synergies on an operating basis of $20 million (as measured in EBITDA) by 2023. In addition to this, management is forecasting another $20 million in revenue-oriented synergies between the two firms. All of this is on top of the $225 million to $240 million in gross cost savings forecasted for the firm’s execution of its Project Fuel endeavor.
Whether or not this will pan out is anybody’s guess, but without mincing words, it’s something management can’t afford to mess up on. This is because, immediately following the transaction, the company’s gross leverage ratio will stand at a hefty 5.2. With free cash flow expected to grow to between $200 million and $300 million per year, EBITDA will also rise if management is correct. This, in turn, will bring the company’s gross leverage ratio down considerably, dropping it to 3.5 by the end of the second year following the transaction. A failure to reduce leverage, though, could lead to a lot of pain for a company that is already posting lackluster results.
In my view, Edgewell has made one of those rare ‘bet the farm’ moments on Harry’s. So far, the Harry’s brand and leadership team has demonstrated the ability to take charge and grow their firm rapidly, which is great for Edgewell, but the question will boil down to whether Edgewell can (or will be willing to) replicate this across its own platform of offerings. This is tough to determine because it’s just as much an operational change as it is a cultural one. If management is flexible moving forward, and able and willing to learn from what Harry’s has accomplished, the future for the combined firm can be quite bright and the acquisition will be looked back on as a good one for the investors in both firms, but a failure on Edgewell’s part to do this will lead to a whole lot of pain, most likely, for the company’s shareholders down the road.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.