New Long Position: Sealed Air (SEE US)
In 2012, Permian Investment Partners accumulated a long position in Sealed Air, an $8 billion packaging and hygiene services company that offers: a) a high quality business masked by a history of mismanagement, b) a new, well-incentivized CEO with a strong track record, and c) a discounted valuation resulting from what we believe is an underestimation of management's capacity to drive shareholder value. Currently trading at 10x Permian's 2015 estimated FCF, Sealed Air is cheap for a business that will organically grow earnings over 10%/year with a 20% return on invested capital. New CEO Jerome Peribere, formerly President of Dow Chemical's multi-billion dollar Advanced Materials group, is economically incentivized to create shareholder value by improving margins in underperforming segments and expanding the business in emerging markets to increase revenue growth. If shares of SEE increase to $45 by 2015, Peribere stands to earn an incremental $10 million, more than 10x his base salary. During his 30 year career at Dow, Peribere was responsible for the successful integration of Rohm & Haas as well as Dow's expansion into a number of key emerging markets. A former colleague with whom Jerome worked closely for eight years said "Dow would have never entered into the generic space without Jerome's leadership" and "I would rank Jerome a 9 for sustainable effectiveness of maximizing return on investment." Our research suggests that in his first several months, Peribere has already started to right-size the company's expense base and raise prices on Sealed Air's legacy packaging products.
To say that Sealed Air had been "mismanaged" over the last 15 years may be a bit of an understatement. After generating stable growth and a 20%+ return on capital through most of the 90's, legacy management fell from Grace (pun intended as SEE bought Cryovac from W.R. Grace) when Sealed Air overpaid for several large acquisitions and never effectively integrated the businesses. In the last three years, management missed quarterly consensus estimates over 80% of the time and fell far short of its long-term revenue and margin targets which it outlined in 2010. As a result, the share price fell from $28 to $13, furthering SEE's underperformance versus competitors and the market. Since the turn of the century, shares of packaging companies Bemis, Aptargroup and Ball Corp returned 70%, 105%, and 310%, respectively. Sealed Air shares, on the other hand, returned just -1.5% over the same period despite the Company having more than double the revenue base and 50% higher EBITDA than it did in 2000.
We believe that Peribere will create value in the following ways: 1) improving margins for Diversey, Sealed Air's hygiene services business, 2) improving margins in the legacy Packaging business, 3) shifting the Packaging revenue mix towards higher growth emerging markets, 4) increasing prices on SEE products, and 5) allocating capital in a shareholder-friendly manner. Currently, Diversey's margins are more than 1000bps below its only major competitor, Ecolabs. The opportunity to turn around Diversey requires a more customer-friendly sales/service staff and a reduction in what we believe is a bloated cost base. The sales/service staff is already showing its ability to provide a full service offering. Sealed Air recently won the Intercontinental Hotel contract (thousands of hotels) over Ecolabs in the first quarter, a clear indication that customer service is improving. Our research also indicates that since taking over at the beginning of the year, Peribere has already started cutting the bloated Diversey employee base. One former Dow colleague told us "it will take Jerome 30 days or less to figure out who is low hanging fruit" and a former Diversey executive indicated that Peribere has a high sense of urgency and has already made material changes to the employee base. Improving margins in the legacy Packaging business is already underway. Specifically, the Company had one-time operating issues while moving plants in Brazil accounting for a big hit to margins. Additionally, the managers responsible for passing through raw materials pricing had been inefficiently and ineffectively re-capturing raw materials price pressure. One company contact shared with us that Peribere has exerted a high degree of pressures on these managers and that now, "their jobs depend on their ability to re-capture all raw materials price increases". We have a high degree of confidence that Peribere can aid in the expansion to higher growth markets as this DM-to-EM shift is, according to our research calls, exactly what he did at Dow during his career. Calls with competitors confirmed that SEE already started to raise prices on packaging products over the last several months, a change that shouldn't hurt competitiveness as both competitors indicated plans to follow suit. Finally, capital allocation has already shown improvement. When his CEO appointment was announced, investors were concerned SEE would have difficultly de-levering and that ultimately, the company would breach its debt covenants. Within two months of Peribere's appointment, SEE announced the $377mm divestiture of Diversey Japan, the proceeds of which were directed entirely to debt payment.
On Permian's estimates, Sealed Air will earn over $3 in levered cash EPS by 2015, almost 50% higher than consensus expectations. Competitors Bemis and Aptargroup both currently trade at 15x 2015 consensus EPS estimates. Sealed Air, in our opinion, is trading at a double discount (discounted multiple on overly-bearish earnings estimates). We expect that the value accretive measures above will fundamentally propel stronger than expected earnings growth and result in 70-100% share price upside over the next two years.
Disclosure: I am long SEE.