Tag: Spin-offs

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Interesting (Hated) Spin-out – Masterbrand Cabinets Stock $MBC
Reading Time: 4 minutes

Intentionally or not, Fortune Brands has created a Good Co, Bad Co with their spin-out of Masterbrand Cabinets stock. It is very easy to be cautious on 2023 and say, cabinets are F’d. Instead, cling to your Fortune Brands shares which sell into plumbing, security products, and decking.

Cabinets are a super cyclical business. I tend to think a cabinet sale occurs during new construction… or when they fall off the wall. But really they are also replaced when there is heavy remodeling work done. All require some discretionary income.

The cabinet business proved its cyclicality back in the financial crisis. Featured below is Masco’s (since divested) cabinets business operating income. It took until 2016 to get back to Op income profitability! Woof.

Now, of course we were in a housing bubble back then… Masco also added in a ton of capacity right before the market turned. This number includes some impairments and restructuring charges. In addition, China started to nip at the heels of the industry by competing in the really commoditized, “stock”, low-end product (ready-to-assemble cabinets).

American Woodmark’s EBITDA perhaps is a better example:

Typically, competition is pretty localized in cabinets as shipping costs can be really expensive. That’s still true, but the industry had to flush out losing some of that lower-end business.

Fast forward a bit to today, American Woodmark (AMWD), Masterbands (MBC) and Cabinetworks (private, but bought the former Armstrong and Masco cabinet businesses along with Elkay), now dominate the industry. Definitely flip through Masterbrands investor day deck if you want more background

It is still a tough business, no question.

In 2021, they were hit by labor costs (building cabinets is labor intensive), freight, as well as hardwood costs. It’s a high fixed cost business too, so when operational issues occurred (omnicron absenteeism for example), it really hit them on the chin as throughput suffered.

As such, the industry has been trying to get price to recover this. Backlogs have been huge, but that wasn’t necessarily a good thing as the price on the backlog didn’t match the new input-cost reality.

The industry is doing better to recover margin. As you can see from American Woodmark’s EBITDA margin, they are slowly but surely getting back to a reasonable margin level.

We’re talking big price increases rolling through now.

Volumes for the industry are pretty flat lately, but price increases are 15-20%. That will help margins going forward. KCMA publishes data and in October, volumes fell 2.6%, but price was up 17%

AMWD’s FQ2’23 (ended Oct’23), showed EBITDA margins expanding from 6.8% to 12.0% Y/Y. And therefore EBITDA $ more than doubled.

Taking a step back, I think this tends to surprise people – demand was so strong for cabinets that it hurt profitability. And as demand has cooled a bit now, that’s helping? WEIRD.

Back to Masterbrand – Fortune Brands decided to spin the company out. My guess is for a re-rating. Get rid of the more cyclical, lower margin business. Heck, that’s what Masco did (though it didn’t really re-rate).

But my guess is everyone is thinking the same thing on MBC. “Get away”

Masterbrand, I will say, has outperformed its peers on maintaining margin. They have a long history of that. I believe they are THE best run cabinet player in the space. Even so, they think they can get to 16% EBITDA margins over time.

I like low hurdles to jump over. So I did some rough math. I used their estimate for “high-single digit” sales decline next year, 25% decremental. But then I basically say no growth from there. I give no credit for W/C being a benefit either, after a couple years of a large build. Maybe that’s too aggressive? I don’t know, I think expectations for Masterbrand Cabinets stock are probably pretty low…

That looks like a lot of cash…. And when I compare it to the current market cap, we’re talking nearly a 20% FCF yield for Masterbrand Cabinets stock.

Historically, cabinets businesses have traded for 6-8x, in some cases higher for private M&A. It intuitively makes sense given what we’ve discussed. But I think this valuation, IF YOU HAVE A LONG TIME HORIZON, makes a lot of sense.

Obviously there are risks. The cycle could be a nasty one. The spin could have some stutter-steps (though MBC was a separate segment for a long time). But I like the risk-reward here and the forced selling.

The other major risk is I am writing this the day of the spin! That’s a no no. Wait for it to bleed out, Dilly D! This is a $1BN market cap and hated industry right now!

Ehhhhhhh whatever. AMWD is trading at 7.3x ’23 and in my view, has performed worse. Capital intensity is also higher there. I like the risk reward.

 

Columns

Google Should Take a Page from the IAC Playbook: Spin-Offs $IAC $GOOGL $GOOG
Reading Time: 3 minutes

I’ve been thinking about Google recently… especially as concerns arose around COVID-19 and what it would do to the new era advertising giants. Everyone knows “search” is such a powerful business in advertising and benefits from the scale / platform benefits of everyone “googling” what they need. Though I can’t help but think that Google’s assets are underappreciated.

I think Google should take a page from IAC. For those of you unfamiliar with IAC, they essentially are a publicly traded venture capital firm. However, unlike VC the business is “home grown” and once it matures, they tend to spin-it out and maintain a stake or take a dividend from the business (like they have recently done with Match Group, the owner of Tinder and other dating apps).

IAC’s track record is impeccable. Recognize any of these names?

 

The point is, IAC understands that sometimes a company is worth more operating outside of a large corporate umbrella and with its own balance sheet, making its own strategic decisions, and having its own separate shareholders.

They also understand that a company may need to have a shareholder early on with a long-term view. I think Google’s assets could benefit from this treatment as many of them are mature at this point.

Imagine Google does the following spin-offs:

  • Google Nest, Google Home – Hardware play
  • Google Maps – logistics tolling play in the long run
  • Waymo – Driverless Cars
  • Google Cloud Business
  • Android, Chromebooks, other hardware etc.

Search, YouTube, & G-suite (Google Sheets, Gmail, Google Drive, Google Pay) is the “RemainCo” as the assets really do benefit from being combined.

Do you think the assets of the company are worth more than what Google currently trades at? I do.

I think YouTube and Google probably are worth where Google trades right now.

Facebook has roughly 50% EBITDA margins on its advertising-driven business. Let’s say Google’s is in a similar ballpark.  The company disclosed in 2019 that Google and YouTube generated around $135BN in revenue, so applying a 50% EBITDA margin to that implies $67.4BN in EBITDA. At the time of writing, Google’s entire Enterprise Value is $837BN, so that foots to ~12.5x EBITDA for a company that is a secular grower. That doesn’t seem excessive to me.

Next, lets look at Google Cloud, which is growing like a weed and competes with AWS.

Back when AWS was around this size in revenues, it had low 50% EBITDA margins.

Therefore, I can assume again around 50% EBITDA margins for the Google Cloud business, which foots to $4.5BN of EBITDA. This too is a secular grower, an oligopoly business between the tech giants, and likely going to double earnings in a couple years. Therefore, I do not think its is unreasonable to say this is worth $75BN (frankly, if earnings do double in 2 years, that’s only an 8-9x forward multiple).

The point is though that that one segment could add a lot of shareholder value if it operated outside of Google. We haven’t even touched “other bets” Google has, which seems to be a lot of cookey stuff like barges for some reason.

There are so many things within Google that I bet we don’t even know about. This list of acquisitions by Alphabet is insane and as a layperson, I don’t know what many of them do. Its also hard for me to actually see what value they bring to Google or to me as a shareholder — but if Google separated out its businesses, maybe that wouldn’t be the case!

Security Analysis

Otis Stock Spin-out from United Technologies – Quick Thoughts $OTIS
Reading Time: 4 minutes

It’s not every day that you hear “recurring business model”, “razor / razor blade”, “route density will drive margins higher” story associated with an industrial company, but here we are. Otis stock has officially spun out of United Technologies so here’s my initial read. In other words, a starting point to see if there should be more work done. I like to take quick looks at topical names (and spin-outs can get interesting) so more of these will likely follow.

Things I like:

  • Service Drives Profitability:
    • New equipment sales were 43% of sales, but just 20% of operating profit. That means service revenue, while 57% of sales, makes up 80% of operating profit
    • This is positive, as it means revenue is much more recurring. Represents a “razor / razorblade” model too in that once the new equipment is installed, the customer needs to come back to Otis for service
    • The model is pretty simple: Otis sells new equipment and operates under warranty for a couple years. After that, Otis sells long-term service agreements that typically last ~4 years.
    • According to the company, an elevator will generate 2.5x its original purchase price in aftermarket service
    • In fact, service is contractual. And I like that the company reports “Remaining Performance Obligations” because it gives a sense of what sales will be in the next 2 years.

  • Generates a lot of unlevered FCF:
    • I was somewhat surprised at the low capital intensity of the business. I would say that this level of capex spend based on my experience is top quartile and that checks a box for Otis stock
    • Further, working capital is really low relative to total assets & sales
    • This means the company likely can use a lot of cash for dividends (looking at 40% payout ratio) and buybacks plus possible M&A of other service providers as the company says the space is fragmented.

  • Consistent business model – life threatening to “skimp” on the service:
    • I like how this business really hasn’t changed in 100 years. It tells me that the next 10 years will probably look similar to the last. That’s something you can’t say about every business so perhaps this deserves a “consistency premium”
    • If I was a firm deciding which elevator to choose, I’m not sure I’d take the lowest offer. I think a firm with a solid track record actually matters here. Elevators not only get people to work
    • Failure here might be unlikely, but the cost is so huge it makes no sense to change. For me, I sense that being true on both new sales and maintenance.
    • In fact, the company says it has a 93% retention rate following end of the warranty period – not bad!

Things I don’t like

  • Operating Margins have been declining
    • At first glance, I thought this might be due to new equipment sales becoming a larger portion of the mix. However, that’s not the case. It has been relatively consistent.

    • It seems to be China sales are the issue. The company has called out this “mix” effect, but also Otis doesn’t not have leading share there. In this business, density matters. So it will take time for the company to build density and improve margins.
    • Quote from prior call on Otis on the importance of route density:

“So today, if you look at us versus our peer competitors, we have a 200- to 300 point — basis point premium margin. We believe with our scale and density that will continue through the future. Add that to, again, this drop-through of productivity enhancements. But scale and density matters in this industry. You go to any city, whether it’s this building, anywhere else, if you’ve already got mechanics, if they’re already out on a route and you can add new customers, you get, obviously, a little additional incremental cost, but you get to add to the portfolio significantly.”

  • Mitigant: Company is targeting supply chain savings (3% of gross spend per year) and thinks it can reduce SG&A from 13.6% of sales to ~12.25% over the medium term, but somewhat of a “show-me story”
  • China is the growth story
    • China’s construction growth worries me. The talk of “ghost cities” being built to support GDP makes me concerned that a reckoning is eventually coming. And the problem is that many of these buildings may be unoccupied and therefore you don’t need to service them.
    • China is the largest elevator market – 60% of global volume. It’s also more competitive it seems.
    • Mitigant: China is getting more focused on building maintenance code, which should support global players like Otis. It should allow more sales to the big players as well as larger service contracts. Real estate developers in China are also consolidating, so it likely means they will want to work with one supplier.

Otis Stock Valuation:

I would say the valuation here is reasonable. Not super compelling in the COVID world, but at least it should be a long-term compounder.

Thysennkrupp’s elevator business was acquired by private equity for $18.7BN, or roughly 17x forward EBITDA. That would point to Otis stock being very cheap on that basis… Given it’s stability and strong cash flow, I can see why P/E would buy out a player. Otis stock is actually a mid-cap, but not too big for someone in Omaha…