This article is a reprint of my August 19 2008 RealMoney column.
Can a market leader in clothespins hang short-sellers out to dry? Investors in Jarden (JAH) may soon find out. The company has acquired a portfolio of leading brands in outdoor and consumer products that includes Sunbeam, Oster, Coleman, Rawlings and Mr. Coffee. I think these market leaders, sold in a wide range of stores, are generating more than enough cash flow to service debt and fuel additional growth, making life uncomfortable for their considerable short float.
According to its latest 10K, Jarden is now a leader in a variety of categories, including (deep breath) alpine skis and bindings, snowboarding and snowshoeing, baseballs, bats, softballs and gloves, camping gear, cordage, firelogs and firestarters, soft baits, rods, reels and combos, home canning, home vacuum packaging, matches and toothpicks, personal flotation devices, playing cards, boxed plastic cutlery, selected small kitchen appliances, warming blankets and a number of other branded consumer products. (Does that give you an idea of the breadth of their product lines?)
The 2007 acquisitions of K2 and Pure Fishing helped make outdoor solutions the company’s largest business segment. Unfortunately, they also helped saddle the company with $2.8 billion in total debt just as the consumer slowdown began in earnest. Investors headed for the exits, sending the shares down by nearly half since last summer’s peak. Short-interest stands at nearly 23% of the floating shares.
I think the shorts may now be pressing their luck. For example, some investors consider Jarden’s high exposure to Wal-Mart (WMT - Annual Report) a cause for concern. However, judging from last week’s earnings report, Wal-Mart looks like exactly the place to be supplying these days.
Meanwhile, I think the same credit crunch that is giving investors such concern is likely to prove the remedy for their concerns. If Jarden does not have additional access to debt, obviously the debt load won’t get any bigger — and they can use their cash flow to reduce the current debt load while waiting for the market to improve.
And quite a flow of cash it is. Over the last 12 months, the company’s operations generated $402 million in cash flow and required just $89 million to build and maintain productive capacity. The remaining $313 million can be used for anything the company wants. Historically, it has been acquisitions, but in the current environment, I’m betting they will clean up the balance sheet.
Finance theory says there shouldn’t be a difference in the value of a firm based on whether it is financed by debt or by equity. But we all know that theory and reality don’t always mesh. Last year when debt was cheap, the sensible thing to do was to grow by borrowing money to acquire other companies, and that’s what the company did. This year, with the debt load higher by $1 billion, and the market capitalization $1.5 billion lower, the debt/equity ratio is all out of whack. I think nervous investors have taken the market cap lower than is justified by the cash flow, and that each dollar used to repay debt will increase the value of the company by more than one dollar as investor concerns subside.
Without any further growth in cash flow, I think a strong debt reduction effort could increase the market capitalization from $1.9 billion today to at least $2.2 billion next year and $2.5 billion the following. While that would not be sufficient to restore the stock to its previous highs, the 15% annual returns and $33 potential value after two years are well worth the effort. Jarden management did the right thing in last year’s credit environment, which leads me to believe they will do the same in this one.
Disclosure: At time of publication, William Trent has no financial position in the companies mentioned in this column.