Hain Celestial (HAIN) is, in my opinion, one of the clearest opportunities for investors looking for alpha in the market today. The company operates in the natural and organic products segment of the market where buyouts and acquisitions are happening at a furious pace. Over time, Hain has become a collection of brands focused on more than just organic snack foods, and this diversification away from the company’s roots has clouded the true intrinsic value of the company. Hain now has brands that include wellness and beauty products, organic meats, and other niche focuses. The growth strategy of acquiring these bolt-on organic brands led to Hain reaching a valuation of almost $7.5B in 2015. As recently as six months ago, the stock was valued at over $4.6B. Fast forward to June 2018 and the company has seen its value plummet to $2.9B.
The obvious question is what changed to cause this high-flying company to fall so far and so fast. There are a number of factors such as the following:
- The overall portfolio of brand sales in the U.S. has flatlined
- Costs have gone up, and profitability has gone down
- An impressive growth strategy has resulted in a complex and costly web of brands and products that is pressuring operational efficiencies
- A general uncertainty as to the health/organic space given events such as Amazon (NASDAQ:AMZN) buying Whole Foods (Will the space be “Amazoned” with further margin pressure)
However, all of the above taken together do not justify Hain’s valuation to be ~65% below its peak in 2015 or ~40% below its valuation six months ago. Why?
- Growth is flat to down in the US as the company dramatically lowers its SKU/Product count to drive efficiency and investments in its top brands
- Reducing the amount of product being sold, while making marketing investments to grow the core products, is a double whammy of lower revenue and more costs. This is a transition period and the company has an ongoing effort (Project Terra described below) to permanently transform its cost structure.
- See Note 2 Above
- Amazon buying Whole Foods has had an impact on the market. In a way that should benefit Hain. M&A activity has increased in the sector as companies seek to grow through acquisitions while seeking cost synergies at the same time. Hain now benefits from a scarcity effect as peers have been gobbled up by larger companies.
Hain is telegraphing the value creation that is about to happen, and, for some reason, the market is thumbing its nose and appears to be saying “show me”. The common complaint about Hain is that the company has become too complex with too many brands (i.e., too complex to be acquired). So what does the company do? They begin to clearly tell the market at analyst events and in earnings calls that it will be eliminating over 1,000 SKUs. They highlight that just 500 of its 1,000s of SKUs generate 93% of consumption or purchases. They have no problem in admitting that 11 of its 60+ brands are driving over 80% of the company’s revenue. Finally, they announce that their protein business (over 15% of the company’s EBITDA) is for sale. In a nutshell, the company is polishing the portfolio for a future buyer.
The opportunity for investors is now, and waiting for the “show me” moment, will be too late. The margin of safety is ridiculous with where shares are trading. Hain could potentially double in a short period of time, and it is clearly at least 30% undervalued with multiple events on the horizon that should make this clear.
The most likely event is an outright purchase of Hain by an acquiring company. The event that will happen sooner is the sale of Hain’s protein business which, as detailed below, should generate close to $750M in cash. Hain management and its friendly neighborhood activist investor have already noted that the sale of the protein business is being done in the spirit of value creation and will be returned to shareholders. At $750M, Hain shareholders could be looking at stock repurchases or a one-time dividend (per management guidance) equivalent to almost 30% of the current market cap of the company. My opinion more closely resembles the out-sized bet made by the activist investor and leans toward an outright acquisition, with 30% upside as the floor and the potential for shares to nearly double.
Hain Celestial And The Opportunity
Hain is an international manufacturer and distributor focused on “Natural, Organic, and Better For You” Brands and Products. Hain has been in business since 1994 and, between organic growth and a multitude of bolt-on acquisitions, has grown into a company generating over $3B in annual revenue.
As noted in the introduction, Hain’s growth strategy was rewarded by the market as the organic food industry burst onto the scene and went mainstream in the minds of consumers. Today, health and wellness is front and center like never before, with life expectancy increasing and an ever increasing awareness of the importance of food choices to a healthy lifestyle. 67% of U.S. consumers in a Nielsen survey noted that they would be prioritizing healthy or socially conscious food purchases in 2017. The global market for organic and health foods will be approaching a $1 Trillion opportunity.
The above statistics make it clear that Hain operates in a massive market with ample room for growth. However, there are risks as consumers become more comfortable with healthy and organic brands. Do you remember when you would only by Claritin for allergies? Why buy Claritin today when you can purchase Wal-itin for a significant discount (generic version from Walgreens (NASDAQ:WBA)). If the brand doesn’t mean anything consumers are smart enough to buy the generic version and save money. The organic food industry is different than the drug industry. When you buy a drug over the counter, you know it is regulated by the FDA, and the active ingredient is the same in Claritin as it is in Wal-itin. The same can’t be said for the food industry. Consumers want to know what their product is made of, where it is made, how it is made, and whether it fits their specific diet or lifestyle.
Hain’s success is also where it has fallen short. The company has acquired too many products. When 11 of your 60+ brands (18%) are generating almost 80% of revenues, that is a problem. Below are the 11 core brands within the Hain portfolio:
As a semi-health conscious mid-30s father (semi as I am still willing to eat a Big Mac), I can tell you I have personally purchased 7 of these 11 brands in the last 90 days. The irony is that I didn’t know they were all part of the Hain portfolio until I saw the above graphic. These are mainstream brands that you see every day. We effectively raised our children on Earth’s Best squeezes when they would not eat anything else (and paid a fortune for them without batting an eye if it meant peace and quiet).
As you read through this Hain’s investor presentation, what will stand out is how dramatically the non-core brands, that Hain is purposely pulling back on, are weighing on the company’s results. As an example, in channels such as online sales, the top 500 SKUs (from top brands) have recently been growing at a low double digit rate. This is occurring while SKU rationalization, or removal or products from the market, is weighing down overall sales.
Over time, the strategy of reducing the focus to the core products and brands will significantly reduce the costs required to support those non-core brands. Given that the industry and the market opportunity as a whole is over $1 Trillion in size, I am certainly willing to watch Hain make the right moves, that will lead to a healthier bottom line or in my opinion an acquisition in the near future.
What Does Hain’s Activist Investor See That The Market Doesn’t?
Engaged Capital is an activist fund that has a strong track record of significant value creation. Engaged targets small and mid-cap companies that where it effectively has the sole focus of creating value for shareholders. On its website, Engaged makes the point that those managing public companies are often so focused on building their companies and growing them that they lose track of their primary fiduciary responsibility: creating value for their shareholders.
As I noted above, Engaged has a great track record of finding companies whose value the market is ignoring, or, whose management is not willing to take the actions that will create shareholder value. Some recent examples:
- Outerwall (Redbox)
- I highlighted Outerwall back in February 2016 with this article noting that shorts were trapped after Engaged took a position in the company with the intent to create value.
- Less than four months later, the company was taken private by Apollo for $52 per share. This was a 75% gain for anyone who followed my recommendation (or followed Engaged) in just a four-month period
- It is important to note that Outerwall was the largest holding for Engaged at the time of their investment. In the case of Hain, Engaged has made an even larger bet, in terms of how big a position Hain in as percent of Engaged’s total AUM.
- Boulder Brands
- Providing a good proxy for Hain, as Boulder was an organic food company that Engaged took a position in around August 2015.
- Again this was a large position for Engaged representing almost 28% of Engaged’s total AUM.
- Within 4 months again, in November 2015, Boulder was purchased by Pinnacle Foods (NYSE:PF) at $11 per share which represented over a 60% gain for Engaged from the price it purchased Boulder at.
Engaged has taken an activist position in a number of other companies as you can see here.
Engaged has made a very significant bet on its ability to create value at Hain. They began building their stake in Hain as early as Q1 2017 with a confidential order allowing themselves to mass a 9.9% stake by June 2017. During that time frame, Hain shares generally averaged around a $34 share price. That compares to the $27 price Hain trades for today. Engaged continued to build their stake in Hain as recently as February 2018 when they added to it at a share price of $35 per share. All told, it is likely Engaged has a basis of just about $34 per share (or even a little higher). They own 11.7M shares of Hain that had a market value of $377M as of their May 2018 13F filing.
In the 13F filing noted above, we can see that Engaged had about $750M of total investments spread across about a dozen companies. If you correlate the size of an investment, with the level of conviction, Hain is clearly the highest conviction investment that Engaged has made. The investment in Hain is just about 50% of the total pool of investments shown in the 13F.
If we do the math using $34 as an approximate basis for the 11.7M shares of Hain owned by Engaged, we also know the company is currently sitting on a big paper loss. The cost basis of this investment is almost $400M. With shares trading at just under $27 the investment is worth just over $300M today. Engaged is sitting on a paper loss of about $100M. With a fund value of only $750M you can be pretty confident that Engaged is not going to have a significant amount of patience when it comes to creating value at Hain when they are $100M underwater on their investment at this time.
To that end, Engaged has already reached an agreement with Hain, and they now have control of the Board of Directors with 6 of the 11 Directors having been nominated by Engaged. Further, Glenn Welling who runs Engaged Capital, is one of the 6 Board members. Finally, Engaged entered into a standstill agreement with Hain that lasts until the 2018 Annual Meeting. This meeting should occur in November 2018 based on the timing of past annual meetings.
To summarize, we know that Engaged has made a massive bet on its ability to create value at Hain. When Engaged originally took their position they believed that Hain shares were worth $46-73 per share. Not only are shares today not near the low-end of that range, they are almost 25% below the cost basis that Engaged has in Hain. This leaves us with the question of is an activist fund with a phenomenal track record of creating value completely wrong or is the market? My opinion is the market is wrong for reasons noted below.
How Value Will Be Created
As noted earlier, one of the biggest drags for Hain is that its collection of brands has become very costly to manage. Consider that the company has to support and advertise an inordinate amount of brands and products compared to other names in this space who are pure play focused on a limited amount of products. Hain has well over 60 brands that have been acquired or created over the last two decades.
The brand dilution, and inefficiency of managing all these brands and products, is a problem Engaged and Hain are in the process of fixing. From an operational standpoint, Hain management has noted that 11 brands drive over 80% of the company’s revenue. This entails a significant investment in the other 50+ brands, many of whom might have great growth prospects, but today are not delivering meaningful results. The company is in the process of drastically reducing its SKU count (number of product types sold). Additionally, there is an internal project named “Project Terra” with the goal of driving over $350M in savings through 2020. Understand this is a company generating about $300M in EBITDA annually. $350M in savings is an enormous number comparatively speaking. More importantly, the company is giving the broader market a signal of just how much more efficient and profitable it could be by streamlining its businesses.
When Hain announced their latest earnings in February 2018, the company also announced it was putting its protein business up for sale. Hain’s Pure Protein “HPP” began to be treated as a held for sale operation as part of the Q3 2018 earnings report, and the company gave us detailed guidance on HPP as part of its earnings presentation. HPP is projected to generate over $530M in revenue and almost $50M in EBITDA in FY 2018. This value of HPP, and estimating the value at which it will sell, is critical to understanding how to value Hain. The sale of HPP is the first act in the process of Engaged creating value at Hain. HPP is a capital intensive business that an acquiring company is not likely interested in owning. When you think of Pepsi (NYSE:PEP), Nestle (OTCPK:NSRGF), or General Mills (NYSE:GIS) do you think about turkeys and chickens? Probably not. Those are the types of companies that could acquire Hain and divest of this business, which would be non-core for any acquirer, will ultimately help to facilitate a sale of Hain.
Valuation And M&A
There is significant activity in the food sector, with a focus on healthy offerings, and the snack food segment in the US is almost a $90B industry. A Capstone Partners report shown here highlighted over 160 M&A transactions occurring in the Food and Beverage industry during FY 2017. This is an industry in flux where the larger players are gobbling up the smaller players in an effort to find growth. In this quest for growth, they are willing to pay lofty multiples. The table below shows two of the most recent M&A activities in the space and the multiples paid:
|Year||Company Acquired||Acquirer||Sale Price||Multiple|
|2018||Snyder’s-Lance||Campbell Soup||$6.1B||16x EV/EBITDA|
|2018||Amplify Brands||Hershey Company||$1.6B||18X EV/EBITDA||**Includes $600M of Debt|
While the above multiples are healthy, we can’t apply the same logic and multiples to Hain (yet). The reason is because of the complexity noted above. Hain is not an easy business to swallow and ironically the growth strategy that garnered Hain a $7.5B valuation a few years is now what is dragging down the company’s market value.
This complexity induced valuation hangover is why Hain has announced it is selling HPP, and this is where the valuation fun begins. Based on its latest quarterly data and projected 2018 adjusted EBITDA (excluding HPP), the below is a current valuation of Hain:
Hain currently has an EV of ~$3.5B. The company plans on selling its HPP (Protein and Poultry) business, and thus, we need to value the company without this business. The Capstone Partners report referenced above shows that M&A activity of companies similar to HPP carried a 15x EBITDA multiple during FY 2017. It is my opinion that HPP is unique and carries a significant amount of sunk costs, and potential synergies, that a larger acquiring company such as a Tyson’s or Pilgrim’s Pride would find value in. The analysis below shows the value of HPP at various EBITDA multiples to aid in a full valuation of Hain:
For the purpose of moving forward, we will assume that HPP transacts at 15x EBITDA generating $750M in cash for Hain. The above tables show a range of potential EBITDA multiples and valuations for HPP. A multiple of 15x is below the recent transaction examples given above (Snyder’s-Lance and Amplify) and equal to the abovementioned Capstone report showing average multiples paid in FY 2017.
To calculate a full valuation of Hain, we will assume that the $750M that could be generated from selling HPP is retained and that no increase in the market cap occurs and the EV is thus reduced to $2.8B.
Now that the messiest (no pun intended) segment of the Hain portfolio has been converted to cash, we can more easily use standard industry transaction multiples to value the remaining Hain operation as seen below:
The above presents 4 valuation scenarios that use an assumed multiple related to the HPP sale and then an assumed EV/EBITDA multiple of the remaining Hain business to derive the potential upside. The scenarios from 1 to 4 are in order based on how conservative the assumptions are. Each scenario also provides various multiples for the remaining “core” Hain business after a sale of HPP to provide a valuation range. Each scenario has highlighted a 15x multiple for the remaining “core” Hain business. Recall that both Snyder’s-Lance and Amplify Brands were recently purchased for closer to an 18x multiple. I believe a 15x multiple is thus conservative.
- Scenario 1 – HPP garners a 15x multiple, and Hain is valued at its trough $255M EBITDA guidance for 2018.
- Scenario 2 – HPP garners a 20x multiple, and Hain is valued at its trough $255M EBITDA guidance for 2018
- Scenario 3 – HPP garners a 15x multiple, and Hain is valued assuming $45M of EBITDA improvement over 2018 related to Project Terra or Synergy opportunities.
- Scenario 4 – HPP garners a 20x multiple, and Hain is valued assuming $45M of EBITDA improvement over 2018 related to Project Terra or Synergy opportunities.
The midpoint of the most conservative scenario to the most aggressive scenario shows Hain being anywhere from ~40% to ~80% undervalued when considering a potential acquisition.
There is a strong likelihood that even the most aggressive assumption I used in Scenario 4 is far too conservative with regards to the EBITDA assumptions. Why do I say that? For two reasons. The first is that Hain management is investing a significant amount in increasing brand awareness in FY 2018 which is dragging down EBITDA. Prior to making the decision to accelerate brand awareness investments in Q2 2018, and excluding HPP, Hain had projected FY 2018 EBITDA to be around $300M. My most aggressive assumption that arrives at Hain being 80% undervalued assumes $300M in EBITDA.
Recall that, earlier, I noted Hain is operating an internal program called Project Terra to generate over $350M in cost savings. They expect to achieve $200M of that amount during FY 2019 and FY 2020. On top of that, going back to the complexity theme, any acquiring entity would assume significant synergy opportunities. Campbell announced over $170M of assumed synergies as part of the Snyder’s-Lance acquisition. Snyder’s is a much simpler operation than Hain. If Campbell can wrangle $170M in savings out of Snyder’s imagine what there is to wrangle out of Hain. The best part is we don’t have to imagine because Hain has already told us they expect to find over $200M of savings as a stand-alone company over the next 2 years.
Because it is so blatantly obvious that it feels like a gift from Heaven. Seriously, though, Hain has been rumored as an acquisition target since the beginning of time (or so it feels). However, a long and drawn out accounting issue in 2017 pushed the time-frame back. The accounting woes were a nuisance which turned up nothing material aside from a company outgrowing its processes, but, they made Hain untouchable for almost a year. Engaged Capital showed up about a year ago now and the stock had a false start rallying to over $40 per share on hopes of a quick sale. Those hopes faded and now here we are at $27 a share and I for one won’t look a gift horse in the mouth.
Why now? Because HPP is up for sale which is act 1 in creating value. When Hain management originally announced the potential sale of HPP in February, they noted in the Q2 2018 earnings release that they were “exploring” the divestiture of HPP. In the Q3 2018 earnings release from early May, the company noted that they expected a sale to be completed in the first half of FY 2019. That is a pretty clear change in what Hain is communicating to the market.
Q2 2019 for Hain ends on December 31st, 2018. For a sale to be COMPLETED by that date, it is highly likely a sale is announced in the next 30 to 60 days. A sale is announced, due diligence occurs, and then a closing occurs. Further, it is unlikely Hain would have publicly announced HPP was for sale in early February 2018 if they didn’t have a good idea of potential buyers and that a fair price could be obtained. Why broadcast to the world you are going to sell something if you are not sure what the value is. Hain has to sell HPP now because the market expects them too. Potential acquirers are aware Hain has to sell HPP, and they could use that against the company in negotiations. Hain likely had significant interest in HPP before that announcement was made for all the reasons noted above and the company is now just looking for the highest bidder. All the signs point to an announcement in the near future.
Why now? When the HPP sale occurs the market will begin to do the type of valuation I presented above with the 4 scenarios of the remaining core Hain business. The sale announcement will remind the market that the core business of Hain is highly desirable and the list of potential acquirers becomes larger without the mess of the protein business.
Why now? Scarcity. How ironic will it be if the Hain buyout story comes full circle due to the complexity issues noted earlier. As Hain dealt with accounting issues, an activist investor, and beginning to streamline its operations a plethora of other companies similar to Hain have been acquired. The health and wellness space, within food and beverage, continues to be a bevy of M&A activity. However, there are fewer available targets today, and the age-old target Hain may ultimately benefit from this scarcity effect.
Why now? Engaged Capital. The company is sitting on paper losses of 25%. This is the largest position in their entire portfolio. Yet, for an activist investor, they have been relatively quiet. Why is that? The reason is they almost immediately gained control of the Board of Directors. Engaged is pulling the strings, and you can be 100% confident that every decision that is made will be in an effort to drive the stock price higher.
Why now? The CEO is telling us. Irwin Simon built Hain into a multi-billion company from scratch. For many years, he was resistant to selling the company. Now, thanks to Engaged, the choice is no longer his. Further, in his public comments, he is basically telling anyone who will listen that the company will not be under his control for that much longer. During an interview in late April, Mr. Simon had this to say when talking about the company’s future:
we’re probably not the best guys to take it to the next level
I couldn’t have said it better myself Mr. Simon
I am betting on the smart money. The smart money has 50% of its $750M portfolio invested in Hain. The smart money is also not looking quite so smart today with almost $100M in paper losses on this investment. Just as Engaged Capital looks to force companies to run their businesses for the benefit of shareholders, investors in Engaged Capital, are looking for a return on their investment as well. I love the fact that, over a year into this investment, Engaged is down 25%. This creates urgency. Urgency creates opportunity. Engaged felt like Hain shares should trade for between $46 and $73 per share. I will take the low end of that range, and an almost 80% gain, and call it a day.
While I am betting on the smart money I am just as importantly betting on Hain. This is a company with a phenomenal group of brands that has over time chased growth at the expense of investing in its best brands. Those days are over. While growth in the US is flat as the company purposely pulls products out of the market its International business is growing at close to 20% per year with huge opportunities in India and China that are untapped.
The valuation story is fairly simple with Hain. We have countless comparable companies that have been acquired at healthy multiples, and we also have a scarcity effect that will benefit Hain. What we didn’t have before Engaged Capital showed up was a company committed to rewarding its shareholders. Now, every move that is made, will be made to benefit the shareholders. I am long Hain at a basis just under $26 and believe this could turn out to be my top investment for 2018.
Disclosure: I am/we are long HAIN.
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.