Whole Earth Brands
a fundamental analysis
By Manuel Maurício
October 23, 2020
Symbol: FREE (NASDAQ)
Share Price: $8.53
Market Cap: $327.8 Million
Source: Google
Introduction
As part of my research process, I follow several investors whom I admire. One of them is Matt Sweeney of Laughing Water Capital.
On his latest letter he mentioned a company that got my attention, Whole Earth Brands. Before I proceed, I would like to thank Matt for helping me better understand his views on the business. It’s amazing when someone you admire is kind enough to dedicate some of his time to helping you.
Business
Whole Earth Brands is a newly constituted company that is comprised of two formerly independent businesses; the Sweeteners business (previously called Merisant) and the Licorice business (previously called Mafco).
Before we get into the specifics of the business, let’s rewind the tape so we can understand how we got to where we’re at today:
Recently, there’s been a craze about SPAC’s, (Special Purpose Acquisition Companies). I’ll spare you the details, but a short explanation is needed. SPAC’s are publicly traded companies whose final purpose is to acquire private companies (turning them into public companies). Someone (called a Sponsor) raises cash from investors, puts together the SPAC (even before knowing what business he will acquire) and then he has 2 years to acquire something or return the cash back to the investors. SPAC’s have been around for long, but they’ve recently gained more attention – and not for the best reasons. You see, if you’re an investor in these companies, you’re effectively writing a blank check to the sponsor in the hopes that he will land a good deal for you. The recent proliferation of SPAC’s is said to be a sign of the bubbly environment we’re living in right now.
Back to Whole Earth. There is this guy called Irwin Simon who is known for having mortgaged his house when he was young in order to start a company in the Consumer Packaged Goods sector. That company is called Hain Celestial and it’s now a multi billion dollar business. In 2019, Irwin thought that the “Sugar-Free” industry was promising so he rounded up some investors and created a SPAC (called Act II). That’s how he ended up buying Merisant and Mafco in 2020. When those two companies were bought, the SPAC changed its name from Act II to Whole Earth Brands.
This is also the story of the billionaire Ron Perelman who is known for, among other things, being the owner of Revlon and having a long history of buying companies with the use of large amounts of debt – a famous corporate raider. He was once declared the richest person in the USA. It turns out that all of that debt has come to bite him in the ass. Ron has been going through a rough time and he has been selling everything from his art collection to his mansion in the Hampton’s. You can read about it HERE and HERE. Guess what, Ron was the guy who sold Merisant and Mafco to Irwin.
That’s how the paths of Irwin and Ron have crossed. One was looking to raise cash to pay off his debts; the other had the cash and wanted to buy a business. He got two instead.
There are some great details about the sale. During the negotiations (in the midst of the pandemic), Irwin was able to lower the acquisition price twice from $575 Million (implying a valuation of 8x EBITDA) to $439 Million (6x EBITDA). It seems that Perelman really needed the money. Today’s valuation is $390 Million (including debt), lower than what a private buyer would pay for it.
Immediately after the sale, Perelman must have thought that the shares were selling for less than what they were worth so he bought some in the open market. It’s speculated that he hoped for a quick rebound that never came. He subsequently sold those shares in the open market further depressing the share price.
Management, Ownership and Strategy
When Irwin bought both companies, he wanted the management team to stay in place. Today he is the Chairman and Albert Manzone is the CEO. Manzone is pretty happy with this shift in power. You see, previously, the cash generated by the businesses wasn’t being reinvested back into the business. It was sent to the parent company to help Perelman with his debt problems.
Today the company is in a much sounder financial position and the plan is to reinvest the cash back into the business. How could a CEO be unhappy with that? Add to that the fact that Manzone received $3,7 Million dollars to stay in the company.
The current largest shareholder is Irwin (Act II) with almost 12% of the total shares.
It’s important to say that of the 4.5 million shares that Irwin owns, 2 Million shares will only be awarded to him when the share price reaches $20 (it’s currently trading at around $8) or 5 years from now. That’s $40 Million dollars right there. I would say that the Chairman is highly incentivized to make this company a success.
Segments
Merisant (the Sweeteners segment), manufactures natural and artificial sweeteners under the brands Equal, Canderel, Purevia, and Whole Earth.
Mafco is the world’s largest producer and distributor of licorice extract and licorice derivatives. Licorice extract is made from the roots of the licorice plant and is used as a moistening agent for cigarettes and a flavor masking agent for food and pharmaceutical products.
*Disambiguation: the company calls the Merisant segment “Branded CPG”, and the Mafco segment “Flavors and Ingredients”. For simplification, I will call them the Sweeteners segment and the Licorice segment.
Revenue by Segment, US$ Millions
The Licorice business, although smaller in revenue terms, has much higher margins than the Sweeteners business. It’s the cash cow that will allow the company to pursue other growth opportunities.
You see, 18% of the total revenue comes from the tobacco industry and the fact that the cost of licorice represents a tiny fraction of the cigarette’s cost, together with the fact that Mafco is the largest producer in the world, gives it some pricing power and stickiness. Altria will never want to switch providers because a tiny shift in the flavor of its Marlboro cigarettes could have catastrophic consequences. So much so, that Whole Earth Brands keeps two years worth of inventory. Its clients just can’t afford to not have licorice at hand.
Operating Income by Segment, US$ Millions
Financials
Given that the companies were separated companies, the Prospectus – which is a large document that the company files when it goes public – doesn’t show numbers before 2017. I thought this was too little information to be making a decision upon and I went digging.
Both companies have been public before. The stories are actually quite interesting, but I’ll leave them for another time. For now, it’s suffice to say that I was able to gather the financials of the sweeteners business up until 2007 (the company then went bankrupt and a Private Equity Firm took over before selling it to Perelman in 2014) and for the licorice business up until 2011 (I’m not really sure what happened next. I believe Perelman took it private).
Both companies were different companies back then so the comparison might be a little off, but I believe it can help us get an idea for the long term trends.
LICORICE BUSINESS
My takeaway from the chart below is that the business has been pretty stable over the years with some weakness recently. In 2019 the company lost a big European tobacco client because of regulation banning the flavored cigarettes in Europe, and in 2020, well, you know all about it.
Revenue, US$ Millions
But unfortunately, this steady state hasn’t transpired into the profits. The operating margin has been on a constant decline for the past two decades.
Operating Margin, Licorice
The company has recently announced a new 10 year contract with Altria and the subsequent optimization plans involving moving some production of its licorice plant in New Jersey to Richmond (right next to Altria), France and China.
Mafco old licorice factory in New Jersey
As a side note, I went on Google Maps to check out the factories and I don’t understand how this whole factory you see above can move to the small place they’ve got in Richmond. I know that it’s not just Virginia, but also France (which is a large factory) and China (which I can’t check because there’s no Google Maps in China), but one would expect this factory to manufacture licorice extract mostly for Altria, right? So it’s only natural that its production should stay in the US. I’ve inquired the Investors Relation company about it, but I haven’t had a reply yet.
SWEETENERS BUSINESS
I was interested in knowing the reason for the decline in revenue in the mid 00’s and this is what the company had to say in 2007:
“Merisant’s premium-priced brands had enjoyed a dominant market position among low-calorie sweeteners in many of the Company’s key markets. In recent years, however, Merisant has faced significant competition from McNeil Nutritionals LLC, a subsidiary of Johnson & Johnson, which markets and distributes the artificial sweetener Splenda®“.
Sweeteners Segment Sales, US$ Millions
Although in Europe the company has been the market leader with its brand Canderel, in the USA it has been losing share to its competitor Splenda for a long time. That’s the price you pay for taking all the money out of the business and not reinvesting it adequately.
I went looking and found that Splenda is currently being manufactured by a British company called Tate & Lyle. Tate & Lyle report their sweeteners business under the segment “Sucralose”…
Tate & Lyle Sucralose Sales, £ Million
… which, even while the management has been complaining about increased competition from China, has been delivering steady revenues.
But if we look at the volumes sold, we can see that these have been declining (the 2018 spike was due to the sale of excess inventory so I would say that it was a one off event that doesn’t really represent the true demand for the product).
Tate & Lyle Volume Change
Whole Earth management believes that it now ranks #4 in the sweetener business in the USA. But they’re ready to change that. They’ve recently been marketing a new all-natural brand called Whole Earth that is actually seeing double digit growth. They expect to double its sales every 2 years.
As a marketing strategy, they’ve been selling it in Starbucks, but at a loss. I’ve inquired the company about the duration of this contract, but I haven’t had an answer yet.
The company says that 50% of the total sugar consumption is used for baking. And there hasn’t been a good enough substitute for sugar that can be used in baking. That’s where they’re trying to get in with the Whole Earth brand. The prospects are good, but let’s see what they can do.
Profitability and Valuation
The good thing is that even with all of these issues, for the past 3 years, the company has been generating around $30 Million in Free-Cash-Flow. You can buy the whole company today for $300 Million. That’s a multiple of 10x. Cheap! And Irwin was interested in buying it for a whole lot more just a few months ago.
Free Cash Flow, US$ Millions
Now, we could argue that this FCF has been achieved by cutting down on the much needed investment in marketing and innovation and that going forward they’ll spend more. That’s a valid argument. But there will come optimization as well and new sales from that new investment, so…
Balance Sheet
The company currently has $73 Million of net debt and a leverage ratio of 2,7x (depending on how you count) which is perfectly fine for such a business. As mentioned above, the management and the board expect to be making some acquisitions in the future with the remaining power to leverage the business.
Competition
In the licorice business there aren’t that many competitors. The next largest competitor is 5 times smaller. It seems that Perelman was able to secure a global supply chain and hold on to the right clients long enough to make it just not worthy for the competition to enter this space.
In the sweeteners business, it’s a whole different case. Consumer Packaged Goods companies are no longer what they used to be (ask Buffett and Kraft Heinz). The competition is fierce. If you’re not constantly innovating and fighting for space on the shelves, you’ll soon be losing ground. And that’s what happened to the Equal brand in the USA.
Risks
- Customer concentration. The top 5 clients account for 23% of the sweeteners business.
- 47% of the Licorice segment and 18% of total sales were to the tobacco industry
- Unions and strikes
- There’s risk in acquisitions
- Management is key to turn the business around
- Regulation
- Increased capacity from China
Strategy
The company’s goal is to grow to $1 Billion in sales from the current $272 Million. The management has set a few ways to get there; 1) Product Innovation, 2) Increased penetration in the USA, 3) Geographical Expansion 4) Acquisitions.
The number 4 is similar to that of Berry Global. Lever up, make some acquisitions, use the combined cash flow to delever, rinse and repeat. But we’re seeing a shift from that pattern that is making me quite happy. The company has announced a $20 Million share buyback program, which, at these depressed prices, is the best use of capital. This shows flexibility and commitment to increase shareholder’s value.
Conclusion
As always, I’ve played around with the numbers and I believe that the share price is currently pricing in everything bad about the business and nothing good that may come from the transition of power.
I’ll give you my base case. In the next 5 years the company doesn’t grow, it will generate around $30 Million per year in Free-Cash-Flow that it will be using to buyback stock. Depending on the share price, it could buy up to 45% of the shares outstanding. The FCF per share in year 5 would be $1.4. If you apply a 10x multiple to that, it would mean a share price of $14, almost doubling from where we’re at today. And that doesn’t account for any possible growth or optimization. If the company is able to grow by only 5% (be it organically or through acquisitions), we could be seeing Mr. Market ascribing it a lofty valuation.
To sum it all up, Whole Earth Brands is a predictable business, with low debt, an experienced management team, an incentivized chairman who will get 40 million dollars if the stock goes up to $20, a good capital allocation strategy, all of this while selling at an attractive valuation.
I’ll be adding Whole Earth Brands to the Portfolio on the coming Monday with a €5000 stake.
Further research material
You can listen to Matt’s thoughts on Whole Earth Brands below (at 3:00 and 37:00):
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