Is Jarden Burning The Candle From Both Ends?

By Will Ashworth | September 10, 2013 AAA

On September 3 Jarden (NYSE:JAH) announced it was acquiring Yankee Candle Company for $1.75 billion. Almost all the media I've seen since regarding the acquisition has been quite favorable. As I write this almost a full week has passed; the 10% uptick on the news is holding steady. It appears no one has a problem with this deal--except me. Read on and I'll explain why Jarden may be burning the candle at both ends.

The Deal's Positives

The company does a good job explaining why it's acquiring Yankee Candle. It comes down to six reasons:

1. Yankee Candle are market leaders in premium scented candles.

2. Its brand awareness results in repeat purchases providing recurring revenue.

3. It does well in good and bad economic cycles.

4. Free cash flow is strong and growing.

5. It will add 10% to its pro forma adjusted earnings per share and that's before any synergies.

6. It didn't have to go through a bidding war.

You don't have to be a rocket scientist to see that the deal boosts its margins in impressive fashion. Its adjusted gross margin will increase 320 basis points to 32.1% while its adjusted EBITDA margin improves 140 basis points to 13.2%. And all it has to do to achieve these improvements is to shell out $1.75 billion paid using cash on its books, new equity and some additional debt. In this low-rate environment it doesn't seem like a bad proposition. Especially if it can generate permanent cost savings through economies of scale, etc.

What it really brings to the table is top-line growth. In 2012, Yankee Candle's revenues increased by 7.4% year-over-year to $844.2 million. Meanwhile, Jarden's revenues in 2012 were flat year-over-year at $6.7 billion. Its 542 retail stores delivered same-store sales growth of 2.5% in 2012, which is more than respectable. Where it really shined was online, which saw comparable sales in its consumer direct business grow by 38.1% in 2012. The increase in part was due to the hiring in August 2012 of e-commerce industry veteran Brad Wolansky who took on the dual role of president of its direct business as well as its chief marketing officer. With its retail stores, consumer direct, and fundraising businesses accounting for 58% of its overall revenue in 2012, the big jump in online revenue is clearly a big positive for Jarden as it takes over Yankee Candle.

Bottom Line: Yankee Candle's $844 million in 2012 revenue makes it Jarden's third-highest selling brand out of more than 120 behind only Coleman and Oster. Since 2002 it's acquired 16 major brands (including Yankee Candle) for a total outlay of $5.9 billion with Yankee Candle its single biggest move in the 11-year period.

It could be a game changer.

The Downside

Jarden acquired K2 in April 2007 for $1.2 billion including the assumption of $415 million in debt. Shareholders received $10.85 in cash along with 0.1086 of a Jarden share for each share of K2. If K2 shareholders invested the cash portion of the deal in additional Jarden shares, the $15.50 received in 2007 would be worth $25.87 today, a compound annual growth rate of 8.4% compared to 4% for the SPDR S&P 500 (NYSEARCA:SPY). That's the good news. (L6)

Jarden and Peer Group - Performance 2007-2013

Company

CAGR

April 25, 2007 to Sept. 9, 2013

Jarden

8.4%

Newell Rubbermaid (NYSE:NWL)

0.8%

Tupperware (NYSE:TUP)

23.8%

Helen of Troy (Nasdaq:HELE)

9.3%

Green Mountain Coffee Roasters (Nasdaq:GMCR)

59.0%

SPDR S&P 500

4.0%

The bad news for K2 shareholders is they could have done better elsewhere, whether it be within Jarden's own peer group or in another sector altogether. Heck, they could have taken a flyer on an up-and-coming coffee company called Green Mountain Coffee Roasters who only the year before purchased the remaining 65% it didn't own in Keurig single-cup brew systems. That was a game changer. Yankee Candle isn't. While it's a nice addition to an already busy lineup, it's not going to send Jarden's stock through the stratosphere; here's why.

Share Repurchases

I'll give Martin Franklin credit; he knows how to play the game. Jarden's share count hit a high of 135 million in 2010. It then went to work over the next two-and-a-half years buying back 22.4 million of its shares at a cost of $857.1 million or $38.26 per share. By doing so it's now able to sell up to 17.25 million shares providing $787 million in cash for its acquisition. In 2012, it paid on average 4.9% on every dollar of its $3.8 billion in debt. Another $787 million borrowed would have added an extra $39 million in annual interest expense. More importantly, On the surface it seems sensible. However, in its company presentation it points out that pro forma EBITDA including Yankee Candle will increase by 25% to $1 billion. If you combine the $787 million in cash from its equity raise with the $788 million in cash on hand at the end of June, it should only need to borrow a few hundred million. So, let's make it an even $400 million, which puts its total debt at $4.3 billion or 4.3 times pro forma EBITDA. If, on the other hand it borrows the $787 million instead of issuing shares plus another $400 million, you're looking at total debt of $5.1 billion or 5.0 times EBITDA, exactly where it is right now.

If this is such a great deal why isn't it borrowing instead of diluting existing shareholders by 13%?

The answer is simple. It wants a little wiggle room in case Yankee Candle doesn't provide the ongoing oomph it expects. Fair enough I suppose. However, if Yankee Candle generates so much cash it makes more sense to grow earnings per share by not diluting its stock providing an almost immediate boost to its share price .

Bottom Line

The candle business isn't exactly a house on fire. Sure, this helps with Jarden's margins but if it was such a good deal it would be borrowing the money in my opinion--not issuing more shares. Those who buy at this point are playing with fire because Jarden's burning the candle from both ends. That usually doesn't end well.

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