Packaging isn't normally a very controversial or exciting business; it's hard to work up a lot of enthusiasm for a new type of shrink film or bottle cap. Nevertheless, Sealed Air (NYSE:SEE) has managed to make its corner of the packaging industry a little more exciting with an ill-considered deal that has already squandered meaningful shareholder capital. With new management on the way, and bringing a bold new plan, the question remains as to how much value is available in these shares.
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Along Comes Diversey
There's no question that the enormous delta in the Sealed Air business still revolves around its 2011 deal for Diversey. Sealed Air paid over $4 billion and a double-digit multiple of EBITDA for this large cleaning and sanitation business.
While Diversey does have many proprietary and/or patented processes and products, and there is some arguable overlap in the 20% or so of the business that is in the food/beverage sector, this deal has smelled off from the start. For starters, the timing has been unfortunate - buying a Europe-heavy business in the teeth of a very rough European economy.
Worse still, however, is what I see as a lack of synergy to support the deal. Both arguably operate businesses with razor/razor blade models (Sealed Air sells a lot of packaging/wrapping equipment and then sells the packaging materials), but by that logic Sealed Air could just as well have gone out and bought an actual razor blade business. While Diversey is the second-largest player in the space (behind Ecolab (NYSE:ECL)), and it's a fragmented market, I think it will be a challenging market in which to generate sizable real economic returns.
SEE: Analyzing An Acquisition Announcement
... And Out Goes Management
I don't mean to suggest that the poor performance of the Diversey deal is the sole factor at work, though the company recently wrote off $1.2 billion (more than one-quarter of the purchase price) in the retirement of Bill Hickey, but I do believe it played a role. This may be a change for the better, however, as the incoming CEO (Jerome Peribere, formerly of Dow Chemicals' (NYSE:DOW) advanced materials business) seems to be raring to go.
Just on the surface, there would seem to be opportunities for cost-cutting, restructuring and perhaps even asset sales, as operating margins have been in long-term decline and returns on capital have been wobbly.
Mr. Peribere seems eager to go further, however. He has actively discussed the need for changes at Sealed Air, decrying a "culture of complacency." At the same time, he has confirmed that he believes Sealed Air still boasts good engineering and R&D and a solid product portfolio that just needs a better go-to-market strategy.
This will be an interesting, and likely turbulent, process. If Sealed Air employees and executives have indeed become complacent, it's likely that there will be more than a little involuntary turnover - complacent employees aren't usually known for appreciating or welcoming the kick in the pants that comes with CEOs who want to change things up.
SEE: Evaluating A Company's Management
Still a Good Base Business
The good news for Sealed Air investors is that there's still a good core business here. Cryovac and other food industry packaging materials are still popular, even though Sealed Air does have to contend with rivals products from Bemis (NYSE:BMS) (including its Fresh Case films) and Sonoco (NYSE:SON). While I do wonder if these companies haven't benefited from Diversey-related distractions (to say nothing of the upcoming management transition), industry relationships tend to be enduring. Assuming that Sealed Air can really reignite a product innovation process that gave us products such as Cryovac, Bubble Wrap and Jiffy packaging, I still see solid growth and cash flow potential here.
The Bottom Line
I wish I could be more optimistic about the stock. I love to buy the stocks of once-great companies that screw up and fall from grace. Even though shares here are up about 50% from late summer lows (likely on optimism around the CEO switch), they're still down almost 40% from their peak. That said, I don't see a bargain here.
If Sealed Air can grow its top line at a 7% long-term rate (well ahead of most of its peers) and return to mid-to-high single digit free cash flow (FCF) margins, the resulting free cash flow growth is in the vicinity of 12% a year - quite a high level of growth. Unfortunately, even with that much growth, the company's heavy debt load obliterates a large percentage of the value.
Unfortunately, alternative valuation strategies don't look much better. An EBITDA multiple of more than eight seems plenty fair relative to others such as Bemis, Sonoco and Aptar (NYSE:ATR) (though well below Ecolab's 13.6 times multiple). Looking at core investor earnings, even if Sealed Air can grow these at an 8-10% clip (versus a historical growth rate around 14%), the implied fair value of $20 is still not terribly attractive today.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.
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