Hedge fund activist Bill Ackman first disclosed he owned a big chunk of JCPenney (NYSE:JCP) stock on Oct. 8, 2010. On that very same day, he also announced Pershing Square had picked up an 11% stake in Fortune Brands, the conglomerate that at the time owned Jim Beam, Moen, Titleist and many other disparate brands.
A lot has happened since then, but one thing’s for certain: Bill Ackman has made a lot of money from his investment.
But he could have made more.
Once Ackman built his stake in Fortune, he immediately pressed the company to break itself into three pieces. But before it could, Fortune sold its golf business to Fila Korea in July 2011 for $1.23 billion. On Oct. 4, 2011, it completed the spinoff of its remaining assets into two independent companies: Beam Inc. (NYSE:BEAM) and Fortune Brands Home & Security (NYSE:FBHS). At the end of 2011, Pershing Square held 20.82 million shares in both companies.
Ackman had made all the right moves up to that point. Unfortunately, his team’s presentation at the 7th Annual Value Investing Congress in October 2011 might have been its undoing. They came to the conclusion that if housing starts improved by 2016, FBHS was worth somewhere between $18 and $27 at that point. As we now know, housing starts have been steadily increasing over the last 18 months and are expected to continue to increase over the next few years.
Records indicate, however, that Ackman sold 7.5 million FBHS shares in the first quarter of 2012 and its remaining 13.3 million shares in the second quarter. Selling at $22 per share (my estimate based on trading prices in the first six months of 2012), Ackman netted himself $458 million.
If he had waited another year, that would have been more like $836 million.
Considering Pershing paid approximately $937 million for its original investment in Fortune before its spinoff, it’s puzzling why he sold out so soon when it was clear the housing market was getting much stronger.
Since the split of Fortune’s two companies, BEAM has achieved a total return of 53% in the span of 18 months compared to 229% for FBHS. Ackman’s partially unrealized return (Pershing still held all of its 20.82 million BEAM shares at the end of 2012) up to this point is 97% over an 18-month period. However, if he had held the FBHS shares like he has with BEAM, Pershing Square’s partially unrealized return would jump to 138%.
If it’s any consolation to Ackman fans, the SPDR S&P 500 ETF (NYSE:SPY) achieved a 52% return over the same 18 months.
Two Great Businesses
So why did FBHS outperform BEAM by so much?
It’s the classic spinoff where the sum of the parts is worth more than the whole. Generally, a particular segment of a business — in this case, FBHS — is severely underappreciated compared to its parent.
Ackman’s team correctly assessed that Fortune Brands Home & Security wouldn’t need to make any capital expenditures for annual revenues to increase from $3.3 billion at the end of 2011 to $5 billion in the near future. That’s because it was operating at 60% manufacturing capacity. Pershing’s presentation estimated that FBHS’s stock was worth $14 per share even if the housing market never recovered. Well, it’s definitely on the mend, and with that, FBHS expects 2013 revenue of approximately $3.95 billion and earnings per share of at least $1.23 — 34 cents higher than in 2012. That’s why it’s trading above $40.
Meanwhile, in BEAM, you had the fifth largest liquor company in the world with power brands like Jim Beam bourbon, Teacher’s blended Scotch whisky, Skinnygirl low-cal drinks and Courvoisier cognac. It was easy to overlook the value lying dormant in FBHS’ home-related businesses when you had a liquor business that was and still is profitably growing. Its operating margins are more than four times those of its former housing-related sibling.
And let’s face it, liquor companies generally sell for a much dearer price than cabinet-makers.
More than 18 months into its split, FBHS has definitely made greater progress establishing itself as an investment superstar. But consider for a moment that Ackman estimated FBHS was worth $27 at the top of its valuation range. That makes its shares approximately 33% overpriced at the moment. In terms of price-to-sales, it’s trading at 1.86 times sales, compared to 1 times sales for Masco (NYSE:MAS), one of its biggest peers. BEAM meanwhile is trading around 4.27 times sales, which is about the same as Diageo (NYSE:DEO) and considerably less than 5.4 times sales for Brown-Forman (NYSE:BF.B), the maker of Jack Daniel’s, its longtime rival.
While FBHS has ridden the coattails of a recovery, BEAM hasn’t had the same wind at its back. Long-term, however, Beam Inc. will do just fine. That’s possibly why Ackman was still holding at the end of 2012.
When it comes to understanding why FBHS did so well over the past 18 months, it’s important to remember that its assets were spun off at precisely the time when housing starts turned for the better. Bill Ackman’s team recognized a year prior to its spinoff that it was worth more than investors were valuing it within Fortune Brands. It was an opportunity to gain a good investment in BEAM while also making some easy money with FBHS.
In hindsight, it turned out swimmingly.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.