IFB99: How Acquisitions, Goodwill, and Divestitures All Work Together

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Dave:                                    00:36                     All right folks, welcome to the Investing for Beginners podcast. This is episode 99 tonight we are going to talk about a stock that Andrew recently had some bad walk with and has sold. And we’re going to talk a little bit about some of the lessons that he learned from his investment with this company, including things like activist investors, divestitures and board resignations, and how those can affect what happens with a stock. So Andrew, why don’t you go ahead and tell us about the company and a little bit about your experience.

Andrew:                              01:08                     Yeah, sure. So I think when you talk about stock picks from the past, it’s much more useful to talk about your mistakes rather than your successes. Um, we can, we can all buy stock. I can go out for a multitude of reasons, but you know, if you can look at how you kinda messed up and maybe you can avoid that in the future and maybe some people can kind of recognize a situation like this and maybe stay clear or in the case of, of my, like my personal kind of experience with this and the way that maybe I wish I would have played it is I would have waited longer to, to get into this stock because it was clear that the fallout from the stock hadn’t completely finished. And so I’m keeping this stock on my radar and I’m watching to see how it progresses.

Andrew:                              02:04                     I’ll talk a little bit more about the details as we go along here, but it’s one of those where I would have wished for the dust to settle kind of a thing before, before I bought and one that’s a hold it. So it was by no means like a portfolio killer. I lost maybe 25 to 30% think a lot. So I’ve definitely had gains that have more than made up for that. But, uh, it’s still something that you still want to examine your mistakes and try them group from home. So the stock I’m going to talk about today is Noel brands, ticker symbol and w l. So one of the brand or one of the type of stocks that I really like to purchase, it has, you know, the brand names. It was one of those that kind of picked up a lot of different brands.

Andrew:                              02:54                     So they had, they had brands like as an example, Rawlings, I dunno any baseball fans out there and know of that company. It’s a pretty big company. They make bats, I believe they make gloves and other sorts of things like that. Very, very popular. Um, so they had purchased that, they had acquired that brand and how that for awhile, Yankee Candle, which is pretty popular amongst middle aged women or you know, maybe you don’t want to do. Um, that was a cool brand and just purely on the sense that people are buying those candles solely for the, for the brand name. You know, you can, you can easily buy a candle and I’m sure it costs like cents to produce and you can buy them for pennies. But, um, they were definitely targeting a good premium on those candles and that’s the kind of product or you really want to invest in because if they can carry themselves with a brand name, they can continue raising the, raising the price and um, that’s a great analyst for growth. How the few other brand names. Um, but the problem with, with the way that they acquired a lot of these brands is that they basically overpaid to acquire them. So when you talk about divestitures and acquisitions, I know these are big, kind of more complicated terms, but okay.

M&A or Merger and Acquisition text on black block

Andrew:                              04:24                     The underlying kind of core basic behind it is pretty simple. When you talk about an acquisition, that’s just one business buying another business. A divestiture is simply you selling off a piece of the business to somebody else. So the problem with Noel was that they, they bought up all these businesses and they got into a ton of debt to do it and they paid a big price for these businesses.

Andrew:                              04:52                     So the way that played out was basically so, so if you look at the financial statements, and I always talk about the debt to equity ratio as a risk ratio, a good way to look at, you know, how, how leverage a company is, how risky they are based on how much they can kind of continue running business, make that payments. And just in general, you know, it’s, it’s a lot easier for a company that grow and it doesn’t have many expenses because they can take those profits and re have a greater percentage of them with Noel they have made all these acquisitions, but basically a lot of things happened in the following years and they make good steps to pay the debt back. So if you look at, say from like 2014 all the way till 2018, I, I bought the stock middle of middle to late 2018. So when you look at like 2014 2015 I don’t have the financial statement in front of me, but I’ll just tell you the general trend of it. They had like a normal debt to equity and then they their debt to equity like balloon like crazy. Like they went up to something stupid like five and then in 2017 2018 they really made a strong effort to pay off the debt.

Andrew:                              06:10                     So on the surface and based on just normal metrics, it really looked like they kind of a tone further further bad behavior. Let’s say they, they really, they made a concerted effort but kind of right the ship and that’s very, very good. And that was one of the reasons why I bought it was because I saw, okay there were some reckless spending, reckless acquisitions, but they paid off a lot of their debt and things. It seems to be going in the right direction. They had pretty high earnings based on the fact that, you know, acquisitions tend to push earnings up because now you have this new business that you own and you can take all of those earnings. And add it to your total net earnings. So that was all good. That was all good and good. Some of the things that I’d been at really account for.

Andrew:                              07:00                     Oh. So let’s, let’s talk about, let’s talk about this and how it played out as far as the, how it evolved into divestitures. Now, one way you can really get great information, and this is, this is something that I’ve recently been using and I don’t, no other than like manually googling. I don’t know of a better source. This, again, if you go the Seeking Alpha, which is, which is, a website we’ve talked about before, it’s completely free. You, you give them your email, you, you make a free account and you have access to a lot of information. If you type in a ticker, you look at the ticker overview, you go on the right column where it says news, and then there’s a dropdown for news summaries. So what this is, it’s a place where all of their major news are. The goals are kind of curated. So you know, you’ll, you’ll sift through some of it. So there’s like news I find can be important in news, I find not to be important. So as an example, if it says something like a new l brands is down 3% because they just missed revenue by 6 cents. Like I don’t really care about that. That’s like your typical Wall Street bs, right? Where analysts expectations and and predictions and forecasts. It’s all, it’s all just a bunch of mirrors. It doesn’t have anything to do really with the health of the business. It’s just the way Wall Street works. And that’s kind of the way the industry works.

Andrew:                              08:31                     But while that might move the share price, as we know we are buying these businesses and we’re looking at it as part owners and what happens on Wall Street is all is all going to happen and it’s all going to be mister market up and down bipolar. But in reality we want to look at the longterm health of the business. And I’ll tell you why. What happened with Noel and the divestitures actually showed that the business wasn’t as strong as they were initially presenting.

Andrew:                              09:00                     So some of the things that I, that I see now when you, when you read these new summaries, some of the things that are helpful are things like when they, when they announced acquisitions. So if I go back to like 2016 for new, well they talk about how they were to acquire a food storage and candle business businesses. I’m sorry. So it tells you how am I going to pay usually how they’re going to pay for it. Like if it’s going to be mainly funded through that, if they’re gonna issue shares or if they’re going to pay cash. And there’s some other stuff here like when they talk about of like industry guidance that’s very similar to like analyst’s estimates. I don’t, I don’t really see those as noteworthy news. But like I said, when they, when they announced acquisitions also announced divestitures when they’re selling parts of their business, those are great ways to, in addition to looking at the balance sheet that gives you some context on the balance sheet and how you will probably see it move as, as the balance sheet gets updated from year to year.

Andrew:                              10:11                     Take these calculations and kind of doing the back of a Napkin, okay, well I know that they’re going to pay 500 million to buy this company, so I’m going to subtract 500 million past year. And that’s a way to kind of, you can kind of adjust your analysis based off of that. Now the problem was was that a lot of these businesses they overpaid for. So how I ended up playing out, and this happened basically in the six months, six to nine months, maybe almost a year after I bought it. So in my defense, the fallout from the, the acquisitions and divestitures didn’t, didn’t happen until after I bought. So you can argue there was no way that at least from a concrete sense, there was no way that I could have possibly known. Um, in the future, I will definitely be looking at past years to see if they made huge acquisitions that just because they paid off the debt on those, you know, that’s only one side.

Andrew:                              11:22                     Like they paid off the debt and clear on that side. But if you still paid too much for the acquisition itself, you can have what happened with new well and what killed their earnings and their, their balance sheet. So it’s going to be tough to, not to not get too technical here because it’s a lot of accounting jargon. But again, I’ll try and make it simple. So when you make an acquisition as a, as a business, you have what’s called the goodwill. So let’s say I want to, I want to buy Dave’s cars dealership. So he has a certain amount of cash, he has a certain amount of cars on this lot, and those cars are obviously inventory. So they’re assets, they’re worth something. Then we can put that down in the balance sheet. And then there’s the fact that I’m buying the Dave brand and people love his dealership.

Andrew:                              12:16                     So obviously you pay a little bit more than cash. The cash, you get the cash and his business a little bit more than the inventory. He owns a lot for some real estate. So you have all of those. And then you also have however much more than his assets that I paid for it out requires business. So you still need to, basically the way a balance you work is, is you still need to record for, you need to record for that for, for what you paid. So the way they do that is through this line item called goodwill. And we may or may not have touched on this in previous episodes, but basically what the effect of this and how it can affect a financial statement is that if a company overpays for an acquisition, there is a chance that you won’t see that because it will just get absorbed in the goodwill.

Andrew:                              13:11                     So you know, if his, let’s say his, his cash was like 300 million, has inventory was 700 million. So we’re talking about like a billion in assets. But then I paid like any bill then the way it would show up on my balance sheet, it was I paid 19 billion. Um, and the difference of, of what his business was worth versus what I’m valuing his brand as basically 19 billion. So that’s what’s, that’s what will go in the, in the goodwill statement. So I paid 20 billion for it. 1 billion will show up my balance sheet as inventory and cash and the rest of it will show up as goodwill. So if you think about it, like basically your balance, she is not being punished for making such a huge acquisition. Obviously I still have to pay the 20 billion. Right? So like if I paid that all in cash, you would see the balance sheet shrink by 20 billion in the cash side. But it would get balanced out by the fact that the goodwill, it goes up by the same amount.

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Andrew:                              14:26                     So the next, the next part of that is, and this is due to an accounting thing and something that I’m working on, like a special report for this because obviously this was a huge development, but the way the accounting rules work, and this is kind of similar to the accounting role that Dave and I covered back back earlier when they were talking about accounting world changes. So in the past you would have to analyze basically, I don’t want to get into it too detailed as far as like talking about depreciation, then amortization and stuff. That’s like if you really want to dig in and be a nerd, that’s where you would start research about goodwill, amortization and depreciation. But basically in the past, like if you paid too much, they would kind of smooth out. They would smooth it out basically. But now there’s a, there’s a change where you just take the hit all at once.

Andrew:                              15:21                     As an example, let’s say I bought Dave’s car dealership and in the next three years, you know, I paid 20 billion for expecting a certain income stream from that that would justify paying 20 billion because his brand is very popular. If it turned out that actually I run this business and it didn’t give me as much of an income stream as I thought it would, then what that means is actually his business isn’t worth like 20 billion. Maybe it’s worth 15 billion or 5 billion. So if that were the case, you have to adjust the balance sheet because now you know it’s not what you own with Dave’s business isn’t really worth 20 billion, maybe it’s worth five. So you need to adjust the balance sheet and the goodwill part of that balance sheet in order to make it to be honest. Right? And the, and the SEC wants to make sure that you do that.

Andrew:                              16:12                     So what their rules are is you have to reevaluate these businesses every year. Now, once you find out that that happens, let’s say, on that, that his business is really worth 15 billion. So I have to take a 5 billion hit to my balance sheet. And the way that they record that is they take the 5 billion and then they also will, they will deduct 5 billion from your income statement all in one year. So it’s just like, I don’t like that they do this, but there’s reasons behind it. But basically, so your, your balance sheet will shrink by 5 billion and you’ll take a hit to your earnings for 5 billion. So that’s called a goodwill impairment. And that’s exactly what happened with Noel. So basically, as you can see, and they had all this shakeup and you know, Carl Icahn’s on the board and he’s making moves for new l and there’s all this activist stuff.

Andrew:                              17:07                     And that’s why I bring up the Seeking Alpha because you can read about some of the major players, some of the major activist investors, if there are any, how, how the board shaking up. Another thing that happened with Newell was a lot of their board members resigned. So it’s just, it’s just chaos, uh, made for a great price. And I really think that, you know, the future of their business looks really strong cause they’re that there that’s very men manageable. Um, they have some other brands of, they’re very profitable core business seems to be good. Uh, the toys r us bankruptcy really affected them. There’s just a lot of things that happened and it was just an Estore essentially. But so how, how, how it works is they took that five for Noel, it was like an 8 billion impairment. So they had negative earnings for the year.

Andrew:                              17:55                     And so obviously the way I’ve always been, if they have negative earnings then I’m going to sell. So what essentially happened was management over paid for for a bunch of parts of businesses and then now they have to sell off these parts of businesses. So, and then the business, a lot of the businesses that they kept ended up showing that they overpaid as profitable as they thought. So you have these divestitures where Newell selling off pieces to their business, they’re using that cash to pay off debt. That part’s good. But you still have to tone for previous managements and mistakes. And that’s bad. And that’s painful for shareholders. And in retrospect and looking with hindsight, it’s like, okay, well I should’ve really closely examine those. The acquisitions. That’s something, yeah, that’s like the big lesson behind new al that hopefully we can all learn from. Now how can we do that from a practical standpoint?

Andrew:                              18:57                     Because yeah, the way that financial statements work, you know, some companies might break it down where like let’s say they buy the, let’s go back to Newell, like the baseball brand, let’s say they, they nicely separate that in the financial statement. So you can see, well this is exactly how much the baseball company, his company is earning and they break it out all nicely. But there’s nothing from the FCC that says you necessarily have to do that. And so you might have these acquisitions. So you, you get the news, you get the press release, you’ve checked up on the history if they’re seeking alpha. So you know that there was an acquisition, you know, that it’s for this much. And you know, generally how much they kind of estimate that that new business will earn. But as the years go on, you can’t really track it if they’re not spelling it out for you in the financial statements.

Andrew:                              19:51                     So it’s like, okay, well what did we do? We’re kind of stuck between a rock and a hard place. One way that you can, uh, I like this idea. So it’s not like a cut and fast roll. You can use your own discretion is you look on the balance sheet and you look at the goodwill portion of the balance sheet. And so if the goodwill is pretty high as a, as a percentage of the total assets, well then you know, you don’t know. But it might be a good chance that some of these businesses could actually end up not being worth as much or the, you know, they acquired these businesses are the premium and shareholders will have to pray, pay the price later. So to try to avoid goodwill impairment while you can’t impair goodwill, if there’s none. So you know, that’s, that’s the one strong case for into these businesses that, that have like their own original brand. They didn’t have to buy these brands. They kind of built them or invented than themselves. That’s, that’s a good kind of factor. Right?

Andrew:                              21:04                     Another way you could do it as you can maybe look at the time period that some of these acquisitions were made. So you can go back in history and you can look, okay, well they pay, you know, like for new l, um, maybe, no, I was not a good example, but I’ll use another one like , CVS is a stock that I also did not work out. Like I wanted it to, they had an acquisition that was Aetna and that was made that, what was it, 2018, 2019, I’m not sure when it’s going to close or if it did, but basically you have a situation where if it’s late in the bull market, there’s a good chance that maybe they overpaid for this acquisition. So if it’s significant, if it makes up a big part of their business, well maybe that’s a case where you know, you don’t necessarily want to sell. Because for me personally, like until it tells me in concrete like, yes, there was a goodwill impairment then then you know, I wouldn’t necessarily want to sell just because of business I own makes makes a bad acquisition. I would rather kind of see that play out. But when it comes to like buying a new position, maybe I’m a little bit more weary about, well if this stock okay, you know, and it could the kind of tip it tip the scales one way or the other. It’s like, well I was like kind of unsure about the stock. I liked it, but then at the same token there’s all this goodwill and they did a bunch of acquisitions one at a time when the prices were really high.

Andrew:                              22:34                     Maybe that’s a case to not buy and then maybe there’s another company like a Berkshire, like a Warren Buffett or just somebody who’s in the past shown that they make good acquisitions at good times and they never really had to had this history of making poor choices. Well. Then maybe in that case I don’t. I see their goodwill is justify and I’m okay with buying that stock. Then maybe you and the new El case, maybe we can look at, well, they may, they didn’t make a lot of acquisitions in that goodwill shut up really fast, so even though they eventually paid off that debt, it looked like management was very acquisition hungry and maybe we avoid those types of stocks in the future.

Andrew:                              23:21                     That’s maybe the most tangible lesson out of all these kind of mini lessons is if you see somebody going on the acquisition binge, you might not uncover it with the debt to equity ratio, but you can look at the balance sheet and just look at goodwill and if it’s really, really high or it sky rocketed up, then you want to be careful because a goodwill impairment really hurts. Their balance sheet does not look nearly as strong as it used to. They had the post negative earnings for the year. Even though that doesn’t affect cashflows, it’s still like, well, it remains to be seen how it will continue to play out. I would not be surprised at all if they ended up cutting the dividend at least if not completely, at least maybe cutting the dividend to a more uh, conservative rate where it stopped growing. Because I mean this business is, the stock has already taken the huge beating. It took a huge beating before I bought it, which is a reason why I did buy it. Like I said, the balance sheet got much stronger, but acquisitions, it really wasn’t so, so all things I think to keep in mind, we’ll see how this plays out. I’m definitely keeping it on my radar, but hopefully my mistakes can be somebody else’s lessons and they can take this as another kind of analysis factor moving forward.

Dave:                                    24:44                     Can I ask you a question worse? One of the things I guess I was thinking about why you were talking about that is this kind of illustrates the importance of looking at a longer period of time when you’re looking at the numbers as opposed to just the most recent 10. Kay. So if you just look at the one year of numbers and you don’t look back at it at a longer time period, five to 10 years, I think that looking at a longer timeframe would would help alleviate or maybe avoid some of those problems? What are your thoughts on that?

Andrew:                              25:22                     Yeah, yeah. I think 100% like when I saw the huge binge, the huge acquisition binge, it was kind of after the goodwill impairment happens. So the way I perceived it when I first bought the stock was well that how the high debt to equity and then they made up for it. When in reality, yeah they kind of made up for it, but they also pay the huge price. So the other kind of longterm factor that maybe I should have taken more into effect, again in hindsight was third tenure numbers are 10 year growth numbers looked really, really good because all these acquisitions were contributing to their earnings. So like come on, like when you, when you shoot somebody full of steroids, of course their lift numbers are going to go through the roof. No, that was the earnings in that case, but because they overpaid, they had to pay the consequences of that eventually, and so now we’re seeing that play out and even though they’re getting some cash from these divestitures, it’s not making it for the fact that they overpaid and their balance sheet gets weaker and weaker.

Andrew:                              26:33                     Yeah. Yeah. That’s the very good point. I guess it also illustrates the importance of, you know, when you’re buying a company, you’re not just buying what they make. You’re also the people that run it as well and light. Buffett likes to always say, you better find a company that an idiot can run because eventually somebody will. Yeah, and that’s the case. Like no matter how good the management is, if you inherit this situation where previous management went crazy with their spending, even though it doesn’t show up as that, it can still show up. And I think that’s a lesson I didn’t know in the past.

Dave:                                    27:11                     All right folks. Well that is going to wrap up our discussion on Newell brands. I really enjoyed listening to Andrew talk about that. There was a lot of great points in there and I learned a thing or two a, it was interesting to hear his discussion on goodwill as well as the little tidbit about seeking alpha. I was not, I was not aware of that. So that was Kinda cool. So I hope you enjoyed our discussion. I hope you learned a thing or two that can help you with your investing. You guys go out there and invest with a margin of safety. Emphasis on the safety. Have a great week and we’ll talk to y’all next week.

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