Mittleman Brothers recently released its Q3 2020 Investor Letter, a copy of which you can download here. The Mittleman Global Value Equity Fund – Class P declined 1.4% net of fees (AUD) in the third quarter of 2020, versus a gain of 3.9% in the MSCI ACW Index. You should check out Mittleman Brothers’ top 5 stock picks for investors to buy right now, which could be the biggest winners of this year.
In the said letter, Mittleman Brothers highlighted a few stocks and Revlon Inc (NYSE:REV) is one of them. Revlon Inc (NYSE:REV) is a cosmetics company. Year-to-date, Revlon Inc (NYSE:REV) stock lost 56.3% and on November 17th it had a closing price of $9.36. Here is what Mittleman Brothers said:
“Revlon’s (REV) stock price has been a disaster calendar YTD, dropping from $21.42 on 31 December 2019 to a low of $4.81 on 26 October 2020 (-78% to $256M market cap.).
Revlon is in a very tight spot now as it urgently needs to refinance $345M in 5.75% notes due on 15 February 2021. These bonds are trading just under $30 currently (par $100), somewhat like Revlon’s notes did in 2002 when its 8.625% notes (due in 2008) dropped to $32 before recovering to $100 (after Perelman provided more capital).
MIM asserts that Revlon’s liquidity issues are not a solvency issue, so once cured with asset sales or capital infused by Ron Perelman⁵, much better times lie ahead for Revlon. MIM thinks the probability is very low that Perelman would risk his 87% stake in Revlon to the vagaries of a Federal Bankruptcy Court.
Some key points:
1. Cosmetics in general have suffered longer and more deeply than most would have imagined, yet the market fails to either recognise or properly value the very strong brands the company has beyond its core Revlon branded colour cosmetics.
For example, hair care is 16% of Revlon’s total sales and it holds the #1 market share in hair colour in the mass market channel. As well, Revlon owns American Crew, the maker of various hair styling products and the #1 brand globally for the professional (salon) channel, with an impossible-to-miss retail presence. That business should be worth at least $200M⁶.
2. A value at 2.5x sales for Revlon overall would put the stock at $39 per share based on 2021 sales estimate of $2.2B. But MIM is using only 2x sales now as a fair value guideline for Revlon overall and assuming a 16% EBITDA margin on $2.2B in sales in 2021 (11- year avg. EBITDA margin was 17% from 2008-2018), which is $350M in EBITDA, taking the stock price to $20 (2x sales, 12.5x EBITDA).
3. If Revlon pulls off one or two deleveraging transactions at significantly above 2x sales, MIM would look to raise its fair value estimate accordingly.
4. Revlon has many discreet options for raising cash through asset sales. One subsidiary which might garner significantly north of 2x sales would be Revlon’s Elizabeth Arden business, which pre-pandemic was growing nicely, particularly in China. It is a 63% gross margin business with excellent growth in Asia and a very strong prestige skincare business. Elizabeth Arden could easily garner 2.5x sales, which would be a major deleveraging transaction at $1.3B. Smaller brands like CND (most famous for Shellac, which innovated with gel nail polish), which is also a 63% gross margin business, would also seem to be of the right size and quality for any number of buyers.
5. Revlon engaged Goldman Sachs to run a process in September 2019 and they could be getting closer to an event occurring. Goldman handled the sale of Procter & Gamble’s Covergirl, Max Factor, and other brands to Coty in 2016 (for 2.6x sales), but that took a year and a half from engagement of Goldman to announcing the deal. MIM has always thought Estee Lauder (EL $231, 5.7x sales, 27x EBITDA) would be the perfect buyer for Revlon given EL has no exposure to the mass market (as its main competitor, L’Oreal, does via Maybelline and other brands).
So, despite all of the bad decision making by Revlon management and directors, past and present, and the needless burden of too much debt (that has likely weighed on innovation and brand support), it retains big market shares:
– #1 mass-market stand-alone lipstick brand,
– #1 mass-market stand-alone hair colour brand,
– #1 mass-market fragrances,
– #2 mass-market nail polish, and
– #3 or 4 mass-market face makeup and eye makeup
If unburdened from a relentlessly overleveraged capital structure, these businesses could thrive. While the balance sheet is hideous versus recent EBITDA, it is just very highly leveraged against normalised EBITDA, noting that the mass-market typically benefits from the trade-down effect during economic downturns, so that should benefit Revlon again now (as it did in 2008/2009).
Revlon has not been a cash generator over the past 3 years (2017 through 2019) and COVID-19 deprived it of what should have been a modestly positive FCF year in 2020. However it was a significant FCF generator in each of the prior years in which MIM has owned it (starting in December 2010). As the business returns to normal margins, with the multiple cost-cutting programs on track to achieve that, MIM expects some rendition of that FCF performance going forward.”
This isn’t the first time Mittleman Brothers talked about Revlon Inc (NYSE:REV) favorably either. The investment firm has been a long time Revlon Inc (NYSE:REV) bull. In June 2020, we shared Mittleman Brothers’ bullish Revlon Inc (NYSE:REV) thesis in this article.
In Q2 2020, the number of bullish hedge fund positions on Revlon Inc (NYSE:REV) stock decreased by about 6% from the previous quarter (see the chart here), so a number of other hedge fund managers don’t believe in Revlon’s growth potential. Our calculations showed that Revlon Inc (NYSE:REV) isn’t ranked among the 30 most popular stocks among hedge funds.
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