ACCO Brands (ACCO) has seen an eventful year, not just with the global Covid-19 pandemic taking place, as the company announced a sizeable and rather spectacular acquisition as well. Enough of a reason to provide a quick update on the perspective from here as we are heading into 2021.
The (Former) Thesis
In August 2019 I concluded that ACCO Brands was still fighting an uphill battle. This was based on the premise that this is quite a well-managed business which operates in a rough and declining market, making it hard for even a very high-quality management team to deliver on consistent value creation.
This challenge relates of course to the business in which ACCO is active, that of essentially operating a range of consumer brands which focus on office, school and accessories, often found in Staples and OfficeMax, and others.
With the 2016 purchase of the remaining stake in the joint venture in Australia and New Zealand and the $333 million purchase of Esselte, the company had grown to a $2 billion revenue base. The 2017 results revealed that the company delivered on its promise with sales coming in at $1.95 billion, although comparable sales fell 4% that year.
The company reported earnings of $1.19 per share and with shares trading around the $10 mark, multiples were non-demanding, although net debt was steep at $900 million, even excluding sizeable pension liabilities. In 2018, the company reported flattish sales with earnings coming in at $1.14 per share, a little softer than guided for.
While the 8-9 times earnings multiple at which shares traded late in 2019 was low, I was still cautious. I believed the company was climbing an uphill battle and was doing relatively well, yet I was concerned about the combination of negative comparable sales growth and high leverage ratios, more than offsetting the appeal from a compelling valuation.
In February 2020, the company reported its 2019 results with sales up 1% to $1.96 billion, entirely the result of comparable sales growth. Adjusted earnings of $1.20 per share rose six cents on the year before, with GAAP earnings coming in at $1.06 per share. For 2020, that is of course ahead of the Covid-19 outbreak, the company guided for flat sales and adjusted earnings between $1.20 and $1.30 per share.
Net debt had fallen to around $780 million by the end of 2019 as adjusted EBITDA of $297 million worked down to a 2.7 times leverage ratio. Based on the situation the company traded around the $10 mark at the start of this year. Shares fell to just $3 and change as investors feared the worst with the outbreak of the Covid-19 pandemic.
The impact of Covid-19 was seen in the results reported so far in 2020. First quarter sales fell 2.5% with adjusted earnings slipping a penny to $0.08 per share. The real pain was seen in the second quarter with sales down 29% to $367 million and amidst this, the twenty-four cents decline in adjusted earnings to $0.12 per share was not even that bad.
In October, it became evident that sequential trends were improving with third quarter sales down 12% to $444 million in the important back-to-school season, with adjusted earnings down from $0.32 per share to $0.19 per share. That said, limited earnings, continued dividends and poor working capital conversion made that net debt stood around $825 million by the third quarter, actually up so far this year.
Management sound quite upbeat on the business even if similar sales declines were seen for the fourth quarter, pushing up leverage a great deal, although no concern for management with no maturities due until 2024. Investors were not so comforted, as shares traded between $5 and $6 in October when the third quarter results were released. The $500-$600 million equity valuation worked down to a $1.3-$1.4 billion enterprise valuation, if net debt is included.
A Big Deal
In any circumstance, and certainly today, capital allocation is key and with that in mind it is very noteworthy that the company announced a big deal in November. While there was no immediate reaction, the deal and strong market performance has driven shares up to a current level at $8.50 per share.
In November the company announced the $340 million purchase of PowerA, a provider of third-party video gaming accessories, such as controllers, charging solutions and the assets. The final deal tag could increase to as much as $395 million based on the sales performance in the first two years after deal closure.
This deal is a deliberate choice of management to become a (faster) growing consumer focused company, after its own Kensington accessories business has shown solid growth already. PowerA is expected to generate sales of $200 million this year, a 20% increase from the year before, with EBITDA seen at around $50 million.
Based on the upfront payment number, ACCO is paying 1.7 times sales, which compares to around a 1.0 times multiple for ACCO in normal times (that is ahead of Covid-19). It is evident that PowerA is showing more rapid growth and that its 25% EBITDA margins are about 10 points higher than its own margins!
All of this means that net debt will jump to $1.15 billion, as normalized EBITDA of ACCO runs at $300 million, or $350 million if we include this deal. If that is realistic, it results in a 3.3 times leverage ratio, although the company reports a 3.5 times leverage ratio in the press release, of course taking note that current ratios are high as a result of the impact of the pandemic.
Quite frankly I think that ACCO has made a nice deal, one which is forthcoming and allows the company to improve its growth profile. That being said, the deal only adds 10% to pro-forma sales as organic growth only has a modest impact on the total growth profile of the company, yet it certainly helps the sentiment.
It has a drawback as well in that it increases net leverage a bit in the near term which is a concern, yet overall I think it certainly is a sound deal and welcomed for ACCO. Nonetheless, I realize that shares have recovered to $8.50 per share again, down just a buck this year after a difficult year in which no real free cash flows are being generated.
It still feels as if management is facing an uphill battle as the move to make the company more resilient towards the future certainly is welcomed, although there is still a formidable challenge at hand. Even if things might normalize in the coming year and earnings power might recover to around a dollar per share, I continue to reiterate my cautious stance.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.