Hain Buys Spectrum

Hain’s purchase may be a bargain and it represents an opportunity for growth.

ByAdam Ismail

It has been a few years since there was a merger of two publicly-held companies, but in late August the cold spell came to an end with the Hain Celestial Group’s (Nasdaq:HAIN) acquisition of Spectrum Organic Products (OTCBB:SPOP). Hain agreed to pay approximately $34.5 million for Spectrum, which had nearly $50 million in sales last year and roughly $1.2 million in Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA). At the deal price, the valuation of 28.8 times EBITDA seemed a bit expensive to some people. However, Hain may have had a good reason for paying as much as it did.

Rationale

One can only speculate about the ultimate rationale behind the deal for Hain, but it is clear there are several potential synergies that could justify the valuation.

First are the complementary distribution outlets of their products. Hain has a significant presence in the natural foods retail channel, which is also Spectrum’s largest channel. While it is unlikely Hain will make any substantial gains in retail outlet penetration as a result of the deal, they will certainly be able to save on the costs of distribution. Spectrum relies on several small brokers and some larger distributors to get onto the shelf, but Hain most likely pays significantly smaller distribution fees and doesn’t rely on the more expensive small retail brokers.

Also, Hain and Spectrum sell some competitive products like olive and canola oils. In this category, Spectrum may actually have a competitive cost advantage over Hain because it is core to Spectrum’s business. Spectrum likely purchases more refined oil than Hain, but combined, the two companies may be able to reduce their purchasing costs. This could potentially result in significant savings, since Spectrum only earns a 20% gross margin on its products.

Then of course, there are the traditional deal synergies from reducing overhead. It remains to be seen what Hain’s strategy for Spectrum will be, but Spectrum did have over $12.5 million in overhead costs last year. If you assumed Hain was only paying 28.8 times EBITDA for the existing business, then all Hain would have to do is cut $1.2 million off the overhead to justify the deal! Of course, Hain was not paying only for the existing business, but still there is tremendous opportunity for them to justify the price.

Deal Structure

The deal structure is also particularly interesting. Spectrum agreed to receive half of the deal valuation in cash and the other half in Hain shares. Even though Hain is substantially larger than Spectrum, the company only had a little more than $27 million in cash on its books as of Hain’s last quarterly filing. By paying half of the deal price in cash, Hain was able to pay for Spectrum out of the cash it has on hand, rather than having to finance the transaction with debt. Hain said the deal would be accretive, or additive, to its earnings immediately, which was clearly a core principle for the deal structure. If it had needed to take a significant amount of additional debt to pay for Spectrum, interest expenses could have cut into the profits of the deal. Remember the $1.2 million Hain would need to cut out to justify the deal? If they had borrowed at a 2.9% interest rate (its current rate) to pay for the deal, it would have eaten $1 million of that gain away.

Summary

In the end, Hain may not have overpaid for Spectrum. If it could save 5% in distribution and manufacturing costs and cut $1.2 million in overhead, it would come up with $3.7 million in savings. If Hain could do that the $34.5 million price would seem like a bargain. In fact, you would even be justified paying that price for a company that ONLY had $3.7 million in earnings, but Spectrum offers Hain a lot more than that, and potentially a lot of growth as well.NW