January 5, 2007

Sally Beauty Supply

Members of Fat Pitch Financials Contributor’s Corner have been following my investment in the recent Alberto-Culver Co. (ACV) spinoff, Sally Beauty Holdings (SBH). If you haven’t heard, Alberto-Culver, the beauty and hair care products company that makes VO5, TRESemme, St. Ives, and more, gave their shareholders one share in the newly spun off Sally Beauty, for each share of ACV they owned. The new Sally Beauty is one of the largest beauty supply distributors in the world. The deal was completed after the market closed on November 16th.

I started following this spinoff opportunity on November 14, 2006. Right after I researched the details of this opportunity, I got that tingling feeling in my head that I too could be a stock market genius. I wouldn’t be surprised to hear that Joel Greenblatt, the master of spinoff investing, also bought into this opportunity.

Let me list the details about why I got so excited by this spinoff:

  1. Institutions don’t want it. I discovered that Sally Beauty would not be added to the S&P Composite 1500 index. This means that index funds will have to dump the shares of Sally Beauty that they receive and thus depress the market price of this stock.
  2. Insiders want it. It looks like the new management of Sally Beauty will be highly motivated to boost the value of this stock since they will be receiving generous stock option grants.
  3. A previously hidden investment opportunity is uncovered by the spinoff transaction. Because Alberto-Culver produced many of the products that Sally Holdings distributed, other beauty and hair care product manufacturers that would potentially use Sally Beauty to distribute their products were concerned about potential conflicts of interest. This spinoff frees up Sally Beauty and allows it to now more fully compete to expand their distribution of a wider range of products from a larger base of manufacturers. This seems like a great move to me. I still remember when Wal-Mart spun off their food distributor and Warren Buffett snatched it up. (Hmm… Maybe he’ll be interested in snatching up Sally Beauty as well. One can only dream.)
  4. Leverage! Sally Beauty will also be loaded up with debt ($1.85 billion) and thus be highly leveraged, which is a good thing for spinoffs according to Greenblatt. This leverage will act to turbo charge returns to shareholders if the company is able to generate returns greater than their costs of capital. Based on the numbers I’ve seen for Sally Holdings, I don’t think this will be a problem.
  5. Margin of Safety. Based on my real rough calculations of future earnings for Sally Holdings, I estimate that the intrinsic value of SBH shares is about $10.

These five factors made Sally Beauty a fat pitch. Even though it is not the first spinoff I’ve invested in, it is the first to be added to the Special Situations Real Money Port. I added 300 shares of Sally Beauty Holdings at $7.42 a share to the Special Situations Real Money Port on last Friday, November 17, 2006. Sally Beauty Holdings closed today (Nov. 21, 2006) at $8.75. I’m already up 18 percent in less than a week on this stock.

That boost has raised the performance of the Special Situation Real Money Port. Based on today’s closing value for my son’s Coverdell ESA account ($7,574.02), it has earned a 15.9% annualized rate of return since inception (Oct. 19, 2004) and 19.5% annualized rate of return year to date. You can get timely information on the special situation opportunities I’m researching and my latest transactions over in Contributor’s Corner.

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