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Tomorrow I'll be buying shares of Fortune Brands (NYSE: FO ) as part of my Special Situations portfolio. The company is set to spin off its home and security business later this year, leaving the spirits business, which will be renamed Beam. I think the market is still not recognizing the value of these two remaining parts of the business. But I'm particularly interested in the liquor business.
As I explained last month, when I ran a valuation on Fortune, I expect the freestanding spirits company to eventually be acquired. Diageo (NYSE: DEO ) looks like the likely contender, as it seeks to fill a hole in its liquor portfolio with Fortune's bourbons and compete with Brown-Forman's (NYSE: BF-B ) Jack Daniels on the global stage. I've also seen interest from Pernod Ricard, but that company is more highly leveraged than Diageo.
Currently, I've figured that Fortune's liquor business is trading for less than the average price multiple for takeovers in the last decade. But the liquor unit's operating profit is still depressed well below levels seen in 2006 and 2007, and so I expect a multiple to come in higher than it might otherwise, in order to reflect the unit's ability to generate profit. In addition, the value of an acquisition for a bigger player will come through leveraging its own distribution, meaning that an acquirer can pay up for Fortune and still realize value.
Even if a takeover doesn't come to pass, the liquor business is a solid franchise that I expect will continue to create shareholder value over the long term. And with the company soon to be trading as a pure play and the attractive economics of the liquor business, I wouldn't be surprised to see the multiple expand as well.
While I'm less interested in the home and security business, it still looks attractively priced, too. Its earnings are heavily depressed now compared to the boom years, so a purchase here looks like a value, compared to what the business is capable of earning when times are good. Even better, Fortune has taken initiatives to cut costs and streamline the business. I calculated that the unit is being valued at roughly five times EBITDA, cheaper than peers Masco (NYSE: MAS ) and Owens Corning (NYSE: OC ) at 10 and 16 times, respectively.
So tomorrow I'll be buying $1,000 of Fortune Brands, or about 6% of my total capital.
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