Wednesday, January 03, 2007

Hedge Fund Remodeling Griffin Corp?

Hedge Fund operator Clinton Group, which beneficially owns about 5.2% in Griffon Corp. (GFF-$25.50), recently delivered a letter to the maker of everything from garage doors to specialty plastic films used in baby diapers, adult incontinence, and other products, stating its belief that the “market price of the Shares failed to reflect the stand-alone value of the Company’s operating subsidiaries.” The letter also advised Griffon’s management that they should evaluate multiple strategic alternatives to enhance shareholder value, including, but not limited to, a tax-free spin-off, a sale of one or more subsidiaries, or a going-private transaction.

There is appeal to the Clinton Group’s argument, for Griffin might be too diversified in its manufacturing operations:
  1. Garage Doors—selling to the residential housing and commercial building markets;
  2. Installation Services—servicing the new residential housing market with an array of building related products, ranging from garage doors, manufactured fireplaces, floor coverings, and cabinetry;
  3. Specialty Plastic Films—the maker of plastic and film laminates for use in infant diapers, adult incontinence products, feminine hygiene products and disposable surgical and patient care products;
  4. Electronic Information and Communication Systems—selling airborne maritime surveillance and aircraft intercommunication management systems for defense and commercial markets.


Net sales for the year ended September 30, 2006 increased 17.1% to $1.64 billion. Net income was $51.8 million, or share-net of $1.65, compared with $48.8 million, or $1.55 per share, last year.

Garage Doors represent one out of every three dollars in sales and 38.9% of operating profits. The Company estimates that the majority of Garage Doors’ net sales are from sales of garage doors to the home remodeling segment of the residential housing market, with the balance from the new residential housing and commercial building markets. Driving growth in this $2.2 billion market is the shift from wood to steel doors.

[Ed. note. Griffin did not breakdown how much of this segment’s total revenues are generated through its aftermarket service operations—which of itself would provide the division with a stable revenue base during economic downturns.]

Over the past decade, an increasing number of garage doors have been sold through home center retail chains. The Company estimates that approximately 35% of its
garage doors are sold through this retail channel of distribution. The segment’s largest customers are The Home Depot, Inc. and Menards, Inc.

In FY ’06, Griffin invested approximately $22 million in equipment and plant expenditures to support future growth in this segment.

With respect to the overall outlook for garage doors, management is cautiously optimistic. Despite weaker housing markets, Griffin benefited from a shift in customer demand to more premium doors, a trend that should contribute to future revenue and margin growth.

The Installation Services segment provides installed specialty-building products primarily to residential builders. In a fragmented market, characterized by small operations offering a single type of building product in a single market, management believes it has the economies of scale and scope that small and national builders (alike) find convenient.

Sales by Installation Services have provided approximately 21 percent and 8.7% of the Company’s consolidated revenue and operating profit in 2006, respectively.

Management expects that fiscal 2007 sales will be below 2006 levels due to weaker housing markets and the loss of certain customers in the segment’s Las Vegas market, offset by attractive interest rates on home equity financing driving demand for retail remodeling projects.
Still, even in a hot construction market back in 2004, this segment contributed only 8.6% to operating profit. Might the Company be too diversified in trying to satisfy the scope of builders’ demands? Granted, this segment installs and services the Garage Door’s sales; nonetheless, find the lower-margin product lines and ditch them!

Specialty Plastic Films are primarily used as moisture barriers in disposable infant diapers, adult incontinence products and feminine hygiene products, as protective barriers in single-use surgical and industrial gowns, drapes and equipment covers, and as packaging for hygienic products.

The segment’s major customer is Procter & Gamble (59 percent of specialty film’s sales), with whom the company supplies products used primarily for its infant diapers, both domestically and internationally. Design changes by Procter & Gamble for its infant diaper products have resulted in a change in products produced by the company from laminates to narrower and thinner gauged printed film. As a result, the volume of film products sold by the segment for this customer has declined.

Looking to expand its market presence, in FY ’06, Griffin spent approximately $11 million in equipment, research (in new advanced products such as cloth-like, breathable, laminated, and printed products), and in manufacturing capacity (such as a new manufacturing facility near São Paulo, Brazil).

Resin price increases had an unfavorable impact on operating income of approximately $7 million for the year. According to management, resin prices have been weaker and they believe that fiscal 2007 prices will be flat to slightly favorable.

Sales by Specialty Plastic Films provided approximately 23 percent and 8.7% of the Company’s consolidated revenue and operating profit in 2006, respectively, from 30 percent and 8.7% in 2004, respectively.

In our view, the sale of this division would be welcomed by existing shareholders, for as management itself says, “There can be no assurance that the capital expansion program that we have implemented in the specialty plastic films segment will generate the revenue and profits anticipated.”

Electronic Information and Communication Systems are sold through its
Telephonics Corp. subsidiary. Telephonics is generally a first tier supplier to prime contractors in the defense industry, with Boeing and Lockheed Martin being significant customers.

This segment is growing, generating about 24 percent and 37.5% of Griffin’s net sales and operating profit in FY ’06, respectively, up from 14 percent and 16 percent, respectively, in 2004. This substantial growth was primarily attributable to the Warlock-Duke program with Syracuse Research Corp. to manufacture equipment that is designed to defeat roadside bomb threats.

The Clinton Group is targeting this segment for a possible spinoff (to unlock its intrinsic value).

Corporate Governance

Readers will note that an LBO would probably get the thumbs up signal from its CEO, Harvey R. Blau. Irrespective as to whether or not his employment is terminated upon a “Change-in-Control” at Griffin (defined as the acquisition of 35% of the voting power of the Company), he shall automatically be entitled to a lump sum payment of approximately $7.63 million (excluding the gains from stock currently held and/or restricted stock units).

In the year that a Change-in-Control occurs, Blau would also be entitled to an additional bonus (which would mirror the then current fiscal year before the Change in Control), based upon performance for that portion of the year. For example, if Griffin were bought on July 1, 2007, he would receive three-quarters of his FY ‘06 (ending September 30) bonus of $4.1 million, or approximately $3.08 million.

[Ed. note. Despite Return on Assets falling from 7.5% (2004) to 5.8% in 2006, the Board still felt that Blau had “earned” his $4.1 million and $4.09 million in cash bonuses paid out to him in 2005 and 2006, respectively. The Company’s Senior Management Incentive Plan provides for an annual bonus to Mr. Blau based upon company performance—defined as Griffin’s consolidated pretax earnings: For each fiscal year. Mr. Blau's annual bonus equals 4 percent of the first $5,000,000 of consolidated pretax earnings, plus 5% of the amount of consolidated pretax earnings in excess of $5,000,000.]

In addition, Griffin would provide Messer. Blau with a tax gross-up payment to cover any excise tax due on the $10.71 million!

Mr. Blau acquired 660,000 shares on exercise in FY ’06, with a realized value of $10.1 million. He also owns exercisable in-the-money stock options worth an estimated $25.4 million

In our view, it makes sense for Mr. Blau to vocally support a Change-in-Control, too, because the normal retirement age under Griffon Corporation’s Supplemental Executive Retirement Plan (GSERP) is 72. Mr. Blau will celebrate his 72nd birthday in 2007. As of November 30, 2006, Mr. Blau had 34 years of service, and has already maximized his GSERP annual benefit payment (30 years). Under the GSERP plan, Mr. Blau is entitled to receive annual benefits of $2.25 million (before the reduction of Social Security benefits).

Retirement benefits are payable for life, with a guarantee of 10 years of payments. In addition, the SERP provides a pre-retirement death benefit payable for 10 years to the participant's beneficiary. Ergo, if the Grim Reaper were to come a-calling, Mr. Blau’s beneficiary would receive $22.5 million (less already paid sums).

The new owners would also be obligated to provide Mr. Blau, 71, with lifetime medical benefits after his termination of service. After two years—in the event that these benefits would become subject to taxes (under Section 409A)--Blau would forego such future benefits and receive instead a lump sum payment equal to the foregone economic benefit.

Valuation Analysis

Shares of Griffin sell for 12.6 times FY ’07 analysts’ estimate of $2.02 per share, a three-year low.

Segment performance is driven by industry-specific factors—which complicates matters when trying to tag the aggregate with a valuation. Shares of Griffin sell for 0.58 times enterprise value-to-revenue valuation (EV/REV), compared with EV/REV valuations of 3.3x, 0.73x, 1.15x, and 1.05x for consumer products maker Procter & Gamble, kitchen cabinet maker American Woodmark, home improvement manufacturer Masco, and defense contractor Lockheed Martin, respectively.

The due diligence conducted by the Clinton Group suggests that the fair value for Griffon's stock would approximate $31-$35 per share (adjusted for certain adjustments, such as the full conversion of outstanding convertible notes). The per share value was calculated with trading multiples of 7x – 8x, 6x – 7x, 10x – 11x, and 7.0x – 8.0x (EBITDA) for the Garage Doors, Installation Services, Defense, and Specialty Plastic Films segments, respectively.

[Ed. note. Our due diligence suggests that these peer comparables are appropriate.]

If the Clinton Group is successful in its goal of unlocking shareholder value, buying at current prices could result in a 21.5% to- 37.2% gain for new investors.

At $33.00 per share, however, Griffin would be charting at 16.3 times ’07 earnings (near the top end of its historic three-year P/E multiple).

Editor David J Phillips does not hold financial interests in any of the companies mentioned in this posting. The 10Q Detective has a Full Disclosure policy.

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