Laughing Water Capital recently released its Q3 2020 Investor Letter, a copy of which you can download here. The fund posted a return of 26.4% for the quarter (net of fees), outperforming their benchmark, the S&P 500 Index which returned 8.9% in the same quarter. You should check out Laughing Water Capital’s top 5 stock picks for investors to buy right now, which could be the biggest winners of this year.
In the said letter, Laughing Water Capital highlighted a few stocks and Whole Earth Brands Inc. (NASDAQ:FREE) is one of them. Whole Earth Brands Inc. (NASDAQ:FREE) is a global platform of branded products and ingredients. Year-to-date, Whole Earth Brands Inc. (NASDAQ:FREE) stock lost 13.9% and on October 20th it had a closing price of $8.41. Here is what Laughing Water Capital said:
“Whole Earth Brands (FREE) – FREE is a packaged foods and flavorings company that recently came public through a SPAC, and joined our portfolio as a top five position. SPACs have a terrible track record for value creation in the early years, but there are rare gems available for those willing to sift through the rubble. I believe that FREE is one such gem.
The business operates in two segments and features dependable, recession resistant revenues tied to non-sugar sweeteners (think little blue packets of Equal and natural stevia based sweeteners) and licorice extract that is primarily used to flavor tobacco. Where it gets more interesting is why we were able to buy our shares at a very low price.
Ron Pereleman, formerly the 47th richest person in the world, has been in the news quite a bit lately because his fortune was built on a mountain of debt, leaving him with a liquidity crisis. Notable headlines have included that he is trying to sell his Hamptons estate for $180M, his art collection for hundreds of millions, and that he has agreed to sell his stake in casino gaming company Scientific Games (SGMS) for $1.5B. He also sold two smaller portfolio companies, Merisant and MafCo, which have been relabeled as Whole Earth Brands. Of particular note, the deal was originally arranged prior to the onset of Corona virus, but was then subsequently renegotiated to a lower price on two separate occasions as Perelman’s liquidity problems were exacerbated by the pandemic, and he seemingly became more desperate to raise cash. Curiously, Perelman may have recognized that the deal price was very low because he subsequently bought more than 3 million shares in the open market, presumably because he expected shares to rally upon the close of the transaction.
When shares did not rally, he aggressively reversed course, and began to sell these shares in the open market, driving the price down to where we bought our shares. SPACs have a bad reputation for a multitude of reasons, but one of the most often cited problems is that SPAC sponsors are incentivized to just get a deal done at any price. That may be true, although with a two year runway, presumably sponsors have ample time to consider attractive options. Regardless, in the case of FREE, even today shares are wallowing at a roughly 50% discount to the original deal price, which suggests a large margin of safety to where a knowledgeable buyer was willing to purchase the company.
Importantly, not only were these assets available at fire sale prices, the trailing GAAP financials do not accurately represent the true earnings power of the business. Under Perelman, cash generated by these businesses was primarily used to service debt, rather than to reinvest in the businesses for efficiency and productivity gains. For example, there were two accounting departments, two IT departments, and two packaging procurement groups, all of which are in the process of being rationalized. Additionally, there was room to rationalize the company’s manufacturing footprint, which is also in progress, and when these steps are complete, the company’s margins and free cash flow should be significantly improved.
Also of note, FREE is now being overseen by a board chairman with an unusual level of experience for a company of this size. The SPAC that purchased these assets was known as Act II Global Acquisition, and was sponsored by Irwin Simon, who previously started Hain Celestial (HAIN) from scratch by mortgaging his apartment. Under Simon’s leadership, HAIN grew from nothing into a company with more than $2.5B in revenue. It seems clear from the name of the SPAC that there are growth ambitions here as well, and this assumption is fortified by the fact that the bulk of the founder’s shares are locked up until the stock price reaches $20 per share. However, thus far the company seems to realize that their capital is best spent repurchasing their own shares rather than seeking acquisitions, as they have recently authorized a buyback plan, and several executives and board members have been buying shares on the open market.
As the overhang from Perelman selling his shares dissipates and as the company executes on their very easily achievable operational improvement plan, shrinks the float, and begins to publicize their story, shares should re-rate significantly higher. The fact that the company is very likely to be added to the small cap indexes in the spring is also a positive as it would result in a wave of forced buying, and in my view, shares could double in the years to come and still be cheap next to peer packaged food and ingredients businesses. When factoring in that many of these peers are no/low growth and that FREE has the balance sheet to support more meaningful growth, I would not be surprised to see FREE trade at a premium to the group over time. There is also the possibility that shares become wildly expensive as alternative natural foods are very on trend at the moment, as evidenced by shares of alternative natural creamer company Laird Superfood (LSF) which trades at ~20x revenue for reasons that are a puzzle to me. I owe a thank you to friend of LWC Dan Roller at Maran Capital, who prompted me to investigate FREE.”
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In Q2 2020, the number of bullish hedge fund positions on Whole Earth Brands Inc. (NASDAQ:FREE) stock increased by about 53% from the previous quarter (see the chart here), so a number of other hedge fund managers believe in FREE’s growth potential. Our calculations showed that Whole Earth Brands Inc. (NASDAQ:FREE) isn’t ranked among the 30 most popular stocks among hedge funds.
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Video: Top 5 Stocks Among Hedge Funds
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Disclosure: None. This article is originally published at Insider Monkey.
