Church & Dwight Co., Inc.

    • Spruce Point has significant concerns about Church & Dwight (NYSE: CHD), an S&P 500 company, and roll-up acquiror of personal care and consumer products. Under its older leadership, management pursued a conservative strategy to leverage its core Arm & Hammer brand by diversifying and integrating acquisitions, while still prioritizing product innovation, and manufacturing excellence. With the elevation of Matt Farrell to CEO in 2016, Spruce Point believes CHD’s strategy has pivoted towards extreme financial engineering, aggressive accounting, and managerial self-enrichment practices. As fundamentals deteriorate in CHD’s retail environment, and it’s now clear that 60% of its legacy Power Brand acquisitions are failing, Spruce Point believes that CHD’s recent Waterpik and FLAWLESS levered acquisitions were made in desperation at outlandish valuations. If history is any guide, recent deals will disappointment investors. With CHD’s shares at a 8% premium to average analyst price targets, and debt rising, investors seeking safety in CHD’s stock face 35%–50% downside ($40 – $52/share).
    • Old School Brands Traditionally Following A Copy-Cat Like Strategy Against Leaders Proctor & Gamble, Clorox, And Others. Best known for its iconic Arm & Hammer brand, CHD embarked on an acquisition strategy in the early part of the 2000s to diversify into condoms, sex toys, hair care, rectal cream, vitamin gummies, oral care and other assorted product categories. However, we believe 6 out of 10 of its “Power Brands” acquired pre-2017 are struggling or outright failures. With 23% of sales through Wal-Mart, and reliance on struggling brick-and-mortar channels such as ULTA, Sally Beauty, Bed, Bath & Beyond, pharmacy (ex: Walgreens, CVS, Rite Aid), and discount stores, we believe CHD is experiencing channel pressures, and has been slow to transition to online sales and marketing to millennials. These factors, along with an increasingly promotional environment, has been pressuring margins.
    • Long promising international growth opportunities, CHD hasn’t been strategic about acquiring brands that can readily be sold in foreign markets (most notably vitamins) and has failed to implement common sense strategies (e.g., multilanguage labeling) to accelerate and scale the “export” strategy. Our research indicates that recent international success is attributable to new market entries, establishing distribution agreements and putting through significant price increases. We don’t believe that any of these drivers are sustainable and that CHD is now too late to many of its core product categories around the world. As a result, we believe that international growth is likely to disappoint
    • Investors Fail To Appreciate The Change of Leadership Style Under Matt Farrell, An Executive Who Blind-Sided Investors At Alpharma. In early 2016, Matt Farrell and Rick Dierker were appointed CEO and CFO, respectively. Based on our interviews of former employees in key roles, CHD experienced a culture shift that would deemphasis manufacturing, R&D and supply chain investment in favor of greater financially engineered acquisitions. One former employee even described management as “financial magicians”. We believe investors fail to appreciate the abysmal failure overseen by Farrell when CFO of Alpharma (formerly NYSE: ALO). While we acknowledge that some of Alpharma’s issue may have pre-dated his arrival in 2002, there is evidence that under Farrell’s leadership, the situation became even worse, culminating in Alpharma issuing more material weaknesses, a “non-reliance” opinion on its financial statements, a covenant breach, and later a DOJ settlement for bad sales and payment practices to promote unsafe products
    • Under Pressure To Financially Engineer Results, CHD’s Two Recent And Expensive Deals Already Showing Signs of Disappointment. In August 2017, CHD spent $1 billion to acquire Waterpik, a dental water flossing product that has been flipped twice by private equity owners. From the deal conf call, management showed little understanding of the business, punting on simple questions such has what % of sales is online, and the split of kit vs. consumable sales. When we asked a former long-time executive about the deal: “Waterpik has been for sale for years, and I’m a bit surprised they bought it given product liability concerns”. Sales Decline Quickly Post Acquisition: CHD obscured the contribution of sales by Waterpik post acquisition, lumping results in consumer domestic and international with smaller acquisitions Anusol and Viviscal. However, total consumer revenues from acquisitions declined from $102m (Q4’17), to $85m (Q1’18), to $79m (Q2’18) in the following quarters that can be cleanly analyzed. The FDA also recalled products mid 2018 for safety issues.
    • Margins Already Failing: Documents show Waterpik’s gross margins were 47.7% – 49.1% pre-acquisition, and the CFO said he expected 200-300bp gross margin expansion. Fast forward to early 2019, the CFO’s recent comment that gross margins are now “on par” with the company’s gross margin (pre-China tariffs), indicate that margins have contracted lower and are now closer to 44%
    • MSpruce Point Has Identified Many Flaws In The Flawless Acquisition That Should Give Investors Grave Concerns. In May 2019, CHD announced it acquired FLAWLESS hair care removal product for $450m. The product has grown quickly to $180m of sales since its 2017 launch, but has unproven staying power in a rapidly maturing category. Management is using bold and potentially misleading language to promote the deal, even claiming to be creating a “brand new category” for an “unmet need” and that it will “blow out” sales. Spruce Point finds undeniable evidence of aggressive accounting, revenue recognition problems, and operational delays at FLAWLESS: Notably, we have sourced Nielsen retail data for recent FLAWLESS product introductions. The data shows slowing growth for its headline Finishing Touch FLAWLESS brand, and rapid maturation cycles historically for new product introductions. FLAWLESS and CHD’s Batiste are sold at ULTA Beauty, which just cut guidance, and said recent new product cycles in women’s cosmetics are not driving growth.
    • CHD Touts Its Industry Leading Cash Conversion >100% of Net Income, But It’s Not As Sexy As It Appears. Aggressive M&A Accounting: On average, CHD accounts for 96% of its deal values as intangibles and goodwill, enabling it to receive tax deductions over 15yrs that improve cash flow. As an example of how aggressive management has been towards applying this strategy, it said on the FLAWLESS conference call that it had no synergies, yet later marked $82m of the value as goodwill and attributed it to synergies!
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