Follow-Up Interest Post: Resideo Technologies (REZI) – Stock Falls, My Interest Rises
The Resideo spin-off has taken place. And the stock has traded on its own for a bit now. So, I thought I would very quickly re-visit the stock here.
You can check the ticker REZI (Resideo Technologies). It’s $19.56 a share as I write this. Here is a link to the press release announcing the completion of the spin-off:
https://www.otcmarkets.com/stock/REZI/news/story?e&id=1207602
“Honeywell distributed one share of Resideo common stock for every six shares of Honeywell common stock held as of 5:00 p.m. Eastern Time on October 16, 2018, the record date for the distribution.”
Honeywell had 740 million shares outstanding about 17 days before that date. So, let’s assume Resideo now has 740 million / 6 = 123 million shares outstanding (actually, slightly more – but I’m simplifying).
Actual quote from a recent 8-K: “Immediately following the Spin-Off, we estimate that approximately 123,451,420 shares of our common stock will be issued and outstanding.”
Before we re-visit my initial interest post, you may want to read it.
Here’s my initial interest post (where I give Resideo a 30% likelihood of me following up further with it):
And here are the notes I took when reading the company’s spin-off document:
Now that you have that background. Let’s talk about why I’m upgrading my interest level in Resideo.
So, as I write this…
Resideo Technologies (REZI)
Price: $19.56 / share
Shares Outstanding: 123 million
Market Cap = $19.56 * 123 million
Market Cap = $2.41 billion
Net Debt = $1.15 billion
Taken from this recent investor presentation:
https://www.sec.gov/Archives/edgar/data/1740332/000119312518296364/d617866dex991.htm
(Slide 45)
So…
Enterprise Value = Market Cap + Debt
Enterprise Value = $2.41 billion + $1.15 billion
Enterprise Value = $3.56 billion
Let’s call it $3.6 billion in enterprise value
Now, there are two ways of doing this. One: we can capitalize the environmental obligations and add that capitalized value to the EV and add-back the $140 million a year payment to Honeywell to arrive at some sort of “adjusted EBITDA” figure.
Or, we can just use $3.6 billion in EV and we can fully include $140 million a year payment as an annual expense. We then have to understand that the expense can go down from $140 million toward zero over time.
The easiest way to do this is to assume the $140 million annual payment is a perpetual obligation that will never be less than $140 million a year and will never go away.
In that case…
Enterprise Value = $3.6 billion
Last 12 months EBITDA = $475 million
Enterprise Value / LTM EBITDA = $3.6 billion / $475 million
Enterprise Value / EBITDA = 7.58x
Let’s round that up…
EV/EBITDA = 8x
Is that cheap?
It seems like it. Historically, an EV/EBITDA of 8 was pretty normal for a U.S. stock – paying a 35% tax rate at the federal level – because an EV/EBITDA of 8 translated into about an unleveraged P/E equivalent of 15 or 16. Basically, what I’m saying is that if a company had zero debt and traded at a P/E of 16 (the long-term historical average for big U.S. stocks) that company would also often have an EV/EBITDA of 8.
But, is that true anymore? And is Resideo an average company?
Today, an EV/EBITDA of 8 would translate into well under a P/E of 16 (because the federal tax rate dropped form 35% to 21%). The new normal EV/EBITDA ratio is probably more like 9-10x to get a P/E equivalent of around 16. Resideo also probably converts more EBITDA into pre-tax cash flow than other companies. So, I’d say you need an EBITDA of 10 times to get a “normal” P/E on this one.
This implies the stock price should be around $29.16 a share. You could probably appraise the stock at around $30 a share.
In fact, because of the way we did this calculation – there’s a risk we underestimated the intrinsic value of the stock. It might be higher than $30, because environmental obligations may decline.
On the other hand, the company has a fixed charge of $140 million a year it can’t do anything about. It also owes $1.15 billion in debt. In a sense, the company is probably capitalized with about an equal amount of equity (at today’s prices) and debt (if you capitalized the environmental obligations and added them to the financial debt).
My best guess is that the stock is “worth” $30 a share.
However, the margin of safety is NOT 33% ($20/$30 = 0.67x). It’s smaller than that.
And the upside is NOT 50% ($30/$20 = 1.5x). It’s bigger than that.
If I had to put a number on it: I’d say the stock is trading at about two-thirds of what it’s worth. But, this isn’t an especially low risk stock. It has debt and fixed costs it has to cover.
However, it also has the possibility of the fixed costs one day decreasing.
If you were agnostic about risk (basically, you didn’t care how much of EV was debt and how much was market cap – you just bought whatever was cheap on an EV/EBITDA basis) I’d say the stock is priced at about two-thirds of what it’s worth and has an obvious way to like 50% upside.
I would also upgrade my interest level from about 30% to about 60%. This is purely due to the price at which the stock now trades.
If you look at my notes, Resideo now trades at less than the market cap I guessed it would have. However, the debt is the debt. It hasn’t changed. Only the market cap is different than I expected.
So, I’ll upgrade my interest level from 30% to 60% based on the price of the stock.
Geoff’s follow-up interest level: 60%