Revlon: High-Quality Co.Trading for Big Discount to Peers

What we like about a unique, well-known, enduring brand like Revlon in the beauty-products business is the steadiness of demand, high profit margins (EBITDA margin @ 20%), and the resulting predictability of free cash flow over time.

Revlon's business proved to be highly recession resistant during “The Great Recession,” when consumer spending retreated sharply worldwide, company sales dropped about 5% from 2007 to 2009, but EBITDA and free cash flow actually rose.

On top of that intrinsic business stability is a company that has been transformed over the past three years since Alan Ennis took over as CEO. He had been the CFO, but was promoted in 2009 to navigate the company through the financial crisis and put it on more solid operational and financial footing. He’s done just that, paring the product line-up, refinancing debt and significantly cutting costs, to the point where Revlon’s EBITDA margin, at just under 20% (up from 16.5% in 2007), is now on par with much larger industry peers such as L’Oreal and Estee Lauder.

Free cash flow, which has been negative until 2008 because the company was burning so much money on interest expense and an unrefined cost structure, should be around $100 million this year, or $1.91 per share, before extraordinary items. In addition to using that FCF to deleverage (net debt + preferred stock = 4.4x est. 2012 EBITDA, vs. 6.4x in 2007), they have also made tuck-in acquisitions of Sinful Colors in 2011, for $39 mil., and Pure Ice in 2012, for $66 mil., both businesses primarily produce nail polish.

Beside the limited float and resulting illiquidity in the shares and lack of analyst coverage (only two sell-side analysts cover the stock), we think the main reason that the market hasn’t more fully recognized Revlon’s recent transformation is the fact that Ronald Perelman, who took the company private in an LBO in 1985, before bringing it public again via an IPO in 1996 at a split-adjusted price of $219.63, still controls 76.3% of the shares.

The quality of the business is high enough and the discount to intrinsic value here is large enough that we’ll accept the illiquidity in the stock and the risk that Perelman might act against our interests at some point in the future.

Valuation

Public peers like Estee Lauder and L’Oreal currently trade for around 13x EBITDA on a total enterprise-value basis, with market cap. to free cash flow multiples of about 25x on average. Revlon, at today's closing price of $15.10, trades at a TEV/EBITDA multiple of 8x and a mkt. cap./FCF multiple of 7.9x.

Although Revlon's nearly 20% EBITDA margin is similar to its much larger peers, those other companies have achieved much better track records of growth, so Revlon probably does warrant somewhat of a discounted valuation, just not such a gaping disparity as we see it today.

Our estimate of fair value for REV is $26 (72% higher than current price), which is derived by applying a 10x multiple on estimated 2012 EBITDA of $280 million, which equals a $2.8 billion total enterprise value, subtracting $1.18 billion in net debt, $48 mil. in preferred stock, and $217 million in pension liabilities, yielding an equity value of $1.355 billion, divided by 52.35 million shares outstanding, equals $26 per share. That equity value also equates to about 13.6x the $100 million in free cash flow the business should generate in 2012.