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The following segment was excerpted from this fund letter.
Griffon Corp. (NYSE:GFF)
Last quarter I wrote about a new position in a small cap consumer products business that manufactures tools and home improvement items as well as residential and commercial garage doors. The company is Griffon Corp., and is one of our top five positions heading into 2023. This is an attractive situation for several reasons, but mostly due to the strength of Griffon’s Home and Building Products segment and the significant corporate governance improvements recently enacted.
Griffon Corp. is made up of two business segments, Consumer and Professional Products (‘CPP’) and Home and Building Products (‘HBP’). CPP manufactures popular home accessories and garden tools through quality brand names such as ClosetMaid and Ames. HBP is one of the leading manufacturers in the US of residential garage doors and rolling steel doors, with a nearly 50% market share through their Clopay and CornellCookson brands. CPP has struggled under the weight of poor acquisitions, lack of cohesiveness and underinvestment, but possesses strong market share in garden tools and has typically done well through various business cycles. Griffon’s HBP segment has cockroach-like elements, with a history of strong organic growth and resilience over multiple decades. Today, Clopay and CornellCookson are responsible for nearly half of Griffon’s revenue and around 60% of EBITDA. Given their strong characteristics of resiliency, cash flows and returns on capital, these businesses make great acquisition candidates and recent industry consolidation adds a valuable element to the mix. Valuing HBP using an EBITDA multiple in line with similar businesses as well as recent transaction comps reflects a per-share price that could exceed Griffon’s current enterprise value.
One would think that quality like this would be efficiently priced. I don’t believe it is. Despite strong organic growth and profitability, GFF has been its own worst enemy thanks to CEO Ron Kramer, an overpaid and entrenched CEO with a poor history of capital allocation. Ten minutes of research into Griffon Corp. would reveal years of nepotism, egregious management compensation, underinvestment into key areas and bloated corporate costs. This, plus an outdated conglomerate structure, has made GFF difficult to analyze and value. Historically, nothing has been done about this, until recently. Voss Capital, an activist investor who currently owns around 6% of the business, has stepped in and demanded major changes, including a restructuring of incentives, initiating the sale of some business segments, facilitating the declassification of the board of directors and, for the first time in a very long time, outlined levers to pull to drive value for shareholders.
At the urging of Voss, the company is currently undergoing a strategic review where all signs point to a value-unlocking event occurring at the conclusion. It’s possible that either the business is sold outright, HBP is sold in a separate transaction, or the two segments are separated into stand-alone public companies. Should I be wrong about my assessment of any value-unlocking event in the near term, we should be more than happy to own the business in its entirety with its strong demand tailwinds, room for margin improvement and increased returns on capital. Lastly, with new board members in place, underneath a quality business remains better capital allocation policies moving forward, allowing the business to be valued more appropriately over time.
It should be noted that COVID and housing related tailwinds have caused HBP results to look phenomenal during the past two years. In case they are overearning, conservative estimates surrounding sales and margins that are below management guidance for the segment would still indicate material upside from here. I would also continue to point to the favorable housing related replacement and repair dynamics as well as the resilience of the business over various cycles as a margin of safety here.
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Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.