Is Reliance Worldwide the next Isentia?
If a company's major shareholder is rushing for the exits while it's buying businesses to boost growth, other shareholders should start to worry.
There are differing views among Intelligent Investor's analysts over the importance of directors' transactions. But when a director and 30% shareholder sells two-thirds of his holding within days of his stock coming out of escrow, it's at least worth thinking about.
In Reliance Worldwide: Springing a leak? in February, I outlined why I couldn't see any value in this market darling's stock. With Reliance Worldwide's (ASX: RWC) share price up 44% since that article, call me wrong if you like. But I'm even more concerned now.
In fact, the situation has parallels with Isentia (ASX: ISD), a company that turned out to be a disaster for those who bought its shares in 2015 and 2016 (well before we recommended the stock at half the price in early 2017).
Last month Jonathan Munz, the Reliance Worldwide chairman, reduced his stake in the company from 30% to 10%. It would be less noteworthy but for the haste with which he sold as soon as he was able.
Follow the money?
Private equity firms are much the same. They rarely hang around on a company's share register for a moment longer than necessary. They also have a pretty good record of timing their exits.
‘Positive' news has been flooding out of Reliance Worldwide in recent months. First was the announcement in May that the company had acquired Holdrite, a supplier of ‘engineered product solutions' to plumbers and contractors.
After a quick look around that company's website, Peter Lynch's wonderful word ‘di-worse-ification' springs to mind. But Holdrite is expected to deliver ‘mid to high single digit [earnings per share (EPS)] accretion' to Reliance Worldwide in the first full year of ownership (2018). Of course it is.
Then there was the fact that Reliance Worldwide handily beat its 2017 prospectus forecasts. At the 2017 results release the company also provided nice, neat guidance for 2018: $145m–$150m of earnings before interest, tax, depreciation and amortisation (EBITDA).
That represents a minimum profit increase of 20% over the 2017 figure. However, up to half of the growth will come from the Holdrite acquisition.
Finally, there are a couple of other red flags waving. Home Depot, which accounts for 32% of Reliance's revenue, has destocked some of the company's products in certain regions. While the company has explained it away – and it coincides with Lowe's rolling out Reliance's Sharkbite range – I am wary. Reliance's customer concentration remains a significant risk.
So what are the parallels with Isentia?
Well, in August 2015 Isentia acquired King Content. The company announced the acquisition would be ‘EPS accretive in the high single digit range'.
On the same day Isentia announced it had exceeded its 2015 prospectus forecasts. It also forecast EBITDA growth of around 20% for the 2016 year (again, some of the growth was due to King Content).
Within days Quadrant Private Equity had sold its remaining shares in Isentia. The company's managing director sold around one-fifth of his holding the following month.
We outlined all these concerns in Isentia's unfriendly trends. Our concerns proved well-founded, because King Content was a disaster and multiple profit downgrades followed. Isentia's share price has almost halved since that review.
Who knows whether Reliance Worldwide is an accident waiting to happen? But there's no room for error with the stock trading on a 2018 forecast price-earnings ratio of 29.
I'm certainly not accusing Mr Munz of anything untoward. He is of course perfectly entitled to sell his stock at any time. But he now clearly thinks there are better places for (most of) his money than in Reliance Worldwide.
If you're a Reliance shareholder, take note. Bitter experience has shown that major shareholders selling stock as soon as they are able can be an ominous sign. I'll certainly be continuing to steer clear of this company for now.
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