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When hairy met Sally

20 Jun 2006 By Cyrus Sanati

Clayton, Dubilier & Rice is known for investing in hairy, complicated deals. It turned Kinko’s around and is trying the same with Hertz. What then to make of its latest deal – the $575m acquisition of a stake in US cosmetics retailer Sally Beauty?

After all, buying a slice of a public company that retains its management seems like the kind of simple transaction any private equity firm with ample cash can pull off. But the deal is knottier than appears at first blush.

Sally’s owner, Alberto-Culver, long wanted to trim itself of the beauty-supplies chain. That’s because the retailers buying Alberto’s products, like VO5 shampoo, were miffed about competition from Sally. Meantime, Sally was hurt because Alberto’s rivals didn’t want to sell their products in a competitor’s stores.

So it had to get rid of Sally – the question was how. It tried to merge the business with Regis, an operator of hair salons, but that deal fell apart. It could’ve sold the whole thing to private equity. But that would’ve triggered heavy tax liabilities. A spin-off made sense – but it wasn’t clear whether it would create value.

The deal with CDR gets around all these issues. By spinning off Sally through a so-called Morris Trust to shareholders, Alberto claims it will avoid paying $600m in capital gains taxes. In addition, it’s loading up Sally with debt – $1.9bn in total. That’s allowing it to give shareholders a dividend of $25 in cash.

At the same time, CDR puts a value on Sally’s equity. For its money, CDR gets a 48% stake. That values Sally at about $1.2bn – or $3bn including the debt. That compares favorably with the spin-off option. Sally will earn $162m in 2007, according to A.G. Edwards. At 16 times – the multiple it might fetch as a standalone entity – it would be worth $2.6bn. That suggests CDR paid a premium of about 13%.

The stock should, then, trade at a discount to the price CDR paid. So how will it make a profit? As with Kinko’s, CDR will have to roll up its sleeves and boost Sally’s profits. But jazzing up marketing and getting new products on the shelf won’t be easy under Sally’s highly-leveraged capital structure. On second glance, Sally appears to fit perfectly within CDR’s niche of making over companies with not-so-pretty complexions.


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