This RH acquisition makes all the sense in the world to us – not because we’re bullish on all things Resto. We’re not, actually. But we do think that the current valuation egregiously misses the mark in capturing the real economic value that RH will deliver in the coming years. Here’s a few points…
- I (McGough...and probably Richards too) saw the press release that ‘RH acquires Waterworks’ and I nearly had a coronary. Why should a company that is going through such uncharacteristically ugly growing pains in the front end (changing its promotional strategy) and the back end (vendor realignment) be doing a deal? Is it to buy earnings growth that otherwise does not exist? To deflect investors’ attention from a core strategy that might have taken a turn for the worse?
- The answers are No and No. This is a very good deal for RH. Waterworks is one of the few premium Kitchen hardware companies in the business, and in 2014 it launched its own custom cabinet business. Remember how RH talked two years back about how big an opportunity Kitchens was? Then it got quieter as each quarter passed as it realized the sheer complexity with creating a brand and presence in that business. Then Richard Harvey resigned last summer, after having been plucked from Williams-Sonoma to run Kitchens at RH. Now this deal immediately gives RH a retail presence as well as an imbedded vendor network throughout Europe.
- WW also has a very strong presence with the trade. RH, does not. We hate to hear about ‘cross selling’ opportunities with acquisitions, because we’ve very rarely seen them play out. But this one seems like a no-brainer to us.
- Most importantly, we actually think that this deal is a big tell about the state of RH’s business today. If the company was concerned about its trajectory in the launch of Grey Card or in realigning its vendor network, we don’t think it would go within striking distance of any form of M&A. Ultimately we think it is bullish.
- Similarly, cash flow is always a major concern for people. But we think that RH would only use the $117MM in cash to buy this brand if it would actually reaccelerate its cash flow goals as 2019/20 loom on the (very distant) horizon.
1) What is it? – Waterworks annual revenues are in the $100mm+ ballpark, with 15 showrooms across the country in key MSA’s: NY, LA, Miami, Chicago, Boston, UK etc. Along with that comes an established Trade business, with the product featured in 50 hotel projects and 45 apartment complexes with a particular emphasis in NY. The brand’s heritage is rooted in Bath and opened its first Kitchen showroom in August of 2014. The product offering is additive on the Bath side to RH’s current offering with a broader selection of technical fixtures. And the Kitchen business is a mirror image of the line RH had talked about creating when it hired Richard Harvey (who is no longer with the company) in June of 2013. The current offering includes: cabinetry, sinks, fittings, surfaces, etc.
2) Deal economics: The $117mm all-cash deal, implies multiples of 1.1x-1.2x sales and 10.5x EBITDA. Slight premiums to where RH is trading, but our sense is that RH has been courting partners that make strategic sense to fill out the category breadth since it closed its first convert in the early part of 2014. The timing here suggests that RH did what it said it would do all along, by taking advantage of market volatility to bolt on strategic partners to broaden the category assortment at a price that makes financial sense.
3) Year 1 accretion: That way we are doing the math, assuming it’s a ~$100-$120mm business, with HSD operating margins (DD EBITDA) closing in 2Q, we get to 3%-4% points of top line growth ($60mm-$75mm in revenue). At a HSD EBIT margin that’s 2%-3% points of EBIT growth, and $0.05 in earnings.
Waterworks product offering: