Morning Flash Snippet: Scott’s big weed deal

On 30 January, The Scotts Miracle-Gro Company’s [NYSE:SMG] stock fell 14% after reporting 1Q18 results that widely missed the mark due in large part to a sales decline at its Hawthorne Gardening division, owner of several hydroponic product brands. In the release, CEO Jim Hagedorn noted, “While we view the recent slowdown within Hawthorne as temporary, it has continued into the second quarter. We now expect full-year organic sales growth at Hawthorne will be flat assuming a return to normal market conditions in the second half of the year. Our long-term prospects for this business remain unchanged and we continue to see Hawthorne having strong long-term growth.” Changes to California’s marijuana laws at the beginning of 2018 have hampered Hawthorne sales as implementation has been unsteady. Hawthorne has been rolling up several smaller hydroponics companies. In September 2017, this news service noted that, while the roster of smaller available hydroponics acquisition targets was shrinking, SMG was still actively looking for further deals. This morning, SMG announced that the malaise at Hawthorne has continued, with unit sales expected to dip 30% in 2Q18 amid an overall 5% drop in company-wide sales due to “extremely unseasonable weather”. In order to remedy the slowdown at Hawthorne, SMG has also announced the purchase of Sunlight Supply, the largest hydroponic distributor in the US, for USD 450m in cash and stock, or about 8.2x Sunlight’s FY17 EBITDA. Some 20% of Sunlight’s sales come from Hawthorne and SMG sees no less than USD 35m in synergies by the end of FY19 for the transaction. The purchase price consists of USD 425m in cash and USD 25m in SMG stock as well as USD 20m in earn-outs. The deal will push SMG’s debt-to-adjusted EBITDA ratio above 4x, beyond the 3.5x it deems appropriate. As a result, SMG’s near term focus will now shift to debt repayment in an effort to get back to 3.5x by the end of FY19. The move ties SMG’s future even more with that of the cannabis industry, making it the only large US corporate company which is significantly involved in the space. How will investors view the move, especially given the federal government’s hostile attitude to marijuana? SMG is already under pressure, as results from its late January AGM showed that only 58% of shareholders approved the compensation of named executives. We wonder if the failure of the Sunlight acquisition to reignite growth could attract an activist.

 

By Justin Zacks & Kevin Ketcham