Rating The IPO

Note: "Before IPO" and "After IPO" measure the use of the proceedings to enhance revenue growth. A small difference between the two Xs means funds from the proceedings probably will have little effect on the index.

Rating Scale

Prediction
The Company has a long history of making products that sell for a profit in the marketplace. New, aggressive management, an infusion of funds, and a focus on marketing and sales can only improve its position. It naturally benefits from annual growth within the industry. However, a stronger marketing image, a reduced cycle time of new product to market, an emphasis on key segments, the exploitation of new niches, and strategic acquisitions should all accelerate the Company’s growth by 8 to 10 percentage points.

The stock will probably open somewhere in the upper teens. It has the fundamentals to move at least to the upper 20s.

"The Company sells and distributes its products in several channels including mass merchandisers, food and convenience stores, drug and specialty retailers, hardware/home centers, department stores, hearing aid professionals, industrial and government/OEM. The Company markets all of its branded products under the Rayovac[RegTM] name and selected products under sub-brand names such as MAXIMUM[TM], Renewal[RegTM], Loud'n Clear[RegTM], ProLine[RegTM], Lifex[TM], Power Station[RegTM], Workhorse[RegTM], and Roughneck[RegTM]."

Summary Of Financial Data
In millions except for Net Income Per Share.

Balance Sheet Data

As of June 29, 1997—

Use Of Proceeds
Of the $92 million in proceedings expected to be received by the Company—

• $38.2 million will be used to redeem or repurchase approximately $35 million principal amount of the Notes and pay the associated premium.
• $53.8 million will be used to repay term loans…incurred in connection with the Recapitalization.

Unfortunately, Rayovac is a distant third to two formidable competitors, Duracell International and Energizer. Duracell did $2.3 billion in ’96 and claims a 50% share of the domestic market in alkaline batteries, by far the largest segment. In ’95 it merged with The Gillette Company on a stock swap valued at $7 billion. Gillette itself will do about $9 billion in ‘97 sales and is ranked tenth among the Fortune 500 in total return to investors over the past decade. Warren Buffett’s company, Berkshire Hathaway, owns 10.8% of the Gillette stock.

The Energizer, its other competitor, which includes the Eveready brand, is owned by Ralston Purina Company. Ralston Purina "is the world's largest producer of dry dog food, dry and soft-moist cat food, and dry-cell battery products." This absurd combination of dog food and batteries makes for sizable earnings. In ’96 they exceeded $6.1 billion in sales. As of 9/19/97 their stock was trading around $92, near its 52-week high. The company can show $3.68 in earnings per share and sports a PE ratio of 24.

Old, Dull & Strong
Such is the level of competition, which Rayovac is up against. Still, this is not a company about to fade away by any means. One can imagine worse business scenarios than being third in an industry consisting of three players who own 90% of the domestic market. The Company was formed in 1906 and has survived the century just fine. Its products have shown up in stores for decades and have been used by generations of Americans. But one must ask why it is that Rayovac lags so far behind the other two.

Product is not the problem with this company, nor is manufacturing, nor distribution. Those three vast areas—having a product, knowing how to make it, and getting it into the consumer channels—are three-quarters of the battle, which they’ve achieved. That’s why they’re ending up on the NYSE instead of the NASDAQ. Where they’ve languished is in their marketing and sales strategies. Fundamental mistakes have been made, the end result being that they’ve spent years getting pummeled by the competition. Duracell and Energizer have so far won the battle in establishing themselves in the mind of the consumer, and Rayovac has been squeezed out, a diminished brand name. Sometimes the Company created its own problems, for example, by applying too many resources and too much effort to small segments of the market, which cannot make a corresponding contribution to revenues.

The alkaline battery market is perhaps the central market of the entire industry. To show significant growth in future years they’ll have to make a bigger dent in it than the 10% they currently have. It means taking share aware from two companies that can eat them alive financially. This will be the ultimate trick—sticking it to the competition without riling them up.

Recapitalization & Reinvigoration
In 1996 new ownership took control of Rayovac. Affiliates of the Thomas H. Lee Company purchased 79% of the outstanding Common Stock and with it gained control. This was the first part of a "recapitalization" of the Company. The second part consisted of debt financing from various banks and other entities to the tune of $270 million.

The new owners have taken two important actions, which may yet infuse life into this lackluster company. First, they’ve swept away old management at the highest reaches and have brought in a team with a demonstrated track record in the consumer products industry. The team consists of a CEO (David A. Jones), a CFO, a Senior VP of Sales, and a Senior VP of Marketing. They claim "70 years of collective experience in the consumer products industry."

And second, they’ve begun the process of accumulating the heaps of money needed to capture more share of an extremely matured market. Aside from the IPO enriching the beneficial stockholders by countless millions of dollars, it will place the Company near the sources of capital needed for accelerated growth. The IPO will seek to put $92 million into the Company’s pocket. An identical offering, called the International Offering, will take place concurrently outside the U.S. and Canada. The preliminary version of the prospectus doesn’t state the number of shares available to the public or its opening price, but it likely will be in the neighborhood of 6 to 7 million shares opening between 16 and $18. With 20.5 million shares outstanding among beneficial stockholders, and options for another 4.3 million shares, there could be as many as 30 million shares in play by the end of its first year.

Recapitalization has burdened the Company with $207 million in debt and an interest expense over the first 9 months of $19 million. Virtually all the proceedings will be used to pay down the debt. However, it would be hard to argue with either the recapitalization or the use of the proceedings. They both appear to be good moves. In the world of marketing, where this game will be won or lost, it cannot go mano a mano against multibillion dollar companies without a strong measure of financial wherewithal.

Strategies For Growth
The North American battery industry is as matured as any industry can be. It’s important, it’s old, it’s rich in product variety, and it’s technologically slow moving. Almost every conceivable niche, which can be exploited, has been by these companies with differing levels of success. We can be assured there will be no sweeping changes among the positions of the players by the technology of one superseding that of another; we’re not talking computers. It’s an industry of incremental changes where the accumulation of small advantages begins to be reflected in increased market share. A product may be repackaged or a price lowered or an ad campaign launched. During the ‘70s and ‘80s it was just such attention to mundane details that the Duracell and Energizer brand names achieved a strong identity with the consumer.

The problem is not product. Rayovac has plenty of variety in its product line of comparable quality to the competition. For each of the different categories of battery, the Company has a viable alternative to any of the products on the market. And those categories are many—from the general consumer sizes, C, D, AA, AAA, and 9-volt, which are bought in supermarkets or mass merchandising stores, to those for hearing aids, watches, cameras, and computers and still others in lighting products and industrial lanterns. The Company keeps a constant flow of new products entering the market. It does so on an 18-month cycle, and the cycle time is coming down.

Plenty Of Product, Weak Image
The problem is not product; it’s image. There is only one way Rayovac can advance in this kind of market and that is to resuscitate its own brand name. Creating brand name awareness on a national scale can be enormously expensive. The Company doesn’t have to start from scratch, but it will be expensive nonetheless. They have the money, and this presumably is what they’ll use it for. They must proceed in a way that doesn’t annoy the competition; otherwise, it will become even more expensive and perhaps less effective.

What then can they do? Management will initiate an aggressive advertising campaign using higher levels of TV and print media. They will attempt to leverage their position in the market as the "value brand," that is, as the least expensive among the three. At the same time they will reorganize their approach toward distribution. Some channels are highly penetrated but small, and others are little penetrated but large. Apparently they’ve re-evaluated which markets produce the biggest return for the amount of resources applied, and they’ve restructured accordingly. It’s a promising sign.

They will play to their advantages by increasing their dominance in the worldwide market for hearing aid batteries. The U.S. market is not large, only $205 million, with a worldwide total of only $530 million. However, the money from this market is highly significant revenue to the Company, and it is an important vehicle for extending the brand name throughout all parts of its product line; hearing impaired people buy other kinds of batteries, as well. To this end they will elaborate on their product line and make it more enriched for the consumer. They will continue to use the much-admired golfer Arnold Palmer in their print media. And they will intensify their advertising.

They will reposition some of their products, in particular their rechargeable alkaline battery. In this segment of the market they hold a 58% share. They’ve lowered the price by as much as 50% to stimulate consumer interest. Rechargeables have the potential for significant additional growth, which may be realized as the Company strengthens the Rayovac brand name overall.

They will attempt to penetrate niche markets with new products. Some of these niches are substantial, such as batteries for computer memory backup. Others are underserved. Opportunities will be exploited especially with lighting products, which is a particularly dynamic area.

And the Company will make strategic acquisitions for all the usual reasons—to extend its reach into new geographical areas or to get key technology or to add to its product line.

Changes Within The Company
The reorientation of the company by the new management is enough to make a business teacher blush with pride. First, they’ve organized the sales, marketing, and administration efforts according to distribution channel, such as mass merchandisers or department stores or pharmacies. This is not an unreasonable action to take. Although the product may be the same for all the channels, the sales requirements can be as different as night and day. Partitioning the groups by channels potentially could cause redundancy and increased overhead. But it also accentuates a sales and marketing focus, which they hope converts into greater market penetration.

Second, they’ve brought in a new advertising agency and have put together a national advertising campaign. To address the important alkaline battery market they’ve come out with a new and improved product line and have given it fancy packaging that makes a stronger statement about the Company. Because of its size this market is critical to any hopes they have about accelerating their growth.

Michael Jordan previously had been used to represent some of the Rayovac products. His contract has been extended now to cover all the products.

Third, the Company has outsourced a number of functions that are more efficiently handled by others—the mainframe computer operations, graphic design, packaging design, and payroll processing. This too is a good move. It reduces staff and complexity and at the same time increases the focus on exactly what the Company should be doing best, which is the manufacture and marketing of batteries.

Fourth, they’ve tightened their entire manufacturing operation by shutting down some facilities and transferring production to other plants, which themselves will gain greater efficiencies with the extra work. Given that the Company has 2,200 employees and an aggregate manufacturing capacity of 580,000 square feet it’s no small matter to reduce operational overhead by a few percentage points.

And fifth, they’ve brought in Electronic Data Systems to implement an integrated information system for the upgrade and modernization of its business operations. It should give them greater visibility and control especially over the manufacturing process where it’s expected to reduce the cycle time of getting new products to market.

If all these changes work, they will have turned an old manufacturer lumbering along into a clever, aggressive, and responsive company.

But Will It Work?
Management cannot be accused of timidity. Out of its stodgy past is arising a dynamic enterprise, which is tapped into all the latest corporate trends and determined to make bold moves against some very worthy opponents. These efforts cost money, but they will improve market share. National advertising campaigns, new products, jazzier packaging, changes in marketing and sales in order to penetrate the markets more deeply—all should have a positive impact in the marketplace; using Michael Jordan and Arnold Palmer as spokespersons can’t hurt, either. The question becomes: How much of an impact can we reasonably expect?

For 1998 a 3% increase in share among the General category of batteries translates into an additional $81 million in revenues. That in turn delivers another $5.8 million to the bottom line assuming 7.2% in net income. Likewise, a 5% increase in the worldwide hearing aid market for ’98 would add another $29 million in revenue and $2 million in net income. The capture of that much market share is probably too much to ask of a company so soon. But all told, it would not be unreasonable to expect a lift in growth for ’98 to 15%, which would be a ten point increase over the 5.1% annual average since ’92. Ten points means their products, programs, and change in tactics should result in a $44.5 million improvement. A result of this size for the coming year would validate their approach.

Goodbye Income, Hello Debt
After the IPO they will still carry $118 million in debt, the interest on which will effectively wipe out net income. It’s a sure bet the Company will stay at high levels of debt over the next number of years in order to fund growth. Loans in large amounts probably will be followed by the sale of stock to pay down the debt. Management will not hesitate to take and show a loss. To palliate stockholders’ fears they will then wax glorious about increases in EBITDA, which is a measure that avoids any consideration of interest expense.

Net tangible book value by the end of June ’97 showed a deficit of $84 million caused by a $128 million cost in treasury stock. Treasury stock is the Company’s stock repurchased by the Company itself. In June ’96 there were 49.5 million shares outstanding. Going into the IPO this figure is down to 20.5 million. The difference of 29 million shares is the amount of treasury stock pulled back into the Company. To have fewer shares in play clearly is important.

The Curious Matter Of Treasury Stock
The inner details of Rayovac’s purchase by the THL Company are not known. But it took a 79% controlling interest in the stock, which means it collected 39 million shares. A large percentage of this amount has to be the stock repurchased by the Company and pulled out of play. If so, it could well be that the purchase of Rayovac by the THL Company ended up being funded by Rayovac itself. It would require, of course, that the sales price of the stock to the THL Company be below the repurchase price. If indeed this is the case, we have an example of the very different laws which apply at high levels of finance. It should be emphasized that the discussion above is a conjecture.

The Stock’s Comfort Level
Total assets for the Company will remain constant at $218 million, both before and after the IPO, but shareholders’ equity will grow to $8.9 million from a deficit of $81.2 million. With the infusion of stock into the market from the IPO, plus the exercise of options, it wouldn’t be a surprise to see the number of outstanding shares grow to 30 million. A stock price of $25 would mean a market capitalization of $750 million or 1.7 times expected 1997 revenues and 3.4 times total assets.

In contrast, The Gillette Company will do about $9 billion in sales for ’97. As of 9/12/97 its share price was $80.69 and had a market cap of $45.2 billion or 5 times expected 1997 revenues. Ralston Purina did $6.1 billion in sales for ’96. As of 9/19/97 its share price was $92.19 with 106 million shares outstanding. This amounts to a market cap of $9.8 billion or 1.6 times revenues.

It would appear the Company can support at least a $25–30 stock price on 30 million shares outstanding if they can demonstrate an increased EBITDA percentage, which is attributable to growth in market share.