Jon Boyar thinks SMG's stock is set to grow (podcast #94)

Jon Boyar from the Boyar Value Group returns to the podcast to discuss his high conviction thesis for Scotts Miracle-Gro (SMG). SMG was a massive COVID beneficiary, and shares have sold off in kind with other COVID beneficiaries. Jon thinks the market is too pessimistic here, SMG's brands have Coke like market share, and the company has a rapidly growing "picks and shovels" cannabis business that he believes investors are basically getting for free at current prices. You can find my notes on SMG here, as well as Jon’s note on SMG here and the Forgotten 40 here.

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Disclaimer: Nothing on this podcast or on this blog is investing or financial advice; please see our full disclaimer here. The transcript below is from a third party transcription service; it’s entirely possible there are some errors in the transcript!

Transcript begins below

Andrew Walker: All right. Hello, and welcome to yet another value podcast. I'm your host, Andrew Walker. And with me today I'm excited to have for the third time on the podcast, my friend, Jonathan Boyar. Jon, how's it going?

Jonathan Boyar: Doing great. Thanks for having me again.

Andrew: Hey, thanks for coming back on. Let me start the podcast the way I do every podcast. First, a disclaimer to remind everyone nothing on this podcast is investing advice. Everyone should do their own work consulting and financial advisor, all that type of stuff. And then the second way I start every podcast with a pitch for you, my guess, this is your third time which I kind of think speaks for itself as a pitch. But it makes you our second most popular guest of all time, right behind Jeremy Raper who's just running away with the title.

I think one of the things that I wanted to pitch was, I know you've got the forgotten 40 I think you're going to talk about that we're going to talk about one of the stocks in the forgotten 40 But it's a really nice product, it's a great way to start the year with the kind of leans a little bit on the media and cable side, which is right up my alley, but it's a nice way to start 40 stocks trading at reasonable values, probably good growth prospects, a nice quick overview of all of them. So I really enjoyed that product. And I'm glad we can talk about one of the stocks on there. Oh, that is the way let's the stock we're gonna talk about a Scotts Miracle-Gro the ticker is SMG I was bugging you. I was like there are cable companies in here. There are media companies here, let's talk about them. But you were saying no, SMG is the one I'm like most convicted on I'm really excited to talk about it. So I'll turn it over to you. What is SMG? And why are you so convicted on it?

Jonathan: First, again, Thanks for having me on the show. Scotts Miracle-Gro is an interesting name. And I guess to start with a little background, just on our firm, one of the things that we're really attracted to our great consumer franchises, that's something critically important to us really, for a few reasons.

One, it gives them a sustainable competitive advantage, it's very difficult to replicate a great brand takes a lot of time, and a lot of money to do so. And especially the time we're in now, I know, we're talking yesterday, what type of economic environment we're in and appears where headed for some sustained inflation. And one of the ways I think the best ways to invest in a period of a sustained inflation is through companies that have great consumer franchises, as they have the ability to raise prices. In fact, they just announced for the third time in a year, that in their core consumer business, they're going to be raising prices. So that's...

Andrew: I was gonna say the exact same thing I was reading through the earnings call last night, and they said, the third price increase in the year and I was like, "Oh if that's not a sign of a little bit of pricing power, I don't know, what is three in one year? Wow."

Jonathan: Yeah, no, I mean, that speaks to the power of the brand. I mean, everyone really knows about Scotts their traditional, they call it their consumer business. They have four brands that comprise most of their sales, each of which has a kind of like Coca-Cola, market share. They're also involved just...

Andrew: Can you just want to list this for brands just for listeners?

Jonathan: You have Ortho, you have Scotts, you have all those types of brands. And if you go to any home and garden center at Home Depot, or Lowe's, which are one of the things that's a little risky is they comprise about 40% of their sales, and just those two retailers alone, but the powers of the brand are fantastic with them, and round up, they're the exclusive agent for Monsanto in them as well, that's about 10% of income or so.

So if these great brands and anyone who's a gardener, or who does any sort of outdoor type of stuff knows very, very well. And the stock, in April of 2021, reached about $253. It's now high 130s, low 140s or so it's been trading around a bit, and I'll go for the I'll talk about the reasons why later on. But just going back, it's been a huge pandemic beneficiary. They picked up about 20 million new customers during the pandemic and five, their surveys, etc. They think about 86% of them are going to stay. In addition, millennials are huge for them. I went back and I looked at you know, we've been following this company since about 2010, 2011. We've written research reports on them and own them for stocks, full disclosure, I own it, and my clients own it, etc.

One of the things that we were talking about as a catalyst, is the baby boomers retiring? That was a big deal. They're literally gonna retire and watch the grass grow. But now it's millennials that are driving it. And they have things like edible gardens and things like that are, which are a huge growth area. And this was a business that they thought was going to be a one to 2% grower, going forward. Now, they've kind of said this is going to be a two to 4% grower going forward. So that's a huge shift. Over the last couple of years, it's a great way of playing demographics, etc, all the millennials moving to the suburbs have homes. And that's one part of their business, which is...

Andrew: Let's focus there because there's lots of talk about, like, we haven't even started talking about Hawthorne yet, which I think is the more exciting growth. You're part of the story. I listened to your podcast with the CEO from I think, early December, and he's fantastic. I mean, I'm surprised I don't hear more about him with outsiders type stuff, but we can get all there. But I want to dive into what you've obviously started by focusing on the core business, Scotts Miracle-Gro the consumer side of the business. And I just want to start there with two risk questions about risk factors. I think you were starting to address them but just to dive in a little bit.

The first is, you mentioned these guys have coke like shares with their brands. And I get it like Scott's Miracle-Gro I've seen the ads, I get that. But at the same time, my mental model is like, the best brands are things that you personally consume or display, right? So a Nike would be a display, that's a status symbol, obviously, this super high-end like amazing stuff. tuber stuff, status symbol, or stuff you consume. So a Coca Cola, everybody's got the taste test where like Coke and knockoff coke tastes basically the same. But because coke spends so much on brands that you put in your body you prefer that over a generic or even something like Tylenol, right? Tylenol is a ibuprofen, right? But nobody really, I mean, people do take generic ibuprofen, but most people go for the Tylenol that's consumed. When I think about Scott's Miracle-Gro, it's one of those things, I'm surprised there's so much brand strength here, just because nobody knows if you're using Scott's Miracle-Grow or knock-off, it just strikes me as one of those things that's very right for private label disruption and that type of stuff. So I said a lot. I'll turn it over to you on why the brands are so strong.

Jonathan: Well, you mentioned displays, which are interesting. So I guess one way I'd say is people won, if you look at it, Scott would say, you'd be able to tell if you're using a cheap knockoff if the grass isn't greener, it's not growing well, that their products are actually better. They're involved in private label, they do produce private label. And that's one of the things that they do for both Home Depot and Lowe's. But the product is inferior. And the other thing that's important is if you're doing some lawn care, etc. You're essentially doing it once or twice a year, you have one shot of doing it, and you really want to cheap out and pay a couple of dollars less and have the risk of your lawn or your garden looking terrible. Because that's like a show showcase for your home.

Andrew: Why are their products so much better than the private labels? Because I know obviously, there's chemistry and biology and stuff in here. But it doesn't strike me as crazy hard chemistry or biology. Scott's Miracle-Gro was around in the 80s and 90s? I'm not sure you've seen leaps and bounds of improvement. Why is it so much better than the private label? Or is that just something they see like, are there actual studies that show that these are better than private labels?

Jonathan: Yeah, I mean, they also produce a lot of the private label, I don't know the exact share of it, but they produced a fair amount of it. And they purposely make the ingredients less powerful, less, not as good. So it's part of their strategy. And one of the things that's interesting is one of their competitors, central lawn and pet or garden pet, in their filings, they actually put as a risk factor that Scott's basically owns the category. It's very hard for them to compete. So whether it's perceived or actual, I think it's probably a little bit of both, they spend lots and lots of money not only on marketing but also on research and development.

Andrew: Central is the spectrum brand instead of I remember that correctly.

Jonathan: I think it's another one. Central home and pet I believe is the...

Andrew: I could be wrong. I thought it was a division of spectrum brands, which is just top of mind because I think they announced the spin-off this morning. So I've been meaning to go back and refresh. Let me turn to the second risk factor I want to talk about you mentioned private label, they made a private label for Home Depot and Lowe's. I think you've addressed the private label side but I do think there is you said. Home Depot Lowe's 40% of sales is a lot I do worry that this is a category that is People could be prone to switch to private label, I think you did address why they might not want to for a couple of bucks. But I'm still a little curious. I want to talk about the concentration risk. And I know somebody just tweeted at me, they said, "Hey, actually, if your case study this Walmart tried to private label in 2017, or 2018, and then kind of kinda like begging back to Scottson saying this has not worked out well." So do you want to talk about Walmart in the context of private label risk? I think that'd be great, too.

Jonathan: Yeah. I guess what, you have to really look into private label risk. I mean, it's certainly important. You're talking about, "I mean, look what happened with foods and supermarkets" and things like that everyone thought they had these great consumer brands. And then, supermarkets decided, why don't we produce this ourselves, this is not like making a cracker. This is a lot harder. But going into concentration risk, it's roughly 40% to stores, they also had to do a fair amount with Amazon.

Part of their strategy is to be fantastic partners, if you go into a Home Depot or Lowe's, you'll be greeted by Scotts actual employees who are there who are helping them out. So they're actually being used as a resource for Home Depot, and Lowe's that help drive sales, and they help bring people into the store. These people are enthusiastic about their garden it's one of the purchases, they actually kind of like to make it's done in the springtime, the weather's good. So that helps, mitigated. I think the proof in the pudding, is they raise prices twice. So far, they've just instituted third pricing increase their biggest 40% are in Home Depot and Lowe's total. So if they're able to do that, it seems like a pretty good negotiating leverage.

Andrew: Perfect. I wanted to alter it in a second, but I guess we might as well stick with risk factors because this will apply to Hawthorne as well. Both the core business and Hawthorne will, again, talk about there in a second. We're massive COVID beneficiaries, right. And you mentioned the stocks gone from 250. To around I think it's like 135, last I checked, it's a huge drawdown for consumer staples franchise, obviously, a lot of people are saying, seeing they're laughing COVID the comps are going to be negative. And I just kept thinking that in I think in like 2019. So pre-pandemic, they earned about $5 per share. And then their trailing numbers are probably around $9 per share in earnings. And there are all sorts of movements, the price increases. They've done acquisitions, but I guess a lot of people look and the mental model, not the mental model, but the thing I've got in my head is peloton, right?

Huge COVID beneficiaries as soon as they start lapping, they've way overinvested into the supply chain, people say oh my god, this is gonna fall off a cliff. And I could see something similar with Scotts miracle, right, where you say, "Hey, maybe sales got too far ahead of themselves." A couple of extra people who really don't want to be gardening are going to be gardening, they probably over-invest in their supply chain. And when things normalize, it's not going from nine to five, maybe it's going nine to three is the super bear case. I don't think that's likely, but I'll just turn all the thoughts on the COVID lapping over to you.

Jonathan: Yeah, I mean, that's certainly a risk. But one of the things I'd say is, you now have a shift of millennials moving out of their parent's basement or from the cities or whatever, to the suburbs, creating new customers that that's huge for them to if someone went to the trouble of producing a garden or doing that type of things, they kind of have some fixed costs and fixed time investment that they're probably gonna continue doing this, they created all this work and it's just gonna sit there otherwise. So I think you're looking at their latest call if you read through it. Their first quarter of the year is not a huge one for them, but they're looking at the point of sale data, they've been pretty impressed that people are staying with the category.

So yes, it's certainly a risk and that's clearly what the street is saying. But I think the difference also with the peloton and this is this was an established company, to begin with, that still was growing not as fast as they said they were going to grow but it was growing nonetheless. So, I think the comparisons probably I would think. But yeah, it's down from 254 to 130 and change for a variety of reasons, margin worried about COVID, comps, etc.

But I think if you really look at that price decline, and you put let's say a-- we can talk about this in a second a cannabis ETF over it. It kind of perfectly correlates and that's because of the second business. Hawthorne is really one of the ways people have been playing cannabis. I talked about consumer franchises, and that's one way that we've to invest invested. A subset of that is great consumer franchises that are masked by a corporate name. And this is sort of the case with Hawthorne. Hawthorne is not known by most people. But it's known by people who are in the cannabis business. It's one of the best brands out there. And that's what makes this such an appealing investment. And in the way that we look at it, we can talk about valuation later. And I know we want to talk about the Hawthorne part is essentially at these levels. you're purchasing Scott's consumer business and getting a fast-growing Hawthorn cannabis business, essentially at zero costs. So to me, this is like the true value investor's way of playing cannabis.

Andrew: Yeah. Well, let's switch to Hawthorne, I do just one other one last thing on the core business. I love what you said, where people have made a time investment into the thing. And I do think, there are some COVID beneficiary things like everyone was baking bread at the height of COVID. Maybe anytime you get new consumers in this store, I'm sure a couple of people are gonna stick with the breadmaking going for but most people have probably dropped the breadmaking. But something like gardening, that is something you've made a big investment, you've got the house. Not everyone will stick with it. But I think you mentioned or they mentioned on a call 86% of people are going to stick with it or something. I would bet that's direction correct. Or you can move away from gardening. Let's do something like fishing. Tons of people took up fishing during things. And yeah, probably fewer people stick with fishing and stick with gardening because there's a little bit of extra work there. But I bet you a lot of those consumers are going to stick with fishing. I mean, you have to go buy a rod, you had to go get a fishing license like there are big investments there. And then fishing has been a popular sport for hundreds of years. Like once you pick it up, some people are actually going to like it. So it's not going to be 100 for Scott's Miracle-Gro, I bet you it's 75 or 80% for fishing. I wouldn't be surprised if it's 40 or 50%.

Jonathan: Yeah, I agree in remote working certainly is helping for these types of activities that you might not have as much time for people are spending more time at their home and they're investing in their home. The other one, another stock that was in the forgotten 40 We can talk about it another time is Callaway golf. Golf certainly was a huge COVID benefit. And I think a lot of people they're gonna stay.

Andrew: And if you took up golf, guess what, you spent a couple of 100 bucks on equipment and stuff. You spent hours and hours and hours. Golf is not a game you go and you pick up in three minutes. If you've spent hours and hours practicing your swing, maybe hire a Swing Coach. You've just sunk a lot of investment in there. And yeah, a lot of people are gonna turn but I do think all these businesses have been taken up to the next level. Let's talk Hawthorne now. Hawthorne is it's the cannabis play. It's the sexy part of the business. It's going to be rocky but it should be a real growth of the story for a long, long time. Great tailwinds. So what is Hawthorne? How do they touch the cannabis thing? Why is this brand so good?

Jonathan: Yeah, well, I think that's the thing. They don't directly touch it. They're essentially a distributor to a distributor they have anything that you need to grow cannabis without actually touching the plant is what they do. They provide a lot of lighting, filtration, and air filtration, anything they need. And what's interesting is, at least in the US, because of legal reasons and banking and all of that kind of stuff that they don't their customers, their direct customers are not the growers, they have about 1600 or so kind of specialty stores that sell this kind of stuff, as well as amazon.com, where what they do is they you know, and 70% of their stuff is proprietary products. So what they do is work as consultants to the growers. Tell them, how much lighting what type of lighting they need, this stuff is super important. These are very technical things and it also relates very well with their other previous business.

Andrew: There was a quote, and I think it was their investor day where they said, "Look, it's easy to grow cannabis indoors, it's not easy to grow good cannabis indoors." And their consultants are out there helping people that provide you with the technical knowledge and the tools to do that.

Jonathan: Exactly. And it's in candidates different where they can sell directly to the growers because of less regulation there. But they work as consultants, they quickly grown this to an over $1 billion a year business grew 100% Over the past two years or making acquisitions they grew this pretty much from nothing it's run. And one thing to take a quick step back is for better or for worse. And I think in this case better. This is the company that is 25% controlled by that Hagon-Thorne[?] family. So you have a controlling shareholder there. And one of the things that he also said is, in the last call, and I think is super interesting is he have to take an activist, he has the ability to take an activist approach in his own company. And Hawthorne is an example of this, where he decided in early 2012 13 around them to get involved in this category. It's been growing, it's being run by his son, Chris, who seems to be doing a fantastic job. But it's a super interesting growth story. And also they know who the really good growers are. And through debt and preferred investments, they're taking stakes in them. Because they can't take actual equity stakes in these growers because of legal and banking regulations. But once safe banking passes, and it will, I think it's a matter of time, that's a huge catalyst for them because the value of their investments will go up as well.

Andrew: Well, we'll talk they are doing... We'll talk about the investments second, because I do agree they're interesting, though, it's a little different than what everyone else is doing in the space. Let's stick with the core Hawthorne business though, I don't think it'd be crazy to say again, they're providing the lightning's the airflow, and everything it's a picks and shovel play on weed industry growth, right.

I want to ask two things about it. And this comes back to a little bit of the moat question in the brand question I asked about Scotts Miracle-Grow. But a picks and shovels play I get everybody loves to provide picks and shovels play. But when I see lightning, like lightning, it's not that technically complex. I don't think there are huge benefits to scale in terms of making the lighting. Obviously, people want to go with the lighting, that's going to work the best. But I have trouble believing like buying lighting is something that's really brandy. So I just want to dive into like, what is the mode here? Because one worry I have is in 2018 when the weed industry was in the doldrums to 2021. There's this huge boom. And they say we're the best business we're the best moat. And one of my worries is well maybe there was just so much demand and it's so far outstripping supply, that you guys were just a huge beneficiary of this, and once like kind of supply-demand normalizes we're gonna say, "Oh, these guys were just selling hardware commodities", and not that it can't be an OK business, but it's never going to be a great business, the brand was a little over said. Does that all make sense?

Jonathan: That makes perfect sense. And that is a worry of ours, but it seems that the kind of the same model that they're doing, helping Home Depot and helping Lowe's, anyone can, with enough expertise, create, all sorts of lawn and gardening kind of products. There, they're doing the same thing with Hawthorne, and they're helping and being a value-added to all of the major growers out there. And they're kind of putting themselves in their process and their research and development process. And that's really what's going to be the sustainable competitive advantage. I mean, at the end of the day, cannabis is a commodity, like anything else. But if you're able to have kind of a branded type of business, that we're Hawthorn, we can help you be the best role are possible. I think that's a really big moat. And they certainly have the first-mover advantage. I think if they're able to take some of the same playbooks that they did at their core consumer business, they should be able to do that, in this business as well.

Andrew: This might be a little bit of a stretch, but is it almost like Hawthorne is a little bit of a consulting agency where they will, the real mode is they've got all the experts who can tell I come into your business and tell you, "Oh, you're not doing this, you're not doing this, you're not doing this, this will improve yield by 5%." And because that side of the business is so valuable, like people are going to buy the Hawthorne lighting and everything just because the consulting side is so valuable.

Jonathan: Yeah, I think that's exactly what they're trying to try to do, especially since they can actually take physical orders from the growers. Now they have to do it at these 1600 or so stores.

Andrew: Let's talk about that. Obviously, federal legalization, I think would be a big catalyst for Hawthorn but I do worry, like, I believe when states legalized the when states legalize cannabis, their business actually initially drops as all the illegal growers stopped buying, and then it takes time to go and find the new legal growers and build and that takes a while. But I do worry like federal legalization comes in and right now Hawthorne has to sell through distributors who then sell it to the end-users. Federal legalization comes in and Hawthorne said then we can start going and selling directly to consumers. But there's that moment of uncertainty and change, does that present an opportunity for other people to come in and beat them to the direct-to-consumer punch? Direct to a distributor, I'm sorry, direct to grower punch.

Jonathan: Well, they have all these established relationships and through their investment in that Canadian company that that's taking these stakes in growers and other brands, they kind of have the inside track there. So I think that they have a huge head start. And listen, there are plenty of companies if you look in the history of business that was the first movers that didn't end up becoming a long-term competitive advantage. But in this one, I think they have such a good head start. And I mean, it's already a billion-dollar a year business, from basically nothing, 10 years ago is, is pretty, it's pretty impressive. And it doesn't necessarily, I think, genies out of allopathic, whatever the expression is. We're not going backward in terms of cannabis regulation would be, I think that's highly unlikely. It's just a question of degree, how many more states legalize it, I mean, New York is going to be legalizing, I believe, sometime this year, that should obviously help the business a lot. But it's really the safe banking reform, that will be the big driver for them. I mean, when I had him on the podcast, I mean, I had no idea that essentially, if you are a business that grows cannabis right now, in the US, you can't deduct any of your expenses on your income tax return, and so effectively have an 80% tax rate. I mean, how does that work? I mean, it's just silly that they haven't had a comprehensive reform on this. This is something that shouldn't be in this kind of legal limbo. And at some point in time, I mean, I think part of the reason why the stock went down from 254 to 131 40, wherever it is now, is there was a lot of excitement that the Biden administration would be able to get safe banking and get federal cannabis reform. And clearly, that's not happening anytime soon, but at some point in time, it will happen.

Andrew: Yeah. Aaron Edelheit has been on the podcast and talks about cannabis plays a couple of times. One of the things like, I'm making the numbers roughly up, but he's like, "Look, you look at all these Canada's plays, they trade for five times, EBITDA, they're growing 40% a year, but because they can't deduct anything from taxes, it's like they trade for 5000 times free cash flow or something. But if you assume they can ever start adopting it, it gets very interesting."

On Hawthorne, right now, they are going through a growth slowdown, right. And I think the argument is, "Hey, things went crazy good during the pandemic, everyone was buying lighting, they were buying ahead of time, all this sort of stuff. There's a slowdown right now." And I believe that I get that but it's a picks and shovels play. And it's not like demand for cannabis is slowing. I get that the industry is struggling because they probably over got into oversupply. But I'm still just a little surprised that a picks and shovel play is having a slowdown when the industry is so immature and seems to be growing so quickly. So can you talk a little bit about the current slowdown at Hawthorne?

Jonathan: Well, the current slowdown at Hawthorne has a lot to do with, there's just a big black market supply of cannabis out there. And that's impeding things, the legal growers aren't buying as much, but it's also a grew so quickly in such a short amount of time. There's going to be kind of growing pains, it's happened to them, 2018, 2019. Just look at the business grew 100% over the past two years. This is not going to be kind of a straight lineup. And they're forecasting and so far, they're generally pretty straight shooters there that second half of the year, there's going to be a turnaround and it seems almost inevitable because you're just having more and more states legalize cannabis. And also part of the issues are just going to self-correct. Where you have a big oversupply of cannabis. This is a product that has, I think one-year shelf life. So at some point in time, you're going to have to regrow the cannabis and that should help them.

Andrew: Perfect, perfect. Last thing I want to talk about on the Hawthorne side, and then maybe we can go into some of the parts. And there are a couple of other things I want to talk about. But on the Hawthorne side, you mentioned they put $150 million, I believe into a strategic investment into RIV capital, which is a big kind of like weed incubator, I would say. And they're taking other as you said, they can't take equity stakes, but they're taking lots of convertible preferred or convertible debt where the second safe is regulated, they can flip it in, and they'll have lots of stakes, and people, it's an interesting strategy, I understand you expose them to a lot of growth. But at the same time, I know a lot of people would say, "Hey, how many picks and shovel plays actually need to go invest equity into their..." Amazon AWS isn't exactly taking 10% equity stakes into every company that comes in gets onto AWS. So just want to talk about that strategy a little bit.

Jonathan: I think it seems more opportunistic, and then they know who the good growers are. And obviously, it helps them get customers later on in life, but if they're able to see who these big brands are going to be five or 10 years in the future, and they're able to get them at really reasonable rates because there's no great outside funding available for them. Why not? This shows them being opportunistic, and this is why we really like kind of family-controlled businesses because they're looking to 510 years ahead and not looking to kind of maximize earnings, it would be better in the short run if they just did a massive share buyback here with that 100 and $50 million, they put into RIV or whatnot. But instead, they're investing kind of into the future, which I think is the better move.

Andrew: Yeah, and in this case, like, I use AWS as a counterexample. AWS customers, they're not exactly having trouble raising venture capital money or anything, right. Whereas a lot of the hawthorn customers, there's absolutely no capital you cannot borrow from a bank because of all the safe stuff. So it's possible, Hawthorne Scotts Miracle-Gro borrows, what, like 20-year paper at 4%, or something, these are investment-grade people, they're taking that in there. Obviously, it's very risky, but they're lending to people who are gonna buy their products, and they're probably doing it at like, 20% Plus, like, kind of, I don't want to use loan shark but very attractive rates probably risk-adjusted. This is a really good bet, especially when it's growing the Hawthorne moat. Do I have that right? Or do I know anything there?

Jonathan: Yeah, it's really kind of a tale of two credit markets really out there. I mean, there was a really interesting article in the journal today about zero-coupon. What is it? Convertibles. I never understood this because I think Dropbox did in a couple of others. There are a whole host of companies out there over the last two years that have been able to issue convertible. convertible securities at 0% interest rates it's absolutely insane. Those are the AWS customers. [crosstalk] true in the cannabis space.

Andrew: Or we talked about peloton. Peloton did a bunch of other growth companies that they all did in February 2021. Volatility was insanely high because of the mean stock squeeze and everything and for a lot of them. It's been an absolute lifeline. Peloton issued, I think was a billion dollars of debt and I think it converts it like 130 or something go look at the peloton. The stock price I don't think that's converting into money. But because the volatility was so high, they could do that. And they could get stuff that really funded them and help them and you're exactly right there.

Jonathan: I wonder just going back, who was the buyer that?

Andrew: It was convertible arms, guys, right? They bought it and then they instantly I'm sure that instantly shorted the stock or sold lots of options around because the IV on the stock on the stock was so high, I think you could do stuff and kind of create it and get a really attractive yield on it. So I'm sure there were really smart mathematic guys was like PhDs and finances who were figuring out risk-free ways to buy these things and generate as 5% annualized, and they were borrowing it to percenters. I just want to one thing you mentioned, this is a family-run business. They look with a two 5, 10 years, and again, I listened to your podcast with the CEO, I thought he was a hoot. He's obviously he might have you might have to censor him if he's on TV for too long or something. But there was one story that said where his board went to him when he was about to invest in the weed industry. And his board was like, "Hey, we want you to..." I'll let you tell it but I thought it was really instructive of how they look long term and probably what they're seeing the bet they're thinking about what the wheat industry today.

Jonathan: Yeah, originally they basically said no way.

Andrew: The board said no way, right?

Jonathan: The board says absolutely no way but he effectively controls the board. But he tries to have built consensus, but he thought it was just such a great opportunity. He was visiting, I guess, some stores out I think in Pacific Northwest and he just saw that people were spending money hand over fist on this thing. And he decided to, say no, we're doing this he did it slowly. And he stepped on the gas when he needed to. And there are certain issues when you have family-run businesses wherein the short and medium-term, could frustrate people, but I look at them and their long-term records. They're fantastic capital allocators, when the stock was in the 240s, 250s, they're talking special dividends. Now they're talking stock buybacks and no special dividends. So they treat us the money like it's their own. And 25, 30% is thereon.

Andrew: I think in that story, where he was going to the when they were about to get in Hawthorne and they were talking scores and stuff, I love where you go to the people who are buying all these systems in straight hard cash. And you'd be like, "What are you buying these for?" They would just stone face look at you, like, "We grow a lot of tomatoes, grow a lot of tomatoes, we need lots of hydroponics to grow tomatoes, and we buy in cash." I just love that.

Jonathan: Yeah, the tomato business ended up being very profitable.

Andrew: Let's talk about some of the parts here. So high level $135 stock, I think EPS is around $9 per share. So 15 times earnings, that is not a lot that is probably on the cheap side, given the borrower again, 10-20 year paper at like 4%. This is a consumer brand, go look at a Procter and Gamble or Coke or something. Its consumer brand that they now think can grow four to 6%. And it's got this really interesting cannabis play. Let's dive a little bit further than in just the headline P number and talk. There's the Hawthorne side, the cannabis side of fast growth, and the Scotts miracle side. How do you guys look at the overall value here? And yeah, because they might spin off the author at some point. So this can build into that conversation as well.

Jonathan: Yeah, no, absolutely. And if you, we recently issued a report on the company. I think in full length, I think in July. I may send it if you want to have it so your readers can see it. I'm happy to begive you a link.

Andrew: If you give me the link, for listeners, I'll be sure to include a link to Scott's miracle note in the show notes. And I'll also include a link to the Forgotten 40 if you're interested in that in the show notes as well, just for any listeners.

Jonathan: Yeah, no, fantastic. This way, they can actually see the assumptions that we do, etc. on it. But when we look at everything, and this is the way our research and our money management arm works through the lens of an acquisition, what would a knowledgeable business person pay for the entire business? And basically, we estimated What 2024 EBIT, da was going to be for both consumer and author and I don't have the assumptions to top my head, but they were not heroic assumptions in any way, shape, or form. And take I think 14 times on the consumer and 15 times on the Hawthorne...

Andrew: This is 14 times I'm guessing net income, but I just want to drive that home.

Jonathan: Yeah, EBITDA gets us to $243 a share. So I mean, could be wrong 10% plus or minus, but you have 130 some odd dollar share price in you have, we think it's probably worth in the 240s. And the thing that's critically important to us is, for any business, you have to worry about value traps, especially in family control companies is to Catullus, what's going to make the stock ascend in value over a reasonable period of time. And to us, a reasonable period of time is 2, 3, 4 years, and one of the catalysts besides the legalization, safe banking, all that kind of stuff, is they said they might split the company up over the next one or two years into two businesses. And I think it makes a heck of a lot of sense to do it, even though there'll be some dis-synergies, as the businesses are related. But it makes a lot of sense, because maybe not at this moment in time, these cannabis shares are out of favor, but at some point in time, the markets gonna value these things very, very differently.

Andrew: Look, push back on that, because you know I'm a big fan of spin-offs and a big fan of financial engineering. You and I talked about IAC a lot before. I love that IAC. They build companies up and then when they're ready to stand alone, they spit them out. They're not trying to compromise. But I did. The Hawthorne spin was interesting to me because I get it. If everybody's trading cannabis companies at 100 times, EBIT, post-legalization, or something, you want to spin this off and you want to capture that multiple.

But on the other end, like, the great builders that I've seen, they kind of ignore, "Hey, the market is the markets a little hot for this side of the company. So let's try to play into that in financial engineering like they look towards long-term value." And I think they said because research between Hawthorne and Scotts Miracle-Gro makes sense. There's a lot of overlapping research and distribution and stuff. They said if we spent if we split these two businesses, I think it'd be $50 million per year in these synergies, and like $50 million per year. This is I think it's a 6 billion market cap company or something like $50 million a year in dis-synergies and costs. That is a lot of money. So I was just a little surprised because the CEO, go read some of the stuff. He says go listen to John's podcast, this is the guy who kind of fits the outsider's type mold. And I was just a little surprised that it seemed like he was willing to entertain a split with a lot of synergies for what it looked to me he wanted to catch sexy gross stuff, sexy growth Popper, catch a multiple that may or may not be there if that makes sense.

Jonathan: Yeah. I think the reason why he wants to do it is not necessarily to get an affiliate shorter term, a higher stock price. It's that if he wants to take stakes in some of these other businesses that are kind of wildly inflated, he needs his own currency. And he's just not going to get that currency as part of a kind of, quote-unquote, conglomerate.

Andrew: Why does he need his own currency? Because, like your own currency, you mean he needs Hathorne's to be able to issue equity to buy these things? But why does he need his own currency? Because I look at the risk capital deal. Like we talked about how right now, all these companies are cash-starved, they'd rather cash as gold to them, they way rather cash like a partner for equity. And Scott's as a whole conglomerate, we've just said several times they borrow 10, 20-year paper at a really low cost like it seems to me, they don't need their own equity, they just need the low access cost of capital to keep funding all these deals.

Jonathan: Well, I think the market would just value them so much higher than they'd be able to use the equity to buy some of these other businesses that do not have so advantage. And he was talking in the podcast about some of these businesses that are being sold for billion dollars, $2 billion and the whole enterprise value of Scott's itself right now is only is $10 billion or so, when you do the debt, so I think he wants to be able to have a seat at the table and not be minority partners with these folks and be able to take majority or somewhat controlling interest it's a tough call. I think in the end he's gonna do what's right for shareholders often there are also family issues involved like he wants his son to stay at the company but I float another thing out there's one you get different. There are people who will not invest in Scott's right now because of the cannabis. I know from selling my research, there are people who start talking about it the minute I say cannabis, they say stop. That's I think a huge part of that story. And too, I'm not saying he would do this, but think about it, it's a parlor game. What kind of business would Warren Buffett buy or Berkshire would buy? Scott's kind of fits that to a tee that traditional consumer business? Maybe one day because it seems like the Son is very enthusiastic about the cannabis business less so about the regular business, maybe one day, they sell the consumer business, and that's a virtue that was just as an example. And that's a way for the company, the family to cash out and run with all fun.

Andrew: It's so funny. You say Berkshire and I agree Scotts would make such a great candidate for Berkshire. But honestly, Berkshire is so big at this point, Scott's a drop in the bucket. I don't even know if Warren Buffett wakes up for that phone call. The other thing I do remember on your podcast, the CEO talked about how in 2007, I think Henry Kravis approached him was like, "Hey, let's just take this thing private, you're gonna make so much money, we're gonna lever it up, take it private." And he said, "I get you. But all you're going to do is take out a bunch of cheap debt from JP Morgan, and then you're going to be my boss." "My family owns 25% of this, why don't I just go take out the cheap debt from JP Morgan, myself, special dividend out to this out to my shareholders will still be in control and our public shareholders who trust us, like will kind of be rewarded over the long term for that." I just thought that was a really interesting way of showing, how they do think about the long term and creating long-term value and kind of partnering with shareholders that I don't know if you want to add anything there.

Jonathan: Yeah, no, I just think that that shows their long-term mindset and he was 100% correct in that kind of assessment. You have to think about it now, though. That was 13,14,15 years ago, he's not getting any younger. He's asked to think about succession planning. He has a son who's shown a real interest in the Hawthorne business. So this could be a great way for him to write off in the sunset and not say this is what they're going to do. But it's at least an option. And what kind of another reason why that $50 million a year and the synergies might not be as big of a deal.

Andrew: You're totally right. And as you said, it's not just Berkshire who would love to take the Scots core business. This is every private equity firm would love to slap 7x turns of leverage on this, buy it and probably go on a little bit of a bolt-on acquisition spree. I'm sure there are plenty of consumer brands, nothing like jumping right off the top of my head. But I'm sure there are plenty of big consumer brand companies that would love to buy this for the relationships, the bolt-on like there would be synergies with other buyers if you want to split this offensive, too. So I definitely hear you there. John, I think we've been talking for almost an hour at this point. I think we've done a really nice job of covering all the different pieces of Scott's anything else on Scott's we should be talking about before we kind of wrap this up?

Jonathan: No, I mean, I think this is not one of the stocks that are gonna you know, I'm saying is going to double overnight or anything to that. I think this is great...

Andrew: Are there any stocks that you say, would double overnight? I love to go check those stocks?

Jonathan: No, no, I'm just saying I think this is a great long-term risk-reward story that takes out a lot of boxes, that we look for investment-grade consumer franchises, family control thinks things like things like an owner. So I think it's really something to look at. And I think, going forward, this is where I think investors are going to be making the money in stocks that are kind of outside the major indices are low in this index waiting and that's kind of things I think investors should be paying attention to.

Andrew: Maybe it's just because I've been more focused on like event yourself recently. But I am surprised I haven't heard more about Scott's from the people who love to buy and hold family-run long-term compounding businesses. Like here, you've got a CEO who go read some of the quotes I've posted or go read the investor day, it's a CEO who talks very openly and honestly about trying to create long term value keep used long term value, free cash flow growth over time is what's going to do it, CEO who's beat the indexes, over the past 20 years, the stocks up like it's a 12 bagger. Whereas if you invest in the Russell, that's under five, so he's smashed the indices over the long term. I'm just surprised I don't hear more people kind of talking about it in the year, you're probably going to not going to make as you said a double overnight or double in a year, but you're probably going to do really well over time with less risk than the indices. I wouldn't be surprised if you outperform pretty significantly over a five-year period. Just surprised I haven't heard more about it.

Jonathan: Yeah, I mean, I think a lot of people just, don't want to invest in family-controlled businesses. That's one of the things they don't like. But I'm not really I'm kind of perplexed. It's a brand that almost everyone, at least in the US knows or it's a great brand. So yeah, I'm not sure why it hasn't gotten the attention but it's I guess it's not a met. It's not Google. It's not any of these kinds of high-flying business but sometimes boring is okay.

Andrew: Meta is market cap dropped. What was it? It was the largest market cap drop of all time, with $250 billion in earnings. So maybe it's a good thing. It's not a Meta right now.

Jonathan: Absolutely. Yeah, it's absolutely crazy. But yeah, I think it's a really interesting idea. And thank you for inviting me on to talk about it.

Andrew: I'm gonna let you go once again. But before we do, I just want to bring it back to the forgotten 40. Obviously, we talked about one of the 40 stocks. What else on the throne 40 is really interesting to you these days?

Jonathan: I mentioned Callaway as one that I think is interesting. We've talked about it in the past before you and I know you have different feelings about another family control business. Both Madison Square Garden sports and entertainment are interesting. I built the Dolans or Audio had their own set of issues but they have a fantastic asset.

Andrew: Did you see my podcast with Chris McIntyre on MSG? I think I introduced you guys separately but did you see that?

Jonathan: I haven't seen that I like what he talked about a year or after.

Andrew: He did really good work I thought just on how a lot of the debt at he is non-recourse so even if you ran into a disaster, you're buying this, and NSG the garden assets are great. The Rock cats, I love the rocket. I'm with gosh, every time I look at those they play exactly into my worldview of like, where the world's going and the compounded assets over time, but man, the Dolans have just really burned me out and the Knicks have been such a bummer this season. It's hard for me to get excited about them.

Jonathan: Yeah, I mean, I know you know, after talking about cannabis, you talking about sports gambling is probably I don't want people to think I just invest in sin stock but like that's a huge growth into both for ENS. I mean, if you look over the last month or so, how many people signed up for DraftKings and all these other things because they legalized sports gambling. And in New York, this is going to be the premier place to advertise it. And with giving nine, was it nine licenses in New York, they just instantly got nine customers to sponsor them.

Andrew: I did a few posts the on the giveaways that the sports gambling companies were giving it was crazy. But more than that the advertising is out of this world. And people don't think about things like the Staples Center, they get that crypto partnership for, I think was $250 million over 10 years, something I can't remember the exact but a Madison Square Garden doesn't have that. But 10 years ago, if I had come to you and like, "Hey, these companies are going to be getting $20 million per year from a crypto firm." You would have said, "Crypto, what's crypto?" There are all these new categories that are always sprouting up. And people always want the brand halo of either the biggest Arena in the world, which is MSG, or the Knicks and Rangers and stuff. So I just think they play so well over time. But gosh, the Dolans have just really bummed me out with a bunch of their decisions recently, and we talked about how bad MSG and MSG deal is. So I know you're kind of with me there.

Jonathan: I know. I'm with your short term. And the long term, just remember, they bought, when they own Cablevision, they bought Madison Square Garden, that own the Knicks, the Rangers, the garden itself, and whole other and real estate and air rights for a few 100 million dollars. Now, the Knicks alone are valued at $5 million. So take the long-term view, although I realized, clients aren't so forgiving. But in the long term, they've created a lot of value. And the other thing to remember is they did sell to Altice at the right time, so they are sellers of assets. I wouldn't give up on them. But it's been a frustrating ride recently.

Andrew: I'm with you, I'm with you. It's one of those ones, one day, they're going to sell and the stock is going to go up 150% that day or something because the asset value is so clearly undervalued. It's just a question of, I wish that there were rumors that that day was going to be like 2019 or 2020. I wonder if that day is two years from now, or if it's 20 years from now. And you and I, I'm going to have a lot more gray hairs on my head. And we're gonna say, "It's finally happening." But we way underperformed the long blonde.

Jonathan: The one thing to talk about is to mention with that is, listen, and I'm guilty of that, too. I've been saying for years selling XL, the Rangers, whatever the right move has been to hold on to this. And they've created value a lot more than just investing in the S&P 500 by just holding on to these assets and compounding tax-free. So I think he's done the right thing. It's just doesn't feel that way.

Andrew: Again, I agree with you. But the right move has been to hold on to the next because the NBA has done great and that rising tide lifts all boats, but in many ways, the Knicks have hindered the NBA because they're the premier franchise in the premier market. And for 20 years, they have been managed like a joke. They've been awful. I mean, more than half the teams make the playoffs in the NBA and the Knicks have made the playoffs like three times in 20 years with all the advantages a big sports team has like they have outperformed it's been the right thing to hold on. But what would have been even better if they had been run properly? And winning titles and stuff which a New York team kind of has the right to do more frequently than any other team. And they haven't done that. So it's just the Dolans man, the Dolans.

Jonathan: Yeah, absolutely. But these are the situations we look at there to show not for everyone when you take a longer-term view. And yeah, in route 45, we talked about next time or whatnot, but some growth names like Uber, so we're not like just a traditional value firm, where we take kind of you know, as I said, a business person approach. So it's, [crosstalk] opportunity in January gave us a lot more opportunity.

Andrew: That's true. That's your book. Hey, Jon, we've been running for an hour, so I'm gonna wrap it up there. For anyone who wants in the show notes. I'll have links to forgotten 40. Jon, if you'll send me the link to the Scotts Miracle Grow, I'll put that too so people can see kind of the numbers behind some of the parts of everything we've been talking about. But Jon, this was your third appearance, and I'm already looking forward to the fourth. Thanks so much for coming on.

Jonathan: Thanks for having me.