Fortune Brands’ biggest foe: the Tax Man

By Jessica Hall and Martinne Geller

PHILADELPHIA/NEW YORK (BestGrowthStock) – Fortune Brands Inc (FO.N: ) could well be the target of a new action plan from activist investor William Ackman, but its bigger concern may be the Tax Man.

Ackman’s fund Pershing Square Capital, known for big investments in retailer Target Corp and shopping mall operator General Growth Properties Inc, earlier this month revealed a 10.9 percent stake in Fortune.

Ackman’s entry has sparked speculation that he would push for changes at Fortune, whose three distinct businesses have little overlap. Ackman has not publicly outlined his plans for Fortune, which has a market capitalization of $8.4 billion.

Fortune, which owns brands such as Jim Beam whiskey, Titleist golf balls and home supply brands including MasterBrand Cabinets and faucet manufacturer Moen, would face hefty tax penalties if it broke apart the company, a source familiar with the company said.

“There’s no magical restructuring that the board hasn’t thought about. There’s a tax leakage problem that makes it hard to shuffle the deck,” said the source, who declined to be identified by name. The source was not authorized to speak with the media.

A potentially unattractive tax bill would result if Fortune sold certain brands or split up the company because it has held the assets so long and they have appreciated in value. Fortune would owe taxes on the increase in value since it began owning them, the source explained.

Tax consequences might also cause Fortune to demand a higher price for its assets to cover the taxes it would owe on a sale.

“That would eat away at any benefit many buyers would see if they bought just part of the company,” the source said.

Fortune Chief Financial Officer Craig Omtvedt said it was too early to discuss the tax implications of restructuring.

“That’s something I wouldn’t speculate on. As you can appreciate, the whole area of structuring is complex. The tax aspect would be complex. At this point, it would be premature to try to comment on that,” Omtvedt said.

FORTUNE OPEN TO ACKMAN TALKS

Fortune said on Thursday that it is open to constructive talks with activist hedge fund manager Ackman and defended its current business portfolio, even after reporting weaker-than-expected quarterly results.

The company has hired Credit Suisse (CSGN.VX: ) and Centerview Partners in anticipation of a battle with Ackman, sources familiar with the situation told Reuters. Credit Suisse and Centerview could not be reached for comment.

“We feel really good about the businesses right now,” Chief Executive Bruce Carbonari told analysts on Thursday following Fortune’s third-quarter earnings report. “At the same time, we’re open to constructive discussions with all of our shareholders, and that includes Pershing Square.”

Fortune is seeing scant sales growth. In the third quarter, comparable sales rose 2 percent in spirits, 1 percent in home goods and 3 percent in golf equipment.

“Our business is structured the way it is because there’s headroom in each of our three attractive categories. We believe there is value to be created there and what we’ve done over time is use the breadth and balance of our portfolio, the combined cash flow of our portfolio, to invest in the business at the right time,” Carbonari said.

Fortune looks at its portfolio “constantly,” he said. “We look at all types of alternatives, whether they be big moves or small moves.”

PARTS WORTH MORE THAN THE WHOLE?

The most attractive takeover component would be the drinks business, which generates about two-thirds of Fortune’s profit.

Diageo (DGE.L: ) has long said it would like to own a major bourbon brand and Fortune has two: Maker’s Mark and Jim Beam.

Pernod Ricard and Bacardi would also make logical buyers, analysts said.

“The real value that seems to be hidden is in the spirits business, in my view,” said Edward Jones analyst Robin Diedrich.

“I could see a scenario where to really get that business to where it needs to be, they need to be larger. Can they do it making acquisitions … or do they need to do something more transformative (like splitting up the units)?” Diedrich said.

“If you outright sell the business, you’re going to have a big tax burden. The spirits business would clearly be a big gain that you’d have to realize,” Diedrich said, adding that a tax-free spin-off to shareholders may be a solution.

Fortune has made some changes to its portfolio, including the 2007 sale of its wine brands to Constellation Brands and E. & J. Gallo and the 2005 purchase of more than 20 wine and spirits brands from Pernod Ricard following the French company’s acquisition of Allied Domecq.

Its smaller deals include the 2009 purchase of Effen vodka, the 2008 purchase of Cruzan rum and the sale earlier this year of the Cobra golf brand to Puma.

Fortune shares, which closed on Thursday at $54.46, are up 47 percent from the 52-week low touched on July 1, double the growth over the same period by the Standard & Poor’s Consumer Discretionary Sector Index (.GSPD: ), of which Fortune is a component.

Fortune trades at 19 times estimated 2010 earnings, according to Reuters data, roughly in line with the multiple of rival spirits producer Brown-Forman Corp (BFb.N: ), but at a premium to the multiple of 11 assigned to wine company Constellation Brands Inc (STZ.N: ).

“We’ve demonstrated our shareholder value orientation, and quite honestly, we’re pretty relaxed,” Omtvedt said. “We look forward to having a dialogue with Ackman and his team as much as we do anybody else.”

(Reporting by Jessica Hall and Martinne Geller; Editing by Michele Gershberg and Steve Orlofsky)

Fortune Brands’ biggest foe: the Tax Man