Hard for me as it is to believe, Ralph Nader, "Consumer Advocate" sometime presidential candidate and general left-loony gadfly and I agree about Cisco Systems (CSCO): John Chambers is bad for shareholders.
In an editorial for Reuters, Nader - apparently a CSCO shareholder with 18,000 shares - complains of the poor use of company cash, which has primarily gone to counteract dilution from the excessive equity compensation the CSCO management team, led by Chambers, has handed itself over the years.
Nader is arguing that with massive cash balances and $3bn a quarter in operating cashflow, the dividend at 6 cents is really insulting and represents hostility towards shareholders.
I myself have written an article detailing my own view that CSCO as a business is cheap, worth probably $30 a share, or even a bit more, but that the business carries a risk that merits the discount - "John Chambers risk" which is the risk that all of the shareholders money will be used for management compensation
While I agree with Nader that management could and should take some near term steps to enhance shareholder value, the fact is, as long as Chambers is there, the stock will price the risk of his management into the stock price
Tuesday, January 31, 2012
Monday, January 23, 2012
2012 Theme: Inflation vs. Deflation
In the embedded video, "Bond King" Bill Gross discusses the outlook for inflation and deflation and shows why getting the right answer to this question is a major factor for investors: asset classes perform quite differently under "reflation" (increasing inflation), disinflation (lowering inflation) and deflation.
Mind you, most financial assets, both nominal and real, perform best under periods of falling inflation, the "30 fat years" described by Gross. Under reflation, both nominal and real assets perform badly, but real assets perform much less badly, as they can "keep up" with rising prices, albeit slowly. Finally, nominal assets do well in deflation and real assets do very poorly in deflation. The problem for nominal assets (e.g. bonds) is default, which rises sharply and can lead to a permanent impairment of capital.
The real question is: which are we likely to have. While Gross doesn't say - he makes it clear that the jury is still out - he does help to deconstruct the problem and lay out some of hte markers.
Mind you, most financial assets, both nominal and real, perform best under periods of falling inflation, the "30 fat years" described by Gross. Under reflation, both nominal and real assets perform badly, but real assets perform much less badly, as they can "keep up" with rising prices, albeit slowly. Finally, nominal assets do well in deflation and real assets do very poorly in deflation. The problem for nominal assets (e.g. bonds) is default, which rises sharply and can lead to a permanent impairment of capital.
The real question is: which are we likely to have. While Gross doesn't say - he makes it clear that the jury is still out - he does help to deconstruct the problem and lay out some of hte markers.
Thinking about M&A Strategy
The McKinsey Global Institute has just published a study that looks at different M&A patterns or strategies that large (non-bank) firms employ to grow the business. The blow matrix shows how McKinsey thinks about what firms are actually doing. Not all strategies are created equal, and McKinsey is quick to note that different industry segments have tended to different strategies.
It is perhaps not a big surprise that the largest companies are the most likely to use acquisitions to grow, as organic growth in mature markets (which large firms dominate) have difficulty growing at faster than the rate of inflation.
Smaller companies are relatively more likely to focus on organic growth or on "selective" deal making, where usually few deals are done, which deals may be transformative (target represents a significant share of acquirerr market cap). McKinsey has found that companies that employ a programmatic approach to acquisitions do best. This may be due to the expertise gained in evaluating and integrating such deals, or it may reflect good discipline in purchaing without overpaaying.
HELE is a bit too small to qualify here, but it too could be said to be selective or perhaps "programmatic". It has looked diligently for additional reveneu and has only really been able to generate organic growth with the OXO brand (thought OXO itself was one of a series acquisitions.
It is perhaps not a big surprise that the largest companies are the most likely to use acquisitions to grow, as organic growth in mature markets (which large firms dominate) have difficulty growing at faster than the rate of inflation.
Smaller companies are relatively more likely to focus on organic growth or on "selective" deal making, where usually few deals are done, which deals may be transformative (target represents a significant share of acquirerr market cap). McKinsey has found that companies that employ a programmatic approach to acquisitions do best. This may be due to the expertise gained in evaluating and integrating such deals, or it may reflect good discipline in purchaing without overpaaying.
HELE is a bit too small to qualify here, but it too could be said to be selective or perhaps "programmatic". It has looked diligently for additional reveneu and has only really been able to generate organic growth with the OXO brand (thought OXO itself was one of a series acquisitions.
Sunday, January 22, 2012
Helen of Troy (HELE) successfully integrating Kaz
In TSI’s most recent post about HELE, we noted that the big
question mark for the company was the effectiveness of the Kaz, Inc.
integration. This was a big
transformative deal, on par with the OXO acquisition, as Kaz would account for
about 40% of the revenue of the combined company. Based on the most recent earnings release,
HELE has done a magnificent job of turning that business into a success, and if
the stated goals of increasing gross margins to reflect those of the historic
HELE are achieved, the acquisition will be a dirt cheap out-of-the-park home
run.
Until this latest earnings release, it was hard to get a
flavor for the success of management in reducing costs and improving operating
performance in the Kaz business.
Clearly, the company was having some success. The pro-forma for Kaz, (which was privately
held) had a full year operating profit of about $4m, or a measly 1% of
sales. Some of this may have been a
function of Kaz’s prior status as a private company, in which several benefits
for senior manager/owners may have been borne by the company, it is hard to
tell from the financials.
HELE demonstrated already in the first quarter that they
intended to improve operating performance.
The Kaz business (which is conveniently listed as separate own segment)
had no reported operating income – HOWEVER – that was after a $1.5m allocation of
operating expense from traditional HELE segments. On a stand-alone basis, Kaz had earned $1.5m
in the first quarter. Ignoring seasonal
effects, this implied a $6m operating profit, or a 50% improvement. This level of enhanced earnings would be just
enough to pay the interest on the additional financing, but not to also count
for the equity, but was encouraging enough that the market bid up the stock to
all-time highs (at which point, management decided to unload its options, and
the stock tanked).
The second quarter earnings report brought additional good
news on the Kaz front. Thru the second
quarter, Kaz managed to earn $7m operating, again, after a $3m allocation of
overhead from traditional HELE. Thus,
after two quarters, HELE management had succeeded in increasing operating earnings
by 2.5 times – with two quarters to go.
Better yet, management indicated that operating profit at Kaz was highly
seasonal, that the first two quarters were not representative and that the
third and fourth quarters would produce far more operating income than the
first two quarters. They delivered.
Kaz earned $13.5m operating in Q3, again, before $1.5m in
reallocated expense – or $15m as a stand-alone entity. The 9 months figures are $20m and $26m, 5 and
6.5 times full year operating as a private company. While I expect the fourth quarter to be
somewhat weaker than the third, an additional $7-$10m operating is not out of
the question, for full year operating of $27-$30m ($33-$36m before allocation
of $6m in corporate overhead). This is a stunning improvement. In 14 months of ownership, management will
have increased operating income of the Kaz business by a factor of somewhere
between 8 and 10! With $194m price tag,
the company will be earning (pre-allocation) something on the scale of 18% on
investment, against a WACC of 12-15%.
Note that much of the purchase was financed with debt issuance of $100m,
at 3.9%, and expansion of the company’s credit line. Cash on hand was also used, and as the credit
line has been paid down, a greater portion of the financing is now coming from
equity, but this is certainly a terrific start.
Were management able to increase margins even five or six percentage
points, they could add another $20m in gross, which should, all else equal,
flow directly to operating profit.
(Management has stated repeatedly its intent to lift Kaz margins from
the mid thirties to the traditional HELE margins of the mid forties, but this
seems unlikely, and in any event a long term goal at best. Were they successful, there would be yet
another $20m in operating, even before any volume growth from market growth or
new product introduction).
Either of these events would increase operating earnings per
share by 60 cents. Kaz, as a US entity,
has a higher tax rate than traditional HELE, which is a Bermuda company, but based
on my expectation of Operating profit for FY2012, NOPAT should be a healthy
$20-$22m or about 60 cents above FY2011.
Figures for the fourth quarter in the Kaz segment will be
distorted by the acquisition of PUR Water.
This will raise gross margins, as the business had high gross, but
operating is less clear at this stage. Advertising
revenues around PUR will increase SG&A.
However, management has identified several opportunities to grow the
business, and given the incredible cost control HELE has been able to exercise,
this looks like another good opportunity to reinvest the company’s growing cash
flows in high return activities. Indeed,
operating earnings are now rising so rapidly that the company can now purchase
a $100m business every year simply from internally generated funds.
PRICE TARGETS
Analysts have begun to argue that the stock could be worth
as much as $50 per share, as EPS will likely top $4 in FY2013. This is based on continued strong performance
from Kaz, continued high single digit growth in the OXO brand and modest growth
in sales of the personal care segment. I
think a price of $45 is quite reasonable, as I believe HELE is entitled to a
11x multiple. This is low for a consumer
staples company, in part because there are several risks.
RISKS
The first risk is that management is becoming overly focused
on growth through acquisition and takes its eye off the traditional HELE
business segments. This would be a
problem because the traditional business is both strong and profitable, and at
60% of revenue, and an even greater share of operating profit, these segments
are crucial to the performance of the company.
Thus far in FY2012 they have disappointed some, as revenue has grown but
only as a result of heavy promotional activity.
This could mean that management has been somewhat distracted and is not
executing as sharply, and is thus relying more heavily on promotion to move
product.
The second major risk is that management makes a poor
acquisition, either by purchasing a product or business unit whose competitive
position is too weak, or by simply overpaying.
Fortunately, HELE tends to acquire mature products, within establish
markets and along with a license for or outright ownership of brand names. Often these have been built by major firms
(e.g. P&G) but are either too mature or too small to get the attention they
need. HELE then focuses relentlessly on
cost and on using the HELE sales force to increment sales. Still, the company’s record is not without
some black eyes. Some years back they purchased
an infomercial business (with a goal of promoting HELE product, I think) and
were forced to close down the business within two fiscal years. More recently, the company massively overpaid
for its acquisition of Belson, and had to take a huge impairment on Goodwill
and intangible assets. TSI hopes that
the increased earnings and cash flow of the business enable the company to look
at a greater range of deals and to be able to be even more successful buying “gems”. (Of course, as a company grows, scale can
also reduce the range of opportunities one can look at, by making many deals “too
small” to have material impact on earnings, but HELE is probably a few years
away from this point).
Third, one has to be concerned about input costs. As a products maker, HELE is subject to
significant commodity cost exposure.
Moreover, many of HELE products are made in China, where labor costs are
experiencing significant inflation. This
matters, because with a managed-fixed exchange rate, labor costs in USD, GBP
and EUR are rising, which could constrain margins. Furthermore, over time, the yuan is rising
against other currencies, compounding the effect. There are ways of combating this, including
increasing scale as the business grows, and moving production to yet lower cost
markets, or even sourcing in the local market.
Again, as the business grows, it has more options.
The fourth major risk is heavy dilution. In FY2012, HELE revised the compensation for
executives, and expanded the number of options available by 3 million, to about
10% of shares outstanding. Not all
available options need be distributed, of course, but TSI assumes that
substantially all will be. The question
is, over what time period – if this is done over 10 years, such that management
only receives about 1% of outstanding equity each year, things will be
fine. If it is more aggressive, current
shareholders should assume dilution and slower growth in EPS.
OUTLOOK
Even with these risks, TSI expects that HELE will continue
to grow revenue and profit at strong rates.
Organic growth will never be super fast, as the company competes in
mature product categories, but the company executes well and, if it remains
selective, it should be able to grow the bottom line even faster than the top
line.
While the company has never paid one before, I look forward
within the next five years to seeing the company begin to pay a small dividend
to attract the value-growth retail investors it needs to expand its
multiple. Most of these will be retail
investors looking for a means to have a decent yield with growth potential.
Finally, if the company can continue to grow revenue and
market cap as it has, it is not unreasonable to believe that it can join the
midcap S&P400 within the next five years, which would certainly give it a
boost, as would an inclusion in the Russell 1000. But one step at a time.
At this point, I am looking forward to seeing the full year
results for the quarter ending the end of Feburary, at which time I fully
expect the company to exceed $100m in net income for the first time, to see how
Kaz and the PUR acquisitions are faring and to hear about management’s next
plans.
Thursday, December 08, 2011
Thoughts on the Evolution of Warren Buffett's Investment Style
Readers of this blog know, I am a big fan of Warren Buffett - hard not to be if you aspire to investing excellence.
Over at "Can Turtles Fly" there is an excellent post on Buffett's investment choices. The author breaks his investments into three phases, each of declining productivity, as assets under management and more expensive (and more efficient?) markets increasingly limited his investment choices.
I think the author mostly has it right, and it is definitely worth a read.
Over at "Can Turtles Fly" there is an excellent post on Buffett's investment choices. The author breaks his investments into three phases, each of declining productivity, as assets under management and more expensive (and more efficient?) markets increasingly limited his investment choices.
I think the author mostly has it right, and it is definitely worth a read.
Tuesday, November 22, 2011
China vs. India vs. US - more details
I focus a great deal on demographics and the interplay between macro regions on this blog. There is a reason for this: I believe that apart from individual firm analysis, the most important structural questions an investor has to ask himself are about the future nature of markets - particularly financial markets. Moreover, I believe that the investing climate in which we are operating is and will remain, driven by macro questions as governments rewrite social contracts that have mostly been stable since the 1940s.
Changing demographics influences work, output, production, consumption and ultimately the propensity to save, invest and to assume risk - these are the key factors for the investment environment. Within that environment, of course, we also have to pick firms with good economics, but these factors will help to understand the ever-uncertain future prospects of a firm.
I also write about demographics and about global growth becuase I believe that much of the information in the public sphere is written with particular agendas in mind - and that most of that is not aimed at investors. Most people are China bulls - either because they think it good that the US lose its preeminence or because they are horrified at the prospect and want to issue cautionary tales to Americans to avoid a declinist destiny. Mostly the arguments are political, or are driven by investment banks who want to have an easy job of selling securities to gullible investors.
I am decidedly on the side of the China bears - and mostly because of demographics. There seems to be increasing evidence that my forecast makes sense.
Awhile back I made a prediction about China, India and the US. I argued that China will become the worlds largest economy before 2030, and based this on some simple calculations from the Economist. I further argued that China would only hold this position for a short time before it was eclipsed by India, which has grown slower, and started later, but is recently accelerating and which also has better demographics (and a better education system) than China.
But perhaps my most surprising prediction was that by 2050 China would rank third, because it would again be passed by the United States. Now, I have some more evidence that this may indeed happen.
An economic think tank that focuses on demography and economics has concluded that China's growth rate, which has already slipped from double digits to high single digits (with the usual investment banks and bulls arguing that slowing growth is an indication of economic health. Funny, I never hear them saying this about the US). According to John Mauldin, this think tank Global Demographics, has further argued that growth will slip to the high sevens, about the level India is experiencing now (though India's economy is much smaller than China's) and after 2016 will likely fall to the 5% range - and to the 3% range after 2021. (Higher Ãnflation means that China's economy will still grow larger than the US in nominal terms).
But this means that the US will have a chance (if it can restore historical growth rates) to essentially keep pace with China. Likely the US will grow at slightly less than 3% because its own demographic profile will be less favorable than that over the past nine decades, but China will not keep outstripping US growth significantly, and the long-term favorable demographics of the US, coupled with its strong R&D and productivity gains mean that the US will be poised to surpass China by 2050. India will be a bigger challenge for the US.
Of course, such dramatic slowing of economic growth will no doubt lead to significant political unrest, as Chinese, having grown accustomed to a world in which everyone is much better off each year than the year before (at least among the urban middle class) will find the economy's inability to keep up with their expectations a sore point - and one which will undermine the legitimacy of the CCP.
It also means that beyond 2021, investors will have to look to other regions for economic leadership. Of course, China will be a very large economy and growing solidly, but so will the US - except that the US will not have the political risks associated with China. Expect asset prices and investor appetites to wane.
Changing demographics influences work, output, production, consumption and ultimately the propensity to save, invest and to assume risk - these are the key factors for the investment environment. Within that environment, of course, we also have to pick firms with good economics, but these factors will help to understand the ever-uncertain future prospects of a firm.
I also write about demographics and about global growth becuase I believe that much of the information in the public sphere is written with particular agendas in mind - and that most of that is not aimed at investors. Most people are China bulls - either because they think it good that the US lose its preeminence or because they are horrified at the prospect and want to issue cautionary tales to Americans to avoid a declinist destiny. Mostly the arguments are political, or are driven by investment banks who want to have an easy job of selling securities to gullible investors.
I am decidedly on the side of the China bears - and mostly because of demographics. There seems to be increasing evidence that my forecast makes sense.
Awhile back I made a prediction about China, India and the US. I argued that China will become the worlds largest economy before 2030, and based this on some simple calculations from the Economist. I further argued that China would only hold this position for a short time before it was eclipsed by India, which has grown slower, and started later, but is recently accelerating and which also has better demographics (and a better education system) than China.
But perhaps my most surprising prediction was that by 2050 China would rank third, because it would again be passed by the United States. Now, I have some more evidence that this may indeed happen.
An economic think tank that focuses on demography and economics has concluded that China's growth rate, which has already slipped from double digits to high single digits (with the usual investment banks and bulls arguing that slowing growth is an indication of economic health. Funny, I never hear them saying this about the US). According to John Mauldin, this think tank Global Demographics, has further argued that growth will slip to the high sevens, about the level India is experiencing now (though India's economy is much smaller than China's) and after 2016 will likely fall to the 5% range - and to the 3% range after 2021. (Higher Ãnflation means that China's economy will still grow larger than the US in nominal terms).
But this means that the US will have a chance (if it can restore historical growth rates) to essentially keep pace with China. Likely the US will grow at slightly less than 3% because its own demographic profile will be less favorable than that over the past nine decades, but China will not keep outstripping US growth significantly, and the long-term favorable demographics of the US, coupled with its strong R&D and productivity gains mean that the US will be poised to surpass China by 2050. India will be a bigger challenge for the US.
Of course, such dramatic slowing of economic growth will no doubt lead to significant political unrest, as Chinese, having grown accustomed to a world in which everyone is much better off each year than the year before (at least among the urban middle class) will find the economy's inability to keep up with their expectations a sore point - and one which will undermine the legitimacy of the CCP.
It also means that beyond 2021, investors will have to look to other regions for economic leadership. Of course, China will be a very large economy and growing solidly, but so will the US - except that the US will not have the political risks associated with China. Expect asset prices and investor appetites to wane.
Monday, October 10, 2011
HELE Earnings FY2012 Q2
Helen of Troy delivered an underwhelming quarter, to say the least. Revenue was well below analysts forecast of $288mn, and net income for the quarter was essentially flat, and due to higher shares outstanding, EPS actually fell. This was also below analyst estimates, which had expected a rather substantial increase in EPS. Worse, the company had the worst conference call I have ever heard; after a delay (for "technical reasons"), it seemed as if management was completely unprepared or distracted - they could not even read their prepared remarks correctly, indicating that they had not prepared adequately. All of this was a reason why the stock tanked when earnings were released last Thursday. Since hitting a peak of $36 in June after the Q1 earnings report, the stock is down about $11, or nearly 30%.
The poor earnings were due to weakness in the traditional Helen of Troy businesses. The personal care segment, which includes most of the styling products for which HELE is known, actually experienced sales declines, in part because in-store promotions, which were used to increase (uh, maintain) volume, were taken as a reduction in sales. According to the company, the increased marketing expense was $4.1mn (although an unspecified portion of this was also credited as SG&A and not as a reduction in net sales).
Management has suggested that consumers are really curtailing their consumption of these products, and that any improvement will be "heavily dependent on improvements in employment, housing markets and consumers' personal finances" (10-Q, pg30). Let us hope they are wrong, since we are likely a good 3-5 years away from any meaningful improvement in any of the three macro factors the company has cited.
It should also be noted that the company sources many of these products from China, and, low and behold, the costs of manufacturing in China and importing to the US are rising. Wage inflation, which has been running around double digit levels is piled on top of a rising currency, leading to margin contraction on top of sales declines. The rising cost of labor and the currency are both secular trends that are set to continue for the foreseeable furture.
Operating income in the segment declined by $3.59mn in the quarter, primarily due to the increased advertising expense noted above. While the company attempted to argue that this was mostly a timing issue (advertising programs occuring in the 2nd quarter of FY2012 occurred instead in the 3rd and 4th Quarter of FY2011), this only reinforces the difficulty of the operating environment, since sales declined even though significant incremental promotional expense was incurred. The $4.1mn, incidentally, is about 13cents on EPS, which would have been enough to lift EPS from $0.74 to $0.87, about what analysts were looking for.
Six month results were better, with an increase in operating profit of $2.68mn. There is a catch, however. The company has started to allocate some corporate overheads to the new operating segment (Healthcare/Home Environment) These costs were previously borne by the Personal Care and Housewares segment. For the six months, the reallocation was $3.01mn. The company does not clarify how these costs had prevoiusly been allocated to the PC and HW segments, but it seems likely that they were shared 2/3 to PC and 1/3 to Housewares. If I am correct, then Personal Care received a $2mn operating income boost, which basically leaves operating income flat for the first half of the year. Note that in Q2, operating results declined, even after receiving a $1mn benefit from reallocation of SG&A.
Taken as a whole, we have a segment that looks set for quite a bit of future weakness. On the conference call, the CEO remarked that "most people have a hair dryer, we need to convince them to purchase a new one even though their existing one still works" a sure sign that saturation is occurring. One wonders if the company does not have rethink its product and category managment and consider offering more discount items to compete effectively in the discount segment. The company notes that people are trading down. The company may be in a tough position, strategically, in that it licenses brand names and produces merchandise for which it believes it can charge a brand premium greater than the cost of the license. In many cases, this license fee is likely to be a fixed cost (at least in part), meaning that increasing sales of unbranded or value branded products may compete with the branded products for which the company already has a fixed expense.
It is difficult to determine the extent to which competitors are experiencing the same challenges in the segment, as most competitors are either private companies or are simply to large to break out sales in this area. The closest analog, Spectrum Brands, had strong sales growth in the category, but that was for the period ended in July, a selling period most closely aligned with the HELE's first quarter, in which sales growth was solid.
As this segment has traditionally represented 2/3 of the company's sales, and after the Kaz acquisition still accounts for 40%, it has the potential to be a drag on earnings for some time.
The story is somewhat happier with the OXO brand (Housewares segment), with strong sales growth in both the quarter and the first half of FY2012. Managmeent was quick to caution that double digit sales growth is likely to moderate such that for the full FY2012 revenue growth is likely to be in the high single digits. Based on FY2011 sales of $216mn, this would imply a full year revenue increase of $11mn - $20mn. Since revenue growth in the first six months of FY2012 is already $13mn, we have to expect relatively flat sales in the back half of the year. Sales this year have been helped by strong volume growth from OXO Tot (baby goods), but also happily, expanded shelf space and small growth in geograpic distribution. It is not clear to what extent this is due to increased leverage as a result of the Kaz acquisition, it may be entirely due to the expansion of the product range. The company's ability to continue to growth this segment will be based on the ability to continue to deliver new product introductions and to increase the geographic reach of distribution. The company has a good track record here, and Kaz ought to help with finding new channel partners and geographies.
One cautionary trend to monitor is the fact that the OXO brand is coming under some price pressure. OXO has generally been able to position itself as a premium product and maintain strong pricing, but the second quarter saw significant promotional efforts around stock-outs. Coupled with higher costs (the China effect, again), the higher discounting led to a decline in operating income in the 2nd quarter, which pretty much cancelled out the gains in the first quarter. Again, this margin contraction occurred despite allocating (my estimates) $500k and $1mn from Housewares to Healthcare. Had these allocations not been made, the declines would have been much lareger.
Nevertheless, there are some signs of optimism. First, the Kaz acquisition is performing better than I had expected. Sales increased for the first half, though sales were lower in Q2, apparently due to supply shortages, which may lead to higher sales in Q3 adn Q4. Operating income was $7mn in Q2 (up from a small loss in Q1). The six month result of $7mn is after taking on $3mn in SG&A from the other two segments. According to the company, this is due to sourcing and synergy savings, as well as improved category managment. Better yet, management has indicated that due to strong seasonality at Kaz, the Q2 and the first half are not indicative of full year results, and it expects to outperform the $7mn operating in each of the last two quarters of the year. This should lift operating profit above $20mn for the year, which is what I estimate is the segment's actual capital cost. After interest charges of about $8mn for the acquisition, Kaz may add $16-$18mn operating, or $0.50 EPS after tax.
Moreover, the company claims to have identified an additional $10mn in synergy costs, which, if it is all incremental, would represent another 30cents (before tax).
The company has also improved working capital ratios, reducing the number of days receivable and increasing inventory turnover, which should help to free up some more cash to reduce borrowings. The company was also able to sell its entire stock of Auction Rate Securities, which converts $20mn in nearly non-interest bearing "investments" into $19mn in cash, which is availáble to reduce borrwings. And speaking of reduced borrowings, the company paid a $50mn note with cash on hand and increased borrowing under its revolving credit facility. Strong cashflows in 2H resulting from an inventory sell down and strong oeprating results should enable the company to make a major reduction in the $105mn in revolving debt.
I am still annoyed that management used its view of Q2 to sell options dear. I am also concerned about the planned compensation for Gerald Rubin, as adjusted EBITDA excuses bad behavior in the form of overly generous Goodwill. However, I can easily see the company earning $3.40 in FY2012 and $3.70 in FY2013, and my own estimates of value based on DCF peg the value of the stock between $35, assuming very negative assumptions (no gross margin expansion and very slow revenue growth) or as high as $54, if growth is a bit stronger and margins can be returned over time to the 45% enjoyed by the legacy HELE.
All of which is to say that the stock still looks cheap. A buyback would be in order.
The poor earnings were due to weakness in the traditional Helen of Troy businesses. The personal care segment, which includes most of the styling products for which HELE is known, actually experienced sales declines, in part because in-store promotions, which were used to increase (uh, maintain) volume, were taken as a reduction in sales. According to the company, the increased marketing expense was $4.1mn (although an unspecified portion of this was also credited as SG&A and not as a reduction in net sales).
Management has suggested that consumers are really curtailing their consumption of these products, and that any improvement will be "heavily dependent on improvements in employment, housing markets and consumers' personal finances" (10-Q, pg30). Let us hope they are wrong, since we are likely a good 3-5 years away from any meaningful improvement in any of the three macro factors the company has cited.
It should also be noted that the company sources many of these products from China, and, low and behold, the costs of manufacturing in China and importing to the US are rising. Wage inflation, which has been running around double digit levels is piled on top of a rising currency, leading to margin contraction on top of sales declines. The rising cost of labor and the currency are both secular trends that are set to continue for the foreseeable furture.
Operating income in the segment declined by $3.59mn in the quarter, primarily due to the increased advertising expense noted above. While the company attempted to argue that this was mostly a timing issue (advertising programs occuring in the 2nd quarter of FY2012 occurred instead in the 3rd and 4th Quarter of FY2011), this only reinforces the difficulty of the operating environment, since sales declined even though significant incremental promotional expense was incurred. The $4.1mn, incidentally, is about 13cents on EPS, which would have been enough to lift EPS from $0.74 to $0.87, about what analysts were looking for.
Six month results were better, with an increase in operating profit of $2.68mn. There is a catch, however. The company has started to allocate some corporate overheads to the new operating segment (Healthcare/Home Environment) These costs were previously borne by the Personal Care and Housewares segment. For the six months, the reallocation was $3.01mn. The company does not clarify how these costs had prevoiusly been allocated to the PC and HW segments, but it seems likely that they were shared 2/3 to PC and 1/3 to Housewares. If I am correct, then Personal Care received a $2mn operating income boost, which basically leaves operating income flat for the first half of the year. Note that in Q2, operating results declined, even after receiving a $1mn benefit from reallocation of SG&A.
Taken as a whole, we have a segment that looks set for quite a bit of future weakness. On the conference call, the CEO remarked that "most people have a hair dryer, we need to convince them to purchase a new one even though their existing one still works" a sure sign that saturation is occurring. One wonders if the company does not have rethink its product and category managment and consider offering more discount items to compete effectively in the discount segment. The company notes that people are trading down. The company may be in a tough position, strategically, in that it licenses brand names and produces merchandise for which it believes it can charge a brand premium greater than the cost of the license. In many cases, this license fee is likely to be a fixed cost (at least in part), meaning that increasing sales of unbranded or value branded products may compete with the branded products for which the company already has a fixed expense.
It is difficult to determine the extent to which competitors are experiencing the same challenges in the segment, as most competitors are either private companies or are simply to large to break out sales in this area. The closest analog, Spectrum Brands, had strong sales growth in the category, but that was for the period ended in July, a selling period most closely aligned with the HELE's first quarter, in which sales growth was solid.
As this segment has traditionally represented 2/3 of the company's sales, and after the Kaz acquisition still accounts for 40%, it has the potential to be a drag on earnings for some time.
The story is somewhat happier with the OXO brand (Housewares segment), with strong sales growth in both the quarter and the first half of FY2012. Managmeent was quick to caution that double digit sales growth is likely to moderate such that for the full FY2012 revenue growth is likely to be in the high single digits. Based on FY2011 sales of $216mn, this would imply a full year revenue increase of $11mn - $20mn. Since revenue growth in the first six months of FY2012 is already $13mn, we have to expect relatively flat sales in the back half of the year. Sales this year have been helped by strong volume growth from OXO Tot (baby goods), but also happily, expanded shelf space and small growth in geograpic distribution. It is not clear to what extent this is due to increased leverage as a result of the Kaz acquisition, it may be entirely due to the expansion of the product range. The company's ability to continue to growth this segment will be based on the ability to continue to deliver new product introductions and to increase the geographic reach of distribution. The company has a good track record here, and Kaz ought to help with finding new channel partners and geographies.
One cautionary trend to monitor is the fact that the OXO brand is coming under some price pressure. OXO has generally been able to position itself as a premium product and maintain strong pricing, but the second quarter saw significant promotional efforts around stock-outs. Coupled with higher costs (the China effect, again), the higher discounting led to a decline in operating income in the 2nd quarter, which pretty much cancelled out the gains in the first quarter. Again, this margin contraction occurred despite allocating (my estimates) $500k and $1mn from Housewares to Healthcare. Had these allocations not been made, the declines would have been much lareger.
Nevertheless, there are some signs of optimism. First, the Kaz acquisition is performing better than I had expected. Sales increased for the first half, though sales were lower in Q2, apparently due to supply shortages, which may lead to higher sales in Q3 adn Q4. Operating income was $7mn in Q2 (up from a small loss in Q1). The six month result of $7mn is after taking on $3mn in SG&A from the other two segments. According to the company, this is due to sourcing and synergy savings, as well as improved category managment. Better yet, management has indicated that due to strong seasonality at Kaz, the Q2 and the first half are not indicative of full year results, and it expects to outperform the $7mn operating in each of the last two quarters of the year. This should lift operating profit above $20mn for the year, which is what I estimate is the segment's actual capital cost. After interest charges of about $8mn for the acquisition, Kaz may add $16-$18mn operating, or $0.50 EPS after tax.
Moreover, the company claims to have identified an additional $10mn in synergy costs, which, if it is all incremental, would represent another 30cents (before tax).
The company has also improved working capital ratios, reducing the number of days receivable and increasing inventory turnover, which should help to free up some more cash to reduce borrowings. The company was also able to sell its entire stock of Auction Rate Securities, which converts $20mn in nearly non-interest bearing "investments" into $19mn in cash, which is availáble to reduce borrwings. And speaking of reduced borrowings, the company paid a $50mn note with cash on hand and increased borrowing under its revolving credit facility. Strong cashflows in 2H resulting from an inventory sell down and strong oeprating results should enable the company to make a major reduction in the $105mn in revolving debt.
I am still annoyed that management used its view of Q2 to sell options dear. I am also concerned about the planned compensation for Gerald Rubin, as adjusted EBITDA excuses bad behavior in the form of overly generous Goodwill. However, I can easily see the company earning $3.40 in FY2012 and $3.70 in FY2013, and my own estimates of value based on DCF peg the value of the stock between $35, assuming very negative assumptions (no gross margin expansion and very slow revenue growth) or as high as $54, if growth is a bit stronger and margins can be returned over time to the 45% enjoyed by the legacy HELE.
All of which is to say that the stock still looks cheap. A buyback would be in order.
Monday, October 03, 2011
HELE Earnings Preview, Part II
In part one of the analysis, we reviewed the Kaz acquisition and set some targets for the financial performance of that business unit.
HELE has also been in the news for some other recent decisions by management - insider stock option conversion and a new proposed compensation plan for the founder and CEO, Gerald Rubin.
Mr Rubin, it may surpise, does not have a very large stake in the company. According to the most recent filings, he owned about 2.4mn shares, less than 10% of the total. At current market prices, his stake is worth about $60mn. This is not a bad thing, except that it means his annual compensation, which can run to above $10mn matters a great deal in comparison to changes in the market capitalization of the firm.
What is particularly interesting is that he, and a few other senior executives, chose to exercise their options back in early July, when the stock was trading at an all-time high of near $36. The stock has subsequently declined by over $10 per share, partly on market fears, but also perhaps because there is a perception that insiders, six months into their largest acquisition, believe the company may struggle going forward. This is particularly true when one considers the fact that Mr Rubin cashed in all of his outstanding options, 1.325mn shares worth - two years before expiration!
How do I arrive at this conclusion? By checking the latest 10-Q which notes on page 22 that there were 2mn options outstanding and exercisable as of May 31, 2011, with an average life of 2.11 years. Mr Rubin's 1.375mn represent over 65% of the 2mn total shares, enough that his expiration cannot diverge significantly from the overall average.
Given the opportunities the Kaz acquisition presents, not to mention the ongoing and rising cash flows from the legacy business, one would assume that Mr Rubin would want to hold out for future appreciation with at least some of his options. Why not leave some skin in the game, unless you believed the stock price had peaked?
Incidentally, Mr Rubin submitted most of these shares in settlement for taxes and the purchase price of the stock. The company retired the tendered shares, so net share issuance only rose by about 300k - or 1%.
In fairness to Mr Rubin, the exercise may have been related to the intent to change the management contract. Mr Rubin had been barred from participating in options under the existing stock programs, becuase of his high number of outstanding options. Cashing them in may have been part of an arrangement between himself and the board to obtain a new incentive agreement. I say this, because in early September, the Board announced a new agreement with Mr Rubin, one which has not been ratified by shareholders. In this agreement, Mr Rubin will no longer participate with a share of Net Income, but rather based on "Adjusted EBITDA". What this does is separate Mr Rubin's pay from the effects of asset impairments, such as writedowns in estimates of the value of intangible assets and goodwill. (It applies to writedowns of other physical assets as well, but over 50% of HELE assets are of the intangible variety).
From my perspective, what this does is insulate management from the impacts of it's own decisions. Mr Rubin has led the company for four decades. He has made the decisions to purchase these assets - subtantially all of the intangible assets are the result of a strategy Mr Rubin has pursued. It makes no sense to release him from the consquences should history show him to have overpaid.
These two decisions, more than anything else, indicate that Mr Rubin believes the company's prospects are less rosy than they appeared in the months after the acquisition.
Incidentally, I encourage you to vote AGAINST this proposal, as I shall.
In purchasing Kaz, HELE decided to grow the top line fast, and enter new categories. The company has incredible cost management and has consistently managed to grow the business. Indeed, the OXO brand alone might be worth more than the market cap of HELE. But the acquisition is risky and it looks as though management is looking for ways to insulate itself from the consequences of those decisions.
Thursday will be most interesting.
HELE has also been in the news for some other recent decisions by management - insider stock option conversion and a new proposed compensation plan for the founder and CEO, Gerald Rubin.
Mr Rubin, it may surpise, does not have a very large stake in the company. According to the most recent filings, he owned about 2.4mn shares, less than 10% of the total. At current market prices, his stake is worth about $60mn. This is not a bad thing, except that it means his annual compensation, which can run to above $10mn matters a great deal in comparison to changes in the market capitalization of the firm.
What is particularly interesting is that he, and a few other senior executives, chose to exercise their options back in early July, when the stock was trading at an all-time high of near $36. The stock has subsequently declined by over $10 per share, partly on market fears, but also perhaps because there is a perception that insiders, six months into their largest acquisition, believe the company may struggle going forward. This is particularly true when one considers the fact that Mr Rubin cashed in all of his outstanding options, 1.325mn shares worth - two years before expiration!
How do I arrive at this conclusion? By checking the latest 10-Q which notes on page 22 that there were 2mn options outstanding and exercisable as of May 31, 2011, with an average life of 2.11 years. Mr Rubin's 1.375mn represent over 65% of the 2mn total shares, enough that his expiration cannot diverge significantly from the overall average.
Given the opportunities the Kaz acquisition presents, not to mention the ongoing and rising cash flows from the legacy business, one would assume that Mr Rubin would want to hold out for future appreciation with at least some of his options. Why not leave some skin in the game, unless you believed the stock price had peaked?
Incidentally, Mr Rubin submitted most of these shares in settlement for taxes and the purchase price of the stock. The company retired the tendered shares, so net share issuance only rose by about 300k - or 1%.
In fairness to Mr Rubin, the exercise may have been related to the intent to change the management contract. Mr Rubin had been barred from participating in options under the existing stock programs, becuase of his high number of outstanding options. Cashing them in may have been part of an arrangement between himself and the board to obtain a new incentive agreement. I say this, because in early September, the Board announced a new agreement with Mr Rubin, one which has not been ratified by shareholders. In this agreement, Mr Rubin will no longer participate with a share of Net Income, but rather based on "Adjusted EBITDA". What this does is separate Mr Rubin's pay from the effects of asset impairments, such as writedowns in estimates of the value of intangible assets and goodwill. (It applies to writedowns of other physical assets as well, but over 50% of HELE assets are of the intangible variety).
From my perspective, what this does is insulate management from the impacts of it's own decisions. Mr Rubin has led the company for four decades. He has made the decisions to purchase these assets - subtantially all of the intangible assets are the result of a strategy Mr Rubin has pursued. It makes no sense to release him from the consquences should history show him to have overpaid.
These two decisions, more than anything else, indicate that Mr Rubin believes the company's prospects are less rosy than they appeared in the months after the acquisition.
Incidentally, I encourage you to vote AGAINST this proposal, as I shall.
In purchasing Kaz, HELE decided to grow the top line fast, and enter new categories. The company has incredible cost management and has consistently managed to grow the business. Indeed, the OXO brand alone might be worth more than the market cap of HELE. But the acquisition is risky and it looks as though management is looking for ways to insulate itself from the consequences of those decisions.
Thursday will be most interesting.
Sunday, October 02, 2011
HELE Earnings Preview, Part 1 - the Kaz Impact
HELE will be releasing its earnings report for the fiscal 2nd quarter this Thursday.
This quarter is particularly important, because of the unfolding informatin about the Kaz acquisition, and investors will want to know how well the economics of the deal are working out. If recent moves in the stock price reflect sentiment about the business and not just reaction to market gyration, then investors are concerned about the performance of this deal.
There are several other factors that could be weighing on the share price. Earnings per share will likely be under pressure because of significant (and early) options excercise (at what turned out to be the recent top around $35 per share). Management also has renegotiated a new contract, and it appears very lucrative. More on this later
I am among those who are curious to see how managment is handling the sudden and massive growth of the business. My own view is that the company will likely earn a fair return on the investment, but that it will be less successful than some of the smaller, more bolt-on, acquisitions (such as Pert and Infusium23) that the company has done in the more recent past. More deals are likely to be avaible in the not-to-distant future as macroeconomic fears weigh on business valuations. The jury is still out on whether this deal was wise - HELE may have overpaid.
The Kaz acquisition was designed to be transformative, with $270mn flowing to Kaz shareholders in an all-cash deal. (The combined company has a market cap of $775mn). This was a high sum to pay for a firm that was not making money prior to the acquisition, so we have to believe that HELE management will be better able to sweat the assets, to break up the assets and sell the pieces at higher prices than they paid, or that other synergies such as increased pricing power with suppliers and consumers will contribute to greater earnings across the company.
The deal recorded $154mn of Goodwill, indicating that HELE mangement believes there is much value to be unlocked beyond the value of the brands themselves. Investors have to be wary, since management has a history of having to take write-offs against intangible asset values acquired at optimistic valuations.
Nevertheless, the Kaz acquisition offers HELE many opporunities: first and foremost significantly increasing revenue - while organic growth of 5.9% was strong for a firm that makes consumer staples, the acqusition increased revenue by an additional 63.9% over the prior year quarter - if Kaz can be made anything like as profitable as the traditional HELE, earnings per share (which remain undiluted in the deal) will soar, and the stock price with it.
Moreover, Kaz helps the company to expand it's geographic footprint and it's overseas sales - so Kaz can also help to grow sales of HELE products and enhance the value of the traditional business.
Unfortunately, Kaz is a much less profitable company. Management has not clarified the extent to which this reflects weakness of its brands compared to competitors, or whether it competes in lower-margin categories. That HELE management has stated its aim to increase profitability in Kaz to levels consistent with the legacy business suggests that it is the former. In the meantime, Kaz weighs on the gross margins at HELE.
In my mind, to be considered successful, the deal must achieve all of the following:
To be a truly fantastic deal -
According to the filing, revenue of $95mn represented an increase of 7.2% compared with the (pro forma) prior year period, so we are seeing nice revenue growth.
In the 53 weeks ended April 30, 2010 (the last full year of operations prior to the acquisition), Kaz earned an operating profit of $4.4mn on revenue of $440mn, so a 1% return on sales. This return was consumed by $5mn in interest payments, so that Kaz made a loss. Gross margins were 32% in contrast to HELE's 45%. In the six months prior to acquisition, margins were even lower, (though they were improved over the comparable period in the prior year). Opearting income was essentially zero, as increased gross profit was consumed by much higher SG&A expense.
In the latest HELE report, gross margins have appeared to increase to around 32.2%. While revenue is broken out by segment, cost of sales and gross margins are not. I have calculated this number by taking sales in the legacy businesses and applying the historical 45% gross margin to derive a cost of sales for the legacy business. The remainder must apply to Kaz, and the difference must be the amount of gross profit earned by Kaz. This number is similar to the previous year, and is in any case, imprecise, due to the method I had to use to determine it. I would like to see an increase above 33% in the current quarter, indicating manaagement is getting better control of product lines.
Operating income was a slight loss, however, management is careful to note that the quarter is a seasonally weak one for Kaz, which averages $110mn in revenue per quarter. Moreover, management noted that some overhead costs have been allocated to Kaz, such that Kaz is now covering $1.5mn of costs from the legacy HELE business, implying that operating income could have been as high as $1.4mn were Kaz a stand alone business - well more than 1% of sales. We can only hope this trend will continue and that operating margins in this quarter will be above 2%.
Unfortunately, this is still not enough to cover the interest costs associated with the acquisition, so that it cannot be said to be self-financing, at least not yet. The company needs to earn about $7mn operating just to cover the interest costs. Based on the metrics above, it must earn another $8mn to cover the cost of equity capital injected by HELE, and finally, we would like to watch this thing delever, so let's say we need a $20mn operating profit - which means that the unit has to earn 5% on sales
Finally, management may come to regret the amount of commitment they have to Kaz because nine months into this exercise, the markets seem shaky, and it appears there may be some real opportunity to pick up quality assets on the cheap. On a positive note, the core business seems to be generating cash quite rapidly, which means that in six more months, the company's coffers should have it in position to do another modest deal.
Part II - Management concerns next.
This quarter is particularly important, because of the unfolding informatin about the Kaz acquisition, and investors will want to know how well the economics of the deal are working out. If recent moves in the stock price reflect sentiment about the business and not just reaction to market gyration, then investors are concerned about the performance of this deal.
There are several other factors that could be weighing on the share price. Earnings per share will likely be under pressure because of significant (and early) options excercise (at what turned out to be the recent top around $35 per share). Management also has renegotiated a new contract, and it appears very lucrative. More on this later
I am among those who are curious to see how managment is handling the sudden and massive growth of the business. My own view is that the company will likely earn a fair return on the investment, but that it will be less successful than some of the smaller, more bolt-on, acquisitions (such as Pert and Infusium23) that the company has done in the more recent past. More deals are likely to be avaible in the not-to-distant future as macroeconomic fears weigh on business valuations. The jury is still out on whether this deal was wise - HELE may have overpaid.
The Kaz acquisition was designed to be transformative, with $270mn flowing to Kaz shareholders in an all-cash deal. (The combined company has a market cap of $775mn). This was a high sum to pay for a firm that was not making money prior to the acquisition, so we have to believe that HELE management will be better able to sweat the assets, to break up the assets and sell the pieces at higher prices than they paid, or that other synergies such as increased pricing power with suppliers and consumers will contribute to greater earnings across the company.
The deal recorded $154mn of Goodwill, indicating that HELE mangement believes there is much value to be unlocked beyond the value of the brands themselves. Investors have to be wary, since management has a history of having to take write-offs against intangible asset values acquired at optimistic valuations.
Nevertheless, the Kaz acquisition offers HELE many opporunities: first and foremost significantly increasing revenue - while organic growth of 5.9% was strong for a firm that makes consumer staples, the acqusition increased revenue by an additional 63.9% over the prior year quarter - if Kaz can be made anything like as profitable as the traditional HELE, earnings per share (which remain undiluted in the deal) will soar, and the stock price with it.
Moreover, Kaz helps the company to expand it's geographic footprint and it's overseas sales - so Kaz can also help to grow sales of HELE products and enhance the value of the traditional business.
Unfortunately, Kaz is a much less profitable company. Management has not clarified the extent to which this reflects weakness of its brands compared to competitors, or whether it competes in lower-margin categories. That HELE management has stated its aim to increase profitability in Kaz to levels consistent with the legacy business suggests that it is the former. In the meantime, Kaz weighs on the gross margins at HELE.
In my mind, to be considered successful, the deal must achieve all of the following:
- Produce operating cashflows in excess of both the direct financing costs
- Demonstrate an ability to delever the firm on its own (i.e. to generate enough cash to repay the debt assumed to acquire it without resorting to cashflows from HELE)
- Produce a satisfactory return on company cash employed in the deal - $77.5mn. This is money that had been avaible to invest in other HELE product lines, make smaller acquisitions (with less imapact on the balance sheet)
To be a truly fantastic deal -
- Kaz should begin generating substantial operating earnings within the next 12 months
- Kaz should show ongoing incremental margin expansion as a result of the increased market power of the combined entity
- Kaz should be able to do so while shouldering costs formerly assumed by the legacy busienss (i.e. improving profitability in the legacy business through efficiencies
- Grow it's own revenue at a faster pace than the legacy business
- Support improved margins in the legacy business.
According to the filing, revenue of $95mn represented an increase of 7.2% compared with the (pro forma) prior year period, so we are seeing nice revenue growth.
In the 53 weeks ended April 30, 2010 (the last full year of operations prior to the acquisition), Kaz earned an operating profit of $4.4mn on revenue of $440mn, so a 1% return on sales. This return was consumed by $5mn in interest payments, so that Kaz made a loss. Gross margins were 32% in contrast to HELE's 45%. In the six months prior to acquisition, margins were even lower, (though they were improved over the comparable period in the prior year). Opearting income was essentially zero, as increased gross profit was consumed by much higher SG&A expense.
In the latest HELE report, gross margins have appeared to increase to around 32.2%. While revenue is broken out by segment, cost of sales and gross margins are not. I have calculated this number by taking sales in the legacy businesses and applying the historical 45% gross margin to derive a cost of sales for the legacy business. The remainder must apply to Kaz, and the difference must be the amount of gross profit earned by Kaz. This number is similar to the previous year, and is in any case, imprecise, due to the method I had to use to determine it. I would like to see an increase above 33% in the current quarter, indicating manaagement is getting better control of product lines.
Operating income was a slight loss, however, management is careful to note that the quarter is a seasonally weak one for Kaz, which averages $110mn in revenue per quarter. Moreover, management noted that some overhead costs have been allocated to Kaz, such that Kaz is now covering $1.5mn of costs from the legacy HELE business, implying that operating income could have been as high as $1.4mn were Kaz a stand alone business - well more than 1% of sales. We can only hope this trend will continue and that operating margins in this quarter will be above 2%.
Unfortunately, this is still not enough to cover the interest costs associated with the acquisition, so that it cannot be said to be self-financing, at least not yet. The company needs to earn about $7mn operating just to cover the interest costs. Based on the metrics above, it must earn another $8mn to cover the cost of equity capital injected by HELE, and finally, we would like to watch this thing delever, so let's say we need a $20mn operating profit - which means that the unit has to earn 5% on sales
Finally, management may come to regret the amount of commitment they have to Kaz because nine months into this exercise, the markets seem shaky, and it appears there may be some real opportunity to pick up quality assets on the cheap. On a positive note, the core business seems to be generating cash quite rapidly, which means that in six more months, the company's coffers should have it in position to do another modest deal.
Part II - Management concerns next.
Buffett rationalizes repurchases
In this interview with Andrew Ross Sorkin, Warren Buffett explains his logic for repurchases. His logic supports my thesis from an earlier post that Buffett is really making a statement about how to do buybacks - not as an annual and ongoing "return of cash" (as another Strategic Investor favorite, CL, does) but rather as a choice among investment alternatives. Buffett wants to buy large companies with good prospects at low prices: BRK qualifies and so long as the price remains attractive relative to intrinsic value, he is a buyer.
A similar approach was explained by Lee Raymond, the man who made ExxonMobil. Having done many deals building the world's largest non-goverment run energy company, people asked him why he suddenly stopped doing deals. Mostly, the critics argued that the acquisition of Mobil had been too difficult for XOM. Raymond countered that there were no deals worth doing: he noted that "we looked around and the cheapest oil we could find was our own, so we bought back stock". You can read more of the interview here.
Buffett, I think is saying the same. Sure there are opportunities, and from time to time a business that meets his criteria will become avaiable. In the meantime, there is a business that meets his criteria which he can purchase as common stock - and unlike other stocks he buys, he has an opportunity to use the treasury shares in private market transactions when the stock more closely reflects intrinsic value, to acquire firms.
A similar approach was explained by Lee Raymond, the man who made ExxonMobil. Having done many deals building the world's largest non-goverment run energy company, people asked him why he suddenly stopped doing deals. Mostly, the critics argued that the acquisition of Mobil had been too difficult for XOM. Raymond countered that there were no deals worth doing: he noted that "we looked around and the cheapest oil we could find was our own, so we bought back stock". You can read more of the interview here.
Buffett, I think is saying the same. Sure there are opportunities, and from time to time a business that meets his criteria will become avaiable. In the meantime, there is a business that meets his criteria which he can purchase as common stock - and unlike other stocks he buys, he has an opportunity to use the treasury shares in private market transactions when the stock more closely reflects intrinsic value, to acquire firms.
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