HOOVER CAPITAL MANAGEMENT INC.116 W. 47th Street, Suite 205Kansas City, MO 64112-1615(816) 561-9990Fax: (816) 561-9997RESEARCH NOTEBERKSHIRE HATHAWAY'S ACQUISITION OF BENJAMIN MOORE & CO.REPORT DATE: November 12, 2000The DevelopmentOn Wednesday after the market closed, Berkshire Hathaway (BRK.A) announced that it had agreed to acquire the paint company Benjamin Moore (MBEN.OB) for $37.82 per share in cash. The value of the transaction is approximately one billion dollars, and the deal is expected to close quickly. Prior to the announcement, Benjamin Moore & Co. was a seldom-heard-from company that traded on the “pink-sheets” (i.e., very thinly traded). Most of us know Benjamin Moore through its paint brands, but not many of us even knew the company was public, or if we did, watching it trade was, well, like watching paint dry. Even among so-called professional investors, I am aware of only one organization, Horizon Research Group, that covered the company. Institutional ownership of Benjamin Moore was modest: Kayne Anderson (476,000 shares), Cardinal Capital (201,000 shares), and one of the Gabelli funds (44,000 shares). Yet Benjamin Moore's thinly traded stock was available at $20 to $22 per share, that is, at a total-company purchase equivalent of approximately $550 - $600 million, prior to the announcement.Once again, Mr. Buffett makes a shrewd acquisition in a mature and non-glamorous industry, paints and coatings. Rapid growth in sales, which are in fact accelerating, is not what is being acquired, which is why Berkshire was able to buy this at a mere 1.2 to 1.3 times sales. Rather, Berkshire is acquiring an uncomplicated business that is a huge cash generator and has untapped brand-name improvement potential. The company meets most of Mr. Buffett's criteria for an acquisition, including: A debt-free balance sheet; Significant insider ownership (32% of outstanding shares); High (but still untapped) brand name recognition; Management that has made regular share repurchases; A return on equity of over 25%; High operating margins (1999: 16%) versus competitors; Net profit margins of greater than 10%; Low capital expenditure requirements.The Competitive Environment for Paint CompaniesBenjamin Moore is the third largest company in an industry that is estimated to have more than 700 competitors. Only two competitors are larger than Benjamin Moore: Sherwin-Williams Company and Valspar Corporation. Taken together, the three of them have a dominate presence and constitute the “one, two, three” of the paint and coatings industry. They are all 3 similar in a number of respects: (1) They all have low or no net debt; (2) They all have low capital expenditure requirements relative to sales volume; (3) None has increased shares outstanding for years; and (4) All three companies have high levels of insider ownership (S-W 22%, Valspar 31%, and Benjamin Moore 32%).Three (3) Largest U.S. Paint Companies1999 SalesCOMPANY SALES in $ PRIMARY SOURCE OF SALES Sherwin-Williams $5,004,000,000 56% from its own retail stores Valspar $1,292,000,000 60% from packaging & industrial Benjamin Moore $780,000,000 75% from trade, 15% own retail stores Benjamin Moore's revenues are a little more than half those of Valspar and 15% of those for Sherwin-Williams. In analyzing the numbers, however, I note that the bulk of Valspar's sales go to customers in the packaging and industrial sectors, while three-quarters of Benjamin Moore's sales come from Trade Sales (paint contractors and the public). Thus, Benjamin Moore's and Valspar's market share and dollar volume to “the Trade” may be about equal.Likewise, in analyzing Sherwin-Williams' $5 billion in sales, we note that S-W derives the majority of its sales from its own network of retail Sherwin-Williams stores. These stores have a large proportion of sales in housewares, a non-paint category. Therefore, the three companies are not that far apart in actual paint sales to the Trade as the above raw sales data may suggest.Despite variations in product mix, we present below company-wide growth of sales, earnings, book value, and return on equity for the three companies:Five-Year Average Growth Rates 1995-1999 (Annualized)Sales and EarningsCategory Sherwin-Williams Valspar Benjamin MooreSales 10.1% 11.8% 7.3%Earnings per Share 11.0% 12.4% 15.4%Book Value per share 10.8% 18.1% 8.3% (11.2% adj.)Return on equity 18.3% 23.5% 21.2%In other words, sales growth for Sherwin-Williams and Valspar have been 10-12% per annum over the past five years, compared to 7.3% average annual sales growth for Benjamin Moore over those same five years. And earnings per share growth have been growing at low- to mid- double-digits for all three companies over that same 5-year time frame, with Benjamin Moore's being the highest.Benjamin Moore is 32% controlled by management, leaving it with only 68%, or about 17.7 million shares, available for trading, making it a small-capitalization company with very little attraction to the majority of the large institutional investment funds. This worked in Warren Buffett's favor, as the premium that Berkshire is paying over current market value is a less than 100%. The brand name “Benjamin Moore Paints” may itself be worth more than Berkshire is paying for the entire company.History and Background of Benjamin Moore & Co.In 1872, at the age of 17, one Mr. Benjamin Moore emigrated from Ireland to Brooklyn, New York, and found employment as a paint salesman. Eleven years later, in 1883, he and his brother William founded the Moore Brothers Paint Company. In 1891, the company incorporated in New Jersey as Benjamin Moore & Co. Today, Benjamin Moore is based in Montvale and Flanders, New Jersey. The company has done one thing and one thing only since its founding: manufacture and sell paints, stains, and finishes. The company has a history of innovation. In 1892 it introduced the first dry powder paint that required only water to constitute it. Until this innovation, painters had to mix their own ingredients. Benjamin Moore's first major product, Calsom Finish, became the best-selling white-wash or calcomine coating for ceilings and walls in the United States. These innovations helped make the company profitable from its very first year of operation. Over the past 100 years, the company has developed washable flat finishes, lead-free paints, and latex-based paints.Today, Benjamin Moore & Co., guided by descendants of the founder, produces a wide range of coatings, including stains and clear finishes, as well as their line of well-known premium paints. A recent new paint product innovation is Pristine, which is a solvent-free, low-oder coating system that uses advanced materials technology. Benjamin Moore conducts extensive research and development and invented the industry's first computerized color matching system.The largest percentage of the company's sales (75%) is classified as Trade Sales and sold to painting contractors, industrial and commercial users, and the general public. End uses for their paint are primarily for the decoration and preservation of interiors and exteriors of residential, commercial, institutional, and related buildings and structures. Benjamin Moore paints are the preferred choice among those who paint our homes, office buildings, bridges, factories, and other structures that constitute the essential infrastructure of our modern nation.The Benjamin Moore brands include, among others, the eponymous brands such as Benjamin Moore, Moorglo, Moorcraft, Moorgard, as well as other brand names including Impervo, Regal, and Aqua Glo. Each brand name represents a family of products.Benjamin Moore owns interests in retail stores that specialize in the sale of paint and related home decorating items. In June 1999, the company purchased Janovic/Plaza Inc., suggesting an expansion into this area. This acquisition doubled the company's retail store segment sales to about 15% of total company sales. If management intends to continue expanding into retail sales, Berkshire will now provide large amounts of capital to make this happen quickly.The ValuationBenjamin Moore generated, on sales of $780 million in 1999, profits before interest expense, minority interests, and taxes (EBIT), of $137 million. This is an attractive return on sales that was getting better in 2000: EBIT for the 9 months ended September were $121 million on sales of $595 million, suggesting full-year 2000 EBIT for the company of approximately $175 million. These are profits relative to sales that Berkshire should have probably paid more for, had the world been watching. Despite the commonalities mentioned before of the three major paint companies, such as balance-sheet and income-statement characteristics, a wide gap existed prior to the acquisition in valuations between Sherwin-Williams and Valspar on the one hand, and Benjamin Moore on the other. Prior to the announcement, Sherwin-Williams traded at about 11 times net income for calendar 1999, and Valspar traded at 18 times fiscal 1999 earnings ended October 1999. By contrast, Benjamin Moore was trading at only 8 times 1999 net income and at 7.6 times prospective 2000 net income. Given Benjamin Moore's recent restructuring, the expected cost savings assuming no growth in 2001 would have further reduced the P/E ratio to 7.2 times 2001 net income. Why the discount? Benjamin Moore has demonstrated rising operating margins, rising returns-on-shareholders equity, and rising earnings. Furthermore, these measures exceed those of its competitors. The company also had a debt-free balance sheet, high-quality management, and a proven business model. The name is synonymous with high-quality paints and coatings. Yet, until the announced merger into Berkshire, these factors were insufficient to accord Benjamin Moore stock any sort of premium valuation in the marketplace. As Horizon Research said in their report, stock market investors still value observable revenue growth over other components of value. As a result, Berkshire Hathaway was able to exploit an excessively low valuation to acquire a company that will generate very high cash-on-cash returns for many years to come.Stevin R. Hoovershoover@chestnutfund.com800-248-2135 816-561-9990ADDITIONAL INFORMATION IS AVAILABLE UPON REQUEST. INFORMATION AND OPINIONS IN THIS REPORT WERE PREPARED BY HOOVER CAPITAL MANAGEMENT INC. AND ARE BASED ON INFORMATION AVAILABLE TO THE PUBLIC. NO REPRESENTATION IS MADE THAT THIS INFORMATION IS ACCURATE OR COMPLETE. THIS REPORT IS NOT AN OFFER TO BUY OR SELL, NOR A SOLICITATION OF AN OFFER TO BUY OR SELL, THE SECURITIES MENTIONED.
Any word on how the mben deal was sourced?stevenglenn
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