The Brooklyn Investor: 2013

So, someone commented on another outsider-esque investment idea backed by some billionaires.   Platform Acquisition Holdings is another Martin Franklin - Nicolas Burggruen SPAC (special purpose acquisition corporation, otherwise known as a blank check company).   Bill Ackman also owns a stake.

I think this is Ackman's second investment with Franklin - Burggruen.   The first was in Justice Holdings, which ended up buying Burger King and is now listed on the NYSE (and Ackman still owns). He was a co-founder of Justice, but at Platform he is just an investor; after the relisting on the NYSE, Pershing Square will have a representative on the board.

This is certainly not Twitter, but a new listing to take a look at.

Liberty and Freedom
Franklin - Burggruen had some other SPACs too in the past. Two of them were U.S. listed; Liberty Acquisition which I suppose we can call a disaster and Freedom Acquisition. The other one, Liberty Acquisition International was listed (like Justice and Platform) in Europe, so I am not too familiar with that one.

I only looked at the two U.S. listed ones (at the time); Liberty Acquisition merged with Prisa; I remember reading about it at the time and I wasn't comfortable at all with it as it was an entity in Europe and I had no familiarity with it. Freedom Acquisition acquired (or merged with) GLG, a hedge fund manager. I looked at that too and wasn't particularly interested in GLG.

I don't know much about Nicolas Burggruen other than what I read in the press; that he is a homeless billionaire (living in hotel rooms), so I can't say anything about his style or philosophy.

Anyway, I suppose someone might have done an IRR on the above SPACs, but I don't have those handy with me (But as you will see, even though that is important, I am sort of interested in what Platform just bought).

Martin Franklin is well-known to U.S. investors because of his work at Jarden Corp (JAH).  He sort of does fit the outsider CEO mold (prudent acquisition driven growth). JAH is certainly a candidate for a post here on this theme I seem to be on here these days.

Martin Franklin took over JAH as Chairman and CEO in September 2001 and now is executive chairman (gave up CEO post in 2011).

For those who don't know him, check this out:

Jarden Corp Stock Price Performance Since September 2001

Returns since September 2001:

JAH:                           +33.5%/year (total return)
S&P 500 index:          +4.6%/year (excluding dividends)
Berkshire Hathaway: +7.8%/year

Ackman's interest in investing with Martin Franklin is clearly due to his performance at JAH (that's exactly what he said).

Platform Specialty Products
So anyway, the fact that PAH (Platform Acquisition Holdings, listed in London but trading halted due to deal) is a SPAC started by Martin Franklin and Nicolas Burggruen is enough to be interesting. But I generally don't invest in SPACs, even with reputable founders. There was a time when it was a free call option; you can buy them at book or a discount and then vote either way on an acquisition; if it is voted down (or you choose to), you can get your cash back. If not and the acquisition is sweet, then you make money on the pop.

In fact, the Special Opportunities Fund (SPE) owns a basket of SPACs and SPAC warrants as a sort of cheap option on good acquistions. It's certainly a good idea, but for me, I just tended to think that this SPAC trade was a sort of pre-crisis thing.   Since it was basically an arbitrage between private market values and public market values, maybe this trade is getting more interesting again; public market valuations are up a lot in the last couple of years. So maybe this 'pop' will start to come back. In the past few years, public market prices tended to look cheap and private market prices seems to have gone up due to the private equity boom.

Crumbs and American Apparel are two SPACs that come to mind that have been disasters. I'm sure there have been some great ones, but I'll leave that game to others. I'm too lazy to find things that pop; I want to find long term places to put my money (of course, owning SPE will give you some of that exposure!).

In any case I did have Platform Acquisition at the back of my mind but it wasn't really a priority for me to look at. But thanks to a commentor in the POST post (no pun intended), I had to front-burner this because:

The business Platform Acquisition bought might be an outsider CEO company.

Platform Acquisition, in October (closed in November), bought MacDermid, a specialty chemical company. They will change the name of Platform Acquisition to Platform Specialty Products and relist on a U.S. stock exchange.

MacDermid an Outsider CEO Company?
MacDermid was a publicly traded company until 2007 when there was a managment buyout.   The MBO happened at $1.3 billion, or around 9x EV/EBITDA. The Platform acquisition happened at 10x adjusted EBITDA (at $1.8 billion). So the valuation looks more or less in line with what management thought it was worth back in 2007 (OK, 9 is not 10, but close enough for the blogoshpere!).

But first, let's look at what raised my eyebrows. MacDermid is run (and has been run since 1990) by Daniel Leever (65 years old so not young, but not too old either!).

On the investor conference call when the acquistion was announced, they said that during Daniel Leever's tenure, MacDermid increased revenues five times. He has been with MacDermid for 34 years and has been CEO for 24 years. I assume his "tenure" is the time he was CEO. That's a modest 7%/year in revenue growth; 5x in 24 years = 7%/year.

They said he increased the value of the company from $80 million to the current $1.8 billion through those years. So that's +13.9%/year since 1990. Not bad at all.   I think they said he increased market cap or equity value 30x during his tenure. Assuming that means 1990-now, that's +15%/year. This growth includes acquisitions, but no equity raises.

Although pretty good, it's not quite up to par of the original "outsiders". Here, look:

1. Tom Murphy (Capital Cities Broadcasting):
    +19.9%/year over 29 years versus +10.1%/year for the S&P 500 index
2. Henry Singleton (Teledyne):
    +20.3%/year over 27 years versus +8.0%/year for the S&P 500 index
3. Bill Anders (General Dynamics)
    +23.3%/year over 17 years versus +8.9%/year for the S&P 500 index
4. John Malone (TCI)
    +30.3%/year over 25 years (up to ATT acquisition) versus +14.3%/year for the S&P 500 index
5. Katharine Graham (The Washington Post)
    +22.3%/year over 22 years (since IPO) versus 7.4%/year for the S&P 500 index
6. Bill Stiritz (Ralston Purina)
    +20.0%/year over 19 years versus +14.7%/year for the S&P 500 index
7. Dick Smith (General Cinema)
    +16.1%/year over 43 years versus +9%/year for the S&P 500 index
8. Warren Buffett (Berkshire Hathaway)
    +20.7%/year over 46 years (through 2011) versus 9.3% for the S&P 500 index

But then again, these guys are really special.   You're not going to find a lot of these lying around.

Let's take a quick look at valuation.

Valuation
The MBO of MacDermid happened at around 9x EV/EBITDA. Since MacDermid was a publicly listed company, you can go to sec.gov and get 10-k's and other filings including the MBO merger proxy from 2007. I was going to use that proxy for valuation, but there is a more recent proxy from the Solutia acquisition by Eastman in early 2012.  There is probably a more recent acquisition/merger, but this is good enough for comparative transaction analysis.   Since this is not a Conde Naste publication and I don't have free interns working for me, I will do the comparative company analysis myself.

Anyway, here is some info from the Solutia merger proxy (dated May 2012, analysis by Deutche Bank and Moelis):

Date	Bidder	Target	Consideration	Total Enterprise Value ($ billion)
Core Selected Transactions
July 2011	Lonza Group Ltd	Arch Chemicals, Inc.	Cash	1.4
May 2011	Ashland Inc.	International Specialty Products Inc.	Cash	3.2
April 2011	Solvay S.A.	Rhodia S.A.	Cash	7.3
March 2011	Berkshire Hathaway Inc.	The Lubrizol Corporation	Cash	9.6
July 2008	Ashland Inc.	Hercules Inc.	Cash and Stock	3.4
April 2004	The Lubrizol Corporation	Noveon International, Inc.	Cash	1.8
Other Selected Transactions
October 2011	American Securities LLC	Unifrax I LLC	Cash	0.9
July 2011	Ecolab Inc.	Nalco Holding Company	Cash or Stock	8.1
June 2010	BASF SE	Cognis Holding GmbH	Cash	3.2
September 2008	BASF SE	Ciba Holding AG	Cash	5.0
July 2008	The Dow Chemical Company	Rohm and Haas Company	Cash	18.9

Date	Bidder	Target	Consideration	Total Enterprise Value ($ billion)
August 2007	Akzo Nobel N.V.	Imperial Chemical Industries PLC	Cash	10.7
May 2007	Saudi Basic Industries Corporation	GE Plastics business of General Electric Company	Cash	11.6
September 2006	Court Square Capital Partners II, L.P. / Weston Presidio V, L.P. / Management	MacDermid Incorporated	Cash	1.3
September 2006	Apollo Management L.P.	GE Advanced Materials business of General Electric Company	Cash and Stock	3.8
February 2006	BASF SE	Construction Chemicals business of Degussa AG	Cash	3.2
March 2005	Texas Pacific Group	British Vita PLC	Cash	1.3
March 2005	Crompton Corp.	Great Lakes Chemical Corporation	Stock	1.8
February 2005	Cytec Industries Inc.	Surface Specialties business of UCB SA	Cash	1.8
July 2004	Apollo Management	Borden Chemical Inc.	Cash	1.1

With respect to each selected transaction and based on publicly available information, Solutia’s financial advisors calculated the multiples of the target’s total enterprise value to its EBITDA for the twelve-month period prior to announcement of the applicable transaction, which is referred to below as “TEV / LTM EBITDA.”

This analysis indicated the following:

Selected Transactions TEV/LTM EBITDA Multiples

High

Mean

Median

Low

Core Selected Transactions

9.2x

8.3x

8.7x

6.9x

Other Selected Transactions

12.4x

9.3x

6.1x

All Transactions

12.4x

9.0x

6.1x

So anyway, this analysis includes transactions between 2004 and 2011 so includes a lot of deals. The core selected group deals were done at a mean of 8.3x EV/LTM EBITDA which looks lower than the current MacDermid deal. For all transactions, the multiple is 9.0x. Platform paid 10.0x last twelve months adjusted EBITDA so looks higher than previous deals.

The comparative listed valuations in the 2012 proxy for Solutia is a little dated since the market has done very well since early 2012, so here is my quick update on the listed comps. I just took the last twelve month figures, EV and things like that from Yahoo Finance.

Publicly Listed Comps (Specialty Chemicals)

This is the same universe of comps that was in the Solutia proxy. It looks like specialty chemicals trade at around 10x EV/EBITDA, so the deal price is within range of where specialty chemicals trade these days.

But here's the interesting thing. McDermid is asset-lite and has very little capex; they generate a lot of free cash (sound familiar?). Here's a slide from their recent presentation:

If they are generating 90 cents of free cash (unlevered, pretax) per $1.00 of EBITDA, then a 10x EV/EBITDA might be pretty cheap. With 90% cash conversion, then a 10x EV/EBITDA translates into a 11x EV/(EBITDA-Capex).

The table above shows that EV/(EBITDA-Capex) for specialty chemicals averages 21x. Average capex to sales is 8% versus less than 2% at MacDermid. Free cash conversion is only a little over 50% at other specialty chemicals versus over 90% for MacDermid. So on that basis, it looks like a good deal.

Cumulative Preferreds
MacDermid planned on doing an IPO in 2011 / 2012 so they filed an S1 (and many amendments). It's a good summary of what MacDermid is about.

One thing jumped out at me that shouldn't be an issue going forward. As part of the MBO in 2007, they issued payment-in-kind cumulative preferreds shares. This is from the S1 that shows how much the preferred owners are getting (or accruing):

	Year ended December 31,									Three months ended March 31,
	2011			2010			2009			2012			2011
(amounts in thousands)										(unaudited)
Statement of Operations Data:
Net sales	$	728,773		$	694,333		$	594,153		$	182,195		$	178,521
Cost of sales		388,298			371,223			333,963			95,884			94,980

Gross profit		340,475			323,110			260,190			86,311			83,541

Operating expenses:
Selling, technical and administrative		185,649			179,786			156,508			45,746			45,629
Research and development		22,966			21,005			20,103			6,718			5,359
Amortization		28,578			29,694			29,868			6,655			7,362
Restructuring(1)		896			6,234			4,228			114			(181	)
Impairment charges(2)		46,438			—			68,692			—			—

Total operating expenses		284,527			236,719			279,399			59,233			58,169


Operating profit (loss)		55,948			86,391			(19,209	)		27,078			25,372
Other income (expense):
Interest income		500			696			458			175			108
Interest expense(3)		(54,554	)		(56,196	)		(60,740	)		(13,556	)		(14,088	)
Miscellaneous income (expense)(4)		9,412			15,106			(5,020	)		(4,353	)		(16,172	)

Income (loss) from continuing		11,306			45,997			(84,511	)		9,344			(4,780	)
Income tax (expense) benefit(3)		(9,953	)		(21,723	)		6,427			(4,366	)		(1,145	)

Income (loss) from continuing operations		1,353			24,274			(78,084	)		4,978			(5,925	)
(Loss) income from discontinued operations, net of tax(5)		—			—			(4,448	)		—			—

Income (loss) from continuing operations		1,353			24,274			(82,532	)		4,978			(5,925	)
Less net income attributable to the non-controlling interest		(366	)		(343	)		(295	)		(91	)		(88	)

Net income (loss) attributable to MacDermid, Incorporated		987			23,931			(82,827	)		4,887			(6,013	)
Accrued payment-in-kind dividend on cumulative preferred shares		(40,847	)		(37,361	)		(34,124	)		(10,788	)		(9,874	)

Net (loss) attributable to common shares	$	(39,860	)	$	(13,430	)	$	(116,951	)	$	(5,901	)	$	(15,887	)

From the balance sheet:

Stockholders’ Equity
Cumulative preferred shares, 316,000 shares authorized and issued, 315,254 shares outstanding at March 31, 2012 and 315,264 shares outstanding at December 31, 2011, respectively, including cumulative dividends of $175,237 and $164,449 at March 31, 2012 and December 31, 2011, respectively	$	491,237		$	480,449		—
Common shares, 50,000,000 shares authorized and issued, 9,946,140 shares and 9,946,439 shares outstanding at March 31, 2012 and December 31, 2011, respectively		50,000			50,000		314
Class A Junior shares, 430,000 shares authorized and issued, and 314,245 vested shares and 314,245 vested shares outstanding at March 31, 2012 and December 31, 2011, respectively		—			—		—
Class B Junior shares, 324,000 shares authorized and issued, and 100,156 vested shares and 49,878 vested shares outstanding at March 31, 2012 and December 31, 2011, respectively		—			—		—
Additional paid-in capital		2,254			2,156		542,171
Accumulated deficit		(280,359	)		(274,458	)	(280,359	)
Accumulated other comprehensive income		(9,261	)		(14,959	)	(9,261	)
Common and preferred shares in treasury, 746 preferred shares and 736 preferred shares and 53,860 common shares and 53,561 common shares at March 31, 2012 and December 31, 2011, at cost, respectively		(1,006	)		(994	)	—

Total Stockholders’ equity		252,865			242,194		252,865
Equity (deficit) in non-controlling interest		69			(388	)

Total equity		252,934			241,806

Total liabilities and equity	$	1,232,981		$	1,221,418

See accompanying notes to consolidated financial statements.

This looks really scary and unacceptable, but if the IPO happened, these cumulative preferreds would have been converted to common equity so on a pro-forma basis, those cumulative dividend accruals wouldn't be there (and wouldn't recur in the future).

The recent presentation doesn't include a detailed balance sheet so I don't know if these preferreds are still outstanding. If they are, I would assume that these preferreds will be converted into common equity.

The accumulated deficit of $280 million looks very un-outsider CEO-like. But much of this is MBO related; up until the end of 2006, it looked like a normal company (from their 2006 10-K):

	Twelve Months Ended December 31,
	2006	2005	2004	2003	2002
OPERATING RESULTS:
Net sales	$817,609	$738,043	$660,785	$619,886	$611,490
Earnings from continuing operations before cumulative effect of accounting change	$51,850	$47,043	$53,224	$49,820	$31,477
Earnings (loss) from discontinued operations, net of tax	—	—	—	5,592	(22,128	)
Cumulative effect of accounting change, net of tax	—	—	—	1,014	—
Net earnings	$51,850	$47,043	$53,224	$56,426	$9,349
Basic earnings per common share:
Continuing operations	$1.68	$1.55	$1.76	$1.60	$0.98
Discontinued operations	—	—	—	0.18	(0.69	)
Cumulative effect of accounting change	—	—	—	0.03	—
Net earnings	$1.68	$1.55	$1.76	$1.81	$0.29
Diluted earnings (loss) per common share:
Continuing operations	$1.66	$1.52	$1.72	$1.59	$0.98
Discontinued operations	—	—	—	0.18	(0.69	)
Cumulative effect of accounting change	—	—	—	0.03	—
Net earnings	$1.66	$1.52	$1.72	$1.80	$0.29

		Restated(1)	Restated(1)	Restated(1)	Restated(1)
FINANCIAL POSITION AT YEAR END:
Total assets	$924,681	$819,927	$793,427	$709,794	$708,873
Long-term debt (including short-term portion)	$300,851	$301,275	$301,341	$301,761	$316,467
Shareholders’ Equity	$414,671	$339,077	$323,740	$251,570	$218,718
SHARE DATA:
Cash dividends declared per common share	$0.24	$0.24	$0.16	$0.10	$0.08

From the balance sheet:

Shareholders’ equity
Common stock, authorized 75,000,000 shares, issued 47,686,761 at December 31, 2006 and 47,131,950 shares at December 31, 2005, at stated value of $1.00 per share	47,687			47,132
Additional paid-in capital	57,584			42,869
Retained earnings	411,261			366,807
Accumulated other comprehensive income (loss)	22,924			(3,051		)
Less—cost of common shares held in treasury, 16,845,198 at December 31, 2006 and 16,546,763 at December 31, 2005	(124,785		)	(114,680		)
Total shareholders’ equity	414,671			339,077
Total liabilities and shareholders’ equity	$	924,681		$	819,927

So that's quite normal. The 2007 MBO was disastrously timed (right before the great recession) so the income statement and balance sheet looks like a total mess.

But if you look through the capital structure issues and just focus on the operations, it looks fine.

Great Annual Reports
I just read through the annual reports from 1994-2006 which are available at sec.gov. I wasn't familiar with MacDermid at all when it was listed, but the annual reports are really well-written. They are inspired by Warren Buffett.

Here's a snip from the 1998 annual report:

     Nineteen ninety-eight was an eventful year. After 60 years of
inspirational leadership Harold Leever, our Chairman, has chosen to become
Chairman Emeritus. He will continue as a Director. What a ride! In 1959
Harold, with a number of employees, bought out MacDermid's founder, Archie
MacDermid. In the early '60s, in what turned out to be a brilliant
strategic move, he led a tiny metal finishing cleaner company into the
electronic chemical business. This was a huge bet at the time, and we are
still enjoying its fruits today. Perhaps more importantly, Harold
established the MacDermid Philosophy. It is printed as usual on the
inside front cover of this report (before the numbers). Today the "Clan
MacDermid" with over a thousand members in 19 countries around the world
is as focused as ever on the Philosophy's core principles:

focus on the customer                     honesty and integrity
supreme worth of the individual    challenging and demanding environment
entrepreneurship                            teamwork and cooperation

Harold has been our spiritual leader for 60 years and will continue to be
forever. I hope you can join us to celebrate this milestone with Harold
and Ruth Ann at our annual meeting on July 22.
     Another important event in 1998 was a non-event which we believe
defines who we are as clearly as what did occur. We entertained acquiring
a fairly large company that would have immediately added to earnings per
share. But, given our optimism about our internal growth prospects, we felt
the acquisition would dilute per share results several years out and thus
turned it down. We are focused on building long-term shareholder value.

While acquisitions can be and have been important, we will issue shares only
when we receive at least as much in business value as we give. Tomorrow
becomes today rather quickly. Not only is that our responsibility to you,
but it is in our own self interest. Your employees, through our investment
plans and options, own 35% of the company. Many, like myself, have the vast
majority of our net worth invested in the company.

I added the italics.

The shareholders' principles were plagiarized (Leever's term) from Berkshire Hathaway with the permission of Warren Buffett.

MACDERMID CORPORATE PHILOSOPHY

OUR BUSINESS
     MacDermid Incorporated is in the international business of researching,
developing, acquiring, manufacturing, marketing, and servicing, for optimum
profit to us and our customers, specialty chemicals and systems for the chemical
treatment, surface preparation and finishing of metals, plastics and other
materials in accordance with accepted ecological and social considerations.
OUR CUSTOMERS
     We will create an industry image that automatically causes people in the
industries we serve to think first of MacDermid.
     We will justify their action by first thinking of the customers' needs ---
what's right for them makes it right for MacDermid --- by supplying a total
system including processes, know-how and services that assist in meeting all
their needs.
OUR PEOPLE
     We continue to believe in the supreme worth of the individual and the
dignity of his or her work for the benefit of all. We will provide the
opportunity for our people to fulfill satisfactorily their own personal
objectives and ambitions and reward them in proportion to their contribution
toward achieving the Corporate objectives.
     We will continue to be a place of opportunity where people "have the guts
to fail." We will encourage the entrepreneurs and innovators. We will
continually challenge the goals, objectives, organization and all the operating
and procedural aspects of our business and modify them when needed.
     Our progress and your progress, our Company's long-term advantage and your
long-term advantage, lie in our human resources. Other advantages that come
about from technological improvements, the opening of new markets, lower costs,
etc., all prove to be relatively short run. So, basically, it is the initiative,
the will and the motivation that people bring to their work on which we rely for
our survival and growth.
     We will continue to try to attract new people who have creative and probing
minds; people who will at times be disturbing -- questioning policy and
procedures. If we are wise, we will welcome it, resolve it, put it to work or
forget it.
     We will continue to expand with the best possible talent available and
continue to train them, and ourselves, so that we each increase our ability to
contribute to the Company's progress.
     We will each strive to exemplify the MacDermid Spirit of teamwork and
cooperation throughout the organization which has been instrumental to our past
and present growth as a corporation.
WHAT WE CAN EXPECT FROM YOU
     First and foremost, we expect of you a fundamental honesty --- honesty with
yourself, with your Company and with all those with whom you interact, whether
they be associates within our organization, our customers or society in general.
Character and strength have always been born of honesty and a willingness to
face up to the truth of each situation as it arises.
     Second, we expect and insist on hard work. An easy life, marked by the
absence of difficulty, builds neither character nor happiness. We believe that
self-realization of the individual is founded on accomplishment, which implies a
willingness to make the sacrifices necessary to get the job done the way it
should be done.
     Third, we expect you to accept responsibility. Every assignment you will
have carries with it a responsibility for accomplishment. Commit yourself to
achievement which you consider beyond the scope of your talents and then program
your effort to translate it into a reality.
     Fourth, we expect of you a loyalty --- loyalty to yourself, your family,
your associates, your organization and our customers. We have always worked
together as an organization and your own personal achievements will be measured
in terms of the contribution you make to our joint effort.
     Fifth, we expect you to demonstrate good judgment. Judgment is essentially
an ability to appraise facts. Factual knowledge must come before good judgment.
This means you must continually educate yourself on our Company, our products
and our industry. In this way, you will have the material on which a sound
appraisal of good judgment is based.
     This is what we expect of you, and being in an extremely competitive
environment, we have a real urgency in this expectancy.
WHAT YOU CAN EXPECT FROM US
     One, you can expect from us the fairest treatment of which we are capable
--- fair in respect to matters of compensation, fair in respect to working
conditions and fair in respect to personnel policies.
     Two, you can expect from us, as a Company, complete honesty in whatever we
do. Your assignments will never compromise the principles of honesty and common
decency which we also expect you, as an individual, to uphold.
     Three, you can expect that we will provide assignments which will represent
challenges to you --- assignments which will enable you to grow toward your
professional and personal objectives.
     Four, you can expect that we will offer opportunities for advancement. Our
desire is to grow from within.
     Five, you can expect that we will be a demanding organization --- demanding
of your time, your talents and the best which you as an individual have to
offer. In this way our company will grow and you will grow with it.
     Perhaps all this can best be summarized in these words from an unknown
author:
"Create mental pictures of your goals, then work to make those pictures become
realities.
Exercise your God-given power to choose your own direction and influence your
own destiny and try to decide wisely and well.
Have the daring to open doors to new experiences and to step boldly forth to
explore strange horizons.
Be unafraid of new ideas, new theories and new philosophies.
Have the curiosity to experimentto test and try new ways of living and
thinking.
Recognize that the only ceiling life has is the one you give it and come to
realize that you are surrounded by infinite possibilities for growth
and achievement.
Keep your heart young and your expectations high and never allow your dreams to
die".

MACDERMID SHAREHOLDER PRINCIPLES

1.OUR VISION IS TO BUILD ONE OF THE WORLD 'S GREATEST INDUSTRIAL COMPANIES
We believe that the excitement inherent in the culture of ultra high performance
will differentiate us from our competitors, who, while fine companies in their
own right, simply will find it impossible to keep up with the fighting Clan
MacDermid.
2.OUR FORM IS CORPORATE, OUR ATTITUDE IS PARTNERSHIP
Unlike many public companies, our employees and Directors own close to 33% of
the shares, so, we obviously think as owners. We hope that you consider your
investment in MacDermid as being a part owner of a business, much as you would
if you owned a small business in partnership with your close friend or family.
You would not be concerned about the evaluation of that small business weekly or
monthly. Many employees, including your CEO, have the vast majority of our net
worth in MacDermid stock. We intend to be very long term holders, thinking in
generational terms. We desire to partner with like-minded individuals and
institutions. We will not respond to short term pressures from the market.
3.WE FOCUS TO BUILD INTRINSIC VALUE,PER SHARE
We define intrinsic value as the present value of free cash flow, measured per
share. Cash flow will be invested in growth opportunities. We will build in
significant margin for error in investment assumptions. We have no interest in
top line growth for growth's sake. Per share cash flow is what counts. Our goal
is to increase per share intrinsic value by 25% per year. We believe in setting
stretch targets even though sometimes we may fall short of our goals.
4.PERSONAL AND CORPORATE RESPONSIBILITY
MacDermid will demonstrate the highest standards of personal and corporate
ethics and responsibility, with special emphasis on our environment. We take
seriously our leadership commitment to the communities in which we do business.
5.CARE OF OUR PEOPLE IS A TOP PRIORITY
We know to build one of the world's greatest industrial companies requires an
unusual partnership with the people charged with making the vision a reality. We
are guided by the MacDermid philosophy, including our clear statement of
commitment to our people, and our expectations of their commitment to MacDermid.
We maintain policies that encourage long, productive service. We avoid short
term policies like layoffs and restructuring simply to make the current quarter
or year numbers. That's not to say that we will not have reductions in staffing
based on performance, or if we feel the long term health of the business
requires us to do so. But even then we will do so with great reluctance. Our
people are our most important asset. We treat them as such by investing heavily
in training and education and management development.
6.LONG TERM INVESTMENT HORIZON
We will aggressively fund sound internal growth opportunities mostly in research
and market development regardless of short term impact. We will fund these
opportunities when the time is right, not necessarily when it is convenient. Our
internal investment opportunities normally offer an exceptional return, but
often require multi-year horizons. We will avoid the stop-start method of
investing, which is typical of a short term mentality.
7.LOW COST OPERATING STRUCTURE
We know that our ability to invest aggressively requires us to have a cost
structure lower than our competitors. Investing AND lowering our current costs
constantly is a core principle of our company.
8.HIGH OPERATING MARGINS
Growth opportunities will be passed through a margin filter prior to investment.
9.LOW CAPITAL EXPENDITURES
We invest shareholder funds in high return assets after a healthy margin for
error. Bricks and mortar have no attraction if they will not produce a high
return.
10.CAPITAL STRUCTURE
Cost of capital is an important consideration. Our ability to generate
relatively high amounts of cash allows us to carry significant debt while still
maintaining a healthy margin for error. We will issue common stock only when we
receive at least as much in intrinsic value as we give.
11.DIVIDENDS
Our current dividend is a result of history. Increasing our dividend is not a
high priority. We believe we can better serve shareholders by using internally
generated funds to grow the business or purchase shares.
12.ACCOUNTING
We will be candid in our reporting to you. We will tell you the business facts
that we would want to know if the positions were reversed, while safeguarding
information which would aid our competitors.
13.REPORTING
We will be communicating with you in several ways. Through our annual report, we
will try to give all shareholders as much value - defining information as
possible. At our annual meeting we will spend as much time as necessary to
provide information and answer questions. The forum section of our web site,
macdermid.com, provides shareholders the opportunity to submit questions
directly to the CEO. We will answer questions honestly and as promptly as
practicable. In all of our communications, we try to make sure that no
shareholder gets an edge. Our goal is to have all of our shareholders updated at
the same time.
14.FAIR VALUE
To the extent possible, we would like each MacDermid shareholder to record a
gain or loss in market value that is proportional to the gain or loss in
per-share intrinsic value. Obviously we cannot control MacDermid's share price
but by our policies and communications, over time we believe, are likely to
attract long term investors who seek to profit strictly from the progress of the
Company.

From the 2002 annual report

A COMMENT ON WEIGHING VS. VOTING: Many of our shareholders know we are long
time followers of what I call "Buffett Principles", taken from the business
philosophies of Warren Buffett. An important Buffett principle is, "In the
short term the stock market is a voting machine and in the long term it is a
weighing machine". This means that at any given point in time the market may
overreact in it's valuation of a particular stock, either too high or too low.
In the case of the late 90's bubble it overreacted towards the whole market.
Just because the market says the dot com is worth so much "per hit", it doesn't
mean it is so - long term. A business model that generates no cash over time is
valueless. Further this principle holds that over time, financial performance
and market value tend to converge. This principle is what drives our cash flow
discipline. Frankly I wouldn't take great comfort if I thought I had to depend
on Wall Street to "vote" on our relative success. Our cash flow in effect
allows us to take matters into our own hands. Here's an overly simple example.
Say we generate $60 million in free cash flow per year for the next ten years.
At the end of ten years we would have $600 million in cash in the bank. Today
our market cap is a little over $600 million. Do you think all else being
equal, our market value would still be $600 million, or equal to only the cash
in the bank? Not likely. Regardless of how depressed Mr. Market felt at the
time, one would assume the more objective 'weighing' would have to take over at
some point. Maybe a better way to look at it is as follows. Assume Mr. Market
was depressed for the whole 10 years, our stock price never moved, and we simply
took the cash and bought back our stock each year. In ten years there would be
one share left that generated $60 million in free cash! I think Mr. Market, no
matter how depressed he was, would offer more than $20 for $60 million in cash
flow! So, we believe that it is a mathematical certainty that if we perform we
will be rewarded over time. The end result is called intrinsic value, defined
as the total amount of cash that can be taken out of a business over its life,
valued in today's dollars. The above example is admittedly superficial and
overly simplistic. However, we have run detailed and sophisticated models and
firmly believe our future is very bright, even using very conservative
assumptions. There is simply no peer company of any size large or small that
comes anywhere close to our cash flow performance. If you want proof, I
recommend you spend the money to come to our meeting for interested shareholders
and investors in Omaha, Nebraska on May 2. At this meeting we will go through
the detailed models and attempt to compare relative valuations over time between
our model and a traditional model.

SEE YOU IN OMAHA. As mentioned above we will hold a meeting for interested
shareholders and investors in Omaha, Nebraska on May 2, two days after our
normal annual shareholders meeting in Waterbury, Connecticut. In addition we
will hold a four day leadership meeting in Omaha at the same time. One hundred
of our top managers from around the world purchased a $2,000+ share of Berkshire
Hathaway this year in order to attend the meeting. We will attend the Berkshire
meeting en masse and then spend a couple of additional days discussing value
creation. As much as I respect Mr. Buffett and believe in the "Berkshire
Principles", the reason we feel so compatible is due to the MacDermid heritage,
most of which was established by my father Harold Leever 50 years ago. If these
principles seem familiar, it's because they are the foundation of MacDermid.

So go ahead and check out the annual reports, the letter to shareholders of MacDermid going back. They are really well-written.

A Look at Some Historical Figures
The key here that grabbed my attention was the high cash flow generating ability of MacDermid. 90% or more of EBITDA becomes free cash flow to them which is very high compared to other specialty chemicals (see above table). Also, their capex is less than 2% of sales. I was wondering if this is sustainable, or if it is just starving needed capex. You never really know in these situations. Sometimes companies will dress things up for a sale or IPO.

So I jotted down some figures from the old filings to see what these figures looked like in the past. Instead of EBITDA, I just used operating income plus depreciation and amortization (OIBDA) because there was less math to do. The ROE figure below is what I calculated using beginning and ending shareholders equity so it won't be exactly the same as what MacDermid reported (ROE wasn't always reported so I decided to use my calculation for consistency through time).

What Leever calls owner earnings in the annual reports is cash flow from operations minus net capex with adjustments for working capital changes, but in my table it's just cash flow from operations minus gross capex. This (owner earnings) wasn't reported consistently throughout the period so I just use my calculation throughout for consistency.

Also, in the recent presentation, they use adjusted EBITDA. None of my figures below are adjusted. The EPS figures are adjusted for a split so is consistent throughout the period.

I split the table in two so you don't have to use a magnifying glass to read it:

MacDermid Financials 1994 - 2006

During this period, sales grew +15.2%/year, net earnings +17%/year, shareholders equity +16.3% and EPS grew +17.4%/year. But you will notice that a lot of the growth came in the period up to 2000.

One of the key measures we are interested in, capex as a percentage of sales, has in fact been pretty low even going back. The average for the 1994 - 2006 period is 2.3%, and since 2001 it has been conisistently under 2.0%. I suppose one can argue that capex was higher when they were growing more pre-2000, but I think a lot of that has to do with the problems they faced in the economy in 2001/2002, restructuring and things like that; they have been recovering since then.

Here is some more detail:

Free Cash Generation 1994 - 2006

First of all, we notice that ROE is pretty decent averaging 21% throughout the period. But again, the period up to 2000 is clearly much higher than post 2000. The OI / avg total cap figure is my proxy for return on capital; it's operating income divided by average shareholders equity plus long term debt. It's a pretax figure, and it shows decent returns.

OIBDA is my EBITDA proxy (less math since it's easier to add operating income, depreciation and amortization than to add earnings, taxes, interest expense, depreciation and amortization). It seems OIBDA margins were pretty good but are now much higher (EBITDA margins above 20% from the recent presentation).

The column all the way to the right shows my proxy for the cash conversion ratio. Again, my figure is different than what they use (OIBDA versus EBITDA, gross capex versus net capex, net working capital adjustments not included in my calculations etc).

But it does show their cash conversion over the whole period is 85% which is pretty high. Even during the period of higher growth, returns and margins (before 2000), cash conversion was above 80%.

So it does look like this high free cash flow generative model is sustainable and is not a case of starving capex for the short term.

Conclusion
This post may be jumping the gun a bit since there hasn't even been a filing for the NYSE listing. I'm sure there will be more detail we need to look at before deciding if this is an interesting investment. I would love to know the final capital structure and ownership details (would love to see if Leever still owns a lot; I know he will roll over his current equity ownership into the new PSP).

But so far this is very interesting to me as:

Management does seem to be outsider CEO-like and even founder/CEO-like as a substantial portion of his net worth was invested in the company. The current CEO, Daniel Leever's father ran the business for decades so it's sort of a family business in that sense too. The annual reports are great.
The high free cash flow generative ability and the fact that this model has been sustained over time is very interesting.
This is not a "a bunch of successful rich guys are involved in this so it should work" kind of investment idea, even though that was the catalyst to make me take a look at this. I wouldn't invest in this just on the reputation of the backers. But it is obviously a positive factor.
So this is like a compound option (a call option on a call option? Don't ask); you have an outsider CEO (Franklin) buying a company run by another outsider CEO (Leever) backed by a very good stock picker (Ackman).

There are many questions to be resolved, obviously. I guess the biggest one would be Daniel Leever and his plan for the future. He is 65 years old now; his father worked until he was 83 years old (but remained Chairman Emeritus) so there is still plenty of room. But in annual reports in the past he did seem to mention the lack of bench depth. I wonder what the situation is now in terms of succession plans. I also wonder if Leever still has most of his wealth tied up in MacDermid.

Leever has said in the past that their goal was to grow per share intrinsic value at 25%/year. They have come nowhere close to that, which is OK. It's better to have a high goal and do OK rather than to try too hard to make the goal and blow up AIG-like. It seems like the growth plans were thrown off with the recession back in the early 2000s, and obviously the MBO was very poorly timed happening in early 2007 right before capitalism jumped off the cliff.

In any case, I have found enough here of interest to "start a file" on it.

The Brooklyn Investor

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Friday, November 29, 2013

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