Colfax Corporation (CFX)

OK, so this is another extension of the footnote to the book post.  Someone mentioned in the comment section that Colfax (CFX) is the younger analog to Danahar (DHR) and it is owned by some Tiger cubs and BDT Capital, a firm run by Byron Trott (Buffett's investment banker).

Here's the 2013 ownership section from the 2013 proxy:



Of course, what is interesting is that BDT Capital owns such a large percentage.  They did sell some shares in a public offering earlier this year but still own a large stake (or at least they didn't sell their entire position on the offering).  Probably the most important owner is Steven M. Rales; this is the Rales that founded Danahar (DHR).

Blue Ridge Capital, of course, is run by the Tiger cub John Griffin.  Tiger Global and other Tiger cubs own shares too.

Maybe interesting to the Buffett followers (other than Trott's involvement) is that Tom Gayner of Markel has been a board member of CFX since 2008 and Markel has owned a million shares or so since early 2012 (when CFX bought Charter, no not Malone's Charter, the Irish welding company... I know, this can get confusing).  Markel paid $23.04/share and BDT Capital got a bunch of shares at that price too in January 2012, related to the Charter acquisition.

Markel still owns it, and it looks like it's 2% or so of their equity portfolio.

Anyway, let's look at the chart:



CFX IPO'ed at $18/share back in 2008.  That was just when the world was falling apart and it shows in the stock price.  But over time, it has done incredibly well.   By the way, the red line is the S&P 500 index and the green line is Berkshire Hathaway.

History
Anyway, I have never heard of CFX until someone mentioned it the other day here.  CFX was originally started back in the mid 1990s with the backing of the Rales brothers.  As I was looking around the SEC filings, I found an S-1 filing for CFX from back in 1998.   I guess they filed an S-1 and never did the IPO. 

So here's a cut and paste from the August 1998 S-1 filing on the start of CFX:

Philip W. Knisely, with the support of the other Principal Stockholders,
embarked in 1995 to acquire, manage and grow world class industrial
manufacturing companies in the fluid handling and industrial positioning
industries. These industries were targeted due to their size, highly fragmented
nature and the Principal Stockholders' belief that these industries provided
the opportunity for accelerated growth and for improvements in operating
margins.

The Principal Stockholders have significant experience in acquiring and
leading multinational industrial manufacturing companies. Mr. Knisely, the
Company's President and Chief Executive Officer, has experience in managing
global industrial manufacturing operations for more than 15 years, including as
a group president of Emerson Electric Company and president of AMF Industries.
The Rales, who will serve as directors of the Company, are also directors and
principal stockholders of Danaher Corporation ("Danaher"), a New York Stock
Exchange ("NYSE") listed company and a leading manufacturer of tools,
components and process/environmental controls with a market capitalization of
approximately $5.6 billion as of July 31, 1998.

  The Company intends to expand its operations through internal growth and
acquisitions. The Company believes that there is a significant opportunity to
increase the internal growth of the Acquired Companies and of
future acquisitions by implementing the Colfax Business System ("CBS"), a
disciplined strategic planning and execution methodology designed to achieve
world class excellence in customer satisfaction. CBS is a customization of a
system which has its roots in the world-recognized Toyota Production System. A
similar system has been successfully deployed at Danaher for more than 10
years. Management has begun implementing CBS in each of the Acquired Companies
and believes that it has resulted in cost savings that have contributed to an
improvement in the Company's pro forma results of operations, as shown in the
following table:

<TABLE>
<CAPTION>
                                                         UNAUDITED PRO FORMA
                                                           SIX MONTHS ENDED
                                                      JUNE 30, 1997 JULY 3, 1998
                                                      ------------- ------------
                                                        (DOLLARS IN THOUSANDS)
   <S>                                                <C>           <C>
   Net sales.........................................   $272,006      $277,201
   Adjusted operating income(a) .....................     22,155        33,364
   Adjusted operating income margin..................        8.1%         12.0%

And like the other outsider companies, the main growth strategy is:

GROWTH STRATEGY

. INTERNAL GROWTH

  The Company believes that there is significant potential to increase the
  internal growth of the Acquired Companies and of future acquisitions.
  Through the implementation of CBS, the Company will seek to grow internally
  by focusing on customer needs and striving to improve product quality,
  delivery and cost. Specific actions to accomplish these goals include: (i)
  leveraging its established distribution channels; (ii) introducing
  innovative new products and applications; (iii) increasing asset
  utilization; (iv) using advanced information technology; (v) increasing
  sales and marketing efforts; (vi) expanding and diversifying the customer
  segments served; and (vii) expanding the geographic markets served.

. ACQUISITION GROWTH

  The Company believes that the fragmented nature of the industries in which
  it participates presents substantial consolidation and growth opportunities
  for companies with access to capital and the management ability to execute
  a disciplined acquisition and integration program. The Company's
  acquisition growth strategy is to acquire companies in the segments in
  which it participates that (i) have leading brands and strong market
  positions; (ii) will expand its product lines; (iii) have reputations for
  producing high quality products; and (iv) complement or enhance the
  Company's existing worldwide sales and distribution networks. The Company
  also believes that the extensive experience of its management team and the
  Principal Stockholders in acquiring and effectively integrating acquisition
  targets should enable the Company to capitalize on these opportunities. The
  Company intends to take a proactive approach to acquisitions and has
  currently identified approximately 50 potential acquisition targets in each
  of its two business segments located both in and outside the United States,
  although it does not currently have any agreements or understandings with
  respect to the acquisition of any such potential targets.

Their growth strategy is more detailed than this in their 2008 prospectus.  But the above pretty much shows you what the original intent was.

I don't know what happened since 1995 until the late 2000s when we get more information through the public filings.  Knisely no longer runs CFX; at some point it seems he went to work for Danahar (executive VP), retired and now is an advisor to Clayton, Dubilier and Rice (private equity shop).

Anyway, the Rales are still involved as owners and Chairman (like DHR) and that's the important thing.  We are looking for another DHR, right? 

By the way, here's the current CEO.  He's a DHR guy:

Steven E. Simms has been President and Chief Executive Officer since April 2012. He has served as a Director of Colfax since July 2011. Mr. Simms also served as Chairman of the Board of Directors of Apex Tools and is a former Executive Vice President of Danaher Corporation.  Mr. Simms held a variety of leadership roles during his 11-year career at Danaher. He became Executive Vice President in 2000 and served in that role through his retirement in 2007, during which time he was instrumental in Danaher’s international growth and success. He previously served as Vice President–Group Executive from 1998 to 2000 and as an executive in Danaher’s tools and components business from 1996 to 1998. Prior to joining Danaher, Mr. Simms held roles of increasing authority at Black& Decker Corporation, most notably President–European Operations and President–Worldwide Accessories.  Mr. Simms started his career at the Quaker Oats Company where he held a number of brand management roles. He currently serves as a member of the Board of Trustees of The Boys’ Latin School of Maryland and is actively involved in a number of other educational and charitable organizations in the Baltimore area.

He's only been on the job for a little more than a year. 

Anyway, let's take a look at how CFX has done over the years.  I'm too lazy to make a table so I'll just snip stuff from the annuals so you can get a sense of how they've done:

This is from their 2008 annual report; the first annual after their IPO.  Things looked fine.  Sales are up, margins are going up etc.  Adjusted EPS is $1.22, so the IPO was priced at around 15x the current year EPS.  Their margins were going up thanks to CBS (Colfax Business System), and was up to 15.0%.  Hold that thought because we'll need it.  By the way, DHR has operating margins north of 15% (17.3% in 2012).

 

And things sort of start falling apart along with the economy.  This is from the 2009 annual report:

And finally this is the five year financial summary from the 2012 10-K:

So it wasn't smooth sailing through the great recession like some of the other outsider companies.  But look what happened in 2012.  In January, they did a huge deal, obviously.  I guess we can call that a tranformational acquisition since it's so big. That's the Charter acquisition that brought in Markel and BDT.

Now look closely at the operating margin.  Even excluding all that acquisition-related and restructuring charges, operating margin is really low.

Remember, how is CFX going to grow?  Through acquisitions and CBS (Toyota-like improvement system), right?  Yes, organic growth too.  But acquisitions and margin expansion are two big drivers.  So for CFX to make such a huge acquisition and for BDT, Markel and others to support it by providing equity funding for the deal, there must be some huge operational improvement potential at Charter, right? 

So that's the story right there.  Of course, the main, full-time story is that CFX will grow like DHR did and like other outsider companies.  But the story now is this huge deal that they did, and I think it's obvious that they know Charter's business well enough to have confidence that they can really get their margins up. 

Valuation
So let's get to the interesting part.  Yahoo finance says that CFX is trading at 60x ttm P/E and 22x next year's estimate EPS.  CFX is guiding $2.00 or so for December 2013-end full year EPS.  At $56, that's 28x P/E.   I notice that there are people calling to short this overvalued stock based on this P/E.

But with shareholders like the above, we know this can't be right.   We have to look beyond the headline metric to see what is actually going on.

So check this out. This is from their June 2013 investor presention:

So the model for the top line is to outdo GDP by 1-2% on an organic basis and then add to that via acquisitions; something that the Rales have sort of been good at doing historically.

And here's the key for my current back-of-the-napkin analysis:  Margins.  They target mid-teens operating margins.  Let's call that 15%.  This was once achieved by CFX (see above 2008 annual report) and is currently done by DHR, so there is no reason why it can't be done here.  In recent years, there was the financial crisis and then this huge megadeal.  But when they work through this huge deal, there's no reason why they can't get up to 15% operating margins.  Well, yes, things can go wrong.  The economy can fall apart etc.   

Also, like DHR, they will get free cash flow above net income.  There's no reason why they can't do that either. 

By the way, here's what the big deal did to their revenues:

They have higher exposure now to higher growth markets.   This may have backfired in the short term as it seems like former high growth markets are having problems (China, Brazil etc...).  But that's probably a short term cyclical problem, and over time, the growth markets will tend to grow faster than the mature markets.

So let's get to the fun part.  This is going to be really rough work so don't take it too seriously.  I am just going to play with the numbers to get sort of a reality check on valuing CFX. 

What if CFX gets operating margins back to 15%?  What would earnings look like then? 

Here's the 2013 guidance from their 3Q earnings slide:

 



 

You will see that on the low end, they are guiding revenues of $4.1 billion, adjusted net income of $223 million and adjusted EPS of $1.98/share. 

Now let's just adjust the above to a 15% operating margin instead of 10%.  Then the above table would look like this:

Revenues:                              $4,120
Adjusted operating profit:        $618
Interest:                                    ($76)
Taxes  (@27%):                     ($146)
Noncontrolling interest:           ($31)       
                                                 $365

I'll just use 115 million shares (102 million shares outstanding plus 13 million dilutive shares) and we get $3.20 in adjusted EPS.   That's 17.5x P/E ratio if, all else equal, operating margin was 15%.

Wait, but there's more.  CFX seeks to have free cash flow exceed net income.  DHR had free cash above net income for 21 years in a row.  If the Rales are focused, they can get that done here too.  Why not? 

For a quick guestimate, I just looked at depreciation and amortization against capex.  For the first nine months of 2013, D&A was $102 million versus capex of $51 million.  So cash earnings were $51 million higher than net earnings so far this year.  Annualize that and you get around $70 million.

Add the $70 million to the above $365 million and you get $435 million in free cash.   That comes to around $3.80/share.   With a $56 stock price, that's 14.7x cash earnings, or free cash per share.  That's a 6.8% free cash yield.

So think about that.  And as they get their margins up there, sales will probably continue to grow and some of the softer emerging markets will start to come back.  So even without any sales growth, just by doing their Toyota thing, they can get almost a 7% free cash yield...  and then add to that the GDP plus 1-2% growth organically and maybe some potential acquisitions and more margin improvements there and you are talking about some serious potential compounding.

Oh yeah, on the earnings calls, they sort of talk about margins for their segments.  Segment margins and overall company operating margin will differ; segment margins don't include corporate overhead.  

I would think that CFX should get company level operating margins up to 15% at some point, but let's say that they only get their segment margins up to 15%.  In that case, we will have to lop off around $50 million for corporate SGA from the above $365 million.  This would make the above figures around 14% lower. 

Conclusion
I don't know why I keep writing 'conclusion' on these posts when I don't often have one.   I just wanted to take a look at this company as there seemed to be so many reasons why I should;

• it's an outsider-type company with a similar strategy
• and it's actually run by the Rales who have done it before with DHR (or at least Chairman'ed by them)
• has a distinguished shareholder list even though BDT seems to be selling.  Blue Ridge seems to have gotten in in the past year or so, so it's still fresh.  Markel still owns it.

Anyway, my analysis above is admittedly very rough, but I don't think it's a stretch to imagine that CFX can keep improving the operations and get their margins up.   This is what they do and what they are good at.  If they do so and they keep sales growing organically and through further acquisitions, I would not be surprised at all if CFX stock does really well.

Having said that, I've only spent a day or two on this so even though I like a lot of what I see, I can't say I am comfortable with it enough to own the stock (or at least own a big position in it).  Maybe I'll get more comfortable after looking more closely at DHR (and get familiar with the way the Rales operate) and following it in real time for a little.

 

Is the Next Teledyne the Old Teledyne?

OK, so I've known about Henry Singleton and Teledyne for a long time.  Buffett has said that he was the greatest capital allocator of all time.   Since I read the outsider CEOs book I got to thinking about Teledyne again.  I am embarassed to say that I have the book, Distant Force: A Memoir of the Teledyne Corporation and the Man Who Created It, by George A. Roberts (published in 2007), but haven't read it yet.  There are a lot of great books in my pile that I haven't gotten to.

Anyway, having read the outsider book, I obviously needed to bring that book up to the front of the queue.  And in the back of the book, there is a CD included with all the annual reports from 1969-1995.  This got me really excited, but unfortunately, I don't know what that stuff is since the 'annual reports' don't seem to include any financials or 'letter to shareholders' or anything like that.   They are scientific articles, basically.  (By the way, here's a business idea:  I would pay for a century worth of annual reports of companies, wouldn't you?   Say, like, all the Coca-Cola annual reports from 1900 - 2012 or something like that.  That would be fascinating to me. Even complete sets of companies that no longer exist would be interesting!)

So I surfed around the internet and duh, I realize that Teledyne (TDY) is still a listed company.   I figured TDY didn't exist on it's own and they were parts of other large corporations by now.  But TDY merged with someone in 1996 but was spun out again in 1999 as Teledyne (along with other parts of the old Teledyne, Water Pik (PIK) and Alleghany Technologies (ATI).  Water Pik was bought out by private equity and ATI is still listed (now I see why Joel Greenblatt was on the board of ATI; it must have been spin-off related).   All of this stuff is in the book, by the way (the merger and the spinoff, and the chapter "Teledyne Renaissance" written by the then (at spin) and current CEO Dr. Robert Mehrabian).

But then again, who cares, right?  TDY was a Henry Singleton story.  Singleton is no longer around so who cares about TDY?

I was surprised, though, at how well it has done since the spinoff.

Danaher (DHR) preview
Before I go on, though, someone in the comments section in my other post about the outsiders book mentioned that Thorndike wanted to do one more chapter but the management didn't want to talk (the guess was Leucadia which I agree is a good candidate).  Well, someone else mentioned in another comment some companies that were run by outsiders and one of them was Danaher (DHR).   DHR is a name that comes up when you talk about industrial conglomerates that are really good allocators of capital and I have looked at them in the past; shame on me for not owning any!

Check this out:

This is the stock price performance of DHR since 1990 or so.  The red line is Berkshire Hathaway, and the green line is the S&P 500 index.  This is just nuts, isn't it?

Yahoo Finance data only goes back to 1987.  According to that, DHR stock has appreciated 21.7%/year over the past 26 years.  That compares to 8.1%/year for the S&P 500 index (excluding dividends).  21.7% versus 8.1%.  That's mindboggling.

So wait a second.  How does this compare to the other outsider CEOs?  I will cut and paste from my original post and see how DHR compares:


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

9.  The Rales Brothers (Danaher)
    +21.7%/year over 26 years versus +8.1%/year for the S&P 500 index (excluding dividends)

Hmm... Seems to fit right in.  

OK, so anyway, DHR is a great company too.  Not completely unknown.  I will look at it in a later post but for now I would point out that they may look expensive at first glance due to the high P/E ratio (well, high for us bottom feeders) but I think the key is that they are earning a lot of free cash; their free cash to net income was 130% last year and has been consistently over net income in recent years.  So from that point of view, the raw P/E ratio may not be the best way to look at this.

Back to Teledyne
OK, so let's get back to TDY.  It's still listed and it has been doing quite well.   As Buffett would say, here lookit:

Again, like the other chart, the red line is Berkshire Hathaway (I'm not picking on Buffett; he's just a very good benchmark!), and the green line is the S&P 500 index.  This looks pretty good too, even though it would have been quite a rough ride over the years.  But you know, we are not supposed to care about price volatility as long as intrinsic value keeps going up.  I haven't followed TDY over the years so I don't have a strong sense of what these years were like for them.

That's a 18.1%/year return for the stock compared to +1.6%/year for the S&P 500 index (excluding dividends).  That's not bad either, and may be worthy of outsider status.  14 years might be a little short compared to the others (but General Dynamics was 17 years, so).

Anyway, who'da thunk TDY did so well post-Singleton?

August 2013 Investor Presentation
TDY too has a great investor relations website so let's snip some stuff from there:

Similar to Transdigm, they focus on highly engineered products.  From looking at the annual reports over the years, it seems like they started focusing more on transitioning over time.

 

This high SGA margin is an area they see as potential for improvement (and margin expansion). 

 

This EPS growth looks pretty good.  But some will argue that the $0.21 might be abnormally low so the CAGR over time is front-weighted.  So let's just look at different time periods:

EPS growth rates from the above graph were:

5 year:       +8.1%
10 year:  +17.3%

So not so bad even starting in 2003.  Of course, we have to keep in mind that the five year growth rate includes the great recession.

Again, if we focus just on P/E ratio, we might miss the more important free cash flow; raw P/E might make this look more expensive than it is.  A lot of opportunities arise when people are misled by 'headline' metrics.  Maybe this is one of those situations.

Anyway, TDY is certainly worth a look.  I haven't spent much time on this; this is just one of those tangents that came from reading that book. That's what's so great about reading!  And then I posted about it and I got other leads from the comments section so thanks to those who do post comments.

Oh, and one more quick thing.  Who is TDY run by? 

Who is Dr. Mehrabian?  
He is 71 years old as of the most recent proxy, so that's an issue; who knows how long he intends to stay on the job here (and what the succession plans are).  I haven't listened to any conference calls or anything like that so there is still a lot I don't know.

But anyway, here's a snip from the proxy:

As I said before, he wrote a section at the end of the Teledyne book; a chapter called "A Teledyne Renaissance".

Dr. George A. Roberts (President of Teledyne during the Singleton era and author of the Teledyne book) in the book says of Mehrabian (page 252; From Merger to Spin-off):

Among those included as new members of the combined companies was a highly competent individual well known to both Dick Simmons and myself, Dr. Robert Mehrabian, who now heads Teledyne Technologies, Inc.  He had been president of Carnegie Mellon University for seven years, and also served there as a professor of materials sciences and engineering.  He was an internationally known authority on advanced technologies, and after joining the board in 1996 he retired from the presidency of Carnegie in June 1997.  Alleghany Teledyne Chairman Richard Simmons offered him the position of senior vice president and segment executive to run the new company's Aerospace and Electronics segment.  A year later he was placed in charge of all Alleghany Teledyne companies other than the specialty metals operations...

So anyway, there you have it.  There is TDY doing wonderfully long after the passing of Henry Singleton. 

This is not a recommendation to go out and buy TDY, of course.  I haven't done any serious work on this yet.  But yes, it's certainly one that belongs on a watch list.