Tag Archives: Case Study

An Insider’s View of Capital Allocation (Corporate Finance and Valuation Case Studies)

This is includes an important reading found here: http://www.scribd.com/doc/75125923/Capital-Structure-and-Stock-Repurchases-Value-Vault.  Also in the Value Vault.

The 58-page document will start with buy backs from a corporate finance (an insider’s) perspective as described by Mr. Louis Lowenstein, the CEO of Supermarkets General and a Law Professor at Columbia University. Then you will read what the masters, Buffett and Graham had to say on the subject. If, when and how a company buys back its shares says a lot about the business and capital allocation skills of management as the Case Studies of Teledyne Corporation and others will show. You will learn the importance of context and circumstance as the principles of good and bad capital allocation are applied. I hope you find the lessons instructive.

From the introduction

Whether the business is a franchise or not, management has two major jobs: operate the business efficiently which is critical in a non-franchise business since earning the company’s cost of capital is the best outcome and allocating capital effectively. Growth is only profitable in a franchise business, therefore capital allocation is critical for shareholder returns.  If a franchise’s core business is unable to grow, often free cash-flow can’t be redeployed at the same high returns. Capital might need to be returned to shareholders but how much and in what way?

Thinking about what management will do with excess cash is important for your valuation work. Should the excess cash on the balance sheet be discounted heavily because management tends to make poor choices (Greenblatt) or will management buy-in shares, causing the per share value to rise (Duff & Phelps valuation case study)?  You will be given a corporate insider view on these issues.

Share repurchase programs should be an integral part of a company’s capital allocation process, one in which management weighs reinvestment opportunities not only against the alternative of cash dividends but also both of those alternatives against a third alternative, the buyback of common stock. Management has several capital allocation alternatives:

Business Needs: Working capital, Capital expenditures, and Mergers & acquisitions

Return Capital to Shareholders: Dividends, Share buybacks, and Debt repayment

You will gain many insights from your reading.

Supplementary materials from a reader:

http://www.capatcolumbia.com/MM%20LMCM%20reports/Clear%20Thinking%20about%20Share%20Repurchase.pdf

Dividends from an investor’s perspective:

Valuation Case Study (ADPI) and Comparison with Fairness Opinions

One trick to hone your valuation skills is to read merger proxies. Thank you Mr. Michael Price.  Investment Bankers will do a valuation for an acquirer in a “Fairness” Opinion.  You will learn more about how Wall Street values companies than through reading the typical brokerage research report.  Investment bankers often lean heavily on multiples of comparable companies in arriving at their valuation. I wonder if the analyst arrives at a conclusion and then works backward.

Insight into other companies within an industry is another reason to read merger proxies.

Try to value American Dental Partners, Inc., ADPI, then compare your work to the investment bankers.

Go here to pick up the case study: http://www.scribd.com/doc/74913098/ADPI-Fairness-Opinion-2011

Good luck.

Sealed Air Valuation Case Study

This is one of the tougher valuation assignments that you will encounter. Place an approximate value on Sealed Air (SEE) 1998.

Use the 10-K: http://www.scribd.com/doc/74030312/Sealed-Air-1998-10-K

My class notes on valuing Sealed Air are here but avoid viewing until after you complete your valuation. http://www.scribd.com/doc/74030486/Greenwald-Class-Notes-6-Sealed-Air-Case-Study

Class handout on doing the valuation: http://www.scribd.com/doc/74030440/Sealed-Air-Case-Study-Handout

The video on this valuation can be found in the Value Vault.

Just email me at aldridge56@aol.com and put: VALUE VAULT in the heading of your email and I will send you the link to the video on valuing Sealed Air.

My hat is off to you if you are able to do this valuation. If you are stuck then I suggest that you go through this blog and read other postings to learn about valuation.

Good luck!

Buffett Case Study on IBM

Do you understand Buffett’s reasons for investing in IBM?  What are the financial characteristics of IBM that are attractive to Mr. Buffett? Look at IBM’s annual report provided in the link below.

From a CNBC Interview

BECKY: Wait. Wait a second, IBM is a tech company, and you don’t buy tech companies. Why have you been buying IBM?

BUFFETT: Well, I didn’t buy railroad companies for a long time either. I—it’s interesting. I have probably—I’ve had two interesting incidents in my life connected with IBM, but I’ve probably read the annual report of IBM every year for 50 years. And this year it came in on a Saturday, and I read it. And I got a different slant on it, which I then proceeded to do some checking out of. But I just—I read it through a different lens.

JOE: What’s the different lens? What’s the different slant?

BUFFETT: Well, just like—just like I did with—just like I did with the railroads. And incidentally, the company laid it out extremely well. I don’t think there’s any company that’s—that I can think of, big company, that’s done a better job of laying out where they’re going to go and then having gone there. They have laid out a road map and I should have paid more attention to it five years ago where they were going to go in five years ending in 2010. Now they’ve laid out another road map for 2015. They’ve done an incredible job. First, Lou Gerstner, when he came in, he saved the company from bankruptcy. I read his book a second
time, actually, after I read the annual report. You know, “Who Said
Elephants Can’t Dance?” I read it when it first came out and then I went back and reread it. And then we went around to all of our companies to see how their IT departments functioned and why they made the decisions they made. And I just came away with a different view of the position that IBM holds within IT departments and why they hold it and the stickiness and a whole bunch of things.
 And also, I read very carefully what Sam Palmisamo…

BUFFETT: …Palmisano, yes, has said about where they’re going to be and he’s delivered big time on his—on his—on his first venture along those lines.

BUFFETT: The other thing I would say about IBM, too, is that a few years back, they had 240 million options outstanding. Now they probably are down to about 30 million. They treat their stock with reverence which I find is unusual among big companies. Or they really—they are thinking about the shareholder.

JOE: But you’re buying this after it’s really broken out the new highs this year, new all-time highs.

BUFFETT: We bought—we bought railroads on highs, too.

JOE: Yeah? They sent it—you know, stocks at new lows that, you know, can hit new lows where they…

BUFFETT: Right. I bought—I bought control of—I bought control of GEICO at its all-time high.

BUFFETT: No, I never talked to Sam. I’ve never talked to Sam. I’ve got this—I competed with IBM 50 years ago, believe it or not. I was chairman of a company, had, and I testified for IBM in 1980 when the government was attacking about on the antitrust situation. But I’ve never—I have not talked to Sam or now Ginni.

BECKY: You—this is the second time in the last several months that you’ve told us about a purchase you’ve made of a company you’ve been the reading annual reports for years.

BUFFETT: Right.

BECKY: Bank of America was the first.

BUFFETT: Right. I read those for 50 years.

BECKY: Read those for 50 years and you’re looking at companies a little differently. You never really bought tech stocks before. You had always said you don’t understand technology stocks.

BUFFETT: Right.

BECKY: Does this mean that this is a new era and you’re going to be looking at a lot of tech stocks and I guess chief among them, would you consider Microsoft?

BUFFETT: I—well, Microsoft is a special case because Microsoft is off bounds to us because of my friendship with Bill and if we spent seven months buying Microsoft stock and during that period they announced a repurchase or increase of the dividend or an acquisition, people would say you’ve been getting inside information from Bill. So I have told Todd and Ted and I apply it myself that we do not ever buy a share of Microsoft. I think Microsoft is attractive but that—but we will never buy Microsoft. It—people would just assume I knew something and I don’t, but they would assume it and they would assume Bill talked to me and he wouldn’t have. But there’s no sense putting yourself in that position.

BECKY: But…

BUFFETT: I can say I’ve never met Sam but I can’t say I’ve never met Bill.

BECKY: But does this change the rules of the game that you would actually look at technology stocks now?

BUFFETT: I look at everything but most things I decide I can’t figure out their future.

BUFFETT: Yeah, it’s a—it’s a company that helps IT departments do their job better.

JOE: Yeah.

BUFFETT: And if you think about it, I don’t want to push the analogy too far because it could be pushed too far. But, you know, we work with a given auditor, we work with a given law firm. That doesn’t mean we’re happy every minute of every day about everything they do but it is a big deal for a big company to change auditors, change law firms. The IT departments, I—you know, we’ve got dozens and dozens of IT departments at Berkshire. I don’t know how they run. I mean, but we went around and asked them and you find out that there’s—they very much get working hand in glove with suppliers. And that doesn’t—that doesn’t mean things won’t change but it does mean that there’s a lot of continuity to it. And then I think as you go around the world, IBM, in the most recent quarter, reported double-digit gains in 40 countries. Now, I would imagine if you’re in some country around the world and you’re developing your IT department, you’re probably going to feel more comfortable with IBM than with many companies.

JOE: Well…

BUFFETT: I said I competed with IBM 50 years ago. Go here: http://csinvesting.org/2011/09/17/buffett-investment-filters-and-cs-on-mid-continent-tabulating-company/

BECKY: Yeah.

BUFFETT: We actually started—I was chairman of the board, believe it or not, of a tech company one time, and computers used to use zillions of tab cards and IBM in 1956 or ‘7 signed a consent decree and they had to get rid of half the capacity. So two friends of mine, one was a lawyer and one was an insurance agent, read the newspaper and they went into the tab card business and I went in with them. And we did a terrific job and built a nice little company. But every time we went into a place to sell them our tab cards at a lower price and with better delivery than IBM, the purchasing agent would say, nobody’s ever gotten fired from buying—by buying from IBM. I mean, we probably heard that about a thousand times. That’s not as strong now, but I imagine as you go around the world that there are—there’s a fair amount of presumption in many places that if you’re with IBM, that you stick with them, and that if you haven’t been with anybody, you’re developing things, that you certainly give them a fair shot at the business. And I think they’ve done a terrific job of developing that. And if you read their reports—if you read what they wrote five years ago they were going to do and the next five years, they’ve done it, you know, and now they tell you what
they’re going to do in the next five years, and as I say, they have this terrific reverence for the shareholder, which I think is very, very important.

And I want to give full credit, incidentally, to Lou Gerstner because when he came in, I was a friend of Tom Murphy’s and Jim Burke’s, and they were on the search committee to find a solution when IBM was almost broke in 1992, and everybody thought they were going pretty far afield when they went to Lou Gerstner. And look what…

BUFFETT: Well, you don’t have to think of—you don’t have to think of another one, Joe. And if you read his book, you know, “Who Said Elephants Can’t Dance?” it’s a great management book. Like I said, I read it twice.

ANDREW: What was it when you’re reading the report? I mean, most investors who are trying to invest like you, they’re reading annual—what is it in the report that you said, ah, I missed it?

BUFFETT: Well, it was—it was a lot of interesting facts and you know, I
recommend you read the report, you know. Go here: http://www.ibm.com/annualreport/2010/
And I didn’t look at the pictures and I’m not sure there were any pictures.
I kind of like that, too. But there were—there were lots of things in that
report but the truth is, there were probably lots of things in the report a
year earlier or two years earlier that you say, why didn’t I spot it then? And
I think it was Keynes or somebody that said that the problem is not the new
ideas, it’s escaping from old ones. And, you know, I’ve had that many times in
my life and I plead guilty to it.

BUFFETT: I will tell you one very smart thing that Thomas Watson Sr. said. I knew Thomas Watson Jr. just a little bit. Tom Watson Sr., this applies to stocks. He said, “I’m no genius but I’m smart in spots and I stay around those spots.” And that’s terrific advice.

Case Study: Berkshire Hathaway–Avoiding Value Traps

A contributor, Sid Berger, generously provided us with a concise case study. Thank you Sid.

Berkshire Hathaway, Inc. Case Study – Avoiding Value Traps

“All I want to know is where I’m going to die so I’ll never go there.” – Charlie Munger

This article is the first in a series of case studies highlighting mistakes by famous value investors. This concept was unashamedly stolen from Mohnish Pabrai. See here for the article http://www.gurufocus.com/news/137071/mohnish-pabrai–his-project-to-learn-from-other-successful-investors-includes-comments-on-dell-and-aig.

In 1962, Warren Buffet came across a struggling textile manufacturer named Berkshire Hathaway. By any measure, the company was cheap. He bought shares from 1962-1965 at an average price of $14.86. This price was 22% below its December 31, 1965 net working capital of $19 per share.

It looked like a classic Grahamian purchase of a company for less than liquidation value. Buffett recognized that the business was unexciting but likely to generate a couple of good quarters which would give the stock price a temporary boost. Yet, Buffett let emotion rule and held on to the business and continued to plow more money into it. He finally pulled the plug in 1985.

What was wrong with Buffet’s investment process that led him to make this mistake? Could it have been avoided?

Buffett himself did a great post-mortem analysis in his 1985 letter to shareholders http://www.berkshirehathaway.com/letters/1985.html. I will draw upon that letter here but will expand upon some of the concepts and highlight their broader applicability.

First off, the company had absolutely no moat. That is, it had no durable competitive advantages such as brand name. To paraphrase Buffet, they couldn’t charge two cents more than their competitors because consumers had to have a Berkshire lining in their suit.

Second, textiles are an industry with no or low barriers to entry. As a result, any capex was simply wasted as all market participants countered with investments of their own. Standing on its own, Berkshire was presented with investment choices that would produce great returns. But, the investments were neutralized by each of the competitors making investments of their own. As Buffet stated, such a situation is like spectators at a parade all standing on their tiptoes to catch a better view – not much is actually accomplished.

Buffet also seems to have missed or at least minimized the threat of low-cost overseas competition. There were non-US textile mills where employees were willing to work for a fraction of Berkshire’s workers. Could Buffet have seen this coming? It’s difficult for me determine as I am not an expert on the textile industry of the mid-Sixties. He does note in his 1985 letter to Berkshire Shareholders that manufacturers in the Southern part of the US were thought to have an advantage over Berkshire because of their non-unionized workforce. So, he was at least aware that labor costs could be an issue.

More broadly, turnarounds seldom turn. Even the most gifted manager will have difficulty turning around a struggling company in a declining industry. As Buffet stated, “When a management team with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.” Buffet convinced himself that new management could turn around the Berkshire business, but the secular decline in the US textile industry was too much for anyone to defeat.

Also, if you’re producing a commodity, you better be the lowest cost producer. A low-cost structure is a powerful competitive advantage in that it enables a company to generate higher profits that it can reinvest into its business and distance itself from its competition. A low-cost structure also provides a business flexibility to use price as a weapon to take market share, weakening higher cost competitors who must match price and risk potential losses.

The Berkshire episode also contributed to Buffet’s move away from anchoring valuations on the balance sheet. For one thing, appraisals of liquidation value are typically unreliable. Buffet notes that Berkshire’s assets had been acquired for $13 million, had book value (after accelerated depreciation) of $866,000 and had replacement cost of $30-50 million. At auction, they fetched $163,122 gross or less than 0 net of expenses.

What checklist items does this case study produce? 1. Can the company be killed by low-cost overseas competition? 2. Is it a turnaround situation? Is this a mere blip (Amex) or an industry in secular decline (Berkshire)? Will it take large amounts of capex to turn it around? 3. Does the company have a moat? Does the industry have barriers to entry? Does the company have pricing power? 4. If the company produces a commodity, is it the low-cost producer?

Compare Berkshire with a Buffet success, See’s Candy. See’s Candy was a high quality business with durable competitive advantages that needed little capex and drowned in cash flow. Unfortunately, some companies failed to learn these lessons – even in the same industry.

See the Munsingwear case study, http://csinvesting.org/2011/09/12/case-study-munsingwear-a-test-in-thinking-strategically/. There, management continued to reinvest in the textile industry even though it was losing money on every sale.

How do these lessons apply to a company like Dell, which shows up in the portfolios of a lot of prominent value investors? In 2004, IBM sold off its PC division. At the time, the IBM CEO explained that the PC had become commodity-like and returns were unlikely to exceed IBM’s cost of capital. Is the US PC business the 2011 version of the New England textile industry in 1965?

Valuing Assets: Hudson General Valuation Case Study

When you look at a business, glance at the financial summary to gain a feel for the financial characteristics of the business, then go to the balance sheet. Or you can start with the balance sheet. Wall Street analysts often spend too much time on the income statement without looking at quantity and QUALITY of the assets that generate the income and cash flow.

Below is the link to the 1997 10-K of Hudson General Company.  Try to value this business and show your work.

http://www.scribd.com/doc/66990171/HUDSONGENERALCO10K405-1997

If you struggle, you can go to the book: Value Investing from Graham to Buffett and Beyond by Bruce C. N. Greenwald and read Chapter 4 starting on page 51.

The complete analysis will be posted in a few days.

June 4, 2012: Here is the analysis. (DON’T CHEAT. Try on your own first)

Hudson General Case Study_Read this Second

Valuing Hudson General and Analysis

Good luck

So What is it Worth?

Let’s take 15 minutes to look at assessing, valuing or passing on the case study with the link below:

http://www.scribd.com/doc/65500378/Case-Study-So-What-is-It-Worth

If you do the work, you will learn many moral, philosophical and business lessons from this case. I promise.

I will post late this week the “answer” or my analysis with further links on this company. We’ll have fun with this one.

Munsingwear CS Solution

Readers were given a case study on Munsingwear here:

http://csinvesting.org/2011/09/12/case-study-munsingwear-a-test-in-thinking-strategically/

Do the work and write out your analysis, then go here for the solution:

http://www.scribd.com/doc/65384865/Case-Study-Munsingwear-Analysis-Q-amp-A

The history of Munsingwear can be glanced at here:

http://munsingwearcorporate.com/thehistory.asp

 

 

 

 

Buffett Investment Filters and CS on Mid-Continent Tabulating Company

Granted Buffett is an obsessive genius.  But even a new investor can learn how he saves time by what is important in an investment’s success and how hard he works. Proper habits drive his results. We can’t become another Buffett, but a careful reading of this case study will dramatically help you as an investor. Focus on a huge margin of safety in your investments rather than predicting the future with a pro-forma spread-sheet model.

The link is here: http://www.scribd.com/doc/65352277/CS-of-Buffett-Filter-on-Catastrophic-Risk.

Lecture 3: A Great Investor Discusses Lear Corp and Value Investing

This lecture includes the 2005 10-K of Lear Corp starting on page 15. Begin reading the 10-K to determine if this is a good business; the price at $33 offers value and what risks are there in this investment. The lecture is here at:

http://www.scribd.com/doc/64823792/Lecture-3-a-Great-Investor-Discusses-Lear-Corp

There are many philosophical question and lessons in the discussion of Lear and what happened in this investment.