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Deliberate Practice: Dairy Queen 1997

July 07, 2012 | About:
whopper investments

whopper investments

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This is the first in a series of weekly posts aimed at establishing a process for becoming a better investor through deliberate practice, based on suggestions found in Moonwalking with Einstein and Outliers. I will post my analysis of the company, as well as a post-mortem of how the investment played out (if we’re studying a historical investment) and the next investment for analysis, next weekend. Please be sure to review why we’re doing this and my suggestions/instructions if you’ve yet to do so, and please leave your analysis in the comments of this post before next weekend if you choose to participate.**** This is our first post on deliberate practice, so I thought we’d kick the process off with a bang, by studying from the master himself.

Many of you know that Dairy Queen is today a small part of the Berkshire Conglomerate. What you may not know is that Berkshire acquired it in 1997, and it was public up until it was acquired.

And, thus, our first deliberate practice challenge: Attempt to value Dairy Queen in the year before Buffett bought it.

Some additional notes before I provide the relevant links: so as not to bias yourself, I encourage you not to look for any other press or filings related to the acquisition, other than the ones I provide below. I bet there’s almost zero chance that you know what Buffett actually acquired them for, so why risk the anchoring bias? I will provide all forms of follow up links in my post-mortem on the investment next weekend.

One last thing: Buffett successfully acquired DQ in late 1997, but I believe he also offered to buy them out (at a higher price!) in 1996. So, while I will give you the last 10-Q before Buffett bought them, feel free to value them exclusively on the two 10-Ks.

That said- here are the four relevant links.

Now try to guess what the company is worth! Good luck- look for my analysis and a post-mortem next weekend.


Rating: 3.9/5 (19 votes)

Comments

varunfriend
Varunfriend premium member - 2 years ago
Great exercize ... my valuation is posted on my blog at _http://compoundwealth.blogspot.com/2012/07/deliberate-practice-dairy-queen-1997.html

DQ is a franchise business selling fast foods and dairy products. Financials suggest it is a steady business with pricing power. Based on the table below, I estimate paying for earnings before taxes of about $55M / year.

1996
Income before income taxes56,745,147
EV multiple12.5
EV = EBIT * Multiple$709,314,338
Debt$24,760,321
Cash and cash equivalents$38,384,589
Equity Value$646,169,428
Outstanding Shares22,122,240
Price Per Share$29


I would not want to pay for more than 15 times earnings, so I expect that EV is not more than $850M and more than likely to be between $700M - $750M. So the buy out price should not exceed $35 and my preferred price would be between $29 - $30 per share.

MultipleEVEquity ValuePrice / Share
8$453,961,176$390,816,266$17.67
9$510,706,323$447,561,413$20.23
10$567,451,470$504,306,560$22.80
11$624,196,617$561,051,707$25.36
12$680,941,764$617,796,854$27.93
12.5$709,314,338$646,169,428$29.21
13$737,686,911$674,542,001$30.49
15$851,177,205$788,032,295$35.62


Adib Motiwala
Adib Motiwala - 2 years ago
Firstly this is an excellent exercise. thanks for doing this.

1) Growth Check: First thing you can notice from the income statement that sales have grown steadily each year and almost doubled from $210m to $411m in the decade. So, this is a nice growing business. Good start. Profits have followed the growth in sales as EBIT and Net Income have more than doubled over the same period.

2) Balance sheet: Cash and marketable securities $41m. Debt $14.5m. Net cash $26m. Also more shareholders equity than total liabilities.

3) ROIC: (using magic formula approach)

Invested capital = 89 - 40 + 14 = $64million (with excess cash not subtracted)

EBIT = $57 million.

Pretax ROIC = 89% ( likely more than 100% if you subtract excess cash). Sign of very high quality business.

4) FCF = $42million

5) Valuation as of 10-K, Market Cap = $306million

EV = $280 million

EV/EBIT = 280/57 = 5x! Certainly quite cheap given the profitability, growth, ROIC, etc

What would be fair value? I would consider 8-10x EBIT as fair value. More closer to 10x EBIT given the high quality business as seen by ROIC.

EV = 10 * 57 = $570 million

Equity Value = $570 + $26 = $596 million (round to $600 million)

Share Count 22.2m shares

Per Share = $26.8 or $27 rounded.

Thanks

Adib Motiwala

P.S In the previous analysis by varunfriend, both cash and debt seemed to have been subtracted from EV to arrive at equity value, which is incorrect.

varunfriend
Varunfriend premium member - 2 years ago
Good catch Adib. I did back out both Cash and Debt instead of Net Debt.

Based on correcting my mistake, I new equity estimate would increase to $723M and I would pay no more than $32.5 per share
Davidash76
Davidash76 - 2 years ago


So far both valuations (revised by Varunfriend and as well as Adib's) are very educational for me thus the importance of this exercise for newbies such as myself.

I do notice that there were different methods used and assume everyone has there own style. Having said that, there seems to be a difference in measurements between the two evaluations including the measurement of debt and enterprise value. I understand debt is a determinant of EV. I see 3mil on the 96 10K unless you consider the 10+m debt that is maturing in 1996 which if you add together, would get you to 14m. I don't see the 24 mil in debt offered by Varunfriend, nor do I see an objection by Adib similar to the one regarding backing out the cash in determining EV.

So I'm curious about the differences in debt presented in the two evals and EV. I am also curious as to the exercise. Are we supposed to value the company as in fair value which both of you seem to have done or would one need to factor a margin of safety in presenting a proposed purchase price. I don't see that is the case.

Again, thanks to you both and Whopper, this is very helpful and useful.

Invest E Gator
Invest E Gator - 2 years ago
Hi Whopper. I'm confused about the premise for Moonwalking with Einstein. Even with all of his developments in theoretical physics, wasn't he very anti-memorization?
Invest E Gator
Invest E Gator - 2 years ago
To give an analysis.

On the balance sheet we have $89 million in liquidable looking things in Current Assets, with $17 million in notes recv (I would have to dig deeper into this prior to buying), minus $40 million in current liabilities and $20 million in other liabilities. This gives like an instant cash bonus of about $50 million.

Along with the strong balance sheet, we see earnings per share are growing in the mid single digits. A PE of 10 is generally acceptable for a no growth company.

34,445,000 net income

x 10 earnings multiple

-----------------

344,450,000

+50,000,000 balance sheet bonus

------------------

390,000,000

They are a steal to purchase at a market cap of $400 million or what comes to $17.66 per share.

34,450,000 net income

x 15 earnings multiple

----------------

516,675,000

+50,000,000 balance sheet bonus

------------------

566,675,000

I would probably take a nibble on them at a market cap of about $566 million, or what comes to about $25 per share.

There are some business aspects that would have to be considered. Dairy Queen is not only the restaurant of their name but also other concepts like Orange Julius (even today I still never see anyone buy anything from those kiosks!), and even a staffing company. The Dairy Queen concept is fine, but some thoughts would have to be made into taking in the whole shebang.
Adib Motiwala
Adib Motiwala - 2 years ago
davidash76,

Here is I compute EV

1) Cash + Marketable Securities are considered cash. If you have Long term investments, you have to consider them as well. Maybe do not give full credit to them all if they are off shore , illiquid etc.

I kept it simple and added the two to get $41m

2) For Debt, i look at Short Term and LT Debt both. So you have _Current maturities of long-term debt = $11m and _Long-term debt = $3.5 m. Total Debt $15m. 3) Net Cash = $26m 4) EV = Market Cap + Debt - Cash. So you are right I dont know how varunfriend arrived at $24m in debt. And for Cash, he may have ignored marketable securities (maybe to be conservative?). Hope that helps
Davidash76
Davidash76 - 2 years ago
Adib,

Thank you for the explanation. That makes complete sense.

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