Baron Funds Comments on Pall Corp.
Our investment thesis has two components. First, we believe that Pall's business has attractive characteristics and good growth prospects. We particularly like Pall's life sciences business, in which Pall supplies a broad range of filtration products to the biotechnology industry.We think Pall is an attractive way to participate in the growth of the biotechnology sector without assuming the risks associated with the success or failure of any one particular biotechnology drug. Because of regulatory requirements, once Pall's products are incorporated into a biotech customer's manufacturing process, Pall's products are likely to be sold during the life cycle of the product, which provides an annuity-like revenue stream. Beyond the biotech business, Pall is well positioned to benefit from secular growth drivers that include stricter environmental regulations and growing demand for clean water and energy. Across the company's different end markets, Pall's products are largely non-discretionary for customers and represent a small portion of operating costs even though they perform critical roles. As a result, Pall has an ability to maintain stable pricing. In addition, most revenue comes from the sale of consumable products that need to be replaced, resulting in relatively predictable, recurring revenue. Pall's competitive advantages include close working relationships with customers; global distribution, service and support; and scientific, engineering and applications expertise.
The second element of our investment thesis is based on the transformation taking place at the company with a new management team at the helm. Pall's new CEO, Larry Kingsley, assumed the CEO role in October 2011 and has been implementing changes to improve business performance, expand margins and increase cash flow generation. Kingsley's long-term objective is to generate organic sales growth at over twice the rate of GDP and incremental operating profit margins of 30-40%. Kingsley also plans to utilize the company's balance sheet, which is underleveraged relative to the company's cash flow, to make acquisitions to enhance top line growth and generate attractive returns on invested capital. Through acquisitions and/or share repurchases, we believe that Pall should be able to generate mid-teens or better earnings growth. We think the company's valuation is attractive relative to our estimate of the company's future growth potential. (Neal Kaufman)
From Baron Funds’ first quarter 2013 letter.