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Murray Stahl’s Horizon Kinetics Comments on Platform Specialty Products

June 26, 2014 | About:
Vera Yuan

Vera Yuan

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A recent purchase in certain strategies is Platform Specialty Products (PAH). Like Wendy’s (WEN), this stock does not trade at a presently low price-to-earnings, or P/E ratio; in fact, it’s somewhat high. However, the company incorporates many predictive attributes that are suggestive that its revenues and earnings several years from now will be far higher than they are today. As a U.S. company, PAH is new, having been listed on the NYSE only since this past January. Its operating business, though, has been around for over 90 years, and PAH was trading on the London Stock Exchange when it was acquired this past October for $1.8 billion by what is known as a blank-check company. The current stock market value is $2.4 billion. A blank check company raises equity capital in order to acquire a target, often within a specified window of time, and this particular one was organized by three well- known parties: Nicolas Beggruen, through his investment company Beggruen Holdings; Bill Ackman, through his hedge fund Pershing Square; and Martin Franklin. At year-end they each controlled, respectively, 6.5 million, 33.3 million, and 7.3 million shares. Martin Franklin is also the founder and Executive Chairman of Jarden Corp (JAH), which is a significant holding in the Core Value and Strategic Value strategies, among others. The same three, also through a blank check company, brought Burger King (BKW) public again in mid-2012.

PAH produces specialty chemicals for a wide range of industries. It manufactures over 1,000 compounds, and its largest customer represents only 3% of sales. It exhibits very little cyclicality. Energy costs are only 2% of sales. It’s important to qualitatively differentiate the nature of the PAH chemicals business from that of the typical chemicals company. These particular chemicals are often proprietary both as to makeup (the company has over 750 patents) and process. Their employees spend considerable time with customers guiding them as to how to use these chemicals, often in multi-step processes, such as might be used to enhance the performance of a circuit board. PAH refers to these as dynamic chemistries and seeks out markets requiring highly technical post-sale customer service. What PAH sells tend to represent a very small portion of the cost of a customer’s product, yet are important to the product’s function or appearance. According to the company, customer retention is very high because the cost savings from switching to another provider are modest, while the switching costs are high due to process complexities and quality control requirements.

All of these attributes differentiate PAH from commodity chemical providers. Perhaps the most obvious way to observe this is via the balance sheet: whereas total assets are $2.2 billion, property, plant and equipment are only $140 million. Now, the balance sheet is distorted because of $1.7 billion of goodwill and intangible assets; nevertheless, $140 million of production assets is inordinately small relative to $750 million of annual revenue and $383 million of current assets. Accordingly, PAH has more of the character of a branded products business than of a commodity business. If so, it should have greater than average pricing power and modest capital expenditure requirements, which should also be reflected in the financial statements, which they are: capital expenditures are only about $10 million per year, such that free cash flow is about equal to net income, and the 2013 free cash flow margin was about 11.8%. As a point of comparison, to pick a branded consumer products company, General Mills (GIS) had a 9.4% net profit margin last year.

The reason the proprietary-product character of PAH is intriguing is because it bears certain commonalities with Jarden Corp., which is a branded products company. Jarden, which we’ve reviewed in the past, has been a very skilled acquirer and integrator of branded products, its portfolio comprised exclusively of either the leading market share products in their categories or the second largest market share. These range from Bee and Bicycle playing cards to Bionaire, Mr. Coffee, Oster and Sunbeam home and kitchen appliances, to Aerobed mattresses, Coleman camping gear, and on and on. Mr. Franklin’s curricula vitae at Jarden include these two statistics: book value per share, from 2001, when he assumed control, through 2013, expanded at a 26.4% annual rate; earnings per share have increased at a 20.2% rate.

The relevance of the relationship of Jarden and Mr. Franklin to the PAH investment thesis is this: it was a stated goal of the blank check company to identify a suitable target not merely to acquire it but also to use it as a platform for additional acquisitions in its industry. PAH, as a company that has relatively proprietary products and which generates relatively high free cash flow, can afford to fund additional acquisitions. Many large companies in recent years, in order to demonstrate a single-minded focus on their core business lines and maximize their returns on capital, have been spinning off or otherwise divesting lesser or ancillary divisions. The chemicals industries are no exception. The buyers have been entrepreneurs and private equity firms. A sterling example of just such a strategy well executed, aside from Jarden, is Colfax Corp. (CFX), established by the Rales brothers, and which came public in 2008. It is also a holding in Core Value and Strategic Value. Not a quarter goes by without one or more acquisitions, in their case, of generally modest-size industrial companies that manufacture gas- and fluid-handling products and services. If you simply look at the 5-or 6-year price chart, you get the picture.

In this instance, the qualitative assessment is of particular importance. The thesis is that Mr. Franklin will oversee a series of acquisitions, priced well, integrated effectively, eventually with the further benefit of scale economies, and that there will be a suitably large supply of acquisition candidates. If this thesis bears fruit, one can readily see that in success mode PAH can be far, far larger in the foreseeable, though not near, future. The rewards for the patient would be suitable.

From Murray Stahl‘s First Quarter 2014 Market Commentary.


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