The Duracell Trade
In a recent 13-F filing, Warren Buffett (Trades, Portfolio) demonstrated his preference of owning the Duracell business over holding on to his Procter & Gamble (PG, Financial) shares. Buffett gave all of his 52.4 million Procter & Gamble shares back to Procter & Gamble itself and received the Duracell business in return; Procter & Gamble is also expected to contribute $1.8 billion cash to Duracell as part of the business’ recapitalization. According to Procter & Gamble’s recent annual report, the Duracell-Procter & Gamble stock for business exchange deal was valued at $2.9 billion.
(Berkshire’s recent annual report)
The deal was thought to be a win-win situation. Procter & Gamble wants to divest and focus on its core consumer-products business, while Buffett wants a steady cash-producing business, Duracell. Further, Buffett did not have to worry about paying taxes on his capital appreciation earned by holding on to his Procter & Gamble shares.
Long-Termism
Interestingly, the 2014 deal that just closed in the past quarter exemplified how long-term type of an investor Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) and Buffett is. Although it is hard to trace how the cost for Procter & Gamble shares were just about $336 million (above picture), Buffett seemed to have never really intended to have Procter & Gamble shares in the first place.
Buffett initially invested in Gillette for $600 million in 1989 (27 years ago). Gillette then acquired Duracell for $7 billion in 1996. After almost a decade, Procter & Gamble came into the scene and bought Gillette for $57 billion. This last transaction converted Berkshire’s Gillette shares into Procter & Gamble shares.
Looking back at Berkshire’s trading with Procter & Gamble shares, the conglomerate only had a couple of quarters in which it was actively buying Procter & Gamble. Those were during the financial crisis. After those purchases, Berkshire reduced its Procter & Gamble stake intermittently to almost 50%, from owning some 105 million shares down to 52.7 million shares by fourth quarter of 2014 when the Duracell stock for business deal was agreed upon.
Duracell Business (A Glimpse)
Duracell’s financial numbers cannot easily be retrieved since its operations are all included in Procter & Gamble’s Fabric and Home Care business segment. This segment had contributed 32% to Procter & Gamble’s total sales and 26% to total profits as of 2014. Procter & Gamble claimed that Duracell’s battery business had over 25% of global battery market share.
In Procter & Gamble’s 2015 annual filing, the company brought a bit more values to Duracell’s financials. The company indicated that the battery business, Duracell, had total assets of $3.5 billion and total liabilities of $1.2 billion (p. 71). This would mean that the Duracell’s book value will be around $2.3 billion. Accordingly, Duracell earned about $2.2 billion in sales and $339 million in profits. Duracell, as a business, only owed about $18 million in contrast to its $2.9 billion valuation at that time.
Competition
In the U.S., Duracell and Energizer have the lion's share totaling about 83%. Rayovac, a business segment of Spectrum Brands Holdings, holds about 10% of the battery market. Profit margins for the two market leaders are observably varied. Duracell has a three-year average of 15%, while Energizer had just 5%.
(Image from the Wall Street Journal)
Valuation
In hindsight Buffett (Berkshire) could not have played the Duracell deal any better. Having Procter & Gamble contributing $1.8 in exchange for its shares valued at $4.7 would indicate that Berkshire’s total Duracell acquisition cost would "only" be around $2.9 billion.
With that said, Berkshire "purchased" Duracell for about 1.25x its book value and 1.30x its sales in 2015. Meanwhile, Energizer currently sells at 1.85x its trailing 12-month sales. Energizer currently has negative 11 million in book value. Energizer seemed to borrowed heavily, $998 million, in mid-2015 secondary to its restructuring — more on this in a little bit. Not to forget Benjamin Graham’s price-earnings valuation, Energizer is currently selling at a 35 price-earnings multiple.
Accordingly, Duracell’s entire valuation had been declining. Duracell’s $7 billion valuation in 1996 down to $2.9 billion in 2014, a negative 4.5% compound annual growth rate (CAGR) basis. A Barron’s article also indicated that Duracell’s profits from operations had been on a decline for the past decade, from $490 million in 2004 down to $414 million in 2014, a negative 0.88% CAGR development.
Prospects
Due to weakening battery sales, Energizer eventually spun off its personal care products and made a company named Edgewell Personal Care. According to Morningstar, the company manufactures and markets personal care products in the wet shave, skin care, feminine care and infant care categories. Energizer performed the spin-off somewhere in mid-2015. After the spin-off, Energizer had beaten its revenue Wall Street estimates in two out of four quarters. In addition, Energizer began its dividend policy, issuing 0.25 cents a share.
Mr. Market seemed to be appreciative of this structural changes by Energizer. Energizer’s market price appreciated by 38% since the spin-off.
Berkshire on Electric Vehicles?
Interestingly, Berkshire’s acquisition of Duracell in 2014 along with its 10% stake in BYD Auto makes it possible for some arrangement that Berkshire can make more efficient electric vehicles in the future. Two years later, I have not found any evidence that Berkshire had any plans.
(Cadillac ELR by PluginCars)
Summary
Warren Buffet and Charlie Munger (Trades, Portfolio)’s Berkshire definitely demonstrated a couple of "old-school" tricks here. One was to buy long term, and the other was to buy a business with reasonable discount to its valuation.
The battery business, on the other hand, has been on a decline. Nonetheless, the business contributes positive cash flow to its owners. Seeing how Energizer had been more likely able to cope up with the difficult environment, it would make sense to stand on the sidelines for the time being.
Happy investing!
