The “Icahn Lift” is a term given to the rise in stock price that occurs when Carl Icahn (Trades, Portfolio) begins to purchase shares in a company. Thanks to his fearsome reputation for unlocking shareholder value and not resting until management has been kicked into action, investors follow Icahn into stocks hoping to piggyback off his actions and profit from the resulting unlocked value.
The same effect is also seen when Warren Buffett (Trades, Portfolio), owner and CEO of Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial), buys into a stock. No matter how large or small the position, when Buffett buys, it is a huge vote of confidence in the business because he tends to spend years researching a position before making a move.
What’s more, the number of poor investment decisions Buffett has made over his career can be counted on one hand. As a result, many investors follow his actions in the hopes profit is almost guaranteed.
So when it was announced Berkshire Hathaway had acquired a 3% stake in German chemicals maker Lanxess AGÂ (XTER:LXS, Financial) earlier this week, the stock’s 10% pop over the next two days should not have come as a surprise. But the real question is; what are Buffett’s motives in buying such a large stake in a company that, at first glance, does not appear to have any Buffett qualities whatsoever.
Buffett qualities
The Lanxess position was acquired through General Reinsurance, a Berkshire subsidiary, and when the 3% threshold was reached, the company had spent around $200 million building the position – small fry compared to the company’s total value of financial investments excluding cash, which totaled $22 billion at the end of last year.
Lanxess does not look to be a typical Buffett investment. The company operates in a relatively cyclical industry, sells products to manufacturers rather than consumers and there is no obvious moat, apart from maybe scale, to the company's business. The lack of moat and competitive advantage is all too evident in the company's return on equity and return on capital employed. For the past six years, return on capital has averaged 7.6% and return on equity has averaged 6.6% for the past five years. Also, the stock is relatively expensive trading at a forward price-earnings (P/E) ratio of 17.5, price-book (P/B) value of 2.4 and price-free cash flow ratio of 30.3.
This is not the first time Berkshire and Lanxess have worked together, however. Berkshire has previously owned shares in Great Lakes Chemical Corp., which now forms part of Lanxess after the company acquired Chemtura, Great Lakes' predecessor.
A history together
The Chemtura business has many of the qualities Buffett would usually seek in any investment. The company produces lubricant additives and flame retardants, which are not specialty chemicals in themselves, but when you combine these products with the size and scale of Lanxess, it is a different picture altogether.
Buffett has made acquisitions like this before. Back in 2011, Buffett spent $9 billion on Lubrizol, the world's largest producer of lubricant additives. Then in 2013, Berkshire Hathaway laid out $1.4 billion to acquire Phillips Specialty Products, a unit that "focuses on the science of drag reduction, specializing in maximizing the flow potential of pipelines."
It seems Lanxess is an investment made with a similar thesis. Lanxess paid 2.4 billion euros ($2.7 billion) for Chemtura, financed with low-cost bonds. Before the acquisition, the acquired company was producing annual sales of 1.5 billion euros. Deal synergies of 100 million euros per annum are expected through 2020. At the same time, Lanxess expects Chemtura's businesses to notch up annual sales growth in the region of 3% to 4%. The deal will help the overall Lanxess group rotate away from the cyclical businesses. Management expects just 20% of sales will come from cyclical markets by 2018 with the rest from higher margin, stable businesses where the company’s size, experience and international presence will give it the edge over competitors.
Put simply, while Lanxess might not look like a Buffett business at first glance, the company is rapidly becoming one.
Disclosure:Â The author owns no stock mentioned.
Disclosure: I do not own any stocks mentioned in the article.
