Will Shareholders Live to Regret This Deal?
Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
“My greatest regret is selling my company” – Vidal Sassoon
I often wonder why someone sells. I’m especially intrigued when I see a multi-billion dollar sale of an asset or a whole division from one company to another. I know why it’s being bought; the acquirer expects to make money. Selling, though, isn’t as easy to figure out. Unless the seller is desperate for cash, they need a pretty good reason to unload a profitable part of their business.
I’m always reminded of something Warren Buffett said in his owner’s manual to Berkshire Hathaway (NYSE: BRK-B) shareholders:
“You should be fully aware of one attitude Charlie and I share that hurts our financial performance: Regardless of price, we have no interest at all in selling any good businesses that Berkshire owns. We are also very reluctant to sell sub-par businesses as long as we expect them to generate at least some cash and as long as we feel good about their managers and labor relations. We hope not to repeat the capital-allocation mistakes that led us into such sub-par businesses. And we react with great caution to suggestions that our poor businesses can be restored to satisfactory profitability by major capital expenditures. (The projections will be dazzling and the advocates sincere, but, in the end, major additional investment in a terrible industry usually is about as rewarding as struggling in quicksand.) Nevertheless, gin rummy managerial behavior (discard your least promising business at each turn) is not our style. We would rather have our overall results penalized a bit than engage in that kind of behavior.”
That attitude isn’t one shared by many these days. That attitude doesn’t unlock value nor does it improve margins, it doesn’t even lend to very much excitement, which is what usually comes from the speculation on how value will best be unlocked. That being said, if the world’s greatest investor isn’t interested in selling off parts of his company, when we do come across this type of behavior it’s interesting to see why the deal is being pursued.
Take DuPont’s (NYSE: DD) sale of their DuPont Performance Coatings (DPC) business to funds managed by The Carlyle Group (NASDAQ: CG) for $4.9 billion. The business is expected to generate $4 billion in sales this year and employs more than 11,000 employees in 35 plants throughout the world. DPC is a maker of automotive paints and related products with 43% of their sales going to auto repair shops.
The business competes in an industry along with PPG (NYSE: PPG), the margin leader in the coatings sector. It’s a sector where PPG also maintains a top three global position in all seven marketplaces. Finally, it's a business that PPG is growing as a percentage of their revenue, mostly because they’ve been divesting some of their other business lines. If PPG likes it so much, why is DuPont selling?
In the press release announcing the deal, DuPont CEO Ellen Kullman said that:
"DuPont Performance Coatings is a leader in the automotive and industrial coatings sectors with world-class products and customer service. The business continues to grow and deliver solid results. After a careful review, however, we have determined that DPC's full growth potential would be best realized outside DuPont and through the sale to Carlyle. This transaction is consistent with our vision to be the world's most dynamic science company and long-term strategy of driving competitive advantages in agriculture and nutrition, advanced materials and biotechnology, which represent high-growth, high-margin opportunities."
For DuPont it all comes down to vision and strategy. Take a look at their vision versus that of PPG for example. DuPont wants “to be the world’s most dynamic science company” while PPG’s vision is “to continue to be the world’s leading coatings and specialty products company.” For DuPont to succeed in their vision they need to pursue a “long-term strategy of driving competitive advantages in agriculture and nutrition, advanced materials and biotechnology.” Meanwhile, over at PPG, “through leadership and innovation, sustainability and color, (they) help customers …to enhance more surfaces in more ways than does any other company.” Not to knock what PPG does but that line of business simply doesn’t jive with the vision and strategy DuPont is pursuing.
That strategy, as Kullman puts, is to “continue to work closely with automotive customers to apply our science-powered innovations related to light weighting of vehicles, revolutionary and environmentally friendly refrigerants, biobased seat fabrics and headliners, and next-generation biofuels." Not exactly the same as selling paint to cover up your last fender bender. So while it’s not a business Buffett would have sold, it’s more likely one he likely would have had interest in buying; by divesting it DuPont can stick with what they do best.
Carlyle, for their part, is acquiring a pretty decent business for their investors, one that they plan on running as a standalone unit in which they’ll be making targeted investments in order to support product development and growth. Still, it’s a lower margin business and one that has among the lowest margins in the coating sector. However, that’s not typically an issue for a private equity firm, as they make it their business to improve margins and operations in order to eventually sell the business for a tidy profit.
DuPont is transitioning their business to a higher growth, higher margin, science-driven organization, and by disposing of their Performance Coating’s unit they are taking another step in that direction. It’s a very good business, just not one that fits in with their new direction. Once the deal closes early next year, they’ll have $4.9 billion to reinvest in their vision of becoming the world’s most dynamic science company. While Buffett certainly wouldn’t be a seller here, it’s a deal that makes sense for DuPont and their shareholders and, unlike Vidal Sassoon, I don’t see where they'll have any regret in their decision to sell.
latimerburned has and options position in Berkshire Hathaway and can see PPG's headquarters from my house. The Motley Fool owns shares of Berkshire Hathaway. Motley Fool newsletter services recommend Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
