Thoughts - Andvari Associates

June 10, 2021

MSA Safety: A Picks-and-Shovels 100-Bagger

The picks-and-shovels investing theme is a favorite of Andvari’s. The theme takes its name from the California Gold Rush. Prospectors were not guaranteed to find gold but the people selling the picks and shovels earned a good living. Suppliers of goods and services that are essential to the creation of another finished product are fertile grounds for prospective investments. MSA Safety is one company that fits the picks-and-shovels theme—and several others—and has turned into a 100-bagger over the last 33 years.

Originally named Mine Safety Appliances, the company was formed in 1914 after a spate of terrible coal mine explosions. Dozens or even hundreds of miners died in these tragic accidents when an open flame lamp ignited methane gas or coal dust. The Monongah Coal mine was the site of the largest coal mine disaster in U.S. history in 1907 with 362 deaths. Thus, MSA enlisted Thomas Edison to help create an electric cap lamp to replace the open flame lamps used in mines. Over the next 25 years, MSA’s lamps helped reduce mine explosions by 75%.

LIFE SAVING, MISSION CRITICAL PRODUCTS

Although not literally selling picks and shovels, the MSA product range includes breathing apparatus products, fixed gas and flame detection instruments, portable gas detection instruments, and firefighter helmets and apparel. These products are all essential to the safety of miners and others working in hazardous environments. Also, these products are often mandated by government and industry regulations. The life saving, mission critical qualities of MSA's products enables high margins and affords them the ability to more easily raise prices.

EXEMPLARY FINANCIALS

MSA’s financials are quite good despite them being a manufacturer of physical products. This is because MSA’s products are: (1) essential to safety; (2) are highly-engineered; (3) are mandated by regulations; and (4) are a small part of the total costs borne by the end users. MSA’s revenues are also more stable compared to the industries to which they sell.

LEADING MARKET POSITIONS AND VALUE-CREATING M&A

There are two other factors contributing to MSA’s success. One is that most of their products occupy the #1 position in their categories. Having the best brands allows MSA to charge more and raise prices more easily. The other factor is MSA’s excellent track record of value-creating acquisitions. Although not quite a serial acquirer like Constellation Software or Halma, from 2010 through 2020 MSA has acquired 5 companies for a total consideration of $716 million. It’s acquisition program has succeeded because MSA has stayed inside its circle of competence. They’ve only acquired manufacturers of mission critical products that help protect the lives of people working in dangerous environments.

ANDVARI TAKEAWAY

Although MSA does sell to cyclical industries Andvari categorically dislikes—mining and oil and gas, for example—it would be wrong to totally dismiss MSA as a potential investment. It has many attractive qualities that we look for. It’s products are highly engineered, have leading positions in highly regulated markets, and are non-discretionary purchases that protect the lives of people. Whether it's miners, firefighters, or chemical plant employees, none of them can do their jobs without products from MSA. This all adds up to a company whose shareholders have enjoyed a 100-fold return since 1988.

A Recipe For Savoury Returns

McCormick, the seasoning and spice company, is an outstanding business with several of the qualitative traits we seek. Spices are a small, but essential part of end products that consumers often grow to love. It has dominant positions in its markets and its CEO is highly aligned with shareholders. The combination of these traits have enabled McCormick shareholders to outperform the S&P 500 over the long term.

SMALL AND ESSENTIAL

According to McCormick, spices are typically 10% or less of the cost of a meal, yet provide 90% of the flavor and satisfaction. Andvari has written about this concept before in “Robertet Groupe: Accounting for Good Taste”. Being a small part of the total cost while also being an essential component gives a company pricing power. This allows the company to more easily raise prices over time, an especially important quality in times of inflation.

MARKET DOMINANCE

Further, the majority of their products and brands are #1 in their respective categories. Market dominance generally leads to higher margins and more stable revenues due to less intense competition. Andvari likes to see this in all companies.

Dominance of McCormick’s type can often come with the price of increased scrutiny from the Federal Trade Commission (FTC). This can be both a good and bad thing. Good because it’s a high-value indicator of a company’s strength but bad because the company may be forced to divest assets to restore market competition (see “The Fertile Ground of Forced Divestitures”).

RELIABLE SIGNALS OF STRENGTH

In the case of McCormick’s proposed $605 million acquisition of Lawry’s and Adolph’s consumer brands in 2007, the FTC alleged McCormick would control 80% of the $100 million U.S. market for branded seasoned salt. To complete the deal, McCormick had to (1) sell it’s Season-All business to Morton and (2) abstain from acquiring another seasoned salt brand for 10 years. Despite the divestiture and 10-year ban, McCormick’s share price continued to produce savoury returns with its consumer segment leading the charge.

VALUE-CREATIVE M&A IN A HIGHLY FRAGMENTED MARKET

McCormick has created value through an effective M&A program. It has acquired dozens of brands and products in the flavors, spices, and condiment categories. It has stuck to acquiring businesses it knows well, one of the key reasons why it's M&A efforts have succeeded (see “M&A Wisdom from the U.K.”).

Despite a robust M&A program, McCormick still only has a 20% market share. A highly fragmented market like this gives a company a very long runway for both organic and inorganic growth. As of 2017, the company’s SVP of Corporate Strategy & Development said they had a list of 1,000 assets it could potentially acquire under the right conditions. Significant opportunities for growth reinvestment are two other qualitative factors Andvari likes to see.

ALIGNED CEO

Finally, McCormick’s current CEO is Lawrence Kurzius. He was CEO and President of Zatarain’s for 12 years when McCormick bought the company in 2003. Since then, Kurzius steadily acquired and retained McCormick shares as he climbed through the ranks of leadership.

In 2016 Kurzius took over as CEO of the entire company and now owns 5.8% of McCormick’s voting class of shares. These shares are worth roughly $100 million. Kurzius has skin in the game, has an excellent track record, and it's highly likely he will continue to maximize his and shareholders’ wealth over the long run.

ANDVARI TAKEAWAY

Whether a company sells spices, software, or rents out space on cell towers, Andvari always seeks out the qualitative factors that increase the likelihood of earning above-average returns over the long run. We like to see a company selling a highly valuable product that’s just a small part of the customer’s total cost. We like market dominance, value-creating M&A, and consolidation of fragmented markets. We like highly aligned CEOs. In the case of McCormick, the returns to shareholders from this recipe have been extremely satisfying.

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IMPORTANT DISCLOSURE AND DISCLAIMERS

Investment strategies managed by Andvari Associates LLC ("Andvari") may have a position in the securities or assets discussed in this article. Andvari may re-evaluate its holdings in such positions and sell or cover certain positions without notice.

This document and the information contained herein are for educational and informational purposes only and do not constitute, and should not be construed as, an offer to sell, or a solicitation of an offer to buy, any securities or related financial instruments. This document contains information and views as of the date indicated and such information and views are subject to change without notice. Andvari has no duty or obligation to update the information contained herein. Past investment performance is not an indication of future results. Full Disclaimer.

© 2021 Andvari Associates LLC

April 28, 2021

M&A Wisdom from the United Kingdom

David Barber is the co-founder and now retired CEO of Halma plc. For the 20 year period preceding David’s 1997 speech on delivering shareholder value, Halma shares had returned 22.5% per annum.

In his speech, Barber described the reasons behind the success of Halma. Although there are several, Andvari focuses on the criteria Halma used in its highly effective M&A program. When nearly everyone agrees most acquisitions destroy value, we can learn much by studying a company with a track record of creating value through M&A (see our prior post, “The ‘Permanent Home’ Advantage”, on the same topic).

Barber’s guidance can be boiled down to four, key recommendations:

#1: USE INTERNALLY GENERATED FUNDS

Barber says the first factor that will improve the odds of an acquisition creating value is whether one funds the deal with surplus cash or by issuing shares. The idea here is if the acquired company was purchased at a fair price and performs well, the value creation will be greater if shareholders weren’t diluted in the process. Simple and logical.

#2: FIND A REPLICA

Next is whether the acquisition target is a “replica” of one already owned by the purchaser. Anyone selling a business likely has more information than the buyer. The owner also wouldn’t be selling unless they thought they could get the better end of the deal. Thus, to reduce the risk stemming from a disparity in information, the buyer should be as much or even more of an expert in the field of the seller. The buyer of businesses should therefore be looking to purchase other businesses that are replicas of the ones they already own.

#3: PURSUE BOLT-ONS

The third way to reduce M&A risk is by seeking to acquire “bolt-ons”. Barber defines a bolt-on company as one that “when purchased can then be readily integrated into an existing Group company.” This necessarily means the target will be of a smaller size, which also usually means lower complexity, both of which increase the odds of generating value.

#4: DO NOT SACRIFICE EARNINGS QUALITY

The last predictor of value creating M&A is if the acquired company will improve the quantity and quality of earnings. From Barber’s perspective, “quality of earnings is paramount” and “you can never pay enough for a good acquisition and never pay too little for a bad one.”

ANDVARI TAKEAWAY

Thanks to the combination of sensible M&A criteria and a focus on quality, niche businesses with high returns on capital, Halma provided extraordinary returns to its shareholders. Furthermore, thanks to Barber cementing the strategy and culture into the business, shareholders have enjoyed great results even after his retirement in 2003.

A great deal of M&A is value destructive, but not always. Companies with excellent management and sensible M&A programs have beaten the odds. HEICO, Constellation Software, Roper, Danaher, Ametek, Teledyne, and Waste Connections are just a few examples of other companies that have similarly successful M&A programs. High-performing, serial acquirers that can compound returns for decades are exactly the sort of companies for which Andvari is continually on the hunt.

Further Reading

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IMPORTANT DISCLOSURE AND DISCLAIMERS

Investment strategies managed by Andvari Associates LLC ("Andvari") may have a position in the securities or assets discussed in this article. Andvari may re-evaluate its holdings in such positions and sell or cover certain positions without notice.

This document and the information contained herein are for educational and informational purposes only and do not constitute, and should not be construed as, an offer to sell, or a solicitation of an offer to buy, any securities or related financial instruments. This document contains information and views as of the date indicated and such information and views are subject to change without notice. Andvari has no duty or obligation to update the information contained herein. Past investment performance is not an indication of future results. Full Disclaimer.

© 2021 Andvari Associates LLC

April 15, 2021

Q1 Letter: Fewer But Better

For the first quarter of 2021 Andvari is down 5.2% net of fees while the S&P 500 is up 6.2%.[i] Andvari clients, please refer to your reports for your specific performance figures. The table below shows Andvari’s composite performance against two benchmarks while the chart shows the cumulative gains of $100,000 investments.