Lubrizol’s filing includes the two ‘fairness opinions’ prepared by Lubrizol’s advisers, Evercore and Citi.
It’s interesting that Lubrizol engaged Citi for this in that Citi brought in Sokol and made the initial introduction. Presumably Citi does not have a financial interest in the deal’s completion, or there'd be a pretty clear conflict. Lubrizol also had adviser Evercore prepare an analysis, though, with similar result. It’s a bit usual to have two fairness opinions but it certainly doesn’t hurt, especially since some might question Citi’s role. It also is reassuring that the results of both, prepared independently, were similar.
Recently there was some discussion on this board about the relevance of the variety of analytical approaches covered in the CFA certification program – the fairness opinions highlight a reason for this. The opinions' preparers pretty much covered the analytical landscape in methodologies. The point isn’t which analytical approach is ‘best’, or which you might prefer for your own use in identifying value in companies - regardless of personal preferences you want to be able to rationally support your position from any perspective.
Judge David Laro is maybe the judiciary’s foremost authority when it comes to putting a value on a business; though he’s semi-retired now, he’s the judge that other judges call (he has a remarkable bio). He’s commented that he generally advises his peers that there are a couple of ‘red flags’ to be mindful of in these types of analyses:
----cherry-picked analytical methods—if an analyst elects not to include a particular established analytical approach, he wonders why; and
---- the use of creative methods or analytical approaches that haven’t undergone rigorous critical review by the analyst's peers.
In the Lubrizol filing we see that despite working on their board presentations independently of each other, Evercore and Citi both performed similar analysis work, with similar results. Subconsciously they both probably had Laro in mind.
To survive a courtroom, analysts generally have to take three anaytical perspectives:
(a) an income-based analysis – for example a discounted cash flow analysis of the company’s projections;
(b) market-based estimate of value – eg, comparisons to similar publicly traded companies, and comparable M&A transactions; and
(c) an analysis based on the balance sheet – just to check that the company isn’t holding some under-recognized assets.
Looking at the balance sheet, both firms elected to work up an LBO-based analysis of Lubrizol. This assumes a theoretical purchase where everything is hocked to the absolute hilt to fund the purchase. The assumption is that the buyer would then throw in his own equity on top of that, to the maximum that would still provide a risk-acceptable ROE on his equity. Both firms used approximately 20% ROE as that rate.
Put it more simply, this is the most an LBO-type buyer would pay, in terms of company debt plus his own equity. If there are under-valued assets on the balance sheet that aren’t being recognized by the DCF analysis or market-based comparisons, this analysis could help bring them to light. This is also a sort of reality check on a temporarily depressed market.
Jumping back to the market-based comparisons (to publicly traded peers and acquisitions), we’ll notice that both firms looked at comparison-companies’ enterprise value to EBITDA. EV (Evercore refers to it as 'TEV') is essentially the market capitalization with cash and debt stripped out. Valuation comparisons are ‘apples to apples’ in terms of capitalization. BTW, we can use this approach to get an estimate of value regardless of corporate structure or status (eg, private companies, including S-corps).
The analysts also give a nod to PE comparisons, but much of the comparison-company focus is on EV/EBITDA. Since Lubrizol is publicly traded, they also look at analysts predictions as to price, and to historical trading ranges of the stock.
EV relates back to the recent discussions of comparisons between Costco and Walmart. These EV-centered analyses strip out the leverage, and cash & securities balances, and derive the market’s valuation of the underlying businesses. This is more akin to our ‘two column’ analyses of Berkshire than to straight PE comparisons.
So back to Lubrizol, what did all this tell us? It looks like while the $135/share price might be ‘fair’ to Lubrizol shareholders – most of the analyses fell in a range of something like $110 up to as much as $150, with $140+ easily supportable depending on assumptions. Typically a strategic buyer--if there is one for Lubrizol—could rationalize a more aggressive price, especially since companies like this don’t become available in their entirety every day.
Assuming reasonable performance versus its projections, and a strengthening market and economy in general, Lubrizol’s advisers seem to be acknowledging that $135 – while ’fair’ for Lubrizol shareholders (the question they are of course answering)—looks to be a pretty decent for Berkshire, too.
It’s interesting that Lubrizol engaged Citi for this in that Citi brought in Sokol and made the initial introduction. Presumably Citi does not have a financial interest in the deal’s completion, or there'd be a pretty clear conflict. Lubrizol also had adviser Evercore prepare an analysis, though, with similar result. It’s a bit usual to have two fairness opinions but it certainly doesn’t hurt, especially since some might question Citi’s role. It also is reassuring that the results of both, prepared independently, were similar.
Recently there was some discussion on this board about the relevance of the variety of analytical approaches covered in the CFA certification program – the fairness opinions highlight a reason for this. The opinions' preparers pretty much covered the analytical landscape in methodologies. The point isn’t which analytical approach is ‘best’, or which you might prefer for your own use in identifying value in companies - regardless of personal preferences you want to be able to rationally support your position from any perspective.
Judge David Laro is maybe the judiciary’s foremost authority when it comes to putting a value on a business; though he’s semi-retired now, he’s the judge that other judges call (he has a remarkable bio). He’s commented that he generally advises his peers that there are a couple of ‘red flags’ to be mindful of in these types of analyses:
----cherry-picked analytical methods—if an analyst elects not to include a particular established analytical approach, he wonders why; and
---- the use of creative methods or analytical approaches that haven’t undergone rigorous critical review by the analyst's peers.
In the Lubrizol filing we see that despite working on their board presentations independently of each other, Evercore and Citi both performed similar analysis work, with similar results. Subconsciously they both probably had Laro in mind.
To survive a courtroom, analysts generally have to take three anaytical perspectives:
(a) an income-based analysis – for example a discounted cash flow analysis of the company’s projections;
(b) market-based estimate of value – eg, comparisons to similar publicly traded companies, and comparable M&A transactions; and
(c) an analysis based on the balance sheet – just to check that the company isn’t holding some under-recognized assets.
Looking at the balance sheet, both firms elected to work up an LBO-based analysis of Lubrizol. This assumes a theoretical purchase where everything is hocked to the absolute hilt to fund the purchase. The assumption is that the buyer would then throw in his own equity on top of that, to the maximum that would still provide a risk-acceptable ROE on his equity. Both firms used approximately 20% ROE as that rate.
Put it more simply, this is the most an LBO-type buyer would pay, in terms of company debt plus his own equity. If there are under-valued assets on the balance sheet that aren’t being recognized by the DCF analysis or market-based comparisons, this analysis could help bring them to light. This is also a sort of reality check on a temporarily depressed market.
Jumping back to the market-based comparisons (to publicly traded peers and acquisitions), we’ll notice that both firms looked at comparison-companies’ enterprise value to EBITDA. EV (Evercore refers to it as 'TEV') is essentially the market capitalization with cash and debt stripped out. Valuation comparisons are ‘apples to apples’ in terms of capitalization. BTW, we can use this approach to get an estimate of value regardless of corporate structure or status (eg, private companies, including S-corps).
The analysts also give a nod to PE comparisons, but much of the comparison-company focus is on EV/EBITDA. Since Lubrizol is publicly traded, they also look at analysts predictions as to price, and to historical trading ranges of the stock.
EV relates back to the recent discussions of comparisons between Costco and Walmart. These EV-centered analyses strip out the leverage, and cash & securities balances, and derive the market’s valuation of the underlying businesses. This is more akin to our ‘two column’ analyses of Berkshire than to straight PE comparisons.
So back to Lubrizol, what did all this tell us? It looks like while the $135/share price might be ‘fair’ to Lubrizol shareholders – most of the analyses fell in a range of something like $110 up to as much as $150, with $140+ easily supportable depending on assumptions. Typically a strategic buyer--if there is one for Lubrizol—could rationalize a more aggressive price, especially since companies like this don’t become available in their entirety every day.
Assuming reasonable performance versus its projections, and a strengthening market and economy in general, Lubrizol’s advisers seem to be acknowledging that $135 – while ’fair’ for Lubrizol shareholders (the question they are of course answering)—looks to be a pretty decent for Berkshire, too.
