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Session 4 Warren Buffett

VIEWS: 117 PAGES: 21

									Session Four:
Investment Lessons from Warren Buffett




      Stanley P. Sakai
      June 20, 2009




                                         1
Agenda


1. Blog Review



2. Key Points of Prior Session



3. Investment Case: The Mindset of Warren Buffett



4. Next Session Background



Private Equity
                                  2            KDI School of Public Policy and Mgt
 Session 3 Review: Carlyle


                                     PE Fundraising
                             T
                             A •Organization:
                             K    •Complexity
                  Learning   E    •

                   Lesson    A •M&A/Value Add
                             W    •Consolidation
                             A
                                  • Way to add
                             Y    revenue or reduce
                             S    costs.



Private Equity
                         3      KDI School of Public Policy and Mgt
Carlyle Organization
C                      64 Funds--$89 Billion                  F
O                IR – Investments -- Fundraising
                                                              L
M                                                             E
                      Investment Types                        X
P      Buyout, Growth Capital, Leveraged Finance, Real Estate I
L                 Industry Specialization                     B
E     Energy, Transportation, Financial Services, Retail, I
X      Automotive, Aerospace/Defense, Health Care,
                                                              L
        Technology, Telecom, Industrial, Infrastructure
I                                                             I
T                       Localization                          T
Y         Europe         North America             Asia       Y

Private Equity
                                  4           KDI School of Public Policy and Mgt
Value Add through M&A
                   Layer 1-                Layer 2                      Layer 3 Leverage
                 Components                 Issues                           Points
S
a
                   More Units         New Markets
l                                     New Products
e    +                                                               •New Products
                  Higher Prices     New Customer Type
s                                                                     to pump
                                                                      through
U                Functional           Judgment                        Existing
p                                                                     Channels and
                   Dev. Cost       Research v. Development
C                                                                     Customers.
o                                   Capacity Utilization v.
                 Production Cost                                     •New Customers
                                     Scale/Cost per Unit
st
                                                                      and channels to
                   Marketing
D    -                 &              Overlap in People               be fed by
o                  Sales Cost
                                       and Channels                   Existing
w                                                                     Products
n                  Admin Cost         Reduce & Control

Private Equity
                                           5                  KDI School of Public Policy and Mgt
Words from Warren Buffett: (1)


“Charlie and I look for companies that have
a) a business we understand;
b) favorable long-term economics;
c) able and trustworthy management; and
d) a sensible price tag. “




Private Equity
                       6         KDI School of Public Policy and Mgt
When do you Understand a Business?
Competitive Value Chains
                       Product/           Sale Channel             Competitive
   Suppliers                                                        Entrants
                       Delivery          (Direct/Indirect)
                         In-source/Outsource                                        Value/
                                                                                    Price
                 Financial Transactions/Cost/Value

                     Product/          Sales/Mktg
                                      Sale Channel               Customers
Suppliers
                     Delivery        (Direct/Indirect)            (Need)
                    Organization/Management
                                                     Value/Price
                       In-source/Outsource
                       Product/           Sale Channel
   Suppliers                                                        Substitutes
                       Delivery          (Direct/Indirect)


Private Equity
                                     7               KDI School of Public Policy and Mgt
Words from Warren Buffett (2)


“A truly great business must have an
enduring “moat” that protects excellent
returns on invested capital…..Business
history is filled with “Roman Candles,”
companies whose moats proved illusory
and were soon crossed.”




Private Equity
                         8      KDI School of Public Policy and Mgt
When do you Understand a Business?
Competitive Value Chains
                       Product/           Sale Channel             Competitive
   Suppliers                                                        Entrants
                       Delivery          (Direct/Indirect)
                                                                                    Value/
                         In-source/Outsource                                x       Price
                 Financial Transactions/Cost/Value

                     Product/         Sales & Mktg
                                      Sale Channel               Customers
Suppliers
                     Delivery        (Direct/Indirect)            (Need)
                    Organization/Management
                                                     Value/Price
                       In-source/Outsource                                    x
                       Product/           Sale Channel
   Suppliers                                                        Substitutes
                       Delivery          (Direct/Indirect)


Private Equity
                                     9               KDI School of Public Policy and Mgt
Key Discussion Points for See’s Candy and other
Investments of Berkshire Hathaway


1. Based on Buffett’s description, why do you think See’s
   has been so profitable? Give 3 reasons.

2. What would be the key financial reason for the profit
   growth of See’s and what ratio would you use to
   measure it?

3. What are the capital drivers of See’s business?

4. Why is the Airline business such a “doggy” business?

Private Equity
                               10         KDI School of Public Policy and Mgt
Next Week’s Session & Preparation




                                    11
                        Next Session
          Tad O’Malley: The Investment Conundrum




Private Equity
                             12      KDI School of Public Policy and Mgt
Deal Summary: (Name of Company)

Industry:                         Financials:
+                                 +
+                                 +
-                                 -
-                                 -
Management:                       Valuation:
+                                 +
-                                 -
Company Positioning:              Deal Structure:
+                                 +
+                                 +
-                                 -
-                                 -




Private Equity
                              13                KDI School of Public Policy and Mgt
Industry and Positioning Stability:

    Does the industry have the attributes that match the
     capital structure?

                          High Volatility
       Cost Side                              Low       Financial Leverage
                                            Leverage    Reflected in:

                                                        1. Debt to Total Cap.
      Volatility                                        2. Debt to EBITDA
                                                        3. Total Debt
                                                        Payments/Cash Flow
                                              High      4. Other Metrics
                          Low Volatility    Leverage
    Demand Side




Private Equity
                                   14              KDI School of Public Policy and Mgt
Industry and Positioning Opportunities
                  Some Drivers:                                            Opportunities
                  Customer Need                                                Spin-outs
                 for Customization                                             Start-ups
                                                      Fragmentation
                 New Technologies    e.g. Airlines, Telecom,
                                     Electricity, Specialty Retail,
                    Regulatory       Education, Autos?
                                                                                   Fragmentation
                                                                      Consolidation
 Industry
                  Some Drivers:
                                                                         Industry Life Cycle
                  Customer Need                  Fragmentation
                   Centralization
                    Scale/Cost                        Consolidation
                                            e.g. Pharma,
                   Globalization       Retail, Semiconductors,              Opportunities
                                                                                 M&A
                                                                               Cost Driven
Private Equity
                                         15                   KDI School of Public Policy and Mgt
Management:
    What has been the past performance of the Company? How has
     management responded to past problems and crises?

    Is the management team complete? What drives the business of the
     company and who are the key drivers within the Company?

    What has been the employee turnover rate in the Company?
     Recently, have there been any key defections?

    To what extent does management have a handle on the details of
     the Company? How does this show in the presentation of financials?

    Does the management act as thought they are owners of the
     Company? Is there financial rectitude in the Company?

Private Equity
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Financials:


    Growth in Revenue

    Stability in Cash Flow                     Commodity like Analysis
                               http://www.youtube.com/watch?v=3h-ZqcPl7rI&feat
    Capital to be Deployed




    Where will you add revenue and reduce costs and/or capital
     prospectively?
      See below




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                                     17           KDI School of Public Policy and Mgt
Valuation: Are you getting a good price?
    Based on metrics of company comparables to other
     similar publicly traded companies and estimates of future
     cash flows (DCF). For purposes of this class, will be
     using company comparables.

    Ability to get a good deal based on number of factors:
      Company Sales Method (Auction vs. Targeted Sale)

      Motivation of the Seller

      Number of potential buyers (and sellers of similar
       companies).

    Ability to sell a price based on the perspective of the
     buyer and what he is comparing it to.


Private Equity
                                  18         KDI School of Public Policy and Mgt
Valuation (continued)


    Common Comparable Company measurement ratios
     based on last twelve months performance:
      Enterprise Value (Debt + market capitalization) to
       EBITDA
      Enterprise Value to EBIT

      Sales to Enterprise Value Ratio (especially for high
       growth situations.
      Price to Earnings ratio

      Market Cap to Book Value (especially used for banks)


    Valuation at or below comparables is usually a fair price;
     it becomes an excellent price with a successfully
     implemented plan to boost or improve cash flow.
Private Equity
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    Company Purchase Price
    Company Purchase Price based on your perspective of the plan (and
    buyer’s perception of selling position)

                      Discount         Fair Value     Premium
                                         Range
Ratio 1


Ratio 2


Ratio 3

                                         $ Price
Ratio 4                                  At Fair
                           $ Price        Value               $ Price
       = Median Ratio
                         at Discount                        at Premium
       = Mean Ratio                     Price Ratio
     = individual comparable company ratio (total of six companies)
    Private Equity
                                              20           KDI School of Public Policy and Mgt
Deal Structure: Details in the contract that affect
the risk and opportunity of the investment

    Timing of the Deal: The speed at which the deal needs to be done.

    Conditions Precedent: The conditions which govern when you have
     to put the money in.

    Governance: Your “say” or ability to legally influence or direct the
     affairs of the Company.

    Extra Powers: Your and other shareholders extra rights that might
     have been given or granted.

    Redress: How are problems and disagreements resolved.

Private Equity
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