A&W Capital CAPITAL HOLDING COMPANY
Buying businesses outright vs buying fractional interests in business via the equities market
Below is an extract from the September 2019 letter to the shareholders. It defines our thinking on buying businesses outright vs fractional interests.
Acquiring fractional interests in business makes sense to us given they provide two significant advantages:
1. Management comes with the business, which is good as we can’t supply it. Furthermore, the management should be subject matter experts within their industry bringing detailed product and service knowledge that we can’t.
2. Fractional interests in business can be acquired for less per share then buying a business outright.
Point number 2 is especially advantageous. This occurs as market price volatility allows us to enter at reasonable prices where an outright acquisition on a per share basis is substantially more. A recent example of this situation comes from of our own holdings.
In late 2018 we were able to acquire a fractional interest in Dulux. Dulux is a business earning good returns on capital and maintained a reasonable debt level. If you walk into Bunnings they own several brands selling on the shelves, from paint and silicones to gardening. It made us comfortable that as long as Bunnings did well, so would Dulux. Also their products don’t lend themselves to be sold digitally. We had intrinsically valued them at $7.32. When the market dipped and their price fell we bought at an average price of $6.67. What we didn’t know was that at the same time Nippon Paint also thought they were a good business. And so on 17th April 2019 they entered into a scheme of arrangement with Dulux to acquire 100% of its shares and in August we received our $9.37 per share ($9.80 including the final dividend).
So to buy the business outright they had to pay a 52% premium to our average purchase price and a 35% premium to our estimated intrinsic value of the business. This is why point 2 above works to our advantage. See Table 1 for the relevant values of equity.
Table 1 Dulux Valuations
Acquiring fractional interests in business makes sense to us given they provide two significant advantages:
1. Management comes with the business, which is good as we can’t supply it. Furthermore, the management should be subject matter experts within their industry bringing detailed product and service knowledge that we can’t.
2. Fractional interests in business can be acquired for less per share then buying a business outright.
Point number 2 is especially advantageous. This occurs as market price volatility allows us to enter at reasonable prices where an outright acquisition on a per share basis is substantially more. A recent example of this situation comes from of our own holdings.
In late 2018 we were able to acquire a fractional interest in Dulux. Dulux is a business earning good returns on capital and maintained a reasonable debt level. If you walk into Bunnings they own several brands selling on the shelves, from paint and silicones to gardening. It made us comfortable that as long as Bunnings did well, so would Dulux. Also their products don’t lend themselves to be sold digitally. We had intrinsically valued them at $7.32. When the market dipped and their price fell we bought at an average price of $6.67. What we didn’t know was that at the same time Nippon Paint also thought they were a good business. And so on 17th April 2019 they entered into a scheme of arrangement with Dulux to acquire 100% of its shares and in August we received our $9.37 per share ($9.80 including the final dividend).
So to buy the business outright they had to pay a 52% premium to our average purchase price and a 35% premium to our estimated intrinsic value of the business. This is why point 2 above works to our advantage. See Table 1 for the relevant values of equity.
Table 1 Dulux Valuations
