While Warren Buffett probably wishes that David Sokol never purchased Lubrizol Corporation (LZ) stock for his personal account, there is a silver lining to the corporate debacle. With media attention focused firmly on the juicy corporate gossip, financial news outlets are ignoring a more pressing question for Lubrizol shareholders, "Should they vote in favor of the cash buyout?"
Berkshire Hathaway's (BRK.A)(BRK.B) $135 per share acquisition price may have been a nice buyout premium at the time of the announcement, but based on Lubrizol's cheap valuations, strong management and the subsequent stock price strength of peers, Lubrizol shareholders should consider voting AGAINST the Berkshire Hathaway acquisition during the June 9th special shareholder meeting.
Lubrizol Corporation is not an expensive stock. It wasn't expensive before Berkshire's $135 per share offer and it is still not expensive now. Based on trailing 12 month performance, the company has profit margins of 13.52%, return on assets of around 14% and return on equity of more than 30%. These are healthy numbers for a company trading at a trailing price/earnings of 12.61 and a forward price/earnings of around 10.8.
Buffett was very clear that the company and its valuations alone were not enough to entice him to buy Lubrizol Corporation on January 14 or 15. As he clearly states in his letter about Sokol's resignation, he didn't become interested until about 10 days later after he heard more from the CEO. In addition, the only reason that Buffett fully embraced the acquisition was because of CEO James Hambrick's willingness to stay at the company post acquisition. While Buffett has always shown a clear preference for buying companies with intact management, there seems to be more to the story in this instance. Based on the revelations in his Sokol resignation letter and subsequent conditions, it seems that Buffett views Hambrick as absolutely essential to the acquisition. With this in mind, Lubrizol should clearly demand a premium industry valuation.
NewMarket Corp (NEU) and Innospec Inc (IOSP) are two of Lubrizol Corp's closest public competitors. Below is a chart of the comparative performances of each company's stock price since the March 11, 2011 stock price. The was the last trading day before Lubrizol announced their agreement with Berkshire Hathaway.
|Lubrizol Corp||NewMarket Corp||Innospec, Inc|
Lubrizol Corp's stock price has had an average return compared to those of NewMarket and Innospec, but considering that Buffett has anointed Lubrizol Corp to be the best of the bunch, maybe Lubrizol shareholders should demand an industry premium. In addition, just based on financials, NewMarket is likely a better comparison for Lubrizol. Not only is NewMarket closer in market capitalization, its profitability and returns on assets are similar to those of Lubrizol. If this is the case, Lubrizol's buyout price is a meaningful discount to its closest peer.
Despite the recent headlines, Warren Buffett still holds the mantle of a super investor and there are clearly bragging rights associated with being pursued by Berkshire Hathaway, but for the intelligent investor, this vanity should not affect their investing process. Warren Buffett built Berkshire Hathaway by acquiring assets below their value and as such, investors should be very cautious when they sell their shares.
In this specific case, Lubrizol shareholders should seriously consider voting against the buyout and paying Berkshire $200 million to walk away. Not only does the company trade at low valuations for such a profitable operation, its most comparable public competitor has meaningfully outperformed Lubrizol even though Buffett views Lubrizol as the creme of the fuel additives crop.