Ecolab & Clorox

This week, we have some merger and acquisition news to pontificate on with regard to our portfolios.  In the Blue Chip Growth portfolio, our long-time holding Ecolab (ECL) announced it had reached an agreement to acquire Nalco Holding Company (NLC) for $8.1 billion in cash (30% of deal) and stock (70% of deal), including the assumption of Nalco’s $2.7 billion in debt.  Ecolab sold off after the announcement (not an unusual response to most large acquisitions) and some pundits thought Ecolab was overpaying for a business, Nalco, with inferior business economics.  Nalco, by our analysis, has a return on tangible invested capital (ROIC) of about 30%, consistent with Ecolab’s business.  Nalco earned about $626 million in adjusted operating earnings in 2010.  Ecolab is paying about 13 times operating earnings or about a 20% premium to where the composite S&P 500 is trading.  Ecolab, itself, is trading around 13 times operating earnings.  While it will be tough for Ecolab to squeeze much more out of Nalco’s 30% ROIC, Ecolab is picking up a good business with its, already, pricey stock.  So, in the end, we think the market’s reaction is more about the value of Ecolab than the quality, or price, of the business it is buying.

In the Equity Income portfolio, Carl Icahn first proposed acquiring Clorox (CLX) for $76.50 per share and then upped his unsolicited takeover price to $80.00 per share about a week later.  We carry a fair value estimate of about $80 per share currently for a minority position.  While we would hate to see a good company like Clorox go from the Equity Income portfolio (good companies trading at reasonable price are difficult to find), we do welcome Icahn pointing out that Clorox was undervalued by the market.  A price of $80 would represent a 13x multiple of enterprise value (stock capitalization plus debt) to adjusted operating earnings.  We think the Board of Directors should reject $80, but be open to accepting an offer between $95 and $100 per share, or a 20% control premium on top of our estimated value.