Description

Danaher’s got a lot of what I look for in a short: it’s overvalued, the accounting smells funny, corporate governance looks shady, and growth depends on acquisitions. As an added bonus, the pension plan is probably underfunded and a good chunk of the cash from operations is coming from working capital and other unsustainable stuff.

Danaher is a conglomerate of low/no growth industrial businesses. The company has been on an acquisition spree for years, and in the process has added a head-scratching amount of goodwill to its balance sheet – so much so that goodwill now exceeds shareholders’ equity. From January 2000 to the present, for example, Danaher spent just over $2B buying businesses and recorded $2.1B of goodwill in the process. With numbers like these, it’s no surprise that some folks suspect Danaher is spring-loading its acquisitions. I am one of those folks, though I’ll admit I can’t prove anything with the disclosure this company provides. But consider, for example, that Danaher initially set aside a $40M capitalized merger charge on the $708 of acquisitions it made in 2000. Then, in 2001, the company ups the charges on these same deals by $54M, to a total of $85M. I find it hard to believe that they couldn’t estimate severance/ plant closure costs more accurately than this. As an aside, the auditor at the time was Arthur Andersen.

Ideally, the income statement should provide a guide to help gauge normalized earning power when a business goes through as many changes as has Danaher in recent years. But with suspicions of spring-loading, I’m forced to pick apart the cash flow statement. LTM cash from operations came to $744M, but $222M of this came from working capital! Now I know we’re in a recession and slower business tends to generate cash from working capital. But the thing is, Danaher’s mature industrial businesses weren’t really growing even in the boom years, which leads me to believe they’ve been throwing off cash from working capital all along. Trouble is, with all the acquisitions and limited disclosure, it’s impossible to tell if this is true or by how much.

YOY Rev chg% (fiscal yr) 98 99 00 01 02YTD
Process/env - reported 23% 6% 32% 40% 20%
Process/env - organic 3% 2% 8% -20% -12%
Tools&components 9% 4% -1% -13% 3%

The best I can do is work with the LTM numbers, which are probably somewhat depressed. From the $744M mentioned above, I subtract $222M for working capital, $13M for option-related tax benefits, and $11M for one-time restructuring cost savings. I’ll further deduct $80M for capex (this is the 2001 number. The LTM number seems abnormally low), giving us $418M in FCF. If we add $25M in tax-adjusted interest expense we can compare this to the EV, which results in EV/FCF of 22.6X – probably high for a bunch of no-growth industrial businesses. If it matters, LTM P/E is 29X.

Pension costs could be an issue. The 10K states that pension assets of $352.7M exceed liabilities of $333.5M. But that’s only if you assume – as Danaher does – that the return plan assets will be 10%. I’ll go out on a limb and say that this company probably doesn’t invest better than Berkshire Hathaway, which assumes a 6.5% rate. Making this adjustment, the 6% overfunded status easily turns underfunded. Danaher has recently stated that it will take a charge to reflect recent investment performance, and that the charge will be less than $50M (!).

To top it all off, the corporate governance looks iffy. One of the acquisitions in 2000 was a company that was sold for $147M to Danaher by its own CEO and the CEO’s brother, who both happen to be on the board. These brothers own most of their Danaher shares via a LLC called Equity Group Holdings (EGH), which has co-leased a planed with Danaher. In 2001, Danaher recorded $3.1M of sales to the Colfax Corporation, which is owned by the same two guys. Danaher continues to sell to Colfax. Two outside directors are lawyers belonging to firms that list Danaher as a client, and another director is a Managing General Partner of a company that shares technology project expenses with Danaher.

Catalyst

Acquisition cost accounting comes under more scruitiny (similar to recent attention to gain on sale accounting, barter deals, round trip deals (GBLX), etc. Danaher finds fewer deals to do and/or debt financing costs increase. Pension requires hefty additional funding