A Public LBO

In our last post, we highlighted a few lessons from Thorndike’s Capital Surgeons. With this sound advice in mind, we’ll take a closer look at one Outsider’s history of success before analyzing the platform he is constructing today.

Ralston Purina was a fairly typical packaged food company during the 1970s. Led by CEO Hal Dean, the company invested mountains of cash flow into a jumbled collection of operating businesses until Dean’s retirement in 1980.

The stock hadn’t budged in a decade, when Bill Stiritz earned the top job by providing the board with a detailed strategy for the company. He wasted little time in implementing his plan, restructuring the company by divesting less profitable businesses, and positioning Ralston as a focused branded products company.

Stiritz proved to be a shrewd seller.  He knew what assets were worth and was a willing seller for the right price – there were no sacred cows and these asset sales were an important source of cash for the company early on.

After selling off noncore operations, Stiritz initiated an aggressive stock repurchase program in the early 1980s, a time when repurchases were controversial and signaled a lack of investment opportunity to the average investor. Contrary to conventional wisdom, Stiritz believed that repurchases were the highest probability investments he could make and went on to repurchase 60% of Ralston’s stock with multiples at cyclical lows.

Once the initial round of divestitures was complete, Stiritz focused on sourcing deals directly from sellers, preferring companies that had been mismanaged by prior owners. He bought businesses that Ralston could improve via marketing expertise and distribution efficiencies.

Stiritz only pursued opportunities that presented compelling returns under conservative assumptions and he disdained the false precision of detailed financial models (so do we).  “I really only cared about the key assumptions going into the model. First, I wanted to know about the underlying trends in the market: its growth and competitive dynamics.” The approach featured a single sheet of paper and an intense scrutiny on only the most important variables, not a laundry list of projections.

Stiritz leveraged (no pun intended) a private equity mindset. He appreciated that businesses with highly predictable cash flows could employ debt to enhance returns. As such, Ralston consistently maintained industry-high debt ratios.  He financed two large acquisitions in the 1980s by taking on debt totaling 30% of the company’s value before making his largest purchase ever, buying Energizer from a motivated seller.

Throughout the 1990s, Stiritz focused on opportunistic share repurchases and occasional acquisitions before developing an appreciation for a relatively new structuring device to rationalize Ralston’s brand portfolio. As some of the company’s businesses were not receiving the attention they deserved, he began to use spin-offs to release entrepreneurial energy while deferring capital gains taxes. In Thorndike’s words:

From the outset, Stiritz had been a believer in decentralization, working to reduce layers of corporate bureaucracy and giving responsibility and autonomy for the company’s key businesses to a close-knit group of managers. He viewed spin-offs as a further move in this direction – the ultimate decentralization – providing managers and shareholders with an attractive combination of transparency and autonomy and allowing managers to be compensated more directly on their operating results than was possible in the larger conglomerated structure of the mother company.

Stiritz began spinning off a collection of small brands in 1994 and concluded the program in 2000 with the spin-off of Energizer, transforming Ralston into a dominant pure play pet food company. In 2001, the company was sold to Nestle for a record price of $10.4 billion.

Stiritz himself likened capital allocation to poker, in which the key skills were an ability to calculate odds, read personalities and make large bets when the odds were overwhelmingly in your favor. He was an active acquirer who was also comfortable selling or spinning off businesses that he felt were mature or underappreciated by Wall Street.

In 1981, it would have been impossible to predict the transformation Bill Stiritz would achieve at Ralston or the remarkable impact he would have on the company’s shares.  Pretax margins grew from 9% to 15% and ROE more than doubled under his stewardship. When combined with a shrinking share base, this produced exceptional growth in earnings per share. A dollar invested with Stiritz when he stepped into the driver’s seat at Ralston was worth $57 nineteen years later.

Investors may not have nineteen years to look forward to with Stiritz today, but we think it’s worth taking a look at what he’s up to.  More to come.

Ralston