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When Duracell was bought by Gillette in 1996 for $7.8bn it was the market leader in alkaline batteries; it’s brilliant marketing, with the Duracell Bunny, had created a global brand. Duracell accounted for one-quarter of Gillette’s sales. But it didn’t take long for competitors to offer cheaper versions; a price war ensued and two years of falling market share. Operations seemed to move into a lacklustre phase, with failed marketing campaigns. It even allowed the Bunny mascot trademark to lapse in the USA – Energizer filed its own bunny mascot. There was also a run-up of overhead costs.
Jim Kilts, CEO of Gillette, imposed financial discipline and invested in new marketing, but Duracell didn’t really recover lost ground – annual revenue growth slowed to 1% and market share was lost.
In 2014 P&G decided its optimum strategy was to concentrate on the 65 brands generating the most profit, such as Tide, Head & Shoulders and Pampers, and to sell off the slow-growing divisions.
Buffett saw an opportunity because he had “always been impressed by Duracell as a consumer and as a long-term investor” (Jonathan Stempel and Devika Krishna Kumar (2014) Buffett’s Berkshire Hat, Reuters, November 13, 2014).
After all it still had 24% of the world market for batteries. He agreed to exchange the $4.2bn of P&G shares held by Berkshire for all the shares in Duracell, but only after P&G injected $1.8bn in cash into the battery company, thus the net price was $2.4bn, less than a third of what Gillette had paid for it 20 years earlier (the deal was completed in February 2016).
Why choose Duracell over P&G?
Both Duracell and P&G are consumer businesses with strong brands and predictable cash flow. Both are easy to understand and have strong competitive advantages; and both are run by competent and honest managers. So why did Buffett choose to put all eggs into the Duracell basket and none in the P&G?
I suspect the decision had a lot to do with price. In 2015 P&G was trading on a price earnings ratio above 20, indicating Mr Market had faith that earnings will grow significantly. Duracell was seen by P&G as, at best, destined for slow growth, as it was bypassed by rechargeables.
But Buffett noted its cash flow was strong and P&G was willing to sell it at seven times adjusted earnings before interest, tax, depreciation and amortisation. This EBITDA measure makes Buffett and all rational share valuers shudder because, not least, it leaves out the need to spend on capital items and to pay taxes. But even if we deduct reasonable estimates for these, Duracell was being sold on a low double-digit multiple of after-tax earnings.
From the table we see that Duracell’s use of net tangible assets was nothing like the net $4.2bn paid for the company. Taking net assets of $4.2bn and deducting $2.4bn of goodwill and intangibles we get $1.8bn. But within that we see that the balance sheet carries £1.8bn in cash.
The vast majority of this is not needed for Duracell’s operations meaning that it can carry on producing batteries with very few net tangible assets, allowing Buffett was to invest the cash in other shares. The significance of this low need for net tangible assets is in the likely destination of the future cash generated by the business: it can be paid out to Berkshire. It also means that high rates of return on net tangible assets can be expected as the company grows.
Table. Fair values of assets and liabilities (and goodwill) of Duracell at acquisition by Berkshire Hathaway
| £m | ||
| ASSETS | ||
| Cash and cash equivalents | 1,807 | |
| Inventories | 319 | |
| Property, Plant and Equipment | 359 |
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