The Founding of a Spin-off Machine

The Founding of a Spin-off Machine

Danaher (DHR) is one of the best performing stocks of all time.

The stock has compounded at 21% per year for four decades. That works out to a 1,800x multiple on invested capital.

🤯

Since 2016, Danaher has spun off 3 separate public companies and has become a life science and diagnostics pure play.

Recently, Danaher cofounder, Mitch Rales, was interviewed on the “Art of Compounding” podcast. The episode was terrific (my rating: 10/10) and I recommend listening to the whole 2 hour interview.

One of the most interesting parts of the podcast for me was when Mitch shared how he and his brother founded Danaher.

1981

The company that became Danaher was founded in 1981 by Mitch and Steve Rales.

At the time, Mitch and Steve had just concluded a fishing trip to Montana.

And they were pondering their careers. Mitch said to Steve, “God, wouldn’t it be great if we could create a business in our lifetime with $250MM of sales and a 10% operating margin.”

And that became their goal.

That’s a hell of a goal. But Mitch and Steve didn’t have any money.

How were they going to create a $250MM business from scratch?

“We Borrowed 100% of the Purchase Price”

Their first deal came about in 1981 when they decided they wanted to buy a vinyl siding manufacturing company called Master Shield.

The fundamental thesis?

At the time, vinyl siding was a new, niche product, but the Rales brothers had conviction that it was poised to explode in popularity because it didn’t chip.

Another interesting aspect of the purchase was that it was owned by a bankrupt parent company that had to liquidate to pay off its creditors.

In effect, the Rales brothers were buying from a forced seller (this is the same dynamic that is often the case with spin-offs).

The only problem?

Mitch and Steve didn’t have any money.

The purchase price was $6MM.

They were able to borrow 80% against receivables, 50% against inventory, and 30% against an appraisal.

That covered $5MM of the $6MM that they needed.

What about the remaining $1MM?

A Maryland bank agreed to extend a loan to cover the balance.

In effect, Danaher was founded as an LBO with zero equity investment.

How Did It Work Out?

Well, we know it worked out well over the long term as Danaher is currently valued at $202BN.

But it also worked out surprisingly well in the short term.

At the time of the acquisition, Master Shield was generating $9MM of sales and $600,000 of operating profit.

Three years later, the business was generating $40MM of revenue and $6MM of operating profit.

Name Change to “Danaher”

In 1983, Master Shield bought Mohawk Rubber for $90MM ($88MM of which was borrowed!).

Shortly thereafter, Mitch and Steve merged Master Shield and Mohawk Rubber with a defunct real estate investment trust called DMG and changed the name to Danaher.

And the rest is history!

I highly recommend listening to the full episode.

Other Good Danaher Resources

Aim of Rales Brothers Rises on Takeovers (NYT) – August 1, 1988

Rales Brothers Eclipse Buffett as Danaher Shares Soar (Bloomberg) – March 31, 2004

Oscar Loser Wins Big Next Day With $21.4 Billion Acquisition Of GE’s Biopharma Business (Forbes) – February 27, 2019

Spin-off Machines

I’m not recommending Danaher today, but two of my highest conviction stocks are also spin-off machines.

One has spun off 5 companies in its history while the other has spun off 8. Sign up for my premium newsletter and get instant access to my full investment case for each.