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Berkshire Details Sokol’s Lubrizol Scandal

Berkshire Hathaway has put out a report on top exec David Sokol’s resignation in March over shares he purchased in Lubrizol before Berkshire’s takeover was announced.

At the time, I was wrong on this blog when I said:

“This seems to me a case of an appearance of conflict of interest rather than a real conflict of interest. Sokol thought Lubrizol was a good investment. He suggested that it would be a good investment for his company, too. Engineering an entire deal to make a tidy—albeit $3 million—profit would be the tail wagging the dog.”

Turns out, according to the report, there was more to the story than that:

He did not disclose:

* the amounts and timing of his purchases;

* the fact that he bought the shares after discussing Lubrizol with Citi and after Mr. Sokol had narrowed the bankers’ initial list of 18 chemicals companies to one, namely Lubrizol;

* the fact that Mr. Sokol had bought shares after Mr. Sokol (acting as a senior representative of Berkshire Hathaway scouting acquisition candidates) had asked for Citi’s help arranging a meeting with Lubrizol’s CEO to discuss Lubrizol and Berkshire; and

* the fact that Mr. Sokol bought shares after learning that Citi had discussed his request for a meeting with Lubrizol’s CEO, who told Citi that he would discuss Berkshire Hathaway’s possible interest in a transaction with the Lubrizol board.

Though, the report suggests that Sokol won’t have to exchange his pin stripes for prison stripes.

We appreciate that at the time Mr. Sokol traded, he did not know whether Mr. Buffett would support, or reject, the idea of an acquisition of Lubrizol. We also recognize that Mr. Sokol did not know how Lubrizol would respond to an acquisition proposal if Berkshire Hathaway were to make one. We recognize the view that those uncertainties might have kept Mr. Sokol’s information below the level of probability required to support a finding of materiality for purposes of finding a violation of federal insider trading law. But the Trading Policy requires a higher standard of conduct than what is required to avoid being charged with a federal securities violation.

I like the last sentence. It reminds me of the old Hebrew National commercials.

My take: Why would someone blow their chance to be Warren Buffett’s successor for a measly $3 million? Berkshire doesn’t disclose Sokol’s salary or stock holdings in its proxies. In any case, I’m sure he’ll land on his feet.

Berkshire Exec Resigns (Apparently) Over Lubrizol Bid

Some of you may have heard the news that Berkshire Hathaway executive David L. Sokol has resigned. Sokol bought 100,000 shares of Lubrizol and suggested to Buffett that Berkshire buy the whole company. Here’s the Lubrizol-related excerpt from Buffett’s statement about the resignation:

Finally, Dave brought the idea for purchasing Lubrizol to me on either January 14 or 15. Initially, I was unimpressed, but after his report of a January 25 talk with its CEO, James Hambrick, I quickly warmed to the idea. Though the offer to purchase was entirely my decision, supported by Berkshire’s Board on March 13, it would not have occurred without Dave’s early efforts.

That brings us to our second set of facts. In our first talk about Lubrizol, Dave mentioned that he owned stock in the company. It was a passing remark and I did not ask him about the date of his purchase or the extent of his holdings.

Shortly before I left for Asia on March 19, I learned that Dave first purchased 2,300 shares of Lubrizol on December 14, which he then sold on December 21. Subsequently, on January 5, 6 and 7, he bought 96,060 shares pursuant to a 100,000-share order he had placed with a $104 per share limit price.

Dave’s purchases were made before he had discussed Lubrizol with me and with no knowledge of how I might react to his idea. In addition, of course, he did not know what Lubrizol’s reaction would be if I developed an interest. Furthermore, he knew he would have no voice in Berkshire’s decision once he suggested the idea; it would be up to me and Charlie Munger, subject to ratification by the Berkshire Board of which Dave is not a member.

As late as January 24, I sent Dave a short note indicating my skepticism about making an offer for Lubrizol and my preference for another substantial acquisition for which MidAmerican had made a bid. Only after Dave reported on the January 25 dinner conversation with James Hambrick did I get interested in the acquisition of Lubrizol.

Neither Dave nor I feel his Lubrizol purchases were in any way unlawful. He has told me that they were not a factor in his decision to resign.

Dave’s letter was a total surprise to me, despite the two earlier resignation talks. I had spoken with him the previous day about various operating matters and received no hint of his intention to resign. This time, however, I did not attempt to talk him out of his decision and accepted his resignation.

This seems to me a case of an appearance of conflict of interest rather than a real conflict of interest. Sokol thought Lubrizol was a good investment. He suggested that it would be a good investment for his company, too. Engineering an entire deal to make a tidy—albeit $3 million—profit would be the tail wagging the dog.

A Good Take on Berkshire/Lubrizol

Peter Mycroft Psaras at Mycroft Research posted a great analysis of the Berkshire/Lubrizol deal on Seeking Alpha.

He uses Buffett’s favorite measure—owner earnings—to assess the deal. Mycroft points out that Lubrizol stands out as among the best in the chemical industry by that metric.

Observations About Berkshire/Lubrizol

Berkshire Hathaway is buying C&EN’s 2009 Company of the Year. C&EN has a Latest News with the main details.

Here are a few observations:

1) It doesn’t seem like the most expensive deal in the world. In fact, it seems like Buffett is comfortably in value territory with this one. Berkshire is getting the company for just under 13x earnings, including Lubrizol’s net debt, and less than 9X EBITDA.

2) The value doesn’t seem to imply that there was a bidding war for the company. Perhaps that makes sense. Lubrizol is a great company, but it is mostly in lubricants. That business, wedded largely to the future of the internal combustion engine, might not capture the minds of the large chemical firms that seek to diversify.

3) Word about the impending acquisition seems to have gotten out before the official announcement.

4) Buffett hinted that a big acquisition was in the works a couple of weeks ago with his annual letter to shareholders. In it, he said, “Our elephant gun has been reloaded, and my trigger finger is itchy.” Good metaphor, BTW. Way better than “loaded for quail”, an expression which never really made sense to me. Though, calling Lubrizol an elephant by Berkshire standards is stretching it a bit. It is more like an elk or something.

5) Berkshire helped Dow buy Rohm and Haas. Lubrizol kind of reminds me of Rohm and Haas, even though both companies mostly serve different sectors. Both are specialty firms that have the winds at their backs, perhaps for different reasons. Rohm and Haas was a bit more focused on technology. Lubrizol strength is being well managed.

6) Buffett thinks so, too. “Just keep doing for us what you have done so successfully for your shareholders,” he said to James Hambrick in the release. I’ve got a lump in my throat. Seriously, though, it is quite an endorsement.

7)  Hambrick has his accomplishments. The company came out of the downturn with strong earnings. He oversaw the acquisition and successful integration of Noveon, which helped diversify the company away from lubricants. This in an industry where large acquisitions towards such aims all too often are the parasites that consume the host.

FutureFuel To Get Listing on NYSE

FutureFuel says it is going to start trading on the New York Stock Exchange on or about March 23 under the ticker symbol “FF”. The company had been trading over the counter.

Who is FutureFuel?

Glad you asked. It is the former Batesville, Ark., complex of Eastman Chemical. Originally, it was a photographic chemical facility for Eastman Kodak. Then it evolved into a custom chemical and performance chemical plant. Its most notable contract was making the bleach activator nonanoyloxybenzenesulfonate (NOBS) for P&G.

Eastman started to convert the facility into making biofuels such as biodiesel, ethanol, and solid lignin biomass.

Private investors under the name Viceroy Acquisition bought the plant from Eastman for more than $75 million. Viceroy had raised about $160 million on the London Stock Exchange’s AIM market to break into the U.S. biofuels sector. (Back in those days, people would throw money at you at the mere mention of biofuels.)

But FutureFuels, despite its name, is still very much a chemical company. During the first nine months of 2010 (Q4’s aren’t out yet) it generated $165.6 million in revenues. Some $131.1 million came from chemicals; $34.5 million were in biofuels. Its gross were $31.2 million from chemicals and a loss of $5.1 million in biofuels. (I’m guessing it will remain a chemical company.)

By the way, that contract with P&G is alive and well. In fact, FutureFuel revenues from this contract alone in 2009 were $73.5 million. That represented about 37% of ALL of its revenues that year. Another $31.6 million in sales came from making a proprietary herbicide for Arysta LifeScience.

A Few Observations About DuPont/Danisco

This morning, DuPont announced a deal to purchase Denmark’s Danisco for $5.8 billion in cash plus $500 million in Danisco debt. Here are some thoughts:

1) DuPont is long overdue to make a large acquisition.

A decade ago, no chemical company was making as many deals as DuPont. An often quoted figure is that DuPont racked up a total of $60 billion in acquisitions and divestitures between 1998 and 2004.

It was early in Chad Holliday’s tenure as CEO and he wanted to leave his mark. He split off Conoco in 1998. (The oil glut is almost perfectly bookended by DuPont’s Conoco ownership.) He also sold off pharmaceuticals. And in 2004, DuPont divested its Invista fibers unit to Koch Industries.

In 1998, DuPont purchased Hoechst’s Herberts automotive paint unit. In 1999, it bought seed maker Pioneer Hi-Bred.

But since it purchased electronic chemicals maker ChemFirst in 2002, for only about $400 million, there’s hardly been a peep out of the company.

2) Valuation is a tough call.

Based on the $6.3 billion price tag and Danisco’s expectations for the full fiscal year ending in April, DuPont is paying 27.4x earnings and 15.4x EBIT. That strikes me as a good full valuation. It isn’t the full you feel on Thanksgiving when you doze off while watching the Lions; it’s more like Big Mac and fries at your desk full.

Looked at another way, DuPont is paying 7.7x book value (equity minus intangibles), which makes the deal seem a little more expensive.

3) There are deals in DuPont’s future

The primary motive for DuPont to buy Danisco is enzymes maker Genencor. The rest of Danisco is all about food. Under “Industry Events” on Danisco’s website the next event Danisco has scheduled is the Banff Pork Seminar, after that company officials are on to the Bread and Butter Tradeshow. (Check the links. These are both real things.)

How deep does DuPont want to get in the food industry? Outside of Genencor, Danisco’s three major units are enablers, which are the gums and emulsiers that go into food; sweeteners, fructose and the like; and cultures, as in probiotics. None of these seems to scream DuPont, though enablers sound like the best fit in DuPont because they are very chemistry oriented.

Worth mentioning: in recent years, Danisco has divested its sugar business and its flavor and fragrances unit.

UPDATE:

In the conference call, DuPont CEO Ellen Kullman argued that Danisco would complement DuPont’s health and nutrition business. In other words, probiotic cultures from Danisco would complement Omega-3 fatty acids and soy proteins from DuPont. Specialty food ingredients from Danisco such as emulsifiers and sweeteners would benefit from DuPont’s “application development skills”.

When Frant Mitsch of BB&T asked about “cleaving off” businesses, Kullman said “we just got this thing agreed to last night.” She added, “I am very excited about the prospects of what Danisco brings us.”

Celanese Says It Is The Amazon Of Ethanol

Yesterday, Celanese hosted a conference call with analysts about its new ethanol technology. On the call were CEO Dave Weidman, CFO Steven Sterin, and senior operations VP Jim Alder.

About a month ago, the company unveiled plans to build one, and possibly two, 400,000-ton-per-year ethanol plants in China based on coal and using its new conversion technology. It is also planning a smaller, 40,000-ton plant in Clear Lake, Texas, based on natural gas.

The conference call didn’t shed a whole lot of light on what the technology is all about. It is pretty obvious that the process is based on gasification. Officials said that the plant can use any hydrocarbon feedstock, including biomass.

Another clue is that Alder said that the technology “integrates elements of Celanese acetyls technology.” What could this mean? Well, acetic acid, also known as ethanoic acid, has two carbons like ethanol. In other words, it is ethanol plus a carbonyl group. Celanese and other companies make it via the carbonylation of methanol using carbon monoxide.

Alder also mentioned that by the time the Clear Lake plant comes onstream in 2012, the company will have some 3,000 patents worldwide covering the technology, many of which are patents covering its existing acetyl chemistry.

Company officials also stressed that the technology is highly selective for ethanol, a point of contrast, they said, between Celanese’s technology and existing processes to get to alcohols via gasification, such as Sasol’s.

The economics, Weidman said, were “very favorable compared to fermentation.” Another advantage is that the technology is very scalable, officials stressed. Celanese can expand a 400,000 plant to 1 million tons at a fraction of the initial cost of building the plant. This seems to explain why Celanese said might build one–or two–plants in China. The options the company is looking at are either building a second plant, presumably at a different location, or expanding its first unit. Either way, Celanese wants to quickly ramp up the technology to about a million tons.

To say that Celanese is excited about the technology is an understatement. I have never once heard a chemical company gloat about a technology more than Celanese has about this ethanol process. “This technology breakthrough is a new platform for earnings growth with the potential to reshape Celanese,” Weidman said.

Weidman said that if Celanese had an operational million ton plant today, it would generate nearly a billion dollars in revenue and ethanol would be the Celanese business with the greatest profit margins. A cash cow is born, lay down some straw and gather the children.

Weidman: Our Ethanol Technology Will Rock Your World

Officials did get a little carried away. One of the principals, I lost track of who, said Celanese entering the ethanol business was “kind of like Amazon entering the book selling business.”