Today’s half-year report from Melrose Industries (LSE: MRO) is dominated by the progress update regarding its gargantuan acquisition of automotive and aerospace company GKN, which propelled Melrose into the FTSE 100.
GKN was a FTSE 100-listed firm before Melrose took it over this year, and those that previously owned GKN shares now own around 57% of the shares of the enlarged business, which gives you an idea of how big a mouthful GKN is for Melrose. But Melrose is no stranger to handling acquisitions. The firm specialises in buying what it describes as “good” manufacturing businesses with strong fundamentals “whose performance can be improved.”
Buy, improve, sell
The company aims to finance its deals with as little debt as it can and then improves operations by investment and by changing the management focus of businesses acquired. When things are ticking over smoothly with decent growth and profit figures, Melrose sells the business and returns the proceeds to its shareholders. So, investors holding shares in the firm can look forward to periodic capital returns, and when the time comes to let GKN go, the payment could be substantial if things go well.
And so far, things are going well. Melrose took control of GKN on 19 April and delisted it from the stock exchange on 21 May. Christopher Miller, Chairman of Melrose Industries, said in today’s report that the directors “moved quickly to decentralise GKN and empower the operational management teams.” That sounds like the approach that well-known investors Warren Buffett and Charlie Munger take when they acquire businesses for Berkshire Hathaway.As well as pushing operational responsibility downline, I reckon it frees the management teams from bureaucracy, allowing them to flourish at their entrepreneurial best. Mr miller said that Melrose has already reduced central functions and agreed strategic plans with operational management, “who are now focused on implementation.”
I think such moves are both necessary and potentially effective. Melrose’s board of directors mainly come from the world of finance so it is necessary to rely on the operational management of acquired companies to run day-to-day operations. But the cost savings and benefits flowing from freeing up and re-energising management teams can lead to spectacular financial returns as we can see in the track records of both Melrose Industries and Berkshire Hathaway. The directors at are pleased with their acquisition of GKN and expressed their confidence in the outlook by pushing up the interim dividend 11%.
Another business improver
The company reminds me of its FTSE 100 peer 3I Group (LSE: III). The firm operates the two divisions of Private Equity and Infrastructure with more than two-thirds of its assets under management in the Private Equity division. The business model is similar to Melrose’s in that 3I buys businesses with the aim of improving them and then selling them for a profit.
However, 3I goes for companies in a wider range of sectors and targets firms with an enterprise value between €100m and €500m in Northern Europe and North America. There is a portfolio of 35 unquoted assets and one quoted stake on the books at the moment and the firms span the sectors of consumer goods, industrials, business & technology services and others.
I think both Melrose Industries and 3I Group have great potential and are worth your research time now.