Cracking the Books: Shareholder Value
Drips from U.S. Filter
By Gregg Wirth
Staff Reporter
9/24/98 11:55 AM ET
U.S. Filter (USF:NYSE), a leader in the
water-purification systems industry
boasting a $3.2 billion market cap, may
be heading into some uncharted waters of
its own.
In the past, the financials of the Palm
Desert, Calif.-based company have been shrouded in a fine
mist of constant deal-making. Even by merger-crazy, roll-up
company standards, U.S. Filter has been acquisitive. It has
completed more than 150 deals in its less than eight years of
existence -- an average of almost 20 deals a year. And
despite the strong growth posted by the company -- earnings
per share grew an average of 45% a year, compounded, for
the four years ended March -- analysts charged with
evaluating the company's financials found it impossible to
accurately gauge the health of the overall operation.
"Historically, the problem was that they grew so quickly that
something could be blowing up and no one would have
known," says Rod Lache, an analyst at Deutsche Bank
Securities. He currently rates the stock a buy, and
Deutsche has done underwriting for USF in the past three
years.
For years, U.S. Filter got away with the growth story -- the
stock has risen 43% a year, compounded annually, from
1994 through its peak in October of last year. But there
always lingered a suspicion that the company's acquisition
strategy would come to tears, and, this year, those fears
appear to have come true. U.S. Filter has taken extraordinary
charges totaling $635 million in the past eight months related
to two huge acquisitions. And the stock is down 46% since
the beginning of this year.
Richard Heckmann, U.S. Filter's chairman and chief
executive officer, says it is the sour market, not the
company's business plan, that is the cause of the stock's
downturn. "We're down just like other companies that didn't
do any acquisitions," says Heckmann. "You're not going to
convince me it's because of roll-up acquisitions."
But in an effort to quell the criticism, the company provided,
for the first time, detailed line-of-business disclosure in its
most recent first-quarter 10-Q for the period ended June 30.
U.S. Filter not only broke out its revenue and earnings
numbers into separate segments of operations, but also
reported internal growth numbers for them, too. The good
news in the latest report was that for the fiscal first quarter,
U.S. Filter reported a 41% jump in revenue to $1.1 billion for
the quarter. Earnings more than doubled to $55.6 million, or
34 cents per share. Much of the hike in both revenue and
earnings was due to the acquisition of one of U.S. Filter's
largest prizes ever -- Culligan Water Technologies, a $1.5
billion deal that effectively doubled U.S. Filter's size
(including the acquisition of some 50 of Culligan's local
distributors).
The bad news was that the Culligan deal also brought with it
a $261.5 million charge against earnings. This drowned the
operating earnings in red ink, leaving a total loss of $155.4
million, or 98 cents per share, after the charge. U.S. Filter
breaks down the charges in the latest report, dividing them
into cash charges ($155.4 million) and non-cash charges
($106.1 million). The company claims it could save $44
million per year from synergies after the acquisition.
Despite the fact that one analyst -- Bear Stearns' Chris
Bodnar -- described the hit against earnings as not that
serious, the slow runoff in US Filter's shares has become a
waterfall. (Bodnar currently has a buy recommendation on
U.S. Filter. His firm initiated coverage of U.S. Filter in June,
after following and doing investment banking work for
Culligan.) Since the release of the earnings on Aug. 4, the
shares have fallen 41%.
Part of that fall may be due to the fact that the whole concept
of a roll-up has come under increasing scrutiny. Investors
have in the past two months decided -- rightly or wrongly --
that companies whose growth strategies rest largely on
acquiring other companies are, at best, a bull-market
phenomenon. As a result, U.S. Filter has taken a dive along
with all the other roll-up stocks.
Heckmann denies that this will be a problem for growth,
adding that U.S. Filter is not dependent on acquisitions
funded solely by the company's stock. He notes that, with
the exception of Culligan, U.S. Filter's next four-largest
purchases were done with cash. "The people who think we're
out of the acquisition business because of our stock price
are not dealing with the facts," he says.
That's good, because without acquisitions, U.S. Filter is, at
best, a plodder. That was evident from the quarter ended in
June. Heckmann pegs the company's sequential growth -- for
the operations it has owned for more than a year -- at
between 6% and 7% for the June quarter. That number is flat
compared to last year's similar period, he adds
However, the average shareholder would have a hard time
accessing that information. Despite Heckmann's assertion
that "All our reporting is done to allow shareholders to
properly evaluate the company," and its new open-book
policy, U.S. Filter had always limited its disclosure of internal
growth figures to analyst conference calls -- never, up until
August, in its press releases or quarterly reports. That figure
was always available to any shareholder who called, asserts
the company.
More worrisome to investors is whether U.S. Filter's last two
mega-acquisitions made sense after taking all the write-offs.
U.S. Filter took a whopping $374.1 million loss in its
third-quarter earnings (ended Dec. 31, 1997) due to the
purchase of Memtec for $380 million in cash. In that
instance, U.S. Filter wrote off the goodwill involved in the
purchase instead of amortizing it, explains Heckmann,
adding this was similar to how IBM (IBM:NYSE) accounted
for its purchase of Lotus. But if U.S. Filter wrote off all of the
acquisition, why did the company do it in the first place?
"Every high-tech company does this," Heckmann says,
adding that Wall Street greatly favors this method. Currently,
12 analysts have recommendations on the stock, according
to Zacks Investment Research -- nine hold buy
recommendations, two have moderate buys and one has a
hold. Analysts expect earnings of 36 cents per share for the
current quarter, which ends Sept. 30, and $1.53 per share for
the year, which ends March 31, 1999, according to Zacks'.
Despite the bullish outlook, U.S. Filter still has plenty of
problems, most stemming from its overdependence on
growth through acquisitions. "As long as it keeps the
numbers coming [through constant acquisitions], the
accounting looks clean," says one short-seller who is short
the stock and requested anonymity. "But overall, it's a flawed
concept: One mistake, and it's a $10 stock." |
