HDG HunterDouglas Singular Diligence June15

8/16/2019 HDG HunterDouglas Singular Diligence June15

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SINGULAR

DILIGENCE Hunter Douglas(Amsterdam: HDG)


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40% 40%39% 39% 39%

40%41%

42%41%

37% 37%

39% 39% 39% 39% 39%

17% 17%

15% 16%

13% 14%15% 16%

14%

10% 9%11%

9% 10% 10% 10%

14% 14%

11% 12%10% 11%

12% 13%

11%

7%5%

7%6%

7% 7% 7%

Gross EBITDA EBIT

- - - -

- - - -

- - - - -

- - - - - - -

- - - - - - -

- - - - - - -

- - - - - - - -

- - - - - -

- - - - - - - -

-


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——JUNE 2015—— -

DURABILITY 3

MOAT 5

QUALITY 7

CAPITAL ALLOCATION 8

VALUE 11

GROWTH 12

MISJUDGMENT 14

CONCLUSION 16

APPRAISAL 18

NOTES 20

SINGULAR DILIGENCE Geoff Gannon, Writer Quan Hoang, Analyst Tobias Carlisle, Publisher

OVERVIEW

Hunter Douglas trades in Amsterdam.The company’s stock is priced in Euros.Financial statements are presented inU.S. dollars. The company gets 81% ofsales from the U.S. and Europe. Salesare split almost evenly between theU.S. and Europe. North Americaaccounts for 43% of sales. Europeaccounts for 38% of sales. HunterDouglas has two brands names. TheU.S. brand is Hunter Douglas. TheEuropean brand is Luxa ex. All otherparts of the world use either theHunter Douglas or Luxa ex brandname.

Hunter Douglas is the world leader inwindow coverings. The company gets68% of pro ts from window coverings.These are blinds and shades soldthrough an independent dealernetwork to consumers who live inhouses and apartments. The companygets 24% of pro ts from architecturalproducts. These are similar to windowcoverings. But they are sold tocommercial customers instead. Theyinclude exterior shades, skylightshades, sun control systems, etc. Theyserve the same func on as blinds and

shades in homes. However, they are ona much bigger scale. A good example ofa Hunter Douglas architecturalproducts customer would be an airport.This segment is broken out separatelyin Hunter Douglas’s results because themarke ng is di erent. Themanufacturing of components is similarin both cases. The type of products are

fundamentally similar. But, the marke ng is completely di erent.

Hunter Douglas gets about two -thirds of its pro ts from Hunter Douglas andLuxa ex branded blinds and shades sold through independent dealers. In the U.S.,Hunter Douglas’s manufacturing is now completely ver cally integrated. Originally,the company had a model similar to many other building products companies. Itmanufactured components in a few plants around the country. Then it shippedthese parts to hundreds or even thousands of independent fabricators across thecountry. The fabricators assembled the parts into nished products. The fabricatorsalso nominated dealers for Hunter Douglas to review and approve. Over me,Hunter Douglas phased out this model. They acquired fabricators and cut out themiddlemen. Now, Hunter Douglas deals directly with dealers. Hunter Douglas hascompletely consolidated its U.S. manufacturing. This means the company can ful llorders much faster than compe tors. A custom order can be ful lled in one weekin the U.S. Compe tors can take 15 to 30 days to ful ll similar custom orders.Hunter Douglas handles all aspects of manufacturing from the making of

components to nal assemble itself. Both the manufacturing and assembly aredone en rely in the U.S. Hunter Douglas does not import any products. Thecompany has 8 manufacturing plants in the U.S. that produce components. Theseparts are then assembled into a custom order at one of three sites in Maryland,Utah, or California. So, the Hunter Douglas brand in the U.S. is manufactured in aver cally integrated way. It is made en rely in the U.S. And it has a one -stepdistribu on process. Parts are manufactured in a plant. They are sent to a companyowned fabricator and assembled into a custom order. They are then shippeddirectly to a Hunter Douglas dealer. Assembly and delivery can be done in oneweek.

The Luxa ex brand in Europe is somewhat di erent. Parts are produced in a fewplants. Manufacturing is centered mostly in the Netherlands. However, some

Luxa ex orders are assembled by local fabricators instead of being put together inHunter Douglas’s own assembly plants. So, the Luxa ex brand in Europe followsthe old Hunter Douglas model in the U.S.

Hunter Douglas is an obscure stock. The Hunter Douglas brand is American. So, thecompany’s name is American. However, the stock trades in Europe. The companyreports its results in U.S. dollars. But, the stock trades in Euros. The stock is 81%owned by the Sonnenberg family. Basically, the Sonnenberg family is the “Douglas”family. That’s because there is no Douglas family. There never was a Douglasfamily.

Hunter Douglas (Amsterdam: HDG) is the Huge HiddenChampion in Blinds and Shades

SINGULAR DILIGENCE Issue 7, JUNE 2015 1


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Here’s how Hunter Douglas wasformed. In 1940, Henry Sonnenbergmoved to the U.S. In 1946, Sonnenbergestablished a joint venture with JoeHunter. They produced aluminum slatsfor Vene an blinds. Later, the HunterDouglas corpora on was created. Thename Hunter came from Joe Hunter'sname. The name Douglas wasSonnenberg’s contribu on. He thought“Sonnenberg” sounded too Jewish. So,he simply picked the name “Douglas”from a telephone book. Hunter Douglasbecame the U.S. leader in aluminumblinds. They sold parts to over 1,000independent fabricators whoassembled orders. In 1956, a falling outbetween Hunter and Sonnenberg led tothe sale of the U.S. business.Sonnenberg con nued in the windowcoverings business in Canada. He

expanded throughout Europe,Australia, and La n America. In 1969,Hunter Douglas went public. The stockwas listed in Canada and theNetherlands. Sonnenberg moved thecompany’s headquarters to theNetherlands. The headquarters are s llin Ro erdam today. In 1976,Sonnenberg was able to buy his formerU.S. business. This combined the U.S.and European opera ons.

Hunter Douglas is completely family

controlled. The Sonnenbergs own 81%of the company. They wanted to take itprivate. However, their tender o ershave never been accepted by enoughminority shareholders to reach thethreshold needed to de -list. RalphSonnenberg is the CEO of HunterDouglas. Ralph is Henry Sonnenberg’sson. Ralph’s two sons – DavidSonnenberg and Marko Sonnenberg –are co -Presidents and co -ChiefOpera ng O cers of the company.

The Sonnenbergs treat the corporatecash like their own. In the past, thecompany invested in a variety ofinvestment funds. At some point in the2000s, Hunter Douglas stock was cheapand the Sonnenbergs probably wantedto take the company private. So, theyused much of this built up investmentmoney to buy back stock in Hunter

Douglas. They were not successful in taking the company private. But, they didincrease their stake in the company to over 80%. The company o en has both debtand cash. Hunter Douglas never hoards cash. Instead, cash is used to buy backshares or is put into investment funds. Those funds performed very well comparedto the market. The stock also pays a 3% dividend yield.

Financial assets are taxed di erently in the Netherlands than in many countries. So,it is possible that tax considera ons play some part in the way the Sonnenbergfamily allocates capital. This is a family controlled company with less than 19% inthe hands of minority investors. So, capital will be allocated in the way that makes

the most sense for the family.

You may recognize the Hunter Douglas brand. It adver ses on TV channels likeHGTV. The Luxa ex brand is probably unfamiliar to American readers. HunterDouglas window coverings are either blinds or shades. Shades are more expensive.In 1992, a “Due e” shade cost twice as much as aluminum mini -blinds. And a“Silhoue e” shade cost twice as much as a “Due e” shade. So, a “Silhoue e”shade cost four mes as much as aluminum mini -blinds. At the me, a Silhoue eshade was the top of the line model for Hunter Douglas. So, this rela ve pricing is agood guide to keep in mind. A cellular shade – “e e” type – product can costdouble what it costs to cover your window with a basic blind. And a top of the linemodel can cost double the low end of the range. Hunter Douglas now competes inall price ranges. The company is best known for its “e e” products. In 1985, theylaunched “Due e”. In 1991: “Silhoue e”. In 1994: “Vigne e”. In 1996: “Lumine e”.In 2004: “Face e”. And in 2007: “Piroue e”. Hunter Douglas spends more onresearch and development than other compe tors. It spends more on adver singthan compe tors. And it is always the rst company to launch a new innova on inthe market place. In the following years, other companies copy these innova ons.Hunter Douglas has 38% market share in the U.S. Unlike its compe tors, all HunterDouglas sales are made through independent dealers. So, Hunter Douglas has agreater than 38% share of the independent dealer channel.


Hunter Douglas gets 68% of its total profit from window coverings


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DURABILITYThe Historical Trend in WindowCoverings is for Countries to Switch from Curtains to Blinds and Shadesas their Economies Develop

The durability of Hunter Douglasdepends on 3 things. One, thedurability of customer preference forspecially designed and manufacturedshades and blinds over more basicwindow coverings like curtains. Two,the durability of domes callymanufactured products over imports.And three, the durability of theindependent dealer channel as a viablevenue for selling window coverings.Customer preference is easy to predicthere. Historically, it has been drivenen rely by brands like Hunter Douglas.

In countries where Hunter Douglas hasli le presence and li le ability to get its“e e” products in front of home buyers – people are happy covering theirwindows with blinds. However, indeveloped countries like the U.S. andEurope where Hunter Douglas has hada strong presence for decades – themarket share of curtains plummets. It isnot too much of a stretch to comparethis with the history of razors orba eries. There are some di erencess ll to this day in the technologies usedby consumers in certain countries forthose products. These are almosten rely due to the limited presence ofthe most technologically advancedbrands in those countries. Onceconsumers have enough money toa ord advanced versions of a productand that innova on is adver sed tothem they will eventually switch to it.In fact, there is a lot of room aroundthe world for addi onal sales of blindsand shades to replace curtains. For

example, curtains are 95% of allwindow coverings in India. They are45% of all window coverings in the U.K.And they are just 25% of all windowcoverings in the U.S. Of those 3countries, the U.S. has the highestmedian household income and thestrongest Hunter Douglas marketpresence. India has the lowest medianhousehold income and the weakest

Hunter Douglas market presence. These two factors are the most likely explana onfor why a country uses a lot of curtains or blinds or shades.

The use of retained earnings to invest in ver cally integrated manufacturing of bothparts and nal assembly, one step distribu on, automa on to reduce labor,research and development to design new innova ons, and adver sing to launchthe latest model are what drives adop on of more advanced technologies inwindow coverings. Again, products like razors and ba eries are a good analog.More advanced versions of these products are pushed by big global brands thathave highly automated plants, spend on researching new technologies, and heavilyadver se the launch of their latest innova ons. Without the presence of a cu ngedge brand in the market, consumers are sa s ed with products that wereconsidered obsolete on other con nents decades ago. This can be seen in windowcoverings. Consumers in India are quite sa s ed with products that Americansconsidered basic even decades ago. Over me, developing markets should followthe same trends as developed markets to the extent the most innova ve windowcoverings brands can penetrate those markets.

Because we don’t think of window coverings as a high tech product, we mayoverlook that fact that some countries are several decades behind others in theiradop on of innova ons. In ba eries, it is easy to understand that a country using

mainly zinc ba eries that were popular 100 years ago in the U.S. is “behind themes” but a country using curtains in place of cellular shades may seem like it isculturally di erent from other markets and simply prefers a di erent fashion. Theevidence does not support this. Americans and Europeans do not prefer blinds andshades for cultural reasons. It is not a western fashion. It is simply that all theinnova ons in window coverings have been launched into the U.S. and Europeanmarkets by a company focused on the U.S. and Europe. There is no reason toexpect a trend away from blinds and shades. And there is every reason to expectthat the more innova ons are launched, the more customers can – over thedecades – be shi ed further and further along the high tech path.

The next threat to durability is imports. Is this a valid concern? Probably not.Hunter Douglas has a 38% market share in the U.S. It uses domes c produc on and

assembly en rely. It does not make use of any imports. Hunter Douglas’s biggestcompe tor is Springs. Springs sells through big box stores as well as independentdealers. This can create pressure to lower selling prices. Springs imports itsstandard products. About 70% of Springs products are custom made. The parts forthese custom made products are all made in the U.S. Final assembly is done inMexico. The other 30% of products are not custom made. They are xed products.These are all imported from Asia. They are very low quality. And they are not soldto independent dealers. These xed styles and sizes are sold through stores likeBed Bath and Beyond, Target, Wal -Mart, and K -Mart. This is a really small part ofthe business. It is for people who simply want to cover a window fast. Most ofSprings business and all of Hunter Douglas’s business does not cater to this group.

Hunter Douglas has no xed business. And even Springs is mostly custom. As

someone from Springs explained: “Custom products…are made to customerspeci ca ons, so it’s impossible to say how many dis nct models or types ofshades, shu ers, or blinds are o ered…It’s in nite…It’s an eighth of an inch thisway, an eighth of an inch that way. You pick the color, you give the dimensions, yousay you need the cord on this side or that side. The bo om could go up, the topcould come down. There are a lot of di erent op ons.”

Making custom orders is complex. In Europe, Hunter Douglas s ll has a two -stepdistribu on process. However, manufacturing parts for a custom product iscomplicated even when someone else assembles the order. A 2000 ar cle in the



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Financial Times explained this well:“The job of matching the produc on ofparts with what the consumer wantsadds up to a massive exercise inlogis cs. Every day, 10 to 15 trucksarrive at (Hunter Douglas’s) centralEuropean warehouse near Ro erdamwith parts from the company’s six mainEuropean manufacturing units. Theseare mainly in the Netherlands, andproduce items such as metal sheets,

xtures, tex les – and even paint usedin the nal nish…The individualcomponents – made in some 10,000di erent shapes and sizes – spend asli le me as possible in the warehousebefore being reshipped either toHunter’s 20 or so assembly plantsaround Europe or to other companieswhich can, under some circumstances,take over the assembly and distribu on

job under a licensing deal.” Hunter Douglas blinds and shades aresold by an independent dealer. This issomeone – like a decorator – who isknowledgeable about the HunterDouglas line -up and can o er fashionadvice. About 80% of window coveringsshoppers are women. The mostimportant services o ered by dealersto these women are measurement,installa on, and fashion advice.Decisions need to be made on color,

material, pleat or slat size, li ingsystem, etc. Dealers provide advice onthis. They also provide warran es.Some dealers told us that customersreturn up to 20 years a er purchasing awindow covering looking for a repair.

In 2010, Hunter Douglas chose todouble down on this independentdealer network. It decided to abandonall other sales channels. Here is thecompany’s Vice President ofMerchandising talking about thatdecision four years a er making it: “Itwas a very big decision. Almostcounterintui ve to what certain peoplethink. But in June of 2010, we madethat decision. Keep in mind that HunterDouglas sells only custom orderproducts, and it’s more di cult to sell acustom ordered product online than itis to sell a (stock keeping unit)….(we)have mul ple size op ons, and each

size op on has hundreds of colors. Plus, there are control op ons that are wide andvaried and some mes dependent on the size you order. So, it’s a complexpurchasing decision and we just didn’t feel comfortable pu ng that totally in thehands of the consumer, who probably doesn’t know a lot about it.”

So, Hunter Douglas will live or die with the independent dealer channel. The biggestrisks to the independent dealer channel are big box retailers like Home Depot andLowe’s, online retailers like blinds.com (owned by Home Depot), and franchises like

Budget Blinds. Some Budget Blinds franchisees actually sell Hunter Douglas despitethe fact they have less bargaining power on Hunter Douglas products – it is not partof the approved supplier list that corporate nego ates with on their behalf. This isprobably due to the ease of selling Hunter Douglas products due to their heavyadver sing. Younger and do -it-yourself customers can shop at Home Depot andLowe’s.

An execu ve at a window coverings company that sells through both independentdealers and big boxes said: “This is an ‘in uencer’ assisted sale in most cases. Thereis a high risk of making an error because it is a custom made product, therefore,with limited sta ng and high turnover the big box stores have struggled to take alarger share. However, (Home Depot) and Lowe’s are both star ng to focus moreon the (Do it for me) customer through their shop at home programs. (J.C. Penny)always had an in home custom decora ng program, but it is a rela ve new thing for(Home Depot and Lowe’s). Therefore, there is a chance they could take more sharefrom the tradi onal designer channel in the future.”

Since 2000, Home Depot and Lowe’s have increased their market share in the do -it-yourself paint category. This hurt Benjamin Moore which was focused en rely onindependent dealers. However, Sherwin -Williams is s ll by far the largest paintcompany in the U.S. and it relies almost en rely on its own network of companyowned paint stores to sell its product. Home Depot and Lowe’s have both courtedBenjamin Moore and Sherwin Williams hoping those companies would allow them


The United States has both one of the world’s highest GDPs per capitaand one of the world’s highest (74%) penetration rates of blinds andshades.


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to sell their paint. Benjamin Mooreagreed to this and then Warren Bu e

red the CEO of Benjamin Moore forbreaking his promised to independentdealers never to enter the big boxchannel. Sherwin Williams just recentlyannounced its rst deal with a big boxstore. Window coverings are a smallerand more customized category thanpaint. Hunter Douglas’s market clout inwindow coverings is similar to Sherwin -William’s in paint. Without access toHunter Douglas products, it is not clearthat Home Depot and Lowe’s can sellenough window coverings to make itworth focusing on this category.

MOATHunter Douglas is the DominantBrand in the Independent Dealer

Channel

A big part of Hunter Douglas’s moat isits strength with independent dealers.Hunter Douglas sells just one brand inthe U.S. and one brand in Europe. Itonly sells through the independentdealer system. So, it can invest more inadver sing the Hunter Douglas brandin the U.S. And it can invest more insupport systems for dealers. Forexample, Hunter Douglas has a websitethat customers can visit and make

selec ons regarding product type,color, li ing system, etc. They see apicture as they make these decisions.Once the visitor has tested out thedi erent Hunter Douglas productsvisually by browsing on the website,the tra c is routed to a dealer througha dealer locator. There is no other wayto buy Hunter Douglas. So, the HunterDouglas website only works to refercustomers to dealers. This is a bene tto dealers who can get tra c from awebsite they themselves do not run.Hunter Douglas also o ers more directtechnical support by providing a pre -designed website. If you visit mostHunter Douglas dealers online, you cantell that the Hunter Douglas sec on oftheir website was obviously designedseparately from the main site. If you gofrom dealer to dealer, you will seethese Hunter Douglas sec ons are

essen ally the same regardless of which dealer’s site you are on. Hunter Douglasprovides a customer management program that allows dealers to take customerinforma on, make appointments, etc.

A few dealers we spoke to started out selling all sorts of window coverings brandsbut now sell only Hunter Douglas. One dealer told us that other companies copiedthe Silhoue e product from Hunter Douglas. This dealer used to sell those copycatproducts. The copycat product was cheaper. But, it would fray in a few years. TheHunter Douglas Silhoue e would last a long me. So, this par cular dealer decided

to stop carrying the compe ng product that is meant as a cheaper alterna ve toSilhoue e. The dealer explained that the quality of the sales they made weresimply not as good.

Dealers – like blinds companies – rely on word of mouth. Several dealers told usthat Hunter Douglas products have a higher ini al cost than a compe ng product ofsimilar appearance. However, the Hunter Douglas product lasts longer. The dealersbelieve this means the amor zed cost of the Hunter Douglas product is lower on anannual basis. This is important because dissa s ed customers may return yearslater if a product frays. They may also refer business to the dealer if the productstays in good condi on. In fact, Hunter Douglas tells its dealers that word of mouthis the most e ec ve means of growing sales. One dealer told us that 80% of theirbusiness is from word of mouth.

A dealer who carriers Hunter Douglas, Levolor, and Graber told us that they usuallybuy all the brands they think their customers will need. But, they don’t see Levoloror Graber as a possible replacement for Hunter Douglas products because Graberand Levolor can’t match the service or premium quality of Hunter Douglas.

Another dealer told us that nobody else adver ses the way Hunter Douglas does.So, it is a lot easier to sell Hunter Douglas products. People get Hunter Douglasbecause they have heard the name. It is a good experience for them. And then theytell their friends about it. So, the product is easier to sell.

A couple dealers we talked to actually stopped selling other brands. One used tosell other brands but then they just kept selling more and more Hunter Douglas sothey decided to become a Gallery Dealer and then nally a Centurion dealer (sellingHunter Douglas exclusively).

Another dealer explained the decision to go to selling Hunter Douglas exclusivelywas partly – but perhaps not en rely – nancial. They said Hunter Douglasselec on and quality was the highest. There were less issues for him and lesscustomer dissa sfac on on his sales. Now, they only sell Hunter Douglas because itgives the customer a be er me. It ended up this way simply because they soldmore and more Hunter Douglas over me. This par cular dealer told us he likesselling quality more because he knows the customer will have less problems in thefuture and they’ll be glad for the quality. He’s not sure that this approach makesthe most money for him. In fact, he thinks he could probably make more money ifhe tried selling everything, but it wouldn’t be as enjoyable a job and wouldn’t be

worth the e ort just to make more money.A di erent dealer who switched to selling Hunter Douglas exclusively told us theymade the switch because other dealers don’t o er the same support HunterDouglas does.

One dealer who s ll sells the other brands but now gets 75% of sales from HunterDouglas said the other brands have cheapened their quality to get into the big boxstores. This dealer carries the other brands at lower price points meant for peoplewho rent instead of own their home or who don’t care very much about the longterm. The implica on here being that other brands have reduced the durability of



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their materials to achieve a similar lookat a lower price – which is what big boxstores tend to want.

Hunter Douglas is best known for itshighest end products. A lot of dealersand customers talked about theSilhoue e being something that othersmay copy but don’t do well. It is an

expensive product. But the qualitythere is unique to Hunter Douglas.

Hunter Douglas has scale advantages inresearch and development and brands.Research and development scaleadvantages are global. The companyspends $35 million a year on R&D. Ithas 100 employees in R&D in the U.S.This $35 million is only about 1% ofHunter Douglas’s global revenue.However, it would be more than 6% ofSprings Window Fashions’s total sales.Springs is the second largest windowcoverings company. Hunter Douglas’sEBIT margin is between 10% and 14% innormal years. It was 5% in the worstyear for the company which was 2009.Springs Window Fashions probably hasa lower EBIT margin. Spending as muchin dollar terms as Hunter Douglas onR&D could eat up most of thecompany’s margin. For this reason, it islikely that Springs spends a lot less onR&D. The history of Hunter Douglas –

not Springs – always being thecompany to introduce new innova onssupports this hypothesis. Obviously,the Hunter Douglas brand in the U.S.has huge scale advantages. It isprobably 3 to 4 mes the size of thenearest compe tor sold through theindependent dealer channel. This scaleis most obvious in signing up dealers.Dealers prefer selling Hunter Douglasbecause the company adver ses whichbrings tra c to Hunter Douglas dealers.Finally, Hunter Douglas may have scaleadvantages in produc on. Thecompany is fully integrated in the U.S.It manufactures parts and assemblescustom orders itself. It then shipsdirectly to dealers. Other windowcoverings manufacturers do not dothis. Hunter Douglas doesn’t do this inthe European Union yet. It has beenmoving toward more integrated

manufacturing there as well. It is possible that Hunter Douglas will one dayorganize its Luxa ex business in the European Union along the same lines it nowruns its Hunter Douglas business in the U.S.

Overall, it is likely that Hunter Douglas invests more in “special” forms of capital likefactories, dealer support systems, brand adver sing, and research anddevelopment. Hunter Douglas is more specialized than compe tors. Tasks likeassembly and impor ng do not require much in the way of specialized capital. Butfactories that produce only parts for use in the company’s own blinds and shadesare a form of specialized capital. This is clear in Hunter Douglas’s low sales rela veto property, plant, and equipment. Sales are just 4.5 mes property, plant, and

equipment. In other words, it takes over $22 of property to produce $100 of sales.Since EBIT margins are 10% to 14%, that $100 of sales would produce $10 to $14 ofpre -tax pro ts. In the U.S., such pro ts are taxed at 35% or higher. So, that meanspro ts are in the $6.50 to $9 range on $100 of sales. Put another way, it takes atleast $22 of xed assets to produce $9 of a er -tax pro t. This is certainly a goodreturn. So, the investment is worthwhile if the EBIT margin can be high. The EBITmargin can be high if Hunter Douglas has some of the lowest costs and HunterDouglas customers have some of the highest willingness to pay. We have nodetailed cost data for compe tors. And it is impossible to make direct comparison.However, it is not unreasonable to believe that in the U.S. at least Hunter Douglasproducts probably have the lowest unit costs and the highest willingness to pay ofany brand. Where compe ng products cost less this seems to be due to usingcheaper materials not to any cost savings in manufacturing. So, Hunter Douglas’smanufacturing is probably low cost. Its marke ng certainly achieves the highestsale prices of any brand. This gives the company the highest pro ts to invest inR&D, marke ng, specialized manufacturing, etc. It also lets Hunter Douglas buy outassemblers to move to a one step distribu on system. There is li le evidence forsigni cant investment in this industry by compe ng companies. They seem toinvest less in both tangible and intangible forms of industry speci c capital thanHunter Douglas does. In this way, Hunter Douglas is similar to Ekornes (theNorwegian maker of Stressless recliners).


Hunter Douglas has 38% of the total U.S. market for blinds and shades


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QUALITYHunter Douglas Should Earn AtLeast a 10% A er -Tax Return onEquity – Without Using Debt – in AllBut the Very Worst Years of theHousing Cycle

Hunter Douglas is a good rather than a

great business. The product economicsof what the company does are notperfect. Hunter Douglas has atremendously strong compe veposi on. And the blinds and shadesbusiness is a good business. Costs canbe low and the willingness ofcustomers to pay for the product canbe high. So, margins can be good. Thisis especially true for the leading brandlike Hunter Douglas. It has the mostscale. It especially has the most rela vescale. Hunter Douglas is the biggestbrand in its industry and yet it sells tothe smallest dealers. Meanwhile, somesmaller brands sell through big boxcompanies. This means that ininterac ons with suppliers, fabricators(in Europe), dealers, and compe tors –Hunter Douglas’s rela ve sizeadvantage is bigger than its absolutesize advantage makes it appear.Compe tors that are smaller thanHunter Douglas are even smallerrela ve to the key rms they interact

with. For example, some smallerbrands than Hunter Douglas are soldthrough big box stores like Lowe’s.Lowe’s is a much bigger customer thanany dealer that Hunter Douglas sellsthrough. So, the bargaining posi on ofHunter Douglas in nego a ons is o enmuch stronger compared to thebargaining power of compe tors intheir nego a ons than it would appearto be. Using the Michael Porterapproach of breaking down an analysisof compe ve posi on into two parts:the compe ve posi on of the industrygenerally and the compe ve posi onof the rm speci cally – HunterDouglas passes the speci c compe veposi on test best. It has more troubleon the industry test.

The window coverings business iscyclical. It is important for investors to

keep in mind that companies in cyclical industries tend to underperform companiesin non -cyclical industries over the long -term. This is because of the errors that arepossible in cyclical industries that are unlikely to happen in non -cyclical industries.Over capacity can be a problem in any industry. It is as bad a problem in theory inthe beverage bo le business as the oil tanker business. However, demand forshipping oil around the globe can be vola le. Demand for soda is not vola le. Forthis reason, it is easier for a company to know it is building a beverage bo le plantthat will add the appropriate amount of capacity to the industry not just for todaybut for several years down the road. When building an oil tanker this is harder totell. The intent may be to build the correct amount of capacity into the industry toget a good return next year. But, next year’s demand for shipping oil could be muchhigher than what it will normally be a few years down the road. Once the tanker isbuilt, the supply will be there whether or not the demand will be there.

This can also be a problem in blinds and shades. Demand for blinds and shadesdepends in parts on renova on and remodeling and in part on new homeconstruc on. There is not a lot of business where people are changing their blindswithout remodeling or renova ng the room the blinds are in. This is especially truefor Hunter Douglas blinds since they have a long life me. People do not buy blindsbecause they wear out. People buy blinds because they want a new look. They arebought for fashion reasons as part of moving or remodeling.

Obviously, people have been moving into new homes and remodeling old homes alot less since The Great Recession. From 1996 to 2007, Hunter Douglas hadexcellent growth numbers. During the housing boom from 2002 to 2007, sales grewat a completely unsustainable rate of 14% a year. From 2007 to 2009, they actuallydeclined 11% a year. And from 2009 through 2014, they grew at 2.5% a year. Salesin 2014 were below the sales peak set in 2007.

Hunter Douglas did not reduce capacity during this me. The same factories makethe same parts and do the same assembly they did before. Hunter Douglas also had


Hunter Douglas failed to achieve the pre-tax equivalent of a 10% ROE in2009 and 2011 during a terrible housing bust in the United States


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spent $684 million on 51 di erentacquisi ons. That makes the averageacquisi on size $13 million. The mostcommon type of acquisi on was afabricator. A fabricator is an assemblerof window coverings furtherdownstream from the company. So, forexample, in the U.S. Hunter Douglashas long made parts for its customorders but it used to have other localcompanies assemble these parts into

nished orders. Buying out theseassemblers brings more of thisdownstream business into thecompany. So, Hunter Douglas becomesmore ver cally integrated. It especiallygets them closer to dealers.

Other mergers were componentmakers. Component makers areupstream from Hunter Douglas. HunterDouglas makes blinds and shades. Itcan buy parts it needs and it can signdeals with fabricators that allow themto assemble Hunter Douglas orders. Itcan also produce parts in house andassemble orders in house. Over me,Hunter Douglas has expanded in bothdirec ons. It has go en bigger in theparts business – which means it makesmore and more of its inputs. And it hasgo en bigger in the fabricator business

– which means it makes more andmore fully nished outputs. This

lengthens the whole chain ofproduc on that is being done insidethe company. This is a pre y importantthing to consider because these arecustom orders. Bringing more of thepart produc on and fabrica on inhouse can allow for greater controlover the nished product. When we saya part maker we really just mean aninput that is used by the blinds andshades business. For example, HunterDouglas bought Kendix in 2005. Kendixis a Dutch fabric maker. In 2005, theyalso bought Mermet. This is a maker ofglass ber and sunscreen bers. In2007, they bought ESI. ESI is a maker ofmotor controls used in blinds andshades. They also bought Hexcelscreenwhich is similar to Mermet in that itmakes things window coveringcompanies use as screens in theirshades.

Hunter Douglas also buys companies that make new window coverings products. In2007, the company bought a maker of translucent architectural material. Thatsame year they bought a German company that makes terraco a facades. And in2010, they bought a metal ceiling manufacturer in Argen na. Remember thatHunter Douglas gets 24% of its pro ts from architectural products. These are verysimilar to the shades and blinds business. However, they are meant for commercialcustomers on larger projects with somewhat di erent needs for covering theirwindows, providing shade, etc. The example we gave earlier of airports is a goodone. You can see how the sorts of acquisi ons men oned above can relate to

Hunter Douglas’s exis ng architectural products business.

Hunter Douglas usually pays a low price for acquisi ons. It’s hard to value theseacquisi ons because while we have sales data or can use employee data andknowledge of the industry to guess at price -to -sales ra os, we do not usually havegood acquisi on price to pre -tax earnings data. We don’t know the EV/EBITDA thatHunter Douglas generally pays. We also think EV/EBITDA is unimportant here.Hunter Douglas is usually buying a company they already do business with as asupplier to them or a buyer from them. Once the company is brought in house, theEBITDA will change. In other words, the EBITDA bene t once the acquired companyis integrated into Hunter Douglas can be quite di erent from what the acquiredcompany had itself been repor ng in EBITDA as a small standalone opera on thatwas either supplying Hunter Douglas or buying from Hunter Douglas. We can,

however, say with certainty that Hunter Douglas o en paid 0.5 mes sales or lessfor the companies it acquired. So, if the company had a 5% EBIT margin, the pricewould be 10 mes EBIT or less. O en, it could be a lot less. Prices paid in 2012 and2013 seem quite low. It’s possible that private companies sold for unusually lowprices from 2008 through 2014. So, Hunter Douglas may not get another chance todo acquisi ons at such low prices. This makes measuring the value crea on ofacquisi ons close to impossible. It makes sense to acquire businesses from 2008 to2014 on the assump on of a recovery in housing in the U.S. However, un l thatrecovery in housing occurs, no bene t to EBIT will appear. So, buying at a low EV/Sales ra o could mean buying at a high EV/EBIT ra o because margins are so poor


From 1991 through 2012, Hunter Douglas’s investment portfolioreturned 11% a year


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in bad mes. But, if EBIT of the industryrises faster than sales in a housingrecovery than paying a low EV/Salesra o today means ge ng a lot offuture EBIT for a small amount ofpresent day EV. We know HunterDouglas has always paid pre y low EV/Sales ra os for its acquisi ons. We alsoknow the acquisi ons are very, veryclosely related to what Hunter Douglasalready does. They simply move thecompany a li le further upstream ordownstream in terms of greater ver calintegra on. Hunter Douglas is a lotmore ver cally integrated today than itwas during the housing boom.However, un l there is a recovery inhousing it may be di cult to assesshow much ver cal integra on reallybene ts the company.

The Sonnenberg family amassed a hugeinvestment por olio for HunterDouglas. They started pu ng some ofHunter Douglas’s free cash ow intothe por olio in 1991. The por olio ranfrom 1991 to 2012. It peaked at $849million in 2007. Over the 21 years from1991 to 2012, the por olio return 11%a year. It returned 14% a year from1991 to 2007 and then declined fromthere. Hunter Douglas picks outsidefund managers to invest in a range ofdi erent asset classes, industries,

geographies, and currencies. It onlygives 0.5% of the fund to a newmanager. It then ramps up theinvestment with that manager over

me if results are good. This leads towide diversi ca on. We have no ideahow Hunter Douglas made 11% a yearfrom 1991 to 2012. It seems reasonableto assume the company used o shorehedge funds. But there isn’t a lot ofdetail about this. The company juststarted up an investment por olioagain. There is no reason to assume itcan do as well as the last one did. It isbest to assume the investmentpor olio will match the market over

me or underperform a li le due tofees. But, it is worth men oning thatthe Sonnenberg family does not buildup cash. The company had net cashfrom 2004 to 2007. Otherwise, italways had some net debt. Right now,

Hunter Douglas’s net debt is 1.5 mes EBIT. This is manageable. The company isusually quite liquid because it keeps a lot of gross debt and gross cash (orinvestment securi es) on hand at all mes. Hunter Douglas won’t have idle cash inthe future. It might use some debt to leverage up its return on equity. And anyexcess cash it doesn’t pay out in dividends will probably end up in investments thatare made in markets similar to the worldwide stock market. Returns on “cash” willtherefore be closer to 6% a year than 0%. It’s unlikely they will comes close to the11% a year Hunter Douglas made from 1991 through 2012.

The exact way Hunter Douglas allocates cash is a li le complicated. It is probablydone for tax reasons. The company tends to put o shore pro ts into its investmentpor olio (instead of repatria ng the earnings). It then uses debt when it wants topay dividends, buy back shares, or acquire something. Over me, the net debtposi on does not rise much. And net debt rela ve to EBIT doesn’t rise. But grossdebt may o en rise because the company doesn’t want to pay any taxes it doesn’thave to. So, it avoids repatria ng earnings simply to have access to cash.

The Sonnenberg family would obviously like to take Hunter Douglas private. Thetop 3 execu ves are members of the family. The CEO is the son of the founder. Histwo sons – grandsons of the founder – hold the le of Co -President and ChiefOpera ng O cers. So, the Sonnenbergs have the 3 top posi ons in the companyand 81% of the stock. It’s almost a private company already. But, Hunter Douglashas been public since 1969. The Sonnenbergs would need to buy out minorityshareholders to go private.

In 2008, Hunter Douglas o ered to buy 13.4 million shares at 43 Euros a piece fromminority shareholders. Only half of the desired shares were tendered. So, 6.7million shares stayed in the hands of outside shareholders. This raised the family’scontrol from 68% to 81%. The company spent $463 million on the buyback. Thesefunds were taken from the investment por olio. So, the family basically swappedother nancial assets for the core Hunter Douglas opera ng business.

There is some danger the company will go private at a price that is not near theintrinsic value of the stock. It s ll seems like a good buy and hold investment. If thefamily buys out investors, it can be a good short -term investment. If the family doesnot buy out investors, it can be an excellent buy and hold investment. The risk isge ng bought out at below intrinsic value – below our appraisal price for the stock

– rather than below the price you would pay for the stock.

Hunter Douglas pays a dividend. It peaked at 2 Euros per share in 2007. From 2010to 2014, it was 1.25 Euros a share. The stock has paid a dividend in each of the 46years it has been publicly traded. Except for the crisis, the general trend is tomaintain the dividend each year with it rising a bit over me. In 2009, the companyalso paid a special dividend. Again, this is evidence of unusual capital alloca oncaused by the family behaving as if this is a private company.

Overall, there is a risk of the company going private below its intrinsic value.Minority shareholders may su er from an unfair price. However, the Sonnenberg

family allocates capital very well. As a long -term buy and hold investor, you canexpect well above average capital alloca on from Hunter Douglas. Share dilu on isvirtually non -existent. Capital alloca on will add value here – it will not destroy it.



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VALUEHunter Douglas is Much Cheaperthan All of its Possible Peers

Hunter Douglas reports in U.S. dollars.It is very important that you as a readerkeep this in mind if you are interestedin buying Hunter Douglas stock. The

stock is quoted in Euros. However, youmust – at the me you are consideringyour purchase – convert the stock pricefrom Euros into U.S. dollars. The valueswe give for the stock will be in dollars.You should imagine you are buying thestock in dollars. However, on the dayyou buy the stock you will need to buyit in Euros. We will not be conver ngdollar nancial statements into Euroshere. There is a good reason for this.Hunter Douglas does not get most of itssales in Euros. So, although the stock isquoted in Euros – it is inappropriate toimagine valuing the business in Euros.The business must be valued in dollars.And then you must make yourpurchase decision by conver ng thestock price as shown in Euros into astock price in dollars. The exchangerate between Euros and dollars willchange from the me I type this on thescreen now ll the me the issue isreleased ll the me you are readingthis issue and nally ll the me you

actually put in a buy order. There is noway for us to an cipate what theexchange rate between the U.S. dollarand the Euro will be on the day youwant to place a buy order. So, we willnot be doing any transla ng of dollarsto Euros here. We will appraise thecompany in dollars. You will then haveto reimagine the stock price as being indollars when you place your buy order.

So, let’s look at Hunter Douglas indollars. The company has $565 million

in debt and $219 million in cash. Themarket cap is $1.6 billion. Theenterprise value is just under $2 billion.Current EBIT is about $200 million. So,the EV/EBIT is about 10 mes. Keep inmind that because the Dutch corporatetax rate is lower than the U.S.corporate tax rate and because HunterDouglas avoids paying taxes whereverpossible – the company’s a er -tax P/E

will tend to be lower than the P/E of a U.S. company with the same EV/EBIT. An EV/EBIT of 10 could translate into a P/E of 13. This is especially true if – as is o en thecase at Hunter Douglas – there is some amount of net debt.

The important thing to keep in mind when valuing Hunter Douglas is that thecompany made $200 million pre -tax last year but will make $300 million pre -tax ina normal year. None of the years from 2008 through 2014 were normal for U.S.housing. The economy in Europe was not especially strong either. Hunter Douglas’sU.S. business (which would normally be close to half of sales) is as ed to the U.S.housing market as companies like Masco, Mohawk, etc. Hunter Douglas is earningwell below its poten al EBIT. The company’s enterprise value to normal pre -taxearning power is less than 7. The numbers are roughly $2 billion in enterprise valuedivided by $300 million in normal EBIT equals 6.7 mes EV/EBIT. The company’s taxrate could be as low as 25% in the Netherlands. That would make the P/E 9. It issafe to assume Hunter Douglas is trading for no more than about 10 mes a er -taxearnings. This is especially true because the company tends to add a li le leveragethrough having net debt in most years. So, if we ignore the results from 2008 to2014, and simply ask what the price and quality of this company would be in aperfectly “normal” year – I think we can say this is a stock with a return on equity ofat least 13% trading at a P/E of no more than 10.

Now, let’s compare Hunter Douglas to some of its peers. The peers we have chosenare Colefax, Masco, American Woodmark, Whirlpool, and Sherwin -Williams.Sherwin -Williams is a great business – in fact, it’s a be er business than HunterDouglas – and a very expensive stock. It’s too expensive a stock actually. The stocktrades for 22 mes EBIT. A slight adjustment for the amor za on of intangiblesbrings this a li le closer to 21 mes EBIT. We are talking about 30 mes a er -taxearnings here. Sherwin -Williams is a great company. It may be a good long -terminvestment. But, we can’t honestly suggest it is worth buying at a P/E of 30. This isan o the charts peer that we are just going to ignore. Sherwin -Williams is a be er


Despite being over 25 times bigger, Hunter Douglas is cheaper thanColefax – an illiquid U.K. microcap stock that makes luxury furniture fabricand wallpaper


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disregard. Hunter Douglas and American Woodmark are both closely ed tohousing. But the quality of American Woodmark is not high and yet the price ishigh. I’m not sure we can trust the market on this one either. So, we will ignoreboth American Woodmark and Sherwin -Williams as reasonable peer valua onshere.

Colefax makes luxury furniture fabrics and wallpaper. It is a small (the market cap isunder $100 million U.S.) U.K. listed company. This is a very good peer for HunterDouglas in terms of the product being interior decora ng related. However, it has

much lower growth than Hunter Douglas. Since 2000, it grew only 1.5% a year. Forthat reason, Hunter Douglas should probably have a higher EV/EBIT mul ple thanColefax. Colefax’s current EBIT is 8.5 mes. This is a bit lower than Hunter Douglas’s10 mes current EBIT. But, Colefax’s results are not cyclical. So, cyclically adjustedEV/EBIT may be lower at Hunter Douglas than at Colefax. Colefax is very illiquid. Ittrades a li le over $10,000 U.S. per day. Perhaps the lack of growth since 2000 andthe illiquidity lead people to ignore this company.

So, there are 3 reasonable peers for Hunter Douglas. Colefax trades at less than 9mes normal EBIT, Masco trades for 10 mes normal EBIT, Whirlpool trades for

around 15 mes normal EBIT. Meanwhile, Hunter Douglas trades for about 7 mesnormal EBIT. As a group: Colefax, Masco, and Whirlpool are not a superior basket ofbusinesses than Hunter Douglas. Hunter Douglas should trade in at least the samerange as these stocks.

To give some perspec ve, Hunter Douglas made $340 million at its peak in 2006.So, the enterprise value to peak EBIT is $2 billion divided by $340 million or just 6

mes peak pre -tax pro ts. Although I don’t like using bubble earnings as a star ngpoint, Hunter Douglas is a bigger company almost 10 years later. It has acquiredthings. There has been a bit of in a on. The next me housing performs normally,it would be perfectly reasonable for Hunter Douglas to make $350 million a year atthe mid -point – not the peak – of that cycle. With a 25% tax rate, that wouldactually give the stock a P/E under 8.

Roughly speaking, the current EBIT and P/E would be 10 mes EBIT and 13 mes P/E. Our favorite method for normalizing – which is today’s sales mes the long -term

average EBIT margin – would be 7 mes EBIT and 9 mes P/E. The peak EBIT pricewould be 6 mes EBIT and 8 mes P/E. I am not sure which of these is true. HunterDouglas will eventually pass its prior peak. But, I’m not sure when. The 10 mesEBIT and 13 mes P/E gure is clearly wrong. Housing is s ll performing poorlyrela ve to what it will normally be in the U.S. A good es mate is that HunterDouglas is probably selling for no more than 7 mes the annual pre -tax pro ts it islikely to earn in the next housing cycle. In fact, this is an understatement. So, I’mcon dent the stock is trading for no more than 10 mes normal a er -tax earnings.

GROWTHHunter Douglas Can Grow 4% a Year in the U.S. and Europe – And a lot Faster in itsMuch Smaller Markets Around the World

Over the 18 years from 1996 to 2014, Hunter Douglas grew sales by 4% a year.There is no reason the company shouldn’t be able to match this rate over the next18 years. North America revenue is now 17% below its 2006 peak. Europeanrevenue is 20% below its 2007 peak. Sales can rebound faster from cyclically lowlevels than they would from a peak. The Great Recession in window coverings is s llongoing. Hunter Douglas’s sales and earnings are lower than their peak. And theyhave been lower for close to a whole decade now. This is unusual. Normally, acompany like Hunter Douglas would achieve a new record in sales and earnings in

business than Hunter Douglas. AndSherwin -Williams has o en been muchcheaper than 20 mes pre -tax earnings.So, we can’t say that Hunter Douglasshould have a price remotely as high asSherwin -Williams does now.

Whirlpool is not a be er business thanHunter Douglas. Whirlpool is less

cyclical. And the possibility thatElectrolux could buy GE’s appliancebusiness – if the Department of Jus ceis not successful in blocking this deal –could reduce compe on in theindustry. But, measures of historicalpro tability favor Hunter Douglas overWhirlpool. Whirlpool trades at 16 mescurrent EBIT and 18 mes “normal”EBIT (the company’s opera ng marginis a bit high at the moment).

Masco trades at 14 mes current EBIT.

But, only 10 mes normal EBIT. Thisnormal EBIT is calculated by takingtoday’s sales and mul plying by thelong -term average EBIT margin. Thismay or may not be appropriate inMasco’s case. It may be the case thatsales – not just margins – aresigni cantly understated. Regardless,Masco’s price is actually higher thanHunter Douglas’s price. Masco tradesfor 10 mes normal EBIT while HunterDouglas trades for just 7 mes normalEBIT. It’s possible that Masco – as awhole – is a pre y good peer forHunter Douglas. Masco’s paint andplumbing businesses are good. Theycould be be er than Hunter Douglas.The other businesses are inferior toHunter Douglas. This could be a goodpeer. But, so could Whirlpool. So, at themoment, we have about 10 mesnormal earnings for Masco and about16 to 18 (depending on whether youthink today’s margins are here to stay)

mes EBIT for Whirlpool. These are two

decent peers for Hunter Douglas. So,that’s an appropriate range to thinkabout for Hunter Douglas.

American Woodmark trades at 17mes normal EBIT. This is a very cyclical

business. It is not as good as HunterDouglas. Again, this may be an o thecharts reading here we should



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far less than 10 years. It is important tokeep the depressed levels of the lastseveral years in mind when looking atHunter Douglas. The company’s EBIT

gure appears to be $200 million.However, it was $300 million at the lastpeak. Likewise, the company’s 18 -yearsales growth record appears to be 4% ayear. However, it was much higher forthe period from 1996 through 2006.Some of this period was a housingboom. But even more of it was ahousing bust.

Hunter Douglas will not achieve thekind of growth it had during the lasthousing boom. From 2002 to 2007,North American sales grew 14% a year.This was in line with the extraordinarilyhigh levels of growth in other newhome and renova on driven productsales. Hunter Douglas may not have aperiod of such fast growth ever again.That housing boom was a once or twicea century event.

But, it followed a at period from 2000to 2002. This is a typical pa ern forHunter Douglas. There is no reason tobelieve that Hunter Douglas’s recentresults are due to either a loss ofmarket share in blinds and shades or toa decrease in homeowner appe te forblinds and shades. All of the decline

seems to be cyclical. There are simplyfewer people moving into new homesor renova ng their exis ng homes.That is when most blinds and shadesare sold. They are part of the moving orrenova ng process. That process hasslowed to one of its lowest levels inhistory. At some point, HunterDouglas’s sales will be able to reboundquickly as renova ng and homebuildingac vity picks up. For a short me, thiswill mean above nominal GDP salesgrowth for Hunter Douglas.

In more mature markets like the U.S.and Europe, Hunter Douglas should beable to grow sales around nominalGDP. In Europe, there can s ll be roomfor blinds and shades to take greatershare of window coverings. Forexample, the U.K. is s ll behind the U.S.in terms of how popular blinds and

shades are. Hunter Douglas adds new innova ons to the top of its line. This allowsthe average cost for covering a window to keep pace with in a on as the quality ofthe window coverings used tends to improve over me. Again, this is similar to therazor business.

Developing markets tend to use curtains. Quan lives in Vietnam. He knows thatmost Vietnamese windows are covered with curtains rather than blinds or shades.In India, curtains have 95% market share. In the U.K., they s ll have 45% of themarket. In the U.S., they have just 25% market share. Flipping that around so welook at it from Hunter Douglas’s perspec ve – only 5% of the Indian window

coverings market is penetrated by the technologies Hunter Douglas competes in.Only 55% of the U.K. market is penetrated by the technologies Hunter Douglascompetes in. And fully 75% of the U.S. market is penetrated by the technologiesHunter Douglas competes in. Over me, there can be higher growth in developingmarkets as Hunter Douglas – and others – convince people to adopt European andAmerican prac ces when it comes to window coverings.

The past record supports this. From 1999 to 2008, Hunter Douglas grew its La nAmerica sales by 11% a year. From 1999 to 2011, Hunter Douglas grew its Asiansales by 13% a year. The gures I am giving you here are a li le di erent than theones you will see summarized by the company. I have broken out windowcoverings sales from architectural product sales. Hunter Douglas is quite strong inarchitectural product sales around the world. Its share of window coverings boughtby individual households is a di erent story. Hunter Douglas is much stronger in theU.S. and Europe than elsewhere in the world. Blind and shade technologies are notnearly as important outside of Hunter Douglas’s key historical markets of the U.S.and Europe. But, Hunter Douglas has the best technology and manufacturing inthese products. So, it should be in the best posi on of anyone to grow in marketslike La n America and Asia if households there can be convinced to buy blinds andshades instead of curtains.


Hunter Douglas’s biggest market (the U.S.) is its slowest growing whilethe company’s smallest market (Asia) is i ts fastest growing


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The U.S. and European markets aremature. There can be some shi toblinds and shades. And HunterDouglas’s compe tors seem to befocusing less on dealers and more onbig na onal retailers like Lowe’s andHome Depot. Hunter Douglas’scompe ve posi on in the U.S. andEurope is good compared to what itwas before the peak of the housingbubble. But, market share is high.Hunter Douglas has 38% market sharein the U.S. And Hunter Douglas onlysells through independent dealers.There are some sales made throughother channels. That means HunterDouglas’s share of independent dealersales – the only channel in which itchooses to compete – is higher than38%. While there is no theore calceiling on a company’s market share –

this is already awfully high. HunterDouglas’s market share in blinds andshades is really not that far fromSherwin -Williams’s posi on in paint. Itwould be wrong to an cipate furthermarket share gains. This is especiallytrue because Hunter Douglas is limitedto the independent dealer channel.

We don’t have as much compe veinforma on about the Europeanmarket. Overall, there is more room forHunter Douglas to acquire fabricators

and move to more of a one - erdistribu on model like it has in the U.S.Also, European compe tors may not beas strong as U.S. compe tors. Theremay be more opportunity for marketshare gains in Europe. But, this iscomplicated by there being manydi erent countries and cultures inEurope. It’s possible Hunter Douglascould grow faster in Europe than theU.S. if it gains more market share and ifcountries like the U.K. shi their buyinghabits to match U.S. households.However, Europe has somedemographic challenges that makes iteven slower growing than the U.S. It isprobably best to assume an overall 4%annual sales growth rate for both theU.S. and Europe. Right now, HunterDouglas gets 81% of its sales from the

U.S. and Europe. So, if those markets grow at just 4% a year – the company can’tgrow much faster than 4% a year.

Other markets can and probably will grow a lot faster. GDP growth in developingmarkets can be higher. And if Hunter Douglas does a good job penetra ng thesemarkets, it could actually grow faster than GDP because these countries currentlyuse so many curtains. There can be a one me societal shi from almost all curtainsto mostly blinds and shades.

You shouldn’t expect Hunter Douglas to grow more than 4% to 5% a year long -term. Annual sales growth equal to the nominal GDP growth rate of the U.S. andEurope seems completely doable. Sales growth will be much faster at some point inthe future. But, this will be a one - me recovery back to the old 2006 -2007 peak.Pu ng aside a return to the old peak numbers, it is reasonable to expect 4% annualgrowth from that peak forward.

MISJUDGMENTThe Sonnenberg Family Might Take Hunter Douglas Private at a Small Premium tothe Market Price of the Stock

The most likely nega ve outcome for shareholders of Hunter Douglas is that theSonnenberg family takes Hunter Douglas private at a low price. The familyincreased their ownership from 53% to 72% of shares outstanding in 2005. In 2008,the family further increased its ownership from 72% to 81%. They wanted to buymore. In both cases, the premium paid to the minority shareholders who wereselling out was around 20%. This is not a high takeover premium. It is not unusualfor a strategic buyer in the U.S. to pay a 30% premium to acquire a compe tor. Inboth cases where the Sonnenberg family bought shares of Hunter Douglas, theypaid a rela vely low premium. The 2005 purchase was targeted at a 24% premiumto the last closing price and a 17% premium to the three month average closingprice. The 2008 deal was done at a 17% premium to the stock’s last closing price.

If the Sonnenberg family manages to own 95% of the stock, it can delist inAmsterdam. The procedure for doing this is a squeeze out. An Amsterdam courtdecides what a fair price is. Usually, any price agreed to by 90% of shareholders isassumed to be a fair price. However, this is not the case when one of theshareholders who owns virtually all the stock is buying out the minorityshareholders. The fair price is determined di erently in this situa on. TheNetherlands has di erent laws than the United States. The way boards and courtswork in the Netherlands may not provide the same protec ons to minorityshareholders as would be the case in the United States. The big risk here isprobably that the stock trades at a low price and the Sonnenberg family o ers tobuy out minority shareholders while the price is low. For example, the stock is nowtrading at a price that is probably more than 30% lower than the intrinsic value ofthe stock. This is easy to see if you look at the prior peak earnings of the company.Taxes in the Netherlands are lower than in the U.S. A company of Hunter Douglas’squality that is headquartered and listed in the Netherlands should trade for at least

10 mes its pre -tax pro ts. Recently, pre -tax pro ts were just $200 million.However, peak pre -tax pro ts were close to $300 million. Hunter Douglas has atleast as great a presence in the U.S. and Europe as it did at the peak in thosemarkets in 2007 and 2008 respec vely. In fact, Hunter Douglas has bought morecompanies since then. So, it should have as great earning power in the next cycle asit did in the past cycle. Both the U.S. and E.U. housing markets are below their long -term poten al. They are actually both below their prior peaks in terms of nominal –and, of course, real – sales of window coverings. At some point, Hunter Douglasde nitely will make more than $300 million in pre -tax pro t again. It doesn’t need



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to do anything compe vely to reachthat point. It just needs to maintain thecompe ve posi on it has had for thelast decade in the U.S. and E.U. andthen wait for those housing markets torecover. Shareholders may not bepa ent enough for that.

If you look at Hunter Douglas stock

compared to its peers – this is obvious.The fact that Hunter Douglas is a U.S.brand name and yet trades inAmsterdam coupled with theSonnenberg family’s 80% control of thestock has made it a sort of hiddenchampion. In the U.S., investors arevery aware of the bad housing market.Peers that sell cabinets, carpets,faucets, paint, dry wall, etc. trade atprices that an cipate what theirearnings will be at a normal point in the

next housing cycle. These companies –and homebuilders – trade at high pricesrela ve to their earnings in the recentpast. That is because investors in theU.S. are very aware of the terriblehousing market since 2007. They knowthat 2008 -2014 results are wrong. Andthey aren’t capitalizing those earnings.They are looking at es mates of whatnormal earnings should be in thefuture.

This is not what is happening at Hunter

Douglas. American investors probablyaren’t paying as much a en on to thisstock. It is a big American brand and abig European brand (Luxa ex) but it islisted in Amsterdam. It does not showup on screens for U.S. companies. Themul ple on Hunter Douglas’s currentearnings is not high. The mul ple onHunter Douglas’s peak earnings isincredibly low. These mul ples are notcyclically correct. The company is very,very cheap compared to peers whodepend on U.S. housing for their sales.

This mispricing in the stock creates apoten al problem for long -term buyand hold investors. Hunter Douglaswould be a great buy and holdinvestment. If bought today and heldfor 15 years, it will provide be erannual returns than U.S. peers. There isli le doubt of that. But there is a big

doubt as to whether a minority investor who buys the stock today will be able tohold it for 15 years.

For the last 10 years, the Sonnenberg family has been interested in taking HunterDouglas private. They may or may not be able to do this. And now that they own81% of the company it may not ma er as much to them to reach 100%. They havealready increased their ownership by nearly 30% over the last 10 years. Ge ng thelast 19% might be hard. It could be expensive. The company has been public formore than four decades. So, the family doesn’t have a problem running a publiccompany. It’s also a big company. There isn’t a lot of money that could be saved

rela ve to earnings by delis ng. The costs of being a public company are not thatgreat when you are talking about a company that now makes $200 million a yearpre -tax and once made $300 million pre -tax. If normal earning power is $300million and the costs of being a public company add $3 million a year, delis ngwould add just 1% to the company’s intrinsic value. The Sonnenberg family wouldhave to pay a premium to take over the company. The premium would be closer to20% than 1%. For a 20% premium to be worthwhile, you’d need to have costs as apublic company in the many tens of millions of dollars range. That is nowhere nearwhat it costs to be a public company. A private company the size of Hunter Douglashas many of the same costs as a public company. Once a company is this big, youdon’t save a lot by delis ng.

So, the real reason for taking the company private would be ge ng the other 19%for yourself. Hunter Douglas stock is cheap. At today’s price, the Sonnenberg familycould simply borrow and pay something like a 30% premium for the remaining 19%of the company – and in the long -run, they’d come out ahead on that deal. Even ano er of 30% above the recent stock price would not destroy value. And thecompany can support some more debt. Debt is also cheap right now. So, if theSonnenbergs wanted to make an o er of 30% or so higher than the stock price totake out all the remaining shareholders and most shareholders were willing to takethat deal – it would bene t the buyers more than the sellers. It’s actually not a


The Sonnenberg family only paid an 18% premium over themarket price to raise its ownership of Hunter Douglas from 53%


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good deal to take a 30% premium onthe current stock price. It’s be er tosimply hold the stock long -term.

And there is no reason to believe apremium would have to be that big. A20% premium was e ec ve in ge ngmany minority shareholders to sell outin the past. Most investors are toofocused on the market price of a stockinstead of the intrinsic value. An o erthat is 20% higher than today’s marketprice would actually be below intrinsicvalue.

So, there is a risk that shareholderscould be squeezed out. They mighthave to se le for a small one - me gainin Hunter Douglas stock instead ofge ng a buy and hold investment.

Investors who buy Hunter Douglas

today should hope to hold it for thelong -term. And they should de nitelyreject any o er the Sonnenberg familymakes to buy them out. HunterDouglas’s intrinsic value is much, muchhigher than the current market price ofthe stock. Value investors should onlyaccept o ers made at a premium tointrinsic value – not just a premium tothe stock’s market price.

ON LUS ON

Hunter Douglas is a Good – Not aGreat Business – Trading at a P/E of10 Times its Normal Future Results

Hunter Douglas is a good business at agreat price. Its compe ve posi on isvery strong. The company is the clearmarket leader in blinds and shades inthe U.S. and Europe. It is a hiddenchampion within its niche. However,the product economics of blinds andshades are not excellent. They are notas good as paint. Sherwin -Williams hasa similar posi on to Hunter Douglas.But, Sherwin -Williams can make ahigher return on equity over me.Hunter Douglas’s return on equity isacceptable. It is reasonable to expectHunter Douglas to make a 9% to 17%return on equity each year without theuse of debt. Good years for housingrelated products will be closer to a 17%

return on equity. Bad years – like 2009 – will be close to a 9% return on equity. Thekey fact here though is that Hunter Douglas should – without using any debt – beable to make a 10% a er -tax return on equity in almost every year regardless of thehousing cycle. This is an adequate return if the stock is bought at a low enoughprice. It is ne for a buy and hold investor to buy a stock with an unleveragedreturn on equity as low as 10% to 15% a year as long as there are very few yearsbelow a 10% return on equity. Hunter Douglas should have almost no years with areturn on equity under 10%. This makes it a good business. But it is not a greatbusiness. So, it needs to be bought at a great price to o er great returns.

Hunter Douglas’s price is truly great. The stock has a 3% dividend yield. It trades for

13.8 mes enterprise value to minimum EBIT. This is a measure of today’s salesmul plied by the lowest EBIT margin in the company’s last 20 years of results. It is avery conserva ve measure. Using the tax rate Hunter Douglas tends to pay, a 13.8

mes EBIT is a P/E of just 18.4. That is not a low P/E. But, that is using a veryconserva ve approach to valua on. It is almost certain that the company is tradingfor no more than 18 mes the worst future year of earnings it will ever have. A lotof stocks now trade for about 18 mes their best year of earnings.

The stock trades for 10 mes its current EBIT. This is a P/E of 13. That is not a badprice. An EV/EBIT of 10 mes and a P/E of 15 are about normal in most stockmarket environments for an average company. Hunter Douglas is a be er thanaverage business in the sense that it has a clearer future. However, its return onequity may be no be er than average for a public company. This means thatHunter Douglas is trading at a fair price rela ve to today’s earnings.

But, we know today’s earnings are too low. The company made $200 million in EBITlast year and $300 million at the top of the housing bubble. Hunter Douglas hasbought more businesses since then. The popula on of the U.S. and Europe (to alesser extent) has increased since then. And there has been some in a on. There isno reason why Hunter Douglas will not reach and exceed its past peak in earnings.It’s easy for some people reading this to fail to understand how certain this is.Because the prior peak was a housing bubble it may seem that Hunter Douglas will


Hunter Douglas trades for 9 mes its normal a er -tax earnings


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never repeat that performance. But,consider that in 2006, the U.S. had apopula on of 298 million people.Today, it has a popula on of 321million people. Also consider that $1 in2006 terms is now $1.17 in today’smoney. This means that if real spendingon blinds and shades is the same perperson in the United States over methe market is now 26% bigger innominal terms than it was in 2006. Ofcourse, the actual amount of buying inany one year will not match 2006because that was a peak. But, it isworth keeping in mind just how farbelow the prior peak and any normalamount of sales ac vity the windowcoverings industry is seeing right now.If the number of people per householdwas not dropping and the amount ofreal spending on blinds and shades per

window was the same you would see25% higher spending on blinds andshades in normal mes today than youdid in normal mes 10 years ago.Instead, you are actually seeing lowerspending on blinds and shades nowthan you did at the peak. This gives yousome idea of both how big the peakwas and how low the level of spendingon new homes and renova ons is rightnow. Europe is actually further from itsprior peak than the U.S. This is becausethe U.S. dropped more than Europe interms of spending on products relatedto homebuilding but then recoveredmore rapidly. It is very important toconsider how cyclically depressedHunter Douglas’s results are right now.The company’s EBIT margins are lowerbecause Hunter Douglas operates thesame manufacturing capacityregardless of the amount of physicalvolume it does and because thecompany spends a lot on adver sing itsbrand regardless of the amount of sales

it does in any one year.

One of the best measures of earningpower – and my personal favorite – issimply to take the long -term medianEBIT margin for a company and apply itto today’s sales. Now, obviously, thisunderstates the poten al future EBITfor Hunter Douglas because sales aredepressed right now – not just margins.

But, let’s pretend that was not true. Let’s pretend today’s sales gure is “normal”but the future margin will be the median margin the company recorded from about1996 -2014. Using this median margin approach, we get a price of 6.7 mes EBIT.That is just under 9 mes a er -tax earnings. In other words, Hunter Douglasappears to be trading for a P/E of about 13 but is actually trading at a P/E of 9 if weuse normal margins instead of today’s cyclically depressed margins.

Even this may overstate the company’s price. It is possible that given growth inother markets since the 2000s housing cycle and the acquisi on of other businessesplus the impact of popula on growth and in a on in the U.S. and Europe – thatHunter Douglas can really earn more like $350 million in the future. That would givethe company a price of less than 6 mes EBIT and less than 8 mes normal a er -taxearnings. Any reasonable adjustment for cyclicality will give you a P/E using normalearnings of 10 or less. So, here we have a stock with a 3% dividend yield, a P/E of10, an ROE of 13%, and a growth rate of 4%. Those are not overly op mis cassessments. It’s possible growth could be be er than 4%, ROE could be higherthan 13%, and it might even be likely that the price to normal earnings is less than10 mes on an a er -tax basis. The P/E es mate of 10 is probably high. The 13%ROE and 4% growth rate are good es mates. A good business that can earn anadequate return on equity without using debt and can grow at the same rate asnominal GDP while paying out a decent dividend yield should trade for 15 mes

normal a er -tax earnings. Hunter Douglas trades for 10 mes normal a er -taxearnings. Those are the two key facts. It seems very likely that Hunter Douglas’sfuture in terms of pro tability and growth and durability will be about as good asthe overall stock market. Meanwhile, it seems very likely that Hunter Douglas istrading for no more than 10 mes normal a er -tax earnings. So, you have a stockthat is equal to the indexes in terms of its normal nancial results. And yet it tradesat a P/E of 10 instead of the more normal 15 mes earnings. This means you canbuy Hunter Douglas at a deeper than 30% discount to intrinsic value. So, whileHunter Douglas is merely a good – not a great – business, its low price makes it agreat buy and hold stock.



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Margin of Safety: 53%

Business Value

Hunter Douglas’s business value is $3,848 million. Normal pre -tax owner earnings are $296million Fair mul ple = 13x normal pre -tax ownerearnings $296 million * 13 = $3,848 million

Fair Mul ple Hunter Douglas’s business is worth 13x pre -taxowner earnings

An average business deserves 15x a er -taxowner earnings Hunter Douglas is a high quality globalfranchise

But Hunter Douglas is of lower quality thanSherwin -Williams Sherwin -Williams deserves 20x a er -taxowner earnings Hunter Douglas deserves 17.5x a er -taxowner earnings Tax rate is below 25% 17.5x a er -tax owner earnings is equal to 13xpre -tax owner earnings

Share ValueHunter Douglas’s stock is worth $103.54 a share

Business value is $3,848 million Cash and investment por olio is $219 million

Debt is $565 million Equity value is $3,502 million $3,848 million + $219 million – $565 million =$3,502 million Equity Value = $100.66/share

34.79 million outstanding shares $3,502 million / 34.79 million =$100.66

Margin of Safety Hunter Douglas’s stock has a 53% margin of safety.

Business Value = $3,848 million Enterprise Value = $1,821 million Discount = $2,023 million ($3,848 million –

$1,821 million) Margin of Safety = 53% ($2,023 million /$3,848 million)

-

- --



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Geo Gannon, Writer

Geo is a writer, blogger, podcaster, and interviewer. He has wri en hundreds ofar cles for Seeking Alpha and GuruFocus. He hosted the Gannon On Inves ng

Podcast, The Investor Ques ons Podcast, and The Investor Ques ons PodcastInterview Series. He wrote the Gannon On Inves ng newsle er in 2006 and twoGuruFocus newsle ers from 2010 -2012. In 2013, he co -founded The Avid Hog(the predecessor to Singular Diligence) with Quan Hoang. Geo has been bloggingat Gannon On Inves ng since 2005.

Quan Hoang, Analyst

Quan is a stock analyst. Quan won rst prize in Vietnam’s Na onal Olympiad inInforma cs in 2006. He graduated from Manha anville College in 2012 with a B.A.in nance and a minor in math. In 2013, Quan co -founded The Avid Hog (thepredecessor to Singular Diligence) with Geo Gannon.

Tobias Carlisle, Publisher

Tobias Carlisle is the founder and managing director of Eyquem InvestmentManagement LLC, and serves as por olio manager of the Eyquem Fund LP and theseparately managed accounts.

He is best known as the author of the well regarded website Greenbackd, thebook Deep Value: Why Ac vists Investors and Other Contrarians Ba le forControl of Losing Corpora ons (2014, Wiley Finance), and Quan ta ve Value: aPrac oner’s Guide to Automa ng Intelligent Investment and Elimina ngBehavioral Errors (2012, Wiley Finance). He has extensive experience ininvestment management, business valua on, public company corporategovernance, and corporate law.

Prior to founding Eyquem in 2010, Tobias was an analyst at an ac vist hedge fund,general counsel of a company listed on the Australian Stock Exchange, and acorporate advisory lawyer. As a lawyer specializing in mergers and acquisi ons hehas advised on transac ons across a variety of industries in the United States, theUnited Kingdom, China, Australia, Singapore, Bermuda, Papua New Guinea, NewZealand, and Guam. He is a graduate of the University of Queensland in Australiawith degrees in Law (2001) and Business Management (1999).

ABOUT THE TEAM



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SINGULAR

DILIGENCE NOTES

Hunter Douglas(Amsterdam: HDG)



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N1

Overview

Hunter Douglas: an Obscure Global Franchise

Window coverings contribute 68% of Hunter Douglas’s operating profit

- Hunter Douglas (HD) sellso Window blinds and shades: 68% of profits

Window blinds Composed of slats or vanes

o Made of Wood Faux wood Woven wood Aluminum (mini-blinds) Fabrics Vinyl

Slats or vanes can rotate from a open to close positiono For privacy and light controlo Can be adjusted or tilted at different angles

To adjust the amount of light needed Window shades

Made of materials on a continuous roll Fit snugly into the window Stack neatly at the top

WindowCoverings

68%

ArchitecturalProducts

24%

Metal Trading

8%


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N2

Shades offer a smooth look to windows Shades can be drawn top-down or bottom-up

o To adjust the amount of light needed Without giving up privacy

Can’t adjust for light filtering like blinds o But you can choose the level of opacity when

choosing a shades Window shades offer

o The same soft quality as curtainso The concise and controlled appearance of blinds

o Architectural products: 24% of EBIT Sells to commercial customers Sun-control solutions

Manage heat and light inside and outside windowed walls Products include

o Exterior shadeso Skylight shades

For horizontal and sloped glazing spaces Ventilated Façade system

Uses lightweight aluminum skinso Attached to a honeycomb aluminum coreo Provides extreme strength and flatness

Panels available in many shapes and curves Suspended ceilings

Metal ceiling systems A wide variety of designs and applications

o Including curved and specialty shapes Deliver

o Superior noise reductiono A clean, monolithic look

- There’s a favorable trend for window blinds and shades o People switch from curtains to window blinds and shades overtimeo HD had grown nicely up until the financial crisis

1996-2007 annual revenue growth was 8% 1996: $1,327 million 2007: $3,028 million

- HD makes a wide range of window covering products


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N3

o From low end to high endo HD is best known for their “ette” products o Duette honeycombed shades

Revolutionized the pleated window-coverings market

Soft, attractive plated shades could be sold to fashion-consciousconsumers A three-dimensional, honeycombed fabric shade

Controls light Offers excellent properties of energy efficiencies

o Trap air in the cell to create insulation Launched in 1985 Made $300 million revenue in 1988 Duette shades captured 60% of the pleated shade market

In the U.S. By 1989

Many competitors copied Duette Their products are called cellular shades

o Silhouette Silhouette took Duette one step further Light-adjustable soft fabric veins A three-dimensional shade Consists of woven, colored polyester fabric veins

Suspended between two sheer polyester knit facings Veins can be opened or closed to control light

Offer privacy Offers the best features of

Curtains Blinds Shades All wrapped into one product

Benefits of Silhouette include UV-protectiono Even when the vanes are open

Reflect the sun heat Light control (rotate the vanes) Transform bright light into soft light

o Reduce blare


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N4

Energy efficiencyo Insulation

Unobstructed views from the inside Shield views from the outside

Launched Silhouette in 1991 There’s no comparable product in the market

o Other “ette” products are Vignette

Launched in 1994 Luminette

Launched in 1996 Facette shades

Launched in 2004 Pirouette

Launched in 2007o HD is known for all these “ette” products

They advertise on cable TVo A typical aluminum mini-blind cost $50-75 a window

Duette sells at retail for $150-180 a shading Silhouette sells for $300 a shading

(From an article in 1992, price should be adjusted for today $)- HD has about 40% market share in the U.S.

o Strong brand Advertising Words of mouth

o Most customers know about the products when walking to dealer stores- HD is a truly “glocal ” business

o Revenue breakdown by regions North America: 43% Europe: 38% Latin America: 9% Asia: 7% Australia: 3%

o HD has presence in more than 100 countries 50 manufacturing 75 assembly operations Marketing organizations


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N5

o They have two brand names Hunter Douglas for North America Luxaflex for Europe Either Hunter Douglas or Luxaflex for other regions

o HD makes custom products Maintain local production In Europe

o Concentrate components in a few plants Mainly in Netherlands

o Assemble products in local fabricators In North America

o Parts are made in 8 manufacturing plants Based in the U.S.

o All assembling is done by 3 plants Cumberland, Maryland Salt Lake City, Utah West Sacramento, California

Deliver custom orders in 1 weeko HD historically has a 2-tier distribution system

HD supplies components to fabricators Several thousands of independent fabricators worldwide 75 company-owned fabricators Fabricators assemble and sell the products

o Fabricators nominate dealerso HD review and select dealers

Dealers Over 100,000 dealers around the world Mom-and-pop operations

o HD switches to 1-step distribution system overtime Acquire and consolidate fabrication Work directly with dealers

o HD took over all fabrication in the U.S. Continues consolidating in other markets

- HD is an obscure stocko HD has an American root

Henry Sonnenberg moved to the U.S. In 1940


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N6

Founded the Douglas Machinery Company Established a joint venture with Joe Hunter

In 1946 Developed “new technology and equipment for the

HDG HunterDouglas Singular Diligence June15

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