Letter #222: Steven Rales (1985)
Cofounder of Danaher & Indian Paintbrush | Danaher Founding Shareholder Letter
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This month marks 40 years since Danaher was founded. And over those 40 years, Danaher has delivered total shareholder returns over 180,000% and is the only US publicly traded company that has outperformed the S&P 500 in every five year period.
Today, I wanted to share with you their very first shareholder letter.
In this letter, Steven Rales explains Danaher’s two new businesses and their operations, when combined with Danaher’s acquisition strategy, will create and maintain value for all shareholders. He starts with Mohawk Rubber, then Master Shield, before moving on to discuss Danaher’s real estate portfolio and acquisition opportunities. In discussing their acquisition opportunities, Steven lays out the characteristics he looks for in businesses before explaining each one. He then shares a special note on shareholder democracy and the motivation behind “corporaphobia.” This is the letter that laid the foundation (and shared the framework) for Danaher’s future acquisitions and successes.
Steven Rales is the Cofounder and Chairman of the Board at Danaher. In 1981, Steven and his brother Mitch went on a fishing trip to discuss what they wanted to do with their lives and what they wanted to achieve in the business world, and came to the conclusion they wanted to create a business that was $250mn in sales that had a 10% operating profit margin.
They immediately got to work—their first deal came later that year, in 1981, when they acquired a vinyl siding manufacturing company called Master Shield for $6mn. They then acquired Mohawk Rubber in 1983 for $90mn ($88mn of which was borrowed from GE Credit Corporation, with the other $2mn in equity coming from Master Shield’s cash flows). The Rales brothers then took Master Shield and Mohawk and merged them into the defunct real estate investment trust DMG, which they then renamed Danaher.
Less than ten years after the deal that started Danaher closed, the Rales brothers fired themselves and brought in an external CEO. However, they stayed on as board members and remain involved in the business to this day, throughout all of its iterations. Today, Danaher is a leading global life sciences and diagnostics innovator and the brothers focus on mentoring, developing, and working with people to try to help them improve their livelihoods through career development.
Outside of Danaher, Steven is heavily involved in media and sports. In 2006, he started the film production Indian Paintbrush, known for working with Wes Anderson. In 2024, he acquired the media distribution companies Janus Films and The Criterion Collection. He also owns a 20% stake in the Indiana Pacers.
For those who want to learn more about the Danaher story, its beginnings, early deal dynamics, current and previous incarnations, and more, I could not more highly recommend the Joys of Compounding (fka Art of Investing) podcast episode with Steven’s brother Mitch.
Related Resources
Danaher
Mitch Rales: The Art of Compounding
(Joys of Compounding fka Art of Investing Podcast)
Conglomerates
Healthcare
Letter
TO THE SHAREHOLDERS OF DANAHER CORPORATION:
As we progress toward our horizon, our vision comes more clearly into focus. During the past year, we completed two acquisitions, significantly reduced an inheritance of debt, and in the process saw our book and market value per share increase dramatically. We also believe we have reclaimed the financial integrity that we trust will be our hallmark in the years to come.
Since Danaher’s business lines have changed significantly from one year ago, and the consolidation of our new operations is barely two quarters old, comparative results from prior years would not be meaningful. Therefore, I would like to devote most of this letter to an explanation of our new businesses and how these operations, when combined with our acquisition strategy, will create and maintain value for all shareholders. I have stated several times in the past, and reiterate here, that the benefits flowing to all of us as shareholders will not be jeopardized by any compromise in shareholder democracy. More about this later.
With overwhelming endorsement at the annual meeting last fall, shareholders approved the acquisitions of The Mohawk Rubber Company and Master Shield, Inc., two companies with established records of profitability and quality management. The lines of business at each company are strategically well situated and we anticipate a steady performance in both revenues and earnings. Although Mohawk’s results last year were a bit disappointing, we attribute this to the transition of the acquisition, a nonrecurring situation. Mohawk’s results for the first quarter of this year support this notion.
With the change in Danaher’s lines of business has come a change in its financial results. Bolstered by the Mohawk and Master Shield acquisitions, albeit for only one quarter, revenues in 1984 increased to $90,884,000, while earnings climbed to $2,880,000. Although last year’s profit was the first since 1980, we expect that earnings this year will increase notably from last year’s fourth quarter results annualized.
Mohawk Rubber
Mohawk aroused considerable interest as a leverage buyout candidate until it was acquired early last year by our largest shareholder, Equity Group Holdings. As leveraged buyouts began to proliferate, Mohawk was well characterized by the quintessential LBO profile: stable earnings and cash flow, little long-term debt, a stock price trading within a reasonable range of book value, and experienced dedicated management. Danaher acquired Mohawk at a very reasonable price, particularly given subsequent purchases of manufacturing firms which have occurred at rather staggering multiples of cash flow and earnings. Many of the more recent acquisitions seem to be fueled as much by the abundance of available capital as sound business judgment. This environment requires prudent analysis of any acquisition opportunity and has caused us to say no to several initially promising situation.
Mohawk’s appeal to its many suitor emanates from its strong position as a manufacturer of replacement tires for passenger cars and a fabricator of other industrial products. The company has developed and maintained a consistency that is a product of its complementary lines of business. As growth in the economy slows, replacement tire sales tend to accelerate, given the desire of many consumers to replace parts on existing vehicles rather than incur debt to purchase new ones. The Industrial Products Group, led by Fayette Tubular Products, fabricates a broad array of rubber and metal components that are purchased in large quantity by the automotive industry. This group has done particularly well during periods of economic recovery and should achieve record results this year if consumer spending doesn’t fade.
While the tire industry was expanding just prior to our last recession, Mohawk was preparing to swallow hard. Having guided the company for the previous 25 years, Hank Fawcett and Bill Ernst recognized the obsolescence of certain facilities and the signals warning overcapacity. The decision was made to close two tire manufacturing plants, including the pilot facility in Akron. Remaining is a modern facility in Virginia, which has the manufacturing flexibility required to satisfy the increasing demand for radial tires. More durable than its counterparts, the radial has become an attractive alternative as the cost of these tires has declined. Rather than expand capacity to increase radial production, Mohawk has been adjusting its product mix so that it can maintain the efficiencies of a single manufacturing facility operating at full capacity. Radial production should plateau within the next few years at approximately 75% of total unit production.
Since Mohawk isn’t broken, we don’t intend to fix it.
Master Shield
Plastic is a burgeoning product which has become more desirable because of diminished natural resources and the escalating cost of energy, as well as its own reputation for consistency and durability. Master Shield manufactures vinyl extrusions with two primary end uses: residential siding and window profiles (i.e., components for the window frame). The company is a logical extension of the plastics revolution, bolstered by the astute management of Nick Martin, the company’s chief executive.
Master Shield is an attractive company because it is a very efficient producer in a growing market. Once dominated by aluminum, steel and wood, the siding industry has embraced vinyl as its mainstay. Approximately two years ago, vinyl surpassed aluminum in market share and became America’s most desired form of siding. It will likely never look back. Such qualities as color, durability and easy maintenance always favored vinyl over competing products, but when rising energy costs brought vinyl and aluminum siding manufacturing costs into line, the demand for vinyl soared.
In addition, Master Shield benefits from an often misunderstood aspect of the building products industry. A substantial portion of siding industry sales are absorbed not by the new construction market, but by the remodeling trade. Although the new construction market relies more upon siding than ever before, this phenomenon has simply increased the size of the market rather than diminished the share maintained by the remodeling sector. Thus, when the economy contracts, and rising interest rates create a decline in new home sales, consumer spending is funneled toward maintenance and repair. With Master Shield’s marketing oriented toward the remodeling trade, Nick has always said that the company can be particularly competitive during those times of consumer thriftiness.
Real Estate
Our real estate portfolio is more stable and better positioned than at any time in recent memory. Michael Mash has performed well in rearranging a seemingly unmanageable portfolio and curtailing a mountain of debt so that our real estate efforts can once again become profitable. Although this segment of the company should not be expected to become the profit leader, we have avoided the discomfort of having these operations drag upon the strength of the others. Although we will not forsake the opportunity to acquire additional real estate, the public market tends to embrace the book rather than fair market value of these assets, often resulting in a discounted market capitalization. Since the interest of all of us as shareholders is paramount, further real estate acquisitions require much thought.
Acquisition Opportunities
In last year’s letter we discussed the prospect of further acquisitions for Danaher. These discussions often involved inquiries concerning our acquisition philosophy, our degree of leverage and our attitude about Danaher as an acquisition target. I have several thoughts regarding each of these.
Since a business can grow only one of two ways, internally or externally, the considerations behind an acquisition strategy are important. Those considerations are particularly significant here because of the company’s tax loss carryforward, which on a present value basis is worth far more if utilized expeditiously.
I noted earlier the absence of discipline that is prevalent in the acquisition market today. That doesn’t mean that sensible acquisitions haven’t been undertaken recently. The merger of Gulf & Western Industries with Prentice-Hall, and the pending combination of Capital Cities Communications and American Broadcasting Companies (ABC) come quickly to mind as potentially beneficial. What it does mean is that the market for attractive businesses has become increasingly more competitive and that caution and ingenuity have become necessary as well as worthwhile allies. Naturally, we would prefer to generate external growth by acquiring businesses that neatly blend with out existing operations. A combination of complementary lines often generates value not otherwise achievable: management, products, markets. In fact, our unsuccessful attempt last year to acquire Aegis Corporation was aimed at that company’s tread rubber group, which would have combined wonderfully with Mohawk. Regrettably, opportunities for complementary value are not common, but if we choose to go afield, any business that we week will likely be characterized by the following:
(i) it must be understandable;
(ii) the earnings must be predictable, generating cash profits;
(iii) it must have a reasonably defined niche; and
(iv) the management must be experienced with an entrepreneurial orientation.
In the first instance, if the business is not simple, then we won’t understand it. What we don’t understand we can’t manage, and something that’s unmanageable isn’t going to benefit shareholders. A brief tour through one of the facilities at Mohawk or Master Shield will cause you to conclude that manufacturing a siding panel or a radial tire isn’t all that complex.
We also like predictable earnings in the form of cash. If the earnings have been consistent, then it’s likely that management knows how those earnings were created. Particularly important, however, is that the profits be cash profits. When profits are in some other form, funny things can happen, most of which are not good. In addition, since Danaher is relatively leveraged, cash is a very valuable commodity.
Niche is a useful term because it implies selectivity. A conscious selection is important in any business strategy because without it there exists no blueprint. The first question one often asks in analyzing any business is: who will our customers be five years from now? Since every technology has a life cycle and markets change, having no plan means any road can take you there. Most companies do something better than their competitors and when they discover that skill and learn to exploit it, their chances of longer term success increase accordingly.
Lastly, we must have confidence in management’s experience and its orientation toward governing the enterprise. Danaher is an autonomous organization with all operating management functions decentralized. Our Directors simply don’t believe in layering the organization with a corporate staff. Since we are not equipped to play an ongoing operation role, we rely significantly upon the judgment of operating management. Our preference is that this judgment reflect some sense of risk taking, a willingness to go against the trend. Trends are far more profitable to fashion designers than they are to shareholders. When I see a trend, I start looking the other way and hope my timing is right. Since all markets are volatile, maintaining a constant pattern will not yield favorable results.
A Special Note on Shareholder Democracy
With the recent increase in takeover activity, I have noticed an alarming willingness by many Boards of Directors to embrace newly created defensive devices that often superimpose the judgment of the Board over that of the shareholders. This infringement upon shareholder democracy becomes particularly concerning when corporate executives begin parading before the U.S. Congress asking the legislators to provide them with protection they know they cannot garner from the shareholders. The fact is, that although management is employed by shareholders to govern the enterprise, shareholders have very few opportunities to exercise their rights, and because their base is generally quite broad, shareholder effectiveness can be limited. To restrict these fundamental privileges even further, particularly at the behest of the federal government, would be an error long remembered.
Many of these new defensive devices transfer discretion regarding a sale or merger of the enterprise away from the shareholders and into the hands of the Board of Directors, which is often heavily influenced by management. The architects of this transfer argue that without it, the enterprise must either maintain a shortsighted focus, or else fall prey to a lurking corporate raider seeking to capitalize upon the company’s unrealized potential. I doubt seriously whether General Electric Company, J. M. Smucker, IBM or Rubbermaid, just to name a handful of unlikely targets, have abandoned their longer term perspective. They are just better managed companies, concerning themselves less with procedural maneuvers, which often depress a company’s stock price, and more with asset productivity.
The motivation behind this “corporaphobia” is not the vulnerability of the enterprise but rather the suspected vulnerability of those charged with managing the enterprise. If one examines a few of the instances where these defensive ploys have been implemented, one will notice a curious absence of management ownership. If management has no interest in protecting its position as an owner, which incidentally runs parallel with the interest of all shareholders, then it must be seeking to protect something else. And if shareholders are not willing to provide the protective cover sought by management, jeopardizing the democratic process to achieve that end just won’t do.
Your Board of Directors will continually strive to promote the rights of all of us as shareholders, seeking value not protection. Poison pills, shark repellents and the like will hopefully remain the folly of a self-interested minority.
Steven M. Rales
Chairman of the Board
April 30, 1985
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The section of the letter on shareholder democracy is excellent. For the period written (1985), the Rales/Danaher viewpoint was definitely in the minority. I do not believe there is any coincidence between this view and the longer term exemplary success of Danaher.