Monday, March 18, 2019

Another Update to Koch Industries Profit Margins, Dividends, and Net Worth

Image result for koch industries headquarters

In many blog posts in the past I have tried to calculate the dividend, profit margin, and the historical net worth of Charles and David Koch. Recently Koch CFO Steve Feilmeier in an Q&A session (I blogged about the Q&A session here) with Startup Wichita Local stated that Koch has earned about a 13-14% return over time (the company targets to earn a 12-18% return on projects it invests in). Typically large companies have hundreds of possible of projects but allocate so much money to the projects they feel will earn the highest return). My previous analysis has pegged the return of Koch Industries return between 5%-13%. Clearly this higher return assumption would change the amount of dividends, reinvestment, and net worth for Koch Industries in their shareholders.

Historical analysis would show that the Koch Industries had a low profit. The Koch vs. Koch trial showed that in 1982 Koch had revenues of almost $17 billion and had pre-tax earnings of $564.7 million which would say that before tax earnings was 3%. However, these days Koch Industries is more than just oil and gas. The company has invested heavily in technology companies (with Koch Disruptive Technologies), has their own equity development arm (Koch Equity Development, and is much more diversified (and higher return) than in the past.

So if we run the math if Koch now has revenues of $130 billion and they earn a 13% return it would say their annual earnings are $17 billion per year. $17 billion is of course before Koch pays any taxes. If you you assume a 24% tax rate (which is the average for S&P 500 companies). After-tax earnings of Koch would be roughly $12.8 billion. The company reinvests 90% of their earnings back into the company which would say on average $11.5 billion per year is plowed back into Koch Industries. Koch Industries for the past 55 years (according to Steve) has reinvested 90% of their earnings back into the company. This would say that about $900 million is left over to pay dividends to all Koch shareholders. Historically, the company has paid 7% of the earnings to shareholders. Charles and David Koch each own a 42% interest in Koch Industries (although Chase Koch has mentioned he is a shareholder in this Startup Local Wichita Q&A). If we take the after-tax earnings of the company ($12.8 billion) x 7% payout of earnings x a 42% ownership interest it would say that Charles and David Koch each pull in roughly $378 million in dividends alone. If the Marshall family owns the other 16% of Koch Industries it would say they pull in a little over $140 million dividends per year.

Another interesting thing Steve brought up in his Q&A was when Charles inherited Koch Industries the company had a net worth of $12 million and grew it by 7500 times. This would say that Koch Industries is worth $90 billion and Charles Koch would be worth close to $38 billion (and not the $55 billion that currently Forbes has-Bloomberg is closer at $44 billion. The Marshall family would have an estimated net worth of around $13 billion. Historically the net worth of Koch Industries has grown dramatically as Charles Koch has plowed so much back into the company. The net worth of Koch Industries in 1982 was $1.5 billion . Before the Koch lawsuit shareholders Charles, David, and Bill Koch each owned a 20.7% interest (oldest brother Frederick Koch owned a 13.7%) interest. This would say in the early 1980's Charles, David, and Bill had a net worth over $300 million (Frederick would have a net worth of a little over $200 million). To grow their net worth from $300 million to $38 billion in a little over 30 years is quite dramatic.

When you look at the dividend yield on Koch Industries it is quite paltry compared to large companies. If Charles and David earn $377 million in dividends per year and their net worth is each $38 billion would say the yield of Koch Industries stock is around 1%. The average yield of a company in the S&P is currently near 1.92%. Another way to look at this is to say if Charles and Koch sold their stock they could generate almost double the dividends then Koch Industries stock is paying! Koch however has had a policy of reinvesting 90% of their earnings back into the company which has led to dividend growing dramatically over time. When Fred Koch passed away in 1967 the company paid out dividends of $300,000 (according to Sons of Wichita). If the total dividends of the company are roughly $900 million this would say the annual increase of dividends has been a staggering 21%/year.

The interview with Steve Feilmeier cleared up some of the issues I had been trying to calculate (again these are strictly estimates since Koch Industries is not a public company and doesn't have to disclose any of this information) for a couple of years in terms of how much Koch Industries throw off in dividends, the net worth of Charles and David Koch, and the Marshall family. It shows that Koch is quite a disciplined company and by earning a 13-14% annual return has not only earned a good return but helped fuel the growth of not only the net worth but the dividends of shareholders of Koch Industries.

Sunday, March 17, 2019

Koch Industries CFO Steve Feilmeier Startup Grind Local Wichita

Steve Feilmeier

Recently Koch Industries CFO Steve Feilmeier sat down with Startup Grind Wichita on February 20, 2019. Chase Koch (son of Charles Koch did a similar sit down back in November 2018 which can be seen here and I blogged about here. Koch Industries is making an effort to get executives of the company out in the public discussing what Koch Industries actually does and what they stand for. These days Koch Industries has grown to a company with $130 billion in revenue and roughly 140,000 employees.

Steve currently is the executive vice president and chief financial officer of Koch Industries. He started with the company back in 1997 as a controller for the Koch Chemical Group and then had various roles in controller operations, tax, treasury, cash management, mergers and acquisitions. In the interview Steve said he had 15 different jobs before he became CFO of Koch Industries. Actually Steve wasn't originally groomed to be the CFO of Koch Industries. Koch Industries had identified someone to become CFO and then after 3 months on the job that individual left the company (it was pointed out that Koch was painfully aware Steve wasn't ready for the job). Steve says one of the most unpleasant days of his life was when Dave Robertson and Charles Koch sat down with him to give him feedback about what he needed to work on. Having these different roles within Koch must have given Steve a really good idea of how the company runs internally. Usually if companies are grooming someone to an executive role they have that individual work in different areas to get exposed to understand how different departments function. Steve points out that Charles Koch has been his biggest mentor over the years. At Koch Industries Steve points out that is it okay to say you don't know the answer a question but jokes if Charles Koch asks you then you better have an answer within a couple of hours or the next day.

Steve discussed the inter workings of Koch Industries in terms of how they perform deal making, the culture of the company, and what it was like working with Charles Koch. In terms of deal making Koch treats a $500,000 deal just like a $5 million or a $50 million deal. When performing an investment the most important thing is the quality of the idea, if the idea is actually solving a problem in society. Also when doing a deal with an entrepreneur Koch likes to see if the company will do the right thing (having integrity), if the entrepreneur is are realistic about projections and are honest saying "hey this project actually may cost 2 or 3 times what I project, but I have a backup plan for that", an entrepreneur that is also willing to not take a paycheck for a couple of years and give up their social life in the process. The entrepreneur also has to have a real business plan and it can't be all in their head. The plan has to have real numbers and make logical sense to solving a problem. Also it is pointed out that when Koch creates profit it consuming less resources. Steve discussed how Koch was going to invest $600 million in a project for Georgia Pacific to use technology to improve the quality of the toilet paper (Quilted Northern) while also consuming less resources. The project is suppose to reduce pulp by 20% (which reduces the number of trees cut down), reduce water consumption by 20% (making toilet paper consumes an extraordinary amount of water), and reduce natural gas by 20% (this is used to dry the toilet paper), while expecting to increase the cash flow of Koch Industries by $100 million per year (which would say the project pays for itself in roughly 6 years or has a 17% return on investment).

When actually performing a deal Koch Industries tries to target a 12-15% return on projects that Koch invests in depending on the risk. Back in 2004 or 2005 Koch embarked on a $40 billion investment plan and then came back in 2011 or 2012 and evaluated the progress report of the return on the projects that they invested in. Koch reviewed 13-14 major projects and when they were reviewing the analysis of the overall return of the projects showed a healthy 14% return but Charles Koch with his engineering training called this type of analysis nonsense. Charles pointed out that the average of all the projects were 14% but when you looked at each project (incremental analysis) that comment was not correct. One project may earn a negative return, 0%, 5%, and then some projects may earn an extraordinary return that increases the weighted average of all the projects to a 14% return. After this presentation Koch changed the way they analyzed projects. When Koch evaluates projects the company looks at all the ways it can go wrong and what are the contingencies if it does go wrong. Steve points out that when Charles is evaluating a deal he has doesn't get emotional, is not strategic, and only looks at the numbers to see if it makes sense. Companies sometimes purchase things to be "strategic" and then later have to take a large write down because of a bad deal. What is also interesting is how Koch isn't run with Charles Koch making all the decisions and everyone just executing his plans. Steve remarks that in 23 years being CFO for Koch Industries he has never been told what to do, however he will let management know what is it doing to get ideas and feedback and if he needs "course correction". These days Charles doesn't have to approve everything on the strategies or acquisitions. Charles in a 2015 interview admitted that he used to get involved in every detail in a deal but these days since Koch is so large it is impossible for him to do that.

On April 30, 2004 at 5 P.M. ET Koch purchased Invista for $4.2 billion in cash. Koch purchased Invista for 6 times (12 month trailing EBIDTA) which is not a bad deal. Invista is a textile company that was in charge of making things like carpet, flooring, nylon, fabric that is used to make pillows, mattress tops, bed comforters and many other products that are used in everyday life. Well Charles Koch was thinking after Koch acquired Invista the company would instantly adopt the same market based management philosophy that Koch Industries used. The issue was Invista was pulled out of a large company (DuPont) that had a different culture than Koch. It took Koch 10 years to unravel this and fix all the issues they had. Today, Invista is one of Koch's most profitable companies. Charles reminds CFO Steve Feilmeier that project deserves an F grade on that acquisition.  In 2017, Koch sold Lyrca (a product sold by Invista) to a Chinese company for $2 billion.

Overall, in the long run Koch Industries has done quite well on their investments. Steve mentions that the company has earned a 13-14% return which has led the company to double in size roughly every 5-6 years. The company has reinvested 90% of the earnings back into the company for the past 55 years which has lead to tremendous growth. The company has in the past 6-7 years spent $17 billion on technology capabilities for the company. Part of these monies were spent on Infor which was presented at a forum for the company. Koch was spending $500 million a year on their HR human capital function. Currently, Koch doesn't have know exactly how many employees it has worldwide and has to rely on multiple records and systems to keep track of everyone. Koch purchased Infor which has software that can be stored in a cloud and integrate all the data into one system. Also another positive is that the software constantly updates itself so upgrades aren't required (Koch was generally performing updates every 3-5 years). With the new technology Koch expects to reduce their costs by 20%-40%. Koch also hopes it will reduce the time it takes to hire employees and also help their internal recruiting. Also they hope this technology will improve downtime at plants and refineries that Koch owns as well.

As Steve points out when Charles inherited the company there was $12 million of equity on the balance sheet which has grown by 7500 times since then. This would say that Koch Industries is worth $90 billion and since Charles Koch is a 42% owner of the business his net worth would be $38 billion which is quite different than the figures that Forbes, Bloomberg, and other sources are reporting. However, even as Charles has accumulated massive amounts of wealth Charles is always worried about the business all going away tomorrow. The constant fear or worrying is throughout Koch Industries. Koch executive vice president Jim Hannan has commented that you have to avoid feeling complacent and having the self satisfaction and have to worry about competitors coming in "and then just get dragged down from behind and get our throats slit".

Overall, I thought the CFO Steve Feilmeier handled himself well in the interview, was quite knowledgeable, and also could be personable too. These days Koch has a deep bench of executives that could step in if something were to happen to anyone which is always a good thing. Feilmeier is only 57 years old so he probably still has another decade or so in that role. He mentioned in his role these days he and Charles both mentor other employees and pass on what they have learned over the years. Hopefully in time the results will be passed on to other employees and will allow Koch Industries to grow even more.