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Will Clean Giant Nab WD-40?

— For more than three decades, San Diego icon WD-40 didn't have to worry about competition. It sold a legendary lubricant by a name that came to be used in 80 percent of U.S. homes. Profits were great, but with its only product selling into a saturated market, the company wasn't getting much revenue growth. So, ten years ago it began diversifying -- into the bathroom and the living room, where, unfortunately, a fierce battle among the world's best-managed corporations began just a few weeks ago.

It's a war for shelf space and advertising bargaining power. Some household- products companies are merging. Others are trimming corporate fat. All hope to sharpen their elbows. Nobody is talking about it openly yet, but it's possible that the local company born in serendipity (WD-40's founders were trying to create an aerospace rust preventative) could be swallowed up in an industry consolidation wave.

Beginning in 1995, WD-40 bought 3-In-One Oil, heavy-duty hand cleaners Lava and Solvol, toilet-bowl cleaners X-14 and 2000 Flushes, and rug cleaners Carpet Fresh and Spot Shot. The acquisitions put the company in direct competition with big boys and have had mixed reviews on Wall Street.

Then came this year's shockers. Last month, Procter & Gamble and Gillette announced plans to go to the altar.

Procter brands are ubiquitous in the world's bathrooms: deodorants, cosmetics, toothpaste, hair and beauty products, shaving cream, soaps, disposable diapers, toilet paper and, of course, Mr. Clean. Ditto for Gillette: razors and blades, electric razors, deodorants, and the like. The $58 billion proposed merger will create the world's largest consumer-products company.

Immediately, competitors knew they were in trouble. Unilever, which had been managed jointly and clumsily from the U.K. and the Netherlands, finally decided to combine under one chief executive. It may also split itself up by product lines. Sara Lee decided to shed 40 percent of its product lines but will retain its household products. Analysts say that Colgate-Palmolive will have to buy another big company to defend itself against Procter/Gillette. WD-40's more direct competitors -- Church & Dwight, Clorox, and the U.K.'s Reckitt Benckiser -- are expected to clean their houses of any cobwebs.

Compared with many of its competitors, WD-40 is a gnat, with $242.5 million in sales last year. The combined Procter/Gillette will have revenues of more than $60 billion.

No company is likely to try competing with the lubricant WD-40. Several big ones have tried, but none has succeeded. And WD-40's other product lines are probably not terribly enticing to the bigger companies -- at least yet. "We don't compete in the mainline categories," says Garry O. Ridge, president and chief executive. "Our strategy is going into niche and specialized categories."

But it's the broad effect of the Procter/Gillette marriage that has the entire consumer-products industry taking emergency trips to the bathroom. There are two big factors behind this deal: Wal-Mart and the media. The combined company will have more leverage negotiating price with Wal-Mart and media companies, including TV, newspapers, magazines, and billboards.

Looking at the possible ripple effects of the Procter/Gillette merger, Ridge ruminates, "I think life will change somewhat, but I don't know what the downstream impact will be."

Wal-Mart represents 17 percent of Procter's business, 13 percent of Gillette's, and 14 percent of WD-40's.

WD-40's diversification efforts have made it vulnerable. "WD-40's brands now compete in categories characterized by increasing retailer bargaining power and the hefty advertising and promotional spending of much larger rivals, including Clorox and the U.K.'s Reckitt Benckiser," says a recent report by Morningstar. Reckitt Benckiser bills itself as the world's largest maker of household cleaning products, not including detergents. Church & Dwight, another WD-40 competitor, "is on an aggressive acquisition program," says Ridge.

Through acquisitions and product innovation, those companies and others could strengthen brands that compete with WD-40. Or those companies could be swallowed up by one of the larger companies, such as Colgate or Unilever, and thus have more muscle to get on the shelves. On the other hand, since most mergers don't pay off, it's possible a consolidation wave among competitors could help WD-40.

Some analysts believe WD-40's acquisition program has not been a winner. The company has been "plowing its cash into poor acquisitions," says Morningstar. The post-1999 purchases were financed with $147 million in cash and $60 million in additional debt "and have not generated sufficient earnings growth." Between 1999 and 2004, earnings per share crept up from $1.41 to $1.50. They were $1.57 in 2002 and $1.71 in 2003, so the road has been rocky.

"In recent years, this conglomeration of [new] products has produced nothing but disappointments," says W.D. Crotty of Motley Fool.

To support the acquisition program, the dividend has been cut. It was $1.28 a share in 2000 and 80 cents the last two years. At one time, WD-40 was one of the few high-yielding stocks in the consumer-products industry. Not now.

Meanwhile, the balance sheet has weakened. Long-term debt has gone up from $1 million in 1998 to $75 million.

To critics of the acquisition program he orchestrated, Ridge has a stiff rejoinder. "I am used to people making comments with limited or scanty information," he snaps.

WD-40 recently reported bang-up results for the quarter ended November 30, 2004. Sales were up 15.5 percent as earnings zoomed 28.4 percent. For the current fiscal year, Ridge expects earnings per share to rise to $1.62. The bulk of expected sales growth will come from overseas, but lubricant sales, including WD-40, did well almost everywhere in the first quarter, he points out, thanks in large measure to a new WD-40 can, called "Big Blast," that sprays large surfaces quickly. He expects big growth this year in the household-products area -- the brands that have been added by acquisition.

"We remain skeptical," says Simon Shoucair of Value Line. He doubts that WD-40's household products have great future-earnings power because of intense competition.

The big question is whether some company might try to buy WD-40. "Despite criticism that it hasn't engineered potential future growth, the company has remained focused and has done a good job protecting its brand image," says David Allen of Palomar Equity Research. So, it's attractive.

"The company has no interest in selling, but if outside investors take a sizable position in the stock and try to pressure the board," it could happen, says Bud Leedom of Comstock Investment Advisors, who thinks Ridge's acquisition program has been more successful than critics say.

Ridge says he has no idea if a potential acquirer is looking at the company. If negotiations were going on, they would be made public, he says. Would the board accept an offer? "We're here to maximize shareholder value," he says -- the standard corporate response. Officers and board members control only 8.7 percent of the stock -- not enough to ward off a hostile offer. However, one large institution, Capital Research and Management of Los Angeles, owns another 10.2 percent. It could have some say in the matter.

One factor that would inhibit a takeover is that the company is already very profitable, says Allen. There has been severe slippage, but margins are still quite high. For example, back in 1996, the company earned an astounding 46.5 percent on equity, or ownership. That has been cut in half -- but last year's 23.6 percent is still very high by corporate standards.

That may be one reason why the stock is not cheap. It sells for 21.3 times its most recent 12-month earnings and 4.5 times its book value, or the value of its assets. "That's a stiff price," says Allen. "This company has always made amazing returns; it's clearly a pretty profitable company, and that's the rub. Any company paying a premium to buy it is not going to achieve a significant increase in profitability of WD-40. It is not a turnaround situation."

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— For more than three decades, San Diego icon WD-40 didn't have to worry about competition. It sold a legendary lubricant by a name that came to be used in 80 percent of U.S. homes. Profits were great, but with its only product selling into a saturated market, the company wasn't getting much revenue growth. So, ten years ago it began diversifying -- into the bathroom and the living room, where, unfortunately, a fierce battle among the world's best-managed corporations began just a few weeks ago.

It's a war for shelf space and advertising bargaining power. Some household- products companies are merging. Others are trimming corporate fat. All hope to sharpen their elbows. Nobody is talking about it openly yet, but it's possible that the local company born in serendipity (WD-40's founders were trying to create an aerospace rust preventative) could be swallowed up in an industry consolidation wave.

Beginning in 1995, WD-40 bought 3-In-One Oil, heavy-duty hand cleaners Lava and Solvol, toilet-bowl cleaners X-14 and 2000 Flushes, and rug cleaners Carpet Fresh and Spot Shot. The acquisitions put the company in direct competition with big boys and have had mixed reviews on Wall Street.

Then came this year's shockers. Last month, Procter & Gamble and Gillette announced plans to go to the altar.

Procter brands are ubiquitous in the world's bathrooms: deodorants, cosmetics, toothpaste, hair and beauty products, shaving cream, soaps, disposable diapers, toilet paper and, of course, Mr. Clean. Ditto for Gillette: razors and blades, electric razors, deodorants, and the like. The $58 billion proposed merger will create the world's largest consumer-products company.

Immediately, competitors knew they were in trouble. Unilever, which had been managed jointly and clumsily from the U.K. and the Netherlands, finally decided to combine under one chief executive. It may also split itself up by product lines. Sara Lee decided to shed 40 percent of its product lines but will retain its household products. Analysts say that Colgate-Palmolive will have to buy another big company to defend itself against Procter/Gillette. WD-40's more direct competitors -- Church & Dwight, Clorox, and the U.K.'s Reckitt Benckiser -- are expected to clean their houses of any cobwebs.

Compared with many of its competitors, WD-40 is a gnat, with $242.5 million in sales last year. The combined Procter/Gillette will have revenues of more than $60 billion.

No company is likely to try competing with the lubricant WD-40. Several big ones have tried, but none has succeeded. And WD-40's other product lines are probably not terribly enticing to the bigger companies -- at least yet. "We don't compete in the mainline categories," says Garry O. Ridge, president and chief executive. "Our strategy is going into niche and specialized categories."

But it's the broad effect of the Procter/Gillette marriage that has the entire consumer-products industry taking emergency trips to the bathroom. There are two big factors behind this deal: Wal-Mart and the media. The combined company will have more leverage negotiating price with Wal-Mart and media companies, including TV, newspapers, magazines, and billboards.

Looking at the possible ripple effects of the Procter/Gillette merger, Ridge ruminates, "I think life will change somewhat, but I don't know what the downstream impact will be."

Wal-Mart represents 17 percent of Procter's business, 13 percent of Gillette's, and 14 percent of WD-40's.

WD-40's diversification efforts have made it vulnerable. "WD-40's brands now compete in categories characterized by increasing retailer bargaining power and the hefty advertising and promotional spending of much larger rivals, including Clorox and the U.K.'s Reckitt Benckiser," says a recent report by Morningstar. Reckitt Benckiser bills itself as the world's largest maker of household cleaning products, not including detergents. Church & Dwight, another WD-40 competitor, "is on an aggressive acquisition program," says Ridge.

Through acquisitions and product innovation, those companies and others could strengthen brands that compete with WD-40. Or those companies could be swallowed up by one of the larger companies, such as Colgate or Unilever, and thus have more muscle to get on the shelves. On the other hand, since most mergers don't pay off, it's possible a consolidation wave among competitors could help WD-40.

Some analysts believe WD-40's acquisition program has not been a winner. The company has been "plowing its cash into poor acquisitions," says Morningstar. The post-1999 purchases were financed with $147 million in cash and $60 million in additional debt "and have not generated sufficient earnings growth." Between 1999 and 2004, earnings per share crept up from $1.41 to $1.50. They were $1.57 in 2002 and $1.71 in 2003, so the road has been rocky.

"In recent years, this conglomeration of [new] products has produced nothing but disappointments," says W.D. Crotty of Motley Fool.

To support the acquisition program, the dividend has been cut. It was $1.28 a share in 2000 and 80 cents the last two years. At one time, WD-40 was one of the few high-yielding stocks in the consumer-products industry. Not now.

Meanwhile, the balance sheet has weakened. Long-term debt has gone up from $1 million in 1998 to $75 million.

To critics of the acquisition program he orchestrated, Ridge has a stiff rejoinder. "I am used to people making comments with limited or scanty information," he snaps.

WD-40 recently reported bang-up results for the quarter ended November 30, 2004. Sales were up 15.5 percent as earnings zoomed 28.4 percent. For the current fiscal year, Ridge expects earnings per share to rise to $1.62. The bulk of expected sales growth will come from overseas, but lubricant sales, including WD-40, did well almost everywhere in the first quarter, he points out, thanks in large measure to a new WD-40 can, called "Big Blast," that sprays large surfaces quickly. He expects big growth this year in the household-products area -- the brands that have been added by acquisition.

"We remain skeptical," says Simon Shoucair of Value Line. He doubts that WD-40's household products have great future-earnings power because of intense competition.

The big question is whether some company might try to buy WD-40. "Despite criticism that it hasn't engineered potential future growth, the company has remained focused and has done a good job protecting its brand image," says David Allen of Palomar Equity Research. So, it's attractive.

"The company has no interest in selling, but if outside investors take a sizable position in the stock and try to pressure the board," it could happen, says Bud Leedom of Comstock Investment Advisors, who thinks Ridge's acquisition program has been more successful than critics say.

Ridge says he has no idea if a potential acquirer is looking at the company. If negotiations were going on, they would be made public, he says. Would the board accept an offer? "We're here to maximize shareholder value," he says -- the standard corporate response. Officers and board members control only 8.7 percent of the stock -- not enough to ward off a hostile offer. However, one large institution, Capital Research and Management of Los Angeles, owns another 10.2 percent. It could have some say in the matter.

One factor that would inhibit a takeover is that the company is already very profitable, says Allen. There has been severe slippage, but margins are still quite high. For example, back in 1996, the company earned an astounding 46.5 percent on equity, or ownership. That has been cut in half -- but last year's 23.6 percent is still very high by corporate standards.

That may be one reason why the stock is not cheap. It sells for 21.3 times its most recent 12-month earnings and 4.5 times its book value, or the value of its assets. "That's a stiff price," says Allen. "This company has always made amazing returns; it's clearly a pretty profitable company, and that's the rub. Any company paying a premium to buy it is not going to achieve a significant increase in profitability of WD-40. It is not a turnaround situation."

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