Griffon Corp, a Very Rugged Cockroach

The lowly cockroach has a tough chin. It's survived all kinds of shocks over the years. Jungles gave way to deserts. Flatlands succumbed to urban habitats. Predators came and went over many millennia. Yet there the cockroach stood, undaunted upon its six spindly legs.

Investors could learn a few things from the cockroach.

For one, the cockroach teaches a great lesson in survival. As author Richard Bookstaber points out: "Its defense mechanism is limited to moving away from slight puffs of air, puffs that might signal an approaching predator."

So simple and so crude - yet so very effective. The cockroach is hard to kill and fit for any environment. In markets, we also have cockroaches. One of the types would be the holding company with lots of cash, little debt and a few different businesses in its charge. These things are hard to kill. They have also often done quite well for investors over their long histories, as Berkshire Hathaway (NYSE:BRK.A), ITT (NYSE:ITT), Loews Corp (NYSE:L), Seaboard (AMEX:SEB) and others have shown.

One up-and-comer that has caught my attention is Griffon Corp (NYSE:GFF). The company operates in three different business lines: radars, plastics and garage doors. Let's look at each of these businesses. Then we'll see how we can pick up shares today for a deep discount to the value of the sum of its parts.

"Telephonics" is Griffon's radar and communications business. It makes, for example, weather radar and search radar for military and civilian applications. It also makes air traffic control systems. It has its talons deep in the market, and you can find Griffon systems on all manner of military aircraft - everything from the C-130 Hercules to the AH-64A Apache helicopter. Its biggest customer is the US military. But it also counts Boeing, Lockheed Martin and the like as customers.

It's a good business with a bright future. The trend toward more surveillance of borders, for example, increases demand for Griffon products. Ditto the trend toward more unmanned aircraft. The technology is also adaptable to civilian applications. Griffon has built, for example, 20 air traffic control systems in China over the last 20 years. And there are more requests for proposals out there, including a big one in Hong Kong.

This is the best of the three businesses, in my view, and one that ought to be able to grow in low double digits even in a challenging economic environment. The second business is called Clopay Plastics. This operation makes films and plastics used in diapers and a variety of medical and industrial uses. Procter & Gamble is a big customer, along with Kimberly-Clark, 3M and Johnson & Johnson. Clopay Plastics is a good business - profitable, steady and entrenched.

The last business is Clopay Building Products, which essentially makes garage doors. As you know what's happened to the housing market, I probably don't need to tell you what happened here. This business has been losing money. However, management has done a good job turning this business around. It closed plants. It got rid of the installation business. As a result, it actually eked out an operating profit last quarter.

This brings up why I think this stock is a buy now. Griffon is in the midst of a big turnaround, one that is already taking shape. New management came in last year when Ron Kramer became CEO. He was the president of Wynn Resorts and before that a managing director at investment banking firm Dresdner Kleinwort Wasserstein. He's brought in a new CFO, the former CFO of International Flavor and Fragrances. He also brought in a new accounting guy from Dover Corp. and new tax guy from Citi. The team is loaded with acquisition-related and strategic experience. One of their top priorities is to put Griffon's balance sheet to work.

And they've got a lot to play with here. Griffon has lots of cash to do a deal - $320 million in cash against only $180 million in debt. On the most recent conference call, Kramer says they've passed on a lot of deals. But this is one way this team could create value, by picking up an asset on the cheap in this market.

Until then, the turnaround continues apace. As Kramer pointed out on a recent conference call: "We are confident that each business is now positioned to operate well even if conditions remain challenging. In the year ahead, we believe that each business will generate significant growth and operating profits and continue to generate cash." I believe him, but the stock market doesn't.

On the conference call, Kramer remarked, "It is clear that at least for the moment investors seem to think that Griffon is worth something decidedly less than what we believe the businesses to be worth." The market is still looking backward on Griffon, on the trends of the past four years, as earnings per share fell from $1.65 per share to 39 cents in the fiscal year just ended, Sept. 30, 2009.

At $13.15 a share, Griffon trades for slightly more than its book value of $11.50 per share. For fiscal year 2009, it generated $50 million in free cash flow in what was clearly a transitional year. Nonetheless, the stock goes for only 15 times that depressed free cash flow number. I would estimate a private buyer would pay around $18 per share on a sum-of-the-parts basis, as is. Better results as the turnaround continues will up that number significantly.

Finally, officers and directors, a group of 16 people, own 28% of the stock. They have every incentive to unlock the value that they clearly see. In this highly fragile economy, I'll take the cockroaches of the investment world.

Griffon is a very rugged cockroach.

Chris Mayer
for The Daily Reckoning Australia

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