Conservative billionaires and liberal bugaboos Charles and David Koch are believed to have spent nearly $100 million on the 2012 elections, hoping to deny President Obama a second term. With the president firmly in office today, that investment appears to have been largely lost -- money down the drain.
But did you know the Kochs have just made another investment that could result in even bigger losses?
A roundabout investment in Apple
Earlier this month, The Wall Street Journal reported that Koch Industries, the Wichita, Kan.-based industrial conglomerate owned by the Koch brothers, agreed to pay $7.2 billion to acquire electronics manufacturer Molex (NASDAQ: MOLX).
If you haven't heard of Molex, that's not surprising. While a big company, it mainly operates as a parts supplier to even bigger companies. You've probably heard of Molex's biggest customer -- Apple (NASDAQ:AAPL). Last year, 14% of the revenues Molex took in depended on sales to the Cupertino computing giant. That's more than Molex got from any other single customer, none of which accounted for more than 10% of sales. A bet on Molex, therefore, is at least in part a bet on continued sales success for Apple.
Considering the sellout success of Apple's new iPhone 5s, that may sound like a good bet. But there are at least a few reasons to suspect that the Kochs' latest investment won't work out as planned.
Molex: by the numbers
Let's start with the most obvious objection to Koch Industries' purchase of Molex: the price. Offering $7.2 billion for Molex, the Kochs are agreeing to pay close to two times sales for their new acquisition. That's not a whole lot less than Apple itself costs (2.5 times sales). Yet Molex is a whole lot less profitable an operation than its marquee customer.
Operating profit margins at Molex were just over 10.2% for the past year (and trending lower), versus the 29.5% operating margin that Apple gets on its sales. On a P/E basis, Molex looks quite overpriced -- valued at 28.5 times earnings at today's share price, and nearly 30 times earnings at the price the Kochs have agreed to pay for it. (Apple's P/E -- just 11.6).
Molex: Better numbers coming?
Granted, Molex is working hard to bring up its earnings and bring down its P/E. The company has a stated objective of achieving 14% operating margins at some point in the future. Last quarter, though, its operating margin dipped to 9.4%. And with Apple aiming to lower the prices of some smartphones to compete against cheaper Android wares, it seems to me Molex's margins are more likely to get squeezed further than to expand.
This suggests that analyst expectations of 12% long-term earnings growth at Molex -- already too slow to justify a 30 P/E -- may prove overly optimistic.
Overpriced? No. Way overpriced.
Simply put, the valuation on this acquisition just doesn't work. P/E is only the half of it. Real cash profits at Molex -- free cash flow -- amounted to a meager $120 million over the past 12 months -- less than half of Molex's reported net income. As a result, the price-to-free cash flow valuation on this acquisition is even worse than the P/E makes it appear: The Kochs are paying a staggering 60 times free cash flow for their new prize.
And again, this is for a company expected to grow at only 12%.
When you get right down to it, I think Molex shares were overvalued even before Koch Industries agreed to pay a 30% premium for them. Ultimately, that's a mistake that will cost the Kochs big-time. It will probably necessitate a writedown of their new assets, even bigger than the amount sunk into losing the 2012 electoral contest.
This just goes to prove that the Koch brothers aren't really the "evil geniuses" they're portrayed as in the press. They're fallible investors just like the rest of us, and just as liable to overpaying for their stocks.