Warren Buffett didn’t become the best investor of his generation by overpaying for stocks or the businesses he chooses to buy outright and tuck into his conglomerate Berkshire Hathaway Berkshire Hathaway .
Warren Buffett didn’t become the best investor of his generation by overpaying for stocks or the businesses he chooses to buy outright and tuck into his conglomerate Berkshire Hathaway Berkshire Hathaway. The ‘Oracle of Omaha’s latest deal, a $37.2 billion takeover of aerospace parts manufacturer Precision Castparts Precision Castparts, underscores the point.
After eyeing Precision Castparts for years, Buffett, in recent weeks, swooped in with a bid the company and its shareholders would be unlikely to refuse. Berkshire offered a 21% more than Friday’s closing share price on Friday, an attractive-looking premium. But the offer amounts to a discount to the company’s stock price at the open of 2015 and it gives virtually no premium to Precision Castparts trading price a year-ago.
NEW YORK, NY – JUNE 03: Warren Buffett speaks during the Forbes’ 2015 Philanthropy Summit Awards Dinner on June 3, 2015 in New York City. (Photo by Dimitrios Kambouris/Getty Images)
Buffett appears to have found the price where management can sell to Berkshire, leaving their business in good hands, while also walking away with a satisfying return for investors. And yet, as with many of Buffett’s previous takeovers, the deal may be cut at a price where it quickly adds to the value of Berkshire Hathaway.
Citigroup analysts call Berkshire’s bid “likely good enough,” given a dearth of potential acquirers for Precision Castparts and Buffett’s insistence that he paid a high multiple. Nevertheless, Citigroup calculates Berkshire is paying a price of 15-times expected 2018 earnings for Precision Castparts, an attractive multiple for a business that may see earnings increase by double digit rates as energy end markets stabilize, margins improve and aerospace firms re-accelerate their parts orders. “[T]his looks like a good deal for Berkshire vs. our out-year numbers,” Citigroup writes.
To underscore the point, Buffett may be capturing a nice value as he deploys a big chunk of the over $60 billion in cash that sits on Berkshire’s books. Since Aug. 9 2013, Precision Castparts shares are up just 3%, while the S&P 500 and Berkshire Hathaway are both up over 20%. Were one to simply think of Berkshire as an index fund, Monday’s deal appears to be the perfect formula to bolster out-performance over the long-term.
It also contrasts greatly with Berkshire’s last mega deal, portfolio company Heinz’s $40 billion takeover of Kraft Foods Kraft Foods, a deal FORBES spotlighted as rare example where Buffett was doling out stock instead of cash.
In that deal, Berkshire and Heinz investment partner 3G Capital offered up just $16.50 a share in cash to Kraft Foods investors and a 49% piece of the combined company, called Kraft Heinz. Instead of just proving to be another winning deal for Berkshire Hathaway — as takeovers of BNSF Railways, Lubrizol Lubrizol, MidAmerican Energy, Geicko and Marmon have been in the past — the mega deal it already proving to be a source of recurring value for Kraft Foods investors that held onto their stock.
When investors crunched pro-forma earning numbers and thought over the financial strategy to combining Heinz’s ketchup with Kraft Mac & Cheese, they bid up Kraft shares to a fair value far above Berkshire’s takeover price. The $40 billion bid by Berkshire and 3G was priced at a $67 a share, or a 9% premium, but Kraft closed that day’s trading up over 30% at nearly $90 a share. And since then, the stock has easily trumped the S&P 500′s return.
In early July, Kraft paid out its $16.50 special dividend and after the July 4 long weekend it began trading on Nasdaq as Kraft Heinz at a price of around $73 a share. Since then, shares have climbed to nearly $80, already returning roughly 8% even before 3G has even begun plying its cost-cutting and margin boosting expertise, which has turned the firm into Berkshire’s preferred investment partner. It’s no surprise that some of the savviest value investors have been scooping up Kraft Heinz shares.
Put a different way: Investors selling into the Berkshire-backed takeover of Kraft Foods have already left a sizable chunk of money on the table.
Buffett’s cash takeover bid for Precision Castparts offers no similar way for existing shareholders to try and reap further gains – though they could use cash proceeds to buy Berkshire stock.
It means the current crop of Precision Castparts investors, which include large mutual funds and a number of well regarded hedge funds such as Soroban Capital, Farrallon Capital, Third Point Capital, and Vulcan Value are likely foregoing future proceeds if they quietly accept Buffett’s $235 a share takeover bid.
Article originally posted in Forbes website.