No due diligence, no advisors, no fees, no frills. That is how Berkshire Hathaway does acquisitions, and that's how it should be done as well. Of course, the due diligence part can remain a bit distinct. I like, however, the idea of not having any outside professional help; what do they do anyway other than making money for themselves? Berkshire has been an exception in an otherwise sticky framework for acquisitions. With its Chairman & CEO and Vice Chairman, it remains grounded on most of its business decisions. Warren Buffett and Charlie Munger can be as rational as we can expect in a corporate executive or a businessman. It is never that easy, but those men make it simple. Just look into eyes before dealing with people. It can't get better than that. One of the finest run firms in the world of business, Berkshire announced acquisition of Precision Castparts for $37 b including debt in August 2015 at a price of $235 per share in cash. Its has 137.59 m shares outstanding.
Interestingly, when it was announced the stock price of Precision jumped nearly 20%. So is this deal good for shareholders of both Precision and Berkshire? Precision managers consider that their stock is cheap at the price of $222.64, for that's what they paid when they bought back 7.21 m shares during the year that ended in March 2015. Later, they accepted the offer for the entire company at a premium of just over 5%. It appears that Berkshire got the better of Precision shareholders, unless, $222.64 a share was not cheap in terms of its intrinsic value, which then would mean their managers wasted $1.6 b in an expensive buyback. Knowing Berkshire's history, I am not surprised that they got a better deal; note that the price is 21 times its 2015 earnings. Precision's past performance and future prospects should tell us how good the deal is.
Precision's share price was as high as $275.09 in 2015 and as low as $47.08 in 2009. From its high market value of equity of $18 b in 2009, it has come a long way. Its revenues grew by 12.77% annually over the last five years; operating earnings increased by 12.86%, net earnings by 10.67% and earnings per share by 11.19%.
It did not have a particularly good year in 2015 though. $10 b revenues were not enough to show a good performance.
Precision's growth has come mainly through acquisitions. In the last eight years, it spent $9.78 b in acquiring other businesses, and recorded a goodwill of $6.67 b as of March 2015. Its net reinvestment in the business during that period was $13.13 b. Because of this, it never paid large dividends, and its free cash flows are not that robust. Surely, both its managers and Berkshire must consider Precision as more of a growth company.
Its return on equity (13.44% in 2015) and after-tax return on capital (11.96%) have been declining over the years. This is because its capital efficiency has come down significantly, requiring larger reinvestment for generating revenues. Perhaps, managers and Berkshire must consider that results of reinvestment would show up in the future years.
Debt of $4.58 b is not too much compared to the market value of its equity, which was mainly raised for the purpose of a large acquisition in 2013. It also has a small amount of lease debt. As in any manufacturing company, a good amount of capital is tied up in working capital requirements. I reckon, there might be some discrepancy between discount rate and expected return assumptions used in its pension liabilities.
If Precision were to grow at 12% annually in the next five years, and then slow down a bit to become a mature business by its eleventh year; if it were to become efficient in capital utilization (i.e. lower reinvestment to bring revenues), say, as it was in 2009; if its return on capital were to reach 20% during its stable growth period; if its operating margins do not deteriorate anytime; then the value of the firm would be a function of expected rate return of the investor.
As you can see, I have not used conservative assumptions regarding growth rate and reinvestment. Nevertheless, I am not going to argue with Berkshire on its acquisition price. Precision, surely, appears to be a good business to keep for Berkshire. As much as it has grown in size and as much as its free cash available for use, Berkshire cannot continue to buy common stocks from open market and make any meaningful contribution to its value. It has been correctly pursuing an acquisition policy that suits its size and cash flows.
No comments:
Post a Comment