19 Sep

Elephants Elusive: Should Buffett Seek a Smaller Animal?

WRITTEN BY Mohit Oberoi, CFA
  • In this year’s annual shareholder letter, Berkshire Hathaway (BRK-B) (BRK.B) chairman and CEO Warren Buffett discussed an “elephant-sized acquisition.” The company has been looking at such an acquisition since at least the fourth quarter of 2018.
  • So far, these big deals haven’t materialized. Because Berkshire Hathaway hasn’t been very active in publicly traded securities, its cash reserves have grown significantly.

Warren Buffett

Buffett is known for value investments. Along with acquiring stakes in publicly traded securities, Berkshire Hathaway also has a vast portfolio of fully owned subsidiaries, as well as its insurance business, which generates a lot of float.

In this year’s annual letter, Buffett segregated Berkshire Hathaway into five groves. He identified the non-insurance subsidiaries as the conglomerate’s most valuable grove. Berkshire Hathaway mostly holds a 100% stake in these companies.

Berkshire Hathaway

Historically, Buffett has acquired companies that are strong brands, generate good cash flows, and have low capital requirements. These businesses and Berkshire Hathaway’s insurance operations generate the cash used to acquire other companies and build a portfolio of publicly traded securities.

Currently, Apple (AAPL) is Berkshire Hathaway’s biggest holding in its portfolio of publicly traded securities. Berkshire Hathaway first took a stake in Apple in 2016, which it has gradually increased. However, Berkshire Hathaway sold some Apple shares in Q4 2018.

Earlier this year, Berkshire Hathaway also took a small stake in Amazon (AMZN). However, it wasn’t Buffett but a different investment manager who took the stake in Amazon.

Buffett’s “elephant-sized” aspirations

In this year’s annual letter, Buffett mentioned an “elephant-sized acquisition”—a big company that Berkshire Hathaway can acquire. The last such elephant was Precision Castparts, which Berkshire Hathaway completed in 2016. At that time, Buffett noted that the acquisition wasn’t cheap.

Now, Berkshire Hathaway is looking at its first big acquisition since at least Q4 2018. Buffett alluded to pursuing such a transaction in a February interview with CNBC. So far, Berkshire Hathaway and Buffett haven’t been able to seal such a transaction.

Why elephants have been elusive

In examining why an “elephant-sized” acquisition has been elusive so far for Buffett, these deals take a lot of time to materialize. It’s always possible that Berkshire Hathaway might be pursuing such a deal, and we wouldn’t know about it. Information related to such deals is typically kept secret. Beyond these possibilities, finding the perfect elephant might not be easy even for someone like Warren Buffett.

Value investment

As a value investor, Buffett might not see many opportunities in these markets, which he noted in this year’s annual letter. Plus, Buffett tends to invest in his circle of competence, which narrows the choices for Berkshire Hathaway.

Finally, there is no scarcity of capital today. With interest rates set to go even lower, there’s a lot of easy money in the system—both on the debt and the equity side. In such a scenario, we see too much money chasing too little quality. Also, given the fact that the US economy is still looking strong, there aren’t many distress deals on the market.

What’s the way forward?

As big acquisitions seem to be elusive, Buffett and Berkshire Hathaway might look at alternate ways to deploy the company’s cash. The easy path could be deploying more money into publicly traded securities. However, Buffett might not be too comfortable with stocks at these valuations.

Berkshire Hathaway could look at more Occidental Petroleum–like transactions. In this deal, Buffett committed $10 billion to Occidental in its bid for Anadarko Petroleum. However, Carl Icahn criticized Buffett’s investment.

Buffett indicated that Berkshire Hathaway could look at more deals like Occidental. In our view, such transactions could be the company’s best bet under the current market scenario. The Occidental transaction involved an 8% annual coupon and the opportunity to profit more from the upside in Occidental’s stock price.

To sum it up, elephants have been elusive for Warren Buffett. The legendary investor might look at more Occidental-like transactions. Although not strictly in the elephant family, these transactions still look like a nice animal to have in the current market scenario.

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