Did Berkshire Hathaway pay too much when they agreed to pay $37.2 billion for aerospace parts manufacturer Precision Castparts?
That seems to be the Wall Street consensus based on the way the stock price has sagged a bit. Analysts slammed the deal, proclaiming that unlike the 2009 takeover of BNSF Railway this is a case of buying at the top of the market, not the bottom.
While Warren Buffett doesn’t believe he is paying too much, after all, he’s buying a company Berkshire plans to still own in a hundred years, he has acknowledged, “This is a very high multiple for us to pay.”
Not So Fast
While almost everyone thinks the price is too high, Georg H. Krijgh of the G.H. Krijgh Guardian Fund, a private partnership based in the Netherlands, thinks it is way too low, and that Buffett has pulled a fast one again.
In a letter to Precision Castparts’ Board of Directors he states:
“Precision Castparts is the largest investment of our fund. We believe that the true value of the company is far in excess of the USD 235 per share offer by Berkshire Hathaway. In our view:
1. An independent Precision Castparts is worth at least USD 40 billion.
2. Berkshire Hathaway is not paying an appropriate premium.
3. Accepting the USD 235 per share offer is not in line with the fiduciary duty of the Board of Directors.
4. We will vote against the proposed sale.
We believe that the PCC Board of Directors is leaving significant value on the table.
We expect earnings of USD 2 billion
First, Mr. Buffett is telling the media that the multiple is high. This might be true based on 2015 earnings but it is incorrect when using future expected earnings and free cash flow. Current earnings are temporarily under pressure due to lower volumes in energy markets. PCC’s aerospace business is much less cyclical than widely believed and the ramp-up of several programs such as the Boeing 737 MAX, A320neo and the H-class turbines is likely to significantly increase earnings per share in the next few years even when energy markets remain weak. Mr. Donegan confirmed this in several recent earnings calls. We believe that free cash flow will grow to USD 2 billion annually.
Multiple of at least 20 times
Second, PCC deserves a high multiple because it has a tremendously strong market position, which is clearly visible by the continuously high return on equity. It is the low-cost and often sole-source provider of mission critical components in a secular growth market, a leader in metallurgical technology, owner of intellectual property and strategic assets such as TIMET and has a strong balance sheet. Especially in these times of low interest rates, PCC deserves a multiple above 20 times earnings. PCC is worth at least USD 40 billion.”
More From Krigh
“Berkshire Hathaway is offering a normal multiple on depressed earnings. Mr. Buffett, whom we greatly respect, and his team have a reputation of finding companies that are not aware of their true fair value. A case in point is Berkshire Hathaway’s takeover of Burlington Northern in 2009. He bought the railroad just before the economy and earnings rebounded. In 2009, shareholders may have been distracted by the credit crisis. Currently, there is no reason to sell for a low price in a hurry. The quoted 21% premium is based on a short-term dip in the share price. For many days during the past year the share price was trading above USD 220, a 6% discount to the offer price.”
Is There Really A Premium?
Krigh cites Precision Castparts’ own stock repurchases to question whether Berkshire is even paying a premium for the stock at all in light of the stock’s 52-week high of $249.12 being above Berkshire’s offer of $235 per share.
“During the past two years, the Board of Directors approved and executed share repurchases at prices around Berkshire Hathaway’s offer price. A significant part of the buybacks seems to have occurred at an average price above USD 230. It is puzzling why you are willing to buy Precision Castparts shares at this price and at the same time sell full control of the business at the same price. In addition, in 2014 and 2015, Berkshire Hathaway bought additional shares of PCC for a price between USD 200 and USD 240. You are aware that they are intelligent investors and only buy when the intrinsic value is significantly higher than the price. This confirms the fact that the USD 235 per share offer is too low.”
So, is Berkshire paying too much or too little? Only time will tell, but when you plan to own something a hundred years or two, it will probably look like quite a bargain at some point.
For Berkshire shareholders alive today, here’s hoping that the bargain is now.
© 2015 David Mazor
Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.