Bagging an elephant in 2019: What could it be?


Warren Buffett has been earnestly on the hunt for what he calls an "elephant," the next major corporate acquisition to add to Berkshire Hathaway's empire.

"Even at our ages of 88 and 95 — I'm the young one — that prospect is what causes my heart and Charlie's to beat faster," Buffett said in his latest letter to shareholders, referencing longtime right-hand man Charlie Munger.

There are only so many business behemoths big enough to move the needle at Berkshire, the $500 billion conglomerate that checks in at No. 3 on the Fortune 500 list.

So the potential pachyderm is both much anticipated by Berkshire investors and much-speculated upon by analysts, with Target, Valvoline, 3M, Home Depot, GE, Cummins, Deere, Honeywell and Southwest Airlines among the many names recently bandied about.

At this point, though, no one — most likely not even Buffett himself — knows what the big prize will be or when he'll bag it.

"It's hard to say," said Cathy Seifert, a Buffett watcher with CFRA Research in New York. "What I can say is that I think they would like it to happen in 2019."

One reason Buffett would be so eager to see it soon is that it's already been quite a long time in coming. Buffett's last mega-deal was four years ago — the $32 billion acquisition of metal fabricator Precision Cast parts first announced in August 2015.

In the years since, it's seemed at times that Buffett was pursuing a white whale as much as an elephant. Meanwhile, Berkshire's pile of cash, sitting at $112 billion at year end, and perhaps the chairman's level of frustration, have continued to mount.

Given Buffett's age — he turns 89 in August — it's also always possible that his next major acquisition will be his last at the helm of Berkshire.

Whenever the time to step aside does arrive, Buffett surely doesn't want to saddle his successor with a pile of unproductive cash. But more than that, this could represent one final opportunity for Buffett to put a major stamp on the wildly successful enterprise he's built from the ground up in his hometown. "I think he's thinking how 15 or 20 or 30 years from now Berkshire will be better off because of one of these deals he does," said Patrick Brennan, an Omaha native who owns a California value investment firm and invests in Berkshire. "He's already mentally compounding all the value he will create."

So why has the next elephant proved so elusive? And what are the most likely targets?

When it comes to why, the easiest answer, quite simply, is that the price hasn't been right.

Buffett and Berkshire aren't the only ones out there playing the mergers and acquisitions game. Private equity firms have been attracting huge inflows of capital to deploy on mergers and takeovers, and those equity firms also aren't reluctant to go into debt to make their buys.

"Private equity has $2 trillion in dry powder," said Paul Lountzis, a Pennsylvania investment adviser and longtime Buffett-watcher and investor. "It's unbelievable how much money is out there."

All that capital has in turn driven up prices in the M&A market. So even with his ability to simply write a check on the spot for whatever he wants to buy, Buffett has been unwilling to paywhat he considers excessive prices.

"Prices are sky-high for businesses possessing decent long-term prospects," Buffett himself wrote earlier this year, lamenting that this was a "disappointing reality."

Carter Pearl of Phoenix-based value investment firm Intrinsic Value Partners noted that Berkshire over the years has simply outgrown many of the family-owned businesses Buffett used to like to add to the Berskshire family: think of Omaha's own Nebraska Furniture Mart and Borsheims Fine Jewelry.

"Buffett likes family businesses because of the pride of ownership and their ability to provide generations of future management," said Pearl, who invests in Berkshire. "But there are fewer around of a size that can help Berkshire."

The 10-year bull market also hasn't made Buffett's pursuit any easier.

Buffett has made some of his biggest past plays when the market was dramatically down. The best example is BNSF Railway, acquired in 2010 in the wake of the Great Recession at what Buffett considered a bargain price.

Now all the major stock indexes have recently been at record highs.

"There are not a lot of stock values right now," said James Shanahan, an analyst who watches Berkshire for Edward Jones Co. of St. Louis. "If it becomes a bidding war, Berkshire will never win. That's not their strategy."

To keep the cash pile — largely generated by insurance company reserves or "float" and accumulating at the rate of about $1 billion a month — from growing too large, Berkshire instead has been making some significant buys on the stock market. While not elephants, they could perhaps be likened to hippo-sized acquisitions for Berkshire.

Since 2016, Buffett has made sizable investments in Apple, now one of Berkshire's biggest stock holdings. He's increased his stake in financial stocks, particularly Bank of America. And he's also bought shares in all four of the major U.S. airlines, with particularly large shares in Delta and Southwest.

"Charlie and I believe the companies in which we invested offered excellent value, far exceeding that available in takeover transactions," Buffett wrote in February. "We continue, nevertheless, to hope for an elephant-sized acquisition."

Apparently he's been close to bagging that elephant at least a couple of times.

A deal with a Texas utility in 2017 reportedly blew up when he was outbid by a competitor. And Buffett hinted that one reason his purchase of stocks slowed in the fourth quarter last year was that he was marshaling cash for a possible acquisition, one that also in the end fell through.

"I get the sense there is a fairly high degree of frustration on their part," Seifert said of Buffett and Munger.

But even if Buffett is indeed getting personally frustrated, no one really expects any such feelings to affect his decision-making. He's not going to compromise his standards. And no acquisition is that important.

Buffett underscored that in his 2018 letter to shareholders, in which he said he and Munger "believe it is insane to risk what you have ... in order to obtain what you don't need."

"I'd rather see him sit on a massive pile of cash than buy something that does not turn out to be a great deal," said Brian Gongol, a Des Moines radio host who's an avid Buffett investor and watcher. "I think it would be grand to see his patience rewarded with a fun acquisition."

What Buffett looks for in Berkshire acquisitions is by now well-known: companies where he sees high future returns on equity, a fair price, minimal debt and strong managers who would be comfortable continuing to manage their firm under the Berkshire umbrella.

Any firm targeted also would probably need to be big enough to make a difference in Berkshire's bottom line. Seifert said she expects that the ideal target would be a firm with a market value between $20 billion and $50 billion.

Given such criteria, some analysts and media members have recently come up with lists of what they see as potential Buffett targets.

Bloomberg listed nearly two dozen companies, among them 3M, Boeing, Caterpillar, Cummins, Deere, Delta Airlines, Home Depot, Honeywell, Hormel Foods, O'Reilly Automotive, PepsiCo, PPG Industries, Rockwell Automation and Southwest Airlines.

They are fun to talk about. The Pepsi acquisition would seem an unlikely one given Buffett's well-known love for an ice cold can of Coke and his longtime investment in the beverage industry giant. Indeed, a Pepsi investment, like many others on the list, would require Berkshire to shed stock holdings to avoid conflicts of interest.

Analysts at Credit Suisse came up with their own list of 141 potential targets. They included many on the Bloomberg list but also familiar names like Valvoline, CarMax, Moody's, J.B. Hunt Transport and Snap-On.

Just the mere speculation about Buffett's possible interest can move the market. Last week, Buffett moved quickly to publicly tamp down rumors that Berkshire was about to acquire PG&E, the California gas and power company. PG&E shares were already up 18% based on the rumors.

There has been much speculation based on Buffett's airline stock buys that he could target outright ownership of an airline, with Southwest and Delta most often mentioned. Last year, Buffett said he wouldn't rule out buying an airline in whole.

That was a bit of a shock, considering he once joked that capitalists should have shot down the Wright brothers' first plane to save investors from the industry. But now he thinks airline consolidation has stabilized pricing in an industry he once called "suicidally competitive."

Despite the recent airline stock buys, Seifert said she still doesn't see Berkshire acquiring one. The profit margins at airlines remain well below what Buffett typically expects to see in his acquisitions.

Without naming any names, she sees health care, a recently lagging economic sector, as one where he might see some future value.

"I would not be surprised if they are looking in that space," she said.

Some think that without some significant market volatility, the kind of disruption that Buffett fearlessly thrives in, prospects of the elephant coming along during 2019 are dim.

That might make 2019 another year of additional stock buys, small "bolt-on" acquisitions from his existing operating companies, and perhaps some buyback of Berkshire stock, something Berkshire's board has largely given Buffett and Munger free rein to do if they both feel the market is sufficiently undervaluing Berkshire. While to date their stock repurchases have been negligible, Buffett recently signaled hewas open to buying back as much as $100 billion in Berkshire stock.

But Pearl said he knows this: When the perfect elephant does saunter down the trail, Buffett will be ready.

"One of the greatest attributes of him and other great investors is their patience," Pearl said. "He's talked about having the gun loaded and waiting for the right one. It's totally possible that elephant could come into view."

Berkshire Hathaway Inc. owns the Omaha World-Herald.

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