August 10, 2015, 00:38 / Business

Warren Buffett prepares for biggest takeover

For Precision Castparts, a supplier to Boeing and Airbus, he can pay more than $30 billion Tatyana Bochkareva

Buffett believes that for the company's reliability it is worth constantly having a $20 billion cash pot, and he is ready to spend the rest / Mary Altaffer / AP

Buffett's company may announce the takeover of Precision Castparts as early as this week, WSJ and Bloomberg report, citing sources. At the close of trading on Friday, Precision Castparts' capitalization was $26.7 billion, which means that, taking into account the premium, the transaction amount will exceed $30 billion.

Over three years, Berkshire increased cash from $40.7 billion to $66.6 billion (as of June 30). Buffett believes that to ensure the reliability of the company, it is worth constantly having a $20 billion cash pot, and he is ready to spend the rest. In a 2011 letter to investors when he was going hunting, he said, “Our elephant gun is reloaded and I can’t wait to pull the trigger.”

Buffett has avoided airline stocks, having been burned by USAir Group preferred stock in 1989 when he had to write off $358 million. Berkshire owns the airline NetJets, but its recent results have not been stellar.

Precision Castparts, founded in 1949, produces components (fasteners, turbine blades, etc.) for Airbus, Boeing, General Electric and Rolls-Royce, as well as equipment for power plants and the oil and gas industry.

“Buying Precision Castparts is a classic Buffett scenario,” Wedgewood Partners managing director David Rolfe told Bloomberg. “He is choosing a unique business in an industry that has potential for consolidation.” Precision Castparts has the qualities that Buffett loves, Rolph continues: with a high barrier to entry that makes it difficult for competitors to reach, it is a business that is only interesting for the long term, with stocks that underperform the market.

Face off against Buffett

Buffett's bet with hedge funds has been going on for eight years now. So far, Buffett is in the lead: his chosen S&P 500 index fund generated 63.5% more income than the Protege Partners hedge fund. “The hedge fund managers have done a very good job,” Buffett said at a Berkshire shareholder meeting in May: with a $1 billion portfolio, an investor would have to pay $20 million “just to have the managers come to the office.” Recently, activist investor Bill Ackman decided to compete with the guru. His Pershing Square fund invested $5.5 billion (7.5% of capital) in cookie maker Mondelez International. Ackman believes Mondelez must either grow revenues faster and cut costs, or agree to be acquired by a competitor. Experts consider Kraft Heinz, a stake in which Berkshire owns and which is also actively cutting costs, to be the most likely buyer.

Precision Castparts shares are down 29% since June 2014. Over the past five years, its stock has gained 65.4%, compared with a 94.9% gain for the S&P 500. For the fiscal year ended March 29, Precision Castparts earned $2.6 billion in profit on sales of $10 billion. Of that, 70% accounted for the aerospace sector, 17% - for the energy sector.

Analysts have criticized Precision Castparts for its lack of transparency, and it has recently begun reporting financial guidance. After reporting in June that despite a slowdown in the energy sector due to falling oil prices, its margins were rising, its shares rose, although its quarterly profit was worse than expected.

“Forget about quarterly numbers, this is a decades-long business,” Rolfe says. “They have very long relationships with some of their customers, and people don't go to a random supplier for slightly cheaper jet engine parts.”

The acquisition of Precision Castparts will be a record-breaking one not only for Berkshire, but also for the US aerospace sector. Demand for planes is growing, with Boeing and Airbus having a combined order book of 10,000 planes, and the sector has seen an acquisition boom in recent years. Under the leadership of Mark Doungan alone, who became CEO of Precision Castparts in 2002, the company has spent $9 billion on acquisitions and is preparing to spend another $5 billion.

Aerospace companies and their related companies are forced to consolidate - shareholders are demanding that they cut costs. In June, Alcoa closed a deal to buy major titanium supplier RTI International Metals for $1.5 billion, and in April Transdigm Group paid $336 million for plastic components maker Pexco Aerospace. Boeing and Airbus are also pressing suppliers to cut costs and invest in production capacity, hurting their profits. "There is concern that the sector is not the safe haven that many investors are hoping for," said RBS analyst Rob Stallard.

Berkshire began investing in Precision Castparts back in 2012. With 3% of the capital, which was worth $814 million as of March 30, Buffett's company was the largest shareholder.

Minority stakes in Berkshire are typically held by managers Todd Comes and Ted Weschler, whom Buffett hired in 2011-2012. and who are expected to be responsible for the holding's investments after his resignation. They now have $18 billion in shares under management, and Berkshire's entire investment portfolio is $117 billion.

Although Berkshire has managed to "shoot the elephant" in recent years (see table), Buffett has repeatedly complained that finding a worthy acquisition target is not so easy. In 2014, Berkshire bought 31 companies, spending $7.8 billion. The largest of these was the purchase of battery maker Duracell from Procter & Gamble (P&G) in November 2014. In a deal that was valued at $4.7 billion, Berkshire paid with her P&G shares. Comes prepared this takeover.

Neither Berkshire nor Precision Castparts are commenting on the upcoming acquisition.

On Friday, Berkshire reported that its second-quarter net income fell 37% to $4 billion. Operating profit was about 20% below the consensus forecast of analysts surveyed by Bloomberg. Berkshire is a $354 billion conglomerate with insurance, railroad, utility, industrial and consumer goods companies. Its core is the insurance business, the premiums of which Buffett invests in various companies. In the second quarter, the insurance business posted a $38 million loss compared to a $411 million profit a year earlier.

Berkshire's investment portfolio increased from $115.5 billion to $117.7 billion during the quarter. Buffett's holding is the largest shareholder of Coca-Cola and Wells Fargo.

Information used WSJ, FT