Buffett Buys What He Knows
One trademark of Warren Buffett's investing style is that he only buys businesses that are simple and that he truly understands. In terms of private companies, Berkshire's holdings are focused in a few areas: insurance, retail operations, railroads, construction, and chemicals. Some notable companies owned by Berkshire include GEICO, General Re, Dairy Queen, See's Candies, Acme Brick, and Benjamin Moore. Berkshire's two most recent massive acquisitions were railroad operator Burlington Northern Santa Fe and specialty chemical producer Lubrizol. Waste Management (WM) meets this criteria as the waste removal business is simple and easy to understand.
Brands and Moats
Buffett often says that he likes to buy high quality brands and companies with wide competitive moats. Evidence of what Buffett likes to buy can be seen by looking at his five largest stock holdings: Coca Cola (KO), Wells Fargo (WFC), IBM (IBM), American Express (AXP), and Proctor & Gamble (PG). All of these companies, with the exception of AXP are industry leaders. Visa (V), is the a bigger player in the credit card business than AXP and Berkshire does own a small stake in V. Waste Management is the clear market leader in the trash industry. Additionally, Waste Management has a solid moat around its business as it is very difficult for new companies to enter the industry for a variety of reasons. Notably, high fixed costs for machinery and the fact that without scale, it is nearly impossible to compete in the trash removal business. Waste Management's leading competitor, Republic Services Inc (RSG) would also make sense as a Berkshire takeover candidate but Waste Management's position as market leader makes it a more likely candidate for Berkshire.
Price & Valuation
Currently, Waste Management trades at 18 times trailing earnings and 14 times forward earnings. Based on these numbers, it is difficult to argue that Waste Management is "cheap", but Buffett does not necessarily seek out "cheap" investments. Buffett has famously said:
It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.
In terms of the value of the deal, currently Waste Management's equity value is $15.8 billion and the company has debt of $10 billion. So, given a reasonable premium, the total cost of the deal for Berkshire would be close to $30 billion. Buffett has said that he is looking for a deal between $20 billion & $30 billion so Waste Management is a perfect sized target.
Given its simple and easy to understand business, competitive advantage, market leading position, and price Waste Management is a good fit for Berkshire and a possible target for Buffett. However, my speculation that Waste Management could be takeover target for Berkshire is not the only reason I am long the stock. I initially turned bullish on Waste Management in a piece entitled 3 Reasons To Consider Going Long Waste Management.