- Coca-Cola is being talked about in the press by activist investor David Winters again.
- Winters asserts that a potential buyout of Coke by Warren Buffett would damage shareholders.
- Could Berkshire actually take Coca-Cola private?
Activist investor David Winters is at it again, this time asserting that none other than Warren Buffett may take Coca-Cola private in what would be a bold move, to say the least. You remember Winters from the compensation battle earlier this year, during which he said Coke (NYSE:KO) executives were planning on diluting shareholders by as much as 15% simply to pay employees. He made waves in airing that concern but nothing came of it; is this time different? In this article, we'll take a quick look at Winters' idea that Buffett could take Coke private.
Before we begin, I think the buyout of Coke is a long shot but to be fair, I don't think a lot of people saw Burlington Northern or Heinz coming either. Those were massive acquisitions, albeit much smaller than a proposed Coke buyout. The point stands though that Berkshire's (NYSE:BRK.A), (NYSE:BRK.B) massive cash pile and impeccable fundamentals lends itself perfectly to the leveraged buyout model. And by the way, perhaps the greatest investor that has ever lived is running the place.
So what would be the business case for doing so? Buffett already owns over 9% of the company which means he'd only have to pay for the other 90.9% he doesn't already own. At today's price KO's market cap is almost exactly $180B. Based on Buffett's current ownership, he'd be on the hook for finding a way to buy the $163.6 billion worth of shares he doesn't own.
Of course, no one is going to sell their shares to Buffett for market price so he'd need to pay some sort of premium. The Heinz deal was a 19% premium to the pre-announcement share price and the BNSF deal was a 31.5% premium. If we average the two, which have an admittedly wide gap, we arrive at something like 25%. Factoring the premium in, we are talking about Buffett needing to buy $205 billion worth of KO shares to take it private.
So what would $205 billion get the Oracle? It would get him a business that makes about $9 billion a year and produces something like $8 billion in free cash flow. These are steep metrics as the FCF yield on this deal would be less than 4% and the earnings yield would be around 4.4%. Those are low numbers but given KO's stability and predictable earnings, it could happen.
If, however, we use a more traditional buyout metric, EBITDA, we get a much rosier picture. The past three years have seen KO produce right at $14 billion in EBITDA and at our $205 billion buyout price, Buffett would only be paying ~14.6 times EBITDA for KO. That is a very manageable number for a buyout to happen as many deals are done on companies that have much less stable cash flows (which is virtually every company on the planet) or even lose money. KO is a gem and thus, would command a premium if taken private.
So I think the EBITDA valuation is reasonable but what about financing? Berkshire's $48 billion cash pile, part of its $221 billion in shareholders' equity, is enough to get a deal like taking Coke private going. Berkshire could easily lever up with, say, $20 billion in cash down, financing the remainder with long term debt and perhaps an equity raise if needed. If Berkshire financed the deal at 3.5%, which would be very easy to do in the current environment, it would be on the hook for ~$6.5 billion in annual interest expense. That interest expense would then flow through the income statement and provide a tax shield of about $2 billion based on Berkshire's 2013 tax rate of 30.2%. Thus, in my scenario, Berkshire's after-tax financing cost for $185 billion of debt would be around $4.5 billion, or around half of what Coke earns each year.
Berkshire could swallow Coke itself but it could also find a willing partner. 3G Capital comes to mind as it has the muscle and expertise to help Berkshire take it private. If Buffett didn't need to finance the entire deal himself it would make the buyout that much more enticing. Buffett and 3G are obviously used to working with each other on big deals at this point and the Coke buyout would be the king of all LBOs. But just because it would be beyond massive doesn't mean it's a bad idea. If Buffett wanted to take it on, he could. He's got the expertise to run it, he's got the balance sheet and earnings from his own company to finance it and he's got motive; what's left other than to pull the trigger? He has said publicly repeatedly that he wants to own Coke "forever" so if he really believes that, he could simply buy the whole thing and keep all of the company's FCF for himself rather than a piece of it. It's a long shot, but I really think he could do it if he wanted. We'll see if Winters' alarmist rhetoric actually means something this time.