What Berkshire's 'Elephant Gun' Means To Investors

| About: Berkshire Hathaway (BRK.B)


The next time you feel the ground shake don't worry about an earthquake. The movement is probably just the world reacting to the latest utterance from investing legend Warren Buffett. This isn't unreasonable - for many people, Buffett's next move, tip, or recommendation is in fact more consequential than an earthquake. Countless articles have been penned on the man not to mention enough books to fill a library. The legions of followers could be seen as a result of mass hysteria if the performance of Berkshire Hathaway (BRK.A, BRK.B) weren't so impressive and if his statements weren't so cogent.

Buffett's outlook can be very telling about the markets in general. Yet, the real value of his words and actions is seen in what they can tell us about the future of Class B shares of Berkshire Hathaway. This more affordable option to becoming a Buffett follower means you can enjoy the same share price appreciation as Class A holders but for less. In fact, BRK.B trades at about 1/1500 the price of BRK.A, making it much more affordable. Additionally, there are differences in voting rights and other ownership details between the two shares.

Whether you own Class A shares or Class B shares you'll certainly want to understand what has been affectionately referred to as "Berkshire's Elephant Gun." This "Gun" has come to represent the means by which the company uses its massive cash pile in an ongoing practice of acquiring other companies. This has been a common practice for Buffett over the years and one that has delivered value for shareholders. Some of the biggest acquisitions have occurred within the last ten years. These include a 2008 $3 billion purchase of preferred shares of the Dow Chemical Company (DOW). In 2011 BRK purchased $9 billion worth of Lubrizol Corp (LZ), valuing the company at approximately 13 times their 2010 earnings.

Buying Into H.J. Heinz

Most recently, Buffett's "elephant gun" has been aimed at an acquisition of H.J. Heinz (HNZ). In a joint venture with 3G Capital, both companies put forward $4 billion in cash with Buffett spending an additional $8 billion for preferred shares. In mid February of this year The New York Times reported Buffett as saying, "It is our kind of company." The writer goes on to explain, "it fits comfortably alongside companies that Berkshire already owns, including the Dairy Queen chain. This shows Berkshire's continued dedication to not only expanding the company, but to doing so in a way that remains true to the spirit of Berkshire and the fundamentals and values of Buffett. But Berkshire and 3G are paying a healthy price for Heinz. Under the terms of the deal, they will pay $72.50 a share, 20 percent higher than the stock's closing price on Wednesday and 19 percent higher than its record high. Including debt, the transaction is worth $28 billion."

The premium paid for the stock indicates the potential Buffett sees in the company's long-term value. Clearly, Buffett sees Heinz as a valuable investment for the long term, even at a 20% premium.

What's more interesting is the reach H.J. Heinz has in their business dealings. Some may be surprised to learn that up to two thirds of their annual sales come from international markets and more than 20% of this is represented by emerging markets. This composition of sales is by design. The Wall Street Journal has reported, "the food company has been increasing its overseas footprint in recent years through acquisitions, including that of Foodstar, a Chinese soy-sauce maker. Heinz in 2011 also took an 80% stake in the Brazilian company that makes Quero brand condiments, sharply increasing the company's Latin American sales." This heavy international exposure and focus on growth is likely a big factor in the decision to buy. However, 3G is expected to have the greatest influence over the management of the company now that the trade is complete, not Hathaway. It is not yet clear what this will mean for the Heinz business. In recent years the company has remained competitive with aggressive cost cutting and fostering a culture of frugality.

Overall, this deal shows the keen ability Buffett has to finding worthwhile deals, of which others may not be aware. Time and time again, Buffett and his company have done this with great success, and this bodes well for the company's future, especially as it relates to additional acquisitions and expansion.

Influence Of 3G Capital

Unlike Berkshire Hathaway's history of leaving management and corporate culture intact after an acquisition, 3G is expected to make significant changes. While it has been agreed upon that Heinz will remain rooted in its home of Pittsburgh, the management could very well change in the future and some jobs might be lost as seen by William Johnson's movement out of his CEO position. Taking his place will be Bernardo Hees from 3G and CEO of Burger King (BKW).

In the short-term, as Moody's analyst Brian Weddington puts it, "the focus will be applying its expertise in extracting major cost efficiencies to try to quickly improve Heinz's operating margins and generate stronger cash flow." In analyzing the impact on Berkshire Hathaway investors should pay close attention to the impact of 3G given their expected heavy influence in the ongoing business. In September of 2012 3G Capital entered into an agreement to acquire the stock of Burger King for $24.00 a share ($4.0 billion) while assuming the company's outstanding debt. Since this announcement Burger King stock has risen by over 38%. This is a promising track history for 3G Capital. The share price appreciation speaks volumes on not only the ability of 3G Capital to express value from their acquisitions but to make wise decisions on whom they acquire.

In the days following the landmark deal to acquire Heinz, Buffett explained that he had a file on Heinz going back as far as 1980. This is not a mere anecdote but rather an important clue on the due diligence of Buffett in his slow and deliberate pursuit of valuable companies. One can only imagine and eagerly anticipate learning what other files reside in the Bard's desk and what new value they'll unlock for investors.

In the end, this deal will provide additional profitability and growth to Berkshire, and it also shows investors that Buffett is never satisfied, and is always looking for a new deal. Additionally, it shows that Buffett always has something up his sleeve, giving investors another reason to be excited for the future.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: This article was written by an analyst at Catalyst Investments. Catalyst Investments is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. This information is not investment advice or a recommendation or solicitation to buy or sell any securities. Catalyst Investments does not purport to tell or suggest which investment securities readers should buy or sell. Readers should conduct their own research and due diligence and obtain professional advice before making investment decision. Catalyst Investments or anyone associated with Catalyst Investments will not be liable for any loss or damage caused by information obtained in our materials. Readers are solely responsible for their own investment decisions. Investing involves risk, including the loss of principal.

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