Why Hasn't Warren Buffett Bought This Industry Leader?

"Stable, predictable and growing free cash flow per share is the hallmark of a great business." -- Ronald L. Havner, CEO Public Storage.

Last week, the news broke that Berkshire Hathaway (NYSE: BRK-B  ) had acquired a $3.4 billion stake in energy giant ExxonMobil (NYSE: XOM  ) . I am not one to second-guess why Buffett might want to put a tiger in the Berkshire tank, but it got me thinking how self-storage industry leader Public Storage  (NYSE: PSA  ) has avoided being targeted as a Berkshire stock holding -- or even made it onto the long list of companies Berkshire owns outright.

BRK.B Total Return Price Chart

Does Public Storage fit the Buffet strategy?
Fellow Fool Jay Yao pointed out in his article focused on Buffett's recent ExxonMobil purchase that "He likes to buy companies with large moats, competitive advantages, and predictable cash flows that will be around for a long time." He also likes businesses that are easy to understand and have strong management in place continue to run them. How does Public Storage stack up? Rather well, I think. Here are six reasons why:

  1. Self-storage is a business most folks are familiar with, and it's easy to understand.  Public Storage CEO Ron Havner mentioned "the four Ds" in the 2012 Annual Report: "The key reasons people use self-storage remains the same: downsizing, death, divorce and dislocation."
  2. There are only four publicly traded self-storage REITs. I think Public Storage's market cap of about $27 billion makes up part of a moat both wide and fairly deep. The company is more than five times larger than its nearest competitor, Extra Space Storage  (NYSE: EXR  ) . 
  3. Public Storage spends over $15 million per year on Internet websites, call centers, online advertising, and search-engine optimization. This, along with sophisticated pricing models, combine to create a serious technology edge and marketing advantage compared to smaller private operators. Public Storage is also able to leverage its scale in many markets by utilizing television advertising -- an option which would not be cost-effective for most rivals.
  4. The eponymous Public Storage brand name is a huge competitive advantage when it comes to reeling in customers who search for storage space on the Internet. Public Storage is keenly aware of this -- in fact, its legal department recently contacted the Fool to clarify how third parties can use this valuable asset in print.
  5. Public Storage has a "fortress balance sheet" with hardly any debt and the highest investment rating of any real estate company. Traditionally, management has chosen to issue preferred shares at rates that allow acquisitions to be accretive to earnings. This, in turn, contributes to a profit margin over 40% for Public Storage. The self-storage business model of recurring same-store revenue results in predictable cash flow. 
  6. REITs are required to pay out at least 90% of taxable earnings as dividends. Public Storage has a long history of paying a dividend each quarter since 1995. It recently announced its latest 12% dividend increase in October -- that's now a quarterly dividend of $1.40 and a current yield of 3.5%.

Orange icing on the cake
Public Storage is also in the insurance business, a Berkshire Hathaway core competency. It is an ancillary business that brought in $64 million in 2012 from 700,000 of its self-storage customers -- representing aggregate coverage of approximately $1.5 billion.

In addition, Public Storage maintains "customary property, earthquake, general liability" insurance for the combined 179 million square foot portfolio of assets. The company is one of the largest landlords in the world -- not a bad insurance client to acquire!

Is this the highest hurdle?
I believe this could actually be a reason Berkshire Hathaway has not pursued Public Storage. According to the company's 2012 annual report:

At December 31, 2012, B. Wayne Hughes, our former Chairman, and his family, which includes two members of the board of trustees (the "Hughes Family") owned approximately 15.9% of our aggregate outstanding common shares. Our declaration of trust permits the Hughes Family to own up to 35.66% of our outstanding common shares while it generally restricts the ownership by other persons and entities to 3% of our outstanding common shares ... unless a specific exemption is granted by our board of trustees. 

Investor takeaway
Large moat: check. Competitive advantage: check. Predictable cash flows: check. Public Storage seems to have the qualities Warren Buffett values in a business. 

Berkshire Hathaway could acquire 3% of Public Storage without any special trustee approval. I feel the company is currently fairly valued. However, that alone would not deter Buffett, who's known for quipping, "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."

Besides, wouldn't it be a happy problem to have Warren Buffett wanting to sit down to discuss allowing Berkshire Hathaway to own more than a 3% stake in your company? My answer to that question is, "So, Mr. Buffett, let's talk!"

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