Elephant Hunting: 4 Companies Berkshire Could Buy

Warren Buffett is looking to make a deal. A big deal. In his recent annual letter to Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) shareholders, the Oracle wrote:           

We will need both good performance from our current businesses and more major acquisitions. We're prepared. Our elephant gun has been reloaded, and my trigger finger is itchy.

My colleague Morgan Housel says that with the $20 billion to $30 billion of unencumbered cash Berkshire has on hand to make an acquisition, "Berkshire buys something huge in China, another U.S. utility company, or another conglomerate like Marmon Holdings." I think Morgan is likely right, though I think there are other options on the table. In an interview with CNBC's Becky Quick, Buffett gave some hints as to what he's looking for:

  • It's easier for Berkshire to buy privately owned businesses than ones trading on the market. A 20% premium to market price is something he doesn't want to pay, with very few exceptions.
  • An acquisition is more likely to be in the United States than any other place, though they haven't bought their last international company.
  • He would prefer to buy an entire company in contrast to having a minority stake.

In addition to those criteria, I'll add a few more based on Buffett's investing style and prior transactions:

  • He'll be looking for a durable franchise that will be as strong (or stronger) 20 years from now as it is today.
  • Buffett will want a business with pricing power. These are companies that can raise prices without driving customers to the competition.
  • He covets superb management that will continue to run the business without hand-holding from Omaha.           

And the winners are ...
I think two compelling elephant-size acquisition candidates are cereal makers General Mills (NYSE: GIS  ) and Kellogg (NYSE: K  ) . These are wide-moat businesses with the strong brands that appeal to Buffett. We can count on Cheerios, Corn Flakes, and Rice Krispies sticking around for a long time. We also know from Berkshire's 1988 annual letter that Buffett likes the pricing power in the cereal industry:              

Take the breakfast cereal industry, whose return on invested capital is more than double that of the auto insurance industry (which is why companies like Kellogg and General Mills sell at five times book value and most large insurers sell close to book). The cereal companies regularly impose price increases, few of them related to a significant jump in their costs. Yet not a peep is heard from consumers.

General Mills and Kellogg have enterprise values of $30 billion and $25 billion, respectively, which puts them right in the sweet spot for Buffett's elephant hunting. The major hang-up would most likely be price. Both stocks are trading near 10 times EV/EBITDA and I doubt Buffett would want to pay an acquisition premium in excess of that amount, even for superb businesses like these.

Another candidate in the food industry is H.J. Heinz (NYSE: HNZ  ) . For a lot of ketchup consumers, there is basically Heinz and nothing else. The company has a dominant brand, earns high returns on capital, and with an enterprise value of $20 billion is the right size to move the needle for Berkshire. Unfortunately, as with the cereal makers, Heinz may be another instance of a superb company that would command too high of a price. Like General Mills and Kellogg, Heinz is trading at a rich 10-times EV/EBITDA multiple.           

While Buffett has stated his preference to buy entire companies, Berkshire does take large minority stakes in publicly traded companies. Outside of the food industry, Berkshire's multibillion-dollar positions in health-care stalwarts Johnson & Johnson and sanofi-aventis catch my eye. Another blue-chip stock in that space that's looking attractive right now is Abbott Laboratories (NYSE: ABT  ) .

Abbott Labs is a cream-of-the-crop health-care company with diverse business segments, including pharmaceuticals, medical devices, and a nutritional business. Abbott's stock is trading at just 10 times its 2011 earnings guidance, so the price could be right for Berkshire to put a couple billion dollars to work. The only drawback is that with an enterprise value of $88 billion, Abbott is too big for Berkshire to absorb.

Foolish final thoughts
I think all four of these companies have the potential to be attractive investments for Berkshire Hathaway if the stars were to come into the right alignment. The quality of the businesses is indisputable and the sticking point would be price. The highest caliber businesses are rarely cheap, especially for a discriminating investor like Buffett.

Click here for a free report containing three more stocks Buffett wishes he could buy.

Charly does not own shares of any company mentioned in this article. Berkshire Hathaway and Johnson & Johnson are Motley Fool Inside Value selections. Berkshire Hathaway is a Motley Fool Stock Advisor selection. HJ Heinz, Johnson & Johnson, and Kellogg are Motley Fool Income Investor recommendations. Motley Fool Options has recommended a diagonal call position on Johnson & Johnson. The Fool owns shares of Abbott Laboratories, Berkshire Hathaway, and Johnson & Johnson. Motley Fool Alpha owns shares of Abbott Laboratories and Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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  • Report this Comment On March 08, 2011, at 9:58 PM, MegaEurope wrote:

    Those are some good guesses.

    Other ideas: Colgate Palmolive, Kimberly-Clark, Whirlpool, Archers Daniel Midland, RWE?

    I think the most likely thing is that Buffett doesn't find another big acquisition for a while.

  • Report this Comment On March 08, 2011, at 10:49 PM, buffalonate wrote:

    If he wants value he should go after Fifth Third Bank or Sun Trust Bank. Both are big enough to be worth his time and even if he pays a 20% premium he would still be paying a historically low price for the bank. He could buy both of them if he wanted to. He will probably just keep accumulating shares in whatever he likes for awhile before he makes an offer so he doesn't have to pay such a premium.

  • Report this Comment On March 09, 2011, at 7:06 AM, Chuck2323 wrote:

    What is the purpose of an ever expanding empire? Is it an ego thing to see how many companies one can own before they die. Maybe Buffett should give those billions to the shareholders as a one time dividend.

  • Report this Comment On March 09, 2011, at 11:53 AM, Apacheman15 wrote:

    Chuck2323, I would rather that Buffett ( arguably the greatest investor of all time) put the cash to work than give it to investors of Berkshire. Buffett is patient. He may not make an aquisition this week, this month, or even this year. The odds (based on his history) are that when he deploys the cash, it will create significant wealth to shareholders. Investors of Berkshire aren't looking for dividends or they would have bought into a high yielding stock like Verizon.

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