What Will Buffett Buy Next?

The recent acquisition of Lubrizol (NYSE: LZ  ) by Berkshire Hathaway (NYSE: BRK-B  ) (NYSE: BRK-A  ) is classic Buffett: For $9 billion, Buffett is buying a wide-moat player with proven management at a reasonable, though not terrific, price (under 18 times free cash flow).

But Buffett's multibillion-dollar "elephant gun" is far from empty, so where will he strike next?

History paints us a picture
Before Lubrizol and Burlington Northern, there was the $1 billion acquisition of paint company Benjamin Moore way back in 2000. I bring this up because Sherwin-Williams (NYSE: SHW  ) today exhibits many of the same characteristics that made Lubrizol (and presumably Benjamin Moore) so attractive.

For one, Sherwin-Williams' return on invested capital is nearly identical to Lubrizol's -- 20.42% versus Lubrizol's 20.93%. ROIC is an important measure to Buffett since a higher number can be indicative of a firm with a durable competitive advantage. As Buffett told Fortune back in 1999:

The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.

I think it is safe to say that society will keep on painting homes regardless of whether Apple's iPad 2 or Research In Motion's PlayBook becomes the next big thing, and it's likely Sherwin-Williams will lead the way. Sherwin-Williams' market share is estimated to be around 30% domestically, bolstered by a network of nearly 3,400 company-owned stores along with strong brands such as Krylon and Thompson's WaterSeal.

Sherwin-Williams also has the kind of proven management that Buffett prefers, with CEO and Chairman Christopher M. Connor having been with the company for more than a quarter of a century. Under Connor's leadership, the company increased its dividend by more than 10% annually compounded from 2001 to 2010 -- far better than Lubrizol's 3.3% annualized dividend growth over the same period.

Sherwin-Williams is the right size as well. The company's $8.8 billion market capitalization is in the same ballpark as the Lubrizol acquisition. And valuation-wise, a $10 billion bid for the company would imply a multiple of 17.21 times free cash flow, about equal to the 17.54 times free cash flow Buffett paid for Lubrizol. Any synergies with Benjamin Moore would only sweeten the deal.

All in all, a Sherwin-Williams acquisition would paint a pretty picture for Berkshire shareholders.

A pretty package
Had a Pepsi recently? Or made a sandwich with Hormel or Tyson meat tucked between two slices of Sara Lee? If so, you may have used one or more Bemis (NYSE: BMS  ) products. Bemis provides much of the packaging and shrink-wrap you see on your supermarket shelf every day, including products for the major companies mentioned above.

Bemis, like Lubrizol, is one of those obscure companies that make a product you use in your everyday life but don't realize it. The company retails for $3.5 billion, so a bid from Buffett at say $4 billion would imply a valuation of only 15.69 times free cash flow -- less than Lubrizol or even the (hypothetical) Sherman-Williams acquisition.

Bemis, however, deserves a lower multiple than the others because the company's ROIC is surprisingly low at 6.59%. Not terrible, but competition from Sealed Air (NYSE: SEE  ) and Sonoco (NYSE: SON  ) enacts a toll. On the plus side, revenue has still managed to more than double since 2001.

The company has also increased its dividend for more than 25 consecutive years, while CEO Henry Theisen has been with the company for more than 30 years. Although with its market capitalization of $3.5 billion, Bemis seems a little small given Buffett's preferred size of $5 billion to $20 billion.

In the master's shoes
Regardless of what Buffett acquires next, one thing is clear: It won't be because he read this column! Buffett has always been his own man, and it's an honor to just try and keep up with him. Still, if I'm right I'm holding a party!

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Fool contributor Chris Baines wishes to meet Warren Buffett. Chris owns shares of Berkshire Hathaway. He actively participates in CAPS as cbaines2. Berkshire Hathaway is a Motley Fool Inside Value recommendation. Apple, Berkshire Hathaway, and Sherwin-Williams are Motley Fool Stock Advisor picks. PepsiCo and Sonoco Products are Motley Fool Income Investor choices. The Fool has written puts on Apple. Motley Fool Options has recommended a bull call spread position on Apple. Motley Fool Options has recommended a diagonal call position on PepsiCo. The Fool owns shares of Apple, Berkshire Hathaway, and PepsiCo. 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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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 26, 2011, at 3:13 PM, JBenzer wrote:

    I don't see where B/H's buy out of SHW would be any advantage to SHW's shareholders. The company has done great on its own for years. Even at 100.00 a share it would be no big deal for the shareholders.

  • Report this Comment On March 26, 2011, at 4:42 PM, cbaines2 wrote:

    You're probably right, but it's hard for management to resist a buyout offer at a substantial premium to market.

    Thanks for reading,

    Chris Baines

  • Report this Comment On March 27, 2011, at 3:36 PM, tshk1221 wrote:

    As a small BRK-B owner, I hope Buffett will buy more of KO now and increase its stake in KO for the fair market value of one share of KO based on 10-year NPV (P/E of 13 =7.7% capitalization rate compounded with the 5-year average EPS increase rate of 20% and with each period discounted with the estimated 10-year treasury yield of 5%) far exceeds the current selling price of $65. PV (not FV) of one share of KO after 10 years is estimated to reach around $280 - $290. $280 translates into an estimated annual compounding yield of 16% from $65.

    *(I used $1 calculator to come with the numbers. There could be some small mistakes. But, let's remember billionaires tend to use extremely cheap and simple calculating devices.)

    Buffett definitely will not be satisfield with only 16%. However, The 16% from KO for the next 10 years will be rock solid, trustworthy and surely guaranteed.

    No blue chip companies are coming up with 5-year average EPS increase rate of 20% now. KO has the capacity to maintain the 20% over the next 10 years.

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