POST OF THE DAY
Berkshire Hathaway
Acquisitions

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By EliasFardo
August 14, 2001

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Acquisitions will not be had on the cheap. You are not going to buy decent companies, in any industry, that will show immediate, huge income yields. Think about it. You own a company that is providing a predictable, sustainable, free cash flow of $10 million a year. What would you sell it for? If a potential buyer explained that "we have this internal capital return hurdle rate of 15%, so the most I can offer is $66 million," you would laugh at him. Imagine yourself as the buyer. Maybe you offer $100 million. That is only a 10% return to you. In today's equity market, such a company could easily be selling for a cap of $200 million. That is 20 times free cash flow, with only a 5% return to the buyer. I believe I would be a hero if I could purchase such a company for only $100 million. But if so, would I be reading about how poorly I had done to only invest the shareholders' cash at 10%? On this board I may be. Nobody is going to sell to anyone a wonderful company at a purchase price that yields 15 to 20 percent to the buyer.

I am not sure that the carpet business and building products businesses will provide $900 million pretax, or $600 million after tax. But if they did, on a $5.5 billion purchase price, that is a return of 11%. How many companies can you purchase that have both a predictable and sustainable earnings stream that passes Buffett's own requirements, and sell for a price that includes a reasonable margin of safety, which is somewhere around 9 times earnings? Not many. So when we find some, rejoice. And, when they start showing earnings that show some validation that they may be a successful as we hoped, rejoice again.

I have been involved in making acquisitions. It is hard, difficult, troubling, confusing, disillusioning, disappointing work. It is not easy at all. It is one of the most difficult, and one of the most risky things a company can do. Do not make the mistake of underestimating how hard it is to do a successful acquisition. Just read about troubled companies in the Wall Street Journal, looking for acquisitions gone bad behind the problem. You will not need to look very far or very long. (Hint - Gillette )

Another poster on this board (who will remain nameless to protect his reputation from association with me) and I have been engaged in a Top Secret private conversation, where we have entertained the following possibility. This is just speculation on our part, but here is how it goes.

The stars are lining up for Berkshire. Three things need to happen.

1) Buffett continues on his acquisitions streak. $500 million here. $800 million there. $2 billion every once in awhile. Cash, bonds and ( yes ) equities are sold to finance these deals. They will have no sex appeal. They will consist of businesses so ugly, that they make carpet manufacturing look glamorous. I am still holding out for an aggregates producer. Some day; in 1 year, 2 years, 3 years, I don't know when, but some day thousands of people, all over the country, will simultaneously say, "That guy Buffett has put together a pretty profitable group of non financial businesses. What did they have; $40 billion in sales last year?"

2) Buffett will continue to do what he wants to do with the insurance group. It may not fit anyone's fixed ideas about what an insurance company should look like, but he doesn't care. It may not be growing much. It may not be producing much new float. But it will be making a ton of money. And some day, all your friends and neighbors will yell at you as you pick up the morning paper, "That guy Buffett has got himself a pretty little insurance company there doesn't he? I wish I had bought some of that stock years ago when you did."

3) The worm turns for Coke and Gillette and American Express and any other equities we have left. I would love to run Coke. Even I could do it. Most companies have many problems; look at the tech.coms today. They have problems. Coke has how many? Two? Three, maybe? I could fix them. Or Gillette. How many problems does it have? Those can be fixed. Any management worth its stock options can fix just a few problems. It just takes time and desire. If you are a tech.com and the life of your product is measured in months, you may not have time. If you are Coke or Gillette or American Express, and the life of your product is measured in decades, or centuries even, you have time. Some day the third of Berkshire's stars will get into line, and talking heads on CNBC will be saying, "That guy Buffett's stocks are finally performing again. It just goes to show you; if you wait long enough, everything comes back into fashion." They still have it all wrong, but who cares. The equities owned by Berkshire are more profitable than ever.

Now I make no guarantees that this will all happen. But that is what I expect to happen. The stars get into their exact positions, and a mass, financial satori regarding Berkshire will occur.

If I turn out to be right, remember; you heard it here first.

If I turn out to be wrong, it will be that other poster's fault. He will be named and blamed.