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Berkshire Hathaway Inc.'s Biggest Win in 2016 So Far

By Matthew Frankel, CFP® – Sep 28, 2016 at 2:04PM

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Berkshire's biggest acquisition ever is looking like a smart move.

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Earlier in 2016, Berkshire Hathaway (BRK.A -1.25%) (BRK.B -1.31%) completed its acquisition of Precision Castparts. The transaction was Berkshire's largest to date, and many experts criticized it, thinking that the $37.2 billion price tag was a bit too high.

I disagree. I think the addition of Precision Castparts to Berkshire's portfolio of businesses was perhaps its best move so far this year.

What is Precision Castparts, and why did Berkshire buy it?

Precision Castparts makes a variety of metal components, mostly for the aerospace and energy industries, and has been around for over 60 years. About 70% of the company's revenue is aerospace-related, with the rest coming mainly from the power generation and oil and gas industries.

Berkshire Hathaway acquired Precision Castparts in March for $235 per share. Including the assumption of Precision Castparts' debt, the deal was valued at approximately $37.2 billion, making the company Berkshire's largest acquisition to date.

There are a few reasons I like the addition of Precision Castparts to Berkshire Hathaway's portfolio of businesses:

  1. Precision Castparts uses proprietary technology to make specialized parts. Because of the complexity and specialization, this is a high-barrier market. As we know, Warren Buffett loves leaders in businesses where there is little threat of losing market share.
  2. Buffett loves Precision Castparts' management team, particularly CEO Mark Donegan, whom Buffett has repeatedly praised, saying that Donegan is "as in love with Precision Castparts as I am with Berkshire Hathaway" and calling him "fabulous." I can't emphasize enough how much value Buffett places on good management, and as he sees it, Donegan and his talented management team are in a much better position under Berkshire's umbrella. Instead of having to worry about answering to shareholders and analysts, they can just focus 100% of their energy on their business.
  3. Despite what some experts believe, Berkshire got Precision Castparts for a good price. Sure, the total represented a premium of more than 20% over the company's share price before the announcement, but it was well below the $250-per-share value experts had been predicting. Shares had already fallen considerably in the months before the takeover announcement, thanks to weakness in the energy industry. Furthermore, the profit Precision Castparts is adding to Berkshire are further proof of the good value -- more on this shortly.
  4. Before the acquisition, Berkshire was sitting on about $70 billion in cash that was doing virtually nothing in the current low-interest environment. This is a high-dollar acquisition that allows Berkshire to earn a substantial return on money that had been just sitting on the sidelines.

Strong results so far

In its first full quarter as a Berkshire subsidiary, Precision Castparts made a big impact on the company's bottom line. Overall profits were up 25%, and Berkshire's industrial-products revenue increased by 40% year over year -- a statistic made even more impressive by the fact that it would have gone down excluding Precision Castparts.

Analysts from UBS Group AG estimate that Precision Castparts will add $2.59 billion in pre-tax profit to Berkshire this year, which translates to a 2016 return on investment of about 7% based on Berkshire's sale price. Furthermore, the fact that Precision Castparts was generating pre-tax quarterly profits in the $500 million ballpark in its pre-Berkshire days also adds to the argument that the two companies are better off together.

A profit boost in 2016, and more to come

The bottom line is that the acquisition of Precision Castparts looks like a pretty smart move so far. The addition of about $2.6 billion to Berkshire's profit in 2016 is impressive, and considering that the energy market is currently down in the dumps and a boom in aerospace manufacturing is getting started, this number could easily swell in the coming years.

Matthew Frankel owns shares of Berkshire Hathaway (B shares). The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares). 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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Berkshire Hathaway (A shares) Stock Quote
Berkshire Hathaway (A shares)
$472,712.01 (-1.25%) $-5,963.54
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Berkshire Hathaway (B shares)
$313.27 (-1.31%) $-4.16

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