Most people wouldn't complain about $116 billion burning a hole in their pocket, but most people aren't Warren Buffett.
In his recent annual letter to shareholders, the Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) chief bemoaned the company's cash hoard, saying of its $116.4 billion in cash and U.S. Treasury Bills, "This extraordinary liquidity earns only a pittance and is far beyond the level Charlie (Munger) and I wish Berkshire to have. Our smiles will broaden when we have redeployed Berkshire's excess funds into more productive assets."
That sum is a record level of cash for Berkshire, and based on that statement it's clear Buffett would like to put it to use in an acquisition or some equity investments. He also noted, however, that valuations have become too stretched, and said that the company considered a "sensible purchase price" as one of four major criteria that it looks for in a deal. Buffett explained that that idea "proved a barrier to virtually all deals we reviewed in 2017, as prices for decent, but far from spectacular, businesses hit an all-time high."
Still, with Berkshire more flush than ever, an increasing array of options present themselves for cash deployment, and Buffett said that the company will have to make at least one huge acquisition in order to accomplish its goal of substantially increasing non-insurance earnings. Let's take a closer look.
An acquisition on the horizon
While Buffett's desire to make an acquisition is clear, what Berkshire would buy is anyone's guess. In recent years, the company's acquisitions have been all over the map, including companies like Pilot Flying J travel centers, in which it took a 38.6% stake, Precision Castparts, an aerospace and defense supplier, and battery-maker Duracell.
Buffett prefers some industries over others, but there is no clear pattern in his acquisition history. Above all, he seems to favor companies that fit his criteria, including value, competitive advantage, and good management.
He did drop a hint in an interview this week when he told CNBC he "wouldn't rule out owning an airline." Buffett already has stakes in all four major airlines -- American, Delta, United, and Southwest -- and dove into the transportation industry in 2010 with his surprise acquisition of railroad operator Burlington North Santa Fe. Considering all four airlines trade at modest valuations, they could be appealing to Buffet, or he could make a play for a smaller airline like Jet Blue, Spirit Airlines, or Alaska Air Group. Even a carmaker like General Motors, which Berkshire already owns a stake in, or Ford, could be a Berkshire target for similar reasons as the two stocks trade at single-digit P/E ratios.
Others have suggested he could buy another food maker, following his deal to take a 27% stake in Kraft Heinz. That company's proposed merger with Unilever was rebuffed, but it showed Buffett's continuing interest in consumer packaged goods.
With $116 billion in the bank and Buffett clearly hungry for an acquisition, a buyout seems to be the most likely option, but there are other ways Berkshire could use its cash haul.
Berkshire has $170.5 billion worth of equity investments in companies like Wells Fargo, Apple, and Coca-Cola. Adding to these holdings with increased stakes in companies it already owns, or new stakes in other companies, would help Berkshire deplete its cash balance, but it would be difficult for it to spend all of its cash that way. Companies like Berkshire are often reluctant to take more than a 10% stake in a given stock as doing so comes with the requirement of increased disclosures and reporting to the SEC. Buffett has at times complained that becoming an equity investor has gotten harder as Berkshire has grown bigger, which has made it more difficult to move the needle as he can only make meaningful investments in large companies. Berkshire just increased its stake in Apple by 23%, but it could add to it as it only owns 3.3% of the iPhone maker. Considering that the five biggest American companies are all in the tech sector and all five have put up strong growth numbers lately, Buffett may want to take a closer look at the industry.
Other possibilities include share buybacks, which Buffett has said were an option if the stock price falls below a threshold of 120% of book value, though that would be a steep drop from its current position around 170% of book value. Dividends, however, are not on the table as shareholders overwhelmingly rejected the idea, preferring to allow Buffett to reinvest the capital. If the 87-year-old Buffett was forced to step down from the CEO chair, talk of a Berkshire dividend could percolate considering the company's cash pile and its profitability.
For now, it seems that Berkshire investors should be on the lookout for another big acquisition as Buffett looks to hunt another elephant -- as he likes to call it. We don't know when or what, but the Oracle of Omaha looks poised to stick with the formula that's suited his company so well for more than 50 years -- buying great companies at good prices.