Few investors have as impressive a long-term track record as Berkshire Hathaway (BRK.A +0.00%)(BRK.B 0.24%) CEO Warren Buffett. Over the past 55 years, Buffett has led Berkshire to an average annual per-share market gain of 20.3%, which works out to 2,744,062%, in aggregate. That's well over 2,700,000% better than the comparable return from the S&P 500, including dividends.
But one thing that has Wall Street befuddled of late is the Oracle of Omaha's unwillingness to put Berkshire Hathaway's cash to work. Though Buffett's company does have a 46-security investment portfolio, Berkshire has also fully acquired five dozen companies over many decades. It's been more than four years since Buffett and his team last made a sizable acquisition.
According to Buffett, there just haven't been any attractively priced businesses. Additionally, the Oracle of Omaha has previously stated that any future deals would have to be elephant-sized and move the earnings needle. As a result, Berkshire Hathaway's cash hoard now sits at an all-time high of $137 billion.
While elephant-sized deals that would fit well with Berkshire Hathaway's business model aren't exactly abundant, I can think of three large deals that would, on paper, make a lot of sense for Warren Buffett to consider. Below I'll present a brief synopsis of why each deal makes sense, as well as the biggest obstacle to it coming to fruition.
Berkshire Hathaway CEO Warren Buffett at his company's annual shareholder meeting. Image source: The Motley Fool.
NextEra Energy
Why a buyout would make sense: Back in February 2018, I referred to electric utility NextEra Energy (NEE +0.32%) as "The No-Brainer Stock Warren Buffett Should Buy." Since making this call, NextEra Energy's share price, inclusive of dividends, has appreciated 72%, which compares to a gain of 11% for the S&P 500 over the same time frame. The thing is, NextEra has the profile to continue to outperform the broader market, despite being in a traditionally slower-growth sector.
First of all, no utility is generating a larger percentage of its electricity from renewable energy sources than NextEra. It's a leader in solar and wind energy, with the company promoting a 30-by-30 project that'll see an additional 30 million solar panels installed by 2030. This is important given that green energy sources reduce electricity generation costs, allowing NextEra's top and bottom line to grow at a much faster pace than its peers.
Furthermore, NextEra is benefiting from historically low borrowing costs. Financing green energy projects isn't cheap. However, the ability to borrow at low rates, all while pushing its generation costs lower, is an added bonus.
It's also worth mentioning that NextEra's traditional electric operations are predominantly regulated. While the company can't just pass along price hikes as it pleases, it also means not being exposed to the potentially volatile wholesale electricity market. This means consistent cash flow from a basic-need company.
The biggest obstacle to a NextEra buyout: Although the business model is right up Buffett's alley, NextEra sports a $121 billion market cap. That price tag is a bit of a stretch with Berkshire holding $137 billion -- and it assumes no additional premium, which is unlikely. Also, NextEra is pricey at more than three times book value, and that could be a tough pill to swallow for the Oracle of Omaha.
Image source: Getty Images.
Intuitive Surgical
Why a buyout would make sense: Another elephant-sized acquisition Warren Buffett should strongly consider is surgical system developer Intuitive Surgical (ISRG 2.64%), which carries a $64 billion market cap at the moment. Similar to NextEra in 2018, I proposed Intuitive Surgical as a no-brainer buyout for Berkshire this past October.
One reason to believe Intuitive is a good fit is because it has the economic moat that Buffett yearns for when making an investment. This is a company that's installed 5,669 da Vinci surgical systems over the past two decades around the world, which is far more than its major competitors, combined. Since these are relatively pricey systems ($0.5 million to $2.5 million), and Intuitive Surgical is the clear go-to for surgical systems, its clients tend to stick around for a very long time.
Buffett would also be a huge fan of the razor-and-blades business model. The da Vinci system may generate quite a bit of revenue, but margins on these machines are only so-so given how intricate they are to build. The bulk of Intuitive Surgical's margins are derived from selling instruments with each procedure, as well as from servicing its machines. As the number of installed systems increases, the percentage of sales derived from these higher-margin revenue channels will only grow, thereby lifting the company's operating margins over time.
The icing on the cake is that the da Vinci system is still nowhere near saturation, in terms of market share, in a variety of soft-tissue indications. This suggests plenty of opportunity for double-digit growth for years to come.
The biggest obstacle to an Intuitive Surgical buyout: Easily the biggest hurdle to this deal is the fact that Buffett largely avoids the healthcare sector. It also doesn't help that Intuitive Surgical carries a hefty premium due to its market share dominance. Even with an operating margin of more than 30%, getting Buffett to pay more than 40 times forward earnings could be a stretch.
Image source: Square.
Square
Why a buyout would make sense: A third elephant-sized deal that I believe Buffett would be wise to consider is financial technology juggernaut Square (SQ +0.40%), which ended the previous week with a $38 billion market cap.
Why Square? For starters, it's in Buffett's absolute favorite sector -- financials. There's little that he enjoys more than money machines in the financial industry, and that's exactly what Square offers over the long run.
Most folks likely know Square best for its seller ecosystem. Long known for providing point-of-sale and lending services to small and medium-sized businesses, Square has seen a shift in recent years that involves larger businesses using its seller ecosystem. Since the U.S. is a consumption-driven economy, larger businesses utilizing its platform can only lead to more robust fee generation. In other words, it would give Buffett an opportunity to get into a fintech stock that has similar potential to Visa or Mastercard in the relatively early innings.
Square's Cash App also has the makings of a juggernaut. Monthly active users more than tripled between the end of 2017 and the end of 2019, and there's a strong likelihood that the coronavirus disease 2019 (COVID-19) pandemic has further encouraged new users to join. With Cash App connecting to Cash Card for more traditional usage, as well as allowing people to invest and send/receive money, it may one day surpass the seller ecosystem in importance.
The biggest obstacle to a Square buyout: Though Warren Buffett has demonstrated a willingness to own fintech stocks with the likes of StoneCo in Berkshire Hathaway's portfolio, asset light companies have always been difficult for him to value. Further, Square is very pricey on a fundamental basis given that it's still early in its growth cycle.
