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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