Berkshire Hathaway Vision about M&A

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Nov 30, 2011
Warren Buffett's company, Berkshire, has a particular acquisition policy: to buy portions or the whole business with excellent economic characteristic and run buy managers Buffett likes and trusts.


Buffett considers that when buying the whole business, there is no reason to pay a premium. The most uncommon cases involve franchises because they can raise prices easily and only require more capital investment to increase sales or market share and cases where there are extraordinary managers that have the skill to identify underperforming businesses and apply talent to discover the hidden value.


Setting aside these two unusual categories, Buffett believes that high-premium takeovers are driven by three motives in terms of buying managers: the excitement of acquiring, the excitement of enhancing size and the excitement of having optimism about synergies.


What does Buffett's company do? Berkshire issues stock only when it receives, in turn, the same business value it gives.


However, not many buyers do the same thing and generally violate this rule. In stock acquisitions, sellers tend to measure the purchase price by the buyer's stock market price rather than by the intrinsic value. From Buffett's standpoint, that is not a good decision. Furthermore, he considers that it is best to have cash to acquire a business or any portion of it because instruments such as stocks, assets and debts tend to be mishandled.


Another form of acquisition that he dislikes is the LBO, or leverage buyout. Buffett believes that LBOs weaken corporations as a heavy premium is placed on the generation of cash to pay enormous debt obligations. Those involved in this type of operation play with others’ money and offload risks on others’ shoulders.


That is not all. Those acquisitions that are paid for in stock are generally described as “buyer buys seller” or “buyer acquires seller.” Buffett considers that thinking should follow from “buyer sells part of itself to acquire seller.”


Actually, this is what occurs and it would enable an investor to deeply analyze what the buyer is giving up for this purpose.


Buffett is very clear with his position. If the worst is to use undervalued stock to pay for an acquisition, then the other way about is to buy it back.


The stock will be selling at half its intrinsic value in the market and the company will be able to pay $1 in cash for a stock traded at $2.


Is there any better use of capital than this?


No, there is not. But Buffett considers that companies should be careful. He particularly dislikes management repurchases at premium prices to fight back unwanted acquisitions. He calls them corporate robbery. More often than not, the losses are disguised by acquirers’ management teams.


But Buffett also admits that value-enhancing acquisitions are not easy to find without additional costs. Actually, acquisitions are value-decreasing. So he fosters concentration on opportunity costs, which can be measured vis-a-vis the alternative of purchasing small portions of a great business through stock market purchases.


Berkshire can profit from certain advantages it has in acquisitions. First of all, it has high-quality stock to pay with any purchase and high managerial autonomy to offer.


Furthermore, Buffett is savvy. He only puts money where his mouth is. He always reminds sellers that many of the businesses Berkshire has acquired come from family or other closely-held groups and invites them to verify Berkshire's initial promises vis-a-vis later actions.