What precisely does
Berkshire Hathaway CEO Warren Buffett see in Precision
Castparts Corp.? Its understandable that investors are
asking themselves that question, given the renowned
investors penny-pinching reputation.
Clearly, Berkshire Hathaways $235-per-share deal for
the airplane component maker, announced Monday, was no fire
sale. The price represents a 21.2 percent premium over its
previous close. The price-earnings multiple of Precision
Castparts, at 22.2, stands well above that of the Standard
& Poors 500 index, which is 19.2, as well as the
companys own five-year average of 20.5, according to
In terms of price-earnings multiples going in, this is
right up there at the top, Buffett told CNBC Monday in an
interview. Precisions earnings have fallen off
moderately because of developments in the oil and gas field,
where they do some business, as well as in aerospace. But this
is a very high multiple for us to pay.
And the purchase is a monster bet, totaling $37.2 billion,
including assumed debt making it Buffetts biggest
purchase ever. The deal depletes enough cash on Berkshire
Hathaways balance sheet to the point that it may curtail
big acquisitions for a healthy spell.
Still, Precision Castparts is a classic wide-moat business
the kind that value investors like Buffett salivate
over. The Portland, Oregonbased company manufactures
critical castings and components for jet engines and turbines.
Rivals find it difficult to wrest market share because
customers such as the
Boeing Co. and Lockheed Martin Corp. are loath to switch to
unproven suppliers, especially when the cost of doing so is
expensive. Accordingly, as is the case with a lot of wide-moat
companies, operating income margins are fat. For the fiscal
quarter ended June 30, they were 25.7 percent.
There may be turbulence ahead for Precision Castparts.
Despite forecasts of rising commercial air travel, net income
from continuing operations was $399 million, off 17.7 percent
in the fiscal quarter ended June 30 from $485 million a year
earlier. Sales of $2.4 billion were down slightly from $2.5
billion a year ago. And in addition to the weakness in the
energy sector that Buffett mentioned, there was a falloff in
military sales as well as currency headwinds.
Precision Castparts shares were down more than 19 percent
this year before the bid, following a double-digit decline in
2014. All this may have combined to make a sale more attractive
to Precision Castparts CEO, Mark Donegan. Some of the
companys shareholders are probably delighted by the
A key thought for Berkshire Hathaway shareholders to ponder
is that Buffetts company certainly hasnt shot the
lights out with its aerospace investments over the years. In
1989 Berkshire Hathaway bought $358 million in preferred stock
of USAir Group, which yielded 9.25 percent, just as the highly
unionized company was coming under increased competition. In
1994, after years of USAir losses, the preferred payments were
suspended and Berkshire wrote down its investment by 75
percent. My analysis of USAirs business was both
superficial and wrong, Buffett wrote in his 1996 letter
to shareholders. Still, the preferred holdings were probably
worth about par by that point, and Berkshire had received
$240.5 million in dividends. So no one should complain too
Berkshire Hathaway had a somewhat better experience with
FlightSafety International, a top-notch pilot-training business
that it bought in 1996 for a reported $1.5 billion in stock and
cash. In his 2007 annual report, Buffett wrote that at the time
of its purchase, pretax operating earnings were $111 million,
which grew to $270 million. Since its acquisition, depreciation
charges totaled $923 million and capital expenditures $1.635
billion. Still, Buffett characterized the return on the
FlightSafety investment as only good, given the
amount of reinvested earnings it required.
The biggest aerospace problem was Executive Jets, a
fractional jet ownership business, which CEO Richard Santulli
sold to Berkshire Hathaway in 1998 for about $725 million in
stock and cash. Over ten years, Berkshire Hathaway helped
bankroll the renamed NetJets expansion in Europe, losing
a cumulative $212 million on the build-out before turning a
profit, Buffett wrote in his 2007 letter to shareholders.
Things, however, soon took a turn for the worse. In his 2009
letter, Buffett revealed that in the 11 years that Berkshire
had owned the company, NetJets had recorded an aggregate pretax
loss of $157 million. Debt rose to $1.9 billion in 2009 from
$102 million at the time of purchase. Without
Berkshires guarantee of this debt, NetJets would have
been out of business, he wrote. Its clear I
failed you in letting NetJets descend into this
condition. In 2009 alone, NetJets lost a
staggering $711 million, Buffett added.
David Sokol, who led the expansion of utility giant
MidAmerican Energy Holdings Co., renamed Berkshire Hathaway
Energy, replaced Santulli and returned NetJets to
profitability. Sokol later left Berkshire Hathaway after
successfully lobbying Buffett to purchase Lubrizol Corp., a
chemical company in which he had only days earlier bought
Characteristically, the story-loving Buffett waggishly
traces the aviation industrys problems back to the days
of the Wright brothers. If a farsighted capitalist had
been present at Kitty Hawk, he would have done his successors a
huge favor by shooting Orville down, Buffett concluded in
the 2007 letter.
So, why the change of heart on aerospace? A glance at the
Berkshire Hathaways June 30 results, released just last
week, may provide a clue. The conglomerate posted an insurance
underwriting operating loss of $38 million for the quarter,
versus a profit of $411 million for the year-earlier period.
For the six months, underwriting operating profits fell by
nearly half, to $442 million.
Whereas property and casualty rates are cyclical, Berkshire
Hathaway is facing secular headwinds at its insurance
subsidiaries, which include National Indemnity Co., GEICO and
General Re Corp.. Excess capital is flooding into the industry.
Disciplined, Berkshire Hathaway is renowned for eschewing
market share in favor of profitable underwriting. That portends
Berkshires insurance float paid-in capital that
it may pay out in claims some day but in the meantime can be
invested for profit grew just 1.4 percent year-to-date,
to $85.1 billion. Reinsurance isnt as attractive as
it used to be because of an abundance of capital, says
Mark Curnin of White River Capital, a Chappaqua, New York,
hedge fund firm that invests in financial stocks. All
this means, Berkshire will have a much more diverse stream of
Precision Castparts, like Berkshire Hathaways myriad
other industrial businesses, including its utilities, BNSF
Railway, Marmon Group, Lubrizol and IMC International
Metalworking Cos., will be able to help deploy plenty of that
money. Precision Castparts Donegan has a strong track
record of successful tuck-in acquisitions with two
announced just last quarter.
Thats something to think about as Buffett marches
through his ninth decade.