“We’re prepared. Our elephant gun has been reloaded, and my trigger finger is itchy.”
–Warren Buffett, appearing on CNBC’s “Squawk Box”, Valentine’s Day 2013.
With Berkshire Hathaway Inc. (NYSE:BRK.A)‘s mega-buyout of Heinz in January, billionaire Warren Buffett showed that he still has the tenacity and eagerness of a much younger man. The Heinz acquisition cost Berkshire $13 billion in cash, with 3G Capital kicking in the rest of Heinz’s $28 billion takeover value. Even after Heinz, Berkshire Hathaway Inc. (NYSE:BRK.A) is loaded with more than $35 billion in cash, which it could easily leverage into a huge deal.
Mr. Buffett has foreshadowed the potential for a very large takeover in the future, but to make money from a Berkshire buyout, individual investors will need to stay one step ahead of Buffett’s hunt. So the question is not if, but when the “elephant gun” will fire again. But where will it shoot?
Undervalued in the financial services industry
With a long and storied history in the financial and insurance industries, one Berkshire target could be Discover Financial Services (NYSE:DFS) Systems. Berkshire Hathaway Inc. (NYSE:BRK.A) is a longtime American Express Company (NYSE:AXP) investor, and currently owns a minority stake of 14% of the credit card company. But a controlling interest in Discover Financial Services (NYSE:DFS) may be preferable to Berkshire’s current minority interest in American Express Company (NYSE:AXP). With an expanding footprint in student loans, home loans, and credit cards, Discover Financial Services (NYSE:DFS) is well diversified and highly tied to the debt of the American consumer.
Discover Financial Services (NYSE:DFS) continues to maintain market share and receives the highest J.D. Power customer scores, reflecting consumer satisfaction scores equal to American Express Company (NYSE:AXP). According to CEO David Nelms in its Q1 conference call, growth in prime credit and strong banking execution is allowing the company to grow faster than the competition.
But given this growth, the market still values Discover Financial Services (NYSE:DFS) (Enterprise Value of 9x EBITDA) at a steep discount to American Express Company (NYSE:AXP) (nearly 13x). Discover generates between $3 billion and $4 billion annually in free cash flow, which it could potentially kick up to the parent company, arming Berkshire with more ammunition for future takeovers. A rotation out of American Express Company (NYSE:AXP) and into Discover Financial Services (NYSE:DFS) would make sense given these factors.
Longshot with high valuation but big opportunities
A longshot for the elephant gun is eBay Inc (NASDAQ:EBAY). With an enterprise value north of $69 billion, eBay would be a mega takeover, and looks quite expensive at a valuation of nearly 17 times EBITDA. However, there are reasons to think that an acquisition would make business sense for Berkshire. eBay Inc (NASDAQ:EBAY) has solid growth of 15% or more, and maintains solid leadership in the online auction marketplace. But eBay’s real growth vehicle is in financial services, through its PayPal subsidiary.
Since Berkshire’s sweet spot is in the financial sector, it possible that Berkshire would greatly value PayPal’s growth prospects. As online payments continue to grow at 15%-plus, according to Internet Retailer, Paypal’s leadership position as “the” online payment service becomes more valuable.
eBay Inc (NASDAQ:EBAY)’s online auction would be a cash generating mechanism or potential spinoff for Berkshire. For all of the potential positives of this deal, valuation is high so shares would first need to drop to a reasonable multiple. As we know, Buffett pays his price–not the market’s.
Iconic middle-American brand
An acquisition of one of the most iconic American brands of our time, Deere & Company (NYSE:DE), would be the proverbial feather in Warren Buffett’s cap. Like eBay, this would also be a huge acquisition, worth over $60 billion. But with Deere, Berkshire knows what it would get: a proven track record of sales growth, the best brand in the industry, and great management.
Trading at 10 times EBITDA, the valuation is not outrageous, and Deere & Company (NYSE:DE) is a highly cyclical stock, so a patient investor like Buffett can wait until the right time to get his price. Similar to Heinz, Deere is an iconic American brand, recognizable and highly valued by a strong customer base.
Deere & Company (NYSE:DE)‘s cash flow, in the $1 billion to $2 billion range annually, would provide further fuel for Berkshire’s coffers. As cliché as it may sound, this deal would be a storybook ending to Buffett’s career as he partners with another middle-American icon.
For speculative investors with long-term horizons, these three companies represent lower-risk opportunities to join the Buffett safari. Wise traders will imitate Buffett by paying the right price at the right time, but will stay slightly ahead of the Wall Street legend. He may only have a few shots left, but given Buffett’s legendary status, they will likely be right on target.
The article Staying Ahead of Warren’s Elephant Gun originally appeared on Fool.com is written by Spencer Houlihan.
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