Although most companies appear largely focused on dividends and buybacks these days, some still see the merits of a growth-inducing acquisition.
In a slow-growth economy, dealmaking can lead to sales synergies and better operating leverage. And that can boost earnings per share (EPS) even more quickly than buybacks can.
That was precisely the rationale behind Packaging Corp Of America (NYSE:PKG) just-announced $2 billion (in cash and assumed debt) acquisition of rival Boise Inc. (NYSE:BZ). The deal will create a $6 billion (in sales) behemoth in the cardboard box industry.
Cardboard boxes? Why should anyone care about such a low-tech old-line industry? The answer: e-commerce. That United Parcel Service, Inc. (NYSE:UPS) package at your doorstep explains why this industry isn’t going anywhere.
Investors loved the deal, bidding up shares of Boise Inc. (NYSE:BZ) nearly 40% and even the acquirer, Packaging Corp Of America (NYSE:PKG), by nearly 10%. The deal was attractively priced, at 6.7 times trailing earnings before interest, taxes, depreciation and amortization (EBITDA), or just five times EBITDA when planned synergies are taken into account.
That’s a price Warren Buffett would love. In fact, everything about this deal would appeal to the Oracle of Omaha.
The combined entity will have:
1). An opportunity to boost market share beyond the pro forma 9% (7% for Packaging Corp Of America (NYSE:PKG) and 2% for Boise Inc. (NYSE:BZ)) in what is still a fragmented industry.
2). Robust projected EBITDA: more than $1.1 billion annually on that $6 billion revenue base.
3). An opportunity to earn more than $4 a share in 2014, according to DA Davidson. That’s up from $2 a share in 2012.
Don’t be surprised if Buffett eventually pounces on this company, as it has the key characteristics he looks for. In the interim, with the ink already dry on a deal early this year to acquire H.J. Heinz, Buffett is likely still on the prowl in search of his next prey.
Berkshire Hathaway’s Recent Acquisitions
The process of studying Buffett-style businesses is extremely worthwhile. It can lead you to great companies that represent solid intrinsic value, even if they are never acquired.
As a quick recap, Buffett likes businesses that have:
1). A strong global brand name (Heinz)
2). A history of consistent, stable cash flow (all of them)
3). An industry that can earn greater returns through infrastructure investment (BNSF)
4). A high level of recurring revenues (insurers such as Berkshire’s GEICO).
Frankly, it’s the absence of recent major insurance acquisitions that is a bit curious. After all, Buffett built his initial fortune by acquiring insurance companies before he ventured into other industries.
Insurance companies are some of the best deals on the market right now, as many of them still trade below tangible book value. And considering that book value will rise more quickly as interest rates (and interest income) move higher in coming years, Buffett’s Berkshire Hathaway Inc. (NYSE:BRK.A) could afford to pay up to 1.25 times book value and still garner excellent long-term returns. Here’s a quick list of insurers that fit the bill:
Below Book Insurers
My favorite insurers: American International Group Inc (NYSE:AIG) (which I discussed a few months ago), Protective Life Corp. (NYSE:PL) and Reinsurance Group of America Inc (NYSE:RGA).
The other fertile area for value investors: high free cash flow. If you’re looking to mimic Buffett, then you need to exclude companies he would never buy anyway, such as airlines.
