Bloomberg reported Nov. 7, 2011, that Berkshire Hathaway (NYSE:BRK.A, BRK.B) invested $23.9 billion in the third quarter ended Sept. 30, the highest sum in more than 15 years. Most investors, when discussing why one should own Warren Buffett's company, trot out the usual refrains: insurance, railroads and equity investments. However, if you look more closely at its latest quarterly report, you'll find three not-so-obvious reasons to own its stock.
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On May 23, 2003, Berkshire Hathaway paid $1.5 billion to acquire McLane Company, Wal-mart's (NYSE:WMT) wholesale distribution business. At the time, McLane generated $14.9 billion of revenue from outside sources and another $7.2 billion from Walmart and Sam's Club stores. In 2011, McLane's revenues were $32.7 billion, with earnings of $369 million. For the first nine months of the year, McLane generated $24.9 billion in revenue and pretax earnings of $311 million. Approximately 30% of its revenue comes from Walmart, its former owner.
McLane Company revenue represents 24.2% of Berkshire Hathaway's overall revenue, yet it delivers just 2% of its pretax profit. Every other operating segment in the Berkshire Hathaway family generates greater profits, from fewer dollars of revenue. The only plausible reason I can think of to hang on to McLane is that many of Berkshire Hathaway's other businesses sell to Walmart and selling the wholesale business could put that relationship in jeopardy. That seems unlikely; more likely is that Buffett has some relationship with the Walton family. Whatever the reason, addition by subtraction would do wonders for its stock. (To know about bad acquisition, read: Biggest Merger And Acquisition Disasters.)
Most people are familiar with the Pritzker family, through their ownership position in Hyatt Hotels (NYSE:H). Less probably know they also owned Marmon Holdings, a conglomerate of industrial businesses. On Christmas Day, 2007, Berkshire Hathaway announced it had acquired 60% of the Pritzker's conglomerate, for $4.5 billion. In the first quarter of 2011, it purchased an additional 16.5% of the company for $1.5 billion, bringing its total ownership position to 80.2%. Berkshire Hathaway plans to buy the remaining interest by the end of 2014. Marmon's revenues for the first nine months of the year were $5.3 billion, a 17% increase year-over-year, and its pretax revenues were $752 million, a 21% increase over the same period last year.
This ranks as one of Buffett's better acquisitions. It generates one-third the business McLane Company does, yet it makes more than double the amount of pretax earnings. You could argue that it's had to pay for those earnings; after all, it's doled out $6 billion, so far, compared to $1.5 billion for all of McLane. The difference being, Marmon's future profitability prospects are much greater. This is a shining star. (To know more about good M&A, check out: The Latest, Greatest Corporate Mergers And Acquisitions.)
By revenue, this is the third largest segment of Berkshire Hathaway's business, behind McLane Company and its insurance group. The same holds true for pretax earnings, where only Burlington Northern Santa Fe and the insurance group earn more. Lubrizol, which it acquired in September, is part of this group. For the first nine months of the year its other businesses contributed $2.6 billion, or 20% of overall pretax profits. Anyone familiar with Berkshire Hathaway knows almost everything but the kitchen sink is included in this group and that's the exciting thing. The rest of the businesses are relatively easy to value, but there are so many diverse companies within this segment, that there's bound to be some mispricing taking place. Dairy Queen, Business Wire, Pampered Chef; the list goes on.
Everyone focuses on the easy part, which is the insurance and the equities, but it's down here near the bottom of the business segment data, where things get interesting. I challenge you to write down the name of every business within this segment and then find a similar business that's publicly traded. You won't be able to get an exact number, but I'm pretty sure you'll find the value of public companies like Starbucks (NASDAQ:SBUX), Thomson Reuters (NYSE:TRI) and Avon Products (NYSE:AVP) are higher than what's on the books at Berkshire Hathaway. Warren Buffett's on record as saying that when he buys a business, it's for life. If he, or whomever succeeds him, ever changes their mind, the proceeds would be tremendous. As Bud Fox said to Gordon Gekko in the movie Wall Street, "The breakup value is higher."
The Bottom Line
Berkshire Hathaway, despite its critics, has plenty of untapped potential. It will continue to generate value for shareholders for many years to come, in the most unlikely of places.
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At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.