What Is Buffett’s Berkshire Hathaway Buying In Precision Castparts Corp. (NYSE:PCP)?
Warren Buffett’s Berkshire Hathaway Inc. (NYSE:BRK.A)(NYSE.BRK.B) has offered to buy Precision Castparts Corp. (NYSE:PCP) for $32 billion, which comes to $37.2 billion including debt. The deal values the metal parts maker at $235 a share, which indicates a premium of 21.2% above the closing price just before the deal was announced.
However, the price that Berkshire has offered to pay for Precision is below the 52-week high of $249. In other words, Berkshire is about to get its hands on Precisionat a good price, or a relatively cheaper price to be precise, given the nature of the company.
Regulators and Precision shareholders will have to weigh in on Berkshire’s buyout offer before the transaction can be closed. If all goes well, the deal is expected to close in 1Q2016. It looks likely that the deal will sail through regulators and shareholders.
Strong cash reserve
Buying out Precision isn’t going to setback Berkshire in any significant way, which is why Buffett has said that they will be in the market again for more but smaller acquisitions. Berkshire had about $67 billion in cash reserve of the end of June 2015, and paying a little over $37 billion for Precision leaves the company with a huge cash balance to spend more strategic acquisitions.
However, what exactly is Berkshire getting into by buying Precision?
Precision Castparts Corp. (NYSE:PCP) is a favorite parts supplier in aerospace, energy and other industrial sectors.
The company has been in business for more than 60 years, building a reputation as a supplier of quality parts for aircraftsand other machines. Throughout these years, Precision has also built expertise in its line of operation, which is why it is able to keep customers for many years. Aircraft engine makers like General Electric Company (NYSE:GE) have been buying components from Precision for more than four decades and the business relationship continues to blossom.
In fiscal 2015, Precision generated sales of about $10 billion and posted $1.5 billion in profit. A majority of the company’s revenue at 70% come from the Aerospace sector in the last fiscal year ended March 29. The company obtained 17% of its fiscal 2015 from Power sector and the rest at 13% of total revenue from General Industrial/others sector.
Going back to fiscal 2014, Precision tapped 69% of the nearly $9.5 billion sales from the Aerospace sector. The rest of the sales came from Power and General Industrial/others at 17% and 14%, respectively.
Further back in fiscal 2013, Precision obtained 65% of its more than $8.3 billion from Aerospace and 20% from Power. General Industrial/others contributed 15% of revenue in the year.
Looking at the above sales trend by sectors, it is clear that the core business at Precision (Aerospace) has been improving year after year.
Precision Castparts Corp. (NYSE:PCP)’s component products are used in aircraft engines and gas turbines as well as other industrial sectors. The company is exposed to major aircraft engine makers such as General Electric, Roll Royce and Pratt & Whitney. Precision is also exposed to major airplane producers Boeing Co (NYSE:BA) and Airbus.
Why Precision is important for Berkshire
Precision will expand Berkshire’s play in the Industrial sector.
The air travel industry is expected to expand in the years to come as standards of living improve. Precision presents an exciting opportunity to tap into the growth of the air travel industry.
It is clear that Berkshire sees Precision as a much safer bet than individual airline carriers for in leveraging on the anticipated growth in the air travel industry.
Precision operates in three business segments. These are Forged Products, Investment Cast Products and Airframe Products, contributing 43%, 25% and 32% of sales, respectively in fiscal 2015.
Disciplined cost management is second nature at Precision. The company CEO, Mark Donegan, who has been at the helm since 2002, is well-known for his drive for efficiency. By eliminating costs where possible in an ongoing basis, Donegan has has been able to lead Precision intosave a lot of money, thus supporting margins improvement and attractive returns to shareholders.
Effective capital allocation
Precision’s growth comes both organically and through strategic acquisitions. It should be noted that the management of Precisionis great at integrating acquisitions. Over the last five years, a total of about $8.2 billion has been spent on acquisitions with solid returns on invested capital. This culture of strategic acquisitions and effective integration is coming to Berkshire, and will certainly help in future acquisitions.
Besides strategic buyouts to bolster its competitive edge, Precision has also rewarded shareholders with significant cash returns. In fiscal 2015, Precision bought $1.6 billion worth of shares and committed to return another $2 billion through stock repurchase over the next 12 to 18 months. As such, acquisition of Precision should boost shareholder returns at Berkshire.
What drives Precision?
Precision Castparts Corp. (NYSE:PCP) boasts high-quality and low-cost products and timely turnaround.
There is high customer stickiness at Precision. Part of the reason is that the company offers the best in-class components that its customers are satisfied. The other reason is that strict regulations in the industries that Precision serves encourage customers to stick with a well-known supplier than risk quality by defecting to another supplier.
The future is bright
Growth is expected in the air travel sector, and this bodes well for Precision. According to Airbus, air traffic will be up 4.7% between 2014 and 2033. That means more planes will be required, increasing the demand for parts, thus to better prices for Precision.
Purchase of Precision will certainly fit in well with Berkshire’s earlier industrial acquisitions, which include Marmon and Lubrizol, a chemical maker.In a news release, Donegan, the CEO of Precision, noted that there is alignment between how they manage Precision and how Berkshire is run.
For Precision, Donegan said, joining Berkshire will enable the company to better serve its customers into the future.
Superinvestors in Precision
In addition to Berkshire, there are a number of high-profile investors in Precision Castparts Corp. (NYSE:PCP), which in a way tells the value in the business. 3Q Advisor by Lou Simpson, ValueAct by Jeff Ubben and 3G Capital are some of the super investors in Precision. Daniel Loeb’s Third Point also has a stake in Precision.
Precision Castparts Corp. (NYSE:PCP)’s balance sheet andmanagement are great inspirations. There is no doubt Berkshire has made a bold and right move in buying out the company.
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