Warren Buffett's New Acquisition

Warren Buffett's investment company, Berkshire Hathaway, announced this week its intention to acquire Lubrizol, a domestic specialty chemical maker based in Ohio. The deal is reportedly worth over $9 billion, and is representative of the types of major acquisitions Buffett and his company have used to turn the small textile firm into a monolithic investment company.

According to The New York Times, Buffett said in his annual letter to shareholders this past year that he was searching for "major acquisitions" to utilize the nearly $38 billion in cash and cash equivalents to further company growth. With his investment in Lubrizol, Buffett did not differ much from his formula for success. Lubrizol, a relatively large company generating $5.4 billion in revenue for the 2010 fiscal year, employs over 6,900 employees in 17 countries worldwide, and had a net earning of nearly $732 million last year. Buffett's previous investments, such as the $26 billion deal for a railroad operator have a strong grip in their respective market share, are large companies, and have a consistent pattern of profitability. In addition, Lubrizol has a strong management team in place that will allow Buffett to let the company continue its day-to-day business operations without much help needed from Berkshire. Buffett released a statement to reporters describing the new deal with Lubrizol as "exactly the sort of company with which we love to partner, the global leader in several market applications run by a talented CEO, James Hambrick."

The deal with Lubrizol is expected to push through near the end of the third quarter 2011. Berkshire Hathaway will pay $135 per share for 100 percent of all outstanding shares in cash and cash equivalents. This price was 28 percent above the closing price of Lubrizol last Friday. Experts speculate that the reason Buffett is purchasing Lubrizol in cash instead of issuing shares of Berkshire Hathaway is because he may believe that his company's stock price, which is hovering around $128,000 per share, is undervalued and thus not worth issuing to stockholders of Lubrizol. Buffett was dissatisfied in using stock in the acquisition of Burlington Northern Santa Fe writing at the time, "If we wouldn't dream of selling Berkshire in its entirety at the current market price, why in the world should we ‘sell' a significant part of the company at that same inadequate price by issuing our stock in a merger? If an acquirer's stock is overvalued, it's a different story: using it as a currency works to the acquirer's advantage." Analysts believe that these same concerns led him to use cash to purchase Lubrizol. Once the deal goes through, Lubrizol will act as a subsidiary of Berkshire Hathaway, and Berkshire will assume the $700 million in debt that the company has on record and maintain all current management.

Over the past few years, Berkshire Hathaway has been looking for new ways to expand its growth. Berkshire still uses the insurance industry to generate capital for investments. Buffett told shareholders in his annual letter that as his conglomerate gets bigger it is becoming increasingly difficult to find ways to make his company grow faster than the stock market. According to The Wall Street Journal, Berkshire holds stakes in a multitude of companies that include American financial companies Wells Fargo and Co. and Goldman Sachs Group Inc., along with the German financial giant Munich Re. Lubrizol is a big step in that same direction. The Wall Street Journal reported that earlier this month Laurence Alexander, an analyst at Jefferies and Co. in New York City, valued Lubrizol around $143 per share to a private-equity buyer. Jefferies also forecasted earnings per share of $11.30 up 12 percent from $9.91 in 2010. These figures excluded tax benefits. After the announcement of the deal on Monday, Alexander stated that, "[he] doubted a rival bid would emerge but that [it] may depend partly on the size of the breakup fee, not yet disclosed." Paul Howard working as director of Solstice Investment Research and an avid follower of Berkshire Hathaway commented on Buffett's strategy, "It looks like Buffett's paying top dollar, but it's probably a hedge against inflation—people will buy some of these products even if their costs go up." Analysts have talked at length about possible rival bids for Lubrizol. Dmitry Silversteyn, an analyst at Longbow Research, told The Wall Street Journal that the company has been consistently undervalued by the stock market and thus could attract rival bids "a rival company able to wring out savings by combining similar operations."