PCP - Precision Castparts Corp.

[wescobrk]

I know nothing about precision cast, but I'm curious if people think on the board precision would outperform the S&P on its own over the next 10 years?

If so, I'm assuming buffett added alpha, if it won't outperform relative to the price he paid, I wonder if he is overpaying.

[VersaillesinNY]

Now that everyone in the value investing community is praising the "very high multiple" paid for PCP; I'm going to stick with Ben Graham's principle: "Price is what you pay; value is what you get".

 

-----------

 

In Precision Castparts Deal, Warren Buffett Finds His Type of CEO

 

http://www.wsj.com/articles/in-precision-castparts-deal-warren-buffett-finds-his-type-of-ceo-1439243049

 

[...] Mr. Buffett said he doesn’t supervise the stocks either of his two managers buys, but that once a month he looks at their holdings. “Usually, I’m already familiar with the companies they buy but I knew nothing about Precision Castparts.”

 

He acquainted himself with the company and by the time Mr. Donegan stopped by Berkshire’s Omaha headquarters for a routine visit with Mr. Combs just before the July 4th holiday, Mr. Buffett knew exactly what the company did. The investor said he joined in toward the end of the visit and spent between 15 to 30 minutes chatting with Mr. Donegan.

 

Less than a day later, Mr. Combs, acting as Mr. Buffett’s emissary, informed Mr. Donegan about Berkshire’s interest in buying the company. Mr. Buffett didn’t want to make an offer unless he knew Precision’s board was open to the idea of a takeover.

 

The following week, Mr. Donegan flew to Idaho where Mr. Buffett was attending investment bank Allen & Co.’s annual conference in Sun Valley. Mr. Buffett took Mr. Donegan to his room, where they had another brief meeting during which the billionaire made his first and final offer of $235 a share.

 

Once Precision Castparts’ directors had agreed in principle, the two sides worked out the details of the deal and signed the contract on Saturday night. [...]

[rb]

I know nothing about precision cast, but I'm curious if people think on the board precision would outperform the S&P on its own over the next 10 years?

If so, I'm assuming buffett added alpha, if it won't outperform relative to the price he paid, I wonder if he is overpaying.

You obviously don't know what the stock prices will do so it's a bit of a tricky premise.

 

Most of PCP's business is to make very complicated parts for use in aircraft. Right now the global plane fleet is the oldest it's ever been and more and more people are flying/will begin to fly. The aircraft companies have huge backlogs and new aircraft programs are just ramping up or yet to start production. PCP is also a company that runs very lean with management that know how to sweat the assets (like 3G). They're also great at acquisitions and they're quite active there too.

 

So PCP is a company that will have a higher organic growth rate than the general economy, who is also great at acquisitions, has higher margins and ROIC than the S&P and it's trading around or below the S&P P/E ratio (don't know exactly what that is now). So yes I think they will outperform the S&P for the next 10 years.

[Jurgis]

Buffett is not overpaying assuming there are no skeletons in PCPs closet and assuming airplane supercycle develops as rb alluded.

 

The deal is not supercheap, but it is OK in this market.

 

If market drops a lot in next year, Buffett may miss other opportunities. But this is unknown.

[Guest Schwab711]

What is this clamoring for stock as part of the acquisition? Why would you want to be forced into BRK stock (market risk) as opposed to cash? Just buy BRK with your cash if that's what you want to invest in.

 

I think this is a fair price for a good company. Definitely a little "changing of the guards" going on though...

[tombgrt]

What is this clamoring for stock as part of the acquisition? Why would you want to be forced into BRK stock (market risk) as opposed to cash? Just buy BRK with your cash if that's what you want to invest in.

 

Maybe to avoid capital gain tax? Not sure as I don't have to pay any (yet!).

[AccentricInv]

What is this clamoring for stock as part of the acquisition? Why would you want to be forced into BRK stock (market risk) as opposed to cash? Just buy BRK with your cash if that's what you want to invest in.

 

Maybe to avoid capital gain tax? Not sure as I don't have to pay any (yet!).

 

Exactly.  Especially for those of us who bought recently and will get hit with ST taxes.

[rishig]

What is this clamoring for stock as part of the acquisition? Why would you want to be forced into BRK stock (market risk) as opposed to cash? Just buy BRK with your cash if that's what you want to invest in.

 

Maybe to avoid capital gain tax? Not sure as I don't have to pay any (yet!).

 

Exactly.  Especially for those of us who bought recently and will get hit with ST taxes.

 

You won't get hit by ST taxes if you hold until deal closes (Q1 2016)

[AccentricInv]

What is this clamoring for stock as part of the acquisition? Why would you want to be forced into BRK stock (market risk) as opposed to cash? Just buy BRK with your cash if that's what you want to invest in.

 

Maybe to avoid capital gain tax? Not sure as I don't have to pay any (yet!).

 

Exactly.  Especially for those of us who bought recently and will get hit with ST taxes.

 

You won't get hit by ST taxes if you hold until deal closes (Q1 2016)

 

Even for those on this board who purchased in the last two months (aka june 2015)?  Assuming it closes Q1 2016 (March 31, 2016 to be conservative), this would be still be less than a year.  So we'd still get taxed at the ST rate, unless there's an aspect of the tax law I'm missing?

 

Anyways, if we got BRK stock instead, we'd get to defer taxes all together.  If you didn't want to hold BRK stock, you could wait till the 1 year period was up, and collect an essentially "risk-free" 4.5% (2% arb spread + 2.5% ST vs. LT tax differential).  Perhaps I'm missing something?

 

 

[loganc]

 

I don't think the deal will get blocked. BRK is definitely not stealing the company and management has incentive to let the deal go through.

 

 

Rishi,

 

I don't mean to be a jerk, but I am somewhat confused by your position on the PCP deal.  It seems to me that you have done quite a lot of work on the company, made an investment, and then you have been taken out at a 20% premium to 52 wk lows.  It seems inconsistent to me that you think the value of the deal is fair, yet made an investment recently.  In other words, there must have been a very low "margin of safety" in this investment for me to reconcile all of this. 

 

Again, I hope I don't come off as a jerk.  I am just trying to understand a little bit more of how you are thinking about this situation. 

 

Thanks,

Logan

 

Edit: I own 1 PCP share as a tracker and am long BRK.

   

[loganc]

Perhaps I'm missing something?

 

I don't think you are missing anything.  I think ignoring tax consequences due to perceived "market risk" of BRK shares is quite a flawed way of thinking.

[rb]

Actually, Yea. He is stealing the company and he know it. But he'll do a whole song and dance about it. I guess it's ok cause I hold a lot of BRK, but we need to be real here. He got a real good deal and the shareholders of PCP a raw one.

[rishig]

 

I don't think the deal will get blocked. BRK is definitely not stealing the company and management has incentive to let the deal go through.

 

 

Rishi,

 

I don't mean to be a jerk, but I am somewhat confused by your position on the PCP deal.  It seems to me that you have done quite a lot of work on the company, made an investment, and then you have been taken out at a 20% premium to 52 wk lows.  It seems inconsistent to me that you think the value of the deal is fair, yet made an investment recently.  In other words, there must have been a very low "margin of safety" in this investment for me to reconcile all of this. 

 

Again, I hope I don't come off as a jerk.  I am just trying to understand a little bit more of how you are thinking about this situation. 

 

Thanks,

Logan

 

Edit: I own 1 PCP share as a tracker and am long BRK.

 

 

Fair enough.

 

When I bought PCP, the current earnings yield was about 5.5%. I assumed that organic growth thanks to long commercial backlog would be in the 5% range for a decade. And Donegan ability to grow the business through acquisitions would add another 2%-5% for a decade. At the price Buffett purchased PCP, the current earnings yield is about 4.5%. The rest of the argument is the same. So arguably he would compound at just slightly slower rate.

 

So, then the question is what is the fair value of a company that has $1 of earnings that can grow at 12% for a decade and then grow at inflation. Here is how I think about this: A $1 of earnings will have compounded to $3 in a decade. A business that can grow at inflation is worth about 16.5x (inverse of what a inflation protected bond should yield - 6%). That makes it worth $50 a decade from now. Discount for time value at 10% makes it worth $19 today or 19x of earnings.

 

PCP made $1.5 billion last year. At a market cap of $27B, PCP was trading at about 18x. So it was trading at "fair value" to begin with as per my math if we assumed Donegan's ability to grow through acquisitions was modest. In my mind, the discount to "fair value" was based on Donegan's ability was better than 2%. On several calls, he said they are looking to do $3 - $5 billion in acquisitions in the next 2 years. This is for a business that has $10B in revenue.

 

Is this ability worth just 20% premium. May be not, but definitely don't think Buffett is stealing the company.

 

So going back to the original question, why did I purchase PCP to begin with. For compounder type business, I am not looking for any deep discount. I am happy to buy at a reasonable discount to "fair value" as long as I am confident that the range of outcomes for the business turns out to be as I understand. If you buy a business at "fair value" and outcomes are narrow in range, you actually compound at 10%. The margin of safety for a compounder type business for me comes from not a deep valuation discount, but a reasonable discount and the strength of the business. Also, I adjust using position sizing. So, I started with a 3% position and would have added if the price dropped (which didn't happen). The fall in price enhances the future return. Over years, I have realized that the best tool I have is averaging down in such businesses. Picking a bottom is almost impossible. I start when the future return is low teens and then average down as it grows to high teens.

 

May be it's me but I like to think in terms of future return instead of discount to fair value.

 

Hope that answers the question.

[Rainforesthiker]

 

I don't think the deal will get blocked. BRK is definitely not stealing the company and management has incentive to let the deal go through.

 

 

Rishi,

 

I don't mean to be a jerk, but I am somewhat confused by your position on the PCP deal.  It seems to me that you have done quite a lot of work on the company, made an investment, and then you have been taken out at a 20% premium to 52 wk lows.  It seems inconsistent to me that you think the value of the deal is fair, yet made an investment recently.  In other words, there must have been a very low "margin of safety" in this investment for me to reconcile all of this. 

 

Again, I hope I don't come off as a jerk.  I am just trying to understand a little bit more of how you are thinking about this situation. 

 

Thanks,

Logan

 

Edit: I own 1 PCP share as a tracker and am long BRK.

 

 

I think there is a pretty big gap between a deal being "fair" and a deal being "not a steal."  It seems to me that Buffett got a good deal - probably not a steal, but probably not what many informed shareholders would have wanted.

[rishig]

 

I don't think the deal will get blocked. BRK is definitely not stealing the company and management has incentive to let the deal go through.

 

 

Rishi,

 

I don't mean to be a jerk, but I am somewhat confused by your position on the PCP deal.  It seems to me that you have done quite a lot of work on the company, made an investment, and then you have been taken out at a 20% premium to 52 wk lows.  It seems inconsistent to me that you think the value of the deal is fair, yet made an investment recently.  In other words, there must have been a very low "margin of safety" in this investment for me to reconcile all of this. 

 

Again, I hope I don't come off as a jerk.  I am just trying to understand a little bit more of how you are thinking about this situation. 

 

Thanks,

Logan

 

Edit: I own 1 PCP share as a tracker and am long BRK.

 

 

I think there is a pretty big gap between a deal being "fair" and a deal being "not a steal."  It seems to me that Buffett got a good deal - probably not a steal, but probably not what many informed shareholders would have wanted.

 

As always, rainforesthiker can put things more concisely and more precisely. +1.

[Kiltacular]

 

I don't think the deal will get blocked. BRK is definitely not stealing the company and management has incentive to let the deal go through.

 

 

Rishi,

 

I don't mean to be a jerk, but I am somewhat confused by your position on the PCP deal.  It seems to me that you have done quite a lot of work on the company, made an investment, and then you have been taken out at a 20% premium to 52 wk lows.  It seems inconsistent to me that you think the value of the deal is fair, yet made an investment recently.  In other words, there must have been a very low "margin of safety" in this investment for me to reconcile all of this. 

 

Again, I hope I don't come off as a jerk.  I am just trying to understand a little bit more of how you are thinking about this situation. 

 

Thanks,

Logan

 

Edit: I own 1 PCP share as a tracker and am long BRK.

 

 

Fair enough.

 

When I bought PCP, the current earnings yield was about 5.5%. I assumed that organic growth thanks to long commercial backlog would be in the 5% range for a decade. And Donegan ability to grow the business through acquisitions would add another 2%-5% for a decade. At the price Buffett purchased PCP, the current earnings yield is about 4.5%. The rest of the argument is the same. So arguably he would compound at just slightly slower rate.

 

So, then the question is what is the fair value of a company that has $1 of earnings that can grow at 12% for a decade and then grow at inflation. Here is how I think about this: A $1 of earnings will have compounded to $3 in a decade. A business that can grow at inflation is worth about 16.5x (inverse of what a inflation protected bond should yield - 6%). That makes it worth $50 a decade from now. Discount for time value at 10% makes it worth $19 today or 19x of earnings.

 

PCP made $1.5 billion last year. At a market cap of $27B, PCP was trading at about 18x. So it was trading at "fair value" to begin with as per my math if we assumed Donegan's ability to grow through acquisitions was modest. In my mind, the discount to "fair value" was based on Donegan's ability was better than 2%. On several calls, he said they are looking to do $3 - $5 billion in acquisitions in the next 2 years. This is for a business that has $10B in revenue.

 

Is this ability worth about 20% premium. May be not, but definitely don't think Buffett is stealing the company.

 

So going back to the original question, why did I purchase PCP to begin with. For compounder type business, I am not looking for any deep discount. I am happy to buy at a reasonable discount to "fair value" as long as I am confident that the range of outcomes for the business turns out to be as I understand. If you buy a business at "fair value" and outcomes are narrow in range, you actually compound at 10%. The margin of safety for a compounder type business for me comes from not a deep valuation discount, but a reasonable discount and the strength of the business. Also, I adjust using position sizing. So, I started with a 3% position and would have added if the price dropped (which didn't happen). The fall in price enhances the future return. Over years, I have realized that the best tool I have is averaging down in such businesses. Picking a bottom is almost impossible. I start when the future return is low teens and then average down as it grows to high teens.

 

May be it's me but I like to think in terms of future return instead of discount to fair value.

 

Hope that answers the question.

 

Fwiw, I think it's a very good answer to a good question.

 

To me, part of what makes this purchase by Berkshire possibly excellent is that Donegan comes with it.  Inside Berkshire, the possibilities for bolt-on acquisitions are obviously much bigger than when PCP was standalone.  PCP may simply be more valuable inside Berkshire.

 

I'm surprised the response by the market has been tepid.  This is a very interesting deal for Berkshire for a lot of reasons.  No share issuance necessary.  Decent price -- it wasn't necessary to pay a huge premium to all time high.  Berkshire probably going to use very cheap (after taxes) debt to fund about 30% of purchase price.  Todd Combs found the idea -- this is useful for analyzing succession and will mean that the next CEO of Berkshire will be expected to listen to Combs (and presumably Wechsler).

 

Berkshire has made huge progress in the 7 years since 2008 especially when compared to what they accomplished between 2001 and 2008, which was comparatively little. 

 

Since then, Berkshire has really supersized the balance sheet and the asset base has exploded, much of it funded with debt that is recourse only to BNSF and MidAmerican.  Meanwhile, with ISCAR, Lubrizol, Marmon, BNSF and now PCP, Berkshire's stable of wholly owned businesses are an industrial powerhouse.  This just wasn't the case a decade ago.  Add in MidAmerican and their obvious advantages against other buyers in this space, and the runway for decent growth is far easier to predict than could be reasonably argued in, say, 2005. 

 

Buffett's old promise of a permanent home for your business, which for a long time appeared sort of hokey (all he got were tiny furniture and jewelry retailers), now has real appeal for other great managers like Donegan.

 

It's annoying for competitors but Berkshire and Buffett have made good on what, for a time, appeared to be just a promise to long-time shareholders that had already made a fortune owning Berkshire stock.  A tax conscious investor, looking to become a new owner today, has a clear pathway for very solid long-term returns, in my opinion.

[loganc]

 

I don't think the deal will get blocked. BRK is definitely not stealing the company and management has incentive to let the deal go through.

 

 

Rishi,

 

I don't mean to be a jerk, but I am somewhat confused by your position on the PCP deal.  It seems to me that you have done quite a lot of work on the company, made an investment, and then you have been taken out at a 20% premium to 52 wk lows.  It seems inconsistent to me that you think the value of the deal is fair, yet made an investment recently.  In other words, there must have been a very low "margin of safety" in this investment for me to reconcile all of this. 

 

Again, I hope I don't come off as a jerk.  I am just trying to understand a little bit more of how you are thinking about this situation. 

 

Thanks,

Logan

 

Edit: I own 1 PCP share as a tracker and am long BRK.

 

 

Fair enough.

 

When I bought PCP, the current earnings yield was about 5.5%. I assumed that organic growth thanks to long commercial backlog would be in the 5% range for a decade. And Donegan ability to grow the business through acquisitions would add another 2%-5% for a decade. At the price Buffett purchased PCP, the current earnings yield is about 4.5%. The rest of the argument is the same. So arguably he would compound at just slightly slower rate.

 

So, then the question is what is the fair value of a company that has $1 of earnings that can grow at 12% for a decade and then grow at inflation. Here is how I think about this: A $1 of earnings will have compounded to $3 in a decade. A business that can grow at inflation is worth about 16.5x (inverse of what a inflation protected bond should yield - 6%). That makes it worth $50 a decade from now. Discount for time value at 10% makes it worth $19 today or 19x of earnings.

 

PCP made $1.5 billion last year. At a market cap of $27B, PCP was trading at about 18x. So it was trading at "fair value" to begin with as per my math if we assumed Donegan's ability to grow through acquisitions was modest. In my mind, the discount to "fair value" was based on Donegan's ability was better than 2%. On several calls, he said they are looking to do $3 - $5 billion in acquisitions in the next 2 years. This is for a business that has $10B in revenue.

 

Is this ability worth just 20% premium. May be not, but definitely don't think Buffett is stealing the company.

 

So going back to the original question, why did I purchase PCP to begin with. For compounder type business, I am not looking for any deep discount. I am happy to buy at a reasonable discount to "fair value" as long as I am confident that the range of outcomes for the business turns out to be as I understand. If you buy a business at "fair value" and outcomes are narrow in range, you actually compound at 10%. The margin of safety for a compounder type business for me comes from not a deep valuation discount, but a reasonable discount and the strength of the business. Also, I adjust using position sizing. So, I started with a 3% position and would have added if the price dropped (which didn't happen). The fall in price enhances the future return. Over years, I have realized that the best tool I have is averaging down in such businesses. Picking a bottom is almost impossible. I start when the future return is low teens and then average down as it grows to high teens.

 

May be it's me but I like to think in terms of future return instead of discount to fair value.

 

Hope that answers the question.

 

I appreciate the detailed response here and thank you for providing a clear elucidation of your thinking.  However, I think it is worthwhile for me address a comment that you made to make clear that I understand the nature of investing in businesses that have the ability to compound.

 

May be it's me but I like to think in terms of future return instead of discount to fair value.

 

I wholeheartedly agree with this statement. 

 

This is why, for example, I felt nauseated when substantial news broke around Thanksgiving of 2014 that Vodafone was going to purchase Liberty Global.  See, VOD could have purchased LBTY at a very large premium and I would have made money in the transaction.  Yay!  However, I would find myself being denied the future compounding ability of LBTY and then be stuck with either all cash (and a bunch of taxes), all VOD stock (deferred taxes, diluted interest in the assets that I wanted to own, possibly turd management, etc.), or some combination of the two.  The feeling of nausea is due to the fact that I would ultimately be worse off by such a transaction being consummated, by my analysis and thinking, than I would be by simply being a LBTY shareholder over a long period of time. 

 

Moving back to the PCP transaction, it seems to me that the same dynamic should necessarily exist for the PCP shareholder.  In other words, a near term cash "premium" was obtained while sacrificing the benefits of future compounding.  I can't really argue with any of the numbers that you are putting forth with respect to the business since you have obviously done more work.  However, given the presumed ability of PCP to compound (I believe you refer to PCP as a "compounder type business") the upside that you give up is really several years into the future (the "future return" that you stated in the quote).

 

Anyway, I just wanted to clarify my question and make it well understood that I understand the value of "future return."  I appreciate your effort in responding to my question.  I think it is clear the board is improved by the clear thinking and effort you put forth in your posts.   

 

 

 

 

 

 

 

[rishig]

 

I don't think the deal will get blocked. BRK is definitely not stealing the company and management has incentive to let the deal go through.

 

 

Rishi,

 

I don't mean to be a jerk, but I am somewhat confused by your position on the PCP deal.  It seems to me that you have done quite a lot of work on the company, made an investment, and then you have been taken out at a 20% premium to 52 wk lows.  It seems inconsistent to me that you think the value of the deal is fair, yet made an investment recently.  In other words, there must have been a very low "margin of safety" in this investment for me to reconcile all of this. 

 

Again, I hope I don't come off as a jerk.  I am just trying to understand a little bit more of how you are thinking about this situation. 

 

Thanks,

Logan

 

Edit: I own 1 PCP share as a tracker and am long BRK.

 

 

Fair enough.

 

When I bought PCP, the current earnings yield was about 5.5%. I assumed that organic growth thanks to long commercial backlog would be in the 5% range for a decade. And Donegan ability to grow the business through acquisitions would add another 2%-5% for a decade. At the price Buffett purchased PCP, the current earnings yield is about 4.5%. The rest of the argument is the same. So arguably he would compound at just slightly slower rate.

 

So, then the question is what is the fair value of a company that has $1 of earnings that can grow at 12% for a decade and then grow at inflation. Here is how I think about this: A $1 of earnings will have compounded to $3 in a decade. A business that can grow at inflation is worth about 16.5x (inverse of what a inflation protected bond should yield - 6%). That makes it worth $50 a decade from now. Discount for time value at 10% makes it worth $19 today or 19x of earnings.

 

PCP made $1.5 billion last year. At a market cap of $27B, PCP was trading at about 18x. So it was trading at "fair value" to begin with as per my math if we assumed Donegan's ability to grow through acquisitions was modest. In my mind, the discount to "fair value" was based on Donegan's ability was better than 2%. On several calls, he said they are looking to do $3 - $5 billion in acquisitions in the next 2 years. This is for a business that has $10B in revenue.

 

Is this ability worth just 20% premium. May be not, but definitely don't think Buffett is stealing the company.

 

So going back to the original question, why did I purchase PCP to begin with. For compounder type business, I am not looking for any deep discount. I am happy to buy at a reasonable discount to "fair value" as long as I am confident that the range of outcomes for the business turns out to be as I understand. If you buy a business at "fair value" and outcomes are narrow in range, you actually compound at 10%. The margin of safety for a compounder type business for me comes from not a deep valuation discount, but a reasonable discount and the strength of the business. Also, I adjust using position sizing. So, I started with a 3% position and would have added if the price dropped (which didn't happen). The fall in price enhances the future return. Over years, I have realized that the best tool I have is averaging down in such businesses. Picking a bottom is almost impossible. I start when the future return is low teens and then average down as it grows to high teens.

 

May be it's me but I like to think in terms of future return instead of discount to fair value.

 

Hope that answers the question.

 

I appreciate the detailed response here and thank you for providing a clear elucidation of your thinking.  However, I think it is worthwhile for me address a comment that you made to make clear that I understand the nature of investing in businesses that have the ability to compound.

 

May be it's me but I like to think in terms of future return instead of discount to fair value.

 

I wholeheartedly agree with this statement. 

 

This is why, for example, I felt nauseated when substantial news broke around Thanksgiving of 2014 that Vodafone was going to purchase Liberty Global.  See, VOD could have purchased LBTY at a very large premium and I would have made money in the transaction.  Yay!  However, I would find myself being denied the future compounding ability of LBTY and then be stuck with either all cash (and a bunch of taxes), all VOD stock (deferred taxes, diluted interest in the assets that I wanted to own, possibly turd management, etc.), or some combination of the two.  The feeling of nausea is due to the fact that I would ultimately be worse off by such a transaction being consummated, by my analysis and thinking, than I would be by simply being a LBTY shareholder over a long period of time. 

 

Moving back to the PCP transaction, it seems to me that the same dynamic should necessarily exist for the PCP shareholder.  In other words, a near term cash "premium" was obtained while sacrificing the benefits of future compounding.  I can't really argue with any of the numbers that you are putting forth with respect to the business since you have obviously done more work.  However, given the presumed ability of PCP to compound (I believe you refer to PCP as a "compounder type business") the upside that you give up is really several years into the future (the "future return" that you stated in the quote).

 

Anyway, I just wanted to clarify my question and make it well understood that I understand the value of "future return."  I appreciate your effort in responding to my question.  I think it is clear the board is improved by the clear thinking and effort you put forth in your posts.   

 

 

 

 

 

I agree that the cash buyout takes away your ability to compound into the future. In my earlier post about Buffett not stealing the company, I meant that the offer is in the fair range and any of the large holders would not put up a fight for taking away the opportunity to compound into the future. I know I wouldn't.

 

Thank you for your kind words.

[vinod1]

Great comments Rishi on PCP and investing in compounders. A minor quibble is that earnings last year are depressed due to asset impairment charges of about $0.27 billion, so normalized earnings are a bit higher. By my estimate Buffett is paying about 18 times owner's earnings - he is paying a $1 per share more than what I thought would be a fair price for this business.

 

I am thinking of selling since it is unlikely that there would be a counter offer from anyone else since management is aligned with Buffett. Thoughts?

 

Vinod

 

 

 

[rb]

Great comments Rishi on PCP and investing in compounders. A minor quibble is that earnings last year are depressed due to asset impairment charges of about $0.27 billion, so normalized earnings are a bit higher. By my estimate Buffett is paying about 18 times owner's earnings - he is paying a $1 per share more than what I thought would be a fair price for this business.

 

I am thinking of selling since it is unlikely that there would be a counter offer from anyone else since management is aligned with Buffett. Thoughts?

 

Vinod

I think that current earnings are fairly low right now. You mentioned the impairment charge. But PCP also has a lot of operational leverage built in. Boeing and Airbus are going to raise production across the lines in the near future. At that point earnings are gonna jump significantly due to the op leverage that PCP has. That's why BRK is getting a fantastic deal.

 

That being said, beside mine and other people's grumbling. I think you are correct I don't see anyone coming in with a better offer. Whether you choose to sell or not depends on your situation and whether you can get margin. Right now it's a pretty good arb bet. Assuming the deal closes at the end of March. When the deal closes you make 3.8% on PCP and that would cost 1% in margin interest. Could be a bit of easy money.

[rishig]

Great comments Rishi on PCP and investing in compounders. A minor quibble is that earnings last year are depressed due to asset impairment charges of about $0.27 billion, so normalized earnings are a bit higher. By my estimate Buffett is paying about 18 times owner's earnings - he is paying a $1 per share more than what I thought would be a fair price for this business.

 

I am thinking of selling since it is unlikely that there would be a counter offer from anyone else since management is aligned with Buffett. Thoughts?

 

Vinod

 

All my investible funds are in tax free accounts. I sold my PCP. I am not waiting for 3.5% merger spread. I already deployed the funds into something else.

[Guest longinvestor]

 

I don't think the deal will get blocked. BRK is definitely not stealing the company and management has incentive to let the deal go through.

 

 

Rishi,

 

I don't mean to be a jerk, but I am somewhat confused by your position on the PCP deal.  It seems to me that you have done quite a lot of work on the company, made an investment, and then you have been taken out at a 20% premium to 52 wk lows.  It seems inconsistent to me that you think the value of the deal is fair, yet made an investment recently.  In other words, there must have been a very low "margin of safety" in this investment for me to reconcile all of this. 

 

Again, I hope I don't come off as a jerk.  I am just trying to understand a little bit more of how you are thinking about this situation. 

 

Thanks,

Logan

 

Edit: I own 1 PCP share as a tracker and am long BRK.

 

 

Fair enough.

 

When I bought PCP, the current earnings yield was about 5.5%. I assumed that organic growth thanks to long commercial backlog would be in the 5% range for a decade. And Donegan ability to grow the business through acquisitions would add another 2%-5% for a decade. At the price Buffett purchased PCP, the current earnings yield is about 4.5%. The rest of the argument is the same. So arguably he would compound at just slightly slower rate.

 

So, then the question is what is the fair value of a company that has $1 of earnings that can grow at 12% for a decade and then grow at inflation. Here is how I think about this: A $1 of earnings will have compounded to $3 in a decade. A business that can grow at inflation is worth about 16.5x (inverse of what a inflation protected bond should yield - 6%). That makes it worth $50 a decade from now. Discount for time value at 10% makes it worth $19 today or 19x of earnings.

 

PCP made $1.5 billion last year. At a market cap of $27B, PCP was trading at about 18x. So it was trading at "fair value" to begin with as per my math if we assumed Donegan's ability to grow through acquisitions was modest. In my mind, the discount to "fair value" was based on Donegan's ability was better than 2%. On several calls, he said they are looking to do $3 - $5 billion in acquisitions in the next 2 years. This is for a business that has $10B in revenue.

 

Is this ability worth about 20% premium. May be not, but definitely don't think Buffett is stealing the company.

 

So going back to the original question, why did I purchase PCP to begin with. For compounder type business, I am not looking for any deep discount. I am happy to buy at a reasonable discount to "fair value" as long as I am confident that the range of outcomes for the business turns out to be as I understand. If you buy a business at "fair value" and outcomes are narrow in range, you actually compound at 10%. The margin of safety for a compounder type business for me comes from not a deep valuation discount, but a reasonable discount and the strength of the business. Also, I adjust using position sizing. So, I started with a 3% position and would have added if the price dropped (which didn't happen). The fall in price enhances the future return. Over years, I have realized that the best tool I have is averaging down in such businesses. Picking a bottom is almost impossible. I start when the future return is low teens and then average down as it grows to high teens.

 

May be it's me but I like to think in terms of future return instead of discount to fair value.

 

Hope that answers the question.

 

Fwiw, I think it's a very good answer to a good question.

 

To me, part of what makes this purchase by Berkshire possibly excellent is that Donegan comes with it.  Inside Berkshire, the possibilities for bolt-on acquisitions are obviously much bigger than when PCP was standalone.  PCP may simply be more valuable inside Berkshire.

 

I'm surprised the response by the market has been tepid.  This is a very interesting deal for Berkshire for a lot of reasons.  No share issuance necessary.  Decent price -- it wasn't necessary to pay a huge premium to all time high.  Berkshire probably going to use very cheap (after taxes) debt to fund about 30% of purchase price.  Todd Combs found the idea -- this is useful for analyzing succession and will mean that the next CEO of Berkshire will be expected to listen to Combs (and presumably Wechsler).

Berkshire has made huge progress in the 7 years since 2008 especially when compared to what they accomplished between 2001 and 2008, which was comparatively little.

 

Since then, Berkshire has really supersized the balance sheet and the asset base has exploded, much of it funded with debt that is recourse only to BNSF and MidAmerican.  Meanwhile, with ISCAR, Lubrizol, Marmon, BNSF and now PCP, Berkshire's stable of wholly owned businesses are an industrial powerhouse.  This just wasn't the case a decade ago.  Add in MidAmerican and their obvious advantages against other buyers in this space, and the runway for decent growth is far easier to predict than could be reasonably argued in, say, 2005. 

 

Buffett's old promise of a permanent home for your business, which for a long time appeared sort of hokey (all he got were tiny furniture and jewelry retailers), now has real appeal for other great managers like Donegan.

 

It's annoying for competitors but Berkshire and Buffett have made good on what, for a time, appeared to be just a promise to long-time shareholders that had already made a fortune owning Berkshire stock.  A tax conscious investor, looking to become a new owner today, has a clear pathway for very solid long-term returns, in my opinion.

 

+1

 

Besides making the next CEO's job description quite different from Buffett's, Todd consummating an elephant deal under Buffett paves the path for T&T and others at BRK to do more of the same in the future. The elephant in the room is that they established a 3% position in PCP 3 years ago and that turned into an elephant deal. Reinforce your Circle of Competence over time! So, the MO is to buy a stake in great businesses, watch until one-time problems surface and make whole. There are plenty such minority stakes in the BRK portfolio that can turn into wholly owned businesses. No need to look for new birds in the bush.

 

What a perfectly boring pipeline for BRK's billions.

 

[vinod1]

Great comments Rishi on PCP and investing in compounders. A minor quibble is that earnings last year are depressed due to asset impairment charges of about $0.27 billion, so normalized earnings are a bit higher. By my estimate Buffett is paying about 18 times owner's earnings - he is paying a $1 per share more than what I thought would be a fair price for this business.

 

I am thinking of selling since it is unlikely that there would be a counter offer from anyone else since management is aligned with Buffett. Thoughts?

 

Vinod

 

All my investible funds are in tax free accounts. I sold my PCP. I am not waiting for 3.5% merger spread. I already deployed the funds into something else.

 

Thanks! I sold this from my tax-deferred accounts but am still thumb sucking for the shares in my taxable account.

 

Vinod

[vinod1]

Great comments Rishi on PCP and investing in compounders. A minor quibble is that earnings last year are depressed due to asset impairment charges of about $0.27 billion, so normalized earnings are a bit higher. By my estimate Buffett is paying about 18 times owner's earnings - he is paying a $1 per share more than what I thought would be a fair price for this business.

 

I am thinking of selling since it is unlikely that there would be a counter offer from anyone else since management is aligned with Buffett. Thoughts?

 

Vinod

I think that current earnings are fairly low right now. You mentioned the impairment charge. But PCP also has a lot of operational leverage built in. Boeing and Airbus are going to raise production across the lines in the near future. At that point earnings are gonna jump significantly due to the op leverage that PCP has. That's why BRK is getting a fantastic deal.

 

That being said, beside mine and other people's grumbling. I think you are correct I don't see anyone coming in with a better offer. Whether you choose to sell or not depends on your situation and whether you can get margin. Right now it's a pretty good arb bet. Assuming the deal closes at the end of March. When the deal closes you make 3.8% on PCP and that would cost 1% in margin interest. Could be a bit of easy money.

 

10 years from now, Buffett would be writing about the high teens earnings yield that he is getting from PCP. Selling to Buffett, almost by definition could never be a good deal for us.

 

The Arb returns does not sound too exciting.

 

Vinod

[Jurgis]

I am thinking of selling since it is unlikely that there would be a counter offer from anyone else since management is aligned with Buffett. Thoughts?

 

Depends on your cash position really. :) I now treat my PCP position as cash equivalent. If I needed cash a lot, I'd sell; if not, I'd wait for ~4% annualized return by Q1/2016. (Of course, there is a risk that merger does not go through and stock drops).