Wednesday, March 2, 2011

Berkshire's Elephant Gun is Loaded

Here's a Wall Street Journal article on some of the possible takeover candidates for Berkshire Hathaway (BRKa). The acquisition targets listed in the article include:
  • Illinois Tool Works (ITW)
  • Automatic Data Processing (ADP)
  • Kennametal (KMT)
  • Expeditors International of Washington (EXPD)
  • Schindler Holding Corp (SHLAF.PK)
  • W.W. Grainger (GWW)
The article does a nice job of summarizing each.

With the exception of Automatic Data Processing (ADP), I do not have a particularly strong view of the above as stand alone businesses or whether they would make a good fit for Berkshire Hathaway.

ADP is a terrific business with durable competitive advantages, high return on capital, strong free cash flow, and an excellent balance sheet. It remains one of just a handful of AAA-rated companies.

At any given point in time, ADP typically has more than $ 20 billion of payroll funds that it holds on behalf of its customers (float). At the end of 2010 the payroll "float" stood at $ 24.2 billion.

ADP has been on my Stocks to Watch  since I started that list in July 2009. I said back then (and in follow up posts) that at or below $ 37/share I'd be willing to buy it (and in fact did) but at the ~$ 50/share it now seems awful expensive as an acquisition target. At the current market price it's selling for roughly 20x current earnings.

Market Cap: $ 24.5 billion, Expected 2011 Earnings: $ 1.24 billion

The multiple looks to be a more reasonable 16x on an enterprise value* to free cash flow (FCF) basis (non-cash depreciation runs ~$ 200 million higher/year than capex spending boosting FCF above net income).

So a great business and probably the right size for Berkshire Hathaway but not cheap.

For me, it remains a long-term hold but wouldn't buy it at current prices.

Adam

* Enterprise Value = Market Cap - Net cash on the balance sheet (excluding the $ 24.2 billion of payroll funds held on behalf of customers). The Net cash and other investments on the balance sheet for ADP is $ 1.3 billion.
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