Friday, November 14, 2014

Berkshire Agrees To Acquire Duracell

Procter & Gamble (PG) is in the process of shedding brands to simplify its business and focus more on its core products.

Well, consistent with that objective, Berkshire Hathaway (BRKa) yesterday agreed to acquire Duracell from the company. Berkshire will acquire Duracell, in part, by exchanging the P&G shares that Berkshire currently owns for the battery business.

P&G will also contribute some cash.

According to P&G's filing:

Berkshire's stock ownership is currently valued at approximately $4.7 billion. P&G said it expects to contribute approximately $1.8 billion in cash to the Duracell Company in the pre-transaction recapitalization.

P&G said the transaction maximizes the after-tax value of the Duracell business and is tax efficient for P&G. The value received for Duracell in the exchange is approximately 7-times fiscal year 2014 adjusted EBITDA. This equates to a cash sale valued at approximately 9-times adjusted EBITDA.

Essentially, Buffett is paying 7-times this EBITDA for Duracell but, for P&G, this is equivalent to selling the company for 9-times EBITDA to a cash buyer. So, based upon the numbers available, Berkshire is paying net $ 2.9 billion ($ 4.7 billion - $ 1.8 billion) for a bit more than $ 400 million in EBITDA.

Well, if that's the case, then pre-tax operating earnings of $ 250-300 million or so doesn't seem like a stretch.

As it stands, the cost basis of Berkshire's current stake in P&G is $ 336 million.*

Simply put, that $ 336 million initial investment has resulted in current annual operating earnings that's not much less than the initial amount paid for the shares.
(If the current earning power remains at all durable, that's certainly quite an earnings yield compared to the original investment.)

Plus $ 1.8 billion in cash.

Plus the very nice and growing stream of dividends that P&G has paid to Berkshire over the years.
(Some of those dividends no doubt have helped fund other investments during that time.)

All accomplished very efficiently as far as taxes go.

Berkshire's ownership of P&G's stock began in 2005 but is directly related to a much earlier investment in Gillette. Initially, Berkshire invested $ 600 million in Gillette convertible preferred shares back in 1989. That original investment became shares of Gillette common stock in 1991. Then Berkshire became a shareholder of P&G in 2005 when P&G purchased Gillette.

In the recent past, Berkshire has done some similar deals that involved the exchange of stock to acquire business assets in a tax efficient manner.


Long positions in BRKb and PG established at much lower than recent market prices

* Before selling some shares both during and after the financial crisis, Berkshire previously had a higher cost basis in P&G. In fact, as recently as 2007, Berkshire's cost basis was as high as ~ $ 1 billion.

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