Procter & Gamble Co.; Market Cap (as of 14/11/14): $238.1bn
Berkshire Hathaway Inc.; Market Cap (as of 14/11/14): $358.8bn
Procter & Gamble Co. (NYSE: PG), the world’s largest beauty and home products maker based in Cincinnati, Ohio, United States, announced last month that it would divest its battery business, Duracell. This Thursday Berkshire Hathaway Inc. (NYSE: BRK/A), the largest conglomerate in the US worth $350bn headquartered in Omaha, Nebraska, United States agreed to buy the Duracell battery business from Procter & Gamble Co. in a stock swap for $4.7bn. Berkshire bought into some of the most valuable brands in the world, such as Coca-Cola, American Express and conducted a $28bn LBO of Heinz, leader in the food industry, in partnership with private equity firm 3G Capital. Berkshire became one of the P&G’s biggest investors in 2005 when P&G bought Gillette Co., the razor maker in which Buffett had a stake.
Berkshire Hathaway is paying for Duracell with its $52.5m P&G’s shares, which are currently worth $4.7bn. The deal is a tax-efficient way for Berkshire to sell its P&G stock and avoid capital gains taxes. On top of that, P&G is injecting $1.7bn tax-free cash into Duracell before handing it over. This means that the enterprise value of Duracell is $2.9bn (4.7-1.8). In fact, Berkshire is buying Duracell for 7 times its fiscal year 2014 adjusted EBITDA, which is considered to be relatively low since P&G is traded at approximately 14 times its EBITDA. Upon the completion Berkshire Hathaway will exit its $336m investment in P&G made in 2005. As a result of his initial investment in P&G, Mr. Buffett’s conglomerate is now sitting on billions of dollars in capital gains, which due to the particularity of the deal structure will not be taxed. In fact, Warren Buffett has already used such deal structure earlier this year trading his shares in Graham Holdings, owner of the Kaplan education company and the former parent of the Washington post, in exchange for a Miami television station, some cash and shares in Berkshire Hathaway that Graham Holdings owned.
The famous stock picker, known to have a preference in buying mature and durable consumer brands that produce predictable cash flows, is planning to narrow his company’s equity portfolio and extend his investments in operating businesses. Furthermore, Mr. Buffett has expressed his willingness to convert Berkshire’s stock stakes into stable, cash-generating businesses with a competitive advantage. As Duracell is considered to be a business with high operating margins and a history of strong cash flows, it did not come as a surprise that Duracell was a suitable target. Under its current business model, Duracell does not have a high growth potential but it is able to provide a stable cash flow considering that there are enough devices around, which require non-rechargeable batteries. On the other hand, Duracell is developing Lithium-Ion battery and is a small player for those rechargeable batteries, as the industry keeps changing and consumers are increasingly relying on rechargeable batteries.
P&G instead is trimming its product lineup in its efforts to unlock the value of its core business operations. As P&G is a major producer of shampoos, detergents and paper towels, Duracell became a logical candidate for disposal. Furthermore, Duracell was dragging down its overall growth and was not one of the P&G’s top performers. In the efforts to shrink the business, the company decided to rehire Mr. Lafley as a chief executive. His plan is to divest non-core businesses and cut expenses across the company. Moreover, he wants to increase productivity savings, sharpen company’s strategies and strengthen its portfolio. Reviving the investors’ interest in the company is going to be Lafley’s main goal.
Upon the release of the news on Thursday, P&G’s stock slipped 1 percent to $88.6 at the close in New York while Berkshire Class B shares rose 0.5 percent to $146.3. The negative reaction of the market received by P&G could be due to the fact that the company is losing a powerful shareholder. In addition, it could have been influenced by the fact that Mr. Buffett picked Duracell over P&G’s stock, being bearish on the future performance of P&G. We believe that since Berkshire Hathaway had $62.4bn in cash on its balance sheet as of September 30, it will keep pursuing its strategy of acquiring full ownership of easy-to-understand businesses with top quality products. In Mr. Buffett’s words, Berkshire Hathaway will continue with its investment strategy targeting “wonderful companies at fair prices, rather than fair companies at wonderful prices.”
Goldman Sachs, Jones Day, and Cadwalader Wickersham & Taft advised P&G.
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