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By Jeremy Glaser | 03-14-2011 12:00 PM

Berkshire's Latest Purchase No Game-Changer

Warren Buffett's $9 billion deal for Lubrizol won't have a major impact on earnings and leaves plenty of ammunition remaining for more big deals, says Morningstar's Gregg Warren.

Jeremy Glaser: From Morningstar.com, I'm Jeremy Glaser.

Berkshire Hathaway recently announced the acquisition of Lubrizol. I am here with Gregg Warren, he is a senior stock analyst that covers Berkshire, to take a look at the deal and see what it could mean for Berkshire shareholders. Gregg, thanks for talking with me today.

Greggory Warren: No Problem.

Glaser: So, let's take a look at the big picture. What does this company do? Was it a big surprise that this is the sort of acquisition that Berkshire would go after?

Warren: Well, it's kind of interesting because there is a lot of speculation after the annual letter to shareholders about what kind of company he might be acquiring because Buffett actually came on and said that his trigger finger was itchy. He was looking to do a deal. He did a CNBC interview recently where he talked one deal that got away from them. So it was kind of a surprise because it didn't really fit in the category that people were talking about--there were some talk about General Dynamics and few other firms. Whereas this firm is not widely followed even though it's a $6-$7 billion dollar market cap company. Primarily their business revolves around oils for manufacturing processes, automobiles and some specialty businesses like medical products. So it wasn't really on the radar per se, but it does kind of when we look at the criteria what Berkshire is looking for sort of fit into that.

Glaser: Sounds like kind of a boring but, cash-generating company that Warren Buffet is known for. Is this going to have a huge impact on earnings?

Warren: The deal itself is slated to close in the third quarter. I mean when we look at the revenue run rate the company has been doing, it's been about $5 billion in the past couple of years. So pre-tax operating income was about $1 billion to $1.1 billion slated to be this year. So with the deal closing in the third quarter, there could be some additive impact on earnings.

That said, they are sitting here doing a $9 billion deal today, but have over $10 billion slated to come in from repayments from Swiss Re, General Electric and Goldman Sachs this year that were earning interest in excess of 10% a year. So there is going to be some offset and when we looked at it sort of back of the envelope, we figured that there probably would be no impact immediately on our fair value estimate.

Glaser: So, if no big change there, it looks like they'll probably have more money to put to work. Do you have any ideas about the kind of businesses that you think they'd want to buy, or is it still too up in the air?

Warren: I think longer term he is still going to look for potentially more of these sort of old economy businesses, things that he understands better than say a high-tech firm. He told us a couple of weeks ago, he was sitting at about $38 billion in cash at the end of last year. If you take this money out and then you add the other cash back in, there is still about $40 billion that he could put to work.

Now when they slated out their acquisition criteria this past year, they were talking about doing deals between say $5 billion and $20 billion. I think we could potentially see some additional deals within the next year. That said, it's anybody's guess where he is going to put the money to work.

Glaser: One of the big questions for Berkshire Hathaway is what happens after Warren Buffett leaves. Do you think that his successor is going to be able to hold this $40 billion, or do you think there is going to be more pressure to pay dividend, do share buybacks or return this capital in some way.

Warren: Well, I think a couple of things have happened just within the past couple of years. First of all they did the Burlington Northern deal last year, and they had to use stock to get some of that deal done. They also were added to the S&P 500 and did the share split on the B shares, so you have shares now in the hands of lot more buyside investors.

So there is going to be some pressure as time moves on with $40 billion plus in cash on the books, to either pay some sort of dividend or start to make share repurchases. That said, Buffett's traditionally been against that and will probably continue to stymie any sort of movement towards that. Once he passes the mantle on to somebody else, I think it probably will be harder for his successor to continue to hold that line and say we think we have better investment opportunities for this cash than giving out dividends or share repurchases.

I think Buffett has been given a little bit of leeway to continue to do what he is doing by his investors because his returns have been so phenomenal.

Glaser: So bottom line, this deal doesn't seem like it's earth shattering, and Buffett's elephant gun seems to still be loaded.

Warren: Yeah, I think there is still a lot of shot left in the gun at this point.

Glaser: Gregg, thanks for your insight.

Warren: Thank you.

Glaser: From Morningstar, I am Jeremy Glaser.

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