The Merger & Acquisition (M&A) Train Keeps on Rolling…

This morning it was announced that another company we own is being taken over: Precision Castparts (PCP) is being bought by Berkshire Hathaway (Warren Buffett) in a ~$37 billion deal.  Shareholders will be paid $235/share (a 21% premium to Friday’s closing price) in cash when the deal closes in the first quarter of 2016.  PCP was the 4^th largest “Growth” position in our portfolios so we’re seeing a nice bump today.

Interestingly enough, I always thought a Berkshire Hathaway takeover was a real possibility.  Berkshire had been a shareholder for a few years now and PCP is exactly the type of company Warren Buffett likes to own.

Takeovers are always bittersweet though.  It’s great to see a quick pop in your investment but PCP was a stock I was planning on holding for years to come.  We first bought PCP last fall after the stock got knocked well off its highs, and increased the position as it continued to trade lower after earnings over the past year were hurt by weakness in the energy markets.  Exposure to the energy industry only accounts for about 17% of sales while the large majority of business is from the aerospace market which is going through a multi-year boom.  This was the real reason I was attracted to PCP and why I was planning on holding the stock for a long time, not to mention that the company has a fantastic leadership team that has executed for years.  All reasons I’m sure Warren Buffett wanted to buy the company.

Here are my thoughts on the deal:

1. I’m not enamored with a price of $235, considering the stock traded at $220 in May, because I think the company could be worth a lot more in the long run – which is why Buffett is willing to buy it today for $235
2. I can only think of two reasons why PCP’s Board would have accepted the deal at a price of $235 – 1) they’re concerned that the business will continue to struggle over the intermediate term, and 2) they know how nice it is to work for Warren Buffett and not have to worry about quarterly earnings reports, disclosures, filings, stupid questions from analysts, etc.

Since the deal is all cash and no Berkshire Hathaway stock, there’s a chance shareholders aren’t too happy with the price and decide to vote against the takeover, in which case the stock would drop a bit.  Warren Buffett doesn’t negotiate and won’t engage in a proxy vote or bidding war – he’ll simply walk away.  For this reason, I’ve decided to trust in PCP’s decision to accept the deal and sold the stock in all tax-deferred accounts.  In taxable accounts, I’ve sold some shares and will be holding the rest until January, 2016 (for tax purposes).

In Other Merger News…

Last week, CF Industries (CF), our largest “Growth” position, announced with their quarterly earnings that they’re merging with (taking over) OCI Beaumont, a European-based producer of fertilizers.  CF initially jumped on the news but then began to trade lower.  I’ve been saying for the past year that the market does not understand the CF story and that I think the stock is still greatly undervalued.  It’s not about this quarter or even this year.  You have to take a long-term view and look out at least 5 years.  I added to our position on Friday with the stock down over 6% and will not hesitate to buy more despite CF already being our largest Growth stock.

Here are the key points of the deal for the new combined company:

• Total production capacity will expand by 65% over the next two years as both companies complete expansion projects
• With CF being based in the heartland of the US, they are able to benefit from the shale gas boom making them essentially the lowest cost producer in the world (the main input to produce nitrogen-based fertilizers is natural gas which has collapsed in price along with oil over the last year)
• The US currently imports about 40% of its annual nitrogen needs, and will still import over 20% even after CF’s expansion, meaning that CF will be able to sell everything it can produce each year
• One of CF’s expansion projects is in Donaldsonville, LA (the end of the Mississippi River) which will give CF the ability to export product if prices are higher overseas (gives them flexibility to maximize profits each year)
• Allows CF to expand into methanol production
• The new combined company will change its tax domicile to the UK, which will reduce CF’s tax rate from approximately 34% to 20% (higher profits)
• Will realize after-tax cost synergies of approximately $500 million per year (higher free cash flow)
• As expansion projects are completed (some in 2016, some in 2017), costs will drop, production and thus sales/cash flow/free cash flow will rise. They’re currently estimating $8 to $9 billion of free cash flow between 2016 and 2019 (on a combined company value of $25 billion)… and that’s at today’s crop/fertilizer prices in the trough of the cycle.

I really hope CF’s stock gets knocked down again because I’ll use some of the proceeds from selling PCP today to buy more.

One last thing – I believe in this story/business model so much that the 2^nd largest stock in our “Income” allocation is Terra Nitrogen (TNH).  CF is the owner (General Partner) of Terra Nitrogen GP while we own shares of the common limited partnership “TNCLP.”  The company is structured as a Master Limited Partnership for tax purposes.  In English, this means that TNH is a high yield/big dividend version of CF.  The shares are very volatile and I don’t think the market understands this story either, which tends to provide us with very nice buying opportunities.  I also added to this position last week.

CF Industries (CF) – 1 year

Terra Nitrogen (TNH) – 1 year

 

Thanks for following!

-Nick

 

Like what you see here?  It’s easy to subscribe using the box in the top-right or share this post with friends using the buttons below.