Stock Watch


3 Companies Warren Buffett Might Want to Own

Elizabeth Ody

These companies could be attractive acquisition candidates for Berkshire Hathaway. Buy their stocks now and beat the master to the punch.



When Warren Buffett sits down on May 4 with tens of thousands of adoring shareholders at the annual meeting of Berkshire Hathaway (symbol BRK-B), one topic that is sure to be at the top of the conversation is which companies he may try to buy next. Even though Berkshire bagged a good-size trophy with its recently announced purchase of half of H.J. Heinz (HNZ), Buffett continues to search for fresh game. "We still have plenty of cash and are generating more at a good clip," Buffett wrote in his annual letter to shareholders. "So it's back to work; Charlie and I have again donned our safari outfits and resumed our search for elephants," he said, referring to Berkshire vice-chairman Charlie Munger.

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For Buffett, an "elephant" means a midsize-to-large company, typically something with a market value of $15 billion to $25 billion. Too small of an acquisition wouldn't make a dent in Berkshire's overall results. At the same time, Buffett has said he likes to keep a buffer of about $20 billion on hand in case of a rainy day, so he's unlikely to spend Berkshire's $47 billion cash pile all in one place.

For Buffett watchers, changes to Berkshire Hathaway's common stock holdings may offer important clues to the Oracle of Omaha's thinking. David Kass, a finance professor at the Robert H. Smith School of Business at the University of Maryland, says DaVita HealthCare Partners (DVA) may be one name on Buffett's list because Berkshire has been increasing its stake in the company over the past few years. Berkshire was buying shares of DaVita, which is one of the largest providers of dialysis services in the U.S., as recently as March of this year. With 13% of the outstanding shares, Berkshire is now DaVita's largest shareholder.

DaVita appears to match Buffett's preference for companies with sustainable competitive advantages. The company accounts for about one-third of the dialysis market in the U.S. &mdash it has almost 2,000 outpatient facilities and serves about 153,000 patients &mdash and its share has been growing in recent years. Kass says the company benefits from economies of scale, meaning that by running a large operation it can keep costs down. It also has a strong brand name.

The impetus for Berkshire's large DaVita holdings appears to come from Ted Weschler, a Berkshire newbie. Weschler and former hedge fund manager Todd Combs, another relative newcomer to Berkshire, are being groomed to eventually replace Buffett as overseers of the company's entire investment portfolio. Each is managing about $6 billion worth of Berkshire's stock portfolio, which totals about $87 billion.

Weschler held a significant position in DaVita through Peninsula Capital Advisors, the hedge fund he managed before joining Berkshire. Weschler also helped to orchestrate the acquisition of a dialysis firm when he worked for W.R. Grace, a chemical company, in the 1980s. "He has been following this industry for maybe 20 years, and he knows the economics of the industry as well as anyone," Kass says.

Kass believes Berkshire could be approaching an acquisition of DaVita in a manner similar to its purchase of Burlington Northern Santa Fe in 2010. In that instance, Berkshire built up a 23% stake in the railroad's shares over a number of years before it struck a deal to purchase the remainder of the company.

The big question is whether Buffett, who's known for his bargain-hunting acumen, would be willing to pay up for DaVita, which at $119.02 per share is already trading for a 16 times the $7.49 per share analysts expect the company to earn in 2013. That may be up to Weschler's powers of persuasion (share prices are as of April 29).

If there is one industry investors know Buffett loves, it is insurance. His company already sells insurance through its Geico auto-insurance subsidiary and its General Re reinsurance and Berkshire Hathaway reinsurance units. One reason Buffett is such a big fan of the industry is the extra cash it affords. Insurers collect and hold on to premiums in anticipation of eventually paying out on claims, and in the meantime they get to invest that cash.

Bill Smead, manager of the Smead Value Fund, thinks Aflac (AFL) would be a natural fit for Berkshire. Aflac sells supplemental insurance to individuals and businesses in the U.S. and Japan. In Japan, which accounts for 77% of Aflac's revenues, the company sells health insurance plans that are designed to offset costs that aren't covered by the country's national health care system. That business model has caught on as Japan has raised deductibles to combat rising health care costs (Aflac's supplemental health insurance policies help to cover those higher deductibles). Smead believes that U.S. employers will need to cope with rising health care costs in the same way, which will set the stage for Aflac's business model to catch on in the U.S. "We think demand for its products is going to dramatically increase over the next ten years," he says.


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