Valuation of Precision Castparts
On August 10, 2015, Berkshire Hathaway and Precision Castparts issued a joint press release announcing that the boards of directors of Berkshire Hathaway Inc. (NYSE: BRK.A; BRK.B) and Precision Castparts Corp. (NYSE: PCP) have unanimously approved a definitive agreement for Berkshire Hathaway to acquire, for $235 per share in cash, all outstanding PCP shares. The transaction is valued at approximately $37.2 billion, including outstanding PCP net debt.
In a notice (dated October 13, 2015) of a special meeting to PCP shareholders to be held on November 19, 2015 to vote on this proposal, PCP’s financial advisor, Credit Suisse, provides a valuation of the company by performing (1) a comparable multiples analysis, (2) a comparable transactions analysis, and (3) a discounted cash flow analysis.
(1) Comparable Multiples Analysis – Taking into account the results of the selected companies analysis, Credit Suisse applied enterprise value multiple ranges of 10.0x to 11.0x to PCP’s CY 2015E EBITDA and 9.0x to 10.0 x to PCC’s CY 2016E EBITDA. The selected companies analysis indicated an implied valuation reference range of $180 to $203 per share of PCP as compared to the proposed merger agreement of $235 per share.
(2) Comparable Transactions Analysis – Taking into account the results of the selected transactions analysis, Credit Suisse applied an enterprise value multiple range of 11.5x to 13.5x to PCP’s last 12 months EBITDA as of June 28, 2015. The selected transactions analysis indicated an implied valuation reference range of $218 to $260 per share of PCP as compared to the proposed merger agreement of $235 per share.
(3) Discounted Cash Flow Analysis – Credit Suisse performed a discounted cash flow analysis of PCP by calculating the estimated net present value of the projected after-tax, unlevered free cash flow of PCP based on company forecasts. Credit Suisse applied a range of terminal value multiples of 9.5x to 10.5x to PCP’s estimated FY 2021E EBITDA of $4.21 billion and discount rates ranging from 7.0% to 9.0%. This analysis indicated an implied valuation reference range of $215 to $256 per share of PCP as compared to the proposed merger agreement of $235 per share.
ValueWalk and Investing.com published this blog post on October 20, 2015.
For most of those in Wall Street, Credit Suisse’s valuation of Precision Castparts is likely satisfactory; two of three methods puts the acquisition price well inside its derived ranges. For students of Buffett-Munger, however, Credit Suisse provided no credible information. All three valuation methods used EBITDA, a metric that Mr Munger describes with unmitigated disdain, and one that became popular with the acceleration of leveraged buyouts in the 1980s. Mr Buffett described EBITDA’s employment in the great LBO era as an attempt to “justify the unjustifiable”.
From a metrics perspective, reviewing PCC’s multi-year pretax margins (Buffett’s sweet spot since selling Coca-cola to neighbors) enlightens the analyst as to why PCC caught BRK’s attention. Further, calculating a conservative estimation of the present value of PCC’s trailing three years of per share pretax earnings — and reducing by approximately one-third for Margin of Safety — gives the BRK analyst a window of value for PCC that makes the acquisition reasonable, if not very attractive. PCC’s market position in relation to General Electric, Boeing, and Airbus, currently, and looking at the next generation of aircraft in development, only sweetens the deal.