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Buffett Takeover Criteria Includes General Dynamics: Real M&A

Warren Buffett wants to use his almost $40 billion pile of cash to pursue bigger acquisitions. That may put companies from Archer Daniels Midland Co. to General Dynamics Corp. (GD) and Exelon Corp. (EXC) in his sights.

The 80-year-old billionaire investor and chairman of Omaha, Nebraska-based Berkshire Hathaway Inc. said in his annual letter to shareholders on Feb. 26 that he was looking for “more major acquisitions,” a year after spending $26.5 billion to buy Burlington Northern Santa Fe railroad in his largest purchase.

The world’s most successful investor is eyeing takeovers after a recovery from the worst U.S. recession since the Great Depression helped Berkshire generate almost $1 billion in free cashflow a month last year and near zero percent interest rates limited returns in fixed-income markets. ADM, the world’s biggest grain processor, and General Dynamics, the maker of Gulfstream business jets and Abrams tanks, are among 45 companies that meet the acquisition criteria listed in Buffett’s annual letter, according to data compiled by Bloomberg.

“He’s probably looking for something along those lines,” said Barry James, who oversees $2.5 billion as president of James Investment Research Inc. in Xenia, Ohio. His James Balanced Golden Rainbow Fund has beaten 94 percent of competitors in the past five years. “All these are great fits for any value investor. Obviously, we’re going to need defense, energy and agriculture. Those are just good, solid companies.”

‘Trigger Finger’

In his annual letter, Buffett said Berkshire, whose cash rose to a three-year high of $38.2 billion, needed more buyouts and that the “elephant gun has been reloaded, and my trigger finger is itchy.”

Buffett didn’t respond to a request for comment for this story e-mailed to his assistant, Carrie Kizer.

He typically prefers “simple” businesses with pretax profit exceeding $75 million, “consistent” earning power, and “good” returns on equity while employing little or no debt, according to his report. He has shifted his takeover strategy as Berkshire has grown to focus on “capital intensive businesses,” such as power producers and railroads, which require consistent investment in infrastructure and equipment.

Buffett said in an interview on CNBC television today that an acquisition is more likely to be in “the United States than any other place, but we have certainly not bought our last international company.”

Historical Standards

There are 45 U.S. companies with market values from $4 billion to $40 billion that have capital expenses accounting for at least 5 percent of their net fixed assets; a return on equity exceeding 10 percent; profit growth in the past five years that ranked in the top 50 percent; and an average price-earnings ratio in that span that was less than the median in the Standard & Poor’s 500 Index, data compiled by Bloomberg show.

So-called value investors such as Buffett also purchase companies when their stock prices are low by historical standards when compared with earnings.

Berkshire, which has a market value of $209 billion and employed more than 260,000 people as of Dec. 31, owns 10 insurers including Geico and more than 60 other companies ranging from food distributor McLane Co. and clothing-maker Fruit of the Loom to toolmaker Iscar Metalworking Cos. and utility MidAmerican Energy Holdings Co.

Shares of Berkshire slipped $650, or 0.5 percent, to $127,400 in U.S. composite trading today.

Relative Value

ADM, with a market value of $23.5 billion, has traded at an average of 13 times profit in the past five years versus 16.7 times for the median S&P 500 company, data compiled by Bloomberg show. While the Decatur, Illinois-based company rose 22 percent this year through yesterday, it traded at 12.1 times earnings.

The grain processor reported second-quarter profit and sales that beat analysts’ estimates last month after exporting record grain volumes from the U.S. Earnings from ADM’s agricultural-services segment, which buys, sells and transports grains, almost tripled to $426 million from $150 million a year earlier, the company said.

Net income has climbed 85 percent in the past five years and analysts estimate profits will rise to records this fiscal year and next, the data show. ADM has also spent more than $1 billion on plants and equipment in each of the past four years.

“ADM, as a food processor and middleman, is more plausibly up his alley,” said Brian Barish, president of Cambiar Investors LLC, which manages $7 billion in Denver. “The jewel of the company is that they have a huge business, which is called agricultural services. This is transporting food, storing food and grains. That’s a very difficult business to replicate. That one seems potentially very interesting.”

Opportunity Fund

Barish’s Cambiar Opportunity Fund (CAMOX) returned 31 percent in the past year, beating 99 percent of value funds investing in the largest companies by stock-market capitalization.

Roman Blahoski, a spokesman at ADM, declined to comment.

Still, Buffett may not be interested in a company that has been accused of fixing prices, according to Howard Ward, a money manager for Gamco Investors Inc., which oversees about $33 billion in Rye, New York.

In 1996, ADM agreed to pay a then-record $100 million antitrust fine after being accused by the government of price- fixing. Buffett’s son, Howard Buffett, worked at ADM from 1992 to 1995, serving as a director and the company’s head of investor relations. He resigned in July 1995, because he was unhappy with the company’s actions related to the investigation, the Wall Street Journal reported at the time.

‘Checkered Past’

“I would doubt Archer Daniels because it is a company with a checkered past,” said Gamco’s Ward.

ADM’s shares advanced 0.4 percent to $36.77 today.

General Dynamics, which Buffett owned a stake in more than a decade ago, has a market value of $28 billion.

The stock traded at an average of 13.2 times its earnings in the past five years, a 21 percent discount to the median S&P 500 company, data compiled by Bloomberg show.

Net income at the Falls Church, Virginia-based company rose 19 percent in the fourth quarter as demand for Gulfstream jets rose and Chief Executive Officer Jay Johnson said the aerospace unit will increase sales at least 10 percent this year.

Buffett already owns NetJets Inc., the luxury air-travel company that he bought in 1998 for $725 million. The Columbus, Ohio-based company allows clients to share ownership and arrange private flights on a fleet of planes operated by the Berkshire unit. NetJets bought some Gulfstream aircrafts for its fleet.

‘One That’s Possible’

NetJets said yesterday it ordered as many as 120 aircraft from Bombardier Inc. of Montreal for more than $6.7 billion.

General Dynamics “does have a business that he’s familiar with,” said Thomas A. Russo, who manages about $4 billion at Gardner Russo & Gardner in Lancaster, Pennsylvania. Russo has owned Berkshire stock since the early 1980s. “That’s one that’s possible” for him to acquire, he said.

Buffett said in the annual report that NetJets’ financial results have been a “failure” since he bought it in 1998. The company, which reported a pretax loss of $157 million in the 11 years ended 2009, would have lost “several hundreds of millions” more without Berkshire’s financial support, he wrote.

General Dynamics bought Gulfstream in 1999, reducing its reliance on defense spending. It has $591 million in net debt and a credit rating of A1L, the seventh-highest level of investment grade, according to Bloomberg’s Company Credit Ratings. That model analyzes borrowers based on their indebtedness, stock volatility, profitability and other financial ratios.

General Dynamics, Exelon

Rob Doolittle, a spokesman for General Dynamics, declined to comment. The company’s shares rose 0.1 percent to $75.11.

Exelon, the biggest U.S. nuclear power generator, may become a takeover target as Buffett looks to build on his investments in utilities and power producers, according to Harry Rady, who oversees $270 million as chief executive officer of Rady Asset Management LLC in La Jolla, California.

The Chicago-based power producer declined 7.6 percent in the past year through yesterday, trailing the 7.8 percent gain for utilities in the S&P 500. Exelon traded at 10.1 times earnings, compared with its five-year average of 14.7, Bloomberg data show.

Its return on equity, a measure of how much a company earns for each dollar it invested, was 20 percent last year, almost double the average for S&P 500 utilities, according to data compiled by Bloomberg.

‘Up His Alley’

“He might look at a nuclear utility, like an Exelon,” said Rady. “Exelon is trading at its historical low valuation. It’s out of favor. That would be one that would be right up his alley.”

Exelon’s spokesman Paul Elsberg declined to comment. The company’s shares fell 0.2 percent to $41.04 today.

Paul Newsome, an analyst at New York-based Sandler O’Neill & Partners LP, said Buffett may ultimately prefer to buy a property-casualty insurer because the companies are cheap versus historical valuation of between 1.3 to 1.4 times net assets.

Chubb Corp. (CB), the Warren, New Jersey-based insurer of commercial property and high-end homes, is currently valued at 1.14 times its book value.

Travelers Cos., the best-performing financial stock in the Dow Jones Industrial Average last year, trades at 1.01 times, data compiled by Bloomberg show. Northbrook, Illinois-based Allstate Corp. (ALL), the largest publicly traded U.S. home and auto insurer, trades at 88 cents on the dollar, the data show.

‘Definitely Makes Sense’

“It definitely makes sense” for Buffett to acquire an insurer, said Newsome.

Shane Boyd, a spokesman for New York-based Travelers, declined to comment, as did Allstate’s Maryellen Thielen. Mark Greenberg at Chubb didn’t return telephone messages left after regular business hours.

Travelers fell 0.7 percent to $58.81 today, while Allstate slipped 0.5 percent to $31.30. Chubb retreated 0.9 percent to $59.15.

Overall, there have been 3,856 deals announced globally this year, totaling $388.7 billion, a 29 percent increase from the $301.7 billion in the same period in 2010, according to data compiled by Bloomberg.

List of Companies:
Market Capitalization from $4 Billion to $40 Billion
Capital Expenditures / Net Fixed Assets > 5%
Return on Common Equity > 10%
5-Year Net Income Growth in Highest 50%
5-Year Average P/E Ratio < S&P 500 Median Company Value
Sorted by Market Capitalization
*Excludes Banks, Technology and Biotechnology Companies

Eli Lilly & Co.
National Oilwell Varco Inc.
Hess Corp.
General Dynamics Corp.
Lockheed Martin Corp.
Exelon Corp.
Dominion Resources Inc.
Archer-Daniels-Midland Co.
NextEra Energy Inc.
Capital One Financial Corp.
Chesapeake Energy Corp.
Cummins Inc.
TJX Cos.
Raytheon Co.
Public Service Enterprise Group Inc.
Williams Partners LP
Cliffs Natural Resources Inc.
Diamond Offshore Drilling Inc.
Humana Inc.
Goodrich Corp.
ITT Corp.
Cooper Industries Plc
AmerisourceBergen Corp.
Joy Global Inc.
Mattel Inc.
Ross Stores Inc.
L-3 Communications Holdings Inc.
ONEOK Partners LP
Hormel Foods Corp.
Flowserve Corp.
TRW Automotive Holdings Corp.
Lubrizol Corp.
CenterPoint Energy Inc.
Family Dollar Stores Inc.
Walter Energy Inc.
Dollar Tree Inc.
Ball Corp.
Hasbro Inc.
Albemarle Corp.
Fossil Inc.
Pinnacle West Capital Corp.
Alliant Energy Corp.
Energen Corp.
Phillips-Van Heusen Corp.

To contact the reporters on this story: Rita Nazareth in New York at rnazareth@bloomberg.net; Michael Tsang in New York at mtsang1@bloomberg.net.

To contact the editors responsible for this story: Daniel Hauck at dhauck1@bloomberg.net; Katherine Snyder at ksnyder@bloomberg.net; Chris Nagi at chrisnagi@bloomberg.net.

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