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January 31, 2005 |
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Following the takeover announcement, Warren Buffett said “It's a dream deal. To quantify that, I intend to purchase enough shares so that by the time the deal is closed, we will have 100 million shares of P&G.” Does this rare outburst of enthusiasm from Mr. Buffett contradict his ‘buy when others are fearful’ beliefs? In a word, yes.
What the above statistics also demonstrate is that each company can, and will, suffer temporary financial setbacks. In the case of PG, ending a three year decline in earnings and a free cash flow miss (2000), the company logged a rare decline in revenues in 2001. As for G, the company’s recent financial turnaround remains marred by the fact that the company is still behind its 1997 revenue pace. Given the long and prosperous history of each company it would be unrealistic to argue that PG and G are prone to financial setbacks. Rather, financial setbacks at PG and G are few and far between. Even so, the investor should be aware of how damaging any decline in financial performance can be to these perfectly prices companies.
When the 1990s mania came crashing down G lost more than 50% of its stock market value (from intra-year peak to intra-year bottom). As of last week, G had rallied by more than 100% off of its 5-year lows. No valuation statistic is screaming undervaluation today. Rather, both companies are perfectly priced. What is Buffett Thinking? Mr. Buffett previously said that he made a mistake not selling Gillette during the late 1990s. Buffett went on to say that “They (Coke and Gillette) weren't the focal point of the bubble, but they achieved bubble prices.” With Gillette shares surpassing $50 a share last week for the first time since 1999, is Buffett’s optimism an indication that the 1990s stock market excesses no longer exist? Hardly. Rather, Buffett continues to hoard cash and warn of an increasingly challenging investment environment.
So why is Buffett going to take some paper gains on Gillette and roll them into PG/G stock? The most logical explanation is that Buffett believes that synergies between the two companies will arrive rapidly. In fact, no other explanation makes much sense. As for Buffett publicly announcing his intentions to purchase (more) P&G stock, this contradicts Buffett’s belief that that Berkshire should be granted special rights by the SEC to conduct stock purchases in secrecy so that other investors do not bid up share prices trying to follow his lead. The SEC need only play a tape of Buffett’s excitable words the next time the Oracle of Omaha asks for permission to buy stock in secrecy. In short, given that both PG and G are trading at extremely rich valuations, Buffett’s reaction to the PG/G deal is surprising Mr. Buffett could have picked up some PG for more than 50% lower than the price today, and/or Buffett could have purchased PG last year when valuation levels were somewhat more attractive. That Mr. Buffett didn’t think P&G was attractive enough to own before the takeover announcement speaks volumes. As for P&G’s gamble on G, it will undoubtedly pay off in the long-term. However, one financial setback is all it will take to send the current price of PG shares tumbling. PG shareholders need to | ||||
