Image Source: The Motley Fool
Billionaire investor Warren Buffett is famous for going big when investing. With the amount of money he has to invest in Berkshire Hathawaysmall amounts of shares are not going to be enough.
He has often bought entire companies, and that got me thinking. Could Buffett buy Rolls-Royce holdings (LSE: RR.)? And if you could, is it the type of company you could choose?
After recent share price gains, Rolls-Royce now has a market capitalization of £12.8bn. To make a successful offer, a buyer would presumably have to offer more than that, but it will work as a baseline valuation.
stacks of cash
At the end of 2022, Berkshire Hathaway had cash on hand of $35.8 billion (£30 billion). So yeah, it’s pretty easy to buy Rolls-Royce with what is essentially petty cash.
By the way, in the last 2022 letter to shareholders, Buffett noted that “Berkshire will always have a pot full of cash,” adding that “We will also avoid behaviors that may result in uncomfortable cash needs at inopportune times..”
It’s hard to imagine a company owned by Warren Buffett facing a debt crisis. So what would it take to acquire Rolls debt free?
debt drop
As of December 2022, net debt has been reduced significantly to £3.3bn. Thanks to disposals and improved cash flow, Rolls had brought it down from £5.2bn a year earlier.
That means buying Rolls-Royce at the current share price and paying off its debt, any would-be Buffett would have to shell out £16.1bn. Again, Berkshire Hathaway’s cash pile would easily cover that.
But what valuation does it represent? Current price-earnings (P/E) valuations don’t really mean much. At least, not at this point in a company’s recovery, when it is expected to still be well below its long-term earnings potential.
earnings growth
Looking ahead, analysts expect Rolls’ earnings to grow strongly over the next three years. And that would drive the P/E of the stock down to 15.5 by 2025. However, it doesn’t factor in the debt portion of the potential buyout.
With debt adjustment, our acquisition proposal would be based on an effective forecast P/E of around 19.5. That’s known as enterprise P/E value, and it helps us compare companies with different levels of debt in a more meaningful way.
I now consider it highly unlikely that Buffett would consider an approach for Rolls-Royce. But I do think that looking at what you would have to pay to acquire the company is valuable to private investors.
Rolls is a buy?
Like Buffett, when I think about buying stock, I consider whether I would be comfortable owning the entire company.
Do I think an enterprise value P/E of almost 20 is fair value for Rolls-Royce right now? With its long-term earning potential, I think it is. But I don’t qualify it as screaming cheap. After all, I’m making risky three-year forecasts here.
There is also a ways to go before the solid gains start flowing again. And we need to see further debt reduction financed by operating cash flow.
But yeah, to me Rolls-Royce stock now looks like a decent long-term buy.
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