Billionaire investor Warren Buffett is famous for going in big when he makes an investment. With the kind of money he has to invest at Berkshire Hathaway, small amounts of stock aren’t going to cut it.
He’s often bought out whole companies, and that got me thinking. Could Buffett buy Rolls-Royce Holdings (LSE: RR.)? And if he could, is it the kind of company he might go for?
After recent share price gains, Rolls-Royce now has a market-cap of £12.8bn. To make a successful bid, a buyer would presumably have to offer more than that, but it’ll do as a baseline valuation.
Piles of cash
At the end of 2022, Berkshire Hathaway had cash on hand of $35.8bn (£30bn). So yes, there’s easily enough to buy Rolls-Royce from what is essentially petty cash.
Incidentally, in the latest 2022 letter to shareholders, Buffett pointed out that “Berkshire will always hold a boatload of cash,” adding that “We will also avoid behavior that could result in any uncomfortable cash needs at inconvenient times.”
It’s hard to see any company owned by Warren Buffett running into a debt crisis. So what would it take to acquire Rolls on a debt-free basis?
Falling debt
At December 2022, net debt was significantly reduced at £3.3bn. Thanks to disposals and improving cash flow, Rolls had got it down from £5.2bn a year previously.
That means to buy out Rolls-Royce at the current share price and pay down its debt, any wannabe Buffett would need to stump up £16.1bn. Again, the Berkshire Hathaway cash pile would easily cover that.
But what valuation does it represent? Current price-to-earnings (P/E) valuations don’t really mean much. At least, not at this point in a company’s recovery, when it’s hopefully still well below its long-term earnings potential.
Earnings growth
Looking at forecasts, analysts expect earnings at Rolls to grow strongly over the next three years. And that would bring the stock’s P/E down as low as 15.5 by 2025. It doesn’t account for the debt part of the potential buyout though.
Adjusting for debt, our mooted takeover would be based on an effective forecast P/E of around 19.5. That’s known as an enterprise value P/E, and helps us compare companies with different levels of debt more meaningfully.
Now I judge it very unlikely that Buffett would consider an approach for Rolls-Royce. But I do think that looking at what he’d have to pay to acquire the company is valuable for private investors.
Is Rolls a buy?
Like Buffett, when I ponder buying shares, I consider whether I’d be comfortable owning the whole company.
Do I think an enterprise value P/E of nearly 20 is fair value for Rolls-Royce right now? With its long-term earnings potential, I reckon it is. But I don’t rate it as screaming cheap. After all, I’m going on risky three-year forecasts here.
There’s also some way to go before solid earnings start flowing again. And we need to see further debt reduction being funded by operational cash flow.
But yes, for me, Rolls-Royce shares look like a decent long-term buy now.
