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What Does Buffett See in Batteries?

Given the commodified, low-growth nature of the battery business, Berkshire's exchange of P&G shares for Duracell may have some other motivations.

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We're not sure what to make of wide-moat Berkshire Hathaway's $4.7 billion purchase of the Duracell battery business from Procter & Gamble, another wide-moat firm. While one would have expected to see Warren Buffett use some of the more than $40 billion in excess cash on Berkshire's books at the end of the third quarter to finance a deal of this size, the transaction has actually been structured as a tax-exempt transfers of assets, with P&G accepting Berkshire's 52.8 million share equity stake in the consumer products firm (worth $4.7 billion at yesterday's market close) for Duracell. That said, it remains to be seen whether P&G's $1.8 billion pre-transaction recapitalization of the battery business will be viewed as a taxable event for Berkshire. We are leaving our fair value estimate in place.

While Duracell is at first glance a classic Buffett type of name, with the Oracle of Omaha even referring to it as a "leading global brand with top quality products," our general take on the battery business has been that it is a commodity business where price tends to be more important to consumers than brands, with the major players having to invest heavily in research and development just to stay one step ahead of the competition. Although the price that is being paid by Berkshire--of 7 times fiscal year 2014 adjusted EBITDA (and 9 times adjusted EBITDA on a cash sale basis)--is well below the 12 times EBITDA that Buffett paid for Heinz, we think the growth prospects for Duracell's core battery business are limited longer-term, given the growth of electronic devices with their own rechargeable batteries.

Ultimately, we see Buffett as basically helping P&G offload a noncore business in a deal that allows Berkshire to eliminate a large investment stake with an extremely low cost basis (of $336 million) without taking too meaningful of a tax hit, and eliminating at least one legacy holding that his two lieutenants would have had to deal with longer-term.

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Greggory Warren does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.