Recently, the rumor mill went wild on reports that Berkshire Hathaway (NYSE:BRK-B) might be looking to acquire Hershey (NYSE:HSY). While BRK-B stock had a muted reaction, Hershey shares moved to new all-time highs on healthy volume.
Now, it’s far from certain that anything is happening. The chatter appears to be primarily due to the Hershey corporate jet arriving in Omaha recently. Analysts famously scooped a Berkshire/Occidental Petroleum financing deal due to tracking corporate jet activity. Omaha is not exactly the most frequented city for executives, after all. That said, Hershey is an official sponsor of the U.S. Olympic team and there was an event at the time the Hershey jet was in town, so that is a potential alternate explanation.
Anyways, regardless of the veracity of the rumors, this intuitively rings true. After all, one of Buffett’s home run deals was buying See’s Candy, another confectionary company. And Buffett loves folksy American consumer brands. Hershey fits that perfectly.
Hershey is also difficult to take over due to its charitable trust ownership structure. Meanwhile, Buffett is famous for buying assets that required more care and attention than you’d get in a normal M&A process. So, intuitively, it makes sense that Buffett may buy Hershey. Options volume was also huge when the rumors surfaced. However, let’s think about this from Berkshire’s perspective for a minute.
Why Not Buy Hershey?
For one thing, it wouldn’t be timely. HSY stock is already up 38% over the past year, so it’s not like Berkshire would be making an opportunistic purchase at this point.
Given how much power the Hershey charitable trust has to block deals given its massive ownership position, it will take a big premium to get something done. The Trust has successfully blocked previous takeover offers. If, let’s say, Berkshire offers a 30% premium to today’s price, for example, that’d put Hershey at $230 per share, which would be nearly double where the stock was selling a year ago.
Additionally, analysts see Hershey earning approximately $7 per share this year, so that’d put Hershey at something like 33x earnings if Berkshire paid $230 per share to acquire the company.
You could make the argument that this is a viable price in a low interest rates world. Still, Warren Buffett and Berkshire Hathaway do not have a reputation for paying huge multiples to buy consumer products companies. A deal at this sort of valuation would be out of character compared to a typical Buffett purchase.
Investment-Wise, Hershey Is A Unique Business
There’s another less obvious reason why this deal doesn’t make sense for BRK-B stock. Buffett has been looking for places to invest capital in his businesses. At first glance, buying Hershey certainly seems like a way to deploy a solid chunk of cash. But that’s just a one-off event.
The interesting thing about Hershey is that it requires next to no capital to run. Hershey has a stated $5.2 billion of property, plant, and equipment on its balance sheet. However, most of this has been around for ages. Once you build a chocolate factory, you generally don’t have to alter it all that frequently, after all.
Indeed, Hershey holds just $2.5 billion of property, plant, and equipment on its balance sheet once you back out depreciation on its long-lived assets. Meanwhile, Hershey has more than that simply in cash, inventory, and accounts receivables. You won’t find too many non-financial and non-tech companies that hold more current assets than hard assets.
Investors have loved consumer staples for generations because they were the best thing before software: You get fat profit margins, heaps of recurring revenues (once people buy your brand of chocolate, they rarely stop), and it takes almost no capital to keep the business humming. The brand is the asset, not the factories. As such, almost all of Hershey’s profits can go directly into dividends or share buybacks, rather than getting spent on reworking the existing plant, building new factories, replacing machine goods or so on.
Berkshire Needs Capital-Heavy Businesses
Let’s tie this back into Buffett. Buffett needs to deploy a lot more capital. Berkshire Hathaway generates tens of billions of dollars in cash annually. That cash is a drag on BRK-B stock returns if the company doesn’t spend it. Berkshire Hathaway has specifically gravitated into higher-capital intensity industries recently as a way of sopping up excess cash.
Think about Berkshire’s BNSF railroad; buying new rail cars isn’t cheap, and there’s a lot of expense in maintaining all the track and rail buildings as well. Or look at Berkshire Hathaway Energy. Building all those renewable energy assets is designed to put billions of dollars to work annually and get guaranteed 8-10% returns on that capital from friendly state regulators.
Hershey would be the exact opposite of this. The amount of capital required to run Hershey is miniscule. And it’s not like you could put more capital into Hershey to get out much more profits. If you built more chocolate factories, it wouldn’t increase sales much. In other words, Hershey is the sort of business Buffett would have bought 30 years ago, when Berkshire didn’t have much capital yet and needed to focus on increasing its available cash flows without deploying too much money upfront.
Now, Berkshire is in the opposite situation. It no longer wants to buy assets that generate heaps of cash flow off a small capital base. Rather, it wants to own businesses where it can incrementally deploy a ton of capital and get solid returns on invested capital “ROIC” in doing so. Hershey is decidedly not that.
BRK-B Stock Takeaway
So no, I don’t think Berkshire Hathaway is too serious about buying Hershey here. If the Hershey Trust ran into trouble and needed a friendly face to acquire the company, I’m sure Buffett would be an interested buyer. But Hershey is doing fine as is right now, and neither the valuation nor the capital structure at Hershey is likely to get Buffett fired up.
It’s hard to fully close the door on a deal. After all, Buffett loves iconic brands, and he might have some non-economic reasons for wanting to make a bid for Hershey. It is certainly a one-of-a-kind American institution, and Buffett might want to snap it up simply on that grounds, given his love for classic food and beverage companies.
That said, if I had to bet, I’d say Hershey is probably not for sale right now, and it is quite unlikely that Berkshire is making a move for it. For Berkshire, the best investment might be simply repurchasing BRK-B stock; a buyback would help boost interest in the company. Otherwise, look for Berkshire to make investments in industries where it can allocate a ton of cash going forward.
On the date of publication, Ian Bezek held a long position in HSY and BRK-B stock. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.