Berkshire Hathaway, Inc. ( BRK.A, BRK.B) has more than $100 billion in cash cash on its balance sheet at the moment, and Morgan Stanley analyst Kai Pan says Berkshire CEO Warren Buffett may be eyeing a buyout of Southwest Airlines Co (NYSE: LUV).
Berkshire already has large investments in Southwest, Delta Air Lines ( DAL), United Continental Holdings ( UAL) and American Airlines Group ( AAL), and Pan says Southwest makes the most sense as a potential full takeover candidate.
According to Pan, Southwest meets all of the requirements Buffett typically has for an acquisition target, including a simple business model, consistent earnings, a strong management team and relatively little debt. Southwest's market cap of just $35.2 billion also makes it a reasonable size for a potential Berkshire acquisition.
"Our screen of potential airline acquisitions by Berkshire suggests Southwest could fit well into Berkshire's family given its acquisition criteria, ownership of capital-intensive businesses, and deployable $100 billion-plus cash balance," Pan says.
Pan says Morgan Stanley has seen no direct evidence that Berkshire is considering a Southwest buyout, but the two companies are hypothetically a good fit.
"Berkshire focuses on quality of business and management in acquisition, which could make for an obvious pairing," Pan says.
Some investors are speculating that, by buying large stakes in all the major U.S. airlines, Buffett is following the same blueprint he used in the railroad industry roughly a decade ago. After initially buying large stakes in Burlington Northern Santa Fe, Norfolk Southern Corp. ( NSC) and Union Pacific Corp. ( UNP), Buffett eventually opted to take over Burlington Northern entirely and dump his other railroad investments.
If Berkshire makes a bid for Southwest, Pan says investors can expect a price of between $70 and $80 per LUV share.
Regardless of the buyout speculation, Bank of America analyst Andrew Didora says LUV is currently the best game in town for airline investors.
"We believe LUV is the highest quality airline in the group with a very conservative balance sheet and low earnings volatility," Didora says.
However, he says industry headwinds could limit upside for LUV stock in the near term.
"Based on published schedules, LUV's capacity will significantly accelerate throughout 2018, which could limit the carrier's [revenue per available seat mile] growth," Didora says.
Morgan Stanley has an "overweight" rating and $67 price target for Southwest. Bank of America has a "neutral" rating and $60 target for LUV stock.
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