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Why FedEx Looks Like It Could Be Buffett's Next Deal

Trying to speculate which business Warren Buffett (Trades, Portfolio)'s Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) will buy next is pretty much a guessing game. Most of the deals he's announced in the past have come out of the blue, mainly because whenever Buffett is associated with any business, its price rises substantially.

However, one company that's recently started to look attractive as a potential Buffett buy is FedEx (NYSE:FDX).

Looking at a deal

At the end of 2019, the president of Seabreze Partners Capital Management, Doug Kass, predicted that Buffett would acquire FedEx in 2020 as he seeks to deploy some of Berkshire's cash pile.

In my opinion, this is definitely a possibility, as FedEx ticks all the boxes of a Buffett buy. For a start, the stock looks cheap. It is off around 41% from its all-time high and dealing at a forward price-earnings ratio of 12.3 as of Jan. 6.

That's dirt cheap for one of the world's largest logistics businesses, which owns and operates one of the world's largest airlines. The company's size and global reputation give it a considerable moat, one that would be difficult to break down even with several billion dollars of investment (another critical Buffett test).

Second, the company is well within Buffett's price range. With a market cap of $41 billion at the time of writing, Berkshire could afford to pay a 20% premium and still have nearly $80 billion of cash on hand. That would give Buffett a large cash cushion to hand over to his successors while still leaving enough money to cover any significant insurance losses.

Third, FedEx has a large owner who might be looking for a buyer. Fred Smith, the founder and CEO of FedEx, owns 7.5% of the outstanding shares. A deal would hinge on whether or not Smith would want to stay as FedEx's manager. We know Buffett only likes to buy businesses that have high-quality management teams that can operate on their own. He's said before that he wants to buy managers who will stick with the business not because they need the money, but because they love their jobs.

Smith certainly does not require the money (and won't at all if Berkshire buys the business), and it seems he's happy to work a bit longer. Earlier this year, FedEx changed its retirement rules to let Smith stay on after he turned 75 in August. His heir apparent abruptly retired in February.

The fourth and final Buffett acquisition test is if he understands the business. You can make a good argument here that he certainly does understand FedEx. Not only does Buffett have a good insight into distribution with Berkshire BNSF subsidiary, but Berkshire also owns a distribution business called McLane Company, which he acquired from Walmart Inc. (WMT) in 2003 for $1.5 billion. The company has the highest revenues of any service business in the Berkshire group.

I know Buffett dislikes the word "synergies" and never merges any of the businesses he acquires. Still, it is hard to ignore the fact that McLane, which earned around $25 billion in revenues last year, would be a great merger candidate for FedEx. Logistics and distribution is a low margin business where scale matters. McLane, for example, earned a pre-tax margin of 0.18% last year. FedEx's profit margin was around the same level.

Combined, FedEx and McLane would have sales of nearly $100 billion, giving the two companies unrivaled pricing power, which could be enough to improve margins just with bulk discounts from suppliers. Such a merger is unlikely ever to happen, but it's interesting to consider anyhow.

All in all, it looks to me as if FedEx ticks most of the boxes when it comes to Buffett's acquisition criteria. It'll be interesting to see if he makes a move over the next 12 months.

Disclosure: The author owns shares in Berkshire Hathaway.

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This article first appeared on GuruFocus.