Recently, there have been rumors that Warren Buffett is considering the outright purchase of Southwest Airlines after Buffett indicated during a CNBC interview that he would not rule out the prospect of owning an entire airline and online rumors suggested that he was in communication with Southwest’s Board of Directors about purchasing Southwest outright for $75 per share.
I will say this about the speculation: If Buffett is contemplating purchasing an airline, it will almost certainly be Southwest. As you may know, Southwest is unique in that: (1) it has a strong cash-positive balance sheet with $3.6 billion in cash and $3.3 billion in debt; (2) it has no preferred stock outstanding or any pension that would require perpetual redress; and (3) Southwest has not had an unprofitable year aside from the 9/11 aftermath, and even managed to earn profits of $140 million to earn $140 million in profits in 2009 when the rest of the cyclical airline industry was collapsing.
Nowadays, Southwest is generating $3 billion in profits for its shareholders. Compared to its peers, the profits are the most unencumbered because there is no pension or debt overhang and Southwest’s labor costs are low compared to peers. These considerations are classic indicators of a Buffett investment.
I see these contrary opinions that suggest Warren Buffett should buy Delta outright, which I regard as a near-zero possibility. Delta carries $10 billion in debt against $1.7 billion in cash. Buffett’s outright acquisitions do not carry high debt burdens. Also, there is an underfunded pension, as Delta has $22 billion in pension obligation but only has funded it to the tune of $15 billion.
Given the current market cap of $33 billion, Buffett would have to pay around $50 billion to acquire the company lock, stock, and barrel, and then the company would require an additional $15 billion over time to pay for the pension and debt. Even though those obligations could be funded from Delta’s current cash flows, Buffett doesn’t walk into those arrangements.
And finally, when Delta is at its worst, it incurs losses. Between 2008 and 2009, Delta lost $1.5 billion. Although Buffett speaks about being able to tolerate cyclical losses provided they are well compensated, his actual style is to buy companies that are still profitable and sending him cash even at the bottom of their industry’s respective business cycle. The fact that Southwest was eking out a bare $100+ million profit at a time when Delta was losing over a billion during the last recession is something that I believe is an important consideration to Buffett, along with the balance sheet debt and pension obligations.
Buffett knows his market history. Southwest has delivered 25% annual returns since its 1971 IPO. Most of the other carriers have either gone bankrupt at some point or dramatically underperformed the market. Given the absence of any pension, as well as the strong balance sheet, I would say that if Warren Buffett adds an airline outright to Berkshire Hathaway’s portfolio, it would be Southwest. I do not believe any of the other major carriers are under Buffett’s consideration for an outright acquisition.