Four Deals Primed for Warren Buffett's $40 Billion War Chest

NEW YORK (TheStreet) -- As Berkshire Hathaway's earnings recover from the financial crisis, the investment conglomerate's founder Warren Buffett increasingly faces the challenge of where to plow his cash hoard to generate investment returns.

From large stock buys such as a $10.7 billion purchase of IBM shares last year to mega deals like the $26.3 billion takeover of railroad Burlington Northern Santa Fe in 2009, Buffett's "elephant gun" is the most talked about financial firearm in the markets.

The latest results from Berkshire released last Friday reported cash up from $37 billion to $40 billion at the end of the second quarter. Additionally, the fact that Berkshire sold $3 billion worth of stock in the second quarter gave Buffett watchers just enough information to make the suggestion that he could be selling stock in plans to finance a major transaction.

Bloomberg speculated earlier this year -- after Berkshire's annual meeting -- that Deere , Henkel, Cummins and Mosaic fit within Warren Buffett's stated M&A parameters.

Meanwhile, others wonder whether a string of minor-sized newspaper purchases will preempt a larger deal for the New York Times Company , Gannett or Lee Enterprises -- which Buffett increased his stake in recently -- turning Buffett into a print media mogul.

At this time last year, Berkshire's cash swelled to $47.9 billion only to fall back below $40 billion after it plowed over $9 billion in cash to buy chemicals giant Lubrizol in early 2011.

Meanwhile, after posting strong earnings growth from most businesses in the second quarter, Berkshire may need a next big investment idea to make use of recovering earnings at some housing-related units and growing revenue in new operations like Burlington Northern and Lubrizol.

For instance, Burlington Northern revenue climbed from nearly 7% to $5.1 billion in the quarter, and its earnings were higher by $110 million versus the year-ago quarter.

Berkshire's manufacturing, retail and services business saw across the board increases in revenue versus the prior year. Housing related earnings from Acme Building Brands, Benjamin Moore (paint), Johns Manville (insulation), Shaw (carpets) and MiTek (roofing) were also part of a manufacturing group that saw revenue increase 35% and earnings go higher by 56% versus the year ago period.

In light of the improving Berkshire earnings and the massive cash hoard, here's a look at some unconventional deals that Berkshire could target in coming quarters, as its cash swells to what could be uncomfortable levels.

A wireless bet on DISH Network

Berkshire Hathaway is noticeably underexposed to the telecommunications sector and the global smartphone boom that may put iPhones and Google -powered Android devices into the hands of billions of consumers around the world. With the likes of AT&T and Verizon beyond the reach of even Buffett-sized 'elephant guns,' the Oracle may yet have way to invest in the smartphone boom, as satellite TV giant DISH Network pushes into the wireless market.

DISH and its visionary co-founder and chairman Charlie Ergen are at a developed but still uncertain stage in a plan to build a national wireless service, which could fit within Buffett's buyout and capital expenditure parameters.

After spending years scavenging bankruptcy courts for spectrum -- government regulated airwaves that smartphone data runs over -- Ergen and DISH have some of the best unused wireless assets in the industry, which could be used to build a national mobile broadband network to challenge the likes of Verizon and AT&T. However, DISH's strategy of pushing into the wireless market after building a satellite TV powerhouse carries large risks, including key pending regulatory approvals and the prospect of billions in capital expenditure needed for a build out.

It's the latter capex needs of DISH's prospective wireless strategy where Buffett and Berkshire may have a comparative advantage over just about every other investor. If DISH's wireless assets were approved by the Federal Communications Commission for development -- a decision is expected in the Fall -- Berkshire could plow billions of its excess cash into the development of the network -- with the prospect that the spending initiative could out earn the S&P 500 Index in coming years, as wireless networks hit a capacity crunch.

For Buffett, wireless appears to be a classic business "moated" from competition -- his favorite type of business -- and it would also be a convincing investment in U.S. infrastructure. Few companies have the stomach to enter the wireless business because of the likely tens of billions in capital expenditure needed to build a national network to challenge AT&T or Verizon. Nevertheless, President Obama and the FCC have made it a priority to solve what's expected to be a giant data crunch in coming years, and wireless upstarts appear to be an obvious solution.

In a DISH investment, Buffett could also resort to his traditional value investing discipline and analysis. After acquiring 40 megahertz frequencies from bankrupt industry players DBSD and TerreStar for a combined $3 billion in recent years, DISH's wireless assets may be worth roughly the same as the company's recurring satellite TV business, which currently has over 14 million subscribers, churns out billions in annual free cash flow, and earned $14 billion in revenue and turned a $1.5 billion profit in 2011.

In the first quarter, Berkshire quadrupled its investment in DISH competitor DirecTV , an investment thought to be led by new Berkshire portfolio manager Ted Weschler.

At a market cap of $13.72 billion as of Monday's close, DISH would be digestible for Berkshire and well below the $22 billion that Buffett was willing to spend on his mystery 2011 deal.

For more on DISH Network and the smartphone crunch, see why DISH is taking bets on its wireless hand. Also see why the iPhone 5 is driving telecoms paranoia in 2012, for more on wireless bets.

Buying out the U.S. Treasury's stake in General Motors or AIG

During the financial crisis, Warren Buffett played hero to the U.S. financial system, taking multi-billion dollar preferred share stakes in Goldman Sachs and General Electric that helped stabilize markets just as the U.S. Treasury was hammering out the Troubled Asset Relief Program to bail out "too big to fail" financial institutions like AIG and rescue the near-defunct U.S. auto industry.

While Goldman Sachs and General Electric have since paid their way out of Buffett's bailout, the Treasury is yet to fully exit its investment in AIG and General Motors. Buffett could buy the Treasury's shares in either company, in stock investments that may be poised for future gains after a government exit.

Earlier in August, the Treasury said it would sell a fourth tranche in AIG shares for $5 billion, paring its stake in the bailed out insurer to 53% or roughly $30 billion. While that's down from the 92% stake that Treasury took in AIG as part of its record $182 billion bailout, it likely remains far too large for the government's tolerance. Meanwhile, AIG, which is instituting a multi-billion dollar share buyback program to absorb some of the Treasury's shares, likely doesn't yet have the earnings to purchase many more shares.

With the Treasury set to break even on any AIG share sale at a price $29 or above, Buffett could buy stock at what may be a discounted price that would benefit from AIG's future earnings, which look bright after the insurer reported a strong second quarter earlier in August. In fact, it is the government's stake in AIG and its eventual sale, which may be the biggest current headwind to the company's shares.

A full stake buyout of AIG shares would likely cost in excess of $30 billion, making the deal large even for Berkshire, especially considering its large insurance exposure. Instead, Berkshire could also target some of AIG's soon-to-be divested assets like its aircraft lending arm International Lease Finance Corporation -- supplementing Berkshire's NetJets airplane unit -- or it could target other parts of the Treasury' stock portfolio.

After investing in General Motors in the first quarter, Buffett could build his stake in the recovering automaker by bidding for part or all of Uncle Sam's 26.5% stake in GM, worth $8.25 billion, as of Monday's close.

Currently, GM's shares are near post-IPO lows as a sovereign debt crisis looms large over the automaker's European earnings. Still, with many U.S. buyers expected to use low interest rates to replace what is the oldest U.S.-wide fleet of cars on record, GM could be on the precipice of a renaissance. Were Buffett to expect a European resolution and a cycle of economic growth in the U.S., GM could be a classic value investment, especially as the Treasury tries to put bailouts in its rear view mirror.

For more on AIG, see TheStreet Ratings' report card for the stock.

Buffett bulks up in utilities

Buffett and his top lieutenant Charlie Munger noted at the company's annual meeting that the company's utility arm, MidAmerican Energy, would look to spend $100 billion in the next 10 to 15 years, making utilities an obvious but unheralded part the company's future M&A plans.

While much of that spending is likely to consist of capital expenditure as the cash-intensive utility business serves as a return-generating sink for all that Berkshire cash, the $100 billion estimate leaves room for strategic deals, and could fit with MidAmerican's recent acquisitive ways. Berkshire could swallow an additional utility company, like PG&E or NRG Energy .

In recent years, MidAmerican Energy has tried to cut large utilities deals, offering $4.7 billion for Constellation Energy amid a broad market slump in September 2008. However, MidAmerican withdrew the bid in December after Constellation divested some nuclear businesses to Électricité de France for $4.5 billion. Constellation Energy was eventually sold to Exelon in a deal that received Department of Justice approval last December.

Recently, MidAmerican Energy cut multiple deals to buy solar energy plants being built by First Solar . In two December deals, MidAmerican bought controlling stakes in First Solar's Agua Caliente and Topaz plants, which have multi-year power purchasing agreements with regulated utilities like NRG Energy and PG&E , respectively. An acquisition of either utility could only further MidAmerican's growth and its push into alternative energy.

At a market cap of over $18 billion, PG&E would be right at Berkshire's "elephant gun" parameter, while NRG's near-$5 billion market cap would be easily digestible.

For MidAmerican, the move into solar energy isn't so surprising. MidAmerican is the largest wind energy provider in the U.S. and expects to generate nearly 30% of its capacity from renewable sources by the end of 2012.

For more on utilities M&A, see Fitch Ratings' pick of 10 dividend rich, deal ready utility stocks.

Berkshire rails into coal players Peabody Energy and Cloud Peak Resources

For investors in the coal sector, even a focus on best of breed industry players like Peabody Energy and Cloud Peak Resources has been a big money loser in 2012, amid concerns on the economics of thermal coal and a demand slowdown for metallurgical coal from Chinese buyers. Quietly, Berkshire Hathaway has been on the losing side of coal's 2012 slump, which culminated with the bankruptcy of Patriot Coal in July.

In buying railroad giant Burlington Northern Santa Fe, Buffett became highly exposed to the U.S. coal industry, which uses railroads like BNSF, Union Pacific , CSX and Norfolk Southern to transport the energy source. In fact, in the second quarter, the coal sector weighed heavily on Burlington Northern's earnings, which grew nearly 7% to 5.1 billion for the quarter. While shipment of consumer and industrial products was higher, the weakness in the coal market as natural gas continues to replace coal as a source for power generation offset gains made by Burlington in more cyclical industries. At the time Buffett struck the Burlington deal, and contrary to analysis that it was a transportation play or" bet on America," as Buffett likes to say, coal analysts viewed the deal as a bet on decades of future coal shipments from the West coast to Asian markets.

Companies like Peabody and Cloud Peak with heavy exposure to profitable coal mines in regions like the Powder River Basin of Wyoming may be poised for a pick-up in shipments that would supplement BNSF's and Berkshire's earnings. If Buffett were to be convinced either of the economics of thermal coal or the continued Chinese demand for met coal, which needs to be transported to the West Coast for export, a coal based acquisition might be well-timed vertical integration for Berkshire.

Still, a coal investment would carry significant risk for Buffett, who normally is a conservative investor even when targeting value stocks. Some analysts say that in spite of share losses that shaved between 30% and 50% off of most coal sector stocks, the sector may yet face headwinds and Buffett isn't in the business of catching falling knives.

For more on coal investments, see why China risk is bigger than bankruptcy fears and why old king coal is headed to the retirement home.

See why Warren Buffet shuns investment banks for more on other Berkshire investments.

-- Written by Antoine Gara in New York