Why Rolls-Royce should call Berkshire
Rolls-Royce is about to embark on an enormously dilutive capital raise. I think it may be a mistake.
They probably should be calling Berkshire Hathaway to discuss a preference share.
Berkshire is highly unlikely to have been considered due to the very unusual position Berkshire Hathaway is in to do large deals, very quickly. Most companies cannot provide $10 billion dollars within 24 hours from a simple phone call. Berkshire Hathaway can. They may be the only company in the world that can do deals of this magnitude and many still do not think of them during situations like this.
Berkshire Hathaway owns Precision CastParts, Flight Safety and NetJets. They have in-depth knowledge of the aviation industry. As a long-term shareholder in Berkshire Hathaway and an expert on the company, I am confident I am able to suggest this alternative avenue to source capital. I have confirmed with other experts on Berkshire Hathaway that Warren may be amenable to a potential deal such as this. Berkshire Hathaway currently has approximately $147 billion USD in cash. They certainly have the ability to do a large deal.
I am also very aware of commitment bias. It is human nature to want to follow a path that you have committed to, despite evidence that there may be a better path. It is very difficult to be able to change course, regardless of whether changing course may potentially be the most rational decision. The Rolls-Royce team has likely put in long hours organising the capital raise and deals with investment banks. No one likes to be told that their work is to be discarded for a different decision.
So, what is the potential cost to Rolls-Royce shareholders with the proposed capital raise? A 10 for 3 capital raise roughly destroys 2/3 of shareholders ownership in Rolls-Royce. Giving away two thirds of the pie is a decision that wipes away decades worth of equity creation. It is not unreasonable to assume a conservative £1 billion of free cash flow in 2025, and a modest free cash flow multiple of around 12 times, Rolls-Royce could be worth approximately £12 billion. Shaving two thirds off this could be an £8 billion decision.
The cost of the preference share would also have a higher interest rate than the debt Rolls plans to raise. Let’s assume another £300 million off the free cash flow amount, bringing the number down to £700 million per annum in 2025. At 12 times £700 million Rolls could be worth £9 billion.
Obviously, Berkshire would require an element of equity stake in Rolls for a preference share. Let’s assume that this is around £3 billion in the form of a warrant.
This still leaves a disconnect of around £3 billion of potential market capitalisation that will effectively be wiped away with this enormously dilutive capital raise.
A secondary, yet potentially important consideration is the increased market confidence that an investment by Berkshire would attract. A seal of approval by Berkshire Hathaway would likely garner market support around Rolls-Royce and make any further dealings with bankers a less arduous task.
I have deliberately left these calculations very rough. An in-depth analysis would be less than helpful as the accuracy of the free cash flow forecast for 2025 is itself liable to be within a wide range of outcomes.
I am well aware that there may be factors behind the scenes that may preclude a deal of this magnitude being done with Berkshire Hathaway. A phone call to Warren may only take 5 to 10 minutes of their time as Warren is extremely direct. He will say yes or no relatively quickly. I am unable to know whether a deal with Berkshire is possible or not, however, if possible, I am confident that a preference share could save Rolls-Royce shareholders somewhere in the vicinity of £3 billion over the coming years. This is not a decision Warren East should take lightly.