Think of it: Southwest Airlines owned outright by Warren Buffett (or more precisely, by Berkshire Hathaway).

This would be a heck of a turnaround for Buffett, who famously told investors in 2007 that "if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down."

But at least one Wall Street analyst says it's quite possible he'll make the move in 2018. Here's the first part of his case: 

  • In his 2017 letter to shareholders, Buffett spelled out, in no uncertain terms, his thirst for a nice, big acquisition.
  • During 2016, after years of reticence, Berkshire started buying airline stocks in earnest, to the point it became the largest single shareholder in both United Continental and American Airlines.
  • In a recent interview, he uttered eight words that have analysts scrambling: "I wouldn't rule out owning an entire airline."

So, how do we get from predicting Berkshire might buy an airline to trying to identify which specific one? According to Hunter Keay of Wolfe Research, it leads to a specific acquisition: Southwest (or perhaps a bit less likely, Delta).

In a letter to investors Friday, Keay spells it out, by breaking down the five criteria Buffett gave in his 2017 letter:

  1. "durable competitive strengths;"
  2. "able and high-grade management;"
  3. "good returns on the net tangible assets required to operate the business;"
  4. "opportunities for internal growth at attractive returns;" and 
  5. "finally, a sensible purchase price."

Apply those criteria to the airline industry, Keay opines, and you wind up with a clear winner: Southwest (or again, Delta as a backup). They've emerged as "the most likely two candidates," Keay wrote, "due to cash flow, balance sheet, brand reputation, and general overall quality."

Separately, Keay wrote, Southwest "has the characteristics of a typical" acquisition by Berkshire Hathaway, which leads him to believe it's more than likely Southwest. 

Worth noting: Southwest recently was judged the nation's best airline by readers of Consumer Reports.

The issue stopping Buffett from making big acquisitions recently, the Berkshire chairman and CEO wrote in his recent investor letter, is simply that he thinks the valuations of most potential acquisition targets are simply too high.

The potential difference here? Airlines like Southwest have market capitalizations below the norm on Wall Street, analysts say. For example, Southwest's market capitalization is about $35.8 billion as I write this. 

Meantime, Berkshire is flush with cash: About $116 billion in cash and U.S. Treasury bills at the end of 2017. And Buffett and Berkshire vice-chairman Charlie Munger are eager to put it to work.

"This extraordinary liquidity earns only a pittance and is far beyond the level Charlie and I wish Berkshire to have. Our smiles will broaden when we have redeployed Berkshire's excess funds into more productive assets," he wrote last month. 

Published on: Mar 18, 2018
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