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What's Behind Berkshire Hathaway Inc's Big DaVita Buy?

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Is there truth to the takeover rumors?

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Warren Buffett's Berkshire Hathaway Inc.(NYSE:BRK.A) (NYSE:BRK.B) currently sits atop its largest cash cache ever -- $69 billion. So its not surprising that takeover rumors surfaced early this month when Berkshire added to its already hefty stake of about 13% in DaVita HealthCare Partners Inc. (NYSE:DVA). The $12 billion market cap behemoth provides kidney dialysis services to hospitals and dialysis centers throughout the US.

However, the takeover rumors are just that – rumors, with little to back them up right now. In May of this year, the two companies reached a standstill agreement in which it was stipulated that Berkshire could acquire no more than 25% of DaVita, and that Buffett's firm will not propose any "business combination, merger, tender offer, exchange offer or similar transactions" without consent from DaVita, according to Bloomberg.

That doesn't mean that Berkshire has lost interest in one day owning a larger stake in the firm, however.

Jumping In on the Plunge

Berkshire has been building a position in DaVita since the fourth quarter of 2011. The stage was set for Berkshire's latest big purchase, however, on July 1, when the Centers for Medicare & Medicaid Services (CMS) unexpectedly announced a proposed rule to cut payments to large dialysis companies by as much as 12% starting in 2014. If approved, the move could close the doors of some smaller dialysis facilities.

After the announcement, many DaVita shareholders headed for the exit. By July 2, its share price had dropped by 6% from the day earlier, and by about 13% from the yearly high reached in May. That day, Berkshire portfolio manager Ted Weschler, known for finding value in distressed companies, moved to buy another 639,400 shares of DaVita, boosting its stake to 14.8%, for a total transaction value of $73.37 million. Also on July 2, Zacks Investment Research upgraded Berkshire Hathaway to a Zack's Rank No. 1 Strong Buy.

Since the July 2 purchase, DaVita's share price has climbed, recovering from an average purchase price of $114.78, to a close of $121.23 for the week ending July 12. Berkshire's move to increase its stake in the firm likely fueled the stock's price hike. DaVita owns about 2,000 kidney dialysis centers throughout the US and provides dialysis services to almost 1,000 hospitals.

A final ruling on the cuts is expected in October. Currently the CMS has opened the proposal to public comment until August 30. The opposition quickly shared their concerns. Among those against the cuts are the National Kidney Foundation (NKF), and Kidney Care Partners (KCP); the latter group's Chairman Ron Kuerbitz urged health-care policymakers to "proceed with caution" in considering adjustments to Medicare's End Stage Renal Disease (ESRD) program. The proposed cuts would take about $30 from the approximately $246 that Medicare currently pays for a 3-4 hour dialysis session.

"People with kidney failure are among our most vulnerable Medicare beneficiaries," said Kuerbitz. "Proposed cuts of this magnitude simply go too far. We are deeply concerned about the implications for dialysis patients and the sustainability of the Medicare ESRD system, especially in rural and inner city areas."

Still, the CMS proposal could go through. Supporters of the cuts contend that the End Stage Renal Disease program allows patients with kidney failure to benefit from a disproportionately large slice of Medicare dollars spent. Currently, although ESRD patients represent just 1% of the Medicare population, they account for almost 7% of the Medicare budget, averaging $20 billion in spending per year. That figure balloons to $40 billion annually when costs for the care of Medicare patients with chronic kidney disease (CKD) are factored in.

Staying Friendly

Either way, speculation about Berkshire's future with DaVita lingers despite the standstill agreement signed in May, and for good reason.
Berkshire, which DaVita's Chief Legal Officer described as "a supportive investor with a long-term view" during a call with investors, reached the agreement with DaVita as a way to signal to the market that the relationship is friendly.

Under the new contract, a buyout is not possible without consent from DaVita, meaning the agreement only blocks unfriendly advances.

And as Michael A. Mazzeo, associate professor of finance at Michigan State University told Bloomberg news: "Berkshire's just not known for making hostile takeovers. They make friendly ones. And so, this might be a way of simply beginning that dialogue."

In other words, stay tuned.
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