Capital Return

[marazul]

Cash is fastly approaching the $150bn mark which Buffett has referred in the past as "unjustifiable". If there are no major investments in the next 2 years, Berkshire will just have too much cash. Is there a way for Berkshire to return capital in a tax efficient way for investors? If it is a regular dividend, most investors would get 70 cents on the dollar. Is there a solution for this problem? obviously, besides repurchases. In the past, Buffett has been creative in deferring taxes (e.g. PG-Duracell transaction). I see it unlikely he would just pay the dividend and return 70 cents on the dollar to investors.

[gfp]

beyond repurchases, the only real solution is to make a very large acquisition.  Berkshire can afford to make an all-cash acquisition much larger than most media outlets speculate.  With access to the stock portfolio and extremely attractive bond rates, Berkshire can afford to buy a very large company.  ExxonMobil would not be too large for Berkshire to acquire for cash at this point.

 

People always speculate that appreciated securities could be spun out tax efficiently, but I do not see that happening.  Assets inside the insurance subsidiaries will likely stay inside the insurance subsidiaries.

 

Repurchases and acquisitions are the only real solution (apart from additional purchases of marketable securities and OXY-type deals).

[scorpioncapital]

Danaher recently made an interesting transaction. It offered to redeem DHR shares for shares in a division it spun-off. Now some may claim this is offloading a poorer business and redeeming higher quality DHR shares. Not saying Berkshire would do this but it could perhaps do something similar if it wanted to divest of some asset that was not bad - but not great to the public.

[Gregmal]

Dont poke the bear!

 

And FWIW, if good old reliable VMware was enough to give some fits, mainly it seems because a Barrons author wrote a negative piece or something, no way XOM goes over well....too many risks, in a universe where it seems any risk becomes a justification not to make an investment.

 

With all the very smart people at Berkshire, I dont see why the dont have a team together who's job is to aggregate a bunch of $1-$20B businesses with synergies and simultaneously make offers to take them all out. Theres just way too many excuses and not a lot of them add up. This company is too small, this is too big, this one is not "Buffett like", this one is too levered, that one is owned by a friend, this one is too controversial....its all bullshit.

 

Its a selfish, ego driven gambit. Best thing he could do if he trusted his "lieutenants" would be to start spinning out some of their businesses and allocating chunks of the cash to their managers. Let them decide to either roll up smaller competitors/grow the business win a way that the scale could create more value or return it to shareholders.

[BG2008]

Dont poke the bear!

 

And FWIW, if good old reliable VMware was enough to give some fits, mainly it seems because a Barrons author wrote a negative piece or something, no way XOM goes over well....too many risks, in a universe where it seems any risk becomes a justification not to make an investment.

 

With all the very smart people at Berkshire, I dont see why the dont have a team together who's job is to aggregate a bunch of $1-$20B businesses with synergies and simultaneously make offers to take them all out. Theres just way too many excuses and not a lot of them add up. This company is too small, this is too big, this one is not "Buffett like", this one is too levered, that one is owned by a friend, this one is too controversial....its all bullshit.

 

Its a selfish, ego driven gambit. Best thing he could do if he trusted his "lieutenants" would be to start spinning out some of their businesses and allocating chunks of the cash to their managers. Let them decide to either roll up smaller competitors/grow the business win a way that the scale could create more value or return it to shareholders.

 

He's a collector.  Like an old stuffy guy who collects model trains or Picassos except he collects real railroads etc.  He's not going to split it up.  I'll bet that the 331,000 share price is a reminder that it once traded at $7 or something for that crappy textile company.  Still a great guy and can't thank him enough. 

[alpha asset strategies]

Dont poke the bear!

 

And FWIW, if good old reliable VMware was enough to give some fits, mainly it seems because a Barrons author wrote a negative piece or something, no way XOM goes over well....too many risks, in a universe where it seems any risk becomes a justification not to make an investment.

 

With all the very smart people at Berkshire, I dont see why the dont have a team together who's job is to aggregate a bunch of $1-$20B businesses with synergies and simultaneously make offers to take them all out. Theres just way too many excuses and not a lot of them add up. This company is too small, this is too big, this one is not "Buffett like", this one is too levered, that one is owned by a friend, this one is too controversial....its all bullshit.

 

Its a selfish, ego driven gambit. Best thing he could do if he trusted his "lieutenants" would be to start spinning out some of their businesses and allocating chunks of the cash to their managers. Let them decide to either roll up smaller competitors/grow the business win a way that the scale could create more value or return it to shareholders.

 

He's a collector.  Like an old stuffy guy who collects model trains or Picassos except he collects real railroads etc.  He's not going to split it up.  I'll bet that the 331,000 share price is a reminder that it once traded at $7 or something for that crappy textile company.  Still a great guy and can't thank him enough.

 

I think BG2000 "hit the nail on the head"; Buffett is undoubtedly an "empire builder".  As such, he has little desire to shrink the company via spin-offs, stock repurchases, etc.  Investors have obviously seen some nominal share repurchases, but I often wonder just how far the stock would need to fall before Buffett would make some major repurchases (ie. 10%+)?

[CassiusKing1]

Maybe Michael Bloomberg will have to divest himself of the company and Buffett can pick it up in an all cash private deal, lol.

[chrispy]

It seems that a correction of some sort is required before BRK can deploy any of it's cash. Therefore, BRK will also be more cheap.

[Guest longinvestor]

“Just the stuff we have is enough”- Munger in the 50th year letter.

 

Some day the cash drag will result in the per share earnings growth to trickle down. Well, it has; from the high teens to the low teens.

 

 

[DooDiligence]

Why not reboot just like he did with the dissolution of the early Buffett partnership?

 

Then we'd see if he really could rip it up with a smaller capital base.

 

www.businessinsider.com/why-warren-buffet-closed-down-his-first-fund-2016-9

[BroKon]

Maybe Michael Bloomberg will have to divest himself of the company and Buffett can pick it up in an all cash private deal, lol.

 

That's not actually such a bad idea. Bloomberg fits all Buffett's criteria around moat and pricing power, and it must throw off enormous amounts of cash. He would pay a fair price for it, and Bloomberg might need a quick sale (although probably not).

[scorpioncapital]

It seems that a correction of some sort is required before BRK can deploy any of it's cash. Therefore, BRK will also be more cheap.

 

I don't take the first sentence as necessarily true. I've seen Buffett often buy when there is just a very long period of flatlining. Philip Fischer said don't time the price of purchase but rather just purchase the time, as in, invest on a regular basis as time and opportunity dictate.

[Dynamic]

I would agree with scorpioncapital. I've usually had the impression that Buffett prices his purchases to achieve an adequate margin of safety and enhance forward returns, but that gives the illusion of unusually good timing. Pricing the market often looks like timing the market.

 

On a few occasions, I've been lucky enough to notice the same effect with my own portfolio - setting the price to buy or sell has seen me buy within a hair of the bottom tick immediately prior to a major run up or on one occasion to sell a large position based on risk/reward balance the day before last year's mini bear market started (which helps offset my index-lagging portfolio market value performance this calendar year). It also caused me to miss opportunities, for example in Apple, this January, by insisting on a margin of safety that never quite came, thus not buying around $145 (and it's now $264). If I had got in at around $135, however, my return would have been greater, so it's a fine balancing act.

 

A deal like BNSF was probably based on seeing something about the long term future profitability of the railroad business including the west coast tailwind from Chinese trade and from low cost debt unsecured by Berkshire that the market didn't fully recognise or price in. Berkshire was derided for over-paying in many quarters at the time.

 

I am sure it was helped by the post GFC market conditions and the temporarily depressed railroad earnings in 2009 that Berkshire could offer an acquisition premium and still end up with something around 18% IRR over 10 years or so, as a great blog post this January mentioned. Essentially, the whole purchase price has already been returned in dividends to Berkshire (juiced a little by adding debt) and in addition the railroad would be worth about 3 times the purchase cost (with 1.5x the revenues in 2009), giving more than a 4-fold return in 9-10 years.

 

I think there can still be opportunities to identify large businesses with untapped pricing power, recovery trends or secular tailwinds, that can therefore return a lot of value to their owners over time, but there will be fewer such opportunities in relatively bullish markets where very cheap debt is in abundance and competitors for acquisitions are paying relatively full prices. So I'd still expect some acquisitions to occur in buoyant market conditions on a very sporadic basis (statistically), but for more of them to occur in depressed conditions simply on the basis that Berkshire consistently prices its purchases for a good long term return regardless of market conditions and that this only rarely puts them among the top payers in the market who tend to most of the acquisitions unless the market is depressed and many competitors are lacking funds.

 

I don't think it's timing, but it's unwavering pricing discipline.

[DooDiligence]

This seems like a good list for BRK to prospect.

 

www.nceo.org/articles/employee-ownership-100

 

I don't know how friendly any of these companies would be to a buyout, but the hands off / shareholder friendly philosophy of BRK seems like it would fit well with a majority employee owned business.

 

If top management were onboard, they could sell the idea to employees.

 

Have they ever bought similarly owned businesses?

 

---

 

Waffle House isn't on this list but seems like it would be a strong business.

 

www.eater.com/2017/5/2/15471798/waffle-house-history-menu

 

Too bad we missed What-A-Burger.

I almost never see coupons & the restaurants are always busy.

Employees seem happy & I've never experienced attitude or bad food.

Kind of like the Publix of fast food.

[gfp]

This seems like a good list for BRK to prospect.

www.nceo.org/articles/employee-ownership-100

 

Weird that they left Kiewit off that list

[SwedishValue]

For me, the astounding thing is not that Buffett is being patient with deployment of capital. Rather, it is that he has had opportunities to deploy capital in securities he liked where volume was readily available (BRK, JPM and airlines comes to mind where he bought for pennies) - but he preferred to instead allocate capital to US treasuries.

 

At some point above 100 BN in excess cash, one should prefer to increase more rapidly the ownership of securities that are trading below intrinsic value, rather than allocating it to treasuries. Buffett, quite obviously, disagrees with me.

 

With the recent small run-up in BRK and bigger in JPM, I’d expect the likelyhood of any investment other than capex and US Treasuries to materially have decreased.

[Spekulatius]

Timely post:

https://berkshirebuffettandbeyond.com/2019/12/03/has-buffett-lost-it/

 

For example, after doing the Cap Cities deal in 1985, Buffett went 3 YEARS without buying a SINGLE stock. Then he made one of his best investments ever, taking a huge and outsized position in Coca-Cola.

[SwedishValue]

I think it's wishful thinking to liken the situation Buffett experienced from 1985 to 1988 to the situation of today.

 

A few considerations:

 

Back in 1988, the one good idea (Coca Cola) made Buffett able to deploy 1/3 of Berkshire capital within a year in a listed company from simply buying a large part of daily volume. For something similar to happen today, Buffett would need to deploy well in excess over 100 BN USD in months. I don't think this could be done in -any- listed stock on the planet.

 

Back in 1988, Buffett could get very material impact from a good 1 BN USD deal. A 10 BN USD deal today would barely move the needle at Berkshire.

 

Back in 1988, the larger investment universe available to Buffett made waiting make more sense.

 

If you're fine with waiting, good for you. Today, after prices have gone up on securities he recently liked, I'm also fine with waiting. I just don't understand the priority in doing minescule buybacks and preferring to invest more in US Treasuries when BRK and JPM were available at prices where he liked the stocks. At his portfolio size, I think it's better to make use of intellient investment opportunities when available, rather than waiting for the once in a decade type of dip.

[Munger_Disciple]

I think it's wishful thinking to liken the situation Buffett experienced from 1985 to 1988 to the situation of today.

 

A few considerations:

 

Back in 1988, the one good idea (Coca Cola) made Buffett able to deploy 1/3 of Berkshire capital within a year in a listed company from simply buying a large part of daily volume. For something similar to happen today, Buffett would need to deploy well in excess over 100 BN USD in months. I don't think this could be done in -any- listed stock on the planet.

 

Back in 1988, Buffett could get very material impact from a good 1 BN USD deal. A 10 BN USD deal today would barely move the needle at Berkshire.

 

Back in 1988, the larger investment universe available to Buffett made waiting make more sense.

 

If you're fine with waiting, good for you. Today, after prices have gone up on securities he recently liked, I'm also fine with waiting. I just don't understand the priority in doing minescule buybacks and preferring to invest more in US Treasuries when BRK and JPM were available at prices where he liked the stocks. At his portfolio size, I think it's better to make use of intellient investment opportunities when available, rather than waiting for the once in a decade type of dip.

 

+1

 

Excellent post. The only argument I would have against JPM is that Berkshire already has a big exposure to banks. However you are 100% right about buybacks (or the lack thereof). Just the whole buyback drama (announcing a P/B threshold, upping it & then finally getting rid of it) is poorly executed in my opinion.

[Dynamic]

On the subject of banks, I think they could provide an outlet for around a hundred billion of dollars more of sensible capital allocation for Berkshire if the bank holding company rules are relaxed in the next year or two and Berkshire is granted confidential treatment by the SEC, the second condition being rather unlikely.

 

Already, Berkshire has passively come to own slightly over 10% of Bank of America (BAC) thanks to their buybacks, yet has actively avoided exceeding 10% ownership of Wells Fargo (WFC) with whom I believe Berkshire has a closer business relationship. At the prices they apparently paid, I'd say that these represent 10%+ return opportunities with decent dividends and with buybacks to further improve returns by increasing ownership percentage over time.

 

Right now, with the 10% rule in place but 25% being considered as a new threshold for being deemed to be a Bank Holding Company, Berkshire has banks as 33.7% of its total equity portfolio (excluding Kraft-Heinz but including the OXY preferred), with the following holding weightings in Financials, based on my quick perusal of the list at 3rd Dec 2019 closing prices:

 

BAC 13.24% Bank of America

WFC 8.97% Wells Fargo

AXP 7.52% American Express (not a bank)

USB 3.75% US Bancorp

JPM 3.32% JP Morgan Chase

MCO 2.36% Moodys Corp (not a bank)

BK 1.73% Bank of New York Mellon

GS 1.70% Goldman Sachs (investment bank)

V 0.82% Visa (not a bank)

PNC 0.62% PNC Financial (regional bank)

MA 0.60% Mastercard (not a bank)

MTB 0.37% M&T Bank

TRV 0.34% Travelers Corp (not a bank P&C Insurance)

SYF 0.33% Synchrony Financial (not a bank)

GL 0.27% GlobeLife (was Torchmark - insurance)

BIT:CASS 0.05% Societa Cattolica di Assicurazione - Societa Cooperativa (not a bank Insurance)

 

Total Financials 45.63% ($107.2bn)

Banks only total 33.70% ($79.2bn)

 

With an increase to 25% bank holding company rule, there's at least scope for bank investments valued at $200 billion at current prices at about the current ratios of the existing 10% or less holdings, meaning that if purchased at current prices, $120 billion of cash could be used on purchasing stock in banks.

 

There is one stumbling block, however, separate from the Fed's bank holding company rules.

 

SEC rules require companies to report trades within 5 days if they own more than 10% of a company and these would be made public unless a confidential treatment order is granted (which is exceptionally rare these days, it seems). I could imagine Berkshire as a committed non-bank-holding-company and an entirely passive owner, might be considered for confidential treatment, but this is far from certain and perhaps is considerably lower than a 50% probability.

 

BAC's volume of around 57 million shares per day at $33 gives about $1.9bn traded value per day. So in 62 trading days a quarter, buying 10% of volume, Berkshire could conceivably add $12 bn or so (360 million shares) to its BAC position of almost 950 million shares in a quarter. Perhaps double that at 20% of daily volume would be around 720 million shares, $24bn. WFC might be around $5-10bn per quarter as a ball park and the other banks combined might account for another $10 bn or so. It is probably possible at the upper bound of fairly aggressive buying for Berkshire to deploy about $40-50bn a quarter into banks, if they can do so under SEC confidential treatment provisions. It's very hard to guess what the effect on prices would be if they had to report within 5 days, but they might perhaps deploy a few billion dollars (e.g. $1-5 bn but probably not much more) before their trades were disclosed publicly.

[SwedishValue]

Dynamic, thanks for your informative post. It is very well written, and also well researched. I feel like the grinch coming off with my negative comments, but here goes my thoughts:

 

Had you made the post one year ago, I would have thought that such a scenario that you are describing would be at least somewhat likely. However, seeing that Buffett has had ample dry powder and at the same time the opportunity to purchase shares in JPM, he chose to do so on a very minescule scale. Today, prices are considerably higher. Therefore, I think we are very unlikely to see any form of active capital allocation into banks at current prices. If we see prices drop more than 30% that might change, but such price movements are rare.

[RadMan24]

Dynamic, thanks for your informative post. It is very well written, and also well researched. I feel like the grinch coming off with my negative comments, but here goes my thoughts:

 

Had you made the post one year ago, I would have thought that such a scenario that you are describing would be at least somewhat likely. However, seeing that Buffett has had ample dry powder and at the same time the opportunity to purchase shares in JPM, he chose to do so on a very minescule scale. Today, prices are considerably higher. Therefore, I think we are very unlikely to see any form of active capital allocation into banks at current prices. If we see prices drop more than 30% that might change, but such price movements are rare.

 

Oh that's not true, particularly for levered financials.