KBW Initiates Coverage of BRK

[dcollon]

Not sure if anyone will care, but Keefe initiated coverage of BRK with an Outperform rating and $107,000 price target.  The put out a 60+ page report this morning.

 

 

[dcollon]

For those interested...

[Grenville]

Thank you for posting the report!

[woodstove]

Yes, thank you -- the report has a wealth of detail re industry context, reserve triangles etc.

 

There is one thing though, that stands out right away, and might want some amendment.

On page 2, the share count is stated as 1.057m which appears to omit B share entitlement.

And the following figure of market cap $92,261m appears to be based upon that share count.

So who knows where else the share count percolates thru the report's tabulations?

It seems prudent for reader to check share-count-related figures against other info sources.

 

But I really appreciate the tremendous operational and industry detail they've collected.

And I wish them well!

[vinod1]

Thank you! I only scanned the report but I am having trouble reconciling their IV estimate of only 107K while using a 1.7 book multiple for Insurance. I am not sure if they missed the investments but this does not sound right.

 

Vinod

[mpauls]

I find it amusing: They don't know how to calculate Float ;D

 

Though, the number the came up with may not be far off right now, it's not the right approach to the calculation.  (Not at least in my mind.)  Eventually this calculation will provide misleading numbers.

 

Don't ask.

 

 

[woodstove]

Well, the raw data - particularly insurance stuff going back decade - was interesting.

 

For several years I've resisted being drawn into the value of Berkshire calc.

But reading thru this report prompted the following:

 

Insurance biz - value at net assets $114b

 

Mfg,serv,retail - value at 16x $4b earning power = $64b.

 

Utilities - value at 16x $1.85b earning power = $29b.

 

Financial services biz - value at 16x $1.0b earning power = $16b.

 

Derivatives book - value at $10b (pull out of hat, no worse than other crap estimates made above).

 

= $233b / 50m B shares = $4700/B share, "risk free value".

 

==> Safe-enough purchase price at 50 pct of RFV = $2350/B share.

 

One other comment - pie chart on page 7 - about 2/3rd of the earnings sources are new in past 10 years.

That is, earnings power tripled over past 10 years.

 

No particular reason to expect similar tripling is out of the question for next 10 years for company.

Past decade was difficult for Berk's investing, due to high P/E ratios in market.  Next might be more opportune.

 

 

 

[mpauls]

 

 

Derivatives book - value at $10b (pull out of hat, no worse than other crap estimates made above).

 

 

 

Woodstove, you might find this estimate (Attached on page 2) more or less compelling.  Note: this estimate was made in April before the revision, but should offer a reasonable way to think about the value of their derivatives book.   (FYI: This was already posted under a different topic)

[woodstove]

Thanks MPauls - that's very interesting.  I'm still reading, plenty of food for thought.

 

The various derivatives seem to allow plenty of scope for hedging until maturity, as prices of the related securities or economic outlook fluctuates - wildly, most likely.  Much of the analysis in media seems to assume that Berkshire will be buy-and-hold; although that has been true in many cases in the past, it's not mandatory if opportunities arise.  Berkshire has been in and out of stuff fast-action in the past, where is it a financial investment not a business building block relationship.

 

On the one hand, I want to say the derivative positions represent only say 5-10 pct of estimates of Berkshire's value, so are not material in terms of making a decision whether the company's stock is substantially undervalued or overvalued in the stock market.

 

But on the other hand, handled astutely (which we can most certainly expect from long past history), the derivatives can form the basis of a very profitable hedge book.  Consider what Fairfax was able to do the past few years.  And Berkshire is being paid to run its hedge book.  So from that viewpoint, the derivatives positions represent far more than 10 pct of potential increase in value over next decade or so.

 

I suppose, poorly managed, they represent a corresponding large potential exposure.  But I think that's where manager skill really matters.  For someone who wants to invest with the "next Warren Buffett", maybe that guy's still available under the same name!

[link01]

Much of the analysis in media seems to assume that Berkshire will be buy-and-hold; although that has been true in many cases in the past, it's not mandatory if opportunities arise.  Berkshire has been in and out of stuff fast-action in the past, where is it a financial investment not a business building block relationship.

 

first of all, thanks dcollon & mpauls for the spreadsheets!

 

with regard to the medias' assumming berkshire is ALL buy & hold, you need only look at brk's realized gains over the years to see the fallacy of that! the media likes to trot out web's famous saying, "my favorite holding period is forever". what they fail to see or mention is that the key word in that oft-quoted bit is 'favorite'. high ROE co's with moats are his preferred investment choice, at a reasonable price, but they are often not available in the size WEB requires for long stretches of time. sometimes investments become available that dont meet his ctriteria of 'favorite', but are simply mispriced. he has frequently bought many of those falling in that category, & when the price to value gap closes WEB sells.

[mpauls]

Woodstove,

 

I think the derivatives are worth about $12 B or so to Berkshire.  I think even more important is to adjust the earnings of Berkshire for the accounting "losses" from derivatives.  When critics discuss Berkshire's derivatives book they overlook a few things that would largely put their concerns at ease.  Though it is not certain where Buffett invested capital received for derivatives contracts, consider for a moment that he invested the $4.9 B received for equity puts as I briefly implied in the document.  That is,  I gave the example that if at the time of the contracts expiration the markets were down as they were after the great depression, Berkshire would need a 10.5% return to break even. (i.e. $4.9 @ 10.5% for 15 yrs. = about $22 B.  Now compare this 10.5% to the yield on Wrigley's Notes & to GE & Goldman Pfd's.  This is admittedly total speculation that he actually invested the capital this way, but I think it's not an unreasonable way to think about it.  This is basically arbitrage.  However also classic Buffett: protected on the downside, but hugely favorable on the upside.  If markets return to normal levels Berkshire not only gets the 10% or so interest as profit but also benefits from the appreciation of the underlying common stocks of the warrants (at least with respect to this discussion, in proportion to the amount received for derivatives contracts).

 

What I mean is that expected loss is effectively zero due to interest, but the upside is huge in comparison.  Why wouldn't you bet big in such a case-the odds are hugely in your favor, hugely.   

[woodstove]

Yes, I agree with ignoring most of the quarterly and annual accounting losses/gains from derivatives - there will be lumpiness.  Although for most companies I like mark-to-market discipliine, because they get overleveraged and mark-to-market imposes a robustness constraint that they are otherwise unlikely to stay within.  But when there is a plan, as with Berkshire, combined with the durability to hold on until that plan matures, then mark-to-plan seems reasonable.  That is, value company based upon the numbers determined from the business model.

 

Looking at the GE and GS investments as re-deploying the float, as you suggest, seems very tidy.  I like that a lot!

 

My own calc on the values of the four categories of derivatives:  Using your info.  I don't actually worry about the details of these deals, trusting Mr Buffett to have done a good job protecting and investing shareholders' assets just as he always has.

 

- Equity puts.  I believe this is pure profit.  No downside in my opinion.  Present value $4.9B equal to the premiums collected.

 

- Credit default insurance on index of 100 companies.  Received 3.4B, paid 0.6B, and company's reserves for future loses are 3.4B over next 4.5 years.  Suppose 2.0B paid out soon, balance of float 0.8B held 3 years for 0.2B income, then payout 1.4B balance of reserves.  Present value -0.4B.

 

- Credit default swaps on 42 corporations (don't know which, but info is presumably available if one wanted to do detailed analysis).  Believe that the upside is that Berkshire will get a say in reorganization of some of those companies' capital structure.  That is, Berkshire ends up retroactively buying their debt at par.  This is a great way to acquire some good businesses, I imagine - along with some from which the opportunities have diminished, no doubt, but mostly good lines of business just poor capital structures or not robust enough for economic turmoil.  Net gain, and get paid $4B in premiums to make purchases.  Effectively almost pure profit, say $3B present value.  That's ignoring opportunity to take significant ownerships, if desired, in various business operations which get into trouble.

 

- Muni bond insurance contracts.  There will be some defaults, but likely not huge numbers because of economic damage - Fed will blink, eg, re California, after poliltical will coalesces to demand federal guarantees of state and municipal obligations.  There is signficant risk to Berkshire, because of moral hazard - encouragement to default - as discussed in the annual report.  Assume value of 7x 2008 premiums, or $4.2B.  Basically long tail reinsurance.

 

So the total portfolio estimates at 4.9 - 0.4 + 3.0 + 4.2 = 11.7B.  More or less created from "nothing" except ... capacity to write those insurance agreements, and being credible counterparty for writing them.  And we have allocated our capacity - have reduced capacity until some of the uncertainty starts to clarify, additional cash flows in, etc.  That will surely happen.  And commentators will wonder why Berkshire share price increased, do lots of backward looking analysis to explain it was obvious!