Notes on the 2011 Berkshire Hathaway Annual Report, Part 2

Picking up where the last post left off:

13) So Buffett told us he has a successor lined up, but won’t tell us who, but will tell us that the successor doesn’t know that he is the successor.  Really does not seem like much of an improvement over the past, except that the CIO function is getting better defined with Todd and Ted.

14) Todd & Ted share their performance 80/20 — 80% of their own and 20% of their colleagues performance.  Seems like a fair idea, balancing the team vs the individual.

15) The regulated subsidiaries, and manufacturing, services and retailing did well. That operating income growth is what drove the year.  The turnaround at NetJets was also a help, and that was fast.

16) We are still waiting to see what problems BRK’s decentralized system can develop.  To this point, the flexibility for managers within a structure that oversees reinvestment of cash flow is admirable.

17) The economic spread of BRK businesses is significant, and I would argue, unrivaled in terms of conglomerates.  It almost makes me think that Buffett is aiming for owning an extra-productive slice of US/World GDP.  It makes acquisition criteria #1 less relevant, because if you are small and private, and want to be acquired by BRK, it means that you analyze BRK, identify the portion of it that you are most similar to, and talk to the CEO of that segment, not Buffett.

18) That brings up my view of Buffett at present.  He has changed as the amount of assets under management has grown.  The last phase for Buffett is not large cap value manager, but private equity manager / conglomerateur.  He uses the float that his insurers produce to invest in a wide number of enterprises that will produce excess returns.  He does not run a closed end fund, but runs a conglomerate.

19) Interesting to see Nebraska Furniture Mart open its third store.  Logical to do, if the experience is replicable.

20) “We do not talk one-on-one to large institutional investors or analysts.” Bravo.  Would that this would be true of more companies.  When I represented a large holder of Safety Insurance, the management asked me what we wanted in terms o market disclosure.  I said that it did not matter to us, and that we would be happy if they never talked to the media/analysts, and only emitted 10-Qs and 10-Ks, even without notifying us as to timing.

21) Buffett notes that a decent number of borrowers that lost their homes did well in the crisis, because of all the money they extracted from loans.  That might be similar to a private equity manager profiting through deals to borrow where he pays himself a dividend.

22) Owning 11% of Munich Re gives Buffett additional influence over the reinsurance market.

23) Because of the need for collateral, BRK will not be making any more significant derivative bets.

24) Buffet repeats his screed that he issued to Fortune regarding bonds and gold.  I repeat my screed.  It’s all logical, Warren, but you have to think more broadly and read about the gold medal gold model.

25) It makes sense that flying to Kansas City is a better strategy than going to Omaha.  But as this becomes widely used, make sure you reserve a car early.

26) If you want to ask Buffett a question at the annual meeting, you can do it by e-mailing the following:

(In your e-mail, let the journalist know if you would like your name mentioned if your question is selected.)

27) There will be insurance analysts at the annual meeting, and they are Cliff Gallant of KBW, Jay Gelb of Barclays Capital and Gary Ransom of Dowling and Partners.  I have a lot of respect for Gary Ransom — listen to the questions that he asks.

28) Minus & Plus: Negative change in AOCI & comprehensive income of noncontrolled interests down.  Strong CFO, net of capex, supports goodwill.

29) At for BRK’s big options: BAC in the money, GS at, GE/DOW out of the money.

30) Do parts of all asbestos liabilities eventually go to Berkshire Hathaway for reinsurance?  Who don’t they reinsure?  “The liabilities for environmental, asbestos and latent injury claims and claims expenses net of reinsurance recoverable were approximately $13.9 billion at December 31, 2011.”

I know that Buffett thinks he can earn money off of the float on these claims in excess of the implied interest rate.  But when he begins to become the preferred habitat for reinsurance, he makes BRK more volatile with respect to legal judgments.

31) “Without prior regulatory approval, our principal insurance subsidiaries may declare up to approximately $9.5 billion as ordinary dividends before the end of 2012.” And that is because only 10% of the regulatory surplus of $95 billion can be released.

32) BRK, unlike many firms, has more reasonable assumptions on DB pensions: expected return: 6.9%, discount rate 4.6%.

33) To date, share repurchases have been insignificant.  Looks like $67 million from the Statement of Shareholders Equity.

34) “On January 31, 2012, we issued an additional $1.7 billion of parent company senior unsecured notes, the proceeds of which were used to fund the repayment of $1.7 billion of notes maturing in February 2012.”

Why not pay down short-term debt?  BRK has the cash, and you state that you have an aversion to debt, particularly at the holding company level, but you are not acting like you have an aversion to debt over the last 10 years.

To Buffett: is there a level of debt at which you would be uncomfortable at the parent company, or subsidiaries?  Also, would you ever make an effort to get the AAA rating back?

35) BRK has a very diversified reserving book if you look at page 84 of the annual report — impressive.

36) I appreciate acquisition principle 6, which deal with aspects of value that accounting does not capture.  Buffett takes the right position to value those fully, because you will eventually get that value, and others will not pay up for it.

37) Buffett makes a lot out of the virtues of deferred taxes and float. He argues “they are liabilities without covenants or due dates attached to them.”  This is true, though deferred tax liabilities assume that you will make money, and will continue to grow.  Float is similar, it assumes you will underwrite well, and it would be nice if you grew.

38) Buffett says toward the end of the annual report:

There is a third, more subjective, element to an intrinsic value calculation that can be either positive or negative: the efficacy with which retained earnings will be deployed in the future. We, as well as many other businesses, are likely to retain earnings over the next decade that will equal, or even exceed, the capital we presently employ. Some companies will turn these retained dollars into fifty-cent pieces, others into two-dollar bills.

I’ve written about this before.  Some managements teams with skill should retain all earnings, and not pay a dividend.  Management teams without skill should act like REITs and pay out 90% of taxable income (or free cash flow).

39) Buffett says he was wrong on housing.  I think he is still wrong on housing; it will take a lot longer for this situation to normalize.  The key variable is the proportion of houses with debts exceeding a 90% LTV.  Those houses are illiquid; can’t be sold except in a short sale.

40) One final wild idea: would BRK consider buying out the corpus of AIG?  I have better small insurance acquisition targets than that, but buying out AIG would be delicious given the comments Greenberg made to Buffett back when BRK was smaller.  He was very dismissive of BRK.  Also, Buffett could fold ILFC into NetJets (or vice-versa), sell off the life companies, and impose greater discipline on the P&C underwriting.  Personally, if BRK made a bid for AIG at $32, I think Buffett could make a lot out of it, and he would not have to worry about a lot of fuss, because the major holder is the US Government.

4 Comments

  • mwilbert says:

    I found your comments interesting, however I think you are possibly misconstruing Buffett’s comments on housing in your point 39. I didn’t see him say anything about housing “normalizing”.

    In my opinion, and perhaps his, the housing market can recover without being normal, and in fact it seems to me as if that is what is happening. I don’t expect 2005 levels of pricing or activity, but that wasn’t normal either.

    • It’s not my intent to misconstrue Buffett, but he clearly says that he expects better things out his housing related companies. I think he will have to wait a few more years on that, because so many property owners have no equity in a normal sale. One-third of the market is not liquid, which is abnormal.

  • revelo says:

    Buffett seems to be trying to deal with the old shareholder-management agency problem, which has really gotten out of hand in the past 2 decades, as stock option plans have proliferated and mutual funds and institutions have pretty much abdicated their shareholder responsibilities, leaving no one in charge other than the occasional corporate raider. BRK is becoming like a mutual fund which owns entire companies rather than slices of companies, and which keeps a tight rein on management compensation and wasteful capital deployment at the companies it owns. Instead of putting your money in a mutual fund, put it all into BRK, assuming your trust BRK mgmt. There’s plenty of business sector diversification at this point. Problem is, if BRK screws up bigtime and goes bankrupt, you lose everything. A better structure would retain the limited liability firewalls between subsidiaries, however shareholders would lose the tax advantages of the current structure in that case.

  • tapertaper says:

    Buffett buying AIG is an intriguing idea. Every single non-AIG insurance exec would rejoice, particularly Hank Greenberg. It opens the gate for Starr to grow like crazy.

    You know as well as any that AIG has an aggressive culture and Warren/Ajit would immediately pull the plug on that. Does AIG make sense in the medium term at 60% of its current top line? It might all fall apart.

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