As reported in a recent Bloomberg article, Warren Buffett's telephone has been ringing off the hook. As the credit markets seize-up, more distressed sellers are looking to Omaha as the last source for funding. As mentioned in the article, "Buffett right now is probably about the only money in the world, in the billions of dollars range, that the check will clear overnight." This has some analysts bullish on Berkshire Hathaway stock. Buffett is known as a value investor, and the market is certainly on sale right now. The combination of his deep pockets allowing him to buy just about whatever he wants, and his liquidity and reputation allowing him to set the terms, makes it likely that he will be able to add value to Berkshire. Of interest in the article is how the price of Berkshire stock has been rising as the TED spread (bank borrowing cost) has been increasing. As usual, market corrections have a way of separating the wheat from the chaff.

Berkshire Hathaway is apparently telling one of its subsidiaries, Kansas Bankers Surety Co., to stop insuring bank deposits above the amount guaranteed by the federal government (see WSJ article). The move will prevent banks from offering "bank deposit guaranty bonds," often used as a way to attract the business of wealthy customers. The decision stems from the fact that when banks are acquired, the company purchasing the bank may not take on the larger deposits beyond what is insured by the government, causing potential losses for those companies that have insured these extra deposits. The current move would help Berkshire reduce future losses that may occur as more banks fail or are purchased. Unfortunately, the move also signals worry by Buffett and Berkshire that more bank failures and consolidation could be expected in the future. This is certainly not the news the markets need right now.

After recently trashing the stock of Berkshire Hathaway just six months ago in December, Barron's is now making a case for its purchase with an article entitled "Cheap Stock?" To their credit the stock has sold off since December. This comes after an article a few weeks ago entitled "The Next Buffett," which discussed how David Sokol, the chairman of MidAmerican Energy, a Berkshire unit, is now the most likely successor to Buffett to be CEO of Berkshire - and more importantly, how he is probably ready for the job. Not wanting to flip-flop too much, or at least provide some balance, this week's issue also has an interview with Doug Kass, the popular short-selling hedge fund manager who is still bearish on Berkshire stock, and has also reiterated this view for readers.

While the criticism of Berkshire has varied over the years, the issues of the exposure of the company to its insurance business and that of Buffett's age are still often cited as reasons for selling and staying out of the stock. As for the insurance business, its impact seems to show up in October, as seen in the weekly chart below (from stockcharts.com), although this is simply a three year view and anecdotal. Nonetheless, for the past three Octobers, after the annual hurricane and storm season is over - and the quarterly results begin to show how much of the float is left for Buffet to invest, the stock will often have a nice end of the year rally before leveling off or making a slower accent to the next October.


The difference of course has been this year, where the stock has sold off and been more volatile after the December Barron's article, and recent news of other hedge fund managers, such as Kass, taking a short position in the stock. The latest positive article and opinion from Barron's may stem the tide, but many of the short-sellers remain. Even Buffett at the recent "Woodstock for Capitalist" shareholders meeting in May alluded that Berkshire may under-perform (at least its historical self), and there may therefore be better opportunities elsewhere. But then again, Buffett is known for lowering expectations and feigning a sense of weakness, only to later make large acquisitions and investment, such as the recent decision to help finance the Mars acquisition of Wrigley, while taking a small position for himself.

While it is difficult to value Berkshire Hathaway, compared to some other public companies, and even more difficult to predict where Buffett is deploying his capital - at least until the quarterly reports are released, it does appear that the recent sell-off of the stock has taken some of the "Buffett premium" out of the stock. This extra boost to the valuation of Berkshire, simply because of his skill and the brand that Buffett has become, is often cited as one of the concerns for the stock as it relates to both the valuation and Buffett's age. In the past the premium has seemed justified based on past performance, and still does, but if Buffett were to step down for any reason, there is an expectation that the premium will be immediately taken out of the stock. Yet, Buffett appears to be in good health and even better spirits, not to mention remaining active in looking for investment opportunities (not withstanding showing up on soap-operas and CNBC at every chance Becky Quick gets).

Still, some investors are waiting on the sidelines for fear that Buffet will be replaced. This seems silly to me since you are missing out on the opportunity of letting one of the greatest investor of all time put your money to work. Furthermore, what happens if Berkshire is then run by someone else, maybe 1, 5, or 10 or more years from now? Will this give you a reason to jump in? Sure, succession will be more clear, but the management of your money will be less so, regardless of Barron's pick (or guess) for a successor - for CEO, not CIO(s). In a sense it comes down to staying out of the stock while you wait for a pullback and possibly new management, compared to staying in the stock and benefiting from Buffett's expertise, even with a lack of succession clarity. I think many current investors will continue to take their chances.

In the end, maybe the biggest hurdle for Buffett may not be his age, or overcoming the "Buffett premium," or worrying about the next catastrophe that will reduce the investment float. What may be more of a challenge is overcoming the law of large numbers. The company's cash for investment is considerable. To make any dent in the stock price of Berkshire, Buffett has to take a considerable position in an outside company in order for it to register enough to potentially affect earnings and move the stock. This takes time, and certainly offers less flexibility to get in and out at an acceptable price. More than likely this is one reason why Berkshire Hathaway has simply made large equity investments and outright purchases of companies in the last few years, although the recent volatility and credit / housing related sell-offs in the stock market have created more of the values that Buffett looks for, and has resulted in more equity positions - recent purchases include Kraft (KFT) , Ingersoll Rand (IR), Burlington Northern Sante Fe (BNI), US Bankcorp (USB), United Health Group (UNH), Wells Fargo (WFC), and Wellpoint (WLP), along with small positions in Carmax (KMX), M&T Bank (MTB), and Sanofi Aventis (SNY) - see previous post for share numbers and dollar values. Of these position, only the added positions in Kraft and Burlington Northern Sante Fe were large enough to generate any interest on the buy side, and even then, they were adding to already existing positions.

So what is an investor to do? Barron's does provide some guidance by referring to an analysis by the hedge fund T2 Partners. T2 highlights that the intrinsic value of Berkshire has continued to grow steadily and significantly over the last few years. From Barrons:

Meanwhile, for a truly big company -- with a market cap of $190 billion, total assets at last count of $281 billion, total equity of $119 billion and book value per share of $77,014 -- it has been enjoying quite impressive growth, especially where it really counts. The value of investments per share has climbed to $90,343 in 2007, from $52,507 five years earlier; during this stretch, pretax earnings per share, excluding investment income, has quadrupled from the $1,479 posted in '02; and intrinsic value -- which T2 calculates as investments per share, plus 12 times earnings per share excluding investment income -- at the end of last year ran somewhere between $156,300 and $158,700 a share, or comfortably more than double '02's $70,000.

As a result, T2 believes that Berkshire is undervalued by approximately 20%. Furthermore, if you are to assuming a 10% growth rate for the intrinsic value of the company, which is not speculative for Berkshire by any measure, with a business and cash buildup of $6,000 per share over the next year, the total intrinsic value could approach $178,700 per share. Given the current price, this represents a 46% premium on the stock. Going out further to two years, the number approaches $200,000. While short-sellers like Kass will continue to short Berkshire, and give good explanations - such as Buffett's age and lack of a visible succession plan, new hedge-fund competition, new uncharacteristic exposure to derivatives, and waining benefits from the insurance industry - it is difficult to bet against someone with so much cash to deploy, as well as a track record for wisely putting it to work. While the stock has been volatile, and is receiving attention from the short side, it is difficult for many investors to sell at these levels until more of the issues that Kass describes come to light. For the time being, most of the current long investors will no doubt hold, and look for others to join in - maybe in October.

A recent report provided some insight into the changes in equity holdings for Berkshire Hathaway. While important knowledge for Berkshire investors, this report has also become a market news event, given that any signal that the Oracle of Omaha is buying or selling a company you currently own could make for either a pleasant or long weekend, even though the Berkshire stock transactions may have occurred over three months ago.

As highlighted in the report, Berkshire Hathaway disclosed that it no longer has a position in Ameriprise Financial - AMP, selling 661,742 shares ($34.3 million), but has added to its positions in Kraft - KFT, buying 5.88 million shares ($182.3 million, giving 138 million total shares), increased its position in Ingersoll Rand - IR, buying 300,000 shares ($13.4 million, giving 936,000 total shares), increased its position in Burlington Northern Sante Fe - BNI, buying 2.96 million shares ($272.7 million, giving 63.8 million total shares), and decreased its position in Iron Mountain - IRM, selling 1.29 million shares ($34.2, giving 3.4 million total shares).

Other new positions include purchases of US Bankcorp - USB (1.05 million shares valued at 33.9 million), United Health Group -UNH (400,000 shares valued at $13.7 million), Wells Fargo - WFC (1.4 million shares valued at $40.6 million), and Wellpoint - WLP (300,000 shares valued at $13.2 million). Berkshire also sold a smaller stake in Trane - TT (60,500 shares valued at $2.8 million), and make smaller purchases in Carmax - KMX (300,000 shares valued at $5.8 million), M&T Bank - MTB (6,300 shares valued at $500K), and Sanofi Aventis - SNY (16,828 shares valued at $600K).

To read a little more detail regarding the Berkshire Hathaway selling of index puts, check out this post at the Financial Crookery Blog. We have recently discussed this issue, but this article goes deeper into the ramifications, in particular looking at the impact of vega and dividends when writing puts with long expiration dates. Nice read and well worth the time.

Tickers: BRK.A, BRK.B

Jason Zweig of Money (as reported at IndexUniverse.com) was asked a question about what a young individual in their 30s should invest in. What is the single best investment idea? Buffett quickly suggested investing all they had to invest in a very low cost index fund from a reputable firm, a suggestion he has made on numerous other occasions. Buffett mentioned Vanguard in particular, the John Bogel founded company with a number of index funds to choose from. Of course, Buffett could have suggested another - Berkshire Hathaway. While technically not an index fund, or even close for that matter, it does have some of the diversification effects that an index fund would delivery, albeit Berkshire is exposed more than average to the insurance industry. Barron's also recently declared it fairly priced, after not long ago mentioning that it was a little expensive (before it pulled back). But touting his own stock would not be Buffett's style. Furthermore, Buffett is correct that an index fund would certainly track the indexes better, something that rarely seem to occur with Berkshire anymore, although I would have to run the numbers to be sure. Rather than touting his stock, Buffett is more comfortable touting the individual companies within Berkshire, along with their products - and sampling them with the freedom and joy of a school boy. Then again, I imagine $60+ billion would make you feel a little giddy at times, but how would I, or just about anybody really know.

Tickers: BRK.A, BRK.B

Warren Buffett was smiling this morning on CNBC while announcing his role (and that of Berkshire Hathaway) in helping Mars Inc. buy Wrigley. Berkshire will be contributing about $6.5 billion to help with the acquisition. What does Buffett get in return? The $6.5 billion consist of $4.4 billion of subordinated debt to help Mars pay for the acquisition, along with a $2.1 billion equity stake in Mars after the deal closes, with the shares being bought at a discount. Just another version of the "golden rule" - those with the gold make the rules. On the other hand, a nice premium is being paid for Wrigley, something that Buffett usually tries to avoid, although he has paid-up a few times to get a strong name. At least here he is getting a discount on the premium (if that makes sense).

Of course, everything may not be as sugar coated as the company's products. A combined Mars - Wrigley will control a large segment of the confectionery market, creating a "global powerhouse" to use the WSJs words. It will be interesting to see if this becomes an anti-trust concern. After all, regulators do not have anything else to work on right now, so making sure the chocolate and sugar markets are not being cornered should be a priority.

Finally, the real story may have been the fact that Goldman Sachs was willing to step up to the plate and fund the merger to the tune of $5.7 billion. Not a big risk or huge numbers for Goldman (interesting how $5.7 billion is not considered huge anymore), but certainly big enough to show up on the financial statements. Personally, I kind of miss Merger Mondays. It always starts the week off with a little momentum. Not sure this is the blockbuster that will break the trend, given that Berkshire was needed to co-sign the loan, but it is a start.

Tickers: WWY, BRK.A (for those driving Mercedes), BRK.B (for the rest of us)