Analyses and investment views

Berkshire after Buffett

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Berkshire after Buffett

Berkshire Hathaway, the company run by Warren Buffett, has been our largest investment for a number of years now, and we can easily see it remaining so for a long time. I first encountered the name Warren Buffett in 1989 at Madame Tussauds wax museum in London. As a person growing up under communism, that name meant nothing to me. The only thing I remember to this day is that he had glasses like Elton John. Probably some eccentric billionaire, I had thought. The world changes quickly, however, and in 1995, a long time before the founding of Vltava Fund, I had Berkshire stock in my portfolio for the first time. Berkshire is the company we have been following for the longest time and probably know best.

We believe it is the only large US company which is today significantly undervalued. This undervaluation along with the very low risk related to its business creates a combination we like very much – even despite that Buffett is 87 years old. Buffett is in excellent condition, shows no signs of mental decline, and is not yet ready to make his exit.

The life expectancy of an 87-year-old man in the US is currently about 6 years. Considering Buffett’s health, it is very possible that he can stay at the helm of the company for a little longer than that and extend the time he spends managing it from the current 52 to a nice round 60 years. Time is relentless, however, and his activity at the head of Berkshire is gradually coming to its end. Any analysis of Berkshire stock must take this into account. Here is our analysis of what Berkshire could look like after Buffett hands it over to his successor.

Most people still hold incorrect and distorted ideas about Berkshire and Buffett. They frequently consider Berkshire to be an investment fund managed by the legendary investor Warren Buffett. Berkshire, however, is no investment fund and never has been. In addition, it has been moving further and further from looking like an investment fund for decades. Although Buffett is a legendary investor, he is primarily the CEO of a large US corporation. Buffett could have been described as a pure investor in the 1950s and 1960s. Since that time, the relative weights of his roles have been substantially transformed. In the end, Buffett may end up going down in history more as the boss of a big corporation than as an investor. While his investment results are excellent, it is the business model he has created in Berkshire that is exceptional. No one has managed to emulate him to this day, even though he has been in the spotlight for decades. This is the company’s greatest competitive advantage, and it will certainly survive Buffett by many years.

Buffett has spent the past 20 years in preparing his succession. This, by the way, is several times longer than most managers even spend heading a company. This preparation can be divided into two parts: first, changing the form of the company and second, finding and designating his successors.

At the beginning of the century, more than 90% of Berkshire’s value consisted in a portfolio of publicly traded stocks. From that time, however, Buffett began systematically to build the second half of Berkshire. This consists of private companies, the majority of which are fully owned by Berkshire. Both parts today contribute to the overall value of the company in approximately equal parts, and in future we may expect the holding of private companies to become more and more dominant. There are dozens of such companies. The largest among these are the insurance companies Geico and General Re, the railway company BNSF, manufacturing companies Precision Castparts, Lubrizol, Marmon, and Iscar, as well as the BH Energy group. Each of these companies has its own management and operates independently. Buffett does not intervene and neither does anyone else.

The portfolio of publicly traded companies (including bonds and cash) is currently worth around USD 290 billion. Berkshire is the largest shareholder in Wells Fargo, Bank of America, Coca-Cola, American Express, and Kraft Heinz and is one of the top five shareholders in Apple and IBM. After Buffett’s departure, this entire part of Berkshire will be managed by Todd Combs and Ted Wechsler. They have been with Berkshire for several years and each of them currently manages an equity portfolio of USD 11 billion. Todd and Ted, as they are familiarly called, are excellent investors. They had their own investment funds before joining Berkshire and they did great. They are doing equally great within Berkshire. If someone can recognise investment talent, it would probably be Warren Buffett. So, we really need not worry about this part of Berkshire in the future.

Berkshire as a whole will be headed by a new CEO after Buffet leaves. That CEO has been chosen and approved by the Board of Directors. Two names are most commonly mentioned as guesses: Ajit Jain and Greg Abel. Our bet is on Greg Abel. First, he is 55 years old and is therefore 11 years younger than Ajit. Second, he manages BH Energy, which is an energy holding within Berkshire and his job is therefore closer to that of a CEO than is that of Ajit Jain, whose speciality (and brilliance) is in insurance. According to what is known about Abel, he should be a strong leader for the entirety of Berkshire Hathaway. He will have three main tasks: to allocate capital generated by the individual parts of Berkshire, to decide on remuneration for the individual companies’ managements, and to supervise future preservation of the culture across the entire company.

It is first and foremost here that we see a potential long-term risk. In total, Berkshire has 370,000 employees and revenues of USD 230 billion. This colossus is headed by Warren Buffett, the only person in the world who can by himself decide on an investment of USD 100 billion in a telephone call without having to ask anyone or fear that his decision might be seriously questioned. Such is the legendary position he has built over his career. His successor, whoever it may be, will not have that. It is precisely the culture of the company – the possibility of acting rapidly and flexibly – that will need to be protected. It is not probable that this would change quickly, but it is definitely not guaranteed forever. Berkshire is in a situation today where it receives plenty of offers from companies wishing to sell themselves from all around the world. For many owners, Berkshire is an ideal haven for parking a company over the long term, and being acquired by Buffett is a matter of high prestige. Only time will tell how much this position is due to Buffett himself and how much to Berkshire.

If Buffett were to depart today entirely unexpectedly, it is probable that Berkshire’s share price would drop. In such case, very probably the announced massive buyback of the company’s own shares would follow, and that would have a substantial impact on the price of the significantly undervalued shares. A long-term investor need not worry about such thing. Even in case Buffett leaves as planned in, let’s say, 7 years, a decrease in the share price may follow. At that time, however, that price may be double what it is today.

It is not easy to estimate the value of a Berkshire share. Last year, at the Third Czech Investment Conference, we had a seminar entitled Valuing Berkshire Shares and we could not go sufficiently into details during its 90 minutes. Whoever puts in the work, however, does not expend the energy in vain. Berkshire is one of the best and most robust businesses available and at a price much lower than its actual value. The reason for this could be Buffett’s age. Today’s price of Berkshire shares does not include the “Buffett premium”, taking into account that Buffett is its leader. On the contrary, it has something we could call the “Buffett discount”. And there is only one thing to do about that.

Invest with care!

Daniel Gladiš, 11 October 2017

P.S. This document expresses the opinions of the author(s) at the time of its writing and is intended exclusively for educational purposes. It is not an investment recommendation. Our estimates and projections of the future may and probably will contain errors. Do not rely on them but use your own common sense and your own analyses when making investment decisions. Vltava Fund holds Berkshire Hathaway shares in its portfolio.

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