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Whitney Tilsons 2012 Update of Berkshire Valuation
Here are his thoughts on Berkshire's business and stock
a) Berkshire has never been stronger. Its balance sheet is awash with cash and the company has a diverse and robust collection of exceptional businesses that are collectively generating more than $1 billion per month for Buffett and Munger to allocate.
b) The company is firing on all cylinders. As Buffett writes: “Our major businesses did well last year. In fact, each of our five largest non-insurance companies – BNSF, Iscar, Lubrizol, Marmon Group and MidAmerican Energy – delivered record operating earnings. In aggregate these businesses earned more than $9 billion pre-tax in 2011. Contrast that to seven years ago, when we owned only one of the five, MidAmerican, whose pre-tax earnings were $393 million. Unless the economy weakens in 2012, each of our fabulous five should again set a record, with aggregate earnings comfortably topping $10 billion.”
c) We have increased our estimate of intrinsic value to more than $178,000/share, based on $98,366 in investments/share plus applying a 10 multiple to our estimate of normalized pretax operating earnings of $8,000/share.
d) Given the diversity of Berkshire’s businesses, the company’s performance is a good indicator of the overall strength of the U.S. economy (outside of the housing sector, which Buffett says remains in a “depression”).
e) At many points in his letter, Buffett shows the wide gap between book value and intrinsic value, concluding that book value is a “considerably understated” proxy for intrinsic value. However, we think he is being too conservative when he writes: “Over time, the divergence will likely become ever more substantial in absolute terms, remaining reasonably steady, however, on a percentage basis as both the numerator and denominator of the business-value/book-value equation increase.” As Berkshire’s value has increasingly shifted in recent years from its investment portfolio, which is valued at market (i.e., book value), to operating businesses like GEICO and Burlington Northern, we think Berkshire’s intrinsic value is becoming a greater percentage of book value – yet the stock is currently trading near the lowest premium to book value in the past two decades.
e) Buffett makes it very clear that he believes that Berkshire’s stock is significantly undervalued and that he’s eager to buy it back, up to a price equal to 1.1x book value, or $110,000/a share as of 12/31/11 (Buffett’s limit price is likely higher today, as book value has almost certainly risen this year). We think the share repurchase program puts a firm floor on the stock price only a few percentage points below today’s level of $118,000.
g) Berkshire is our largest position because of its asymmetric return profile: only a few percentage points of downside vs. 50% upside, with intrinsic value growing at roughly 10% annually.
h) On the first page of the letter, Buffett did his best to put the succession issue to rest, writing: “Your Board is equally enthusiastic about my successor as CEO, an individual to whom they have had a great deal of exposure and whose managerial and human qualities they admire. (We have two superb back-up candidates as well.) When a transfer of responsibility is required, it will be seamless, and Berkshire’s prospects will remain bright.” We don’t have a strong view on who the successor is, but don’t care because we think it’s highly likely that Buffett will be running Berkshire for at least five more years, maybe even 10. In addition, our estimate of intrinsic value doesn’t include any Buffett premium.
Since Berkshire reported earnings, the stock is actually down a bit so we took advantage and, though it was already our largest position, we added to it.
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