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Doug Kass Questions Whitney Tilson's Berkshire Valuations - And Tilson Responds

March 06, 2012 | About:
CanadianValue

CanadianValue

211 followers
I came across an interesting interchange between Seabreeze Partners Doug Kass and Whitney Tilson of T2 Partners. Kass was questioning the “two-column” valuation approach of Tilson, and Tilson responded to the specific questions.

Here is the exchange:

Doug Kass on Tilson’s Berkshire (BKR.A)(BRK.B) Valuation

Here are the two questions about BRK valuation that I would like to ask Whitney about Berkshire Hathaway at 10 a.m. block today:

Whit values Berkshire's intrinsic value at $178k vs. today's share price of $120k. In his email today he explains, as he has in the past, his methodology in determining his intrinsic value calculation:

FROM WHIT EMAIL 2) Attached is our updated slide deck, showing (on page 14) that we have increased our estimate of Berkshire’s intrinsic value to $178,366 ($98,366 in investments/share plus 10 x $8,000/share of pre-tax earnings of the operating businesses), nearly 50% above today’s price of $120,000. Page 15 shows that the stock trades at close to the largest discount to intrinsic value in two decades (despite the fact that we think the company has never been stronger, with fewer risks and a better mix of earnings drivers than ever).

But, Whit, why should we still pay full value of Berkshire's investment portfolio (or $98,366/share) given 1. Warren Buffet's age, 2. that he has begun to delegate investment portfolio selection to (two) others, 3. Berkshire's portfolio size makes it difficult to find that diamond in the rough (so he is basically buying what the other funds are buying) AND importantly (Given 1 and 2 and 3), 4. most closed end publicly traded investment funds trade at about an eight percent discount to net asset value.

Secondly, why do you value the non-investment businesses at a rich 10x pre-tax earnings ( or about 14x after tax earnings) when a large amount of those are in the financial sector (banking and insurance) which, in today's markets, are accorded a relatively low price earnings multiple well under 14x?

Whitney Tilson Responds:

A) Whether a haircut is warranted is a function of two things: the nature of the investment (cash, bonds, stocks, venture capital investments, etc.) and the capital allocation track record of the company. Let’s start with the facts: 51% of Berkshire’s investment portfolio is cash and bonds (nearly all cash equivalents: short-term, ultra-safe bonds) and the other half is stocks (57% of which was in four stocks at the end of 2011: Coke, IBM, Wells Fargo and Amex). The cash and bonds are easy to value and, as for the stocks, one can look at the major holdings and decide if they’re over- or undervalued (we only own one of the four, Wells Fargo, but think that overall the stocks Berkshire holds are moderately undervalued, along with many big-cap blue-chips).

If this was an average company run by an average CEO, I’d agree with Doug that a haircut was warranted – but it isn’t. For more than 50 years, Buffett have proven beyond a shadow of a doubt that he can consistently: a) take $1 of cash and invest it to create far more than $1 of value; and b) pick stocks that go up and beat the market. I’d bet a lot of money (in fact, we ARE betting a lot of money) that this continues as long as Buffett is running Berkshire.

Doug implicitly seems to agree when he highlights Buffett’s age and the fact that he’s begun to delegate to his two successors on the investment side – but Buffett is still going strong (see page 22 of our updated slide deck (www.tilsonfunds.com/BRK.pdf), the CNBC interview last week (see below), as well as countless other data points), plus he’s only delegated a few percent of Berkshire’s investment portfolio. With all the talk about his age and succession, you’d think Buffett was on his death bed! In truth, Buffett is highly likely to be running Berkshire five years from now, and even money I think to be running it 10 years from now.

B) We don’t think applying a 10 multiple to the pre-tax earnings of Berkshire’s 79 or so operating businesses is “rich.” That’s roughly a market multiple for a collection of businesses that’s far superior the average American business. As a group, they are market leaders, are superbly run, and most generate very high, unlevered (or low-levered) returns on equity. Only $1,000 of our $8,000/share estimate of Berkshire’s normalized pre-tax operating earnings are from the low-multiple insurance businesses (13%), vs. $5,500/share (68%) from these five higher-multiple businesses: BNSF, Iscar, Lubrizol, Marmon Group and MidAmerican Energy. We think a 10 multiple is conservative. Incidentally, as we show on slide 13, we think Buffett has used a 12 multiple historically.

The last point I’d make is that even if one agrees with Doug, Berkshire is STILL super-cheap. If we haircut investments/share by 8%, that's an $8,000 haircut to our estimate of $178,000, and then if we use 8 rather than 10 for the multiple on pre-tax operating earnings, that's a $16,000 haircut, so $178,000-$24,000=$154,000 vs. today’s price of $118,895 – it’s STILL at 77-cent dollar (vs. the 67-cent dollar we think it is) AND it’s super safe and growing at a healthy clip…

About the author:

CanadianValue
http://valueinvestorcanada.blogspot.com/

Rating: 4.5/5 (22 votes)

Comments

Matt Blecker
Matt Blecker - 2 years ago


Doug Kass got owned!

This exchange is the classic difference between a long-term investor and a short-term speculator.
AlbertaSunwapta
AlbertaSunwapta - 2 years ago
Articles like this serve to support a high price of Berkshire Hathaway. That's a real pity.

Nonetheless, strange as it is, apparently EVERYBODY deeply discounts Buffett's ability to pick suitable if not superior successors and students of his methodologies. (It's like Jain, Simpson, Munger never existed.)

They also doubt Buffett's past ability to have picked companies that, now owned by Berkshire, will continue to outperform the general market for many years to come.

They also ignore the power of free cash flow and float.
Matt Blecker
Matt Blecker - 2 years ago
AlbertaSunwapta,

I don't think articles like this serve to support a high price for Berkshire. The annual report was just released, leading to a discussion of Berkshire's intrinsic value. The headline of the article is "Doug Kass Questions Whitney Tilson's Berkshire Valuation." If anything, this article is providing balance by mentioning an opposing viewpoint.

Not only do people discount Buffett, but also all of Berkshire's managers. Buffett has always been about decentralization, ie pick the right people but stay out of their way and let them manage their way. Berkshire's success is not only due to Buffett, but also all its other managers. A point always emphasized by Buffett.

Buffett values Berkshire by assuming the insurance segment breaks even, however, the insurance segment has been profitable over time. Tilson adds this into his valuation, but Buffett still thinks Berkshire is undervalued using his approach which assumes no profit from the insurance businesses.

Even if you used a multiple of 8x pre-tax 2012 estimated earnings for the operating businesses excluding insurance earnings and the estimated book value of the investments at the end of fiscal 2012, Berkshire is still undervalued using the assumptions below:

7000 per share pretax earnings from operating businesses ex Insurance x 8 multiple = 56000 per share

105,000 ending value of investments per share, this is only slightly more than 6% growth. Very conservative as Berkshire is generating at least $1 billion monthly of FCF. This would suggest a fair value of approximately 161000 per A share or $107 per B Share far above the current stock price below 80 per B share. And this is about as conservative as you can get, not including any earnings from insurance which over time has been profitable, a conservative 8x pre tax or roughly 12x after tax multiple for the operating businesses, and virtually no investment appreciation to book value, only adding in some additional funds from free cash flow.

Great point about the power of free cash flow and float. Buffett can afford to pay a little more for acquisitions because of these two factors. The float is free money as long as the insurance businesses break even, and the free cash flow will replace money used on acquisitions. So Buffett buys Lubrizol for $9 billion, and nine months from the date of acquisition he will have easily replaced the funds used for the acquisition and now he has increased the intrinsic value of Berkshire because he has added Lubrizol's earnings power which is growing. This is how Buffett looks at an acquistion like Lubrizol, very different from short-term thinkers like Kass.

Cogitator99
Cogitator99 - 2 years ago
I thought it showed very little familiarity with BRK on Kass' part, though I suppose that is to be expected.
lolla
Lolla - 2 years ago


To understand Buffett, you would have to read about Cicero's preference for the wisdom of age over the energy of youth. i.e. He's just getting started :)

-Lolla.
LwC
LwC - 2 years ago
It looks like Kass has flip-flopped and bought BRK. He credits his abrupt change of mind to learning that a BRK insider bought shares. There is also an honorable mention for GuruFocus. Read it here:

http://finance.yahoo.com/news/why-doug-kass-finally-bit-182437503.html

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