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