Warren Buffett (Trades, Portfolio)’s Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) is arguably one of the safest investments there is. The company holds over $80 billion in cash and is well diversified across many different industries. All the cash generated from operations is reinvested into the company. Over the years, Berkshire has compounded book value at a double-digit rate per annum. Unlike bonds, which are considered safe but lack any potential for capital gains (when brought at issue), an investment in Berkshire is safe with upside optionality.
However, the single biggest issue stopping investors from buying Berkshire today appears to be the company’s key man risk. Warren Buffett (Trades, Portfolio) is not a young man, it is likely that at some point within the next decade he will be forced to step down as Berkshire’s leader. What happens to Berkshire after Buffett leaves the business is difficult to predict. It is widely believed that, for the most part, the business will continue as normal.
Anlaysts at UBS wrote on the matter earlier this year:
“A key question on most investors' minds is: what will Berkshire look like after Buffett is no longer at the helm? The short answer is that we believe very little will change, especially in the near term. The company has already decided to split leadership responsibilities between operations and investments and the CEO of the operations will likely be someone from within the organization. Additionally, operating company managers already operate autonomously, with Buffett weighing in on capital allocation decisions. This structure should make a leadership transition relatively smooth.”
Decentralized operating model
Berkshire’s decentralized operating model means that even without Buffett at the top of the pyramid, the company’s individual operating businesses will continue to perform as usual. It is at the holding company level where the most significant changes are likely to occur.
Warren Buffett (Trades, Portfolio) is a master capital allocator. It is unlikely Berkshire Hathaway would be where it is today without Buffett’s capital stewardship. While the conglomerate’s component businesses will continue to operate as usual after Buffett, how and where the cash generated from these businesses is deployed will most likely change. Trying to speculate who will be the next leader of Berkshire after Buffett is not as important as trying to establish how they will approach investing. Most of Berkshire’s managers do not have a similar degree of experience to Buffett when it comes to capital allocation, a job made even more complicated by Berkshire’s increasingly large cash pile.
Chasing large deals
To continue to replicate the returns Berkshire has achieved in the past, the manager who follows Buffett must chase larger and larger deals, or hundreds of smaller deals (unlikely as the volume of transactions would overwhelm Berkshire’s small staff and increase the risk of making a mistake). Therefore, it is likely that the biggest change to Berkshire after Buffett’s departure will be the group’s cash allocation strategy. Rather than chasing acquisition opportunities, the next manager may instigate a dividend policy and spend money on share repurchases, prioritizing short-term shareholder returns over long-term book value per share growth.
The bottom line
Overall, I believe Berkshire Hathaway after Warren Buffett (Trades, Portfolio) will look much the same as it does today. The conglomerate’s individual operating businesses will continue to operate as normal as Buffett has basically no input in their day-to-day management.
The biggest change is likely to come at the holding company level. Following Buffett’s departure, it is probable Berkshire’s capital allocation decisions will change to include fewer acquisitions and more cash being returned to shareholders. This shift will not be a true result of Buffett’s departure; it will also be inspired by Berkshire’s growing cash pile and continued healthy cash generation. All in all, both current and prospective investors should not be worried about the future of Berkshire Hathaway after Buffett.
Disclosure: Rupert does not own any stock mentioned within this article.
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