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Alice Schroeder on Buffett and BNI; Which Company Will Berkshire Hathaway Acquire Next?

I know this is probably the millionth article written about Buffett's recent bid for BNI, but I thought I had something to add to the controversy over his move. I was disappointed by the interview with Charlie Rose, since there was only a few minutes devoted to the BNI acquisition.

However I was listening to Alice Schroeder (the author of Snowball) Buffett's biography, talk to Tom Keane on Bloomberg radio and something she said caught my attention. Schroeder said that one of the reasons that Buffett bought BNI was to diversify Berkshire away from the financial and insurance services. She said that right now Berkshire consists of 50% financial, and insurance services, and 50% other industries. She argued that Buffett can manage these financial services but is unsure that his successor would be able to manage these risks.

One of the reasons for the BNI acquisition was to gear Berkshire more towards non financial services for the future. On the surface this seems like a valid argument. The sub-prime and overall recession have proved that financial geniuses with PHDs from MIT cannot devise formulas or computer programs to manage risk. Common sense hands down beats complicated financial formulas. Risk assessors from the largest financial institutions and mortgage lenders devised sophisticated models, that supposedly were able to determine whether their loan portfolio was risky. Yet these "financial experts" miserably failed at their task. (A similar lesson should have been learned 10 years earlier from the collapse of LTCM but was not.) Common sense says that someone with no income or assets will quickly default on a mortgage, and lending to borrowers like this on a mass scale could lead to huge losses for a lender, yet this common sense was ignored. Therefore, this shows that it takes someone with the skill of Buffett to manage risk in financial and insurance services to produce large profits while guarding against downside risk. This could not be guaranteed for his successor.

I decided to look at other possible acquisitions, Buffett may have pursued that could have fulfilled this goal of diversifying away from financial services. I figured Buffett's favorite companies were his largest holdings, therefore I decided to examine them.

Coke

Buffett's largest holding is Coke. It would have made sense for Buffett to buy it since it has a huge moat, dominates its market, and has high returns on equity( and of course is a non financial company.) Yet Coke has way too large a market cap for Buffett to buy there is simply no way he could have bought out the entire company.

Wells Fargo

Wells Fargo is another company Buffett loves, however it is a financial company and even at its low of $8 dollars reached in March Buffett would have had to pay far more to acquire it then he paid for BNI

American Express

American Express is a company Buffett loves and he could have easily afforded to purchase it when it reached its low of $10 in March, however it too is a financial company which entails the risks Buffett was trying to move away from. I saw someone ask why Buffett did not buy AXP since it seemed like a great company which could have been purchased at a bargain price and I think this answers that question.

Johnson and Johnson, and Proctor and Gamble

JNJ and PG are also large holdings of Buffett and are non financial companies. Yet both companies are two of the largest in the world, and way out of Buffett's reach.

Kraft

The only company that would fit on the radar is Kraft. Kraft has only a slightly higher market cap than BNI. Buffett would have likely had to pay a similar price that he had paid for BNI so it would have been a toss up between the two, and perhaps Buffett sees more of a future for BNI and that is why he did not offer to acquire Kraft. In addition, considering that Kraft is trying to make a large offer for Cadbury I doubt the Kraft management would have been interested in a takeover.

The only one of Buffett's favorite companies that he could have bought out entirely is BNI using Schroeder's criteria. However without getting into the whole question of whether the BNI acquisition was intelligent I have two points to make. Firstly Buffett did not have to make one large transaction. He could have purchased smaller businesses in the non financial sector with a large moat and excellent managements throughout the past year. My second problem is why Buffett waited so long to make the deal. Buffett is famous for his principle to be fearful when others are greedy and be greedy when others are fearful. Buffett offered to buy out BNI when it was at $70 a share at a 30% premium which translates to $100. If buffett had been greedy when others where fearful he could have purchased BNI at $65 a 30% premium when it was trading as low as $50 in March. This would have saved Berkshire shareholders billions of dollars to buy the same exact business. Of course I being a BNI shareholder up until two weeks ago, was very happy to sell out at $98 a share instead of $65!

About the author:

Jacob Wolinsky
My investment ideas have been inspired by many of value investors including Benjamin Graham, Charles Royce, John Neff, Joel Greenblatt, Peter Lynch, Seth Klarman,Martin Whitman and Bruce Greenwald. .I live with my wife and daughter in Monsey, NY. I can be contacted jacobwolinsky(AT)gmail.com and my blog is www.valuewalk.com

Visit Jacob Wolinsky's Website


Rating: 3.7/5 (40 votes)

Comments

softdude2000
Softdude2000 - 4 years ago
I am surprised that this article implies WEB is afraid or concerned or moving away or dislikes financials. He understands them very well. He was investing in them for long time.
dew_nay
Dew_nay - 4 years ago
Alice Schroeder seems to be acting like she is the spirit of Warren Buffett. She's acting like she knows every move, thinking, idea and all about how Buffett is thinking and seeks attention through it. She could not even get the facts right when she said Buffett had acquired more of American Express. But everyone is giving her the attention that seems to be all that she wanted.

One of the cornerstone to investing as embraced by Buffett that was highlighted on the recent video hosted by Evan Davis of BBC on the life of Buffett is he doesn't believe in diversifying. He doesn't think anyone is capable of having 50 good ideas and knowing equally good for all 50 and thus, it doesn't mean sense to diversify for the sake of spreading risk across. What I think he meant further is all you need is a few good ideas and a willingness to bet big on that few good ideas that you truly understand when the odds are extremely favorable, with the resources at hand that was accumulated based on based prudence & patience.
yswolinsky
Yswolinsky - 4 years ago
I did not mean that Buffett doesnt understand financials. I meant that Schroeder thinks his successor might not understant them.
alanb9
Alanb9 premium member - 4 years ago
You wrote, "Buffett offered to buy out BNI when it was at $70 a share at a 30% premium which translates to $100. "

When a company's stock is trading at 70, and you offer 100 for it, you are not offering a 30% premium. You are offering a 43% premium.
yswolinsky
Yswolinsky - 4 years ago
sorry my mistake. BNI was trading at 75 before the announcement so it was slightly more than a 30% premium. Thanks for bringing the error to my attention
owen.bernard.ii
Owen.bernard.ii - 4 years ago
I believe the reason Warren Buffett does not buy more of his current financials is that he will then be required to file Berkshire Hathaway as a Bank Holding (correct my terminology if I am wrong) which then requires him to fail under far different regulation from an Insurance company. I believe this was an issue way back when he originally took control of the company back in the 1970's. Read his letters to Shareholders.
PHILCIR
PHILCIR - 4 years ago
He should have just returned the excess capital to shareholders, but I guess that was way too easy for "the great one". this investment will prove to be a total disaster in the long run.
benethridge
Benethridge - 4 years ago
"Common sense says that someone with no income or assets will quickly default on a mortgage, and lending to borrowers like this on a mass scale could lead to huge losses for a lender, yet this common sense was ignored. Therefore, this shows that it takes someone with the skill of Buffett to manage risk in financial and insurance services to produce large profits while guarding against downside risk."

...or maybe just someone with some common sense. :-)

yswolinsky
Yswolinsky - 4 years ago
My point was that it is not easy to manage a large and diverse financial portfolio as Berkshire does. A railroad company entails much less risk than an insurance company.
benethridge
Benethridge - 4 years ago
I understand. It was a good point.
Cowboy77
Cowboy77 - 4 years ago
Common sense says that someone with no income or assets will quickly default on a mortgage, and lending to borrowers like this on a mass scale could lead to huge losses for a lender, yet this common sense was ignored. Therefore, this shows that it takes someone with the skill of Buffett to manage risk in financial and insurance services to produce large profits while guarding against downside risk."

...or maybe just someone with some common sense. :-)

How do you get that Buffett successfully managed the risk in financials? It took a government bailout to save something like 13 of the companies in which he held a major position. He didn't manage that well. You could argue that he got very lucky....and bailed out. If he knew how bad the derivatives were then why didn't he sell his positions? He said himself something to the effect that he thought housing would always go up and was surprised by the extent of the collapse and I believe Schroeder called him on that.

Look, I love Buffett but he was one of the many fat cats that got saved by government intervention. There's no denying that. Give him credit where it due but also give him criticism as well. There's something very distasteful about billionaires having their backsides saved by the average Joe and their kids and their grandkids, etc. etc. etc....... At some point, we need to reinstitute Capitalism and its creative destruction.


Buffett is not, and should not, be above the destructive process if he makes bad investments. This time he was. Me thinks that sucks.[/b]
yswolinsky
Yswolinsky - 4 years ago
You make a very good point and I agree that Buffett made some very big mistakes over the past few years. Yet Id still rather have Buffett managing Berkshire than the Nobel Laureates at LTCM.
Cowboy77
Cowboy77 - 4 years ago
"It looked to us like an oil play. He has a history of making bad oil play decisions. And that was at $75/share, we thought there were better oil plays. At $100/share we think he has lost his mind."

---Bruce Greenwald commenting on Buffet's purchase of BNI

Just another view from a Columbia professor. Right? Who knows but it makes you wonder.
benethridge
Benethridge - 4 years ago
Time will tell... or maybe he just wanted another train set for his basement. :-)
yswolinsky
Yswolinsky - 4 years ago
lol, I dont think BNI can fit in his basement
kfh227
Kfh227 premium member - 4 years ago


I think it's farily obvious that WEB wants to own all of USG. That is next on his list as far as I am cocnerned. The thing is, this is not going to happen any time soon.
batbeer2
Batbeer2 premium member - 4 years ago
>> I think it's farily obvious that WEB wants to own all of USG.

LOL that makes two of us then. Yes, you can read that both ways.
James Nyka
James Nyka - 4 years ago
Problem with writing equals problem with credibility. Place a semi-colon before however and a comma after it when it follows as complete thought (sentence). ...(AXP...when it reached its low in March; however, ......................
Sivaram
Sivaram - 4 years ago


James Nyka: "Problem with writing equals problem with credibility"

What does writing have to do with credibility? Perhaps you meant to say "professional" rather than "credibility." I agree that writers should attempt to write well but I personally don't think it has anything to do with credibility (I'm taking credibility to mean investment success, quality of investment ideas, etc.)

yswolinsky
Yswolinsky - 4 years ago
ames Nyka: "Problem with writing equals problem with credibility"

What does writing have to do with credibility? Perhaps you meant to say "professional" rather than "credibility." I agree that writers should attempt to write well but I personally don't think it has anything to do with credibility (I'm taking credibility to mean investment success, quality of investment ideas, etc.)

Thank you Sivaram. I am new to posting here and I thought the moderator would edit most of my mistakes. Therefore I was not so careful with my grammar in my first few articles. As you can see from my latest article about bonds _http://www.gurufocus.com/news.php?id=76871, I have been much more careful about grammar. I think people agree that I have credibility since I have one of the highest rated articles. I will be more careful about my grammar in the future.

Someone very famous in the financial world emailed me to tell me that she thought my analysis was very good. I will not say who because I am not sure she wants me to mention her name, but everone here has heard of her.

I will post her email with her name deleted

Hi Jacob,

I just read your very intelligent analysis on gurufocus. Pulling apart Berkshire's other investments and looking at them this was was a very, very smart thing to do. Just wanted to say that it was a great idea.

I wrote a Bloomberg column on Buffett's many complex motives for this deal. There are obvious multiple motives but also want to pass along a thought on the timing for whatever it is worth because you raised that issue. I don't know why the timing but have these thoughts a) he did describe it as a simple matter of opportunity and b) last spring when the stock was cheap, Berkshire probably was not in a position to buy the stock. It was being downgraded by Moody's, its book value was depressed and Warren had had to renegotiate the derivatives to reduce their financial exposure to Berkshire. He was working to address the financial services problem in other ways at the time and I think probably had other things on his mind. Nobody will ever know. As a matter of relative value I haven't done the math but Berkshire's stock is up and they are paying 40% in stock. Clearly it would have been better to pay a lower price in cash but at least this offsets some of the pain.

anyway great job - thanks and keep it up - XXXX

Cowboy77
Cowboy77 - 4 years ago
First of all, Jacob, I thought your article was very good. Screw the grammatical errors. I enjoyed the thought process. Probably just some bored holier-than-thou English teacher trying to make themselves feel smart.

Another out of the box thought about Buffet's purchase of BNI. Is there a chance that Buffett could be thinking that cash (with the sinking dollar) needs to be put to work very quickly since it may not be worth that much? He's always said that equities are better than cash. If Bruce Greenwald's analysis is correct about Buffett WAY overpaying for BNI, could it possibly mean that Buffett thinks that the "Black Swan" may be about to fly?
cm1750
Cm1750 premium member - 4 years ago


It sure does not seem that WEB buys into the V-shaped recovery. He has been selling off recovery plays in Q2 and Q3 (WBC, ETN) and been buying defensive (WMT, RSG, JNJ etc.). I realize some are Lou Simpson sales, but I think WEB probably agrees with them.
sabonis
Sabonis premium member - 4 years ago


why does everyone (including WEB) say that diversification is wrong? Berkshire Hathaway is about as diversified of a company as possible. Candy..Oil...Railroads...Carpet...Credit Cards...Insurance...thats diversification and WEB is investing his 50th best idea.
dew_nay
Dew_nay - 4 years ago
Nobody says diversifying is wrong. I mean it depends on the individual. If you think you understand more by diversifying, you are not wrong. But if you think you understand only one or two specific businesses more than any others, than you should not diversify your capital into other businesses that you understand less.

As for Berkshire, the reason why they hold so many businesses in their portfolio and not one is because of the huge sum of money they are managing. They cannot buy out the whole of Amex, or Wells Fargo or US Bancorp because BRK will then have to turn into a bank holding company, nor can they hold more than 10% (if I am right on the %) of any bank holding company. Then, if BRK could, I am sure they would like to own the whole company of Coca Cola, it will cost them over $100B to own them (just to purchase through the open market), and if they do a buyout, the buyout value of KO is surely much more than that. But if you look at it, his action is similar to what he preaches, when he invests, he invests a meaningful amount to what he likes best.
Sivaram
Sivaram - 4 years ago


Sabonis: "why does everyone (including WEB) say that diversification is wrong? Berkshire Hathaway is about as diversified of a company as possible. Candy..Oil...Railroads...Carpet...Credit Cards...Insurance...thats diversification and WEB is investing his 50th best idea"

Diversification isn't wrong but some people like me don't pursue it because diversification limits your potential (but it also saves you if you make a mistake.) It shouldn't be considered as being wrong; rather it should be considered as a portfolio strategy that may or may not suit you. For instance, Benjamin Graham, Walter Schloss, and others, favoured wide diversification.

As for Warren Buffett, yes, you are right in saying that Berkshire Hathaway appears to be diversified in some sense. But in reality it isn't if you look at its history.

First of all, Berkshire Hathaway may own clothing makers, carpet makers, etc, but they have little impact in the grand scheme of things. I'm not an expert on Berkshire but I would say it is heavily concentrated in insurance, financials, and utilities. If Gen Re or MidAmerican blow up, you'll see how little diversification they have.

Secondly, and most importantly, as Buffett and Munger have said before, the vast majority of the wealth that has been created over the history of Berkshire Hathaway has come from 5 to 10 investments (or something like that.) Buffett may have invested in, say, Dairy Queen, or ACME bricks, or Fruit of the Loom, but they are largely irrelevant in the grand scheme of things. Heavily concentrated bets on companies like Washington Post, Geico, Coca-Cola, etc, are what made the company.

In my opinion, the only reason Buffett invests in secondary and no-name companies is because he has very high free cash flow and is unable to invest at low prices into the good ideas. If he did not have so much free cash flow (say he owned some high growth technology companies that re-invest most of the cash flow), I'm sure he wouldn't own all these small stakes in low-quality companies.

Having said all that, I think Buffett is attempting to purposely diversify Berkshire Hathaway now. My theory is that he has lost confidence in his potential replacements (particularly on the investment side) and is attempting to create a broadly diversified, albeit low return, conglomerate. A few years ago, it appeared that the 4 successor portfolio managers were going to have several billion each to invest but now it appears like they will barely have a billion each or maybe even less (depending on what Buffett does in the near future.)
Cowboy77
Cowboy77 - 4 years ago
“The thing that drives our business the most is job creation,” Donald Tomnitz, chief executive officer of D.R. Horton Inc., said today on an earnings call. “If we look at the macro economic environment, it’s not good for us.” (From a Bloomberg story)

If I remember correctly, Buffett has said the most important thing to watch is the unemployment rate. With many people saying that the unemployment rate will stay high for years to come because the sheer math of creating that many jobs is so difficult and unprecedented, could that be another reason to think that Buffett thinks that this could be getting a lot worse soon and he wants to own something tangible other than cash and, hence, a possible overpaying for BNI?
Sivaram
Sivaram - 4 years ago
Cowboy77 Wrote: ------------------------------------------------------- > If I remember correctly, Buffett has said the most > important thing to watch is the unemployment rate. > With many people saying that the unemployment rate > will stay high for years to come because the sheer > math of creating that many jobs is so difficult > and unprecedented, could that be another reason to > think that Buffett thinks that this could be > getting a lot worse soon and he wants to own > something tangible other than cash and, hence, a > possible overpaying for BNI?

Good hypothesis but I don't think that's the case. If unemployment stays high (i.e. economy performs poorly), cash should be a better investment. The way I look at it--this is one reason I lean towards deflation--is that poor economic performance will be deflationary and, under deflation, cash is king. Tough times are when businesses, including Burlington Northern Santa Fe, will do poorly; in contrast, cash will do poorly when the economy is strong and corporate profits are good.

There is another reason I don't buy the scenario you have outlined. BNSF is a very-long-term investment (Buffett is buying it outright and will keep it forever.) What happens in the next few years, or even decade, is largely irrelevant to what happens over the next 50 to 70 years (assuming railroads become extinct in 70 years.)
benethridge
Benethridge - 4 years ago
Maybe Buffett's prep'ing for another round of stagflation, like in the 70's, or high inflation, in which case ownership of a railroad and all those coal reserves will have been a good move. Are railroads pretty much free to raise prices as their costs increase due to inflation?

I'm betting on high inflation, not depression. I think the latter is possible for sure (so is global nuclear war :-)), but the former is more likely, given our fiat currency.

yswolinsky
Yswolinsky - 4 years ago
Buffett stated several months ago that he thought we would likely see massive inflation in the coming years. But doesnt he have enough of an inflation hedge with large positions in Coke, Kraft, Proctor Gamble etc.?
benethridge
Benethridge - 4 years ago
Maybe he just needed to deploy the cash somewhere, like someone said before in this thread, as I remember. In times of "massive inflation" cash is trash...sometimes literally :-)

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