Bruce Berkowitz: Where is the free Cash Flow?

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Aug 03, 2010
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I must make a disclaimerabout this article that it is in no way a criticism of Bruce Berkowitz. Berkowitz has proven himself to be an excellent money manager, with a spectaculor record over the past ten years. He certainly deserved Morningstar’s award for equity fund manager of the decade. What I do wonder is why his investment philosophy has changed so much over the past year or so. That is the basis for this article.

"At Fairholme, we treat common stock as the most junior bond in a company's capital structure, where the true earnings, the free cash flow of a company, are akin to a coupon without a maturity date. We get really excited when we can find more senior and secure bonds that yield better than average equity-like returns. We then compare market prices to our estimates of free cash flows, to determinean expected return on investment. Price matters, and buying right is half the battle. Getting a reasonable estimate of expected free cash flow is the other half." Quote from Bruce Berkowitz

This is not the only quote where Berkowitz mentions FCF, Berkowitz almost always mentions FCF when he speaks about stocks that he likes. For the past few years these stocks consisted of many pharmaceutical, defense, and consumer goods companies.

Below is a list of stocks Berkowitz has been selling, along with their P/FCF:

PFE: 9.1

FRX: 8.7

WLP: 3.7

ACF: 3.1

Bruce Berkowitz has been stocking up on financial stocks lately. Financials now represent over 60% of his portfolio. Some of the companies Berkowitz has been buying lately include; MBIA, BAC, AIG, Regions Financial, and CitiGroup.

Let us look at the price over free cash flow of each:

MBIA: -0.9

BAC: 1.5

AIG: 0.2

RFF: 2.4

C: -12.8

MBIA, and Citi are both FCF negative. Regions Financial, AIG, and Bank of America are all P/FCF positive. However, this is only recent phenomenon. Until recently, these companies were losing tremendous amounts of money. AIG lost $100 billion in 2008. However, stocks like WellPoint and Forest labs have experienced much more stable earnings (and FCF) over the past several years, than the financial stocks Berkowitz has been buying. The FCF of the companies he is buying are much more unstable then the companies he is selling. Why not go with Wellpoint at 3.7 P/FCF over Citi at -12.8 FCF?

It seems that Berkowitz has had a large change in strategy over the past few months. Maybe he is relying on the fact that these companies will in the future generate large amounts of FCF, however they are far different than the companies Berkowitz has purchased in the past. If anyone has an answer including Berkowitz himself I would be curious to know.

Disclosure: long WLP, and FRX for one of my clients.