From 2002 to 2019, Berkshire Hathaway (BRK.A) (BRK.B) barely managed to keep up with the S&P 500 Index. Many investors have hoped that CEO Warren Buffett (Trades, Portfolio) would be able to turn things around by deploying the $128 billion in cash on Berkshire’s balance sheet, especially during a downturn when bargains are more plentiful.
Waiting for an opportunity
With asset prices soaring ever higher during the decade-long bull market following the Great Recession, Berkshire has found it increasingly difficult to identify acquisition opportunities. In his 2018 letter to shareholders, Buffett admitted that sky-high valuations had limited the scope of acquisition opportunities:
“In the years ahead, we hope to move much of our excess liquidity into businesses that Berkshire will permanently own. The immediate prospects for that, however, are not good: Prices are sky-high for businesses possessing decent long-term prospects. That disappointing reality means that 2019 will likely see us again expanding our holdings of marketable equities. We continue, nevertheless, to hope for an elephant-sized acquisition.”
Berkshire’s best returns over the past decade came during the last financial crisis, thanks largely to sweetheart deals such as the Goldman Sachs (GS) and Bank of America (BAC, Financial) rescues. A similar crisis could, many investors hope, present similarly attractive opportunities to make those “elephant-sized acquisitions.”
Ready to seize crisis bargains
In August 2019, venture capitalist Josh Wolfe opined that Berkshire’s cash represents a “large call option” on a number of opportunities in the event of an economic disruption. In particular, Berkshire would be perfectly placed to make bolt-on acquisitions, act as lender of last resort to financially strained companies and acquire hard-hit businesses – especially industrial companies with strong economic moats.
I have written about Berkshire’s massive cash pile at length. Most recently, on Oct. 25, I discussed how the company’s cash reserves could be deployed to great effect in the event of a market downturn. With such a downturn now playing itself out, one might expect Buffett to be in the thick of the action making deals.
However, this has not been the case. Indeed, Berkshire has thus far continued to sit on the sidelines.
Government ruins the party
A key reason Berkshire has been stuck on the bench is that it cannot offer struggling companies the best deals. Buffett has a long track record of leveraging his reputation and cash resources to make deals with desperate companies that end up highly favorable to Berkshire.
Yet, even though the ongoing economic crisis has hit nearly every industry and threatened the existence of otherwise profitable businesses, few – if any – cash-strapped executives have been knocking on Buffett’s door. The reason is simple: They can get better terms from the federal government, which has proven unprecedentedly generous with bailout cash.
During the last financial crisis, federal bailouts came with severe strings attached. In the case of General Motors (GM), for example, the government rescue saved the company, but wiped out the equity. That is obviously not an attractive option for most managers, especially with the proliferation of stock-based compensation over the past decade.
A better bailout option
Companies have been getting far better terms from the government this time around. The passenger airline industry, for example, was allocated $50 billion from the federal economic rescue package, money that came with few strings attached. One such beneficiary, as I discussed last week, was Southwest Airlines Co. (LUV, Financial), which received $3.3 billion in grants and loans in exchange for warrants that will barely dilute existing equity.
By comparison, a rescue from Berkshire would be far less attractive, even in a best-case scenario. Naturally, that has made it hard for Buffett to find a deal, even in the midst of an economic crisis.
Disclosure: Author is long Berkshire Hathaway.
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