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John Engle
John Engle
Articles (529) 

Berkshire's Lost Crisis Opportunity, Part 1

Warren Buffett has been hoarding cash for years, but he seems to have few options to deploy it, even in a downturn

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 (NYSE:BAC) 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. (NYSE:LUV), 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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About the author:

John Engle
John Engle is president of Almington Capital Merchant Bankers and chief investment officer of the Cannabis Capital Group. John specializes in value and special situation strategies. He holds a bachelor's degree in economics from Trinity College Dublin, a diploma in finance from the London School of Economics and an MBA from the University of Oxford.

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Comments

dirt2624
Dirt2624 premium member - 3 months ago

When markets are 70% overvalued a drop of 30% results in what - oh yah - a market that is still 40% overvalued - DUHHHH

Buffett can wait for the next 50% down before getting interested as should everyone else.

I am always amazed that writers just don't have a clue what valuations are required to play by the 1st rule - DON'T LOSE MONEY - that means a sizable discount from intrinsic value - probably not a lot of opportunities that can qualify in makets still 40% OVERVALUED

TonyTiger
TonyTiger premium member - 3 months ago

The problem is: the FED has signalled it will not let asset prices fall to distressed levels. So buying cheap does not work anymore as long as the FED stays course.

dirt2624
Dirt2624 premium member - 3 months ago

If we get the concensus gdp drop of 35%, it would take over 17 years of 2,5% growth to return to the gdp level of december 2019 - you seem to have a lot of faith in the Fed and their ability to purchase etf's to control current rich valuations - I would bet they fail - so I stay in cash waiting for a better opportunity set for investing - just seems rational

TonyTiger
TonyTiger premium member - 3 months ago

Believe me, I would love to see market forces at work, resulting in lower asset prices on Wall Street so I can buy great companies at acceptable prices.

But we do not have a market anymore. We have a government agency (the FED) setting prices for financial assets. In fact, it would save everybody a lot of work if the FED announced equity and bond prices on Mondays for the following Fridays.

The only way the FED can fail is if they continue to print money and production stays low or continues to fall - but then your cash is falling in value...

dirt2624
Dirt2624 premium member - 3 months ago

Time to start shopping in markets that are not under the thumb of the Fed. Not every central bank can pull that large of a crime off successfully.

No change allowed in prices, unless up of course - even as earnings evaporate. Dead money to be in stocks for every pension and institution - how long will they play along???

So the only way the Fed can assert such control is to own every share of every stock traded in the USA. Going to be fun when a pension or other institution wants to get $50 million in redemptions from SPY, which might cause others to want out triggering $billions in etf sales. The etfs have to sell the underlying shares to do the redemptions. Or do they just call the Fed and it issues the checks and the cash then goes to the institutions while the etf shares are assigned to the Fed.

Lots of room for fraud from every angle. I am sure that there will be a lot of fake sell orders from the hacker community. And every etf will be targeted. And then the spoofing orders will be coming fast and furious by the front runners to test the resolve of the arrangement.

Should be fun to watch from a safe distance. This is the USA we are talking about, right - or what used to be the USA.

TonyTiger
TonyTiger premium member - 3 months ago

I agree, there are some markets where the FED is not buying - although prices there get pushed up, too, because of FED actions and spillover effects. Some emerging markets are still beaten down and might fall further, as they can't print dollars (around 100 countries have already phoned the IMF...).

So maybe the FED has to bail out the emering markets at some point, too.

Even with zero earnings private investors might still buy stocks and front-run the FED, as we are already seeing in bonds with negative interest rates (see Japan).

Business model of the future: build a large new business, get into an index to get into an ETF and the FED will buy your business. In the endgame, we will all end up printing shares all day long and nobody will work anymore...

dirt2624
Dirt2624 premium member - 3 months ago

Thanks Tony - Time for everyone to read Atlas Shrugged

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