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John Engle
John Engle
Articles (529) 

Berkshire’s Lost Crisis Opportunity, Part 2

Warren Buffett may have good reasons for keeping his powder dry

During the financial crisis in 2008, Warren Buffett (Trades, Portfolio) found himself in high demand. Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) had a bumper year for deal-making, orchestrating large-scale – and ultimately very lucrative – private rescue packages for the likes of Goldman Sachs (NYSE:GS) and Bank of America (NYSE:BAC). Yet, as I discussed in the first part of my analysis of Berkshire’s crisis reaction, Buffett has thus far largely kept to the sidelines of the current economic crisis.

No competing the with Feds

One big impediment of late to Buffett’s conventional deal-making strategy has been the federal government. The terms of the recent airline industry bailout package demonstrate all too clearly why Buffett could have trouble finding takers for a private rescue deal.

Berkshire has always structured such deals to maximize its own eventual returns. The federal government has shown that it has no such compunction. As analyst Rational Walk observed on April 14, generous government bailout terms have made a Berkshire rescue look rather unappealing:

“Say you're CEO of an airline and have liquidity problems. You've got a 10% owner, Berkshire, that's known to have a lot of cash. Do you go to Buffett where he'll probably offer to buy a double digit yielding preferred + massively dilutive penny warrants? Or do you call Mnuchin?”

While a deal with Buffett might have been the best way for companies to preserve their capital structures in crises past, things are clearly different this time around.

So long as the government remains this generous, any private deal will be a tough sell. But that may not be the real reason Berkshire has been out of the deal-making loop in recent weeks.

Waiting for another drop?

There is another plausible reason for Buffett’s continued waiting on the sidelines: He may think the market downturn is not over. There is good reason to believe this since the global economy remains essentially frozen, unemployment claims have skyrocketed and large parts of the real economy face increasingly dire distress.

Even if the economy is allowed to rev up again in the next couple months, much of the damage has already been done. A protracted recession is likely, and that may well weigh on asset prices, despite the Federal Reserve’s relentless liquidity injections and the government’s generous bailout packages.

Stock market professionals appear to be less than confident that the current bounce back can be maintained for long. According to an April Barron’s poll, only 39% of money managers say they are bullish on U.S. equities in 2020. Buffett may share a similar outlook.

Further declines would mean better buying opportunities. Buffett could well be keeping Berkshire’s powder dry to deploy in the near future, as the true economic impact of the incipient recession are finally priced in. That would be in keeping with his penchant for patience and clear-headed thinking, even in the midst of a crisis.

My verdict

Buffett’s lack of visibility during what is shaping up to be the worst recession in a generation has left many investors and commentators perplexedly scratching their heads. But there may be very good reasons for the Oracle of Omaha to be keeping his own counsel. Whether said reasoning would – or could – be able to support Berkshire’s policy of holding vast cash reserves going forward, however, remains uncertain.

Rather than a case of not being able to compete with exceedingly favorable and generous federal bailout terms, Berkshire’s recent quiet may actually be a case of waiting for the right moment to strike. But Berkshire shareholders will need to see the company’s cash pile put to good use at some point during this crisis. If it is not, I expect that investors may start to question the utility of keeping so much cash in Berkshire’s bank account.

The clock is ticking.

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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