For years, Berkshire Hathaway (BRK.A) (BRK.B) has been hoarding cash, amassing a warchest that could be deployed to great effect in the event of a market shock, much as it did during the Financial Crisis.
Yet, when the market finally stumbled in the face of severe economic headwinds brought about by the outbreak of the Covid-19 pandemic, Buffett was nowhere to be seen in the markets.
Cash as a call option
As I have discussed in previous articles for GuruFocus, Berkshire’s cash pile has widely been viewed as a powerful resource waiting to be deployed by Berkshire's CEO Warren Buffett (Trades, Portfolio) when the time is right. In essence, Berkshire’s cash was supposed to be a sort of call option to be exercised when the long bull market finally faltered.
Berkshire has lagged the broader stock market for years, and has only managed to keep pace with the S&P 500 thanks to the raft of sweetheart deals made in the teeth of the last financial crisis. Many investors hoped for a similar situation to play out in this crisis. Thus far, they have been disappointed.
Heading into 2020 with $127 billion in cash and cash equivalents, Berkshire had enormous resources at its disposal. Thus, when the market crashed in the first quarter, many investors thought Buffett would spring into action. Yet, Buffett opted to stay his hand. In fact, rather than dive into beaten-down positions, Buffett actually ditched some of his largest positions, such as the four major U.S. airline stocks.
Fears of option decay mount
Even before the current economic crisis, not everyone was convinced of Berkshire’s ability to put its vast cash reserves to work effectively. Investors were proving increasingly skeptical of the value of Berkshire’s cash reserves. David Rolfe (Trades, Portfolio) of Wedgewood Investments, for example, blasted Berkshire’s continued cash accumulation in his October investor letter, reversing his prior conviction that it represented “a valuable call option on opportunity in the hands of one of the most elite capital allocators extant.” Rolfe things Berkshire will need to start deploying cash if it ever hopes to achieve market-beating performance:
“The efficacy of putting this cash pile to work (plus +$25 billion in annual operating cash flows in Omaha) will be paramount if Berkshire Hathaway is to once again regain their former status as a meaningful grower over just baseline U.S. GDP growth."
During the first quarter, Berkshire’s cash pile actually grew, rising to a record $137 billion. Instead of seizing an apparent opportunity to inject new life into Berkshire, it appeared that Buffett was letting the crisis opportunity slip away.
Optionality goes out of style
If Berkshire will not put its cash pile to work during the worst market rout in more than a decade, when will it?
The answer seems to have more to do with exogenous factors than with any internal pathology. Specifically, the federal government has proven phenomenally generous to ailing companies during the Covid-19 crisis. When General Motors (GM) was forced into bankruptcy in 2009, the federal government extended a lifeline that effectively wiped out the troubled automaker’s equity. This time around, many troubled firms have received massive government cash infusions in exchange for little more than a handful of warrants and modest operating concessions.
There is little reason for the managers of a beleaguered company to seek out Buffett for a rescue deal when they can get better terms from the government. As The Rational Walk, an equity research firm, observed on June 11, Berkshire’s cash call option has little value under such circumstances:
“BRK’s cash, diligently accumulated over years, was supposed to represent optionality in a market panic. But when the supply of dollars is unlimited, when the Fed guarantees ZIRP for years, when asset prices are inflated due to encouragement of speculation, cash is just a drag.”
In a world where borrowing is cheap and governments will backstop any major business, private rescuers are likely to fall out of style. Such has been the case for Berkshire.
My verdict
My recommendation to investors is to watch Berkshire’s cash closely in the coming quarters. If Buffett cannot deploy it externally, he may soon feel compelled to spend it internally. While the Oracle of Omaha’s long-standing antipathy toward dividends is not likely to soften, he may well decide to expand Berkshire’s buyback program. That could result in considerable tailwinds for the conglomerate’s stock.
Disclosure: Author is long Berkshire Hathaway.
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