Berkshire Hathaway and Fairfax Financial Holdings Gaining From USG Debt to Stock Conversion

On February 12, we reported that Berkshire Hathaway (BRK-A) headed by Warren Buffett and Fairfax Financial Holdings (FFH, Financial) Chaired by Prem Watsa obtained the right to acquire additional shares in the drywall company USG Corp. when the shareholders of USG approved the conversion of the $400 million debt into stock. The conversion price was reported to be $11.40.


In addition, we reported Fairfax Financial Holdings bought 200,000 shares of USG in the open market at $5.24 per share on March 11, 2009. The current USG ownership of the two Investment Gurus is as follows:

Ticker	Guru Name	Portfolio Date*	Current Shares	% of Shares Outstanding
USG		2009-03-11	7,311,500	7.37
USG		2009-02-09	43,387,981	43.75

In 2009, the stock declined to a 52-week low of $4.16 in early March but has climbed since then. Today it rose above the conversion price of $11.40 at which Berkshire Hathaway and Fairfax Financial Holding gets their shares. Once again, Warren Buffett and Prem Watsa are making money for their shareholders.


In the article mentioned above, we questioned how USG fits into the model of companies that Warren Buffett likes, given its declining revenue and earning trend, shrinking gross margin rate, and increasing debt. The Investment Gurus’ high profile investing activity also invited heated discussion on the intrinsic value of USG in GuruFocus Forums, when the stock price fell around $5.


Naturally, our users had a wide range of intrinsic value estimate of the company, from about one (1) billion dollars (about $8-12 per share) to greater than $5 billion or about $50 per share, however, the consensus was that at $5.00, USG represented a decent discount from its intrinsic value. In the Forum discussion, a question was raised by GuruFocus user mahmutpasha and he or she asked: “Should we trust Gurus on these – USG & UFS”. Here are two very insightful Forum posts, representing the two extremes of the intrinsic value estimate:


The first post came from user buffetteer17:

Take a look at tangible assets and free cash flow. USG has net value of $1,500M, or about $15/share. A lot of that is plant and equipment, $2,500M. Presumably a competitor would have to spend around this amount to set up an equivalent operation. So their sheer scale may give them somewhat of a moat. Over a full economic cycle, USG seems to average around $100-150M of free cash flow per year, but it is very lumpy. In the current environment they're bleeding about $300M of cash per year.


With 100M shares outstanding, they look to earn $1.00-$1.50 a share of free cash flow once the economy turns around, giving them a multiple of about 5x with the current share price of $5. If you use the 10x free cash flow rule of thumb, they ought to be worth $10-15/share. They have a lot of debt and who knows when or if they'll return to profitability? Since there's a housing and commerical property glut right now, I'd discount the value of the future free cash flow by a couple of year, say 20%, and estimate the intrinsic value at about $8-12/share.

The second was by user batbeer2:

I think USG has ~125 M shares outstanding and I think the debt is ~2.5 B (back to dec 2007 level) as opposed to the 100M and 3 B reported on many good sites ;-)


I am not known on this forum for my impeccable calculations but based on your estimate of free cash flow lets call it a $ 10 stock.


I work with a 15% cashflow yield; that implies ~6.5x cashflow multiple. That would make USG a ~$12 stock. So with those assumptions our valuation is more or less the same.


Looking back you find years with ~ 5 B in revenue and a ~ 10% net margin. A 5B company. With 200 M shares that would be a $ 25 stock on a p/e of 10 if the world ever returns to normal. No asbestos and no deflating housing bubble. IMO USG is less cyclical than it is perceived to be. The stock has been all over the place, but revenue has not. Also, the price of wallboard is not directly related to the price of houses.


All based on reasonable numbers for the past 10 years. Rearview mirror etc.


IMO USG will be a far better company from 2010 on than it was at any point between 1998 and 2008. USG will have > 7 B of revenue and a > 15% net margin within 10 years. A 10 B company.

With mr. Market being what he is, we just might be able to sell him the USG shares at $ 50.


No matter how I look at it I cannot imagine a reasonable scenario where the investor today stands to loose money over the long term. My subjective, personal, murky windscreen valuation says this is a 10 B company. My worst case calculation says 2B. Market cap today is ~0.7B if you adjust for the number of shares outstanding.


Sure, there are scenarios where the investor looses money

1) WEB/Watsa stealing it private;

2) bankruptcy filings and shareholders loosing out to creditors

3) Another asbestos only this time it is not asbestos but some other hidden danger.

4) Commercial realestate market gets much worse and more so than the housing market.


I just don't think those scenarios are reasonable.


You will note WEB and Watsa are doing their bit to make sure #2 never happens.


What I cannot understand is why WEB was buying > $ 50 but it sure helps.


To me it is obvious that USG is a >> 5B company now trading < 1B.

Whether USG will proper and fetch a rich valuation in the market remains to be seen. To participate in the discuss, we at GuruFocus would like to throw in our two cents in the discussion by presenting this 10-year Valuation results that is only normally available to the premium members (7-day free trial available)





According to the 10-year valuation tool, we can tell the USG stock price is at the low end as measured by P/E, P/B, P/S metrics.


Users are encouraged to submit your question by posting a question in GuruFocus Forum! Chances are, it will be answered by a very insightful value investor.