This is part four of a series on Warren Buffett (Trades, Portfolio)’s Geico story. You can access the previous three parts via the links below:
- Warren Buffett's Geico Adventure Part 3: The Turnaround
- Warren Buffett's Geico Adventure Part 2: Western Insurance
- Warren Buffett's Geico Adventure Part 1: The First Buy
In part three of this series, I covered the Geico bankruptcy and the steps Buffett took to help refinance the business and put the right people in the right places to ensure Geico's turnaround was executed quickly and efficiently.
Without Berkshire Hathaway’s (BRK.A, Financial)(BRK.B, Financial) cash (and certainly without Buffett’s connections), it is unlikely Geico would be around today. To help bolster the balance sheet to fund the company through its transition, Geico worked with Salomon Brothers to sell $75 million of convertible preferred stock. Of this total, Berkshire backstopped $19 million, or approximately 25%. In addition, Buffett spent $4.1 million buying stock on the market at an average price of $2.55 per share.
The recovery
After its near collapse in the mid-70s, Geico had returned to profitability by 1977. The dividend was restored and profits hit $220 million by 1979. Buffett kept buying as the company recovered and by 1980, Berkshire had acquired $45 million worth of stock, around one-third of the whole business. Buffett’s all-in bet really started to pay off in the 1980s. By 1982, Berkshire owned 35% of Geico, representing around $250 million of annual insurance premiums -- more substantial than Berkshire’s insurance businesses. By 1984, as Geico continued to grow, Berkshire’s interest represented $320 million of Geico’s total $885 million premium volume.
By 1987, Geico was earning a little over $9 per share, compared to Buffett’s initial purchase cost of $6.67 all in.
The acquisition
In 1995, Disney (DIS) announced that it was acquiring Cap Cities / ABC for $19 billion, providing Buffett with a cash windfall of approximately $2.5 billion. Using these funds, he swooped on the 50% of Geico (ownership had increased thanks to buybacks) he did not already own for $70, or $300 on a split-adjusted basis -- a 48-bagger for Berkshire.
Buying Geico gave Buffett the seventh-largest automobile insurer in the country and its $3 billion "float," which Buffett describes the benefits of in his 1995 letter to shareholders:
“Since 1967, when we entered the insurance business, our float has grown at an annual compounded rate of 20.7%. In more years than not, our cost of funds has been less than nothing. This access to 'free' money has boosted Berkshire's performance in a major way."
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"Since our float has cost us virtually nothing over the years, it has in effect served as equity. Of course, it differs from true equity in that it doesn't belong to us. Nevertheless, let's assume that instead of our having $3.4 billion of float at the end of 1994, we had replaced it with $3.4 billion of equity. Under this scenario, we would have owned no more assets than we did during 1995. We would, however, have had somewhat lower earnings because the cost of float was negative last year. That is, our float threw off profits. And, of course, to obtain the replacement equity, we would have needed to sell many new shares of Berkshire. The net result - more shares, equal assets and lower earnings - would have materially reduced the value of our stock. So you can understand why float wonderfully benefits a business - if it is obtained at a low cost.
Our acquisition of GEICO will immediately increase our float by nearly $3 billion, with additional growth almost certain. We also expect GEICO to operate at a decent underwriting profit in most years, a fact that will increase the probability that our total float will cost us nothing. Of course, we paid a very substantial price for the GEICO float, whereas virtually all of the gains in float depicted in the table were developed internally.”
Since Berkshire acquired Geico, the business has continued to boom and, coupled with the tailwind from the float, has grown exponentially.
Conclusion
The Geico-Buffett story is fascinating because it gives us some great insight into how Buffett operates and the way his investing style has changed over the years.
In the beginning, when he first invested in Geico, Buffett saw it purely as a deep-value play, which he swapped out for another equally undervalued business after a relatively short period. Over the following years, he built a considerable fortune and following in the investment world, which allowed him to strike the right deal when the time came.
One interesting point is Buffett was able to execute the Geico deal and make a fortune thanks to his connections. This touches more on his activist side than his role as a value investor. He used the same approach in his early career with opportunities such as Sanborn Map and Dempster Mill. Later, he helped American Express (AXP, Financial) with the salad oil scandal and Salamon Brothers. In short, Buffett's successes have not resulted from value investing alone. He has had a huge part to play in making the investments work in his favor as well.
Disclosure: The author owns no stocks mentioned.
