Berkshire's Massive Cash Pile Will Be an Asset in Next Crisis, Pt. 2

The conglomerate should thrive in a recession

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Oct 25, 2019
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Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) has found incredible success as an owner and operator of a variety of businesses. When CEO Warren Buffett (Trades, Portfolio) likes a company, he often attempts to own it outright. According to Buffett, this blueprint for success came courtesy of his longtime business partner, Charlie Munger (Trades, Portfolio):

“The blueprint he gave me was simple: Forget what you know about buying fair businesses at wonderful prices; instead, buy wonderful businesses at fair prices.”

However, as the long bull market has ground on, even in the face of mounting macroeconomic and geopolitical headwinds, Berkshire has found it increasingly difficult to find bargains. Thus, it is unsurprising that the company is stockpiling cash. Indeed, it is well placed to profit handsomely from a market correction in the relative near term.

Not enough elephants

Unsurprisingly, a market environment in which stocks are testing all-time highs (even as flows into private capital markets continue to hit historic levels) has not been fertile ground for Berkshire’s buyout-heavy strategy. In his 2018 letter to shareholders, Buffett lamented the lack of 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.”

Still, this has not stopped Buffett from trying. Unfortunately, many of these transactions have been at anything but bargain prices. Precision Castparts offers one such case. Berkshire bought the company for $30 billion in 2015, which was a big premium given it only had $1.5 billion in annual earnings that year. Precision Castparts has grown since then, but not massively – 7.2% revenue growth in 2018 and a 2.3% increase in 2017. Meanwhile, other big-ticket investments, such as Berkshire’s big stake in Kraft Heinz (KHC), have soured considerably.

Given the dearth of bargain buyout opportunities, it makes a lot of sense that Buffett would opt to keep Berkshire’s powder dry in the face of mounting economic turmoil.

Combining cash and courage

Buffett has rarely allowed a good market panic go to waste, instead leveraging Berkshire’s unique financial strength to great advantage in crises past. Indeed, he has profited handsomely from market panics, which have allowed him to scoop up excellent companies at discounts, as well as to play an important role as a provider of vital liquidity to otherwise good businesses. Buffett, known for his many quotable aphorisms, has one for this exact situation:

“Cash combined with courage in a time of crisis is priceless.”

This strategy was on full display during the financial crisis at the outset of the Great Recession. When Bank of America (BAC, Financial) and Goldman Sachs (GS, Financial) teetered on the brink, Buffett swooped in to offer liquidity. Berkshire saved the faltering banks, which quickly recovered, netting the company about $19 billion for its troubles.

In essence, Berkshire’s cash gives it a powerful tool to leverage any time the market turns south. In the words of venture capitalist Josh Wolfe, that $122 billion in cash represents a “large call option” on a number of opportunities, especially for bolt-on acquisitions of “strong moat industrial companies” that will be much cheaper in a downturn.

Profiting from panic

Berkshire’s ability to make opportunistic plays during downturns, as well as acting as a stable financial rescuer, has resulted in access to a variety of alpha-rich private deals. As Ben Hunt of Epsilon Theory has pointed out, private information is perhaps the only stable source of market alpha today. While we have argued previously that this is an overly extreme and reductive stance on investment alpha, Berkshire has undoubtedly benefited from private information. When Goldman and Bank of America needed support, Buffett was able to leverage private information to Berkshire’s ultimate profit. Similar informational superiority will inform any potential buyout deal.

Private information is no guarantee of market-beating performance, however, as the Kraft Heinz debacle clearly shows. Moreover, Berkshire has struggled in recent years to match the performance of the broader stock market, despite its frequent access to more and better information. In fact, it has barely tracked the performance of the S&P 500 Index since 2002, even when we include the impact of the sweetheart deals like the Goldman and Bank of America rescues.

A substantial downturn could help get Berkshire out of its current rut. Indeed, another recession may be just what the doctor ordered. For Berkshire, anyway.

Disclosure: No positions.

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