Why Buffett’s Berkshire Hathaway Must Not Be Broken Up. Ever.
Financial vultures are always eager to descend upon companies they have no interest in as businesses. Their only goal is a quick hit from compelling a company to break off pieces or break up altogether. Long term investors beware! The scavengers who do this and call themselves activist investors have neither the business itself nor the interests of its shareholders at heart. Sometimes their approach is to say that a future breakup is “inevitable.” In the case of Berkshire Hathaway (BRK.A)(BRK.B) it most certainly isn’t. Encouraging a break-up of Berkshire into its pieces would be the equivalent of floating the notion that the Eiffel Tower should be turned into scrap metal.
Sometimes journalists pitch in with stories that support the position of the circling buzzards. Barron’s, to my great disappointment, had a story this past weekend by Andrew Bary which pushed suggestions for a dividend and ultimate future breakup. These are two things that no investor who has owned Berkshire for long enough to gain some knowledge of it would be likely to support. I won’t question the author’s motives but I must say that it is not the sort of story I expect from a magazine I have read for 50 years, in the early years savoring every word.
Who else might cheerlead for break-ups and spin-offs? Oh yes, Goldman Sachs (GS). As far as I know they haven’t singled out Berkshire, but they have made the general case that break-ups and spin-offs can double a company’s valuation by creating more focused businesses (with a few additional CEO salaries and corporate headquarters costs, of course). Bear in mind that Goldman Sachs makes a lot of money putting businesses together and after a decent interval taking them apart again, and vice versa. Which is better for Goldman: is it businesses which plug along successfully in the long term or businesses which spin things off or break themselves up? Which do you suppose is better in the long run for shareholders?
The most perplexing argument for a partial breakup and dividend was in Mike Lipper’s Weekly Blog #710 (December 7, 2021) published here on Seeking Alpha. Lipper is an analyst and advisor I have respected for decades. What made it the more surprising when I first read it was that Berkshire came second on a list of highly favored investments the first of which was Apple (AAPL). It was part of a very insightful piece on how to deal with corrections and what companies to own in a tough market. Here’s what Lipper had to say in his paragraph on Berkshire:
Berkshire Hathaway is managed for the non-shareholder heirs of current holders. This fits the desires and needs of a large portion of Berkshire’s owners. At some point, I suspect pieces of the operating company will be hived off to shareholders or other operating companies. The book value of these companies starts with their acquisition price, plus earnings less dividends paid to the holding company, which in a number of cases is way below what these activities are worth in an open market. I can envision a day when my grandchildren will receive a growing cash dividend from a smaller, regularly managed company.”
That’s a variant of the Goldman argument. I had to think a bit about why I disagreed. His first two sentences are spot on and provide very accurate descriptions of me and probably most other Berkshire shareholders. My only real uncertainty about the ultimate disposition of Berkshire shares is whether the step up provision which resets cost basis at the time of death will still be in effect at the time I die. The rest of the paragraph is also well reasoned. What I realized was that while it was accurate as far as it goes, it breaks down on two key points that are very important. They involve the subtleties of two basic principles that any decision about break-up and/or dividends at Berkshire will hinge:
- While Lipper may be right on the immediate pricing of pieces “hived” away, well-informed long term investors know that short term prices have little to do with long term success. Short term choices undertaken to produce an immediate higher price may in fact undercut long term success. Long term success comes entirely from operating results. The market may sometimes undervalue this – in Berkshire I think it does right now – but eventually the market catches on and values a business by its ability to grow and generate profits. I’m pretty sure Mike Lipper knows that and I encourage him to comment or send a message telling me how I am wrong. Ben Graham said something on this subject, calling the market a voting machine in the short term and a weighing machine in the long term. Don’t be too fast to pitch in your influence with the short termers.
- Synergy is the essence of Berkshire. Unlike the earlier conglomerates Berkshire doesn’t consist of a group of businesses thrown randomly together. It’s the way the businesses relate that matters, with the various parts fitting with other parts to enhance the overall results. Think of Berkshire as the Golden Goose in the tale. Berkshire shareholders should not yield to the desire for instant gratification like the folks in the Golden Goose tale who chopped it up in the hope of getting at the eggs faster.
This article will lay out the ways that Berkshire Hathaway benefits from a conglomerate form with synergy that would be destroyed by a breakup.
Synergy Is The Defining Characteristic Of Berkshire
The term “conglomerate” has been for many years a swear word in the market. Berkshire Hathaway is indeed a conglomerate, but the term as generally used doesn’t apply. Conglomerates have a truly awful reputation, much of it well earned. The term itself is sullied by a group of multi-business companies which no longer exist. The heyday of the bad conglomerates was the 1960s, a time when P/E ratios grew from high to astronomical much as they have in recent years. This created an opportunity for CEOs of highly priced companies to buy junky low priced companies whose earnings were thus elevated in value to the P/E ratio of the parent company. Put together this way, conglomerates like Ling Temco Vought looked like brilliant growth companies for a while despite the fact that they actually had little or no organic growth at all. It was a great trick while it lasted. In the end it produced devastating results when it inevitably ran backward as interest rates rose, P/E ratios fell, and corporate debts became unmanageable. I described these earlier conglomerates in an earlier article as
…often projections of egocentric CEOs who overpaid themselves and strove to create empires. They accomplished this with the financial engineering trick of using their own highly priced stock to buy cheap but inferior businesses and temporarily lever up earnings per share. Worse yet they also used bonds, which were a cheap way to raise capital with the low rates which prevailed through much of the 1960s but blew the companies up as rates rose in the 1970s.
Putting these disparate businesses into a single entity had no real purpose for either their shareholders or society as a whole. Berkshire arguably sells at a conglomerate discount today, although the reasons for such a discount clearly do not apply.”
The overall architecture of Berkshire consists of businesses which are decentralized operationally combined with centralized asset allocation. Overall allocation is done in its 30-person corporate headquarters in Omaha. In Berkshire all the pieces fit together in a way that makes the whole more valuable than the sum of the parts. To argue the contrary is to miss the point which makes Berkshire the best risk-adjusted investment on the market. Berkshire is made up of excellent businesses most of which are number one or two in their industries and many clusters of which interact favorably with one another. Buffett put this structure together with skill that increased as he went along. In the long run it is the structure itself, not any single man, which makes Berkshire what it is.
The fact that Berkshire is made up of great companies, many of which are acquisitions carried on the books at far less than their fair value, could indeed be taken as an argument for a breakup, This argument has a major fallacy. It makes little difference how acquisitions which appreciate in business value are carried on the books. As long as they continue pumping out cash and sending the amount beyond their own needs to Omaha they are performing in exactly the right way. To argue otherwise neglects the fact that the pieces of Berkshire were acquired with attention not only to their individual virtues, but to the way they fit into an overall scheme. The thing never to lose sight of is that Berkshire was put together with attention to a synergistic whole.
The intricate structure of Berkshire Hathaway is something that evolved over time with a positive interaction among the parts deepening in several stages. This is a fact so large that it is easy to miss. The parts were put together with attention to capital allocation. Capital allocation is the essence of capitalism. The fact that Berkshire is aligned with the basic principle of capitalism also requires stepping back to a distance from which it is possible to see it whole. It’s like those shots of the earth sent back from the moon. It takes the distant view and gives a sense of the connection, value, and beauty of what we have. To understand why breaking up Berkshire would kill the Golden Goose it’s useful to start by understanding how it was put together.
Phase One: The Buffett/Munger Partnerships Made Value The First Principle
The first phase in Buffett’s journey through the world of capital allocation came before Berkshire Hathaway was his vehicle. It was heavily influenced by the simple value principles of Ben Graham whose approach involved buying dirt cheap and neglected stocks of little distinction, “cigar butts” with one puff left. Most had net cash or another obscure asset which the market hadn’t noticed.
This was Buffett’s guiding principle through the years of the Buffett Partnership (1957-1969). It was innovative at that time and it worked brilliantly. From its inception to the time it shut down because of diminishing opportunities the return of the Buffett Partnership was 31.6% compounded annually versus 9.1% annually for the Dow Jones Industrial Average (DJI). Meanwhile Buffett’s friend Charlie Munger, observing this success, put together a similar hedge fund (1962-1975) returning 19.8% compounded annually over a much more difficult and volatile period. The ultimate problem for the pure Ben Graham approach was that it didn’t scale. You can’t do it with investments of any size.
Taking control of Berkshire Hathaway, a failing textile company, Buffett began by using cash from the textile business to buy insurance companies, creating a company divided between a failing textile business and a rising insurance group. This process, interesting in itself, produced two important principles. The first was using the cash from a business which couldn’t do anything productive with it as a source of funds to buy businesses which could. The second was the fact that your successes will eventually outgrow and overwhelm your mistakes. All you had to do was keep getting better. For the rest of his career these principles provided the larger idea behind Buffett/Munger actions.
Phase Two: From See’s Candy To Coca-Cola
Looking backward from the present Berkshire, the early decades of Berkshire are both surprising and revealing. As late as 1972, the year Berkshire purchased See’s Candies, Buffett mentioned in his letter to owners (nothing like the present Shareholder Letters) that Berkshire had purchased high yield muni bonds which it intended to hold to maturity to offset probable future insurance claims. Raise your hands if you knew that Buffett’s first use of insurance “float” was buying muni bonds, in the middle of a terrible long-term bond bear market, by the way. That’s the common approach of insurance companies to this day, and over the past decade it has held their investment returns to peanuts. Buffett had a better idea. The Insurance Investments segment of the 1976 letter was the first to include a list of common stock investments, to wit:
- California Water Service
- Government Employees Insurance Co Convertible Preferred
- Government Employees Insurance Co Common Stock
- Interpublic Group
- Kaiser Industries
- National Presto Industries
- Ogilvy & Mather Industries
- The Washington Post Class B
The Government Employees Insurance Company (now GEICO) Preferred and Common were together the most important positions and are the only part of that original portfolio which is still an element of Berkshire. Berkshire purchased the remaining shares that it didn’t already own and made it a wholly owned part of Berkshire’s insurance group in 1996. None of the other companies are exactly money-compounding blue chips. In fact, many now look rather like dull value stocks. The Washington Post may have looked a bit like a growth company at that moment. Like several others on the list it got by with minimal capital.
Meanwhile a learning process was going on for the Buffett/Munger partnership with Charlie providing the prod to shake things up. The major influence which Charlie passed along to Warren was the 1958 book by Phil Fisher entitled Common Stocks and Uncommon Profits. It’s a virtual textbook for growth investors and is still very much relevant. It wasn’t exactly new information and it didn’t entirely depart from the concept of value. What it did was reframe value for a more expansive task. The goal was a strategy for compounding money over an extended period. The challenge for which Fisher’s book provided the template was finding companies that could compound money internally. As Warren put it succinctly: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”
Oddly enough, the major success accounting for the good long numbers of Ben Graham himself had been achieved by buying and holding GEICO for many years. For the Buffett/Munger team the first “wonderful company at a fair price” was See’s Candy. See’s is now a cornerstone of the Berkshire legend but it didn’t begin to be mentioned in an annual letter until 1977 and was not treated prominently until 1986. Through the 1970s more attention was paid to the failing textile business. The company most often mentioned was Blue Chip Stamps, a Ben Graham type of business more or less in run-off. See’s was a gem, but a small gem. What it contained was a major idea. It took a backward look to see that it was growing at a good clip with very little additional capital needed.
Buffett bought See’s Candy at a price of $25 million, almost nixing the deal when the owner wanted $30 million. He toughed it out until the owner caved. Its return to this date is in excess of 8000% meaning that it has returned $2 billion in pretax earnings. It has gone from $80 million to $380 million in annual sales and from $5 million to $30 million in pretax profits with only $40 million in investment. You can read an inspiring account of it here with mentions of Buffett Shareholder Letters in which it is more fully discussed. The absolute numbers for See’s Candy are still small within the overall picture at a Berkshire which now has a current market cap in excess of $700 billion, but its influence has been massive.
The See’s acquisition combined a number of characteristics which made it a prototype for Berkshire’s future. It required very little capital. It had the asset of a highly recognizable brand which provided it with what Buffett came to call a “moat.” It had high quality personnel and great management. What made it great was the specific company not the broader industry. Most candy stores don’t do very well. The fact that See’s could raise prices from $2 per pound to $20 per pound now is evidence of another very important trait of a strong brand: pricing power.
See’s model was the prototype for companies which needed little capital and turned their inventory over rapidly. It worked equally well for publicly owned stocks and companies acquired in their entirety. In 1983 Berkshire bought Nebraska Furniture Mart which shared many of these characteristics. In 1985 Berkshire bought Cap Cities/ABC, an even more capital light company, in which it already owned shares. Among publicly traded stocks American Express (AXP) fit perfectly, and shared the “float” aspect of insurance companies in money it held for travelers’ cheques. In 1988 Coca-Cola (KO), perhaps the ultimate capital light company, appeared on the annual portfolio list for the first time and by 1990 it had surged ahead to be the largest position by far.
Almost hidden among the many virtues of See’s was the most important thing. Thanks to its having so little need for additional capital it served as a cash cow which could provide funding for Berkshire’s other ventures, which at the time were primarily insurance companies. This introduced a basic principle for the structure of Berkshire. Wholly owned companies like Nebraska Furniture Mart, Cap Cities/ABC, and See’s and publicly traded companies like American Express and Coca-Cola served perfectly as counterparts to insurance companies which generated “float,” funds which were produced by underwriting, but which had to be invested to offset future liabilities. The synergy was ideal.
Because of its enormous and “clean” balance sheet Berkshire could use these wholly owned businesses and common stock investments to offset future liabilities – and then some. In effect, Berkshire businesses like See’s aligned perfectly with the need for places to invest the “float” provided by Berkshire’s growing number of insurance companies. That was the first great synergy and Buffett would add it to the growing repository of knowledge and experience combined in putting together Berkshire Hathaway.
Phase Three: Never Waste A Problem, Especially If It Has To Do With Holding Too Much Cash
By the late 1990s Buffett recognized that capital-light businesses like See’s, American Express, and Coke left a problem stemming from the excess cash they throw off. The trouble occurs when capital-light businesses can’t reinvest their own cash. It’s a problem you can see today with FAANG stocks like Alphabet (GOOG)(GOOGL) and Meta (FB) which require very moderate investment and are left with cash that is hard to reinvest at rates of return equal to the return of their main business. Even Apple has this problem to a degree. For Berkshire the solution was obvious, but involved a departure from the direction it had taken for three decades: buy businesses which need and can profitably employ a lot of capital.
The prototype of such a company is MidAmerican Energy. Berkshire acquired a controlling interest in late 1999 and now owns 91%. MidAmerican, with its 2014 name change to Berkshire Hathaway Energy, now serves as the model for a shift in Berkshire toward industrials, utilities, and a railroad. These businesses share the need for large capital investment but can employ their own cash flow and sometimes a good deal more in operations and/or bolt-on acquisitions. Buffett also grasped the tremendous unnoticed advantage of regulated industries which compel strict adherence to a few rules, but in exchange more or less assure an unspectacular but very solid return on all invested capital.
MidAmerican was an ideal prototype because its industry provides frequent opportunities to acquire bolt-on acquisitions. Unlike large stand-alone acquisitions which often require the buyer to pay a 20-30% premium above market valuation, bolt-ons are often done at fair value or a bargain price. A recent example was the BHE purchases of a pipe line system and storage facility from Dominion Energy (D). Dominion no longer wanted the asset as its withdrawal from the Atlantic Coast Pipeline project greatly reduced its value as an asset at a time when they needed cash. For Dominion it was essentially a distress sale. For Berkshire it was an opportunity.
The pipelines and storage facility bought from Dominion are especially notable in that it was Berkshire’s largest acquisition in 2020. It was acquired by the side of Berkshire run by Greg Abel whose responsibility for Berkshire Hathaway Energy is part of his larger responsibility as Vice Chair of Non-Insurance Business Operations. Abel is also Buffett’s anointed successor. This bodes well not only for bolt-on acquisitions but for overall capital allocation in the future.
BHE as a whole has been a home run for Berkshire with earnings increasing from $122 million at the time of purchase to $3.5 billion in the most recent report, an amount including a tax saving to Berkshire of $1 billion as credit for wind power installation. It thus now earns one and half times the original equity investment, an accomplishment paralleling the fact that Coca-Cola, though no longer a growth stock, pays dividends to Berkshire in excess of its original cost. But there’s another advantage of BHE as a subsidiary inside Berkshire. As a subsidiary to Berkshire it does not have to pay dividends itself or return cash to Omaha to be reallocated. As a result it has these advantages as presented in bullet points at the 2021 EEI Financial Conference in November 2021 under the heading “Competitive Advantages”:
- Diversified portfolio of regulated assets.
- Weather, customer, regulatory, generation, economic and catastrophic risk diversification
- Berkshire Hathaway ownership
- Access to capital from Berkshire Hathaway allows us to take advantage of market opportunities
- Berkshire Hathaway is a long-term holder of assets which promotes stability and helps make Berkshire Hathaway Energy the buyer of choice in many circumstances
- Tax appetite of Berkshire Hathaway has allowed us to receive significant cash tax benefits from our parent, including $1.3 billion in the nine months ended September 30, 2021, and $1.5 billion in 2020
- No dividend requirement
- Cash flow is retained within the business and used to help fund growth and strengthen our balance sheet
- We retain more dollars of earnings than any other U.S. electric utility
Buffett himself described the BHE approach in this way in the 2020 Berkshire Shareholder Letter:
BHE, unlike BNSF, pays no dividends on its common stock, a highly-unusual practice in the electric-utility industry. That Spartan policy has been the case throughout our 21 years of ownership. Unlike railroads, our country’s electric utilities need a massive makeover in which the ultimate costs will be staggering. The effort will absorb all of BHE’s earnings for decades to come. We welcome the challenge and believe the added investment will be appropriately rewarded.”
If there is a single aspect of Berkshire Hathaway which should raise a red flag about breaking up the company, it is Berkshire Hathaway Energy. A spin-off would reduce it to the status of an ordinary utility, carrying a heavy debt load and forced to pay out more than half of its earnings in dividends. Goodbye growth, goodbye focus on renewable energy and the environment.
Berkshire’s other large acquisition in the asset-heavy space was Burlington Northern Santa Fe Railroad which was acquired for a total cost of $44 billion in a deal that closed in early 2010. It followed upon a number of minor deals in the late stages of the real estate/CDO financial crisis. Some criticized Buffett for being too tentative in his purchases during the crisis, and on the other hand some critics in 2009-2010 had a cool response to the price paid for BNSF. The numbers are the only response necessary. Over the 11 years since being acquired, BNSF has returned $41 billion in dividends to Omaha for reallocation after taking care of its own capital requirements. It was cited in the above-linked 2020 Annual Letter as being tied for second among Berkshire’s “Family Jewels” as roughly the equal of Apple. Apple was worth about $120 billion at that time. That’s close to a triple in 11 years even before the $41 billion of dividends returned to the parent company. Unfortunately BNSF cannot add bolt-ons or any other railroad assets because of anti-trust considerations.
For those who felt his crisis deals were too small, a further rebuttal was his convertible preferred loan which helped restore Bank of American (BAC) to health and after paying substantial dividends was converted into common shares which have more than tripled in price.
Phase Four: Buying Apple And Berkshire Hathaway Itself
With financial markets at a place where stocks that can be bought in size are very expensive and acquisitions of meaningful size are virtually impossible, the good problem of too much cash continues to nag. Buffett has been criticized by those who would have him do something – anything – but he has kept his stock purchases small because the prospects of long term good results are so doubtful at present prices. Even small investments in publicly traded stocks have had mixed results, in part because they were bushwhacked by the pandemic and ensuing lock down. As a result Berkshire has undertaken something which Buffett had resisted for years: meaningful buybacks.
The way to find the exact level of buybacks is to go to Berkshire’s Balance Sheet under the SA category Financials and scroll down to the entry for Treasury Stock. Treasury Stock consists of shares retired from the market, mainly buybacks. You will see that buybacks were about $1.3 billion in 2018, $5 billion in 2019 (ramping up in the fourth quarter), about $25 billion in 2020, and $32.8 billion for the Trailing Twelve Months, meaning about $21.3 in the first three quarters of 2021. The fourth quarter number will be available this coming Saturday and will certainly be a point of interest in the 2021 annual report.
Doing a little reverse engineering of Buffett’s thinking, it’s not too hard to see several reasons buybacks became more attractive starting in 2018. One major reason is that over the last decade the prices of all other assets became increasingly unattractive. The market may be on its way to fixing that problem, or it may not. The Buffett/Munger team does not spend a lot of time making predictions about future events in the market as a whole, and neither do I.
Even if the market becomes cheaper, however, Berkshire itself presents the hurdle for all investments. Except for bond substitute investments probably bought with future insurance liabilities in mind, an outside acquisition or a large purchase of publicly traded stock should match or in some way improve upon Berkshire itself. It should measure up in return on equity and return on capital and/or have characteristics that diversify in a positive way. Apple, now second in size among Berkshire’s “Family Jewels,” is the example. For an acquisition a company must be at least as good as Berkshire by the most important measures, and that’s after considering the premium required to buy it. Apple is a great example of the optionality of cash, which can be used at any time in the future to take Berkshire in a promising new direction.
Thinking in those terms Berkshire’s Apple position, now valued around five times what Berkshire paid for it, is the equivalent of an acquisition among the top 60 companies of the S&P 500. It would buy you all of Texas Instruments (TXN), for example, although that’s before considering the likelihood of being forced to pay up probably 30% for that amount of value. In short, Buffett had a huge acquisition three years ago. It was Apple.
Berkshire itself can be bought on the open market with no significant premium. A $25 billion buyback of Berkshire shares, by the same thinking, is the equivalent of one acquisition per year of a company with the approximate size of WW Grainger (GWW), Vulcan Materials (VMC), Albemarle (ALB), or Hormel (HRL). Just add on that 20-30% or more premium paid and be sure that you believe that the company acquired will fit in the large picture and is as good a business as Berkshire itself.
The idea of Berkshire as a hurdle for acquisitions comes down to a simple choice. Is the acquisition a better deal than a $25 billion company we can call MiniBerk and which we know very well? One thing we know for sure is that there will be no unhappy surprises. It can be bought at your convenience at the market price. Buying $25 Billion worth is easy to do annually and not only is it unnecessary to pay up, but a little arithmetic shows that a buyback provides slightly more than your money’s worth because the divisor into company value (shares outstanding) is lower after the buyback. Thus a share reduction produces benefits slightly better than an addition of shares of equivalent value.
There’s also an internal benefit to using cash with very little yield to retire shares. Once again the reduced divisor (shares outstanding) elevates such things as return on equity and return on invested capital and gives hints of what the operating parts of the business are really worth.
Then there’s the dividend thing. Buybacks provide an improved version of dividends. They accommodate both those who want dividends and those who don’t. The entire shareholder base gets what it prefers. Those who do nothing get an increased percentage of Berkshire as a business enhanced by that same little piece of arithmetic. Those who cash out the same percentage of their Berkshire shares as the buyback get the cash equivalent of a dividend at the rate of the buyback percentage of shares. They likely do so at a much friendlier tax rate, and retain their percent of ownership of Berkshire.
One of the attractions of Apple, mentioned in the 2020 Annual Letter, is that it too uses some of the cash beyond the amount needed for internal investment to persistently reduce share float. Tim Cook may have had some influence on Warren Buffett. The Apple buybacks are applied to a company which currently appears more expensive than Berkshire (you can never know this for sure). Buffett has appeared much more reluctant to pay up a little with buybacks. Tim Cook may be confident that his buybacks will look cheap in the future, as they already do for buybacks a couple of years in the past.
It’s possible, of course, that buying back Berkshire shares closer to fair business value or closer to the top of the band estimating business value may emerge as the best capital allocation policy in the future. It depends a lot on whether the price of other investments improves. If you reverse the acquisition equation, including the inevitable premium to market price, it might justify some compromise in the buyback hurdle as long as it continues to be well under the amount you would have to pay up for an equivalent acquisition.
To Grasp Why A Breakup Is A Horrible Idea, Read Berkshire’s History Backward
Now let’s slowly strip away elements of Berkshire Hathaway and note in the process what would be lost in every step of a break-up. To start with, take note of the characteristic Berkshire shares with the S&P 500. I wrote about it here. The gist of the argument is that a cap weighted index elevates the importance of winners and shrinks the importance of losers. This must be part of Buffett’s choice for the amount in his will which would go to his wife as well as his recommendation of the S&P 500 for investors who don’t follow the market closely. I should add here that it may not be such a good idea at the present moment while the market is reining in recent favorites. Recall that mega-cap techs make up 25% or more of the S&P 500. Again I make no prediction other than suggesting that you buy the S&P 500 over a period of time.
As it happens, however, Berkshire itself has much the same characteristics as the S&P. Over time its winners swamp its losers and both its portfolio of wholly owned subsidiaries and its portfolio of publicly traded stocks becomes more heavily weighted to winners. Coca-Cola, once a growth stock and number one in the Berkshire portfolio, is now a dividend cash cow and has fallen to number three, far behind Apple with purchases that began five years ago and substantially behind Bank of America which originated from that deal struck in 2011. Go to a list of companies owned by Berkshire with their dates of acquisition and you will see how recent acquisitions like MidAmerican Energy (now BHE) and BNSF have pushed older subsidiaries into much less significance. Buffett’s policy on clearly failing investments is to let them continue as long as they generate cash flow with no additional capital and then sell them cheap to someone who sees virtues in them.
A breakup of Berkshire would put an end to that healthy process in much the same way that a breakup of the S&P 500 would compel investors, many of them not close followers of the markets, to decide what to sell and what new businesses they want to buy. We saw a bit of the likely outcome last year as inexperienced investors tried to do that with the sort of stocks in ARK Innovation ETF (ARKK). Many are now second guessing those decisions. But let’s peel off some Berkshire elements one by one and note what is lost:
- Peeling off BNSF leaves a company with good internal reinvestment prospects but nothing to do with excess cash flow remotely as positive as returning it to Berkshire central in Omaha.
- Peeling off Berkshire Hathaway Energy produces an ordinary utility which has to pay out at least half its earnings in dividends and has little left to invest in growth. Goodbye to the ability to simultaneously help the planet and invest all its present earnings profitably in a very long term project transforming its power generation to renewable energy.
- Farewell to the diversification and balance provided by the combination of publicly traded stocks and wholly owned subsidiaries as well as the balance between capital light companies and asset heavy companies with assured return.
- Farewell to the sort of diversification which assures that major parts of Berkshire are doing well when other parts have headwinds. In the pandemic lockdown, for example, BNSF had to face the challenge of being required to operate most of its schedule with a reduction in customers (a task which it performed well under the circumstances) but fortunately insurance businesses are more or less immune to that problem as is BHE. Apple also did well.
- The greatest synergy is that between Berkshire’s largest group, the various insurance businesses which need a way to invest cash profitably to offset future claims and the many other elements of Berkshire which provide cash from diverse investments. Most other insurance companies have had no organic growth to speak of for a decade because of the need to invest in bonds. Imagine Berkshire’s insurance group having to invest in bonds as it did in 1972.
- Don’t even be too hasty to criticize the large cash position. Cash has optionality. It is the best defense in uncertain times, and it has the optionality to lead Berkshire into the future as the investment in Apple did.
I’ll stop there, and let others fill me in on anything I have missed. Even if investors were willing to pay up for a few of Berkshire’s high quality businesses immediately after a spin-off or break-up any reasonable person should be able to see the enormity of what would be lost. Here’s how Berkshire stock has performed since 2000 versus the two major indexes:
That purple line is Berkshire’s stock price while the other two lines are the S&P 500 (SPY) and the NASDAQ 100 (QQQ) with dividends. Why would any rational person wish to break up a company with this long term performance?
Oh, And By The Way, You Can Buy A Part Of This Company Every Day The Market Is Open
No one knows the exact business value of Berkshire Hathaway. I certainly don’t. There are several ways of putting it together. Hold one element constant and assign a P/E ratio to others. Measure separate units like BHE and BNSF against free-standing companies they resemble. Make assumptions about the future of Apple, BAC, and other parts of its publicly traded portfolio, perhaps including a use of ‘look through” earnings treating them as businesses. Make an estimate of the value of insurance holdings if they were separate, or had to function without the parts of Berkshire investing their “float.” Treat the publicly traded stock portfolio separately or as a subordinate element of the insurance businesses. There’s no single right way to frame the fair business value problem.
Considering all of these factors, I can’t come up with a single number in which I have full confidence, and I doubt that Warren Buffett and Charlie Munger themselves use more than a broad estimate. You could start with the book value and add a significant percentage, a percentage which probably increases every year. The only thing I know with reasonable confidence is that Berkshire is currently available on the market at something less than fair value in absolute terms. In relative terms (which are ultimately less important) it is quite a bit cheaper than other companies near its size. That’s a cushion in case things go badly wrong in the market and/or economy.
There’s little cause for worry about the long term future of Berkshire’s leadership. Greg Abel is well prepared for the day when it is his turn as CEO. Berkshire has one of the deepest and most capable management teams of any company. Its managers are attached to the company as a great place to work. There are no stock options, although Buffett said a few years ago that they should probably be provided to the next CEO because the job will come with responsibility for the company as a whole.
The amount of experience Greg Abel will bring to capital allocation is underrated. He has run the operational segment which is growing the fastest and has years of experience with the bolt-on acquisitions which have been important to that growth. He can clearly evaluate businesses and arrive at the right price. Buffett’s two lieutenants in the investment area have chosen publicly traded stocks on almost the same scale as Buffett’s investments of recent years, and Todd Combs provided the initial push into Apple and has now gained operating experience while running GEICO.
Berkshire Hathaway is likely the cheapest high quality company on the market, and on a risk-adjusted basis it is almost certainly the number one choice. It’s a stock to build your portfolio around. It isn’t overpriced by any of the various ways of summing value. It diversifies in a way that makes it about as safe as an equity investment can be, and it is likely safer than the more expensive and tech intensive S&P 500 at this moment. Who wants to invite the risks that come with breaking up this wonderful company?
As I wrote here, Berkshire has done well at weathering storms in the market and the economy. A valuation-driven bear market similar to the one in 2000-2003 would damage it very little and it would bounce back quickly. That’s why I’m totally comfortable making it a strong buy in the face of what may be a hiccup in the market and the economy. Berkshire will be fine. Through buybacks it pays a back door “dividend” as an efficient way to let those who want a cash return have one while sparing those who don’t want a dividend because of the tax consequences. The cash return made available by buybacks has recently been well above the S&P 500 dividend.
What’s not to like?