Thu, 13 Dec 2012
Berkshire, Bernanke, and others revealed further details on their purchase plans this week.
Jason Stipp: I'm Jason Stipp from Morningstar, and welcome to The Friday Five. Lots of interesting buying activity in the market this week. Here to offer the details is Morningstar markets editor Jeremy Glaser.
Jeremy, thanks for being here.
Jeremy Glaser: Jason, my pleasure.
Stipp: What do you have for The Friday Five this week?
Glaser: We're going to talk about the Federal Reserve, the Treasury, Best Buy, Berkshire, and finally dividends.
Stipp: We got news this week that the Fed is going to be buying more bonds, but there is an interesting way in which they're going to be doing that buying. What are the details?
Glaser: This was not a huge surprise. It was widely expected that the Fed was going to introduce even more stimulus when the Operation Twist, which was this idea of extending the maturities of Treasuries, was done. Instead of getting rid of that program, they're just going to go out and continue to buy more Treasury bonds. This is on top of the so-called QE3, which is the buying of the mortgage bonds that's going to be happening every month.
But like you said the really interesting thing here was not that this bond buying is going on, it's that the Fed has changed its communication about how long this bond buying is going to go on. For a while, everything was always tied to the calendar. Historically that's how it's been. They said, we're going to do it for x number of quarters, or we think it will go on for this many years. This is what Bernanke has said, and now they've switched to looking at economic indicators.
We saw the first inkling of this with QE3, where they said employment was going to be really important. We got an explicit target this time of 6.5% unemployment rate. Until the unemployment rate gets to that level, while inflation is remaining under control, the Fed is going to keep these extraordinary measures and going potentially add even more measures to get to that.
Now, this certainly is not said in stone. Bernanke was very clear that if it turns out that we just get to that rate because a ton of people dropped out of the labor force or if inflation gets out of control, or if things look stronger elsewhere, that they'll make moves when they need to. But providing that target certainly is a big change in strategy, and I think it's an interesting move for the Fed.
Stipp: The Treasury found buyers for AIG shares this week. These are shares that it bought in the height of the financial crisis. Can we finally put a bookend now on the financial crisis?
Glaser: Well, we're getting closer to that. The Treasury unloaded about $7.6 billion of AIG shares. This is its last tranche of shares, and it's really incredible that by the Treasury's calculations, they've made money on this deal. If you think back to 2008, AIG really just looked like a black hole, and the government took a huge stake in the company in an effort to keep it afloat and to keep all of the derivatives contracts that AIG held from going south and potentially being a big source of contagion across the global financial world.
And AIG has really rehabilitated itself since then. They've sold off its non-core assets. They've really strengthened their business position, and the Treasury has been able to sell off, in bits and pieces, their entire stake now.
So, this certainly is a good sign that the financial world is getting slightly more back to normal, but you don't have to look that far to see signs that we're still not completely out of the woods yet.
The FDIC and Bank of England came out this week with a report about needing to come up with a system to help unwind global financial firms in a crisis; right now it is not clear which regulators across the globe are responsible for what assets, what parts of the businesses. If we have another Lehman-like collapse, if you remember, one of the big issues with that was a lot of confusion about European assets versus assets in the United States. They're still working on this plan. It could still be while before both sides really trust each other enough to really make something like that happen.
So, we're still exposed to some of the big issues that we really had before the financial crisis. We just don't know how to end these too-big-to-fail firms. Until we really figure out a way to have that resolution authority in order to make sure that these firms can fail, we're still going to have those same issues with more hazard, so it shows that the immediate crisis is gone, but we still have work to do to prevent future crises from propping up.
Stipp: In corporate news we got some information about the Best Buy buyout. This is something we were skeptical about. Is it actually proceeding forward?
Glaser: I think we're still skeptical about it, but it does seem to be moving.
Richard Schulze who was the founder and former CEO and chairman of Best Buy has been talking for a while of his desire to bring Best Buy under a private umbrella, let it really rehabilitate itself outside of the public eye. He has now lined up financing to make a solid bid. The expectation, according to the Minnesota Star Tribune is that it would be about a $5 billion to $6 billion deal, which translates to $15 to $18 a share, which is well below the $24 to $26 range he was talking about a little bit earlier and well above our analyst R. J. Hottovy's $12 fair value on the stock.
This deal probably just isn't going to be richly valued enough to get the board to bite right now. Certainly he'll have a chance to come back and raise that bid, he potentially has the financing to do that. This is just kind of an opening negotiating tactic, but he is really going to have to come out with a big number to convince current management that it's worth taking the risk of going private, and he is going to have his hands full to turn the business around no matter where it is, if it's public or private. So we're still not sure that this is really a silver bullet for the electronics retailer.
[Note to viewers: It seems that our skepticism that a deal would get done was well founded. Since we taped this segment, Best Buy has announced that it has extended the window for Richard Schulze to make an offer into February, and shares of the electronics retailer have plunged. Morningstar’s R.J. Hottovy sees this as reigniting questions about whether Schulze will ultimately be able to secure the funding to submit a formal offer.]
Stipp: Berkshire Hathaway out in the market making a big share buyback. Also interestingly coincident with the change in the rules of how it does share buybacks. What were the details there?
Glaser: This was a bit of a surprise move from Berkshire. They announced that they're buying back about $1.2 billion worth of the A shares from the estate of a very long-term Berkshire shareholder. And chances are that estate had to sell due to maybe fiscal cliff tax issues; they had to get rid of all of their shares, all at once, if they didn't want to get hit with those higher tax rates. And potentially, Buffett felt like it was time to buy back more shares, and they just saw that as a deal that really made sense for both sides.
But Buffett did have to bend his own rules a little bit to get it done. Initially he said, 110% of book value was the level at which he would buy shares below, and that anything above that would potentially be diluting shareholder value, and he moved that up to 120% in order to get this done.
And either that's an admission that book value maybe isn't the best way to value the company, and what he thinks it might understate. Maybe he felt this deal was important enough that it had to get done, but certainly that was a bit of a moving target that we saw in this deal.
I think it absolutely raises questions about what Berkshire is going to do with this big cash stake. We talked before about Buffett trying to raise the guardrails a little bit around his successors to make sure they can't do anything too outrageous. This is probably a continuation of that trend. Getting that money deployed either in big capital-intensive businesses, be it through share buybacks or investing some more money, is a way to make that pile maybe a little bit more manageable for when it comes time for his successor to take over.
Stipp: This week on Morningstar.com, we had Income & Dividends Week. We did this because we're seeing tremendous interest from our readers in income-producing investments. But just because there are buyers doesn't mean there are a lot of great deals on income investments right now.
Glaser: I think that certainly was the big takeaway from this week. There just aren't any good places to find income right now. With the Federal Reserve keeping rate so incredibly low--and now we know they're going to keep them low until employment gets a lot better, which is something that no one's expecting to happen overnight--it's going to be challenging for a while.
For investors who are in retirement or about to enter retirement, this creates a real dilemma. It is difficult to create a portfolio today that's going to produce the kind of income that's necessary, at least in the short run, in order to fund their retirement lifestyles.
And I think this means that everyone has to focus on total return. Almost everyone we talk to about income, about dividend, this theme kept coming up. Instead of trying to find just the absolute biggest amount of yield you can get right now, no matter what the risk is, you have to find securities that might provide some yield now, but that are going to give you a really nice total return over the course of your retirement, and over the course of the years. [Investors should avoid] thinking in the very short term, and just trying to maximize [yield] while taking on risk, which could reduce your capital over time, as say, interest rates rise or if we enter into another recession.
So, I think there are no good answers, but the total return idea certainly is one of the best options out there.
Stipp: Jeremy, I'm always buying shares in the Friday Five. Thanks for joining me again this week.
Glaser: You're welcome, Jason.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.