Sat, 4 May 2013
Morningstar's Drew Woodbury and Gregg Warren give their take on how Berkshire's culture will change after Buffett departs and other key issues from the first half of the Berkshire Hathaway Annual Meeting.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. We're half way through the 2013 Berkshire Hathaway Annual Meeting. I'm here with Gregg Warren and Drew Woodbury, our Berkshire analysts, to get their take on the first half of the meeting.
Gentlemen, thanks for joining me.
Drew Woodbury: Thanks for having us.
Gregg Warren: Thanks for having us.
Glaser: So let's start with the successor. That was a big topic. We had a couple of questions on it. Warren Buffett basically said that he thinks the culture will be able to sustain itself, but he did mention there might be some reorganization that would have to go on for the CEO to run it. What were your takes on those comments? What do you think about the successor?
Woodbury: Yeah, the successor was talked about a few times. Buffett still has not named a specific name but has assured investors that there is someone that the board and him have agreed upon. In our opinion, we'd like them to be a little bit more forthcoming on that score, maybe some kind of a transitional role in some regard.
Warren: I think one of the more interesting points that came out that I noted was, he said that the successor who they want taking over the role has a more intimate knowledge of the subsidiaries and has gotten more involved with what the subs are doing. So I think that's important to look at. I think he also noted that because of how Berkshire is structured now, it's completely decentralized. Mainly it's the major subs, the heads of the major subs, that are reporting up to him. It's about a dozen people.
He anticipates that potentially changing when the successor takes over. They may want to reorganize just to get a better feel for a lot of the smaller operations that they may not be as familiar with. So, overall, Berkshire is not going to change its decentralized structure. Managers down at the subsidiary level are still going to run things when the new CEO takes over. It's just they may do things a little bit differently.
Glaser: He mentioned culture maybe a dozen times through a couple of different answers. Will they be able to sustain that culture? Do we have any signs of what they're doing to keep the culture intact?
Warren: I think it's a lot easier to keep the culture intact because, again, as a conglomerate, it's almost a true conglomerate, because it is completely decentralized all the way down. Really, Warren's job and role as CEO is to allocate the capital that comes up from the subsidiaries and talk to them about business strategies that they want to. But ideally he wants them to run their own operations. So, I can't really see the culture changing dramatically, unless the CEO that comes in decides that they want a more centralized focus, and that I think could really upend the apple cart for them.
Glaser: So one of the changes this year was that a short-seller of Berkshire stock was going to be asking questions. What do you think of his questions so far? Were you surprised by anything that he came up with?
Woodbury: There were not too many surprising questions from him. They were along similar lines of what's been discussed in the past. Size is a concern for the company. We've raised some of those concerns in our Analyst Report, as well. He hasn't really laid out a clear reason to be shorting the stock but rather kind of some overhangs that are out there.
Warren: Yeah, I agree. There wasn't really much additional that [the short seller] added with the questions he brought this year. I mean, he did delve a little bit deeper into some of the issues, like the fact that the returns maybe over the last 10 years have been much smaller than they have been historically, but Berkshire has already admitted that. I mean, Buffett has already come out and said that's going to be case, and as we go forward don't expect the same kind of returns we've seen in the past. What I'm surprised by is the fact that [the short-seller] did not even bring up the dividend, which is still kind of a hot-button issue for us, and I would have expected him being in his role to sort of bring that up right away.
Glaser: There was some discussion of recent transactions on Heinz, and also some newspaper deals. Buffett admitted that he stretched a little bit on the Heinz valuation because he was comfortable with management. Does that surprise you to hear that he's kind of budging on valuation a little bit?
Warren: Not so much because he also, in the same sentence, said, "There's companies we looked at 20, 30 years ago that were really well-run companies, good franchises, companies we should have bought, but didn't buy because we sweated the valuation too much." So in his view, he is looking at Heinz and saying, "Listen, we've got a great company. We may have paid up a little bit to get involved in the equity part of it." But at the same time, they're not managing it. The private equity guys that are the other half of the transaction are going to be overseeing Heinz overall. I mean, Buffett's interest is mainly the equity stake and then the preferred shares that are earning, I think, about 9%.
Glaser: So he did admit that those newspapers are bit of a hobby for him but came up with a 10% of return. Do you think it's reasonable for him to kind of be playing this hobby with the shareholder money?
Woodbury: I would say that he laid out his arguments for why he does the deals, but in the end these are such small deals that it's not even really material to Berkshire's bottom line. There are some questions about the validity of them, and Charlie Munger kind of raised that it's more Warren enjoys buying these newspapers rather than it's a great return. But the bottom line is that they are not large enough to really make an impact.
Warren: I mean, at the end of the day, as long as they are earning more than the cost of capital that's employed to get them, it's not really a big deal. Again, size is a much bigger factor. If he were going to go out and buy huge newspaper operations on the size of, say, a Burlington Northern, it would be much more of an issue for the firm.
Glaser: Buffett started off the meeting by going over quarterly results and made a point to say that GEICO is still performing very well. But there were a lot of questions about if new competition, such as Progressive with its Snapshot tool that allows people to get customized rates depending on their driving habits, would be a big threat. Buffett dismissed it last year; he dismissed it again this year. Do you think they're missing out on a big opportunity here?
Woodbury: There are a lot of questions about the Snapshot-based discount, which is, for those who don't know, it's a device that gets plugged into the user's car and measures the actual driving behavior. So, Buffett kind of said that GEICO saves a lot of people lot of money, and at the same time generates a very good underwriting profit, so obviously their algorithms are doing well, which is true. But at the same time, there is no better measure for actual driving behavior than plugging into the car and measuring it. So it seems a little bit that they could be missing some additional variables, which could help them with their rating algorithms.
Glaser: So when you look back over the first half of the meeting, is there anything that you're surprised wasn't asked and you are hoping will get picked up in the afternoon?
Woodbury: I think the main thing that we were surprised, we won't probably see a different answer or change of stance, was about the dividend. We kind of thought that would be brought up more, especially since there was talk about it so much in the letter this year.
Warren: Yeah, it's been a much different meeting this year around. I mean, there was a lot more politically based questions last year. A lot of that has sort of fallen off. But the dividend did really surprise me. I would have expected especially [the short-seller] Doug Kass to come out and say, "You are sitting on $49 billion in cash, and probably about $15 billion-$17 billion of that is money that's earning nothing because it's not earmarked for something else." So, I mean, I would have expected that to be a bigger question, and it could still come up this afternoon.
Glaser: Gregg, Drew, thanks for your thoughts.