Fri, 2 May 2014
Despite high stock valuations and the lack of a marquee buyout recently, Buffett and Munger are willing to be creative to put cash to work.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Warren Buffett's Berkshire Hathaway has been mostly making smaller bolt-on acquisitions recently instead of some of the larger deals that they've done in the past. Does this mean they're finding it hard to deploy their giant cash hoard? I'm here today with Gregg Warren, our analyst for Berkshire to see what the state of capital allocation is within the businesses.
Gregg, thanks for joining me today.
Gregg Warren: Thanks for having me.
Glaser: Like we mentioned, there haven't been any huge acquisitions this past year. We had Heinz and NV Energy recently and, obviously BNSF in the not-so-distant past. Why do you think that is? Is it just that these deals have become too expensive for Buffett?
Warren: I think in a lot of ways, with the market running up since early 2009--it's over 100% at this point--it's made it a lot more difficult. Valuations are certainly a lot higher. When we looked at the NV Energy deal last year, it was at the higher end of valuations overall. It wasn't that small of a deal, but it certainly wasn't enough to put a dent in Berkshire's cash.
The same thing with Heinz. It was an interesting deal; it was structured differently than a lot of the deals we've seen from Berkshire in the past. Berkshire took a 50% equity stake with a private equity firm, and then invested $8 billion into preferred stock in Heinz and that sort of guaranteed an income stream from that business.
But overall, there haven't been, say, Burlington Northern-size deals in the last few years, and that meant, in a lot of ways these guys have had to go out and do a lot of bolt-on acquisitions. You've had Lubrizol doing a lot of deals over the past year, you had McLane doing deals over the past year. Marmon's been involved in some restructuring and some other deals. Even MidAmerican, aside from Nevada Energy, they've done a lot of stuff where they've bought some solar assets out of bankruptcy and have been making some heavier investments in renewables.
There's definitely money being put to work. It's just not a big, single deal.
Glaser: When you are the size of Berkshire, you need to put a lot of money to work in order to keep all of that cash productive. Do you think that they actually can do that these days? Should they be returning more of it to shareholders?
Warren: I think the biggest conundrum for Berkshire here is what do they do with the excess cash on the books? And when we look back over the last, say, eight or 10 calendar quarters, they've probably been carrying about $40 billion to $50 billion in cash on the books.
Now, you subtract out about $20 billion that they'd like to keep as a backstop for the insurance business--and we don't disagree with that; we think that's good, sound business practice--but you still are looking at anywhere from $20 billion-$30 billion in cash sitting there earning nothing in a low-interest-rate environment. Technically, it is sort of dry powder for investments; it's also capital that's available for share repurchases. The problem is the shares have not gotten down to the level at which Berkshire is willing to buy them.
And when we look at the environment out there for big deals, Buffett's talked about looking at some deals here and there, looking at some big elephants, but not really being able to pull the trigger. And the question in our regard is, "What's the opportunity cost of that cash just sitting there?" It becomes problematic for them in the long run.
I think this is probably one of those topics that's going to come up at the meeting again this year. If you're retaining earnings but you're not doing anything with it, doesn't it make sense to give it to shareholders. And if you don't think that the stock is attractively enough priced to buy back shares, then maybe a special dividend or one-time dividend as a solution--I'm not saying to initiate a dividend and then commit to one longer term--but maybe returning some of that excess cash to shareholders in a special dividend might be the best way to go.
Glaser: But is that something you think that Buffett would even consider given his stance against dividends in the past?
Warren: I think it's going to be a tough sell. He laid out a very strong case in last year's annual letter about why the money was better kept within Berkshire than being handed out to shareholders, that he and Charlie could earn more on that capital over the long run than shareholders could on their own. I think it's going to be a harder sell.
Glaser: We've spoken in the past that a lot of the economic moat or competitive advantage around their firm comes from that asset-allocation scale that Buffett and Munger are bringing to the table. Do you see that as diminishing in any way because they haven't gotten a lot done, or is this just more of a temporary setback and that you'd expect them to still have these great skills in the future?
Warren: No, I think it's more of a temporary setback. I think it's more of a reflection of the markets and where they are right now. I think the other thing to remember and to think about is the asset allocation and where Berkshire has positioned itself in different businesses. The diversification that's in the portfolio has actually helped them in the past few years.
Insurance was a bit better this year. But in 2012 they struggled, they had a difficult year. And it was the other businesses--the railroads, the energy, the other services and manufacturing businesses--that really picked up the slack and helped them continue to expand book value at a decent rate. And last year was the same sort of thing. You had some businesses that were underperforming like Marmon, insurance was looking better, MidAmerican was sort of middling, but Burlington Northern had a great year.
It's not just the allocation abilities; it's not just the returns that they can generate off their businesses. But it's the fact that these businesses kind of offset themselves.
Glaser: Even though the elephant gun hasn't been shot in a little bit, it's no reason for investors to worry too much that [Buffett and Munger have] lost the touch?
Warren: No. I think they're still looking for stuff. And I think that there's been some willingness here. The fact that Buffett bought IBM stock for the investment portfolio I think is a sign that he's opening up to other potential things. And having Ted Weschler and Todd Combs involved in the investment process and getting their insight and getting sort of their knowledge about what's going on, or what we saw more recently with Washington Post--with Berkshire willing to step away from what had been a very longstanding position within the organization and looking for the most tax-efficient way to swap out those assets for different assets to put in the portfolio--I think is a sign that they're willing to look outside of the box.
Glaser: Gregg, thanks for your thoughts today.
Warren: Thanks for having me.
Glaser: For Morningstar, I'm Jeremy Glaser.