April 29, 2013

What to Expect at the 2013 Berkshire Hathaway Meeting: The Berkshire Bear Case

This Saturday, May 4, as many as 20 thousand Berkshire Hathaway shareholders will wait expectantly for CEO Warren Buffett and Vice-Chair Charlie Munger to appear on the stage at Omaha’s CenturyLink auditorium.  The two will kick off the 2013 six hour shareholder Q&A marathon.

This annual meeting has a new face–Doug Kass, the founder and President of Seabreeze Partners. He was chosen by Buffett in early March to be the Berkshire Bearand argue why investors should not buy Berkshire stock.  Kass got the nod from Buffett thanks to an article he published in theStreet.com in 2008 laying out 11 reasons to short Berkshire Hathaway stockHow do these reasons hold up in 2013?

Apple’s post-Steve Jobs valuation is a cautionary tale of what could happen to market value after the loss of a unique, charismatic leader.  And Kass was spot on when he wrote there will never be another Warren Buffett.  But will investors dump shares when he is no longer at the helm?

Perhaps this is why the media is now searching for CEO succession clues– such as Berkshire’s hiring of four AIG stars last week to join Berkshire’s reinsurance unit.  This move could allow legendary BH Reinsurance manager Ajit Jain to assume other responsibilities.  After all, Buffett has said that Ajit, who creates the bulk of Berkshire’s valuable float, is the only manager he speaks with daily.  Jain has Buffett’s gifts for capital allocation and shrewd risk analysis.  It would make a lot of sense to let investors get familiar with a Berkshire successor like Ajit (or whomever is chosen) to ensure a “seamless” transition.

Kass stated in his 2008 article that a sum of the parts analysis of relative EPS and Price/Book comparisons showed that Berkshire shares were overpriced.  But later in the piece, he complained that Berkshire’s opaque disclosure is a reason to short the stock. It made me wonder: if Berkshire’s disclosure is so weak, then what assumptions did Kass make to conduct his sum of the parts analysis?

Kass ignored the importance of corporate culture.  Remember: companies that did not survive the post-2008 economic collapse all provided plenty of numbers that proved to be inaccurate and inadequate.  These companies fostered corporate cultures that damaged trust and destroyed value.  What kinds of people led these companies?  Hard to tell.  Investors don’t get six hours to see them unscripted as they do at Berkshire.  Perhaps this is why BRK is the preferred investment for those who like to sleep at night.

Kass also expected in 2008 that significant investments like American Express, Wells Fargo and Coca-Cola in the Berkshire investment portfolio would no longer represent outstanding value.  However, not only has each survived the economic collapse, they are thriving.

Kass went on to state that: 1) Berkshire’s market value has slowed; 2) the company faces headwinds from inconsistent economic growth and high inflation; and 3) BRK’s premium valuation in 2008 was simply a byproduct of the credit crisis.

Kass forgot that Buffett values Berkshire not by market value, but by book value growth (“a significantly understated proxy” of intrinsic business value) and compares this to the S&P 500 Index (including dividends).

Buffett has stated that Berkshire is a defensive investment, recently writing in his 2012 shareholder letter:  “Our relative performance is almost certain to be better when the market is down or flat.”  Buffett also wrote in his letter that while Berkshire has outperformed the Index in 39 out of the past 48 years, five of the losing years have occurred within the last 10.

Yes, growth has slowed at Berkshire.  Buffett predicted years ago that as the company got bigger, he would need to acquire larger elephants to mitigate the headwinds from “the law of large numbers”.  In his 2012 letter he wrote that “Berkshire’s intrinsic value will over time likely surpass the S&P returns by a small margin.”

Hmmm.  Seems that some of Kass’s 2008 arguments are still being made, and by the Oracle himself.  It looks like Buffett is ready for the debate and loaded for bear.