Published: April 30, 2009
Berkshire Hathaway shareholders are on their way to Woodstock. Or rather, they are heading for Omaha and the company’s annual gathering, known as Woodstock for capitalists. Warren Buffett, the Berkshire boss who holds deceptively folksy court at these occasions, has changed the format to encourage more questions about the company’s business. Investors should take him up on that and listen. Through Mr. Buffett’s choices and market forces, Berkshire is changing.
Shareholders don’t yet know the result of one of Mr. Buffett’s most important decisions: his successors. The influential investor is 78, and his longtime business partner, Charlie Munger, is 85. With his track record and public profile, Mr. Buffett is the epitome of the corporate “key man,” as Fitch Ratings pointed out in knocking Berkshire’s triple-A rating down a notch in March.
Although Mr. Buffett’s chosen successors’ identities remain undisclosed, it’s a safe bet they know what they are doing. But they aren’t Mr. Buffett. Moreover, the leadership of Berkshire and the management of its investments will be separated, requiring some adaptation. The culture that brings 30,000-odd shareholders to Omaha every year will unavoidably change, too.
Another important Buffett decision of late has been to expose Berkshire to big derivatives bets — $67 billion worth in terms of the worst-case exposure at the end of 2008. Despite having once called such instruments “financial weapons of mass destruction,” he appears to think they are safe enough in his hands.
He recognizes the apparent double standard and brings to derivatives much of the common sense he applies to other investments. The types of contracts he has written — long-dated stock-index put options and credit-default swaps — are relatively straightforward, and he collects premiums up front to avoid the danger of trading partners running short of cash. So far, he has also limited expected losses, a fraction of the worst-case figure, to an amount Berkshire could easily handle.
Even so, Berkshire’s recent performance will take some explaining. In recent years, the company has released quarterly earnings on the eve of the annual shareholder meeting. That would be this Friday, but the report is instead expected in a week.
That’s the company’s prerogative and doesn’t necessarily signal any trouble. But with further losses anticipated, Mr. Buffett might be glad for the chance to explain his derivatives holdings to shareholders at Saturday’s meeting before the bald numbers are published.
Another change is Berkshire’s growing vulnerability. The company looked good in the wake of the dot-com bust because Mr. Buffett avoided technology investments. But in the wake of global market turmoil centered on financial businesses, Berkshire’s shares have lost a third of their value in the past year, and its vaunted triple-A rating is gone. Berkshire suddenly looks like what it is: a largely unhedged equity investment vehicle with a focus on the financial sector.
Its giant insurance businesses, which generate gobs of free investing capital in good times, don’t look so special at the moment, and its large stakes in American Express, Wells Fargo and the ratings agency Moody’s underline the finance focus. Then there are those out-of-the-money derivatives trades that, in hindsight, seem to have been badly timed.
Along with the succession question, that may all help explain why Berkshire’s shares appear to be trading at a discount to the market value of the company’s holdings, even after allowing for stock market declines during the first quarter.
That stocks have turned upward recently is one positive thought for those traveling to Omaha this weekend. But another development should also generate optimism among the Berkshire faithful: opportunities to invest on the cheap ought to be plentiful now.
In his annual letter to shareholders, which showed 2008 to be his worst investing year on record, Mr. Buffett gleefully noted the disappearance of debt-financed private equity firms after the credit crisis (“they’re keeping their remaining funds very private,” he observed). Far less money is sloshing around markets.
Partly as a result, Mr. Buffett picked up some good deals last year, including what now looks like a bargain $5 billion stake in Goldman Sachs. Berkshire still has strong credit and plenty of cash. And the sage is still around. After years in which few bargains were available and Berkshire’s size made meaningful deals hard to come by, Mr. Buffett has the chance to redeem himself. RICHARD BEALES