This commentary originally appeared on Real Money Pro on Nov. 15 at 11:00 a.m. EST.
Owning (or selling) a security is not synonymous with respecting (or not respecting) management and its past corporate accomplishments.
If we distill owning equity to only one factor -- to me, is whether the forward-looking reward relative to risk in a company's share price is attractive.
Case in point:
, which I sold yesterday.
I, as most other professionals, worship at the altar of Warren Buffett. I have written voluminously about Berkshire Hathaway -- sometimes
. I have studied Berkshire Hathaway over the years and have carefully read Whitney Tilson's comprehensive research and analysis on Berkshire. I even endorsed the back of Jeff Matthews'
Pilgrimage to Warren Buffett's Omaha
One can safely conclude that Buffett is the single greatest stock investor of all time, and his net worth reflects his past achievements. He also seems to be a genuinely great human being through his personal charitable efforts (his massive commitment to the
Bill and Melinda Gates Foundation
), and his arm-twisting of fellow billionaires in "
" is an amazing accomplishment in its scope and likely ultimate impact.
But the shares no longer have the appeal that they once did for several reasons, and I have sold my long position in Berkshire Hathaway.
Size Creates Its Own Performance Anchor; Investments May Become More Pedestrian
Berkshire's past growth and successes are one of its greatest enemies to future growth. Ever-larger investments/acquisitions are required to produce an impact and provide differentiated returns for shareholders. At the time of Buffett's acquisition of Berkshire Hathaway in 1965, the company's market value was under $20 million; it stands today closer to $190 billion.
Yesterday's $10 billion investment in
is, to this observer, a reflection that larger deals are needed to move the needle and that more ordinary and plain vanilla investments will be the feature of Berkshire's portfolio strategy in the future. Vice Chairman Charles Munger has previously talked about the inevitability of less-than-special investments for the past two years or so.
Moreover, size reduces the marginal benefit of preferential $5 billion PIPE deals (private investments in public entities) -- such as those previously effected by Berkshire Hathaway in
Bank of America
. I would add that the share prices of Goldman Sachs and General Electric have massively underperformed the markets after Berkshire purchased their preferreds, meaning that it was the sweetener (i.e., the attached warrants) that gave Berkshire Hathaway the true value to Buffett's investments in those companies.
Succession Brings Delegation, Diluted Returns
By all counts, Buffett is a clear-thinking, spry 81-year-old. But, given actuarial tables, his life expectancy is 92 to 93 years of age. Buffett recognizes the need to delegate investment and operating responsibilities in the passage of time. David Sokol was a
, and I (and many) gave him a mulligan.
Buffett has already hired two co-investment managers, Todd Combs and Ted Weschler, to help him with Berkshire's large portfolio. Will they do as well as Buffett? Probably not, as they are mere mortals, and with the benefit of hindsight and history, Buffett was a true investing immortal! What is almost certain is that Buffett's old black magic will not be easily duplicated by his appointees.
Whitney Tilson expresses sensible reservations on Buffett's replacements:
Being offered investment opportunities on terms/prices not available to anyone else also applies to buying companies outright. There's a high degree of prestige in selling one's business to Buffett. For example, the owners of Iscar could surely have gotten a higher price had they taken the business public or sold it to an LBO firm.... Buffett's Rolodex is unrivaled, so he gets calls (and can make calls that get returned) that his successors might not.
In the next several years, a CEO will likely be named. Again, some more balanced views from Whitney:
Most of the 75-plus managers of Berkshire's operating subsidiaries are wealthy and don't need to work, but nevertheless work extremely hard and almost never leave thanks to Buffett's "halo" and superb managerial skills. Will this remain the case under his successors...? Buffett's reputation is unrivaled, so he is offered deals (such at the recent $5 billion investment in BofA) on terms that are not offered to any other investor -- and might not be offered to his successors.
Buyback Provides a Floor, but My Issue Is Potential Upside
In late September, Berkshire announced a buyback "no higher than a 10% premium over the then-current book value of the shares. In the opinion of our Board and management, the underlying businesses of Berkshire are worth considerably more than this amount...." There is no time limit and cap in terms of amount of the buyback. Based on quarter-end book value, the company's buyback will be no higher than $107,000 a share, or about 5% less than the current price. It is important to note that there is no guarantee that when the shares reach that level that Berkshire will go all-in -- one would think that they would not, so the floor is lower than $107,000; let's call it $100,000 a share). Nevertheless, the buyback creates something of a floor to the shares (probably $100,000-$107,000 a share) but does little to provide upside to the share price.
Size Constraints, Buffett's Age Limit Upside
In a recent presentation, Whitney Tilson concluded that Berkshire Hathaway's intrinsic value was about $170,000 a share. Whitney concludes that against a closing yesterday of about $114,000 a share, Berkshire is dramatically undervalued and is at a "multi-decade low" relative to its intrinsic value calculation. In support of the $170,000-per-share figure, Whitney takes the investments per share of $95,500 and adds that amount to 10x the pretax and non-investment earnings of approximately $7.2 billion, which equates to nearly 15x non-investment after-tax profits. With its core business growing at about 5% in 2012 and with another $7 billion of cash buildup in 12 months, Whitney sees the intrinsic value rising to $187,000 a year out, representing a near-40% undervaluation based on Berkshire's price today.
My difference in intrinsic value calculations relative to Whitney's analytical exercise is that, given the company's size, succession issues (dilution of Buffett's contribution) and other factors (discussed earlier), the multiple of one attributed to the company's investments per share will, in the fullness of time (and as Buffett ages and delegates), become a discount as the Buffett premium evaporates -- just like any other closed-end stock fund that trades publicly. A more sizeable discount will reduce Whitney's intrinsic value. Moreover, when coupling the issues above with the still-important contribution of low-P/E-multiple insurance activities (about 40% of operating income), I would place a lower multiplier than Whitney's 10x to the non-investment earnings at Berkshire.
Bottom line: My calculation of intrinsic value, which is based on a 10% discount to Berkshire's investments per share -- Whitney used the full value -- and on a lower P/E to its non-investment income at 7x vs. Whitney's 10x, is closer to $135,000 a share, or $35,000 a share less than Whitney's calculation.
As Economic Crisis Diminishes, PIPE Opportunities Are Reduced
While this is a relatively unimportant factor, the opportunities for favored private investments in public entities are likely to diminish for Berkshire Hathaway as Buffett ages and when (and if?) the U.S. recovery becomes self-sustaining. Berkshire may no longer be sought out as an investor of last resort.
Bottom line: Based on my calculations, Berkshire's A shares have $10,000 to $15,000 per share of downside risk and about $15,000 to $20,000 per share of upside reward.
I would be a buyer of Berkshire at around $100,000 a share, but, for now, I see better opportunities elsewhere.
Doug Kass writes daily for
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At the time of publication, Kass and/or his funds were long GS, although holdings can change at any time.
Doug Kass is the president of Seabreeze Partners Management Inc. Under no circumstances does this information represent a recommendation to buy, sell or hold any security.