Long Term Stocks

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Berkshire - >>> Everyone Needs To Calm Down About Buffett Being Quiet


Seeking Alpha

Apr. 20, 2020


https://seekingalpha.com/article/4338575-everyone-needs-to-calm-down-buffett-being-quiet


Summary

Recap what Buffett actually did during '08-'09 and expand upon the possible reasons why.

The really big move he made was actually buying the rest of Burlington Northern Santa Fe, which occurred in November '09.

Comparing BRK's balance sheet: cash as a percent of equity is twice as high now versus '08-'09.

Why I'm long BRK.B for the first time in my career: trading at the lowest P/BV and P/TBV ratios since the mid-90s.

Introduction:

Recently there has been a litany of articles asking the same essential question: why haven't we heard or seen anything from Warren Buffett investing in companies as we did back in the fall of 2008? In my mind, I always remember THE big move he made was in buying the rest of Burlington Northern Sante Fe [BNSF], announced in November of 2009. However, when I would point this out to people on FinTwit, the responses I received mostly listed off other famous moves he made during the fall of 2008 and ignored the magnitude of the BNSF deal that came later. For the first time in my investing career, I have long exposure to Berkshire Hathaway (BRK.B), so I decided to take a deeper look into comparing BRK's actions between then and now.

The Great Financial Crisis:

If you run a search for articles about the deals Buffett made during the Great Financial Crisis [GFC], then you'll turn up a number discussing his October 2008 preferred and warrants deal with Goldman Sachs (GS). You'll also find discussions mentioning his General Electric (GE) investment, also comprised of a preferred and warrants transaction. You might even find one like this referencing his investment in Swiss Re (OTCPK:SSREF) from March of 2009, which is rarer since it clearly isn't consequential to the 'Buy America' mythos that was attached to his actions, in large part due to his October 2008 Op-Ed in The New York Times. You'll even find articles declaring his preferred and warrant deal with Bank Of America (BAC), as his "Masterpiece" investment from this GFC period. That statement is interesting on its own since the BAC investment didn't even occur until the fall of 2011! Generally, though you don't see people refer to his acquisition of BNSF in anything close to the same light, and usually not at all.

Berkshire Hathaway Buys Out Burlington Northern for $26B - CBS NewsSource

One of the interesting things in researching this article is that the patterns of Buffett's style emerge clearly. Despite owning numerous businesses outright, we probably all fall victim to thinking of Buffett more as a traditional equities portfolio manager, than the leader of a financial and industrial conglomerate. Reviewing the actions he took during the GFC, I would separate these transactions into three bucket types: 1.) merger finance, 2.) distressed finance, 3.) business investment. Here's the list that I compiled with major transactions that occurred during this period:

The merger finance deals might be the most interesting because they often are sited as major moves made by Buffett during this period, but as you can see by the announcement dates, they were very early in the decline process of the market. You also see his propensity for doing preferred securities to reduce his risk profile, but it does remind me of how early on Merger Arbitrage was an important part of Buffett's investment strategy. Over time, the strategy became crowded out with more professionals employing it which narrowed the spreads. Now, Buffett has turned to financing mergers rather than just playing the price spread.

If Buffett started out the GFC period just by financing mergers, then you can clearly see in the chart above how that changed in the fall of 2008. The GS and GE deals were of the second type I mentioned, but interestingly they too occurred at a point that turned out to be early in the acceleration phase to the downside. Only the Swiss Re deal looks well timed in hindsight. What all three of those investments have in common are more than just preferred securities, either convertible to equity or attached with warrants. They are also all finance deals, and by that, I mean that these were companies that were all in trouble due to their financial leverage. In fact, I would argue that they were all effectively insolvent at this point. That's a discussion for another much longer article perhaps someday. I would add that I'd like everyone to consider not so much which firms failed, but why the few firms that survived were spared.

Buffett has been quiet so far, but right now Charlie Munger is talking about why BRK is going to wait and see. Here's a quote ascribed to Munger from this recent article:

"Warren wants to keep Berkshire safe for people who have 90% of their net worth invested in it. We're always going to be on the safe side. That doesn't mean we couldn't do something pretty aggressive or seize some opportunity. But basically we will be fairly conservative. And we'll emerge on the other side very strong."

All of those points should have been true in 2008 as well, but why did Buffett get active with three financial companies in the heart of the GFC? I like to say 'your answer here is probably your bias.' In my case, my bias is that I believed BRK itself was effectively insolvent too. Buffett's motive wasn't just about saving GS and GE, it was about saving BRK and its significant financial exposure through its GEICO unit as well. Years later Buffett himself provides the key clue in this interview in 2018:

What we all learned in that particular panic is that we're all dominoes. And we're all very close together.

Consider this concept when you think of that Op-Ed he wrote on October 16, 2008. Buffett is a master of presentation. He often has argued for higher ethical standards and board diversification in corporate America yet does little in this regard in his own backyard. Maybe I'm being too critical of him in this regard, but I personally value what people do over what they say. Bottom line, I think there's a compelling argument for why BRK made those financial investments in the heat of the GFC, and they had a lot more to do with BRK's own financial well being than just the opportunity to increase returns. If you think of it in this manner, then the reasons behind BRK's lack of action to date makes more sense. Essentially, it's not the same setup. Despite the severe economic declines we're all facing as a nation right now, the risk of a total financial system collapse is not comparable in my opinion. In pure numbers, the GDP impact will be worse in these quarters. However, back then the financial system was carrying magnitudes greater leverage than it is currently, and it was loaded with significantly inferior assets collateralized by collapsing real estate values. We were weeks away from complete societal collapse. The commercial paper market had essentially shut down. That's how grocery store shelves go empty. I have not had the same concerns this time despite the panic stocking behavior people have unfortunately succumbed too.

Comparing the GFC to our Current Period:

There were other investments than the ones I've mentioned so far in 2008. Buffett bought a stake in BYD Company Limited (OTCPK:BYDDF) in September of 2008. He also increased his exposure to USG Corporation (USG), but these were all in the 300 million type size outlays. I've tried to focus on the multi-billion dollar plus deals because that's the size that really moves the needle for a conglomerate the size of BRK. We also need to consider how BRK's balance sheet was entering the GFC and today's environment to fairly gauge their motives for the moves they have and haven't made.

In the above chart, I've added the cash, equity, and the level of industrial debt from BRK's balance sheet. When looking at those few items from the balance sheet, (yes, this is not all encompassing obviously), but in terms of the amount of cash as a percentage of total equity, BRK clearly has entered this period with considerably more of a safety net and flexibility than during the GFC. Only if we consider the level of net industrial debt/capital ratio does BRK's current standing look slightly inferior to back then. I chose to use only industrial debt versus the financial as well, because, to be honest, the complexity would require another article in itself. You can also see that the deal sizes as a percentage of cash tend to occur around similar levels.

Finally, of course, it should stand out massively that the BNSF deal was a galaxy in comparison to any of the others in terms of capital deployed. It effectively matched all of the other deals combined. He also received a lot of criticism for the deal at the time, with many suggesting he was overpaying for the railroad business. Below is a chart with the trailing EV/EBITDA multiples for the three remaining primary American freight railroad companies: CSX Corp. (CSX), Union Pacific Corp. (UNP), and Norfolk Southern Corp. (NSC). I've drawn in the approximate point of when BRK announced the acquisition. There were points in the future when the multiple went lower, but that was more to do with the growth in EBITDA than a reduction in the long term outlooks for the businesses. Point is that Buffett certainly did not pay any sort of a significant premium for this business, and now the market rewards these businesses with essentially a 50% greater multiple range.

In summary, it was the BNSF deal that deployed significantly greater capital resources than any of the other more heralded Buffett deals from that period. It was also made eight months after the low in the market of March 2009, and over a year after the financially distressed deals with GS and GE. In other words, give BRK some time before getting all upset about the lack of news. If history is a guide here, then we really shouldn't expect any business type acquisitions to be made until at least the end of this year or early 2021. That assumes that we're not making a new low in the future.

Summary & Valuation:

To conclude, I would argue that many of the deals Buffett made during the GFC were not done so for opportunity, but instead out of necessity. The real big business move was made by acquiring BNSF well after the lows had been made. Considering the greater financial flexibility that BRK has today versus then, Buffett is remaining quiet because he doesn't have to invest out of necessity. It also is nearly impossible to get valuable businesses not in distress to sell at these levels. The time to strike will likely be in the future after stocks have somewhat recovered, and everyone has a better sense of what the other side of the economic valley is going to look like.

At the start of this article, I also mentioned that for the first time ever in my investing career, I am a holder of BRK.B common stock. This is a complicated business with large exposures over various parts of the economy. I'm not going to go into a long summary of why I like this and that etc... Instead, I'd point the reader towards two key features: 1.) Yes, BRK has a lot of cash to deploy, and bluntly Buffett is often able to buy great businesses for less than other suitors. That's the benefit of just assimilating managements versus replacing them. You can often strike deals that cost shareholders less to complete in the near term. 2.) The price to book and tangible book values of BRK is at or below their respective lows since the mid-'90s.

Thus, the stock is trading cheaper on these all encompassing metrics than it did in the GFC when I have just argued that Buffett made those investments out of necessity to save his own business from financial collapse as well. If I'm not going to own it now, then I should just take the ticker off my screen.

I hope everyone is safe, healthy and happy out there.

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