or three more years without those worries.
The thing to think about here is if Valeant merges with Allergan, the Allergan shareholders are going to be getting $11 to $12 of earnings per share. If they were to use what they are getting in cash to buy the new Valeant, they could probably — even if Valeant traded up to $160 — they would still be getting enough stock that they would get 1.1 shares of Valeant. The new company could earn $12 to $13 next year — it might earn $14 next year. Allergan’s shareholders have to compare what the new company would earn to Allergan’s new forecast, which has shareholders earning $6.70 next year. It is $6.70 versus $14.
The way that I think about it is you have a choice of savings accounts and you could invest $5 in an account that is growing at 10% or 15% a year, or invest $10 in an account that is growing at a slower rate. I would prefer the $10 account, and that is the way I think about the deal. Allergan on its own will probably be growing faster, but while the combined companies may be growing a little bit slower, you might be getting almost twice the money early on. At least that is the way that I think about it. Allergan shareholders could make a lot of money, if they take the deal, because they would be getting twice as much in earnings power, probably within a year, if they use the cash to buy the stock. Even if they did not use the cash that way, they would still be getting $12 or $13 potentially with the cash.
Ruane, Cunniff & Goldfarb Investor Day St. Regis Hotel, New York City – May 16, 2014
Question:
What percentage of the fund is in cash? Are you ever going to lower the 1% fee?
Bob Goldfarb:
Right now the fund is about 80% invested. Our asset base is about $8 billion and our cash is about $1.6 billion. We charge a flat 1% on both the separately managed portfolios and on Sequoia because they are treated the same. They get the same allocations; they buy the same stocks, et cetera. We have had that fee structure for decades and we hope to be able to continue to earn it.
Question:
Congratulations to Jonathan for being one of the questioning analysts at the Berkshire meeting. I was wondering what your major takeaways from the meeting were and how you view the security.
Jon Brandt:
When you have been following Berkshire as long as I have, and many of you have, and Warren has been running it for 49 years, I would say that the major purpose of the meeting is just to see how sharp his mind is. And it is as sharp as ever.
Bob Goldfarb:
Five hours of Q&A.
Jon Brandt:
His stamina is amazing. It is almost impossible for anything material to come out of the meeting. It is a little bit of a carnival. There were some better questions asked, I think because of the format changes. But I would struggle to come up with any significant takeaway. In terms of the responses to my questions, I thought it was interesting that he said that he is not going to 3G Berkshire, if I can use 3G as a verb. But I cannot say I was surprised by that answer. Bob, did you have any key takeaways?
Bob Goldfarb:
No, I would just say in the last year or so, both in the annual reports and at the meetings, he has been more optimistic. Do you have that sense?
Jon Brandt:
Yes, certainly last year with the 12% growth, I would not call it guidance, but saying that it was a possibility or there was a reasonable chance of getting there, that sounded more ebullient than I would have expected.
Bob Goldfarb:
He has always wondered about the barriers that size would present to him. And clearly, as Jon said, the compound has slowed down as it has gotten larger. But he feels pretty good that even at this level of assets and stock price that he can continue to compound at a pretty good rate. So that has been the message that he has conveyed both in the annual report and at the annual meetings.
Greg Alexander:
One of my favorite lines of all time came from the most recent Berkshire annual. Jon, you are going to have to correct me on this. But he said that he now owns eight and a half — you like the line too — he now owns eight and a half companies, half of Heinz being the half, out of the Fortune 500, so he still has 491 and a half to go. Then he said the most remarkable thing, which is that he has bought most of those without issuing a material number of shares or running up the debt.
Jon Brandt:
David, did you have any key takeaways?
David Poppe:
I thought he was a little less connected to some of the businesses than you would like to see, and it just shows the size of Berkshire. It is harder to keep your head around everything that you own, even as smart as he is. I thought there were a few businesses that he was just not as connected to as I might have expected.
Jon Brandt:
I would say that is a good point. I asked a question about Forest River and the company’s competitive advantage versus Thor. He said he did not know much about Thor. I think maybe 20 years ago, he would have devoured the annual reports and tried to get intelligence on the competitors. But he just seems to be trusting in Pete Liegl to do a good job at Forest River, which would include keeping an eye on his competition. There just might be too much for him to follow and maybe his attention flags a little bit from things like that.
Bob Goldfarb:
What percentage of Berkshire’s earnings is Forest River?
Ruane, Cunniff & Goldfarb Investor Day St. Regis Hotel, New York City – May 16, 2014
Jon Brandt:
It is not material. These things are not really material. He focuses on the important things. But I think back in the day, he would have tried to devour everything. But there just are not enough hours in the day.
Bob Goldfarb:
I think he counts on you for that!
Question:
This week’s Economist has an editorial and articles following it urging Berkshire to break into pieces for the sake of efficiency. Could you comment on that?
Jon Brandt:
I think you will see some difference of opinion up here on the dais about what Berkshire should do in the next 20 years. Bob does not believe it should be split up and I do not think so either. But I think Bob would like to see it cleaned up a little bit. The companies cannot really be sold because of the promise he makes. But there are a lot of advantages Berkshire has from putting all the businesses together.
Just one example is MidAmerican. It has put a lot of money into wind and solar assets. These renewable investments generate massive tax credits. MidAmerican may now be big enough to absorb the tax benefits with its taxable income because it has grown so much, but certainly at the time of some of these transactions, the fact that it filed consolidated income tax returns with Berkshire allowed MidAmerican to do these deals. Other utilities would have a more difficult time benefiting from these tax credits because they do not have enough taxable income to make full use of the tax break.
MidAmerican has still more options for deploying capital. Right now MidAmerican can either acquire or not acquire based on whether other things are attractive. Warren can decide. MidAmerican might be bringing him one deal and Iscar might be bringing him another deal. There might be junk bonds that are down. There might be auction rate preferred bonds that are attractive. He can do whatever he wants with the cash flow. He can go in whatever direction he wants. If you are just a utility or you are just a railroad or you are just a metal cutting company, you do not have as many choices about what you can do with your capital. So that capital allocation eclecticism or the ability to go
wherever you want — it is a go-anywhere fund — is an advantage. You see these hedge funds called go-anywhere funds where you can invest in stocks. Look at what Warren has done with derivatives. Which division would be doing the derivatives? Those have been very profitable. So that is one example of something that would be lost.
Another example is in insurance. I do not know that Berkshire Re could take the type of risks that it takes if it were just a standalone company. I am not sure it could have done the kind of super-cat deals it has. Berkshire can absorb a $3 billion to $5 billion loss on an earthquake or a hurricane because it has all these non-insurance businesses pushing out the cash flow and earnings so that it would still be profitable in a very bad year for insurance. There are a lot of other insurance companies that will not write that business because they just do not have the capital base. I just think it would be a terrible mistake to break up the company.
Bob Goldfarb:
He is enormously proud of what he has created, and he should be proud. He does not want to split it up; he does not want to divide up his creation. He wants to build on it successfully and he will.
Question:
Two follow-up questions on Berkshire. I was at the meeting, and I do not know if you want to comment on this, but there was a lot of discussion among the people who attended about succession, which was also part of the Economist story. Also, Warren discussed Burlington and how much capital is being used to fix up and improve the railroad. Any comment?
Jon Brandt:
As I think I have said before in this forum, it is impossible to replace Warren Buffett. He is a master capital allocator. But as the company gets bigger, the ability to add value — it just gets harder. Even the most ingenious of capital allocators hopes at best to do two percentage points to three percentage points better than the S&P over time. One of the most important things over the last few years that have happened is that he has hired two investment managers, Ted Weschler and Todd Combs. I do not know that they have been there long enough to judge their records meaningfully, but they seem to be doing extremely well. Both have outperformed every year since taking the job at Berkshire, Todd for the last three and Ted for the last two years. They seem like sensible people; they seem to fit in with the culture.
Ruane, Cunniff & Goldfarb Investor Day St. Regis Hotel, New York City – May 16, 2014
I have often thought to myself, why not make an investment person the next CEO? Warren seems more interested in dividing the duties between a CEO and a CIO. But unless and until Berkshire goes with paying out much or all of its earnings as a dividend, which could happen, the CIO’s job is going to be more important, arguably, than the CEO’s. If Ted and Todd are as talented as they seem to be, Berkshire shareholders can feel pretty comfortable that the capital, the cash flow that is generated, is going to be allocated in a reasonable and rational and assertive manner.
The railroad — I think there is more to what happened in the last few months than just the weather. But it certainly got some bad luck with the weather, and the company is going to spend the money it takes to fix it immediately. That is another example of what I think makes Berkshire different: The managers at Burlington are not going to be worried about meeting some kind of earnings estimate for the June quarter. They are going to fix what is needed. Warren said in the first quarter report that he thinks that the problems of the railroad with the customer service levels are going to be fixed by the end of the year. And it is an irreplaceable asset.
Look at Union Pacific ten years ago — the trains were not even moving. You would have said — why would anyone ever trust Union Pacific to deliver any containers ever again, or grain or coal. But really the customers have no choice. Union Pacific has fixed its problems, and Burlington, whose problems are much less severe than what Union Pacific went through ten years ago, is going to fix them too. I am confident of that.
Question:
About fifteen years ago, I asked Charlie Munger at a Wesco meeting what he thought of investing in natural resource stocks as a hedge against inflation. He said in very strong terms that he thought it was one of the dumber ideas he had ever heard. He proceeded to lecture about the advantages of investing in companies “awash with cash,” are the words he used. Lots of free cash flow that does not have to be pumped back into plant and equipment at inflationary prices. At this past meeting, according to theMorningstar blog, he said, “It is a blessing to have capital intensive businesses like BNSF and Berkshire Hathaway Energy, which give us an opportunity to reinvest large sums of capital at attractive rates of return.” Then he went on to indicate that future acquisitions are likely to be in
capital intensive businesses. Why the complete change in investment philosophy?
Jon Brandt:
Size.
Question:
That is what I figured.
Jon Brandt:
He has to find a way to put the money to work, and he has to accept less of a return than he did in the past. Charlie would say something like it is too damn bad that we cannot invest like we did in the past. But you are just going to have to suffer through it.
I still think Berkshire can get to a double-digit growth in intrinsic value per year, even with these horrible capital intensive businesses. But ideally you want to be investing in a company that can grow and does not need to put the money to work in capital expenditures. Then you can buy more companies and you have a compound interest wealth-creating machine. Berkshire is going to be a wealth-creating machine that goes just a little slower in the future. Warren said about utilities — it is not a way to get rich, but it is a way to stay rich. I think that would be true of the railroad also.
If you look at the return on equity of the railroad — everyone talks about return on capital because that is how railroads are quasi regulated — but the return on equity at the railroad is quite adequate. That is partly due to the fact that the railroad’s leverage ratio has increased somewhat since Berkshire bought it. Also, at the utility, MidAmerican is intelligently using an increased amount of leverage in its acquisitions resulting in satisfactory returns on equity employed. The railroad has paid dividends to Berkshire
