Blog

Ajit for CEO?

Tuesday, March 22, 2011 - 18:34

In a recent interview, Buffett suggests that the board would approve Ajit Jain as the next CEO of Berkshire, and he would love it if Ajit would take the job (if he volunteers).

 In my opinion, this is Buffett's way of begging the shareholders and media to insist by acclamation that Ajit volunteer. UPDATE -- APPARENTLY NOT JUST THAT. GIVEN THE TIMING, IT WAS PAVING THE WAY FOR THE SOKOL RESIGNATION. Buffett, and his family, have always wanted Ajit to become CEO, if it were to be a manager. The problem has been that Ajit doesn't really want the job -- especially its profile. Ajit loves Warren, however, and he's dutiful. My guess is that, if necessary, he'll step up to the plate. At this point he also is possibly the one candidate that the board could choose without doing an outside search, without it causing controversy.

 Let's look at the pros and cons of Ajit.

Pro -- he understands how Buffett thinks better than anyone else at Berkshire.

Pro -- it's very unlikely he'd ever do anything he believed was against Buffett's wishes or Berkshire's best interests.

Pro -- he's modest and unassuming. He would not think of himself as being compared to Buffett, competing with his record, or doing anything more than simply carrying on.

Pro -- He's had the benefit of years of training in how Buffett thinks about risk management, and in an insurance, balance sheet management, and to a degree, investment setting. This is a huge pro. It's been under recognized, in my opinion, as a critical part of the job.

Pro -- Now that Buffett has made it clear that there will not be a CIO, the CEO must be able to, in effect, assume that role. Ajit can do it. I don't think there are a lot of operating managers who lack a financial services background who would be ideal in this role.

 Pro --He's as tough a negotiator as Buffett. He won't give up a nickel of shareholders' money needlessly.

Pro -- The shareholders have been exposed to Ajit over the years and are favorably pre-disposed toward him, as are the other Berkshire managers. He would start out with the mantle of authority.

Pro -- To those who know him and his reputation, he is somewhat feared in the business world (as is Buffett).

Pro -- I should have listed this first. He has a natural instinct for making money.

Pro -- He is a workaholic. He lives for Berkshire. Again, like Buffett.

Are there an cons? There are always cons to every alternative.

Con -- he's modest and unassuming. He really does not like public exposure. Not only would the show abruptly end, but he might be scarcer than a groundhog in January.

Con -- Unlike Buffett, Ajit does not enjoy answering questions. Those who have had the pleasure of spending time with him know that he is expert at wringing every last bit of juice from his conversation partner while shedding only the tiniest crumbs of (possibly useless) information in return.

No more 3 hour marathons with Becky Quick on CNBC. (Ajit is spectacularly unsusceptible to the charms of women interviewers and could not care less about being seen with or getting attention from them.)

Con -- Ajit is a master deal-maker. I would not cite administration as either his passion or an area of expertise. He's also as ruthless as Buffett, without the concern for appearances. He knows this. Ideally, he would buck Berkshire tradition and appoint a chief administrative officer. Without one, chaos could ensue (or worse) at Berkshire. Say, for example, the first time the audit committee has to meet and it discovers that because Ajit decided not to or forgot to pay the auditors, the audit never took place. joke, joke. Sort of.

Milestone

Friday, March 11, 2011 - 23:07

 In case you have not heard, Rich Santulli is back -- see story. In addition to helicopters, the company is financing aircraft sales. 

BYD Story Gets Weirder Thanks to Wikileaks

Thursday, March 10, 2011 - 09:43

 It had to happen: sooner or later Wikileaks will name-drop all the really important people on the planet, so it only figures that something connected to Buffett would show up on the list. See this story from Reuters. Who would have guessed that instead of one of Buffett's many friends in politics, the Wikileaked newsmaker would turn out to be BYD?

Feuds over "who invented it" make juicier press than they do business; they usually wind up in some sort of stalemate that, at most, ends in a financial settlement. The real significance of this is that Buffett does not like to be associated with controversy, contention or scuffed reputations, lest it detract from Berkshire's or his own.

Insider Trading and Berkshire

Tuesday, March 1, 2011 - 13:31

 This just in: a former Goldman Sachs director has been charged with insider trading in the Galleon case -- for, among other things, leaking the information he learned, as a board member, that Berkshire Hathaway was going to invest $5 billion in Goldman during the financial crisis.

If true, this is one of the most blatant insider trading cases I've heard of in years.  In a sense, it's also not surprising. People have been trying forever to spec out which investments Buffett is making (through legitimate means and guesswork).  Money managers, bankers, and individual investors used to badger me constantly for inside knowledge on this subject, not that I had any. The temptation for someone to cheat was always there.

What's really shocking is that insider trading came about through a company board member. During Goldman's lowest moment, when its survival was on the line, instead of being fully focused on the firm's affairs, a board member (allegedly) used his knowledge of the same to defraud the markets. 

I don't think there is anything particular to Goldman Sachs about this situation. It simply happened to be the firm Buffett was bailing out. The cheating fit the "I'm too clever to have to play by the rules" attitude that permeated the whole financial crisis era. Feeling that one is too special to be subject to the normal rules of life -- including, it seems, the laws of gravity that eventually weigh down Ponzi schemes -- led to so many of the problems we are still cleaning up, from subprime mortgages to Madoff to the hedge fund scandal. 

UPDATE: Here's a very good synopsis from Bloomberg which points out the irony that news of an investment by Buffett -- who is the quintessence of buying for long-term value -- was used as fuel for a short-term trading strategy.

NetJets Europe

Monday, February 28, 2011 - 18:18

A bit more information and statistics. Eric Connor of NetJets Europe, speaking to FractionalLife about its caution on future prospects. Quote from article: “We have lost customers as a result of the recession. Around a quarter of the 50 aircraft brought back by [parent company] NetJets Inc were from our fleet and this is equivalent to around 100 owners. We thought that 2010 would be a year for stabilizing, followed by modest growth in 2011 and then that there might be an uplift in 2012, 2013 and 2014. But now we will have to see whether there will be any growth in 2011 or 2012 – there probably will be some in Western Europe.”

> The reference point for NetJets Europe was its base of about 175 aircraft in 2008 (this is in addition to US fleet, Marquis and "core fleet" which add up to the 600-some-odd total planes managed by the company);

> According to Connor there is growing interest in the (least profitable) 1/32nd share;

> New aircraft will be added to fleet only to replace aging planes.

 

New Info on NetJets

Sunday, February 27, 2011 - 15:26

 Buffett has some nice praise for NetJets in the annual report. Following is an analysis of the significant new elements of the report (some were repeated from last year).  To begin with, “I can’t overstate the breadth and importance of David Sokol’s achievements at this company…” Let me also state at the outset that I do not want a round of anybody-bashing to begin on this comment page for the sake of venting. Please comment if you have something substantively new to add. Now let's just move on to analyzing the results.

Cost-cutting. Buffett wrote: “David’s quick restructuring of management and the company’s rationalization of its purchasing and spending policies has ended the hemorrhaging of cash and turned what was Berkshire’s only major business problem into a solidly profitable operation.” This tells you what was truly irking Buffett. He cannot stand waste, grandiosity, sloppiness or high overhead. When NetJets was making money and Buffett was having fun with it, he overlooked some things. Now, Buffett is obviously pleased about the margin numbers. He wanted NetJets’ cost structure rationalized. Yes, there is a question of whether too much cost-cutting took place. For now, however, Buffett appears happy with the profits.

Please note also what these compliments do not mention: customers and growth. Which leads us to...

Revenue increase. The annual report mentioned that revenues increased 7% because of  “higher worldwide flight revenue hours and increased pass through costs, partially offset by lower management fees due to fewer aircraft in the NetJets program.” Translation:

A) NetJets customers are using a higher percentage of their purchased hours.

B) NetJets is passing along rising costs (especially fuel costs) to customers.

C) Revenue is not coming from growth. In fact, fewer aircraft are owned by customers than a year ago, resulting in lower monthly management fees.

There has been some confusion about growth. Some news articles about NetJets have cited number of customers and growth of customers, perhaps giving the impression that NetJets is growing. In addition, as Marquis customers migrate to NetJets, they might appear to be new customers even though they are using the same shares.

Berkshire was careful to disclose that the company is actually shrinking, not growing. Below you will see the numbers. NetJets has lost “whole aircraft equivalents” (i.e., if customers are slices of the pie, whole aircraft equivalents is the number of pies. If you sell pies, you care how many pies you sell, not how many slices your pies are cut into).  The whole industry is down – NetJets’ competitors’ numbers are terrible, too (Flexjet, CitationAir, Flight Options). Put simply, the industry's customers are reducing owned share, moving to charter, returning to wholly-owned aircraft, and/or, giving up private aviation altogether. Nonetheless, shrinkage is shrinkage, and dividing a smaller pie into more slices is not growth. Buffett, who is always very literal and precise, was careful not to mislead in what he wrote in the report.  Here are the NetJets stats for whole aircraft equivalent numbers from the industry surveyor, (confusingly named) JetNet LLC database (by the way these and the rest are US numbers, I hope to have some numbers for the rest of NetJets shortly): 

2005      233.19

2006     243.12

2007     260.30

2008     257.06

2009     231.41

2010     215.80

Aircraft sales and valuation. Also from the annual report: “NetJets continues to own more aircraft than is required for present operations and we expect to continue to dispose of selected aircraft over time.” In 2010, for example, NetJets sold 2 Boeing Business Jets, 3 Citation Excels, 3 Citation Ultras, no Citation Sovereigns, no Citation Xs, and no Falcon 2000s. In 2011 you should expect more sales.

NetJets aircraft are flown a lot more than the average plane of same vintage & model and therefore sell at lower prices, or simply do not sell, when there is an oversupply. The average fleet age of nearly every NetJets make/model is five years old or older and many are much older. Some statistics, again from JetNet, as of January 2011.

 = Citation X aircraft – 64 out of 70 in the NetJets fleet are 7 or more years old. 38 are 10 years old or older.

= Citation Ultra – 13 aircraft, all 20 years old or older.

= Falcon 2000 – all 31 are 7 or more years old; 11 are 10 or more years old.

= Citation Excel – 45 of 47 are in the 7 to 10 year category.

= Citation Sovereign – 24 of 34 are in the 4 to 6 year “bucket” and will soon tip over into the 7 to 10 year bucket.

 In total, NetJets had 2,405 unique shareholders on 284.5 aircraft in use as of January 2011. (Please note that to sell a plane, you have to take back title to all 32 shares from every owner. This makes selling more complicated as the aircraft age.) For the premium price they are paying, NetJets customers expect to fly on newish planes.  Also, the maintenance costs of aircraft, which must be passed along to customers, increase in a nonlinear manner -- faster with older planes.

 So: more sales next year of an aging fleet means what? A lot of these aircraft have probably already been written down. It’s possible that further writedowns may be taken but just as likely that gains may be booked into income. Or, gains may offset new writedowns on other aircraft.

My best guess, in the short term, NetJets may book some gains as it finally begins to move some of these older aircraft that have been written down. In the long term, as the fleet continues to age, you may well see more writedowns.

 No mention of Marquis acquisition. Recall that the Marquis acquisition took place primarily to prevent Marquis’ bankruptcy after NetJets’ began competing with it by selling 32nd shares. Marquis owned 54 aircraft as of January 2011. If I understand the situation correctly, Berkshire in effect was forced to spend a lot of money for nothing to buy these aircraft that it was already flying and which are worth far less than the debt it assumed as part of the transaction. Under the circumstances, it's likely that Berkshire took a writedown of about $200 million in purchase accounting adjustments.

How can you tell? On page 12 of annual report (Buffett letter) there is an asterisk that says manufacturing, service and retailing operations pre-tax earnings of $4,274 excludes purchase accounting adjustments. (I may be missing something but this is the only place I saw that footnote – please correct me if that is wrong.) Thus NetJets reported earnings excludes any purchase accounting adjustments related to Marquis. The writedown is maybe $80 per A share. Not that big a deal, but I have to admit curiosity. 

The more interesting question is why didn't Berkshire just let Marquis go into bankruptcy? Buffet is not know for throwing money away. I suspect that it has to do with brand. The Marquis brand is so closely associated with NetJets that it could be expensive for Berkshire if Marquis filed for bankruptcy and have Kenny Dichter, Marquis's founder, running around in the media blaming Berkshire. This was most likely not a a pleasant decision. As Buffett always says, some businesses throw you one tough decision after another, and other businesses throw you one easy decision after another.

 

How to Run a Bank

Sunday, February 27, 2011 - 13:31

Buffett has studied banking all his life -- he likes being in the position of the guy who has the money and gets paid to let other people use it. (He also likes being in the position of getting paid to use other people's money -- Buffett likes to win either way, but i digress.) Buffett would really love for Berkshire to own a bank outright, but it can't, legally. So Berkshire buys bank stocks and performs as many bank-like functions as it can.  Berkshire Finance is where many of these functions take place.

This year, Kevin Clayton and Clayton Homes got special mention, and they deserve it. The manufactured home industry has shrunk from sales of 372,843 to 50,046 over 12 years. That’s incredible. In the intervening time, Clayton has come to more or less own the industry. It has been able to survive because of access to Berkshire’s capital and because its loan loss levels are extraordinary.

 Clayton is lending to subprime borrowers and has been getting loan loss ratios of 1.17 – 1.86% on originated loans over the past five years.  A commercial bank would be proud of these ratios.  

When you consider the horrific losses suffered by banks in the mortgage crisis, Kevin Clayton’s achievement (obviously, made under Buffett’s philosophy) is a wow. Buffett tooted the patriotic horn in this section of the report -- the fact is that Berkshire is making very good money lending money to people who can repay. 

(These numbers illustrate all the more why it is so shameful that nearly all the other banks thought they were too clever to make money this simple way, and nearly went broke and had to be bailed out.)

 

Who Will Create the Third Pillar of Value?

Sunday, February 27, 2011 - 12:43

Let’s start this topic by saying that nobody knows who will be the CEO of Berkshire after Buffett and thus in charge of creating the "third pillar of value." Nonetheless, there have been some recent indicators about this role and who might fill it, so let’s parse them.

My overall conclusion is that what seemed to be a consensus a year ago that David Sokol was a shoo-in for a job that would be primarily an operating role is changing. The role has expanded, Buffett is focusing more on capital  management, and the number of candidates has expanded. Buffett did some clarifying by stating unambiguously that the CEO will run the company, rather than being partnered with a CIO who is more or less a co-equal. On the other hand, it’s definitely less clear who the CEO will be.

 1. New information: the roster of CEO prospects has expanded. Now there are four, with the addition of Greg Abel. This can be considered semi-official based on Fortune’s endorsement of Vanity Fair’s January 18th claim. (Nothing is written about Buffett or Berkshire in Fortune without Carol Loomis’s approval. If Vanity Fair’s version was wrong, Fortune would have been quick to contradict rather than support it.)  The other three contenders are David Sokol, Matt Rose and Ajit Jain. Matt Rose’s name surfaced earlier, and was a logical addition. (As an aside, I’ve heard concern expressed in some quarters about Matt Rose’s fundamentalist brand of Christianity (as it is sometimes described, whether accurately or not) and what this would mean to Berkshire “culture,” which is “spiritually diverse,” to put it mildly. I really think this is a non-issue. Another lead contender is named Jain, and if he becomes CEO, no one expects Berkshire to compel all its employees to become vegetarians and turn in their flyswatters.)

 2. New information: Sokol’s role less clear. Buffett had nice things to say about NetJets and Sokol in the letter. On the other hand, Sokol has stayed at NetJets for a year longer than he originally intended. Greg Abel, Sokol’s #2, is now on the list of CEO candidates. I don’t know what these seeming contradictions mean, except that Buffett is hedging his bets in some manner. Although if I were David Sokol I would not be pleased to find I am suddenly competing with my own #2.

 3. New information: it’s clear that the CEO will have full capital management responsibility. No more ambiguity about possible CIO and joint decision-making. Buffett has high bar for capital allocation skills. He views this as his own greatest strength and also as the skill in which most other CEOs are weakest.

 4. New information: capital allocation is “third pillar” of value at Berkshire. Not only did Buffett discuss this directly, but he pointed toward it indirectly by talking about all the capital that will be invested in the regulated businesses and the $1 billion of cash flow that Berkshire is churning out each month.

Most of the people reading this are probably investors and we tend to think of capital allocation as managing opportunity cost of one investment vs. another.  The role, of course, includes asset allocation, M&A and will incorporate overseeing the investment managers. But there is more, a lot more.

= the CEO approves major capital transactions of subsidiaries (build a warehouse or retail showroom; buy aircraft;

= decides to take on debt or lease obligations or other commitments either directly or through structure of comp plans, and has final say on when to pay off;

= deals with rating agencies (when anything nonroutine occurs, Buffett is very involved like most CEOs, albeit he does not handle day-to-day personal interaction with rating analysts;

= approves how much capital a particular business gets (especially insurance; in answer to the question below about whether the insurance companies are massively capitalized etc. the answer is, no, not necessarily and not even usually. The rating agencies do consider Berkshire as a whole but are always upping the ante. Balancing these needs against the opportunities of the insurance businesses and other places to put the money is one of the *most* challenging jobs of the CEO of Berkshire, in my opinion).

= decides in which subsidiaries an investment will be housed (e.g., National Indemnity owns BNSF);

= deals with insurance regulators (they may prohibit upstreaming of dividends);

= sets intercompany capital charge; decides when Berkshire will (or preferably, won't) guarantee debt;

= rewards and punishes good/bad insurance underwriting by giving and withdrawing capital through intercompany reinsurance;

= makes major decisions on asset/liability matching and duration;

= makes final call on bank relationships;

= sets cash level and (currently nonexistent) dividend and share repurchase;

= oversees treasury (Buffett likes to know where the money is going);

= controls size of Berkshire World Headquarters; evades the dreaded "Institutional Imperative";

= above all, looks at Berkshire as an integrated capital allocation business in which, as Buffett describes in his “third pillar,” funneling money with the right risk/reward ratio is at the heart of how the company creates value.

In conclusion, Buffett’s emphasis on this “third pillar” means investors should be very focused on who is the manager that can step up to the CEO role and perform all these functions. Less is known about the person that formerly, but more is known about the role. I would be willing to bet that more information will be trickling out over the next year that will clear up some of the murkiness.

 

The Three Pillars of Berkshire

Saturday, February 26, 2011 - 18:20

Everybody knew it was coming but the results had to be seen to be fully appreciated. In the annual report released this morning, just about every page spoke of how Berkshire produced an outstanding year. And you can almost certainly count on more of the same in 2011, because the economy is slowly recovering, BNSF will be consolidated for the full year, and interest rates are rising (even if only a tad so far). With that perspective, let’s consider some of Buffett’s comments.

Berkshire is cheap and will beat S&P by "several points." Buffett wrote frequently and at length on Berkshire’s value in this letter. It’s atypical for him to sound so blazingly optimistic. The letter was permeated with a sense that he wanted to convey that Berkshire is undervalued. While Buffett did pay lip service to the annual chorus of “the future will never match the past,” his overall tone was more as if the heavens had opened up and the angel Gabriel was singing Berkshire’s song. 

By almost any measure, Berkshire is indeed cheap. Simply looking at the stock price vs. tangible book value, Berkshire has been trading below 2X tangible book vs. its former, fairly consistent valuation of around 2.3x tangible book. Moreover, the growth of the operating businesses means that Berkshire's multiple should be expanding. Using this very simple metric, if Berkshire were trading at around 2.5x tangible book, an A share would be worth $35,000 more than where the market is trading today.

Buffett also made a very striking prediction that Berkshire will beat the S&P by “several points” in the future. Several points is a lot. Buffett devoted a lot of space to what he called "normalized earnings power." He stated that the operating businesses will provide most of the firepower because they will grow faster than investment income. Training investors to think in terms of operating earnings is another key to Berkshire earning a higher valuation. Without getting into whether this is the right way to value Berkshire, or any stock, it's simply a fact that Berkshire's low return on reported equity has been a constraint on the valuation. The market has declined to value future earnings from potential acquisitions that might be made by Buffett as it would a predictable stream of earnings from an owned business. In this report, Buffett seems to be declaring victory in the sense that the operating businesses have now reached critical mass. 

Capital Management as Key Pillar of Value. In what was perhaps the most important section of the report, Buffett discussed what he called the three pillars of Berkshire’s value. Two of these he's talked about in the past. These are the two variables he feels that you need to know to value Berkshire as an investor – earnings of the operating businesses and the growth of the investment portfolio. The third pillar is capital management.

It goes without saying that historically, capital management has long been the single greatest creator of value at Berkshire. The company has been built from a series of capital transactions and asset/liability matching and capital allocation decisions over many years. Therefore it is not really surprising to see Buffett acknowledge this as the third pillar. Yet one could almost see Buffett salivating as he wrote that Berkshire is now generating $1 billion of free cash flow a month, a threshold it crossed this year. That’s an astounding figure. Wal-Mart, the world’s largest company, does not even come close to generating cash flows like this.

Buffett was speaking of free cash flows. In another part of the letter, he wrote about how happy he to be committing enormous amounts of capital to regulated businesses like BNSF and utilities. This is *not* coming out of the $1 billion! Berkshire will either be making acquisitions or buying securities to the tune of $1 billion or more a month for the foreseeable future. By way of comparison, the cash expended for the enormous BNSF acquisition took Berkshire about 16 months to accumulate (at today's run rate). Imagine Berkshire buying the equivalent of more than two BNSFs every three years. (In answer to the question below about cash flows, take a look at the cash flow statement. Over time, cash flows should at least equal earnings, if not exceed them.)

Managing this enormous amount of cash is absolutely critical to the future of Berkshire -- and this has implications for the CEO's role. In another key part of the letter, Buffett clarified one important fact about succession. As presently laid out, he has strengthened the role of the future CEO. He confirmed that there will not be a CIO. The future investment manager(s) will report to a CEO who oversees all of Berkshire's capital management. The investment manager(s) will not be coequal to the CEO and will be consulted, but will not have an equal vote on acquisitions. #1 I'm glad to see a bit of clarity on this subject. #2 think about what it means for the skills required to run the company. But more on that in a future post.

As an aside, Buffett has always personally liked having a lot of cash around and has a fascination with collecting it. If anyone had told him 50 years ago that someday he would own a substantial part of a business that produced $1 billion of free cash flow a month (that's almost $33 million every day), he might have had a heart attack out of sheer joy, & I would not be here today writing this.

The next best thing to an unregulated monopoly is a regulated monopoly. Returning to the subject of the regulated businesses, Buffett sounded awfully patriotic when he went on about how the money Berkshire will spend in these heavily capital-intensive businesses will be invested in America. I think by now we can all agree that he's repaid Obama for giving him that Presidential Medal of Freedom.

The patriotic talk did not distract those who know of Buffett’s dislike for capital-intensive business. There was clearly some scratching of heads going on today as people tried to reconcile Buffett’s newfound enthusiasm for throwing money into hard assets with his longstanding preference for businesses like See’s Candies that require no investment at all. Last year in discussing these hard asset businesses, he tempered his comments with a reminder that businesses that require no capex are better than those that do. Not this year.

Why then, is Buffett so fascinated with regulated utilities right now? The answer may surprise you -- and it is extremely revealing of his underlying opinion about the future of the economy.

Regulated utilities are one of the few businesses where you earn an automatic profit on your capex. Capitalized assets are folded into your rate base. As a result, the “real” economic return on invested capital of a utility is often quite a bit higher than the reported return. So profitable is the ability to increase the rate base in regulated industries that regulators’ main problem is preventing companies from capitalizing everything, including the tuna fish sandwich the CEO ate for lunch.

What happens when inflation accelerates? There may be a lag between cost increases and the ability to pass them along to customers, but ultimately utilities have a form of pricing power. Even better is the fundamental nature of regulatory rate-making rules for utilities. You are helped – not hurt -- by making capital investments in an inflationary environment. The utility gets a percentage of capex as profit – not a fixed dollar amount. Increases in capex generate increases in revenue, which fall to the bottom line in a proportionate amount. This means that margins are guaranteed by regulation.

It is the exact opposite of the economics of a "normal" capital-intensive business. 

We all know that Buffett loves monopolies. In an inflationary world, the next best thing to an unregulated monopoly is a regulated monopoly.

With respect to railroads, they are largely deregulated and they are attractive businesses with reasonable returns most of the time. One unique feature of railroads as a transportation business is that, unlike airlines, trucking, shipping,  they own the "road" as well as the means of transportation. Thus railroads are a form of toll bridge. Their pricing power is limited by alternative forms of transportation (trucking). Nonetheless, as prices inexorably rise over time, rate increases drop straight to the bottom line. The beauty of toll bridges in an inflationary world is that returns on capital that was expended long ago increase constantly. The more that is invested in a railroad in an inflationary world, the higher the return. 

It suggests that Buffett is pretty sure the economy is set on a course for major inflation.

 More later on the shareholder letter….

 

Succession at Berkshire

Thursday, February 24, 2011 - 20:40

Preparatory to the annual report's issuance on Saturday, Friday's Financial Times features the following editorial I wrote about the urgency of the succession issues at Berkshire. How the $166B investment portfolio (and derivatives book) will be managed, the ever-shifting list of names on the hypothetical list of internal CEO candidates, and the question of who will serve as non executive chairman after Buffett should all be at the top of investor's minds.

These questions exist because of Buffett's titanic achievements, not despite them. His success is the very reason why it is so difficult to envision Berkshire without him, much less plan for it. But that is all the more reason why the transition roles should be crafted far in advance and with great care.

It is not enough to know that one or more investment managers may have some responsibility for something, and that one person, Todd Combs, has been hired and may or may not have an expanded role someday. Likewise, if Buffett wants the option to change his mind about the CEO candidates, of course that's fine, but other companies go through this all the time and it is not surrounded by so much secrecy.  And when it is .... the company is heavily criticized. See Steve Jobs and Apple.   I know that to some people, any criticism of Buffett is heresy. The market, however, has reached a verdict with Berkshire's valuation having declined steadily from what used to be consistently well over 2x tangtible book. It is not doing Buffett, his legacy or his shareholders a favor to be in denial.

I am very much hoping that Saturday's annual report demonstrates a change of heart and contains some new information that clarifies things. Otherwise, it is very worrying that the stock's valuation may simply keep declining.