He starts out quoting Buffett on the Dexter Shoe acquisition for stock:
What I had assessed as a durable competitive advantage vanished with a few years. But that’s just the beginning: By using Berkshire stock, I compounded this error hugely. That move made the cost to Berkshire shareholders not $400 million, but rather $3.5 billion. In essence, I gave away 1.6% of a wonderful business – one now valued at $220 billion – to buy a worthless business.
In the case of Dexter, he bought the business, it made no money, and became worthless. There are three things to note: Buffett bought a bad business, he used stock instead of cash, and the stock (with no help from Dexter) went from roughly $10k per share in 1993 to over $100k today. Not that different from selling Apple stock in 2000 and buying Enron stock. Two bad decisions, selling a winner and buying a loser.
In the case of Gen Re, he bought a profitable business which contributed to BRK's current share price. He issued stock priced at $80,400 10 years ago, and is now selling for $125,000. The 267,750 shares of stock issued to buy Gen Re at today's price makes the cost $33.5 billion rather then the $40 billion quoted by Jeff. If you stick to the metrics used when Gen Re was purchased, the float over the 10 years has increased from $15 billion to $23 billion, right in line with the 50% increase in the stock price. From this simplistic perspective, everything is a wash.
After making points about the deal being awful in regard to regulatory issues, which I agree with, he then finishes with the assertion that, "It is hard to imagine that for $40 billion, Warren Buffett could not have re-created General Re, with money to spare." I don't know how to answer that except to say that it is hard to imagine creating a global direct reinsurer like General Re period. Gen Re (along with Munich Re and Swiss Re) are franchises of a sort that can't just be created out of thin air.
The real story is classic Buffett. A deal with compelling economics meets with awful luck and becomes just a reasonable deal. The bad luck include awful timing, since reinsurance pricing in 1998 was worse then anyone realized at the time. As a result, Gen Re was under reserved by $2 billion and business on the books was underpriced by another $2 billion. This was followed in 2001 by the September 11th terrorist attacks which cost another $2 billion. And then, two of the worst hurricane years on record, 2004 and 2005 capped off by Hurricane Katrina.
At the time of the acquisition, Gen Re had about $15 billion in float or investable assets from policy holder supplied funds. They also had a tangible book value of $7.5 billion. This is $22 billion in new investment funds amounted to $84,000 in investments per share for each of the newly issued shares. This increased the investments per share of the combined entity, as noted in the 1998 Chairman's Letter, " During 1998, our investments increased by $9,604 per share, or 25.2% [to $47,647]."
And of course, Buffett went from the tailwind of the 1990's equity markets to the headwinds of this decade. Putting $20 billion in investable funds in Buffett's hands seemed compelling in 1998. In 1998 over a third of Berkshire's stock portfolio consisted of 200,000,000 shares of KO (Coke), then valued at over $13 billion ($13.4 billion out of $37.3 billion at 12/98). A decade later, that holding is valued at $11 billion. So the new money had to do some heavy lifting to get Berkshire to its current level of investments per share of $90,000.
As far as the 'bad luck' that Gen Re suffered over the last decade, they are unlikely to suffer from under pricing or under reserving. A reasonable expectation for catastrophes is more like one $2 billion event (for Gen Re) rather then the two they suffered. However, the real benefit of a company like General Re in Berkshire's portfolio is that it will not need additional capital, but will continue to generate investable cash. What's not to like about that?
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1 comment:
Awesome article
Thanks!
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