Berkshire Hathaway’s annual letter to shareholders has included pages on the stock market and where it’s headed in previous years. This year? Silence. Buffett lost nearly $900 million exiting biggest buyout ever

Buffett keeps mum on stocks and successor

By Stephen Gandel, senior editor March 1, 2014: 8:00 AM ET

Berkshire Hathaway’s annual letter to shareholders has included pages on the stock market and where it’s headed in previous years. This year? Silence.

FORTUNE — The Oracle of Omaha’s crystal ball must be cloudy these days.

In Warren Buffett’s annual letter to Berkshire Hathaway (BRKA) shareholders, released Saturday morning, he says little about the stock market or where shares might be headed. Buffett does say, as he has in the past, that he still believes in America. Berkshire spent $11 billion on plant and equipment in 2013, and Buffett notes that 89% of that money was spent in the U.S.

“Though we invest abroad as well, the mother lode of opportunity resides in America,” writes Buffett, who is the chairman and CEO of Berkshire. But he doesn’t say whether stocks are the best investment opportunity in America these days. Clearly, owning a company that makes stuff that Berkshire buys is swell. There’s a section about how Buffett and his partner Charlie Munger think about investing, which Fortune excerpted earlier this week. Buffett cites two of his best investments, and both are in real estate.

Buffett has gone other years without commenting on the stock market or making a prediction where shares are headed in Berkshire’s annual letter. But in the last few years, Buffett has dedicated at least some of his letter to opining on the market. Two years ago, Buffett spent three-and-a- half pages on a detailed explanation of why he thought stocks were a much better investment than, say, gold or bonds. (See Warren Buffett: Why stocks beat gold and bonds.) He also said he was bullish on U.S. housing.

Last year, Buffett devoted four paragraphs to the case for stocks, and he said that he thought the market would still “do well.”

But even a year ago, Buffett’s enthusiasm for the market seemed to wane. He wrote that investors should expect setbacks in the market from time to time. If that was supposed to be a wink that one could come in 2013, Buffett missed that call. In 2013, the S&P 500’s total return was 32%.

Buffett’s favorite gauge on whether equities are expensive or cheap is to compare the total value of stocks to gross domestic product, and he alluded to this comparison a year ago. Last year, GDP rose 1.9%. Stocks rose nearly 16 times that. A year ago, stocks collectively were trading at a value equal to 133% of GDP. After last year’s market gains, we are now at 154%.

The metric has been higher — it peaked at 190% in 1999 — but not too often. That doesn’t mean stocks are headed for a crash, but it does mean they may not have much room to grow. Back in 2001, Buffett said investors who buy when the relationship of stock values to the economy falls in the 70% to 80% range should do well. That means stocks would have to plummet 48% before we are back in Buffett buy territory.

Even so, Buffett and his managers are finding stocks to buy. In 2013, Berkshire bought more shares of Wells Fargo (WFC) and IBM (IBM), two companies that are likely to go up only if the economy and the rest of the market does well. All told, Berkshire put $4.7 billion of new money into the stock market last year.

Buffett also reveals nothing new this year about who would take over Berkshire if, or when, the 83-year-old executive retires. The only section in which Buffett talks about who will run Berkshire in the future comes at the very end of the annual report and is nearly word-for-word the same as a year ago, as it has been for the past few years. The only difference is the number of employees who work at Berkshire. It is now 330,745, up from 288,000 a year ago.

Berkshire’s succession planning became an issue after Buffett announced in April 2011 that he had been diagnosed with stage 1 prostate cancer. Buffett went through treatment for the cancer, returned to work shortly after, and has resumed his normal heavy travel schedule. Buffett says, like last year, that he has never felt better.

As he has said in the past, Buffett’s plan is for Berkshire to split his job in two when he leaves the company. One person will become the CEO of Berkshire’s operating company. Another person or two will be left in charge of managing Berkshire’s investment portfolio. Buffett says the names of his successors may change, but he says he has picked who should get those jobs if he were to leave the company suddenly. But only he and the board knows who those people are.

It appears that the investing job is close to being locked up. A few years ago, Buffett hired money managers Todd Combs and Ted Weschler to help run Berkshire’s portfolio. In this year’s letter, Buffett says Combs and Weschler each manage more than $7 billion of Berkshire’s money. And they both outperformed not only the market but Buffett himself last year. If Combs and Weschler don’t get the job, at the very least it sounds like they will be able to get a nice reference.

As for the operating job, Ajit Jain, who heads up Berkshire’s largest insurance unit, is seen by many as the frontrunner. This year, Buffett calls Jain’s mind “an idea factory,” and says that he has built a business that “no other insurance CEO has come close to matching.” What’s more, profits at Jain’s insurance unit more than quadrupled in 2013.

Buffett also says Greg Abel, who runs Berkshire utility MidAmerican, and Matt Rose, who co-heads railroad BNSF — two other Berkshire executives who are often talked of as possible successors — are “extraordinary managers.” But they get grouped into the same sentence, along with another BNSF executive Carl Ice, who didn’t even get a mention last year.

Does that mean Jain is pulling ahead of the pack? Perhaps, but only Buffett knows.

 

Buffett lost nearly $900 million exiting biggest buyout ever

By Stephen Gandel, senior editor March 1, 2014: 8:00 AM ET

The Berkshire Hathaway chairman and CEO lost big on a wrong way bet on Energy Future Holdings.

FORTUNE — Warren Buffett wishes he never got involved in the largest private equity deal ever. Given the outcome, that’s not much of a surprise.

In his annual letter to shareholders, released Saturday morning, Buffett says Berkshire Hathaway (BRKA) lost $873 million on his wrong way bet on Energy Future Holdings. And Buffett says it was his bad bet. He says he made the investment without consulting his long-time lieutenant Charlie Munger. He also said Berkshire no longer holds any of Energy Future’s debt, having sold its remaining stake last year.

“Most of you have never heard of Energy Future Holdings,” Buffett writes in the letter. “Consider yourselves lucky; I certainly wish I hadn’t.”

In a deal, struck at the peak of the pre-financial-crisis deal boom, Texas energy giant TXU was bought by private equity firms KKR (KKR), TPG Capital, and Goldman Sachs’ private equity arm for $45 billion, making it the biggest leveraged buyout in history. TXU was later renamed Energy Future.

The deal was highly leveraged. KKR, TPG, and Goldman (GS) put up $8 billion for their ownership stakes. And the company came with $13 billion in debt already on its books. The rest of the deal was financed by issuing more debt, and Buffett bought just under $2 billion of those bonds.

On top of the excessive leverage, falling natural gas prices made Energy Future’s coal-fired power plants much less profitable, hobbling the company. It’s widely believed that Energy Future will soon file for bankruptcy. Buffett predicts that outcome in his letter as well.

From the start, the investment was an unusual one for Buffett. He has generally criticized leveraged buyouts in the past. And Buffett has already publicly declared the investment a mistake. Starting three years ago, Berkshire began to write down the investment, already booking at least $1.4 billion in losses prior to last year. (So, oddly enough, the fact that Berkshire didn’t lose that much money in the end may have resulted in an accounting gain last year.)

But for the first time in this year’s letter, Buffett fully accounts for Berkshire’s loss on the deal. He said Berkshire sold its bonds for $259 million. Add that to the $837 million Berkshire had collected in interest payments during the time it held the bonds, and you get to nearly $900 million loss.

Buffett has been involved in bankruptcy fights before. But apparently he thinks it’s best to not take part in Energy Future’s potential proceedings, which are likely to be messy. Energy Future has nearly $40 billion in debt. Berkshire held debt in Texas Competitive Electric Holdings, an unregulated subsidiary of Energy Future that sells power in wholesale markets to big companies and other utilities. Energy Future wants creditors to take over Texas Competitive at a value of $7.5 billion. Creditors say it is worth $10 billion more than that. Buffett must have thought he could get a better deal getting out now, or that he could get a better return investing his money elsewhere.

That is certainly the case for the original investment.

 

Buffett: We’d like to own more of Heinz

By Stephen Gandel, senior editor March 1, 2014: 8:00 AM ET

The Oracle of Omaha says he is pleased with the results of his biggest deal of 2013.

FORTUNE — Warren Buffett may end up putting more money into ketchup maker Heinz.

Last year, Buffett’s Berkshire Hathaway (BRKA) bought the company with Brazilian investment firm 3G Capital. The deal essentially split the ownership of the company down the middle. Berkshire and 3G put up $4.25 billion each to buy the common shares of the company. And Berkshire put in another $8 billion for preferred shares, which paid a 9% dividend. 3G got the job of managing the company.

Some initially called the deal expensive — particularly for Buffett, who is known as a value investor — as it valued Heinz at 20 times expected earnings. Some speculated that Buffett only did the deal because of the large dividend he got on the preferred shares.

MORE: In a first, Buffett gets beat by the S&P 500 over five years. (But wins over six.)

But in Berkshire’s annual letter to shareholders, which was released on Saturday, Buffett goes out of his way to say that he expects Heinz to be a long-term holding for his company. In fact, he says he would be interested in upping his stake in Heinz, presumably at the same or higher price. And he eludes in his letter that he may have the chance. Buffett writes that “certain 3G investors” may be looking to sell part of their Heinz stake in the future. When they do, Buffett said he would be willing to buy up the shares. He also said Berkshire would be willing to discuss swapping its preferred shares for common stock at some point in the future. That would also increase Berkshire’s ownership stake in Heinz.

“Though the Heinz acquisition has some similarities to a ‘private equity’ transaction, there is a crucial difference,” Buffett writes in his letter. “Berkshire never intends to sell a share of the company.”

The company has so far been a good investment, but not without some pain. 3G has laid offnearly all of Heinz top management and hundreds of its employees. That’s made the deal an unusual one for Buffett. Berkshire rarely makes large management changes or layoffs when it takes over a company. Because of the all the restructuring, Heinz lost $84 million in 2013.

MORE: Buffett: Learn from my real estate investmentsStill, Buffett calls the operating results at Heinz “encouraging.” And he has made money so far on the investment, though not much. Factoring in the dividends and Heinz’s losses, Berkshire calculates that it has made $149 million on the deal so far, a 1.2% return on its investment. Clearly, Buffett thinks the investment will post better returns in the future.

 

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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