Category: Commentary

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Commentary Warren Buffett

Commentary: Is there Money for Berkshire in an A-B InBev Merger with SABMiller?

(BRK.A), (BRK.B)

As soon as the news hit that a megamerger was in discussion between Anheuser-Busch InBev and SABMiller, my first thought was “Is there money to be made for Berkshire?”

There sure is.

A merger of Anheuser-Busch InBev and SABMiller would create a $275 billion company, and would need somewhere around $100 billion in financing to complete the deal.

With Anheuser-Busch InBev controlled by Brazilian private equity firm 3G Capital Management, it would be logical that such a mammoth deal could use at least some financing from Berkshire Hathaway.

The companies previously collaborated on 3G’s Burger King takeover of Tim Hortons, and 3G and Berkshire’s worked jointly to takeover A. J. Heinz, and later to merge it with Kraft Foods Group.

Berkshire and 3G clearly like working together because each provides half of a winning formula. Berkshire produces a lot of cash that needs to be put to work, and 3G is an acquirer of large-scale, high quality assets for which it provides management that aggressively wrings out savings that flow back to shareholders.

Any takeover by Anheuser-Busch InBev of SABMiller is sure to face antitrust issues, as the combined company would own 30% of the global beer market, but if it could get by regulators, here’s what to expect.

Preferred Stock Financing

For the past decade, Warren Buffett has especially used the issuance of preferred shares that pay Berkshire a fixed dividend in exchange for billions in financing.

Buffett’s love of preferred stock financing provided much needed cash to Goldman Sachs, Wrigley, and Bank of America during the Great Recession, and more recently helped 3G finance its Burger King/Tim Hortons merger and the A. J. Heinz and subsequent Kraft Heinz deals. In each deal, Berkshire ended up receiving juicy dividends that ranged from 6% in the case of Bank of America to 9% with Burger King/Tim Hortons.

Common Stock for Berkshire

An Anheuser-Busch InBev/SABMiller merger would likely give Berkshire a sizeable common stock position as well. For example, in providing financing for 3G’s Burger King takeover of Tim Hortons, Berkshire received warrants for 8,438,225 shares of the new combined company, Restaurant Brands International Inc., for a penny a share. The warrants came attached to 68,530,939 Class A 9.00% Cumulative Compounding Perpetual Preferred Shares, and gave Berkshire 4.18% of the outstanding Common Shares and 14.37% of the total number of votes attached to all outstanding voting shares of the Corporation.

Berkshire as the Linchpin

With 3G’s Burger King merger, Berkshire provided roughly 25% of the financing and was the linchpin that quickly brought other financing to the deal. When Warren Buffett wants in, others surely follow.

Look for Berkshire to take a portion of any Anheuser-Busch InBev and SABMiller deal if regulators ever allow it to happen.

© 2015 David Mazor

Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.

Categories
Acquisitions Commentary Marmon Group

Commentary: Is Now the Time for Berkshire to Pull the Trigger on USG?

(BRK.A), (BRK.B)




With demand for housing finally outstripping supply in a number of markets, the need for drywall and other construction supplies looks finally to be reviving from the lingering doldrums of the Great Recession.

Building permits for new houses rose a stellar 30-percent in June 2015, as compared to the same time period in 2014.

The rise in new housing starts, which are up 26-percent year-to-year, is certainly welcome news for Berkshire Hathaway’s Johns Manville, which makes insulation and roofing products, and it’s good news for many of Berkshire’s Marmon Group companies that manufacture materials used in both commercial and residential construction.

The revival in new housing is also great news for USG Corporation (formerly known as United States Gypsum Corporation), which is North America’s leading manufacturer of drywall and related building products.

About USG

In 1902, 30 independent gypsum rock and plaster manufacturing companies merged to form the United States Gypsum Company.  Over more than a century, USG has been issued 1,100 patents for its products. In addition to drywall, the company is a leading manufacturer of acoustical panel and specialty ceiling systems. The company has 34 manufacturing plants in the U.S., and has roughly 9,000 employees in more than 30 countries.

USG and Berkshire

Berkshire played a key role in saving USG during the nadir of the Great Recession.

In 2008, with the housing market imploding and lending all but frozen, Berkshire came to USG’s rescue with $300 million of convertible notes that paid Berkshire 10-percent interest.

At the time, the boost in confidence the company received from Warren Buffett’s financing helped the company avoid bankruptcy. The day of transaction the stock soared 22-percent to $6.89 a share.

Today, the stock is hovering around $29 per share.

Berkshire has not only profited from the healthy interest payments, but the stock’s appreciation as well.

In December 2013, Berkshire exchanged $243.8 million of the convertible notes for common stock, and with additional purchases its stake in USG now sits at just under 40-percent.

The Chinese Drywall Scandal

As an American manufacturer, USG has been a beneficiary of the Chinese drywall scandal that came to a head in 2009. Imported drywall from China that had high sulfur content brought reports of fumes that created upper respiratory problems, and the market for drywall from China was hit hard. Thousands of homes in Florida and other states had their drywall ripped out and replaced.

Time to Pull the Trigger?

The Chicago-based company has seen its ups and downs, including three bankruptcies.

The last bankruptcy was in July 25, 2001 under Chapter 11 in order to deal with a mountain of asbestos litigation costs related to asbestos containing joint compounds.

The establishment of the The United States Gypsum Asbestos Personal Injury Settlement Trust put the company’s asbestos woes in the rear-view mirror, and its stock price reflects it. With the growing strength in the new housing market, its roughly $29 share price looks poised to move past the 5-year high of $35.33 that it hit in February 2014.

With a Market Cap of just over $4.2 billion ($1.5 billion of which is already owned by Berkshire), USG is a great fit for Berkshire if it wants to gobble up the whole thing, or if it just wants to continue its incremental takeover by moving to over 50-percent ownership.

USG would fit nicely into the Marmon Group of companies, which include a host of companies that supply the construction industry.

Berkshire might want to consider a tender offer for the company’s outstanding stock, because it just looks to get more expensive from here, as the housing market finally has put the drywall business back in high demand.

All it takes is a little cash, which is something Berkshire’s got a lot of.

© 2015 David Mazor

Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.

Categories
Commentary Forest River

Commentary: Forest River Learns a Painful Lesson

(BRK.A), (BRK.B)




Unlike the world of automobile manufacturing, which has for decades been ruled by giant corporations such as Ford, GM, and Toyota, the world of RV manufacturing still is a relatively small business (at least as compared to automobile manufacturers), and has yet to adjust to the increased scrutiny all types of specialty vehicles receive in regards to reporting safety defects.

Not that major automobile manufacturers have done all that well lately, with Toyota having received the largest criminal penalty ever for a car manufacturer when in 2014 it was fined $1.2 Billion for concealing safety defects.

Putting the Hammer Down

In a move that underscores the seriousness of this reporting duty, Berkshire Hathaway’s Forest River, Inc., which manufactures RVs, shuttle buses and other recreational vehicles, has been fined $5 million, plus $30 million in deferred penalties by the National Highway Traffic Safety Administration (NHTSA).

According to the NHTSA, both RV maker Forest River Inc., and Spartan Motors Inc., which manufactures custom chassis for Class A motorhomes and specialty vehicles, have “each acknowledged failure to launch timely safety defect recalls as required by the Motor Vehicle Safety Act, and to report critical data such as technical service bulletins and Early Warning Report data.”

“Safety is a critical shared responsibility, and when manufacturers fail to meet their responsibility, the Department will enforce the law,” U.S. Transportation Secretary Anthony Foxx said on July 9, 2015. “Today’s action sends a message to these manufacturers and to others that withholding critical safety information is not an option.”

Also, according to the NHSTA, Forest River, “acknowledged it failed to report early warning data and failed to launch two safety recalls in a timely fashion. Forest River agreed as part of a consent order to pay a $35 million civil penalty, including a $5 million cash penalty and a $30 million deferred amount.”

$30 Million in Deferred Penalty

NHSTA is requiring the $30 million deferred penalty to insure compliance. Forest River is “also is required to retain an independent monitor to conduct periodic audits of the company’s safety practices. Failure to resolve any issues discovered in those audits will result in deferred portions of the civil penalty coming due — $3 million for a first violation, $7 million for a second and $20 million for a third. Forest River also is required to hire an in-house consultant to assist in meeting requirements of the consent order.”

As for Spartan Motors, the company “acknowledged that it failed to report service bulletins to NHTSA as required by law and that Spartan did not launch three previously-initiated safety recalls in a timely manner. Under a consent order, between NHTSA and Spartan, Spartan is required to launch recalls to remedy three additional safety defects that NHTSA identified in previously undisclosed service bulletins. Spartan also will pay a total civil penalty of $9 million, including a $1 million cash penalty. The company commits to spending $3 million on compliance with requirements of the consent order; the remaining $5 million will come due immediately if Spartan fails to comply with the consent order.”

The consent order requires Spartan to “undergo a third-party audit of its reporting practices; develop new written reporting procedures; and engage in an education and outreach campaign aimed at increasing awareness of reporting requirements in the medium and heavy-duty vehicle industry.”

“These companies face not just financial penalties, but increased oversight designed to ensure these safety lapses are not repeated,” said NHTSA Administrator Mark Rosekind. “NHTSA will continue to use its enforcement authority in innovative ways to protect public safety.”

Forest River has pointed fingers at its software vendor for its reporting troubles but the message from the NHSTA has been we don’t care.

As for its safety defects, Forest River announced a recall on July 6,2015, of 1,497 model year 2016 travel trailers citing concerns that a wheel might detach from the vehicle.

An Even Bigger Hammer in the Wings

Specialty vehicle manufacturers would be wise to spend money now to improve their systems and culture of compliance, as the Department of Transportation is seeking enhanced safety enforcement, including greatly raising the power of the department’s safety authority by increasing the statutory cap on NHTSA civil penalties from $35 million to $300 million.

© 2015 David Mazor

Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.

Categories
Berkshire Hathaway Energy Commentary

Commentary: If You Can’t Beat ‘Em, Join ‘Em?

(BRK.A), (BRK.B)




Berkshire Hathaway’s Nevada Energy is in a battle for the energy consumer that could be the bellwether for utility industry. With consumers pushing legislators to expand the percentage of “net metering” that Nevada Energy must purchase, Berkshire Hathaway Energy is stuck on the side of trying to hold down consumer demand for rooftop solar so its non-solar consumers don’t see their rates rise as the utility passes on legacy costs from closing outdated coal-fired plants.

Rooftop Solar an Unstoppable Force

In Nevada, 108 companies installed 339 megawatts of solar power in 2014. Even in markets without Las Vegas’s 294 sunny days per year, the cost of rooftop solar is dropping so quickly that Bloomberg News is predicting that there will be “a 17-fold increase in installations.” They note that “By 2040, rooftop solar will be cheaper than electricity from the grid in every major economy.”

While the cost of utility scale solar is also dropping as witnessed by Berkshire’s 1,271 megawatts of solar capacity and growing. (It’s Topaz Solar Farm, a photovoltaic power station in San Luis Obispo County, California, alone is already generating 579 megawatts of power.) The question is whether Berkshire should stand on the sidelines while more and more consumers put solar panels on their roofs.

If You Can’t Beat ‘Em, Join ‘Em

Nevada’s the perfect opportunity for BHE to test adding rooftop solar installation and leasing to its portfolio. The company’s got deeper pockets than the numerous but small players in the market. Other utilities are already testing rooftop solar. Georgia Power rather than fighting rooftop solar companies is joining them in the installation business through a new subsidiary.

Another Key Advantage

Berkshire Hathaway Energy already has a number of unregulated businesses, including its Berkshire Hathaway Home Services real estate empire. Rooftop solar offers another unregulated business opportunity.

So, as the saying goes, “If you can’t beat ‘em, join em.”

© 2015 David Mazor

Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.

Categories
Commentary Special Report Warren Buffett

Berkshire Hathaway’s Biggest Question

(BRK.A), (BRK.B)




Who will succeed Warren Buffett, who turns 85 in August, as the head of Berkshire Hathaway? This would seem to be the biggest question hanging over the shareholders of the massive conglomerate. Will it be Greg Abel, the head of Berkshire Hathaway Energy, or Ajit Jain, who heads up Berkshire’s reinsurance business? Both are frontrunners, especially since Vice-chairman Charlie Munger, who is himself 91 this year, specifically dropped their names in his shareholder letter included in the 2014 Berkshire Hathaway annual report. Yet while people speculate on Buffett’s successor, I would suggest there’s a far more important question. After all, CEOs come and go, and whoever follows Buffett and Munger will eventually be succeeded by others.

So, the biggest question is not who will succeed Buffett; it’s how will they be compensated. In other words, how will they participate in the growth of the company as compared to how has Buffett participated?

Can a unique situation be replicated?

Berkshire Hathaway may be unique in the sheer number of companies that operate under its umbrella. It’s not only a conglomerate; it’s a conglomerate of conglomerates. For example, Berkshire’s Marmon Group has 160 independent manufacturing and service businesses, and Berkshire’s Scott Fetzer Group oversees 21 diverse companies. But even this is not what is most unique about Berkshire. What’s most unique is that Warren Buffett is participating first and foremost just as you do, as a shareholder.

The most underpaid CEO in the Fortune 500

For a man overseeing a conglomerate with a market value of roughly $347 billion, you would think that Buffett receives sky high compensation, especially since that conglomerate’s share value has risen 1,826,163% (yes, that’s not a misprint) from 1966 to 2014. However, Buffett (and Charlie Munger) have annual salaries of only $100,000. What’s more, there are no stock options and no bonuses. Buffett and Munger’s rock bottom salaries mean that they are participating in Berkshire just like you are, as long-term shareholders that care more about increasing the underlying intrinsic value of the company than any short-term trick to boost the stock price.

Think that doesn’t matter?

“The more CEOs are paid, the worse the firm does over the next three years, as far as stock performance and even accounting performance,” notes Michael Cooper of the University of Utah’s David Eccles School of Business. Prof. Cooper co-authored a paper that proved just that.

Just look at David Zaslav, CEO of pay-TV channel Discovery Communications. Zaslav had a total compensation package of $156.1 million in 2014, yet the same year the stock lost a quarter of its value, even as the broader market boomed. The shareholders felt the pain, while Zaslav got the gain. That’s not exactly participating on the same basis.

At the 2015 Berkshire annual meeting, Buffett acknowledged that when CEO incentives get out of line with a company’s goals bad things can happen.

“Charlie and I believe in incentives, Buffett said. “But we have seen decent people get into trouble with incentives. The CEO promises a certain number, and his executives don’t want to make the CEO look bad. Egos get involved. You have to be careful in the messages you send as CEO. If you don’t want to disappoint Wall Street, your managers will react.”

A Hedge without the 2 and 20

Hedge fund managers built their fortunes on the 2% annual management fee and a 20% of the profits, but that’s not necessarily the same for the hedge fund’s investors, who don’t get that management fee to cushion any tumble in profits. Remember in 2008 when Buffett bet hedge fund manager Ted Seides that a low-priced index fund tracking the S&P 500 would beat the average of any 5 hedge funds over a 10-year period that Seides picked? Well, the “Million-Dollar Bet” is looking more and more like a sure bet for Buffett, because he knew the high friction costs would hurt the hedge funds’ returns.

In fact, Berkshire’s a conglomerate that operates as hedge fund without the management fee structure. Like a hedge fund, it can buy 100% of a company (unlike a mutual fund), it uses derivatives to increase its leverage and hedge its risk, and because its leadership is in lock step with its investors, all that benefit goes right to each shareholder.

Whose side will they be on?

In 2011, David Sokol, who once looked like the heir apparent to Buffett, abruptly resigned after it turned out that he had accumulated over 96,000 shares of Lubrizol before bringing the company to Buffett’s attention as a potential acquisition. Buffett later called Sokol’s actions “inexplicable” and “inexcusable,” and while the SEC dropped its probe, the Sokol fiasco showed that’s it’s not automatic that Berkshire’s leadership will align with its shareholders interests.

Or, as Charlie Munger has said, “Trustworthiness is more important than brains.”

Berkshire’s Future Leadership

Berkshire’s future generations of leadership may be great stock pickers, able to build portfolios that equal the $100 billion portfolio that Buffett built. They may be great capital allocators like Buffett, able to use the profits from one company to by other companies with even greater growth potential. They might even be as savvy opportunists, unleashing Berkshire’s mountains of cash just when others credit has dried up. However, the big question is whether they do it on the same basis as Buffett and Munger, on behalf of all the shareholders.

© 2015 David Mazor

Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.

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Benjamin Moore Commentary

Commentary: What a Can of Paint Says About Warren Buffett

(BRK.A), (BRK.B)

Founded by the Moore brothers in 1883, Benjamin Moore Company has been a leader in indoor and outdoor paint for over a century. The company introduced the popular Regal® Wall Satin interior latex paint in 1957, and in 1982 became the first company to do computerized color matching. The company positions itself as a premium paint manufacturer, and its products consistently rate well. In 2014, it was ranked highest in interior paint customer satisfaction by J.D. Power for the fourth year in a row.

In 2000, Berkshire Hathaway acquired the company for roughly $1 billion in an all cash deal. It’s a deal that has worked out well for Berkshire, and Warren Buffett told CNBC’s “Squawk Box” in October 2013 that Benjamin Moore had generated $1.5 billion in profit over the previous decade.

Independent Dealer Strategy

Since its founding, Benjamin Moore has sold its paint through a network of independent dealers. The dealer network encompasses 6,500 stores coast to coast, and the company sells its paint internationally as well, with a growing presence in China and Russia as the stand outs.

However, the place you won’t find Benjamin Moore paint is in big box stores, such as Lowe’s and Home Depot.

The Growth of the Big Box Store

The big box stores that are leaders in the do-it-yourselfer retail category have undergone explosive growth, with Home Depot claiming the record for fastest growth of a retail outlet. Founded in 1978, Home Depot reached its 100th store in 1998, and by 2011, it had 2,248 locations in the United States, Puerto Rico, Canada, and Mexico. Similarly, Lowe’s operates more than 1,830 stores within the same geographic area. Combined, they represent over 4,000 locations, with each one doing many times the business of a mom-and-pop store.

Where is Benjamin Moore?

The rise of the big box stores would seem to leave Benjamin Moore on the outside looking in, so why isn’t Benjamin Moore on the inside?

The answer is simple.

If Benjamin Moore made its paint available to Lowe’s and Home Depot, it would devastate the independent dealer network. The independent dealers count on their product exclusivity to protect their pricing and sales model. And, Buffett’s promise to protect that dealer network was such that when he got wind of Benjamin Moore’s CEO Denis Abrams plan to start selling to a major retailer, Abrams was fired on the spot.

Keeping a Promise

The move protected the independent dealers, but the deal also did something else. It protected Berkshire Hathaway’s reputation for living up to its word, especially when it comes to acquisitions.

Berkshire Hathaway’s sterling reputation for honoring its word has become another bullet in Warren Buffett’s famed “Elephant Gun.” It helped him land Iscar Metalworking Companies in 2006, when he received an unsolicited letter from Iscar’s Chairman Eitan Wertheimer offering to sell Iscar to Berkshire. Seven years later, Wertheimer cited his great relationship with Buffett and Berkshire as one of the reasons he felt comfortable selling his remaining 20% interest to Berkshire in 2013.

A Priceless Weapon

As Buffett goes on the hunt for the next elephant, he’s got $30 billion in cash in his arsenal. He’s also got the priceless value of keeping his word.

Hopefully, his successors will recognize the power of that weapon too.

© 2014 David Mazor

Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.