Even the 'Oracle of Omaha' Makes Mistakes

Even Warren Buffett, the “Oracle of Omaha”, is capable of making mistakes in this down market. It appears that after displaying resiliency last year, Berkshire Hathaway may be in for a rough year. Buffett and his company, Berkshire Hathaway (BRK.A), haven’t been able to avoid the credit problems that most of the financial industry has already encountered. Berkshire is down over 40% from its 52 week high, and has lost $11.6 billion in net worth. After losing 9.6% in share book value it’s now questionable whether this blue chip company can keep its luster and demonstrate the strength and leadership that it has shown for decades.

Credit Problems

This past month, credit issues have been the biggest concern for Berkshire Hathaway. Earlier in March, its rating was reduced by Fitch from AAA to AA+, and its senior unsecured debt rating lowered to AA from AAA. Fitch cited a negative outlook and a need for capital in the future. Standard and Poor’s has also reconsidered its rating of Berkshire, downgrading its outlook to negative. However, Standard and Poor’s did affirm Berkshire’s rating of AAA, but will continue monitoring the company giving them approximately one year to raise capital in order to ensure stability.

I feel that Berkshire is solid from a credit perspective, since Fitch also states that no company in the financial sector should have a AAA rating. This appears unfair and has had a negative impact on the stock value of Berkshire. Additional reason for concern is that the price for Berkshire credit swaps has increased significantly. These swaps are essentially insurance on Berkshires liabilities, and the rise in price emphasizes a need for Berkshire to stabilize its finances. High swap prices insinuate a higher possibility of Berkshire defaulting on its debt obligations.

In response to credit issues, Berkshire Finance sold $750 million in three year notes that will yield 282 basis points above the treasury rate. This sale was originally meant to be for $400 million, but Berkshire decided to increase the transaction this past Thursday. Buffett also recently announced that some of his company’s financial troubles pertain to the rising price of capital, since others choose to take billions in bailouts while he chooses to remain independent. This should allow Berkshire a faster rebound than its competitors and also allows them to stay clear of all the stipulations tied with Federal aid.

Bad Investments

The greatest investor of our time has made a few mistakes himself. These small mistakes by the tycoon have cost his prestigious company billions. He admits to foolishly upping his investment in ConocoPhillips (COP) stock when oil and gas prices were at their highest in 2008. This mistake cost equity holders several billion dollars in value. He also made a smaller blunder that cost him $217 million when he bought vast amounts of stock in two Irish banks, which where revalued at roughly $27 million on his books.

The outcome of Buffett’s $5 billion investment in Goldman Sachs' (GS) is yet to be seen. At first glance, it appeared to be a bad decision, as Goldman dropped to $52 a share, deeming the ability to strike at $115 useless. However, the stock has rebounded very well and it appears that this will be a smart long term play. The warrants do not expire until 2013, so there is still ample time to allow Goldman Sachs' to rise even further in price. The 10% dividend on these preferred shares is a bonus that could help Berkshire solidify these shares in the future.

The Outlook

Warren Buffett didn’t earn his nickname, the “Oracle of Omaha”, for no reason. While he has made some blatant mistakes in the past year, they shouldn’t affect his company in the long run. His current objective is to secure capital at a competitive rate compared to those who are receiving aid from our government. While its credit rating has been questioned, Berkshire Hathaway should have the time and certainly the leadership to pull through and demonstrate why it has averaged 20% returns for the last 44 years. The economic recession has proven to be deep, leaving even the premier investors and seemingly most stable companies vulnerable.

-Joe Gallo

Disclosure: The mutual fund the author is associated with is Long GS

Comments

[U Dontknow ...:]

BRK is just another victim of 'mark to market' accounting now.

It's own credit rating has been lowered due to obligations that don't come due for years to come and may never hurt them.

Apr 05 09:02 AM

[Jimmy Lathrop:]

After reading the WB biography, the thing that struck me the most was his constant reiterating of the broken state of his insurance purchases. He kept referring to how he always had to pull the tow truck up to the ditch. Yet most of the cash from BRK.A comes from his insurance float from premiums. That set off an alarm in my head.

He was also very candid about fumbling around as an investor in Salomon Brothers and how it was out of his comfort zone. Most of the phantom profits in the 2002-2005 period came from the Housing Bubble that the financial institutions profited from. If his insurance companies wrote swaps on the S&P, those earning are not coming back.

The lower value of corporate bonds are also hurting the insurance companies book value. He has a lot of headwinds. The other companies require consumer consumption, like See's Candies and things that make stuff.

Sometimes in life its better to be lucky than right. And sometimes your luck runs out.

Apr 05 01:17 PM

[Allan Frain:]

"Warren Buffett didn’t earn his nickname, the “Oracle of Omaha”, for no reason. While he has made some blatant mistakes in the past year, they shouldn’t affect his company in the long run."

Similarly, that GE is the only stock remaining from the original DOW is no small feat.

But when you forego a core business of value-addition in favor of financial shenanigans your former success within the abandoned business model will not help you.

GS success lies significantly in putting its alumnai in Treasury and influencing policy to its own benefit. GE and Buffet are in a new game for which they are unqualified.

Apr 06 10:45 AM

[Vox Rationalis:]

"Buffett and his company, Berkshire Hathaway (BRK.A), haven’t been able to avoid the credit problems that most of the financial industry has already encountered."

Really? BRK has had trouble getting financing? Or are you saying they've had borrowers defaulting?

"Berkshire is down over 40% from its 52 week high, and has lost $11.6 billion in net worth."

I guess you mean book value. As of 12/31/08. Quite a bit more than that by now, with some $9 billion of equity losses YTD, don't you think?

"...it’s now questionable whether this blue chip company can keep its luster and demonstrate the strength and leadership that it has shown for decades."

I'd probably dispute this statement, if it had any meaning whatsoever.

"This past month, credit issues have been the biggest concern for Berkshire Hathaway."

Please, provide any evidence to support this notion. What gives you the idea that BRK is concerned in the least?

"Standard and Poor’s did affirm Berkshire’s rating of AAA, but will continue monitoring the company giving them approximately one year to raise capital in order to ensure stability."

This is absurd, if by "raise capital" you mean the ordinarily understood definition, or for that matter anything other than "continue operating without any modification." S&P says nothing about BRK needing to raise equity capital.

"I feel that Berkshire is solid from a credit perspective..."

I'm sure my relief is echoed by all BRK holders.

"This appears unfair and has had a negative impact on the stock value of Berkshire."

Another unsupportable notion. Do you seriously think that credit bureau downgrades have had ANY impact on BRK? Where's your evidence?

"Additional reason for concern is that the price for Berkshire credit swaps has increased significantly. These swaps are essentially insurance on Berkshires liabilities, and the rise in price emphasizes a need for Berkshire to stabilize its finances. High swap prices insinuate a higher possibility of Berkshire defaulting on its debt obligations."

Complete misunderstanding, though this one is pretty common. As discussed here: seekingalpha.com/artic..., the best reason I've seen for the broad CDS price is due to the fact that holders of BRK's long-date market puts have no other insurance options. Usually, buyers of such contracts are able to hold collateral to cover potential losses, but this is not the case with the BRK puts. So these holders buy CDS to provide insurance for the next five years as part of a longer-term risk management strategy. There's no other logical explanation I have read.

"In response to credit issues, Berkshire Finance sold $750 million in three year notes that will yield 282 basis points above the treasury rate. This sale was originally meant to be for $400 million, but Berkshire decided to increase the transaction this past Thursday."

"In response to 'credit issues'"? You didn't even read any of the press articles about this, did you? "Net proceeds from the sale will go to Vanderbilt Mortgage & Finance Inc., a unit of Berkshire’s Clayton Homes Inc., which makes manufactured housing, according to documents obtained by Bloomberg News. Vanderbilt provides loans to buyers of homes sold by Clayton." (www.bloomberg.com/apps...). So a mortgage lender borrowed money so that it could then lend it at higher rates. Shocking! I wonder if anybody's ever done anything like this before?

"Buffett also recently announced that some of his company’s financial troubles pertain to the rising price of capital..."

I defy you to cite a single instance of Buffett referring to BRK as having "financial troubles."

"The outcome of Buffett’s $5 billion investment in Goldman Sachs' (GS) is yet to be seen. At first glance, it appeared to be a bad decision, as Goldman dropped to $52 a share, deeming the ability to strike at $115 useless... The warrants do not expire until 2013, so there is still ample time to allow Goldman Sachs' to rise even further in price. The 10% dividend on these preferred shares is a bonus that could help Berkshire solidify these shares in the future."

Again, you show a complete lack of understanding. This investment was in preferred equity, which boosted GS' capitalization ratios while paying BRK a hefty 10% dividend. BRK's investment didn't decline in value with the common, because the BRK shares are not traded, and are only redeemable for a 10% premium. Because the preferred investment also cannot appreciate with the common, the warrants are included to provide sharing in the potential upside.

"His current objective is to secure capital at a competitive rate compared to those who are receiving aid from our government."

Again, says what source? BRK will, AS ALWAYS, raise capital when it has a suitable investment opportunity that for which debt financing makes sense.

The writer should be ashamed to have published such an "analysis."

Apr 06 06:12 PM

[Swashbuckler:]

Vox---There's a company in Omaha,NE., called Berkshire Hathaway. Ever heard of 'em?


On Apr 06 06:12 PM Vox Rationalis wrote:

> "Buffett and his company, Berkshire Hathaway (seekingalpha.com/symbo...),
> haven’t been able to avoid the credit problems that most of the financial
> industry has already encountered."
>
> Really? BRK has had trouble getting financing? Or are you saying
> they've had borrowers defaulting?
>
> "Berkshire is down over 40% from its 52 week high, and has lost $11.6
> billion in net worth."
>
> I guess you mean book value. As of 12/31/08. Quite a bit more than
> that by now, with some $9 billion of equity losses YTD, don't you
> think?
>
> "...it’s now questionable whether this blue chip company can keep
> its luster and demonstrate the strength and leadership that it has
> shown for decades."
>
> I'd probably dispute this statement, if it had any meaning whatsoever.
>
>
> "This past month, credit issues have been the biggest concern for
> Berkshire Hathaway."
>
> Please, provide any evidence to support this notion. What gives you
> the idea that BRK is concerned in the least?
>
> "Standard and Poor’s did affirm Berkshire’s rating of AAA, but will
> continue monitoring the company giving them approximately one year
> to raise capital in order to ensure stability."
>
> This is absurd, if by "raise capital" you mean the ordinarily understood
> definition, or for that matter anything other than "continue operating
> without any modification." S&P says nothing about BRK needing
> to raise equity capital.
>
> "I feel that Berkshire is solid from a credit perspective..." <br/>
>
> I'm sure my relief is echoed by all BRK holders.
>
> "This appears unfair and has had a negative impact on the stock value
> of Berkshire."
>
> Another unsupportable notion. Do you seriously think that credit
> bureau downgrades have had ANY impact on BRK? Where's your evidence?
>
>
> "Additional reason for concern is that the price for Berkshire credit
> swaps has increased significantly. These swaps are essentially insurance
> on Berkshires liabilities, and the rise in price emphasizes a need
> for Berkshire to stabilize its finances. High swap prices insinuate
> a higher possibility of Berkshire defaulting on its debt obligations."
>
>
> Complete misunderstanding, though this one is pretty common. As discussed
> here: seekingalpha.com/artic...,
> the best reason I've seen for the broad CDS price is due to the fact
> that holders of BRK's long-date market puts have no other insurance
> options. Usually, buyers of such contracts are able to hold collateral
> to cover potential losses, but this is not the case with the BRK
> puts. So these holders buy CDS to provide insurance for the next
> five years as part of a longer-term risk management strategy. There's
> no other logical explanation I have read.
>
> "In response to credit issues, Berkshire Finance sold $750 million
> in three year notes that will yield 282 basis points above the treasury
> rate. This sale was originally meant to be for $400 million, but
> Berkshire decided to increase the transaction this past Thursday."
>
>
> "In response to 'credit issues'"? You didn't even read any of the
> press articles about this, did you? "Net proceeds from the sale will
> go to Vanderbilt Mortgage &amp; Finance Inc., a unit of Berkshire’s
> Clayton Homes Inc., which makes manufactured housing, according to
> documents obtained by Bloomberg News. Vanderbilt provides loans to
> buyers of homes sold by Clayton." (www.bloomberg.com/apps...;sid=a1fMG1a86yJk).
> So a mortgage lender borrowed money so that it could then lend it
> at higher rates. Shocking! I wonder if anybody's ever done anything
> like this before?
>
> "Buffett also recently announced that some of his company’s financial
> troubles pertain to the rising price of capital..."
>
> I defy you to cite a single instance of Buffett referring to BRK
> as having "financial troubles."
>
> "The outcome of Buffett’s $5 billion investment in Goldman Sachs'
> (seekingalpha.com/symbo...) is yet to be seen. At first glance,
> it appeared to be a bad decision, as Goldman dropped to $52 a share,
> deeming the ability to strike at $115 useless... The warrants do
> not expire until 2013, so there is still ample time to allow Goldman
> Sachs' to rise even further in price. The 10% dividend on these preferred
> shares is a bonus that could help Berkshire solidify these shares
> in the future."
>
> Again, you show a complete lack of understanding. This investment
> was in preferred equity, which boosted GS' capitalization ratios
> while paying BRK a hefty 10% dividend. BRK's investment didn't decline
> in value with the common, because the BRK shares are not traded,
> and are only redeemable for a 10% premium. Because the preferred
> investment also cannot appreciate with the common, the warrants are
> included to provide sharing in the potential upside.
>
> "His current objective is to secure capital at a competitive rate
> compared to those who are receiving aid from our government."
>
> Again, says what source? BRK will, AS ALWAYS, raise capital when
> it has a suitable investment opportunity that for which debt financing
> makes sense.
>
> The writer should be ashamed to have published such an "analysis."

Apr 07 10:16 PM

[Bullish Ban...:]

Thanks a lot for the constructive criticism everyone.

May 25 07:18 PM