Inevitably investors will look at the individual Berkshire pieces to a greater degree when Warren Buffett and Charlie Munger are gone.
There have been some major developments (including the Heinz deal) since my January 15th Berkshire article. Having recently returned from the latest shareholder meeting, it is time for me to make a new intrinsic value pie chart.
1. 2013 Q1 10-Q
2. 2012 Annual Report (includes letter to shareholders)
This intrinsic value pie and its slices are rough approximations ($ in billions).
(click to enlarge)
Intrinsic Value Summary
Add: Operating Businesses: 176.5b
Add: *Investments: 132.3b (changes to prevent negative slices)
Add: *Excess Cash: 34b (changes to prevent negative slices)
Add: *Interest Free Loan: 10b (changes to prevent negative slices)
Less: Holding Company Debt: 13.4b
Less: Derivative Contract Liabilities: 6.7b
Less: Float Liability: 24.3b
Equals: Intrinsic Value: Around 308b
Pie charts can't have negative slices so we'll start by deciding what slices need to take a hit because of liabilities.
Holding Company Debt
Per the 2013 Q1 10-Q, there is 13.4b in debt under Insurance and other (it was 13.5b in Dec 31, 2012).
We know from past filings that the company issued 8b aggregate par amount of senior unsecured notes in connection with the BNSF acquisition in 2010.
BNSF does not become less valuable because the company used notes to help pay for it. We'll take this 13.4b out of the cash piece of the pie.
Derivative Contract Liabilities
The company has 6.7b in derivative contract liabilities. 6.2b is from Equity index put options and 445m is from Credit default. This lowers the value of our investment portfolio so we'll take it out of a slice on the investment side.
Some critics say Buffett has no right to complain about dangerous derivative contracts because of his equity index put options. That's like telling a person with a parking ticket that he can't complain about dangerous murderers because both parties are lawbreakers.
Per the 2013 Q1 10-Q, float approximated 73b. Here is what the 2012 annual report says about float:
So how does our attractive float affect the calculations of intrinsic value? When Berkshire's book value is calculated, the full amount of our float is deducted as a liability, just as if we had to pay it out tomorrow and were unable to replenish it. But that's an incorrect way to look at float, which should instead be viewed as a revolving fund. If float is both costless and long-enduring, which I believe Berkshire's will be, the true value of this liability is dramatically less than the accounting liability.
A partial offset to this overstated liability is $15.5 billion of "goodwill" that is attributable to our insurance companies and included in book value as an asset.
We know when it comes to intrinsic value, this liability should be dramatically less than 73b but more than 15.5b. We'll go with 1/3rd of 73b or 24.3b. This will come out of the cash piece and the interest free loan piece.
Operating Businesses Slices
14.9b Other Businesses
*Investment subtotal is 132.3b originally but 125.6b after absorbing negative slices.
*Made up of 82.1b equities + 30.4b fixed maturities + 19.8b hybrid.
*Fixed Maturities was lowered due to 12.12b Heinz & 6.7b Derivative Liabilities.
*Hybrid lowered due to backing out Wrigley's Equity into a separate slice.
15b Wells Fargo (WFC)
14.5b Coca-Cola (KO)
13b IBM (IBM)
8.7b American Express (AXP)
12b Todd & Ted
18.9b Other Stock
12.1b Heinz (HNZ)
11.6b Fixed Maturities
2.1b Wrigley's Preferred
17.7b Other "Hybrid" Investments
*Investment subtotal is 34b originally but 6.3b after absorbing negative slices.
*Cash lowered due to 13.4 holding company debt and 14.3 remaining of the float liability (10b float liability already taken out of 10b deferred tax liability loan).
Having a market cap of around 70b, Union Pacific (UNP) is a reasonable comp per the Christopher Owens Berkshire article. Still, UNP had net income that was 10% higher than BNSF in 2011. We'll be conservative and value BNSF at 90% of UNP for a total of 63b.
There was a slide in the latest shareholder's meeting showing how BNSF is outperforming competitors. Specifically, its gain in car loadings for the first part of 2013 compared to the first part of 2012 was 3.8%. The gain for competitors was just .04%.
After backing out Corporate interest, MidAmerican had first quarter earnings of 553b in 2013 compared to 483b in 2012. Berkshire holds an 89.8% ownership interest in this company. The net earnings attributed to Berkshire after income taxes and noncontrolling interests were 394b and 338b for 2013 Q1 and 2012 Q1 respectfully. PacifiCorp and MEC are the domestic interests.
We'll be conservative and keep this slice at the 20b amount mentioned in the Christopher Owens article.
We'll soon have a more accurate idea about the size of this slice based on the price Berkshire pays for the last 10%. Here is what the 2013 Q1 10-Q says about it:
We have owned a controlling interest in Marmon Holdings, Inc. ("Marmon") since 2008 and currently own about 90% of the outstanding common stock. We are contractually required to acquire substantially all of the remaining noncontrolling interests of Marmon no later than March 31, 2014, for an amount that will be based on Marmon's 2013 operating results.
Here is what Buffett says about Marmon in the 2012 letter to shareholders:
The cost of our recent 10% purchase implies a $12.6 billion value for the 90% of Marmon we now own. Our balance-sheet carrying value for the 90%, however, is $8 billion. Charlie and I believe our current purchase represents excellent value. If we are correct, our Marmon holding is worth at least $4.6 billion more than its carrying value.
The size of this slice was too small in my last Berkshire article. It is now a 10b slice based on the amount Berkshire paid in order to buy the last 20% of the company. The WSJ talks about this transaction:
Warren Buffett's Berkshire Hathaway Inc. agreed to pay $2.05 billion to purchase the remaining piece of an Israeli metalworking company that it had acquired a stake in seven years ago.
Berkshire is buying the remaining 20% stake in IMC International Metalworking Cos., called Iscar, from the Wertheimer family, the founders of the company. They had sold the first 80% to Berkshire for $4 billion in 2006, meaning the company doubled in value since the initial transaction.
This is the value in the Christopher Owens Berkshire article and it still seems reasonable.
The author arbitrarily assigns a multiple of 8x pretax earnings. Per the latest 10-Q, McLane earned 132m pretax in Q1 2013. 132*4*8 = 4.2b.
14.9b Other Businesses
The author arbitrarily assigns a multiple of 10x pretax earnings. Per the latest 10-Q, Other businesses earned 1,091m pretax in Q1 2013. 1,091*4*8 = 34.9b. Note that this includes Lubrizol and Iscar so we need to back out 10b for each to get a total of 14.9b.
Per the Christopher Owens Berkshire article, Finance is worth about 6.8 billion.
35b Insurance Operations (non-Float)
Per GEICO Corporate Information, the company has over 11 million auto policyholders. Buffett said each new policyholder adds $1,500 of intrinsic value to the company. We'll value the existing GEICO policyholders at 16.5b.
General Re, BHRG and BH Primary also bring significant value to the company. People like Ajit Jain don't show up in book value.
Per the 2013 Q1 10-Q, we have 97.2b in equity securities, 31.4b in fixed maturities and 21.9b in hybrid securities. We also have unrealized gains of 46.2b, 2.9b and 6b respectfully.
Applying a 35% tax rate to these gains and deducting it, we have 82.1b in equity securities, 30.4b in fixed maturities and 19.8b in hybrid securities for our pie pieces. The details for these slices are broken down below.
82.1b in equity securities after deducting 35% of 46.2b.
19.8b in hybrid securities after deducting 35% of 6b.
12b Todd and Ted
18.9b Other Stocks
75,313,620,000 from the 13F minus the above is what we could do if we had the same closing date from the 13F and the 10-Q. However, the 13F is only through December 31, 2012 while the 10-Q goes through March 31, 2013. As such, we'll do 82.1b minus the above.
Here is what the 2013 Q1 10-Q says about the deal:
On February 13, 2013, Berkshire and an affiliate of the global investment firm 3G Capital ("3G"), through a newly formed holding company ("Holdco") entered into a definitive merger agreement to acquire H.J. Heinz Company ("Heinz"). Under the terms of the agreement, Heinz shareholders will receive $72.50 in cash for each outstanding share of common stock (approximately $23.25 billion in the aggregate.) Berkshire and 3G have committed to make equity investments in Holdco, which together with debt financing to be obtained by Holdco will be used to acquire Heinz. Berkshire's commitment is for the purchase of $4.12 billion of Holdco common stock and $8 billion of its preferred stock that will pay a 9% dividend. 3G has committed to purchase $4.12 billion of Holdco common stock. Berkshire and 3G will each possess a 50% voting interest in Holdco and following the acquisition, a 50% voting interest in Heinz. The acquisition was approved by the shareholders of Heinz on April 30, 2013.
Note that this investment is not yet on the balance sheet. As such, we'll need to deduct this amount from another investment slice.
11.6b Fixed Maturities
As we said before, the 2013 Q1 10-Q shows 31.4b for fixed maturities. It drops to 30.4b after deducting 35% of 2.9b gains.
We also said we'd find a slice on the investment side to absorb the 6.7b derivative liability and the 12.1b Heinz investment. This is the chosen investment slice so we're showing it in the pie as an 11.6b b piece instead of 31.4b piece as it appears in the 10-Q.
2.1b Wrigley's Equity
The New York Times said Mars bought Wrigley's for about 23b in 2008 at a time when Wrigley's had 5.4b in sales. In connection, Berkshire bought 2.1b of equity:
In a statement, Wrigley said Monday that Berkshire Hathaway would buy a stake worth $2.1 billion or about 10 percent.
Here is what the 2008 Q1 10-Q says about it:
On April 28, 2008, The Wm. Wrigley Jr. Company ("Wrigley") and Mars, Incorporated ("Mars") announced a merger agreement in which Wrigley would become a subsidiary of Mars. In connection with this merger, Berkshire has committed to provide $6.5 billion in funding to Mars in the form of $4.4 billion of subordinated debt and $2.1 billion for a minority equity interest in Wrigley. The agreement between Mars and Wrigley is subject to customary closing conditions and those companies believe the transaction will be completed within the next six to twelve months.
Here is what the latest 10-Q says about Wrigley's:
In 2008, we acquired $4.4 billion par amount of 11.45% Wrigley subordinated notes due in 2018 and $2.1 billion of 5% Wrigley preferred stock. The subordinated notes may be called prior to maturity at par plus the prepayment premium applicable at that time. In 2009, we also acquired $1.0 billion par amount of Wrigley senior notes due in December 2013 and 2014. We currently own $800 million and an unconsolidated joint venture in which we hold a 50% economic interest owns $200 million of the Wrigley senior notes. The Wrigley subordinated and senior notes are classified as held-to-maturity and we carry these investments at cost, adjusted for foreign currency exchange rate changes that apply to certain of the senior notes. The Wrigley preferred stock is classified as available-for-sale and recorded in our financial statements at fair value.
We're making this separate slice for Wrigley's Equity but the 4.4b subordinated debt is part of the larger hybrid slice. Wrigley's Equity slice is probably now worth a different amount than the 2.1b paid in 2008 but we'll leave it at 2.1b as there is mixed data. For example, the
Wall Street Journal said gum sales grew until mid-2010 and then declined:
After at least seven years of growth, gum sales began declining in mid-2010. U.S. gum sales in 2011 were down 2.7% to $3.5 billion.
17.7b Other "Hybrid" Investments
This is what the 2013 Q1 10-Q says about other investments:
Other investments include fixed maturity and equity securities of The Goldman Sachs Group, Inc. ("GS"), General Electric Company ("GE"), Wm. Wrigley Jr. Company ("Wrigley"), The Dow Chemical Company ("Dow") and Bank of America Corporation ("BAC").
The 10-Q shows this as 21.9b but it drops to 19.8b in hybrid securities after deducting 35% of 6b gains. We backed out the 2.1b Wrigley's Equity into its own piece so this hybrid slice is now 17.7b instead of 19.8b.
0 Interest Free Loan or Deferred Tax Liability
The 49.6b deferred tax liability has to be fully accounted for when we look at book value.
In the Wesco 1999 Annual Report, Charlie Munger talked about tax liabilities and intrinsic value:
However, some day, perhaps soon, major parts of the interest-free "loan" must be paid as assets are sold. Therefore, Wesco's shareholders have no perpetual advantage creating value for them of $99 per Wesco share. Instead, the present value of Wesco's shareholders' advantage must logically be much lower than $99 per Wesco share. In the writer's judgment, the value of Wesco's advantage from its temporary, interest-free "loan" was probably about $20 per Wesco share at yearend 1999.
In this case he's taking about 20% and adding it back in. We'll do the same type of thing here and add 10b back into intrinsic value from the 49.6b deferred income tax liability.
As we said earlier, this slice is gone because it absorbs 10b of the 24.5b float liability.
Here is how Christopher Owens calculated cash and equivalents in his December article:
As of their latest 10-Q, Berkshire held cash and cash equivalents of $47.8 billion. $41.8 billion of this was held at insurance subsidiaries. $4.2 billion was held in the railroads and utilities segment, much of which will be swept as a dividend to the holding company at year end. The author estimates free cash flow approximates $13 billion in 2012, implying year-end cash balances of $51 billion.
Using newer numbers, we have 44b in cash under Insurance and Other per the Q1 2013 balance sheet. It also shows 3b under Railroad, Utilities and Energy. We'll stay with the 13b cash flow estimate giving us a total of 44 minus 3 plus 13 or 54b. If the company continues to keep about 20b on hand then that leaves about 34b for shareholders.
We've talked about the fact that our pie cannot have negative slices. As such, the cash slice will not be 34b - it will prevent negative slices instead.
We're taking out 13.4b because of holding company debt and 14.3b because of the remaining float liability (it was 24.3b originally but we took 10b out with the interest free loan slice). These come to 27.7b so the cash slice is a fraction of its original value.
Book value is 202.1b and it is a significantly understated proxy for intrinsic value ($ in billions).
The data for this book value pie chart comes from the 2013 Q1 balance sheet numbers below.
292,010m Insurance and Other
124,821m Railroad, Utilities and Energy
25,471m Finance and Financial Products
120,387m Insurance and Other
49,461m Railroad, Utilities and Energy
20,749m Finance and Financial Products
49,599m Income taxes, principally deferred
Net Assets without Income taxes, principally deferred
171,623m Insurance and Other
75,360m Railroad, Utilities and Energy
4,722m Finance and Financial Products
Net Assets with weighted Income taxes, principally deferred
137,804m Insurance and Other
60,510m Railroad, Utilities and Energy
3,792m Finance and Financial Products
Book Value vs Intrinsic Value
Buffett wouldn't give himself the option to repurchase shares at up to 1.2 times book if the intrinsic value was only 1.3 times book. Remember, he's weighing this against a big universe of investment opportunities so the difference must be dramatic. I'm thinking intrinsic value is about 1.5 times book. Book value is just over 200b and I think intrinsic value is just over 300b.
Where does book value come up short of intrinsic value?
48.7b float (2/3rds of 73b)
10b Tax Deferred Liability (taking about 20%)
Looking at UNP gives us an idea about BNSF. The latest UNP 10-Q for the period ending March 31, 2013 shows 20.144b in book value. As of May 9, 2013, UNP had a market cap of over 70b. In the short run market cap can be all over the place with respect to intrinsic value but in the long run they are close. The point is that BNSF has an intrinsic value that is much higher than its book value.
Other Operating Businesses.
GEICO is another ($1,500 per policy).
Other Insurance Companies.
This intrinsic value pie chart at the top of this article is a work in progress.
These are all rough approximations. For example, adding back in 2/3rds of the float liability might be wrong, Maybe it should be 1/2 and when we're talking about fractions of a 73b number they make a huge difference.
Additional disclosure: Any material in this article should not be relied on as a formal investment recommendation.