This morning Berkshire Hathaway issued a press release announcing an open-ended share repurchase program. This is a bold statement by the world’s savviest investor, Warren Buffett, who is saying a number of important things, not only to Berkshire shareholders, but to investors in general. Overall, it makes us even more bullish on the stock and, though it was already our largest position, we added to it this morning as we think this effectively puts a floor on the stock price slightly above the current level, while the upside remains large.
Interestingly, this is only the second time that Buffett has offered to buy back stock. The first was in his 1999 Letter to Berkshire Hathaway Shareholders (pages 16-17), which was released on Saturday, March 11, 2000 (not coincidentally, the very moment that the Nasdaq peaked). At the time, the stock was at $41,300, but it popped 8% on the following Monday and continued rising all week, closing the following Friday at $51,300, up 24.2%, so Buffett didn’t end up buying back any stock. This chart shows how the stock performed in the subsequent year, rising 72% vs. an 11% decline in the S&P 500:
We wouldn’t be surprised to see similar outperformance over the coming year.
Turning to today's press release, here's the full text:
Berkshire Hathaway Authorizes Repurchase Program
Omaha, NE (NYSE: BRK.A; BRK.B)—Our Board of Directors has authorized Berkshire Hathaway to repurchase Class A and Class B shares of Berkshire at prices no higher than a 10% premium over the then-current book value of the shares. In the opinion of our Board and management, the underlying businesses of Berkshire are worth considerably more than this amount, though any such estimate is necessarily imprecise. If we are correct in our opinion, repurchases will enhance the per-share intrinsic value of Berkshire shares, benefiting shareholders who retain their interest.
Berkshire plans to use cash on hand to fund repurchases, and repurchases will not be made if they would reduce Berkshire’s consolidated cash equivalent holdings below $20 billion. Financial strength and redundant liquidity will always be of paramount importance at Berkshire. Berkshire may repurchase shares in open market purchases or through privately negotiated transactions, at management’s discretion. The repurchase program is expected to continue indefinitely and the amount of purchases will depend entirely upon the levels of cash available, the attractiveness of investment and business opportunities either at hand or on the horizon, and the degree of discount from management’s estimate of intrinsic value. The repurchase program does not obligate Berkshire to repurchase any dollar amount or number of Class A or Class B shares.
Buffett undoubtedly wrote this press release and, as all long-time Buffett-watchers know, he careful chooses every word so let’s closely examine what he wrote and what it means.
Most importantly, Buffett is saying that the stock is deeply undervalued. He wouldn’t be buying it back at a 10% premium to book value if he thought its intrinsic value was, say, 20% or even 30% above book. How undervalued? Well, the press release says: “the underlying businesses of Berkshire are worth considerably more than” a 10% premium to book value. The word “considerably” is critical because it’s unnecessary – it’s Buffett’s way of saying the stock isn’t just cheap, but is screaming cheap. We peg intrinsic value at close to $170,000 ($113/B share) – as we outline in our slide deck here – and we think that the announcement today indicates that Buffett thinks it’s in this range as well.
So up to what price is Buffett willing to buy? (Note that of course it’s actually Berkshire that’s buying back the stock, not Buffett himself, but he is setting the policy and is the largest shareholder, with a 23% economic ownership, so it’s effectively him.) The press release says a 10% premium to “then-current book value.” The latest filing is the end of Q2 (June 30), when Berkshire’s book value was $98,716 ($65.81/B share). But this isn’t the current value, so one needs to consider what book value has done since then. There are a lot of moving pieces, but the main factors are that the stock portfolio and index puts have moved against Berkshire a bit, but the company has earned nearly three months of profits, so net net we’d guess that book value today has declined slightly to perhaps $97,000 ($64.67/B share). Thus, a 10% premium means that Buffett is willing to buy back stock up to $106,700 ($71.13/B share), less than 2% below today’s closing price of $108,449 ($72.09/B share).
In other words, you can buy the stock at almost the same price that the world’s greatest investor is willing to pay – quite an opportunity we think.
We also believe that the share repurchase program likely puts a floor on the stock for a number of reasons. First, unlike most share repurchase announcements, there’s no dollar or time limit – Berkshire is free to repurchase as much stock as Buffett wishes, for as long as he wishes, as long as the price is below 110% of book value. Second, as we discuss below, Buffett likely wants to buy back a lot of stock. Finally, Berkshire has enormous liquidity to do so. According to Berkshire’s Q2 10-Q (posted here), the company has $43.2 billion of cash (excluding railroads, utilities, energy, finance and financial products), plus another $34.8 billion in bonds (nearly all of which are short-term, cash equivalents), which totals $77 billion. In the press release, Buffett notes that “repurchases will not be made if they would reduce Berkshire’s consolidated cash equivalent holdings below $20 billion,” so that means Berkshire has $57 billion, equal to one-third of the company’s current market capitalization, that it can deploy immediately in investments or share repurchases. On top of this, the company generated more than $6.5 billion in free cash flow in the first half of the 2011 – that’s right, more than $1 billion/month is pouring into Omaha.
Why is Buffett buying back his stock and, in particular, why now? To answer these questions, let's look again at his 1999 Letter to Berkshire Hathaway Shareholders , in which he wrote:
There is only one combination of facts that makes it advisable for a company to repurchase its shares: First, the company has available funds — cash plus sensible borrowing capacity — beyond the near-term needs of the business and, second, finds its stock selling in the market below its intrinsic value, conservatively-calculated.
…You should be aware that, at certain times in the past, I have erred in not making repurchases. My appraisal of Berkshire’s value was then too conservative or I was too enthused about some alternative use of funds. We have therefore missed some opportunities — though Berkshire’s trading volume at these points was too light for us to have done much buying, which means that the gain in our per-share value would have been minimal. (A repurchase of, say, 2% of a company’s shares at a 25% discount from per-share intrinsic value produces only a ½% gain in that value at most — and even less if the funds could alternatively have been deployed in value-building moves.)
Some of the letters we’ve received clearly imply that the writer is unconcerned about intrinsic value considerations but instead wants us to trumpet an intention to repurchase so that the stock will rise (or quit going down). If the writer wants to sell tomorrow, his thinking makes sense — for him! — but if he intends to hold, he should instead hope the stock falls and trades in enough volume for us to buy a lot of it. That’s the only way a repurchase program can have any real benefit for a continuing shareholder.
We will not repurchase shares unless we believe Berkshire stock is selling well below intrinsic value, conservatively calculated. Nor will we attempt to talk the stock up or down. (Neither publicly or privately have I ever told anyone to buy or sell Berkshire shares.) Instead we will give all shareholders — and potential shareholders — the same valuation-related information we would wish to have if our positions were reversed.
…Please be clear about one point: We will never make purchases with the intention of stemming a decline in Berkshire’s price. Rather we will make them if and when we believe that they represent an attractive use of the Company’s money. At best, repurchases are likely to have only a very minor effect on the future rate of gain in our stock’s intrinsic value.
So Buffett is clearly not trying to prop up the stock – rather, he believes that at a price below 110% of book value, buying it today is “an attractive use of the Company’s money.” He is also implicitly saying that he wants to buy back a lot of stock – otherwise it would only have “a very minor effect on the future rate of gain in our stock’s intrinsic value.”
But in being willing to allocate capital to share repurchases, is Buffett also running up the white flag, admitting that he can’t find better things to do with Berkshire’s money? He admits in his 1999 letter that when the stock was cheap in the past, he didn’t buy it because he “was too enthused about some alternative use of funds.” So why is he willing to buy it now?
The answer is, in part, that Berkshire has become so large that only very large investments – say, $5 billion and up – can move the needle, which means the investment universe is smaller, making it harder for Buffett to find exceptional bargains. But the bigger reason is that Berkshire is drowning in so much cash and free cash flow that Buffett doesn’t have to choose: he can buy back billions – even tens of billions – of his stock and also have plenty of dry powder to do what he prefers: make large investments. In other words, he can have his cake and eat it too.
To understand why, consider Berkshire’s largest acquisition ever, by far: the acquisition of Burlington Northern, which cost $26.5 billion for the 77.4% that Berkshire didn’t own, of which $15.9 billion was cash and the balance was Berkshire stock. Today, Berkshire could buy three Burlington Northerns (at $15.9 billion each) and still have more than $10 billion left over to buy back stock while retaining $20 billion in cash on the balance sheet. It’s simply remarkable…
We interpret today’s announcement as not only a bullish statement by Buffett regarding Berkshire’s stock, but also about the markets in general because Buffett wouldn’t even consider buying back his stock if he thought there was even, say, a 20% chance that the world – and major stocks markets – were going to go off a cliff, as they did in late 2008 and early 2009. At that time, he was able to invest more than $50 billion at distressed prices, which Buffett much prefers to buying back his own stock, so Buffett is clearly saying that he thinks we’ll muddle through and that a major market correction is quite unlikely.
Disclosure: We bought more BRK today (and it was already our largest position).