Berskshire Hathaway and 3G buying Heinz

[EagertoLearnMore]

So Heinz will become a private company with this deal? Who will benefit the most? According to the news, the stockholders are being paid approximately 20% over yesterday's close.

[NYBoglehead]

If existing shareholders are getting a 20% premium on their shares it seems like they are getting a pretty good deal.

[hlfo718]

If you invest in the Total Stock Market Index you will benefit since you got 20% premium on Heinz and if Berkshire can juice up Heinz after, you will benefit again.

[NYBoglehead]

If you invest in the Total Stock Market Index you will benefit since you got 20% premium on Heinz and if Berkshire can juice up Heinz after, you will benefit again.

Per CNBC's website, Vanguard owns 14.7 million shares of Heinz in total, worth about $1.06 billion @ $72/share. I don't think there will be much of a noticeable impact though on the NAVs of Vanguard Funds as a result of this.

[nisiprius]

(Shrug) I don't care. If I tinkered with individual stocks I still wouldn't care, because I don't know anything about Heinz that everyone else doesn't know, and I have no channels that would have allowed me to learn OR INTUIT anything before everyone else already knew it.

I feel that even BRK itself is still an individual stock--not even a mutual fund--but if I really believed in the idea of profiting from Buffett's knowledge/insight/magic/luck, I'd do it by buying BRK and thus, buying whatever Buffett buys at the time Buffett is buying, and owning everything Berkshire Hathaway owns instead of just selective dribs and drabs. I don't think trying to benefit by copying his moves... learned at third hand... after a time delay... is going to help me, any more than I believe I can improve my bicycling by copying what I've read at third hand that Lance Armstrong does Certainly, I'm not going to try to out-Buffett Buffett by selectively copying only his good moves.

So, Total Stock for me, and let me share in oh point oh oh whatever percentage of whatever happens to Heinz stock and/or BRK.

At least Heinz does something real, or at least I think they do. If it turns out that Heinz makes 1% of its revenues from fifty-seven varieties of ketchup and pickles, and 99% from leveraged arbitrage of rough rice futures derivatives, I don't want to know about it. Please please let me go on believing that Heinz actually earns money by manufacturing food products and selling them to happy consumers.

[fareastwarriors]

Hmm ketchup.
Maybe I should eat a burger and some fries for lunch.

[MnD]

A mundane maker of products (ketchup, Ore-Ida, frozen lunches) that the "trendy" sneer at, but just keep making more money and increasing dividends.

http://finance.yahoo.com/blogs/the-exch ... 34688.html
What it is more than anything is illustrative of a bigger story, the one that reminds the regular investor in us of how much good there can be in so many companies that aren't in the daily headlines. They're in your pantry and in your washroom instead. These are names that over time been fine for anyone who can stand to admit they own bleach and tissue paper.

No, you're probably not getting in a heated debate with your neighbor about cash flows at Kimberly-Clark (KMB) or Clorox (CLX) or some other stock that might keep setting new all-time highs and lifting its dividend. This approach may take some patience, and that's extremely difficult when you've got a crummy peanut butter maker down 3% for the year -- they don't go up every day -- and the guy next door owns a biotech that's gained 88%.

You get the idea. In the past, we've covered some of these stocks, like Smucker (SJM) and Hormel (HRL), both of which are up more than 350% since August 2000. Kellogg (K) has appreciated 154%. During that span, the S&P 500 has carved a flat line.

[huntertheory]

I feel that even BRK itself is still an individual stock--not even a mutual fund--but if I really believed in the idea of profiting from Buffett's knowledge/insight/magic/luck, I'd do it by buying BRK and thus, buying whatever Buffett buys at the time Buffett is buying, and owning everything Berkshire Hathaway owns instead of just selective dribs and drabs.

What's interesting is that arguably this Heinz buyout is an example of why evening owning Berkshire as an individual stock isn't always what meets the eye. You might buy it to get Buffett's wisdom, but, based on the disclosure this morning and Buffett's explanation, he's not even going to be managing Heinz or overseeing it.

Based on what came out, Berkshire and the private equity shop 3G (the Brazilians behind InBev/Anheuser-Busch) are each putting in 50% of the common stock equity (around $4.5 billion each) but 3G will oversee day-to-day control. Berkshire is then putting in another $8 billion in the form of preferred stock -- effectively financing for the deal -- where he'll get an interest rate but apparently no voting. (It could have some other protections like a liquidation preference and maybe the ability to convert to common stock -- we don't know.)

My main points are (a) even when the deal seems simple, owning Berkshire doesn't mean you get Buffett's managerial acumen over the businesses, as for Berkshire this seems fundamentally to be a financing transaction with equity upside and (b) those who use Buffett as an example of a stock picker (either to build him up or to knock him down) just don't get how unique his deals are. And I guess my third point is if you're in Total Stock Market, you're not missing out on anything.

[huntertheory]

A mundane maker of products (ketchup, Ore-Ida, frozen lunches) that the "trendy" sneer at, but just keep making more money and increasing dividends.

http://finance.yahoo.com/blogs/the-exch ... 34688.html
What it is more than anything is illustrative of a bigger story, the one that reminds the regular investor in us of how much good there can be in so many companies that aren't in the daily headlines. They're in your pantry and in your washroom instead. These are names that over time been fine for anyone who can stand to admit they own bleach and tissue paper.

No, you're probably not getting in a heated debate with your neighbor about cash flows at Kimberly-Clark (KMB) or Clorox (CLX) or some other stock that might keep setting new all-time highs and lifting its dividend. This approach may take some patience, and that's extremely difficult when you've got a crummy peanut butter maker down 3% for the year -- they don't go up every day -- and the guy next door owns a biotech that's gained 88%.

You get the idea. In the past, we've covered some of these stocks, like Smucker (SJM) and Hormel (HRL), both of which are up more than 350% since August 2000. Kellogg (K) has appreciated 154%. During that span, the S&P 500 has carved a flat line.

I don't disagree with everything in it, but this is a very naive article.

[tetractys]

My first thought on seeing the headline was, "this is classic Buffett". -- Tet

[NYBoglehead]

^I think the main point of the post was to illustrate that while stocks like Heinz, Kimberly-Clark, and Clorox are not sexy and won't get too many people excited, they have proven to be far better investments than have the "sexy, exciting" names like Facebook. Probably because they cause produce something that people want/need, whereas Facebook gets its revenues primarily as a result of people mindlessly wasting their time.

[tetractys]

^ Precisely. But nevertheless as others have commented, no call for action. -- Tet

[huntertheory]

The other interesting angle of this is that when the head of 3G Capital, Jorge Paulo Lemann, announced another major U.S. acquisition -- the proposed acquisition of Anheuser-Busch by InBev -- the uproar was huge about foreign ownership of an iconic U.S. brand, to the point where, even though the transaction went through, they even wrote a book about it ("Dethroning the King," it was just OK).

Now, however, Lemann has teamed up with Buffett, who everyone fawns over, and the headline is "Buffett Buys Heinz," even though it will be Lemann and the Brazilians who conduct day-to-day control over the company. Not really a Boglehead-ish point, but just saying that the headlines aren't always what they are made out to be.

[NYBoglehead]

The other interesting angle of this is that when the head of 3G Capital, Jorge Paulo Lemann, announced another major U.S. acquisition -- the proposed acquisition of Anheuser-Busch by InBev -- the uproar was huge about foreign ownership of an iconic U.S. brand, to the point where, even though the transaction went through, they even wrote a book about it ("Dethroning the King," it was just OK).

Now, however, Lemann has teamed up with Buffett, who everyone fawns over, and the headline is "Buffett Buys Heinz," even though it will be Lemann and the Brazilians who conduct day-to-day control over the company. Not really a Boglehead-ish point, but just saying that the headlines aren't always what they are made out to be.

Excellent point. I've got nothing against Warren Buffett, but the media will never say anything that isn't glowingly positive about the guy. If he were to get a speeding ticket tomorrow, they'd say that the fine that he had to pay helps to finance after-school programs so obviously he did it on purpose.

[avmax8]

I feel that even BRK itself is still an individual stock--not even a mutual fund--but if I really believed in the idea of profiting from Buffett's knowledge/insight/magic/luck, I'd do it by buying BRK and thus, buying whatever Buffett buys at the time Buffett is buying, and owning everything Berkshire Hathaway owns instead of just selective dribs and drabs.

What's interesting is that arguably this Heinz buyout is an example of why evening owning Berkshire as an individual stock isn't always what meets the eye. You might buy it to get Buffett's wisdom, but, based on the disclosure this morning and Buffett's explanation, he's not even going to be managing Heinz or overseeing it.

Based on what came out, Berkshire and the private equity shop 3G (the Brazilians behind InBev/Anheuser-Busch) are each putting in 50% of the common stock equity (around $4.5 billion each) but 3G will oversee day-to-day control. Berkshire is then putting in another $8 billion in the form of preferred stock -- effectively financing for the deal -- where he'll get an interest rate but apparently no voting. (It could have some other protections like a liquidation preference and maybe the ability to convert to common stock -- we don't know.)

My main points are (a) even when the deal seems simple, owning Berkshire doesn't mean you get Buffett's managerial acumen over the businesses, as for Berkshire this seems fundamentally to be a financing transaction with equity upside and (b) those who use Buffett as an example of a stock picker (either to build him up or to knock him down) just don't get how unique his deals are. And I guess my third point is if you're in Total Stock Market, you're not missing out on anything.

I actually don't think this is too unusual for Buffett. BRKs most recent acquisitions and and investments oftentimes are done with the understanding (if not requirement) that the existing company leadership stay in place. I can't think of any recent purchases where Buffett himself has stepped in to have a management role.

[Mikejenny]

Berkshire already has a lot of Coke shares. Heinz seems to be the same type of company. Has a product that is going to be bought and used in good and bad times.
Mike

[leonidas]

I have owned heinz since 2009 and I was pleasnatly surprised this morning to see a 12 dollar pop. My question is now what? Do I just sell my stock since there is a ceiling on the price or do I hold it untill until they take it from me collecting dividends since there is a floor on the price?

[cheesepep]

So sad. I was at a burger place yesterday and was eating some fried zucchini and saw a bottle of Heinz ketchup on the table. I remarked to myself how good of a company this is and lauded the design of the bottle. I proceeded to look at the stock price and saw that it was at a 52 week high. Then today, I see this and wow...

[asset_chaos]

As my core stock investment is global market index, I don't think this means much to me, except for whatever real cash the private equity company is putting in. I presume I partly own, through the index, both Heinz and Berkshire, and I presume I own none of the private equity company. So the purchase money is just leaving my Berkshire pocket and going into my Heinz pocket (again plus whatever real cash there is from private equity). I still have part ownership of Heinz's cash flow, through Berkshire, minus whatever goes back to the private equity company. The Buffett part of it makes no difference to me. It's only the minor---is it minor?---private equity part of the deal that may impact my future stock index returns depending on whether or not the private lump sum is a fair price for their share of Heinz's future cash flow.

[huntertheory]

I actually don't think this is too unusual for Buffett. BRKs most recent acquisitions and and investments oftentimes are done with the understanding (if not requirement) that the existing company leadership stay in place. I can't think of any recent purchases where Buffett himself has stepped in to have a management role.

I agree with you that he tends to leave management in place but what is qualitatively different here is -- depending how the structure is set up -- he doesn't actually have the power to make changes, control day-to-day, etc. Understood that *in practice* he usually doesn't meddle (though he clearly makes them send up free cash flow for him to reallocate), but it's different in this that he doesn't have that control. Presumably the joint venture will have some deadlock mechanisms but it's still a departure.

In any event, Buffett filed his equity commitment letter. He's investing $4.5 billion of common stock but almost twice that, $8 billion, in the form of preferred stock yielding 9%. Nice work if you can get it -- another reason why what Buffett does is just *different* than what we as individuals do.

[LadyGeek]

This thread is now in the Investing - Theory, News & General forum (news, general).

[nisiprius]

^I think the main point of the post was to illustrate that while stocks like Heinz, Kimberly-Clark, and Clorox are not sexy and won't get too many people excited, they have proven to be far better investments than have the "sexy, exciting" names like Facebook. Probably because they cause produce something that people want/need, whereas Facebook gets its revenues primarily as a result of people mindlessly wasting their time.

I don't think you can generalize. I don't know how you define "stocks like Heinz, Kimberly-Clark, and Clorox," unless you define them in a circular way as stocks that have done better than sexy, exciting stocks.

Where is the United States Leather Company, one of the original Dow companies, today? Where is GM, which does make products that people want and need? IBM has far underperformed the S&P 500. Do I even dare mention Eastman Kodak? Meanwhile, Amazon and Google, sexy companies of the high-tech mania days, have done just fine.

It's not as simple as saying the solid stocks of the great American blue chips will never let you down.

[NYBoglehead]

^I think the main point of the post was to illustrate that while stocks like Heinz, Kimberly-Clark, and Clorox are not sexy and won't get too many people excited, they have proven to be far better investments than have the "sexy, exciting" names like Facebook. Probably because they cause produce something that people want/need, whereas Facebook gets its revenues primarily as a result of people mindlessly wasting their time.

I don't think you can generalize. I don't know how you define "stocks like Heinz, Kimberly-Clark, and Clorox," unless you define them in a circular way as stocks that have done better than sexy, exciting stocks.

Where is the United States Leather Company, one of the original Dow companies, today? Where is GM, which does make products that people want and need? IBM has far underperformed the S&P 500. Do I even dare mention Eastman Kodak? Meanwhile, Amazon and Google, sexy companies of the high-tech mania days, have done just fine.

It's not as simple as saying the solid stocks of the great American blue chips will never let you down.

Amazon has basically replaced brick and mortar bookstores and provides an avenue to purchase a variety of goods. Google provides information in a nanosecond and can be used in hundreds of way to help people improve their businesses, academics, and provide the answers/references to just about anything you can think of. Facebook lets you look at your neighbor's vacation photos.

GM carried a business model that worked in the 1950s and assumed it could work forever. They failed to adapt to a global economy and their prohibitively high labor costs made them less competitive relative to their peers. Consumers voted with with their wallets enough that they were losing money. Eastman Kodak failed to get with the times in the digital age. I wasn't trying to suggest that all companies that "make things" will be fine forever.

[ArthurDent]

Based on what came out, Berkshire and the private equity shop 3G (the Brazilians behind InBev/Anheuser-Busch) are each putting in 50% of the common stock equity (around $4.5 billion each) but 3G will oversee day-to-day control. Berkshire is then putting in another $8 billion in the form of preferred stock -- effectively financing for the deal -- where he'll get an interest rate but apparently no voting. (It could have some other protections like a liquidation preference and maybe the ability to convert to common stock -- we don't know.)

The 8 Billion in preferreds has a 9% annual coupon with an option for Heinz to pay in kind, i.e., more preferreds rather than cash! On top of that, he gets 8B worth of warrants. If you think Heinz will continue to make ketchup under Brazilian management, Buffett's getting an amazing deal here!

[Jack]

If you invest in the Total Stock Market Index you will benefit since you got 20% premium on Heinz and if Berkshire can juice up Heinz after, you will benefit again.

Given that both Heinz and Berkshire are in the Total Stock Market, you are just shifting money from one pocket to the other. The premium paid to Heinz comes out of Berkshire (or half of it does). You own them both.

[ArthurDent]

If you invest in the Total Stock Market Index you will benefit since you got 20% premium on Heinz and if Berkshire can juice up Heinz after, you will benefit again.

Given that both Heinz and Berkshire are in the Total Stock Market, you are just shifting money from one pocket to the other. The premium paid to Heinz comes out of Berkshire (or half of it does). You own them both.

True regarding the premium, but not future returns - You used to own them both, now you own only half of Heinz since 3G is private. So now you only get half the upside in Heinz.

[SGM]

Dumb as I am, I was tempted and did buy Heinz in October, with no thought it would be bought out. I am close to retirement and have some dividend paying stocks in addition to broad index funds mostly with Vanguard. Now I will have to sell HNZ as a short term gain in my taxable account. I had no plans to sell it and expected to spend the dividends when I completely retire at least for a few years. Maybe I will get really lucky and will have a short term loss to offset the gain.

[avmax8]

Dumb as I am, I was tempted and did buy Heinz in October, with no thought it would be bought out. I am close to retirement and have some dividend paying stocks in addition to broad index funds mostly with Vanguard. Now I will have to sell HNZ as a short term gain in my taxable account. I had no plans to sell it and expected to spend the dividends when I completely retire at least for a few years. Maybe I will get really lucky and will have a short term loss to offset the gain.

Just so we're clear, you made an approx. 30% return on a 4 month investment. If that isn't lucky, I don't know what is!

[NYBoglehead]

Dumb as I am, I was tempted and did buy Heinz in October, with no thought it would be bought out. I am close to retirement and have some dividend paying stocks in addition to broad index funds mostly with Vanguard. Now I will have to sell HNZ as a short term gain in my taxable account. I had no plans to sell it and expected to spend the dividends when I completely retire at least for a few years. Maybe I will get really lucky and will have a short term loss to offset the gain.

While we try to do our best to limit our tax liabilities, we shouldn't get too upset by having investment gains! It's still a net positive for you, even if the S/T cap gains rate will take more of your return than you'd like.

[riverguy]

20% premium to the all time high stock price. What a deal! Smells similar to him buying COP at the top.

[dkturner]

If you invest in the Total Stock Market Index you will benefit since you got 20% premium on Heinz and if Berkshire can juice up Heinz after, you will benefit again.

Given that both Heinz and Berkshire are in the Total Stock Market, you are just shifting money from one pocket to the other. The premium paid to Heinz comes out of Berkshire (or half of it does). You own them both.

True regarding the premium, but not future returns - You used to own them both, now you own only half of Heinz since 3G is private. So now you only get half the upside in Heinz.

Probably closer to 74% of Heinz because BRK is also getting $8 Billion of 9% Heinz preferred stock in addition to its $4.5 Billion of Heinz common stock.

[Valuethinker]

The way to see this is Buffett has bought another high quality (low volatility) stock but done it with leverage.

Larry Swedroe has had a post on recent academic research on this. Low volatility stocks outperform high volatility ones. Add to that the leverage of the deal (those prefs + BH's leverage as an insurance company) and you can see this is classic Buffett.

BTW he is almost never a hands on manager of a business *unless* there is a problem. What he does is back good management teams in companies with strong market positions, but he retains iron control over their free cash flow-- no acquisitions or big investments without his say so. He's also a compensation guru- no one is compensated by performance of BH as a whole but by the performance of *their* business division. He rations capital as if it is his own money (which it is). In the jargon he significantly reduces the Principal-Agent problem in corporate governance.

His focus the last 10+ years has been on capital intensive acquisitions where he can deploy BH's prodigious cash flows and cash balances.

From the point of view of the management of Heinz this is the dream scenario, potentially. You have the discipline of ownership by the best capital allocators in the world, sitting alongside you on the Board, but you are allowed to get on with it without the disruptions of quarterly earnings reporting, the short termism of public markets. And you get experience and insight into Emerging Markets via the AmBev guy.

[Valuethinker]

20% premium to the all time high stock price. What a deal! Smells similar to him buying COP at the top.

BH is triple A rated and net cash. His weighted average cost of capital is extremely low. And almost anything he does that spends cash increases his return on capital (because he has so much cash around).

If only the preference shares pay out he gets 9% on a big chunk of his investment. And his cost of capital is probably around 5% (might be lower).

Think of Heinz as the consumer equivalent of a railway or an electric utility, other recent Buffett favourites-- fairly steady market is all but guaranteed.

[Valuethinker]

It's not as simple as saying the solid stocks of the great American blue chips will never let you down.

The exception, historically, has been Big Oil. Shell, BP, Exxon were in the indices in 1910, and are now (in various forms). Though BP was nationalized at one point. Ups and downs with the oil price but these are still huge companies (I don't think Exxon has cut a dividend since the 1930s).

Just before WW1 Winston Churchill initiated the move of the Royal Navy from coal fired steam to oil fired steam turbines. And that made oil the centre of world military-political-economic power. It still is. Oil is the Blood of Victory.

It made the Suez Canal and the Middle East, and in particular Iran-Iraq, the crux of the British Empire. Our involvement, to this day, in that part of the world stems from the continued importance of that technology shift. A coal driven empire you can fuel from Yorkshire and Australia and South Africa. An oil driven one?

The age of the hydrocarbon may yet end, but it is not yet. The Shield Maidens may have appeared, but they are not yet ready to carry the 7 Sisters and their children off the battlefield.

The technology of oil exploration and production has changed out of all recognition but, fundamentally, this is still a business where you stick a hole in the ground and hope crude oil comes shooting back out of it. Just as it was in the 1860s in Pennsylvania.

Or as an old bumper sticker would have it 'Conserve Dilithium' .

[nisiprius]

If you invest in the Total Stock Market Index you will benefit since you got 20% premium on Heinz and if Berkshire can juice up Heinz after, you will benefit again.

Given that both Heinz and Berkshire are in the Total Stock Market, you are just shifting money from one pocket to the other. The premium paid to Heinz comes out of Berkshire (or half of it does). You own them both.

And isn't that grand?

That's just what John C. Bogle is talking about when he says that when you hold the total market, the effect of speculators trading with each other cancels each other out.

You don't need to worry about being on the right side or the wrong side of a trade, you're on both sides of every trade. You just get the actual value created by stock-issuing businesses as a whole. You don't play in the zero-sum game part of the stock market, you just collect the results of the positive-sum part of the stock market.

[huntertheory]

The way to see this is Buffett has bought another high quality (low volatility) stock but done it with leverage.

Larry Swedroe has had a post on recent academic research on this. Low volatility stocks outperform high volatility ones. Add to that the leverage of the deal (those prefs + BH's leverage as an insurance company) and you can see this is classic Buffett.

BTW he is almost never a hands on manager of a business *unless* there is a problem. What he does is back good management teams in companies with strong market positions, but he retains iron control over their free cash flow-- no acquisitions or big investments without his say so. He's also a compensation guru- no one is compensated by performance of BH as a whole but by the performance of *their* business division. He rations capital as if it is his own money (which it is). In the jargon he significantly reduces the Principal-Agent problem in corporate governance.

His focus the last 10+ years has been on capital intensive acquisitions where he can deploy BH's prodigious cash flows and cash balances.

From the point of view of the management of Heinz this is the dream scenario, potentially. You have the discipline of ownership by the best capital allocators in the world, sitting alongside you on the Board, but you are allowed to get on with it without the disruptions of quarterly earnings reporting, the short termism of public markets. And you get experience and insight into Emerging Markets via the AmBev guy.

I disagree that this is "the way to see this." That academic study about Buffett was seriously misleading -- I don't disagree with its conclusions about low volatility stocks per se, but it has very little to do with Buffett the actual investor; instead it used a kind of Robo-Buffett that the academics created for purposes of their study. For Berkshire, as I said, this is fundamentally a financing transaction -- making 9% on the preferred/mezzanine financing, which constitutes 2/3 of his cash investment -- with equity upside (warrants and his common investment). I also am not convinced that this is a "dream scenario" if you're Heinz management. When Buffett was asked if the Heinz CEO will still be around, he said "3G will make that decision, as they handle management." 3G goes into companies and *manages* them; we already saw the Behrling guy answering questions and running the press conference the other day.

Look at what the 3G guys did at Burger King, which Buffett referenced as really impressing him, or even Annheuser-Busch. They take over an asset and, even if they leave some senior management in place, they are extremely hands on with management. Buffett repeatedly referenced 3G's "management acumen" as part of his rationale, and again he's really coming in as a financing party with a big equity kicker. Fitting this transaction into the mental model of "here's Buffett again buying a low beta stock!" is just falling into the same trap as that academic study. This is just a unique deal -- and Buffett does a lot of unique deals. This one is fundamentally 3G's deal; Buffett is there, as he is so often, to provide financing on terms favorable to him and to take some of the equity upside

When Berkshire wants to just buy a company, they just buy them, like Burlington Northern. This is something very different. And I wouldn't be shocked to see some turnover with the Heinz management.

I don't think any of this has anything to do with Bogleheadism -- which I agree with nisi, is the way to go so you don't have to get into these weeds -- but if we're going to talk about Buffett or this deal it's worth at least getting it right.

[Jack]

If you invest in the Total Stock Market Index you will benefit since you got 20% premium on Heinz and if Berkshire can juice up Heinz after, you will benefit again.

Given that both Heinz and Berkshire are in the Total Stock Market, you are just shifting money from one pocket to the other. The premium paid to Heinz comes out of Berkshire (or half of it does). You own them both.

And isn't that grand?

That's just what John C. Bogle is talking about when he says that when you hold the total market, the effect of speculators trading with each other cancels each other out.

Well, not exactly. There are huge frictional costs in any merger. Tens or hundreds of millions of dollars are siphoned off by investment bankers and lawyers in this type of deal. So you could say that Goldman Sachs and JP Morgan are in the Total Stock Market as well. However the frictional costs of finance are a deadweight loss. They don't produce anything. They don't build new factories. They don't fund research. They don't produce new inventions.The financial industry collects 40% of all corporate profits in the U.S -- an industry that doesn't produce anything. This is a hidden tax that drags down the economy more than all the regulations and taxes that CEOs normally complain about.

[leo383]

Can someone explain to me in normal human-speak how Buffett uses his insurance company as a form of leverage? I keep hearing that he does this to get an advantage the rest of us don't have, but I don't understand it.

[talzara]

Can someone explain to me in normal human-speak how Buffett uses his insurance company as a form of leverage? I keep hearing that he does this to get an advantage the rest of us don't have, but I don't understand it.

Leverage is when you borrow money to invest. Normal people can get leverage by buying stocks on margin. Your broker lends you the money to buy stock, and you have to pay them interest on the money that you borrowed. Even worse, there's the risk of a margin call. When the stock price declines, the broker may demand that you pay back the loan -- which forces you to sell at the bottom of the market, locking in your losses.

Insurance is a business in which the policyholders pay their premiums up-front, but do not get paid until they have a covered loss. In the time between the premium was paid, and the insurance settlement paid out, the insurance company gets to use the money. In fact, most insurance companies make an underwriting loss -- they lose money providing insurance, and make it up by investing the premium.

Berkshire Hathaway is different, because its insurance operations have historically made an underwriting profit. In essence, Berkshire is borrowing money from its insurance policyholders, and paying a negative interest rate on the funds. What's more, insurance is not subject to margin calls. Hurricanes are uncorrelated to market declines.

Normal people cannot write insurance policies, and thus they cannot use insurance as a form of leverage.

[talzara]

BH is triple A rated and net cash. His weighted average cost of capital is extremely low. And almost anything he does that spends cash increases his return on capital (because he has so much cash around).

Berkshire Hathaway currently has a AA credit rating. Not AAA.

However, this doesn't matter too much, because it rarely taps the bond markets.

[greenspam]

i wonder if they will use the gecko or the cavemen in the new heinz ads...
hmmmmmmmmmm...

perhaps a caveman eating a gecko with ketchup on it ???

[huntertheory]

BH is triple A rated and net cash. His weighted average cost of capital is extremely low. And almost anything he does that spends cash increases his return on capital (because he has so much cash around).

Berkshire Hathaway currently has a AA credit rating. Not AAA.

However, this doesn't matter too much, because it rarely taps the bond markets.

They top the bond market more than people realize. They just did it this past week again:

http://www.sec.gov/Archives/edgar/data/ ... 456d8k.htm

"On February 11, 2013, Berkshire Hathaway Inc. (“Berkshire”) issued (i) $300,000,000 aggregate principal amount of its 0.800% Senior Notes due 2016; (ii) $800,000,000 aggregate principal amount of its 1.550% Senior Notes due 2018; (iii) $500,000,000 aggregate principal amount of its 3.000% Senior Notes due 2023; and (iv) $1,000,000,000 aggregate principal amount of its 4.500% Senior Notes due 2043 ((i), (ii), (iii), and (iv) collectively, the “Notes”), ...."

Berkshire's credit rating is also crucial to their insurance and reinsurance businesses. Buffett just did a $2.2bn reinsurance deal with CIGNA this week:

http://www.bloomberg.com/news/2013-02-0 ... cmpid=yhoo

[dratkinson]

Hmm ketchup.
Maybe I should eat a burger and some fries for lunch.

I prefer Heinz's Zesty Cocktail Sauce as a ketchup replacement.

(Searched for a good cocktail sauce and this was the best I found. Also discovered it was great on fries, too.)

[Valuethinker]

The way to see this is Buffett has bought another high quality (low volatility) stock but done it with leverage.

Larry Swedroe has had a post on recent academic research on this. Low volatility stocks outperform high volatility ones. Add to that the leverage of the deal (those prefs + BH's leverage as an insurance company) and you can see this is classic Buffett.

BTW he is almost never a hands on manager of a business *unless* there is a problem. What he does is back good management teams in companies with strong market positions, but he retains iron control over their free cash flow-- no acquisitions or big investments without his say so. He's also a compensation guru- no one is compensated by performance of BH as a whole but by the performance of *their* business division. He rations capital as if it is his own money (which it is). In the jargon he significantly reduces the Principal-Agent problem in corporate governance.

His focus the last 10+ years has been on capital intensive acquisitions where he can deploy BH's prodigious cash flows and cash balances.

From the point of view of the management of Heinz this is the dream scenario, potentially. You have the discipline of ownership by the best capital allocators in the world, sitting alongside you on the Board, but you are allowed to get on with it without the disruptions of quarterly earnings reporting, the short termism of public markets. And you get experience and insight into Emerging Markets via the AmBev guy.

I disagree that this is "the way to see this." That academic study about Buffett was seriously misleading -- I don't disagree with its conclusions about low volatility stocks per se, but it has very little to do with Buffett the actual investor; instead it used a kind of Robo-Buffett that the academics created for purposes of their study. For Berkshire, as I said, this is fundamentally a financing transaction -- making 9% on the preferred/mezzanine financing, which constitutes 2/3 of his cash investment -- with equity upside (warrants and his common investment). I also am not convinced that this is a "dream scenario" if you're Heinz management. When Buffett was asked if the Heinz CEO will still be around, he said "3G will make that decision, as they handle management." 3G goes into companies and *manages* them; we already saw the Behrling guy answering questions and running the press conference the other day.

Look at what the 3G guys did at Burger King, which Buffett referenced as really impressing him, or even Annheuser-Busch. They take over an asset and, even if they leave some senior management in place, they are extremely hands on with management. Buffett repeatedly referenced 3G's "management acumen" as part of his rationale, and again he's really coming in as a financing party with a big equity kicker. Fitting this transaction into the mental model of "here's Buffett again buying a low beta stock!" is just falling into the same trap as that academic study. This is just a unique deal -- and Buffett does a lot of unique deals. This one is fundamentally 3G's deal; Buffett is there, as he is so often, to provide financing on terms favorable to him and to take some of the equity upside

When Berkshire wants to just buy a company, they just buy them, like Burlington Northern. This is something very different. And I wouldn't be shocked to see some turnover with the Heinz management.

I don't think any of this has anything to do with Bogleheadism -- which I agree with nisi, is the way to go so you don't have to get into these weeds -- but if we're going to talk about Buffett or this deal it's worth at least getting it right.

You make some good points.

I don't mean to minimize Buffett's 'alpha'-- I believe it is there. But as always with a fund manager, what is alpha and what is beta?

Turns out *some* of what Buffett does has a statistical basis (just as people like John Neff had a value bias, and people like Michael Price and Peter Cundill had a small cap value bias)-- leverage on low volatility shares.

On the management on balance I think you are more right than I am ie re Heinz-- I wasn't thinking through clearly the implications of the jv, as opposed to some of Buffett's wholly owned ventures.

[swaption]

Personally, I would like a piece of that 9% preferred that BRK is getting. I think many over here would concur that 9% is above current expected returns to common equity these days. Buffett has a way of using his position and resources to be able to get these kind of sweet deals.

[Valuethinker]

BH is triple A rated and net cash. His weighted average cost of capital is extremely low. And almost anything he does that spends cash increases his return on capital (because he has so much cash around).

Berkshire Hathaway currently has a AA credit rating. Not AAA.

However, this doesn't matter too much, because it rarely taps the bond markets.

Thanks for the correction re AA.

You've still got an opportunity cost though, in working out your cost of capital. ie they *could* gear up, but choose not to.

I think the overall point, which I presume we are in agreement regarding, is that using the CAPM you'd get a wacc for BH of probably less than 6% right now.

[Atilla]

All this is good to know. I'll still refuse to buy Heinz product...from one obnoxious owner with political opinions I disagree with to another. Red Gold ketchup all the way - plus it's lower in carbs and sugar and tastes great.

[shmidds]

A moat of coke and ketchup

[tainted-meat]

All this is good to know. I'll still refuse to buy Heinz product...from one obnoxious owner with political opinions I disagree with to another. Red Gold ketchup all the way - plus it's lower in carbs and sugar and tastes great.

You must be from the Midwest. I buy Red Gold myself and it's made just a few hours north of where I am.

[LadyGeek]

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