While the Berkshire Hathaway Inc. chief executive officer said he’s still happy in his job, his eventual exit will prompt questions on whether to break up the company and how to utilize what will probably still be a large cash pile. The legendary investor on Saturday made an impassioned case for keeping the biggest US conglomerate together, and laid out a precedent on share buybacks that will offer some flexibility.
Over more than five decades, Buffett has taken Berkshire Hathaway from a struggling textile company to a sprawling business empire across the insurance, railway, manufacturing, and energy industries. He painted a simpler picture of the company’s structure on Saturday, calling it a forest with five different groves. He also bought back $1.3 billion in stock last year, relaxing a previous stance that had limited the company’s ability to return capital when there’s a lack of opportunities.
“Those letters, in aggregate over the last 10, 20 years, have a lot of value to guide the board and guide the successors," said James Armstrong, who manages about $750 million including Berkshire shares as president of Henry H. Armstrong Associates. “If they receive pressure from outside sources, they can quote chapter and verse from Buffett’s letters."
For years, Berkshire’s far-flung range of businesses — from Dairy Queen to Geico — has been protected by a shareholder base that trusts Buffett and his business partner Charles Munger because of their track record. There’s a risk that a new chief may not inherit that level of trust and calls for a breakup could grow louder, according to Cathy Seifert, an analyst at CFRA Research.
In his letter, Buffett may have given his successor a helping hand by laying out an argument for keeping it all together, which he called “a point of key and lasting importance." The combined entity can easily allocate huge amounts of capital, obtain low-cost funding, reap tax efficiencies and minimize some risks and costs, he wrote.
“At Berkshire, the whole is greater – considerably greater – than the sum of the parts," the CEO wrote. “Berkshire’s value is maximized by our having assembled the five groves into a single entity."
Last year featured a key step in the company’s succession planning with the promotion of Ajit Jain and Greg Abel to vice chairman. Jain oversees the insurance operations while Abel gained responsibility all the non-insurance businesses. Buffett called the moves “overdue" and said Berkshire is better managed than when he oversaw the operations alone.
While the growth of the company has been enormous, it also creates a few issues. Buffett called Berkshire a “Niagara of cash-generation" as the company ended 2018 with $112 billion, a pile that’s become increasingly hard to put to work in an environment he said featured “sky-high" prices for acquisitions.
Buffett also took a chunk of the letter to talk about his view on share repurchase and predicted Berkshire will become a “significant repurchaser" of its stock in coming years. That makes a shift as he’s typically shunned capital return in favor of buying companies or other stocks.
Berkshire’s board loosened the policy on stock buybacks in July, allowing Buffett and Munger to repurchase about $1.3 billion of Class A and B shares in the second half of 2018, according to the annual report.
While the company ditched a cap on buybacks tied to book value, Buffett argued in the letter that repurchases could still benefit shareholders if they happen at a discount to what he considers Berkshire’s intrinsic value.
That opens up a third way to deploy cash, but in the fourth quarter, the billionaire investor didn’t use any in a major way. Buffett said he continues to hope for an “elephant-sized acquisition" but that the immediate prospects for dealmaking weren’t great. Even smaller deals were hard to come by in 2018. Berkshire spent $1 billion on bolt-on deals last year, less than half what it spent in 2017, according to the report.
Berkshire also repurchased just $418 million in the fourth quarter, down from $928 million in the third quarter, and spent $39 million in net equity purchases in that period, down from $12.6 billion in the previous period. Even though operating earnings jumped 71% in the quarter, the lack of aggression could cause some frustration, according to Jim Shanahan, an analyst at Edward Jones.
“To me, that was the biggest disappointment of the quarter," Shanahan said in an interview. “There was a substantial stock market decline in the fourth quarter and that they didn’t buy back their own stock in any meaningful way, nor does it appear like they actually made significant equity investments."
Some preached patience. Buffett was able to strike lucrative deals with companies such as Bank of America Corp. and Goldman Sachs Group Inc. in times of market turmoil, and he wrote in the letter he aims to maintain Berkshire’s “financial fortress" to use in those moments.
“Warren Buffett with his patience and his capital is going to make us a lot more money if he holds tight and lets the market come to him like he has done so well over time," Thomas Russo, who oversees about $10 billion at Gardner Russo & Gardner, including Berkshire shares, said in an interview.