I’ve been spending a lot of time studying Berkshire Hathaway’s float with the aim of deconstructing its capital structure. As I read and re-read Warren Buffett’s annual letters his true genius continues to fascinate me.
While many readers will know Berkshire is re-known for its insurance float, it will soon be surpassed by its deferred tax float. While one form of this float is unrealised capital gains, the more material source is being generated by depreciation related deferred tax liabilities from the capital intensive businesses such as BNSF (rail-road) and MidAmerican (Utilities). As such, these infrastructure acquisitions were just as much about generating new sources of float as they were about buying ‘great businesses’ – the two ideas go hand in glove.
Float growth is a key driver of intrinsic value for Berkshire, however, now that insurance float is maturing, Buffett needs new and innovative ways to grow it. Railroad assets like BNSF have useful lives of 100 years and will generate deferred tax liabilities for decades after Buffett’s succession – the tax man ‘Uncle Sam’ is a key player of Berkshire’s future…
Liquefied Natural Gas Limited (ASX:LNG, OTC ADR: LNGLY) is an Australian/US ADR listed LNG export play with a A$1.55bn market capitalisation. The stock operates in a similar business but should not be confused with Cheniere Energy which also has the same ‘LNG’ ticker. Its’ key development projects include the flagship Magnolia LNG project in Louisiana, its recently acquired Bear Head LNG project in Canada and the Fisherman’s Landing LNG project in Australia (which remains on hold for now).
While guru investor interest in the US gas export story via holdings in Cheniere is well documented, fewer investors may have noticed that ASX listed LNG contains a quality share register of US hedge fund value investors – so naturally we take notice. US investors make up >40% of the register and include Baupost (Seth Klarman), Third Point (Dan Loeb), Valinor (David Gallo), Claren Road and Fairview.
As the stock is already up a whopping 10x over the last few months, I am naturally wary and generally averse to chasing hot names. Continue reading →
In 2012 Warren Buffett indicated he would buyback Berkshire Hathaway (BRK.A) stock up to 120% of its book value, but have you wondered why 120% is the right yardstick and not 110% or 130%? There have been a few posts explaining why 120% might sound reasonable premised on assumptions around estimated book growth and future multiples, however these arguments are unconvincing in my view.
I believe the ‘magic’ 120% of book value is a simple back-of-the-envelope calculation which makes an adjustment for Berkshires capital structure. Continue reading →
A few months ago I left a lucrative career as a (sell-side) stock market analyst. Many people thought I was crazy for leaving a well paid and highly sought after role.
It was interesting to find that I was not the only one making such ‘idiotic’ decisions. A fellow value investor and blogger has written of a similar experience and highlighted his reasons in this post (link).
I have reprinted verbatim his 20 reasons for not returning to the sell-side below. Continue reading →
I recently met with an insurance executive who manages part of Berkshire’s insurance operation. On the topic of management incentives I was surprised to find out that they were not incentivised in any way through either bonuses or equity participation. Rather, employee contracts were based on three year fixed salaries. After a stint working in investment banking, and having read through numerous listed company remuneration reports this was truly not a common occurrence.
The incentive structure was contrary to what modern theory would suggest is the optimal alignment of interest between agents and shareholders. Why would such a structure exist that ‘derisks’ managements financial incentives by paying a fixed salary and does not penalise management for poor performance nor provide upside for good performance. Isn’t it obvious that carrots and stick theory works?
This is a detailed study of insurance float and its role in the valuation of insurance stocks. Buffett made insurance float famous using it to turn Berkshire into an insurance and investment powerhouse. In doing so he has detailed the importance of float in understanding Berkshires valuation, though much of his teachings around float has been lost outside of Berkshire. However, his process remains highly applicable to mainstream insurance analysis, particularly in the determination of intrinsic value.
The report will explore the application of his principles to Australian insurance companies with a focus on successful valuation and stock-picking. Readers will learn why conventional valuation techniques can be flawed and how float-based valuation can be used within a value investing framework. The key issues I cover include: Continue reading →