What's Wrong With Warren Buffett's Berkshire Hathaway? A Failed Buyout Tells the Story.
Berkshire Hathaway is badly lagging behind the S&P 500. Warren Buffett’s stubborn approach to capital allocation is a big part of the problem.
The conglomerate is badly lagging behind the S&P 500. A stubborn approach to capital allocation is a big part of the problem.
Why is Berkshire Hathaway stock nearly 20 percentage points behind the S&P 500 index this year?
The company’s recent unsuccessful attempt to buy Tech Data (TECD), a distributor of technology products, offers a partial explanation, as it illustrates Berkshire’s current challenges and CEO Warren Buffett’s stubborn approach to capital allocation.
Buffett, who turned 89 in August, continues to search in vain for what he has called “an elephant-sized acquisition” that could total $50 billion or more. Berkshire recently lost a bidding war for a much smaller target, Tech Data, which agreed to be purchased for $145 a share, or $5.1 billion, by Apollo Global Management (APO), the private-equity firm. That followed a Berkshire bid of $140 a share.
Berkshire is sitting on too much cash, has bought back only a modest amount of stock this year despite an attractive valuation on its own shares, has been a subdued buyer of equities, and can’t find suitable acquisition targets because of Buffett’s price sensitivity and unwillingness to participate in corporate auctions.
The latter appears to have come into play in the Tech Data situation, as the company accepted a Berkshire offer only to turn it down when Apollo raised its bid.
Berkshire’s class A shares (BRKA), which are up $505, to $331,000 Monday, have gained 8% this year, against a total return of 27% for the S&P 500. This is one of the worst years of relative performance for Berkshire since Buffett took the reins in 1965. Berkshire’s class B shares are up 65 cents at $220.95 Monday.
There is some frustration among Berkshire holders that Buffett has allowed so much cash — $128 billion at the end of the third quarter—to build on Berkshire’s balance sheet. Despite an expanded authority to buy back stock since the summer of 2018, Berkshire has repurchased relatively little. In the first three quarters of 2019, Berkshire bought $2.8 billion of stock. At that rate, Berkshire will buy back less than 1% of its stock this year—its market value is about $540 billion.
Buffett loves to invest in companies like Apple (AAPL), Bank of America (BAC), and Wells Fargo (WFC) that repurchase lots of stock, but he has long been cool to buybacks at Berkshire. Some big banks are buying back 5% to 10% of their stock, while Apple has retired about 6% of its stock in the past year through the largest buyback program in the world.
Berkshire also has scaled back its equity purchases this year, buying $15 billion in the first three quarters, against $38.6 billion in the same period of 2018.
As one longtime Berkshire watcher tells Barron’s, Buffett and Vice Chairman Charlie Munger are disadvantaged in the acquisition game. Buffett refuses to participate in corporate auctions, which makes it tough for boards of public companies like Tech Data, which have a fiduciary obligation to get the best price.
And it is debatable whether Tech Data, which operates in the slow-growth, low-margin distribution business, would be a better use of Berkshire’s cash than its own stock. Apollo is paying 11.5 times projected earnings in Tech Data’s current fiscal year for the company.
Berkshire trades for 21 times estimated 2019 profits, but the company’s effective price/earnings ratio is lower because Berkshire can reflect only the dividends of the companies in its $220 billion equity portfolio in its earnings. Berkshire is also sitting on an enormous amount of cash -- it is earning just 2% on that cash. And Berkshire owns a higher quality group of businesses than Tech Data.
Berkshire now trades for 1.35 times its Sept. 30 book value of about $244,000 per class A share—near the low end of its range in recent years. And book will likely be up smartly in the current quarter thanks to the company’s $25 billion of annual earnings power and gains in the stock market.
Berkshire’s largest equity holding, Apple, has appreciated by about $10 billion since Sept. 30. Bank stocks, where Berkshire has broad holdings, are up about 10% on average since the third quarter ended. Berkshire’s book could hit $254,000 per class A share at year-end, according to a client note from Barclays analyst Jay Gelb. That means the stock may be trading for just 1.3 times year-end book value, just above the old cap on Berkshire buybacks at 1.2 times book.
One longtime Berkshire holder says that Buffett should look for bigger acquisition targets, where the company has more of an edge because of the difficulty of private equity to do deals that are more than $50 billion. Potential targets include Walgreens Boots Alliance (WBA), which already has had an approach from private equity, or a major airline like Delta Air Lines (DAL) or Southwest Airlines (LUV). Berkshire likes the airline sector and already owns about 10% of both Delta and Southwest.
A lagging Berkshire looks appealing with Gelb carrying an Overweight rating and a price target of $375,000 on the class A shares, about 14% above the current price.
Investors, however, may want to see a greater commitment from Buffett on stock buybacks or an attractive big acquisition before getting more excited about the shares.
Write to Andrew Bary at email@example.com
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.