Buffett quietly reshaping Berkshire

Passing on Transatlantic and buying into IBM signals a change in investment strategy.

By TheStreet Staff Nov 23, 2011 3:16PM

By Antoine GaraTheStreet

Warren Buffett's Berkshire Hathaway (BRK.B) rarely loses a deal fight, which makes Monday's news that the legendary investor was outbid for reinsurer Transatlantic Holdings (TRH) seem like a strange sight.


However, the fact that Berkshire lost out in a hotly contested bid to a competitor a nearly a tenth of its size in Alleghany Corporation (Y) should not be so surprising, given the Omaha, Neb., holding company's move away from its traditional reinsurance and insurance base and its shift to a more diversified portfolio of industrial companies.


With Berkshire's $9 billion acquisition of chemicals company Lubrizol earlier this year, adding to its $26.5 billion purchase of railroad Burlington Northern Santa Fe in 2009 and $4.5 billion acquisition of industrials conglomerate Marmon in 2007, the company has altered a quarter of its overall revenue and profit.


"This isn't an insurance company anymore, it's a defensive conglomerate," Tom Lewandowski, an analyst at Edward Jones, said about Berkshire's transformation through recent deals.

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While the billions spent on takeovers in recent years may look like a tack in strategy from minority investments and an insurance focus, Lewandowski says, "Berkshire has got where they are today because they haven't really changed a lot." Berkshire, as an investment management company, simply is sticking to its style of buying companies that need a giant funding source and have an attractive risk return, even if the nature of its investments are changing, Lewandowski says.


Overall, the company, which may soon generate $20 billion in annual cash from its operations, needs to put that money to work for its shareholders who've grown accustomed to seeing shares rise faster than the S&P 500 ($INX). Signaling the need to make new types of industrials takeovers and bank investments, the company's total insurance group's revenue and profitability is still below pre-crisis levels.


With quarterly cash stockpiles over $34 billion, Berkshires been able to spend billions in new types of investments as the global economic slump has turned many of America's blue chips into attractively priced, even distressed investments.


In 2008, Buffett played hero to the U.S. financial system by taking a $5 billion stake in Goldman Sachs (GS) and a $3 billion stake in General Electric (GE), allowing both companies to raise capital in the most tense moments of the financial crisis. This August, as uncertainty besieged Bank of America (BAC), the second largest bank in the U.S., Buffett made a similar investment. Recently, Berkshire's even entered into a new sector altogether with a $10.7 billion investment in IBM (IBM).


Even with new types of investments with an industrial and distressed focus, Berkshire's shares are lagging the S&P 500 in 2011, after outperforming the index for most of the company's history.


The question is whether plowing cash into industrial takeovers and an array of minority investments have been a boost to Berkshire share returns.


"I would say it's not been tremendously successful," says Meyer Shields an analyst with Stifel Financial about Berkshire's recent diversification. In doing its biggest ever deal by taking over Burlington Northern, Berkshire paid a 30% premium -- and it made a similarly pricey acquisition in Lubrizol at a $135 a share value. Recently, Berkshire's stake in IBM comes at a time when the IT giant's stock hovers near all-time highs above $175 a share.


Meanwhile, Berkshire's bank investments, while a boost to the global financial system, aren't guaranteed to provide a similar lift to its shareholders.


Currently, Berkshire's warrants in GE and Goldman Sachs are underwater and it has sold back preferred share stakes in the companies below market prices paid. Berkshire did see overall gains on the stakes because of stipulations in the stakes like fat dividends and premiums. With its Bank of America stake, Berkshire's returns are less certain. Currently its share purchase at $7.14 a share is well above current trading prices at below $5.16.


The new investment style, whether it's banks, tech or industrial company takeovers is not just about Berkshire putting its prolific cash to work in deals that only it can make. It's also about the small returns in its insurance business. "If there were profit opportunities similar to the likes of Lubrizol and Burlington Northern in insurance, then I'm sure he'd be happy to buy an insurance company," says Shields of Stifel. He adds, "The underlying profitability of the insurance business now is much weaker than it was years ago."


To boost shares, it's unclear whether Buffett's next move will be in continued bank shares, company takeovers or simple stock buybacks. In a recent Bloobmerg interview in Japan, where he was surveying the country's post-earthquake investing landscape, Buffett said, "On the Lubrizol transaction I think we spent about $8.7 billion. We'd love another one like that -- we can handle that. We can manage somewhat larger. We can handle a $10 billion deal very comfortably."


The setting in an earthquake ravaged country, along with a revival in investments amid the financial crisis begs the question of whether Berkshire may look at using its cash in uncharacteristic ways such as distressed investments. When pressed about what the Transatlantic deal said about Berkshire's investment style, Lewandowski of Edward Jones said that Berkshire's obstinacy in engaging in a bidding war or holding the insurance unit as a standalone entity illustrates how it's investing style hasn't changed over the years. About the types of investments Berkshire is willing to make, Lewandowski says, "I think that Buffett is generally indifferent." It's the style that doesn't change.


As that indifference has pushed Berkshire Hathaway into investing in distressed banks, industrial companies and, more recently, technology, it won't be a surprise if the legendary investor switches gears once again if debt-crisis stricken companies provide attractive new ways to spend cash.

Tags: ibm
Nov 23, 2011 5:05PM
Looks to me like large cap American equities is the play here.  Probably to take advantage of the global 'recession' while simultaneously taking advantage of these depressed equities that are still in a unique position to be major players in developing countries' infrastructure growth.  Buffett is a shark man.  He strikes where he sees blood.  I think it's a wise decision and I will be following along on a micro scale by moving assets away from developing countries back into U.S. large caps for the next 2 years.  That is... after staying in cash until after the election.
Nov 24, 2011 12:23PM

If it wasn't for the bank bail outs that Buffet went to DC to lobby for himself there would not be a Berkshire Hathaway today.   The derivative insurance payouts would have wiped out the company's assets and insurance investments..


As for paying 30% more for a railroad... Don't forget, he bought the WHOLE company.   The unit trains for hauling coal 24 / 7 alone are cash cows.   It was a great buy.


Buffett gets inside information that we as little people will never get.  Also being big you get sweeter deals that us little people will never get a piece of.



Nov 23, 2011 10:58PM
All of that to say "Buy low, sell high".
Nov 23, 2011 11:35PM
Buffett.  A pioneer who has lead through gray hair experiences for years and years.  I think he is on to something.  I think his investment in Goldman and Bank of America is brilliant.  Although it will be a little time before they emerge from rough water, I think these two once powerhouses will sail into the setting sun producing profits for all those who invest in them today.  

I also think the investment into Burlington Northern is a great one... In the future I see them as  a major player in development of United States mass transit energy efficient light rail from city to city and place to place.  

IBM... Not sure what he is seeing but as all visionaries he may be 3 of 4 in these latest purchases....  

Warren Buffett has proven over and over that his investment brilliance mark him as the Best & the Brightest investor ever. The rest of the mental"midgets" that pass themselves off as investment "experts" have shown that they would excell as cabdrivers, where they belong. He runs a co. that is valued in the billions with a dozen people, no limo's, no millions in salary's or

bonus's, none of the charade that characterizes Wall st.


God bless him, let's hope he lives a long and healthy life, many, many productive years.

                                                                 Harvey Flax  

Nov 24, 2011 9:55AM
I do not understand the logic of the article.  One missed purchase and Buffett is moving out of reinsurance??
Nov 25, 2011 5:43AM
I'm making tons of cash by just parking my $ in tax free long term bonds until this all rolls over and using the extra capital I earn to attack buying opportunities as the market bottoms out. Cheers! 
Nov 25, 2011 7:20AM
Hopefully now he'll be able to pay the billion dollar tax bill dating back to 2002 that he's trying to avoid.  This is the guy who said rich people should pay their fair share?  Right!
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