twacowfca

How did he talk about the valuation? Was it strictly FCF growth of 16%? What will the $100b in investments earn though? I guess my problem is I do not understand the return characteristics of a utility company. If you are expecting a 10% return from these investments, I am not that enthused because then you will need a growth in float to get great returns. If these companies earn a teens return, that's great. Does anyone have a link to a good article describing the shift in capital returns that twacowfca was describing? This is Buffett's discussion of the Mid American valuation in the 2007 annual letter... 'We agreed to purchase 35,464,337 shares of MidAmerican at $35.05 per share in 1999, a year in which its per-share earnings were $2.59. Why the odd figure of $35.05? I originally decided the business was worth $35.00 per share to Berkshire. Now, I’m a “one-price” guy (remember See’s?) and for several days the investment bankers representing MidAmerican had no luck in getting me to increase Berkshire’s offer. But, finally, they caught me in a moment of weakness, and I caved, telling them I would go to $35.05. With that, I explained, they could tell their client they had wrung the last nickel out of me. At the time, it hurt. Later on, in 2002, Berkshire purchased 6,700,000 shares at $60 to help finance the acquisition of one of our pipelines. Lastly, in 2006, when MidAmerican bought PacifiCorp, we purchased 23,268,793 shares at $145 per share. In 2007, MidAmerican earned $15.78 per share. However, 77¢ of that was non-recurring – a reduction in deferred tax at our British utility, resulting from a lowering of the U.K. corporate tax rate. So call normalized earnings $15.01 per share. And yes, I’m glad I wilted and offered the extra nickel.' Those are great returns, but that was then, and now is now. MidAm's earnings ex the PacificCorp acquisition have been a hair above flat from 2009 to date. PacificCorp is a little better. That is more likely to continue than not for quite a while in the deleveraging of the current super cycle. My questimate is that their incremental return on reinvestment of retained earnings has been below cost of capital in recent years. One problem with reinvestment in the industry is that some capex is actually expense to comply with emissions mandates from a hostile administration. This type of capex doesn't add to productive capacity. The $150/share to $250 over last 5 years is approximately 11% annually. Is it less % growth from 09 thru present? Does that also count the about $1B they got from the break up of the Constellation energy deal? Also, BV growth for electric utilities can be misleading because some of that growth is for nonproductive investments to comply with government requirements, technically investment, but more like a required expenditure.

How did he talk about the valuation? Was it strictly FCF growth of 16%? What will the $100b in investments earn though? I guess my problem is I do not understand the return characteristics of a utility company. If you are expecting a 10% return from these investments, I am not that enthused because then you will need a growth in float to get great returns. If these companies earn a teens return, that's great. Does anyone have a link to a good article describing the shift in capital returns that twacowfca was describing? This is Buffett's discussion of the Mid American valuation in the 2007 annual letter... 'We agreed to purchase 35,464,337 shares of MidAmerican at $35.05 per share in 1999, a year in which its per-share earnings were $2.59. Why the odd figure of $35.05? I originally decided the business was worth $35.00 per share to Berkshire. Now, I’m a “one-price” guy (remember See’s?) and for several days the investment bankers representing MidAmerican had no luck in getting me to increase Berkshire’s offer. But, finally, they caught me in a moment of weakness, and I caved, telling them I would go to $35.05. With that, I explained, they could tell their client they had wrung the last nickel out of me. At the time, it hurt. Later on, in 2002, Berkshire purchased 6,700,000 shares at $60 to help finance the acquisition of one of our pipelines. Lastly, in 2006, when MidAmerican bought PacifiCorp, we purchased 23,268,793 shares at $145 per share. In 2007, MidAmerican earned $15.78 per share. However, 77¢ of that was non-recurring – a reduction in deferred tax at our British utility, resulting from a lowering of the U.K. corporate tax rate. So call normalized earnings $15.01 per share. And yes, I’m glad I wilted and offered the extra nickel.' Those are great returns, but that was then, and now is now. MidAm's earnings ex the PacificCorp acquisition have been a hair above flat from 2009 to date. PacificCorp is a little better. That is more likely to continue than not for quite a while in the deleveraging of the current super cycle. My questimate is that their incremental return on reinvestment of retained earnings has been below cost of capital in recent years. One problem with reinvestment in the industry is that some capex is actually expense to comply with emissions mandates from a hostile administration. This type of capex doesn't add to productive capacity.

I do think that it ticked WEB off that there was no good alternative to the high rates BNSF got to haul coal to utilities or corrosive ethanol that could not be transported via pipelines.

How did he talk about the valuation? Was it strictly FCF growth of 16%? What will the $100b in investments earn though? I guess my problem is I do not understand the return characteristics of a utility company. If you are expecting a 10% return from these investments, I am not that enthused because then you will need a growth in float to get great returns. If these companies earn a teens return, that's great. Does anyone have a link to a good article describing the shift in capital returns that twacowfca was describing? WEB's hurdle rate for BRK's subsidiaries has been 15%, and the Mid American investment has compounded at about that rate. However, the original investment in Mid Am was made at a bargain price, and the current rate environment for utilities is not good. At some point in time, Mid Am may have the opportunity to pick up more assets at a bargain price. Even so, it may be difficult to get a 15% return going forward or even a double digit return. Plus, everything in Mid Am is dead money for the Holdco to redeploy at extremely attractive rates of return opportunistically in the future in other ways that will certainly pop up. Thus, Mid American's opportunities are limited to reinvesting in a subpar industry. This is similar to Net Jets situation, but Net Jets capital and future earnings is much easier to redeploy. There is an active market for business jets.

At the risk of oversimplification, a decent model would require a lot of data over a long history -- really long, of the most important variables that can be obtained or inferred. Then, a regression model might pare down the variables to a few with weighted values that seem to be predictive of outcomes in the historical data. Then, randomness might be introduced into the historical data through a probability distribution derived from the data and new outcomes generated to give a fuller range if outcomes than those in the historical data. These "Monte Carlo" simulations would be run many times and might extend the range of outcomes well into longer tails than occurred in the historical data. I recently reviewed the outcomes from 10,000 Monte Carlo simulations of a new model simulating elemental and non elemental risk. There was a much higher percentage of extreme events in the MonteCarlo simulations than in the historical data. This still is inadequate to model true "unknown unknown" or "black swan" risk. But Monte Carlo simulations are a big improvement over previous methods of assessing risk. Finally, after a big loss event, the new data is very helpful in assessing how models performed and how they can be improved.

They don't really have competitors. Being heavily regulated, and in Midamerican's case, a utility, means you don't really have to compete in the same ways. The railroads have parts of the country where they don't really operate as a matter of history. Now this does not describe the entirety of their businesses but I believe it's a large enough chunk, and really was the core of the thesis. BNSF is the easier of the two to understand. The railroad industry has been very poor for returns on capital for most of its history. However, about 10 years ago, Bill Gates and Cascade noticed that things had changed, especially for Railroads with long routes that were more economical for moving stuff over long distances than trucks. Railroads like BNSF still have lots of potential capex for investment, but that capex now returns more than their cost of capital. BNSF can borrow cheaply to finance a lot of their capex, especially under BRK 's wing. They are also able to pay large dividends to the holding company in addition to their capex. BNSF doesn't have a direct competitor, it would be way too costly for another railroad to encroach on their territory. Trucks are not as economical an alternative over most of their routes. BNSF connects the west coast to the Midwest. The expansion of the Panama canal should not impact them as much as other railroads. Mid American isn't such a good investment in my opinion, although they do relatively well in an industry that is tough.

That's good. :)

Realize that very few people were snared by the top bracket in the 1950's and 60's. It wasn't until the upper middle class began to reach that level that tax rates started to come down. The Obama administration controlled both houses of congress with a fillibuster proof majority during the first half of his first term. If soaking the rich were a priority, this could have been accomplished easily without meaningful opposition then. Instead, the congress extended the Bush tax cuts and threw in two incredible goodies, the one year zero estate tax and the unlimited rollover of 401K's and IRA's to Roth accounts --- and then justified this by saying that they had no choice but to do this because the republicans wouldn't agree! Obama's base of support is the very well off, (although less so than before the last national election), the more educated, those employed by the government (this is now where most union support comes from) and those dependent on the government for handouts. My prediction is that once all the Saul Alinski posturing runs its course and the Republicans are painted as the party of the rich, there will be very little change in the tax code. Paradoxically, first and second generation immigrants, the overwhelming part of the democrats' base that cuts across socioeconomic lines and is more hard working than the average American, are not keen on progressive taxation because that is an impediment to getting ahead in the land of opportunity. ???

The proline bond in peptides found in wheat gluten is most difficult to break by digestive enzymes.

That's interesting. Lancashire said on their conference call that they picked up a $40M ILW that would be triggered at a $20B industry loss event. They bought it because it was cheap, they said. Are you saying that AIG may be the source of such cheap tail insurance? Shades of their selling mortgage CDS dirt cheap a few years ago, something that vaporized most of their equity!

Does anyone know which picks in BRK's history have been Munger's? BYD has been the only apparent Munger pick in recent years. If you go back and read the WESCO shareholders letters, you'll find that Charlie generally bought the pick of the litter stocks that Warren bought. The inevitables. Warren credits Charlie with getting him focused on buying better businesses rather than balance sheet bargains. Warren has done very little stock picking recently other than increasing the holding in a favorite company. IBM is only sort of an exception, because Warren and, before him, Benjamin studied it for a combined total of 98 years since Graham worked with their earlier tabulating machines and invented some of the sorting routines that eventually became part of the programs for computers.

Don't know about now, but a few years ago Vancouver was a preferred route for terrorists trying to slip into the US to bomb the LAX flights. The Canadian authorities were wonderful in their cooperation to stop that madness. Never the less, we've never had any very long delays getting through Vsncouver, going back and forth to Whistler.

I think the frauds that show up on this screen in recent years drag down the results. The screen is useful because a wonderful company will occasionally show up on it. We had a very nice three bagger a few years ago that was a great company that took a V shaped dive and went right back up after we bought it. We also bought a net net that was not a reverse merger fraud, but a real business in the tech field that had a good product that unfortunately was losing its edge. It was company with tentacles that reached back to Taiwan, not ROC. It never bounced. Eventually, they did a deal with a Taiwan affiliate that stripped out all the economic value. That left US shareholders holding an empty bag with little or no legal recourse. In summary, buyer beware with MFI stocks.

Do you ever think about the overlap/diversification between your insurers? For instance most of your insurers are exposed to cat losses. If a big one hits, you will lose a good amount of capital. Do you take that into account when thinking about your portfolio? Although, it seems like most of your insurers think about the maximum they could lose and charge appropriate prices for that risk. So maybe you feel comfortable being exposed to that risk? There is very little tail risk with BRK and FFH, even with multiple, extreme events. Lancashire is more exposed to tail risk than BRK and FFH, but less exposed than their close peers. The acid test is what happens in an extreme catastrophe loss. Lancashire has passed these tests with about half the losses of their peers. That doesn't answer the question of what would happen if they experienced a couple of 100 year loss events in the same year. Say a hurricane two and a half times as damaging as Katrina and an earthquake in California twice as bad as Northridge. That could wipe out 30 to 40% of their capital. However, if they experienced one such extreme loss in a year, I think they would hedge their remaining tail exposure so that their maximum exposure might be only the one loss, maybe 20%+ or so of their capital. That's manageable without doing anything more than perhaps floating a preferred stock offering the way MRH did in 2011. If they did have to raise equity, they would be at the head of the line because of their outstanding record.

Sorry, my answer didn't connect. Good background on the trade can be found in Roger Lowenstein's book: How Genius Failed. Best wishes.

Last year they had the meeting somewhere else. That was a big disappointment. They used to hold their meeting in the Marriott conference room right off the lobby. I hope they will bring it back to Omaha. By the way, I think Combs and Weschler are proving to be cut out of the same cloth as Warren. Their being in the Omaha office is the best thing that's happened to BRK in years. :)

Anyone know what he is talking about? Cayale, You got it! That's what John Meriwether's team was known for at Salamon Brothers when Warren and Charlie came in to clean house. That strategy later blew up at Long Term Capital along with other strategies during a flight to safety. Never the less it is a virtual sure thing if leverage is kept low so that the position can be held until the spread narrows. It's just the sort of thing Warren would do the right way with low leverage that wouldn't blow up. Can i get more than that ? details ? cases ? techniques ? application ? theory ? Please ;D

Anyone know what he is talking about? Caylay, You got it! That's what John Meriwether's team was known for at Salamon Brothers when Warren and Charlie came in to clean house. That strategy later blew up at Long Term Capital along with other strategies during a flight to safety. Never the less it is a virtual sure thing if leverage is kept low so that the position can be held until the spread narrows. It's just the sort of thing Warren would do the right way with low leverage that wouldn't blow up. Can i get more than that ? details ? cases ? techniques ? application ? theory ? Please ;D Read Roger Lowenstein's book, When Genius Failed. :)

Anyone know what he is talking about? Cayale, You got it! That's what John Meriwether's team was known for at Salamon Brothers when Warren and Charlie came in to clean house. That strategy later blew up at Long Term Capital along with other strategies during a flight to safety. Never the less it is a virtual sure thing if leverage is kept low so that the position can be held until the spread narrows. It's just the sort of thing Warren would do the right way with low leverage that wouldn't blow up.

Our portfolio is peculiar. As previously mentioned since 2006, almost all of our assets have been in different proportions of three companies: FFH, BRK and LRE that we understand very well. All three are run by awesome owner operators. Like Giofranchi, we have a strong preference for partnering with great owner operators who treat shareholders as they would like to be treated were the situation reversed.

Welcome to the board, Ghost. Whenever there is a super cat, the new data leads to substantial improvement in the accuracy of the models. This often leads to important improvements in terms and conditions to the advantage of catastrophe insurers or reinsurers. After 911, Richard Brindle led the group of London insurers that rewrote the policies to exclude automatic terrorism coverage and put caps on the usual policies that are written. The terms and conditions can be even more important than the pricing when there is tail risk. The sweetest niches are sometimes not evident unless one is very familiar with the implications of how the policy is written. That said, pricing is not usually perfectly rational. Rates often go up dramatically after a big loss. Risk, as a fractal phenomenon, often is also elevated, but not always. For example, Thai flooding risk is now much lower than before the big floods of last year because the extent of flood damage was largely a consequence of human error. Thailand had experienced drought up until the year of the large flood, so the water authority made a bad decision to keep the level of water in their main dam at a high level going into the monsoon season. They won't make that mistake again, at least not until the current generation dies out. Plus, the flooded factories are being rebuilt at higher elevations with flood walls around them. Plus, one major new diversion channel has been completed and another is under construction. Objectively, flood risk is dramatically lower now than before the deluge, but rates are dramatically higher. Interestingly, my three favorite owner operator companies, BRK, FFH & LRE all jumped in and wrote a lot of business in that area, as other companies tucked tail and ran away, licking their wounds.

Well, I guess one way is to check the ratio Net Premium Earned / Surplus. If it is lower than average, an underwriting loss will be less detrimental than average to shareholders equity. Also, and most important of all, you must have confidence in the management of the company. You must be sure you have partnered with true achievers. Because insurance is nothing but a promise. And how could you know exactly what management has promised?! Paraphrasing Mr. Buffett, if you are willing to promise silly things, people will find you! :) twacowfca, any thought on this crucial topic? giofranchi Net premium/surplus isn't representative for comparison of insurance companies with different underwriting profiles, because one line of underwriting may be more exposed to large losses than another. So, I guess the question is: how can we compare underwriting profiles? First of all there is “frequency” and “severity”: it seems to me that most of the time frequency business is less risky than severity business. Then what? Is there usually sufficient disclosure to dig deeper and know which kind of frequency or severity contracts each insurer is underwriting? giofranchi Monte Carlo model simulations are helpful, but these are dependent on the inputs. For example, the people in Japan who shaved the hill down to build the power station that was swamped in the Tsunami referenced a couple of hundred years of recorded history to project that there was essentially no flood risk in what they were building. However, had they looked at the geological strata, they would have seen that there was a similar monstrous Tsunami that hit that same area 1800 years ago. Models rarely allow for true "black swans", or "unknown unknowns." the Japan Tsunami wasn't even a black swan because it could have been predicted as a low frequency event based on modeling the available data. PML's are usually estimated on the basis of Monte Carlo simulations. I like Lancashire's because they are more robust than most. Even so, all Monte Carlo simulations likely understate risk because of the black swan phenomenon. All things considered, I like catastrophe exposed insurance companies because they think a lot about tail risk and try to model it. That's a lot better than putting your head in the sand and hoping things will turn out OK the way many insurance companies operate. The so called "frequency" types of insurance can be blow ups waiting to explode. Consider the now insolvent mortgage insurers that staked their business on modeling data that only went back a few years while ignoring data from other countries that had had blow ups from inflated property values. Mortgage insurers even neglected to reference US data from the 1930's that would have exposed the fallacy of what they were doing.

Well, I guess one way is to check the ratio Net Premium Earned / Surplus. If it is lower than average, an underwriting loss will be less detrimental than average to shareholders equity. Also, and most important of all, you must have confidence in the management of the company. You must be sure you have partnered with true achievers. Because insurance is nothing but a promise. And how could you know exactly what management has promised?! Paraphrasing Mr. Buffett, if you are willing to promise silly things, people will find you! :) twacowfca, any thought on this crucial topic? giofranchi Net premium/surplus isn't representative for comparison of insurance companies with different underwriting profiles, because one line of underwriting may be more exposed to large losses than another.

FFH is about equally robust to extreme events as BRK, according to statements Prem has made. LRE has more tail underwriting risk than FFH or BRK, although they continue to reduce that risk. Recently Prem says that their risk of a 20% or so hit to their capital from underwriting is about zero. Same with BRK for a greater than 10 % underwriting hit to their capital. Looking at LRE's 100 year and 250 year PML's (Projected Maximal Losses), I estimate that they have about a 5% chance per annum of an 18% to 25 % hit to their capital at any point in time and about a 2% chance that they will have more than an 18 percent loss over an entire calendar year. So far over almost 7 years of operation, LRE has had a couple of about 10% hits to their capital at two points in time on an accident year basis. One of these produced a loss for that quarter and about a 10% profit for that year. The other 10% loss, allowing for subsequent loss creep, produced a tiny profit for that quarter, thanks to reserve releases, and a 13% ROE profit for that year. Markel's underwriting risk, I think is less than, but closer to LRE'Vs than to BRK's. All things considered, FFH has the lowest risk profile because of their hedges, then Lancashire is probably next lowest because they aren't exposed on the asset side even though they have more underwriting risk than BRK and probably more than Markel. Remember that BRK's and Markel's mark to market loss was greater than 20% during the financial crisis and their stocks lost about half their market values. LRE's only quarterly loss from investing was one half of one percent MTM, and their stock price actually went up during the financial crisis even thought they took a big hit from hurricane IKE in September, 2008. :)

:)