Cigarbutt

^I don't have the 'right' background and continue to wonder if that's a disadvantage when dealing with those types of questions. The opening post contains limited info and possibilities are vast but it is implied that the potential breach may be more technical in nature and relatively easy to remediate, simply indicating that, even if a default could be contractually called, this is an opportunity for the lender to revisit the agreement and 'negotiate' better, (in the sense of more constraining) and more expensive terms. Whatever the context, to assess refinancing-type risk, it would be perhaps relevant to look at the other Cs: credit history, collateral, capacity and especially character. Even if we live in an increasingly intermediated world, this could boil down to a face to face outcome. FWIW, reading many bond agreements and much leveraged loan documentation, I continue to be impressed by the degree of easing in covenants with, for example, many companies being able, in the last 2 years or so, to issue debt with an agreement throwing even the going concern requirement out the window. Maintenance covenants used to have a leading indicator type of quality and it seems that, often, value can no longer be appropriately appraised from documents delivered at period ends. This too shall pass.

^I suggest the book too if you have an inclination to this sort behavior analysis. An interesting aspect is that it can be a source of ideas, from a practical standpoint, for applications in activities of daily living. Productivity and the KISS principle have been central in my activities and, maybe, that's why I'm doing nothing these days. Anyways, a while back, my contribution to an infrastructure project was to suggest painting footsteps of different colors on the floor in order to 'nudge' people in the right direction. Scientific evaluation of the input (asking volunteers who had first-line contact with the "clients"): amazingly positive NPV. I've always been amazed how small things can make a huge difference, at the margin. A problem though is that nudging can easily become manipulation and one has to be careful when Mr. Thaler suggests application to the societal level. It think it may form an acceptable compromise of paternalism with adequate checks in place and first-do-no-harm principles.

^Somehow, reading the prospectus doesn't seem inspiring, at this point. After a few seconds on this, two questions come up: 1-Why didn't they do a bond offering? 2-Does the risk section mention the possibility that leaders may lose their heads?

Excellent point. Maybe this deserves a separate thread but here’s an additional and perhaps final comment. On the above supply chain management and working capital comment, RH has done well since fiscal 2016 with a plan to improve sourcing and inventory management that worked. See numbers below. Characteristically, they’ve called this: the new architected, redesigned and reconceptualized operating platform but it basically means getting it right in terms of alignment between their inventory, what the customers want and the efficiency to deliver the product so that the client does not regret that a deposit has been made. fiscal 2014 2015 2016 2017 2018 Q1Q2 2019 GPM (% of R) 37.0 35.7 31.8 34.8 39.9 40.4 OP (%) 8.9 8.8 2.5 5.4 11.5 13.2 NPM (%) 4.9 4.3 0.3 0,1 6.0 7.6 interest expense (%) 0.9 1.7 2.1 2.6 3.0 3.4 From 2014 to 2018, revenues have grown at a 7.6% rate. Q1Q2 numbers show a similar continuing trend. Shares outstanding have decreased very significantly but once dilution is taken into account, the cannibal is not as vociferous as it first appears. For comparison between periods, using the gross measure of inventory over sales for WC management (careful: direct sales were important in the former period). fiscal 2006 2007 2016 2017 2018 Q1Q2 2019 inv/sales 27% 28% 35% 22% 21% 18% The positives: new market position with a brand formula meeting a relatively unmet need, as mentioned above an improved operating platform since 2016 which was matched by a period of market incredulity that allowed a massive share buyback, a loyalty program that reinforces the brand and a marketing strategy that involves (directly and indirectly) designers (quite brilliant in fact). However, the cash obtained from improved working capital needs and inventory was combined with a massive amount of debt to complete the share buybacks. So, after some review, there are clearly some positives in this ‘story’ but the thesis remains basically a (risky) bet on the jockey. Let’s take a look. The early 2000’s is an interesting period and the CEO was the same person. This was a time of transformation and Restoration Hardware (was selling hardware then) reported 5 years of losses. The turnaround was partially a success with growing sales and, eventually, hope for potential enduring profitability but 2007 caused a significant decrease in customer traffic and in-store sales (then negative cashflows etc etc). The CEO scored positively with improved merchandise selection, effective store remodeling, appropriate store closures and debt decrease. The strategy included an increase in imports, a strategy (which has continued to this day, in fact even higher now, with more than 70% coming from Asia and about 41% sourced in China) which IMO is, in a way, hard to reconcile with the ‘classic’, ‘traditional’ and ‘authentic’ America brand but high spenders may not be really bothered by the apparent discrepancy perhaps the same way that wearers of certain caps may not appreciate that the manufacture of the symbol is, in fact, out-sourced. The strategy also focused on catalog and on-line sales dubbed direct-to-consumer sales which grew ++ up until the company disappeared from the public screen and, obviously, this part of the strategy has radically changed (I think for the better in this specific niche) with the on-line connection being defined not as a direct sales channel but as a “virtual extension of the stores”. Of note, however, is that the gross margin in the early 2000’s improved only temporarily from lowish 30% levels under the helm of the CEO, at least in part due to an inability to improve the supply chain management, an area where the CEO succeeded with changes implemented after things started to turn south in 2015-6. Mr. Friedman is potentially an outstanding owner-operator and one has to include character assessment. Mr. Buffett has been unusually clever in this regard and this may represent an opportunity to judge the flair of the next generation. After much reading and thought, I find that Mr. Friedman stands somewhere between Mr. Steve Jobs, Mr. Bernard Arnault and Mr. Adam Neumann. He has the salesman DNA and it all comes down to instinct (more on that later). I think the fundamental weakness lies in the fact that the experiential gallery stores (style, hospitality part etc) may be a well executed idea that may work for a while and hold some iconic value but the essence of luxury is only partially related to the place where you buy the product. IMHO, it’s THE product that really counts. In their specific market, RH will continue to be exposed to the risk related to the anticipation of customer preferences and I think that they may have a hard time with the high fixed cost business during volatility periods that will come from anticipation variance and from the fact that the top 5% may not be bailed out by the top 1% in times of discretionary lifestyle stress. Here’s a link that helps to size the jockey: https://images.restorationhardware.com/media/press/2019/Winter2019-BusinessofHome_PressPage.pdf When reading the article, the underlying act of selling furniture is barely mentioned, the same way prices are not listed in certain restaurants. Speaking of restaurants, the last time I was in Chicago, we went to Bavette’s for a steak and did not particularly like it or at least thought that it wasn’t worth the price, not even the peer value potentially recognized by people reading my nonsense. That night, I enjoyed myself more at The House of Blues which, perhaps, tells more about the person writing than the investment itself. So, all in all, there are positives and potential for some value that I’m missing but there are negatives. I would also say that the entry point is associated with a high price tag to find out but this is the territory. In the end, I conclude that this is likely to be a poor investment (and perhaps a very poor one given the capital posture and certain risks mentioned above) and what helped with the final assessment, the “this is it” moment, was the following excerpt, when choosing the real estate spot for the Chicago Gallery/Showroom, from the jockey himself: “As a man in a long cashmere coat and an Hermès scarf walked by with a well-coiffed poodle, Friedman turned to RH’s president and chief creative officer Eri Chaya and said, “This is it.” As reported by the reporter who worked as a barista throughout high school and college. Apologies for the long post but it was an exercise that was useful for me as I presently consider an investment in a furniture retailer that, somehow, shares many similarities with RH even if it sells to the mid and lower segments of the market, for instance, in the need to reinvent the brick and mortar model in order to better serve certain segments (through an on-line bridge and through a better on-site shopping experience). The target I'm looking at now though is more conservatively financed, has taken a more conservative take on the 'transformation', would actually benefit from a downturn as it has historically shown better inventory turnover management which will help to opportunistically gain market share and would relatively benefit from a general downturn as decreasing traffic from existing customers would be compensated by higher traffic from downgraded people lying higher in the class structure. The end.

^From a personal business experience point of view, profit margins and return on equity are joined at the hip, both when trying to expand the business prospectively and when assessing the historical record retrospectively. The two charts, on the surface, suggest an absence of a strong correlation which, conceptually, is hard to reconcile. Let's try. For a very long time, the corporate profits per gdp as expressed remained in a 'band' between 5 and 7%. During that long period, ROE, as measured in the second chart hovered around 12% (that was one of the premises that Mr. Buffett used in his The Inflation Swindles the Investor article). More recently, profit margins have increased significantly and now deviate from that historical band. See below for a more recent update. I just looked at S&P 500 numbers as a proxy for market ROE and compared earnings to book value in the aggregate and note that, in the last few years, ROE has also settled to around 15 to 16% which, I submit, also appears to be a clear break from the historical band. While the increase in profit margins, as measured, appears to have outpaced the increase ROE, as measured, I suggest that there are confounding variables including the fact that the book value growth of the S&P 500 has outpaced the growth in GDP (both values nominal) by about 15 to 20%, in the last 20 years, which suggests that a higher denominator vs the right chart may contribute in partly "hiding" the paradigm shift that has also occurred at the ROE level. https://fred.stlouisfed.org/graph/?g=1Pik Another consideration is that the aggregate numbers "hide" another factor which is the increasing concentration of highly profitable firms. If you look at the last few years, the number of companies forming the S&P500 responsible for 50% of net income has been decreasing, which adds another level to the concentration problem and the competitive landscape. In 1999, Mr. Buffett said the following: {For an investor to achieve juicy profits}, "Corporate profitability in relation to GDP must rise. You know, someone once told me that New York has more lawyers than people. I think that's the same fellow who thinks profits will become larger than GDP. When you begin to expect the growth of a component factor to forever outpace that of the aggregate, you get into certain mathematical problems. In my opinion, you have to be wildly optimistic to believe that corporate profits as a percent of GDP can, for any sustained period, hold much above 6%. One thing keeping the percentage down will be competition, which is alive and well. In addition, there's a public-policy point: If corporate investors, in aggregate, are going to eat an ever-growing portion of the American economic pie, some other group will have to settle for a smaller portion. That would justifiably raise political problems--and in my view a major reslicing of the pie just isn't going to happen." The above suggests that competition is no longer that alive or that well and some other group has been looking at that growing pie, with envy. Staying away from politics and going back to the personal record, I hope that the highly correlated and high margins and returns were due to talented resistance to competition but I have to admit that some of it (perhaps a lot of it) was due to opportunistic capture of features not related to competition (artificial barriers to entry, excessive regulatory protection etc). I took my market segment as it was and benefitted from the steep inelasticity of demand for my 'products' but somehow wish that people with governance responsibility did better, for the benefit of the aggregate, because I really enjoy tough (even extreme) but fair competition.

Can't say I understand the RH purchase. CEO touting a new business model with magical 50+% ROIC for a furniture retailer, while borrowing heavily to repurchase shares and battling short sellers. I guess that RH is. Weschler or Combs purchase, based on the size. One thing to consider is that the Berkshire folks should know a thing or two about furniture retail, since BRK owns a few furniture retailer (Nebraska furniture Mart, Jordan etc). So I am guessing Weschler/Combs and Buffet know the lay of the land in furniture retailing fairly well. Someboby I’ve learned to respect said the following, last May: “I really don’t care whether Buffet buys are sells WFC stock. He has bought and sold many stocks, some of which performed well or poorly after he bought and sold. Buffets buying a stock just means that there is something special about the company , that it’s cheap and that it’s not a fraud. Other than that it’s my opinion that piggy-packing on other investors never works, not even with Buffet.” and “Buffet buying is a much stronger factor than Buffet selling. For once, it indicates his assessment they it’s is a quality company within its industry. He is usually correct about this, especially about industries he knows a lot about and banking is one of them. Anyways, I typically use buys from other investors as a starting point for research, not as a decision factor.” Given the Restoration Hardware investment now called “RH”, let’s focus on the starting point for a minute. -Investing in an investment that makes investments requires joint approval but also sometimes a level of confidence or even trust. I would say this luxury investment marks a certain departure from classic Buffett. This may eventually have an impact on BRK’s prospects and now is not a bad time to think about it, even if the position is considered ‘small’. -Looking specifically at RH, furniture retailing investments can be profitable although it would seem that one has to start with a high burden of proof against it. Some retailers have done very well by capturing specific customer segments or sensing enduring trends (Costco, TJX, ULTA etc) and it is possible to make money in smaller players with regional advantages or special situations but retail is tough business and the moat can be elusive. Wal Mart has its own 'story' but I can't see how a parallel could be made with RH. The thesis (which obviously may be right) here implies that you believe (or understand?) that the “transformation” of the business by a “visionary” leader will translate in significant profitable growth going forward. The capital structure of RH also lives on this premise. At a basic micro level, the stores are unique and seem to offer a “special” environment (conducive to spending and high spenders) but one can find similar or equivalent products elsewhere for much lower prices. The discounting strategy (which is evolving) is a bet in a way that the high end consumer will continue to see RH items as Veblen goods (items for which demand will increase if the price increases, irrespective of the underlying value), which is a risky bet IMO, especially through a long-term lens. Moving higher in the industry analysis, one has to question the enduring essence of the size of their customer segment. Things have been roaring lately. Luxury items can be real winners but trying to grow in a period of temporary adjustments can have significant effects on liquidity for a retailer and I find RH not particularly well prepared for such a scenario. How they fared during the mortgage crisis is instructive in that regard. The next step would be to assess the funding story behind the customer purchases. I start with the assumption that it’s not all paid cash and some of the customers may be relatively extended as they may well belong to another class. Home Hardware also offers interesting stuff. I don't understand the RH purchase but so far I don't like it as a capital allocation decision. Edit: BTW, I'm told that RH furniture was popular at WeWork and we think that there may be excess inventory there. Perhaps unrelated but perhaps a sign of the times. "It's a sign of the times Welcome to the final show Hope you're wearing your best clothes You can't bribe the door on your way to the sky You look pretty good down here But you ain't really good"

... Read this AM in an unrelated (?) article: "To us, this entire expansion highlights the fact stocks in general don’t need rapid productivity or GDP growth to rise." To me, this eco-system doesn't make any sense and maybe I have some wework to do. :)

In the 5% of time allocated to macro, Mr. Philippon's work occupies a small place. The tribal argument would imply that he has nothing to teach, given his 'origin', but, perhaps, one could listen to a 'reformist' who supports some of the ideas brought forward by the Iron Lady. He has produced solid work on intermediation cost, especially convincing in healthcare and finance. I like his idea of raising tax as a default option because somehow promoting competition would likely be a more effective and 'natural' tool for redistribution, even if associated with transition costs.

BTW, thanks for the thread. I've been thinking about the above for a while and sometimes wonder how it may affect specific investment decisions. Market concentration has increased across many industries and an argument could be made that this is one of the factors behind higher profit margins and stock returns (so who's complaining?). Some figure that tolerating (or somehow allowing) an environment with less competition will permit the "super-firms" to produce better overall results. I don't necessarily buy it. Higher market concentration with pseudo oligopolistic monopolies explains IMO to a significant degree what has happened to wages in general and how low the rise of wages has been despite the incredibly low unemployment numbers now. Some people call this new phenomenon a monopsony. It seems that higher concentration allowed companies to earn 'abnormal' (whenever one hears abnormal, one has to check sustainable) profits and to fund share buyback activity. What is disturbing is that firms in the developed world, despite higher profitability, have not often increased re-investments in their businesses and this new normal has not resulted, at least so far, in promising productivity measures. And I wonder if this increasing concentration is simply linked to the loose application of regulatory control in horizontal mergers or if regulation is the answer. The dilemma resolves around the two definitions of the word maturity. Maturity:a very advanced or developed form or state Maturity:having attained a final or desired state before decay As usual, the 'truth' may lie between the two meanings but I would submit that there is an unusual proximity and collaboration between business and government that needs to be improved. I thought the following to be helpful (balanced): https://rooseveltinstitute.org/wp-content/uploads/2018/09/The-United-States-has-a-market-concentration-problem-brief-final.pdf Rockefeller's story is fascinating. He greatly helped to reduce costs by taking advantage of economies of scale. But I think he went too far to achieve that status and the end result represented a challenge to constructive competition. It is ironic that the anti-trust legislation resulted in the liberation of value embedded in the trust instead of destroying it.

I have done this in the past, in a significant way, by initiating or increasing the position, on three or four occasions. Part of the motivation was because FFH was felt to be an anchor holding that could be held for the long term and part of the motivation was because I thought it was possible to take advantage of the temporary mismatch. I now come to the conclusion that I was wrong with the short term predictive power (process) even if the outcome has always been positive. Maybe others can do this effectively but I come to the conclusion that FFH price had a tendency to go up and luck explains the result. Your post though brought back a nice souvenir when I was planning to do this in November 2012 and, in fact, materially increased my position a certain day which was related to technical selling or something. Then again, if I were a brighter trader, I would have kept the trading chunk for longer as the realized gain on the incremental investment was about 20% vs 100% if I had waited another 2 years or so. Interestingly, I found that this was discussed in 2012. https://www.cornerofberkshireandfairfax.ca/forum/fairfax-financial/fairfax-down-8-this-morning/60/ Edit: Here's the link to the first page of the thread: https://www.cornerofberkshireandfairfax.ca/forum/fairfax-financial/fairfax-down-8-this-morning/ I see that Viking indicated that he was back in the saddle again and felt that things looked good for the next year or two. Nice call! As Yogi Berra said (versus decision making): When you come to a fork in the road, take it!

If it could be Russian Roulette - where is the bullet? A few degrees warmer is going to kill us all? It’s not going to kill us all, but it can kill a lot of people directly and indirectly. Not to worry, most of us will be long dead before the consequences set in. Isn't it hard to plan for the long term? especially the generational things? In 1986, a sensible fellow wondered about the odds and felt that we should look into it. This was at a hearing concerning climate change and ozone depletion due to CFCs. http://archive.macleans.ca/article/1986/6/30/a-threat-to-human-life "Man is irreversibly altering the ability of our atmosphere to perform life-support functions. It strikes me as a form of planetary Russian roulette.” An argument could be made that in 33 years, another pundit may ask the same question but I wonder if it comes down to the notion of margin of safety. Have you ever done cost flow and breakeven analysis for specific products or subs, or financial distress analysis for specific names entering distress due to leverage. The textbooks typically use linear equations and show straight lines on a graph with illusion of precision to the tenth of a %. However, in these not so complex situations, non-linear changes can occur especially at the margin and a way to obtain some confort with the outcome is to use a larger margin of safety. i wonder too and i wonder about your level of trust in institutions or scientific "authorities"?

Note to muscleman: This post is not for you, it’s simply a slightly modified entry that I logged in one of my files this AM. If, by any chance, this is helpful, that’s fine also. Our paths crossed here some time ago (you were looking for places to park cash) and the discussion evolved to the outlook on interest rates. My reply to a question of yours included a reference to rocket science and heroin use and, understandably, was kind of left open-ended. Since then, I closed some relevant transactions last summer and still have some kind of interest in the matter. Continue reading at your own risks. :) In the last 10 years, low interest rates have been a bummer for many financials and insurers in general, with low rates contributing to low NIMs (banks), low investment yields (P+C insurers) and low and declining net spreads (life insurers). So, low interest rates have pushed down return on capital measures, producing lowish returns and life insurers’ market caps have barely reached the pre-crisis levels, accounting for new capital minus dividends at a time when low interest rates have unequivocally pushed up (the gravity argument) valuation levels elsewhere underlining again that everything is relative. What happened to life insurers during the last financial crisis and since then has been incredibly fascinating. At this point, many life insurers’ equity value has ‘recovered’ but the price to book value has not, implying that there may be potential upside here (potential conclusion from the research mentioned by Viking above), a view I disagree with. In a low interest rate world, P+C insurers at least can re-price yearly to catch up but life insurers are stuck with long term contracts that contain various levels of explicit and implicit guaranteed returns. If you look at the long term trend in those guaranteed returns, the trend is getting lower but there has been a significant lag as it takes a while for the new policies to have an impact on the bunch of policies in force. So, if looking for a target in this field, you have to come up with the odds of rates lower for longer, consider the possibility of negative interest rates and even discount for the possibility of an associated corrosive effect from deleveraging (don’t do that on an empty stomach). Before elaborating future-looking scenarios, you may want to take a look at what happened to Japanese life insurers in the last 30 years and to wonder if we are turning Japanese. Summary: The story is fascinating and repeatable and is still ongoing. Japanese life insurers ‘adapted’, more or less. They gradually lowered the promised return on liabilities by using different mechanisms (liability and asset side). Most have, so far, survived and the country has opened its large market (second in the world after the great again country) to foreign capital but returns, overall, for the investors, have been incredibly disappointing and many, punctually especially around 1997-2001, have failed, a phenomenon rarely seen in the land of the rising sun. I won’t expand here but I think the failures during that period were related to excessive reaching for yield behavior associated with expectations that rates would soon rise, resulting in enduring negative net spreads, an issue very difficult to deal with for a life insurer. Somehow, Japanese life insurers came through the Great Financial Crisis and the big feature was investing in longer duration JGBs although the story has evolved recently, as the last chapters of this story are bring written, with a very unusual thirst for yield that includes unhedged bets on foreign and peripheral alternative assets. I have written a tentative epilogue on this. So, if looking for a US target in this field, life insurers will continue to try to adapt and some seem to be better prepared and likely to do better, relatively speaking. I would look at individual names and assess: ---On the liability side --the composition and diversity of the product mix Ranked in order of decreasing interest risk, I would look at the fraction of: fixed annuities, universal life and guaranteed contracts, and then variable annuities, whole life and term life. ---On the asset side --the composition of the portfolio (tedious work) It seems that life insurers behaved reasonably well after the 2007-9 stun, slowly adjusting to the new normal but the net spread has been coming down, the duration mismatch strategy (going longer) has been hurt by the recent inversion and lower reversion and IMO excessive reaching for yield has reared its ugly head in some quarters. And the steam roller may gather steam in a lowering rate environment because of lower than expected investment income, negative impact on the net spread, potential regulatory requirements to fund reserves for the growing asset-liability mismatch and associated liquidity strains in many parts of the Market, including the bond market which hasn’t been really tested in such a long time with a supposedly omnipresent and omnipotent public partner. ---The soundness of the risk management and hedging tools I think I’m done here and don’t intend to follow-up on additional questions, perhaps others will. Final note: I’ve been haunted by QE and, retrospectively looking, QE-boosted secularly lower interest rates saved the day for life insurers and allowed capital replenishment, time to digest the mark-to-market liquidity pain and allowed most of them to come out (mostly) unscathed but I continue to wonder if this was not a pyrrhic victory. When we last talked about the steepness of the curve, I alluded to the escape velocity concept used in rocket launches and then suggested that the Fed was hoping for the second reactor to fire. Since then, the Fed has seen that this could not happen (long rates went down) and has started to lower short term rates hoping that the second reactor does eventually fire but, even if the yield curve slope has been restored, contrary to last time, the hope is based in a context where the rocket is still vertical but is losing altitude. So these days, I’m looking for ways to benefit from this and I’m also shopping for parachutes. In fact, if bright, energetic and a true salesman, I would set up a hedge fund with seeded money earmarked for the eventual acquisition of surrendered policies at a discount, hopefully at the height of liquidity constraints. But I’m not. Today, I will cover up some trees and bushes as we are expecting an unusual amount of early snow and this could be a fun winter.

I would say the interest is there and the finger may be on the trigger. Just look at the stake in Phillips 66. It's an integrated and diversified company but pipelines are part of its core operations and, in 2014, which is yesterday in a way, Mr. Buffett (I don't think that one came from the lieutenants) bought the Philips Specialty Products unit from the parent. The now integrated chemical sub is not a pipeline asset per se but the move constitutes a significant vote of confidence for pipelines in general, an investment posture confirmed by public endorsement of key but controversial pipeline projects. Also look at the ownership in Suncor Energy. Suncor is also diversified and integrated, and pipeline operations may not be the primary driver of future returns but a bet on Suncor is, in a way, a vote that the pipeline approval process will move forward, somehow. Pipeline assets are very interesting but my investing style may prevent me from making easy money like you. :)

I like gfp's answer and here's a slight addition. When determining the rate of return, the bottom line for regulators is to satisfactorily meet capital requirements and investment commitments. Once these hurdles are met, on a basic and first level analysis, regulators should be quite indifferent (but they are obviously not completely impermeable to softer inputs such as the strongly implicit support from a fortress balance sheet) as to how the return is retained or distributed and utilities have historically maintained high payout ratios. BRK has entered the area opportunistically (think the Williams (post Enron) and PacifiCorp capital commitments) and, so far, the investments have occurred in selected geographical areas (expected regulatory compatibility) and in specific troubled assets available at good prices or, at least, in assets available at fair prices. But it seems to me that the comparative advantage related to the soft inputs (flexible capital allocation and parental support) may become more significant in the future and may allow much larger opportunities as 1-a lot of data shows that the electric infrastructure is aging and becoming in an ever larger need for reinvestments with capex not meeting adequate maintenance for some time and 2-technology advances, new sources of energy (intermittent nature), new forms of distribution and safety concerns combine in a way to potentially disrupt the industry in a way perhaps larger than when deregulation attempts were carried out some years ago. If you're the regulator, who are you likely to turn to then, at a time when market perception of uncertainty will result in higher discount rates for motivated or forced sellers? Mr. Buffett has sometimes compared the regulated utilities to insurance which, in fact, has also been heavily regulated (state level), a fact that did not prevent some insurance subs from growing profitably over time. I think he sees regulators as a nagging constraint, limiting what he could accomplish, but also recognizes that regulators tend to prevent excessive incompetency which is a way to maximize the NPV under human circumstances. From the international perspective, I wonder if Mr. Buffett (or his legacy) won't be extra selective as there may be enough investment opportunities in the US and because regulated utility investments are based on the premise that 'society' will treat the private capital providers fairly, a premise that is far from guaranteed, even under the best of circumstances. I don't think that Mr. Buffett uses the CAPM as a tool to calculate the value of an opportunity but regulators do. When dealing with 'international' ventures, regulators add a risk spread related to specific countries and I would doubt that those spreads (countries ranking lower in the institutional grade scale) reach a level which would make Mr. Buffett comfortable in making a large investment.

Today, nationalization risk played out as mayors raised the customer-owned specter right after the governor threatened a more active role during the restructuring. I hear Spekulatius' opinion about the relative advantages of mutually-owned utilities and, in the last few days, have experienced (positively even if the outage touched my household) how a publicly-owned electric utility can efficiently face adverse and unexpected weather-related developments (more than 10% of people in my province had an electrical outage for some time) but there are significant downsides to public ownership and I continue to think that the public ownership model is unlikely to spread in California. From an opportunistic point of view, it is just too bad that nationalization risk did not exactly conjugate with recent fire activity risk. Apart from the nationalization component, bankruptcy risk is strongly related to regulatory risk. This may be too optimistic but the assumption is that the different and relevant authorities with skin in the game will come together to share the risk and to allow an adequate return on capital invested by private inputs in this new normal environment. An example below from the insurance world showing that there may be a realization that the causes behind the recently recognized hardship are multiple. California is special because of the inverse condemnation doctrine but it has applied wrong incentives with the incredibly significant development of property value at risk exposed to wildfires. The application of new building codes is also necessary. Poor incentives have also built up through poor insurance regulation policies. https://www.iii.org/sites/default/files/docs/pdf/fighting_wildfires_with_innovation_wp_110419.pdf There are many options to fund the potential risk outcomes associated with the new reality such as catastrophe bonds and state-sponsored recovery bonds. https://riskcenter.wharton.upenn.edu/wp-content/uploads/2019/02/Financing-Third-Party-Wildfire-Damages.pdf Edit: I forgot to mention the role of the goats but this is covered elsewhere in another thread.

The Applied sale gets more complicated. Regulatory noise and overreach or do they feel like corners are being cut? http://www.insurance.ca.gov/0400-news/0100-press-releases/2019/release086-19.cfm Whatever the situation, the California Department of Insurance is very powerful and the strategy put forth by Applied seems to be counter-productive and is becoming more and more distanced from Berkshire's etiquette.

This seems to be a recurrent discussion. I would say your conclusion is approximately correct but wonder if including more specific inputs would allow the conclusions to be more nuanced (and meaningful?). 8) I got some old notes and updated for the last 2 years. Here are the %s of cash, equivalents and ST bills in Insurance and Other over SE. There is cash held for what seem to be working capital purposes of other operations but numbers are relatively small and do not materially impact the potential insights (numbers not audited!). 1995 16% 2000 9% 2005 44% 2010 21% 2015 26% 96 6% 01 9% 06 35% 11 20% 16 25% 97 3% 02 16% 07 31% 12 22% 17 32% 98 24% 03 40% 08 22% 13 19% 18 31% 99 7% 04 47% 09 21% 14 24% Q319 31% I would submit that the proper context needs to be defined for potential limitations. 1- A remarkable trend has been related to the decrease over time (relative to equity, float etc and even absolute!) of the longer-term fixed income exposure (that's another story) so an argument could be made that the increased cash position over time is partly linked to the decrease in long-term fixed income exposure but this explanation is incomplete. 2- I know you like float and this also needs to be looked at. The period in the early 2000's where cash to equity was high also corresponds to an unusual period in the sense that the exposure to float (versus equity) was +/- double what it was in the years before and what it has been more recently up to now, so an argument could be made that the higher relative float nature of the business required higher liquidity, at least to some degree. In order perhaps to remove some noise involves an exercise that Brooklyn Investor did a while back: http://brooklyninvestor.blogspot.com/2017/11/is-buffett-bearish.html Updated numbers about coverage: 2017: 112% 2018: 101% Q3 2019: 107% The author of the blog comes to his own conclusions. I would add that (assuming that the Master has not lost it which is where I stand now) it's unlikely that Mr. Buffett licks his finger and puts it up in the air to feel the wind in order to decide if risk-on needs to be reversed to risk-off or vice-versa. IMO, the pattern of the float coverage reveals that Mr. Buffett looks at things bottom-up and will not hesitate to buy opportunities if internal hurdles are met, whatever the macro circumstances, like he did in 2018 when, from memory, he loaded up financial equity (coverage ratio down) and suggests that the coverage ratio (as an indirect consequence) will tend to go up when markets are elevated. The 2019 BRK cash situation, even accounting for a relatively minuscule long-term fixed income position and noting the relatively low float to equity ratio, would imply the possibility that markets are indeed elevated, the same way that one could conclude that markets carry a more favorable outlook when the coverage ratio goes to or below 90%.

But isn't life a series of compromises? Take for instance (there will be a link with goats and the environment :) ), Bernard Arnault. The products offered (and potential associated returns) make us dream...But isn't there a need to reconcile instinctual desires with down-to-earth realities? Anyways, I thought you'd appreciate the following link, which you may have missed and which explores some of the subtle intricacies of the wolf in the cashmere coat's personality. https://www.forbes.com/sites/susanadams/2019/10/31/the-100-billion-man-how-bernard-arnault-stitched-together-the-worlds-third-biggest-fortune-with-louis-vuitton-dior-and-77-other-brandsand-why-hes-not-done-yet/?utm_source=newsletter&utm_medium=email#7a5eff834efb "Arnault and ten LVMH brand chiefs took turns on a brightly lit stage reciting their commitments to environmental stewardship, their presentations interspersed with slickly produced videos of models strutting down catwalks and cashmere goats frolicking on the Mongolian steppes." (my bold) To keep a reasonable balance between pleasure and guilt and because of recent concerns raised on this Board which may have been hurt by videos showing models frolicking, I include here a link describing an uncomfortable environmental side effect. :) https://www.sciencemag.org/news/2019/01/exploding-demand-cashmere-wool-ruining-mongolia-s-grasslands Apparently some people have difficulty pronouncing the word "Vuitton". It sounds very bizarre at times especially in presidential mouths.

^Today revealed a resolutely lower mark-to-market adjustment for Resolute (3.62 USD). At some point, this is bound to meet the value tag. :) I've been reading about patience this week. Because of the following disclosure, I will add more harassing comments. Disclosure: presently defining a sufficient margin to re-enter FFH, if the discount to intrinsic value widens more. Perceived near-death assault on the asset side of the balance sheet associated with a systemic credit crunch contributing to further insurance hardening would be ideal but you don't always get what you want. It feels like this is real hardening. Update on a post from last August. Q1-Q3 2018 4.2% Q1-Q3 2019 2.0% So, relatively speaking, reserves are holding up well but there seems to be a trend. Looking across the industry, there have been many false starts but this time appears different. ??? An interesting aspect (when it is disclosed and we'll know more by year-end with more detailed annual disclosures) is that reserve development is developing into a pattern where, for specific companies, years-ago reserves keep releasing redundancies while more recent years are starting to show deficiencies with, still very often, a net redundancy across all years but that may be about to change. Many, including FFH I believe, are likely writing new business and "building" reserves to be released eventually but the race is on. It will be interesting to see. If interested, an example of that 'phenomenon' is found on page 32 of the 2019 semi-annual Beazley report: https://investor.relations.beazley.com/~/media/Files/B/Beazley-IR/documents/interim-results-release-23-07-2019.pdf You know, during elections, they keep talking about ridings (I think they're called bellwether ridings in English) that move with the to-be elected government. FWIW, I find Beazley has this flavor for the underwriting cycle. Looking at the "Liquidity" section of the quarterly report reveals that cash has moved from parent to subs in order to support growth. At year-end, FFH reported significant dividend capacity but growing NPW in a risk-based capital world seems to be a limiting factor for the buybacks and other potential capital allocation decisions.

I'm sure "a hungry herd of as many as 500 goats" can clear a lot of land! Yes, the story is to me fascinating, because the approach to help solve the issue at hand is so simple! -And then there is also more to tuck for the goats when they "come home" after "task accomplished"! Please disregard unless the fascination is real. I've been studying the California bush for a while and, in fact, {if I can eventually convince my wife} would love to move to California one day. A new argument now is that I could become a goat renter or herder in order to facilitate Mr. Buffett's acquisition related to the concept that Californians deserve a better electricity utility. But that's another story. :) https://www.smithsonianmag.com/science-nature/using-goats-to-prevent-wildfires-51327045/ Laguna {cool place where Mr. Buffett used to have his second home}'s Mike Phillips said that just three things contribute to wildland fires. "Fuel loads, topography and weather." He paused, then smiled. "We can't change the topography, and we can't do anything about the weather{or human nature?}. The only variable to reduce is the fuel load. That's what goats do for us." https://www.sierraclub.org/sierra/demand-for-grazing-goats-growing-wildfire https://baynature.org/article/fire-goats/ Even my alma mater suggests to fight the fire by eating the fuel: https://www.mcgill.ca/oss/article/did-you-know-environment/goats-might-be-secret-tool-weve-been-looking-prevent-wildfires Obviously goats are only part of the multi-pronged answer but it's an example that helps to reconcile downside protection and optimism related to human ingenuity, all in harmony {at least to the extent possible} with nature.

Your inputs and others help define entry and exit points in PG&E but I'm still confused as to why the entity would be uninvestable. Putting aside the nationalization risk for a minute. Because of: 1-the bankruptcy process? 2-the fact that PG&E would require new top management? 3-the fact that the bad culture is too deeply ingrained? 4-the fact that assets are of poor quality and not adapted? I see these challenges as potential opportunities. The governor conveniently omits to mention that various levels of the public jurisdictions failed to appreciate the new normal related to climate change and, in fact, encouraged value at risk that is now being 'discovered'. The Oncor bid in Texas indicated that there was value in critical assets in a state where electricity demand is expected to rise significantly over the long term. The bankrupt Oncor had more to do with capital structure deficiencies than operational or cultural issues and Oncor had already discovered the value of cooperation with public boards concerning investment in the grid and safety concerns. However, the PG&E situation may just be a revelation that its infrastructure is in a significant need for further investments which, if negotiated properly, would not be seen as a drag on capital invested but as large investments guaranteed by a reasonable rate of return. The public authorities, seemingly, would only take over the ownership as a default solution and really IMO are in a relatively poor position to massively invest in the new paradigm that involves the transition to distributed energy at the same time as safety concerns need to be massively addressed and accounted for. The public authorities are now explicitly stating that they are looking for a private partner in order to carry out the transition and it seems to me that BRK is bound to at least consider the alternative. PG&E has very valuable assets and we can argue that the challenge is, in fact, a potential opportunity. Another consideration is that the State (and CPUC) seem to be ready to guarantee an access (various ways to do that) to bond markets for the wall of investments that will be necessary to achieve the planned transition which, added to a Berkshire endorsement, would contribute to a very low cost of capital while moderating rate increases for the customer. I would not underestimate the value of an option allowing you "to get out of this mess". Edit (potentially useful and relevant references): https://www.dallasnews.com/business/energy/2017/07/14/if-warren-buffett-s-billions-meet-oncor-s-wish-list-here-s-how-texas-stands-to-gain/ https://www.cpuc.ca.gov/uploadedFiles/CPUC_Public_Website/Content/About_Us/Organization/Divisions/Office_of_Governmental_Affairs/Smart%20Grid%20Annual%20Report%202017.pdf

Why counterintuitive? I would say California has its own specific idiosyncrasies but, on its own, would rank as the fifth economic power in the world and will be at the forefront of the evolving dynamics between centralized and distributed energy. PG&E has a long history, is a major player and is running into difficulties that could be considered temporary and fixable with an outcome that can be influenced by a credible partner with a long term view and deep pockets. Longinvestor and wabuffo (in another thread today) rightly suggested that bankruptcy proceedings are not a natural fit and the Oncor experience was likely a learning experience: after tracing a road map and a valuation baseline, a 'winner' comes from nowhere near the finish line and the breakup fee evaporates. Perhaps a way to win the race here is to make a surprise attack and create a winning gap by proposing (somehow) a solution that the California Public Utility Commission determines to be the only acceptable option (some kind of pre-packaged overall deal), making the emergence decision easier. https://www.caiso.com/Documents/StudyBenefits-PacifiCorp-ISOIntegration.pdf https://www.dallasnews.com/business/energy/2017/08/24/warren-buffett-not-only-was-outbid-for-oncor-but-also-lost-270-million-breakup-fee/

^Your point is well taken but it all comes down to the definition of a whiff (how to deal with negatives). People celebrate the Geico investment as a two-part slam dunk now but the second part was met with skepticism (valuation) and the first part was met with disbelief. In 1975, Geico reported an underwriting loss of 190M with 25M (not a typo) left in capital. Mr. Buffett saw moat in the mess and was reassured by the oncoming Mr. Jack Byrne but the company was very close to bankruptcy. In fact, from the regulatory standpoint, the capital deficiency was severe and compatible with a runoff order. Geico was desperate for cash and it was felt (Mr. Buffett himself and the regulators) that the company was significantly under-reserved. Stock price went from 61$ to 2$. Does that meet the definition of a whiff? The company survived, among other reasons than perfect execution from Mr. Byrne, because regulators critically allowed to bypass capital requirements (amounts and deadlines) for quite some time and granted permissions for very significant premiums rate increases. Also, many investments made in 2008-9 were based on the underlying premise that government officials would "do the right thing". Was that a proposition free of uncertainty? Mr. Buffett has the luxury to wait for the assets to be served on a silver platter but the return of a cheery consensus is possible in the next few months as the entity will likely come out of bankruptcy next year and the climatic situation may have reached its climactic point for some time.

PG&E could be a great deal for BRK, because Berkshire has both utility management, insurance capacity and expertise and the ability to write a Check worth tens of billions of $. There is really no competition out there who can even Doo all three. For sure, BHE stands uniquely positioned . My question is, how does BHE deal with next years’ fires? Is BHE setting up 10 foot hurdles for themselves? Was PG&E that negligent or blamed for an act of God type event? This opens up the Pandora’s box wide open when it comes to regulated utilities, roles, shareholders etc. This may appear simplistic to you but here's an attempt at an answer. There is also a bankrupt thread on PG&E. The situation in California is contaminated by the inverse condemnation doctrine which is enshrined in their Constitution and stuck in political inertia. The doctrine (quite a unique situation in the US) means that the utility will be considered responsible for damages whether it was negligent or not! https://www.insurancejournal.com/news/west/2019/01/15/514846.htm What's nice (for an opportunistic white knight) is that the Pandora's box has been wide opened and bad spirits have hit the high winds down to Sacramento and people from diverse camps have been looking at stop loss options (really attachment points in reinsurance contract parlance), a situation simply and literally unthinkable just a short while ago. There are many alternative scenarios that imply skin in the game for the utility with rate-based and a government-sponsored options. https://www.reuters.com/article/us-california-wildfire-fund-idUSKCN1TM2JX Now longinvestor, note that the bankruptcy judge has to choose between a wounded and bad corporate citizen, and a vulture group with questionable intents to unite conditions leading to some kind of phoenix entity with a viable future. Isn't there a potential opportunity to get to swing at this amazingly slow pitch right in the middle of the plate and with even the umpire on your side?

I'd love to see convincing evidence on this but I feel the same, to some degree. An uncomfortable corollary is that the NPV on a tax scheme or efficiency plans (which may be hard to differentiate at times) may increase significantly despite much larger negative cashflows along the way. The likes of GE, Apple and other corporations have huge inside tax-handling issues departments and some individuals investing in highly sophisticated schemes or pseudo-schemes become eligible to a negotiation process not available to the ordinary citizen when the going gets tough. As to the playing by the rules concept and the corporate world, I think that the evolution in thinking displayed by Andrew Fastow to be vicariously educational. From one of the smartest guys in the room: https://www.irishtimes.com/business/companies/former-enron-cfo-andrew-fastow-you-can-follow-all-the-rules-and-still-commit-fraud-1.2485821