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1965 BRK 10-K


SCMessina
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I saw some posts on here looking for old BRK 10-Ks. I couldn't find any online or on the message boards, so I had to go digging for them. Over the past few months I've tracked them down from various archives. The 1965 10-K was the hardest for me to track down because a lot of microfiches start in 1967!

 

So, for those wanting to look at the first 1965 10-K, I finally found it and have attached it as an appendix to the back of this file. The 10-K starts on page 17: https://www.scmessina.com/wp-content/uploads/2015/04/Analysis-of-the-1965-BRK-Shareholder-Letter_vfc.pdf

 

The coolest part in the 1965 10-K I think is the footnote re: the acceleration in depreciation schedule (double-declining instead of straight-lining) for PP&E immediately after gaining control of BRK. Why? It's exactly what Buffett is doing now with BNSF but on a much, much larger scale, to generate deferred tax liabilities or free, 0% long-duration float borrowed from Uncle Sam. So much for Buffett saying his secretary should pay lower taxes than he does...

 

For those in Omaha now, see you in a few hours!

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Could you elaborate on the BNSF DTL comment? I've read articles on this and it doesn't really make sense to me.

 

I of course get that when valuing BRK, you must understand that the DTLs reduce book value dollar for dollar, whereas economically they are worth way less.

 

What I don't get is the sentiment in some articles that the DTLs related to PP&E are some fabulous insurance-float-like equivalent.

 

Suppose the PP&E earns a 0% return. This would be analogous to a 100% combined ratio on the insurance float. In the PP&R case, the cost of carry is hugely negative because we have to lay out a ton of money upfront to buy it, only to receive a small consolation from uncle Sam. In numbers, suppose the machine costs 100, and the opportunity cost is 5%. If the machine earns nothing, we're losing 5 in year one with a minor offsetting benefit for DTLs (5% on some  number way less than 100). So we still have risk that the government subsidizes slightly.

 

In the insurance case, we don't have to lay out any money upfront (though we'll need to hold a smaller amount of capital), so we still come out ahead at 100% combined ratios.

 

Long winded way of saying these two sources of float seem totally different to me. The insurance kind produces net economic benefits all by itself, whereas the PP&E kind are just standard tax minimization methods that don't add net economic value by themselves.

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There's what's reported as tax payments in GAAP and what was actually paid as cash taxes, as reported to the IRS. One way to think about the concept is to think about it in extremes as it could apply to you.

 

Say you bought a super fast lawn mower for $10 million. Say you rent it out for $20 million per year as revenues.

 

Say it has a life of 2 years. Assume the tax rate is 40%.

 

Straight line D&A would mean depreciating $5 million per year.

 

Year 1:

$20mm revenues

-$5mm D&A

=$15mm pretax

-$6mm tax

=$9mm earned

 

Year 2:

$20mm revenues

-$5mm D&A

=$15mm pretax

-$6mm tax

=$9mm earned

 

Now assume 80% depreciated in the first year as reported to the IRS

 

Year 1:

$20mm revenues

-$8mm D&A

=$12mm pretax

-$4.8mm tax in cash ($6mm-$4.8mm=+$1.2mm DTL)

=$7.2mm earned

 

Year 2:

$20mm revenues

-$2mm D&A

=$18mm pretax

-$7.2mm tax in cash ($6mm-$7.2mm=-$1.2mm DTL)

=$10.8mm earned

 

So in the first year $1.2mm was deferred as a liability and this liability increase was a source of $1.2mm of cash in the cash flow statement.

 

In the second year $1.2mm more than what was reported in GAAP taxes was actually paid to the IRS. This decrease in DTL is a use of cash in the cash flow statement. So in the end, the paid amount "catches up" to the deferred amount as the same amount of cash taxes are paid out on a cumulative basis as the reported taxes paid in the straight line depreciation scenario which is $12mm in aggregate over two years.

 

But the lag in cash tax payments is the float. While it's technically a liability, Buffett at the BRK meeting just now called it an asset and he also just called insurance float an asset. Accountants won't like it when I say this but liabilities and assets are synonymous in this case because due the time lag, a return can be generated within the timeframe or duration of the float. Now imagine that $1.2mm was invested and yielded a return, or you bought back undervalued shares, or used it to finance working capital. Now imagine you bought a new super lawn mower every 2 years or spent the same capex to restore it to the previous full replacement value. In this case, the duration of the DTL float could theoretically be eternal with little room for error. Imagine what this could look like if we said the life of a depreciating asset was 20 years. The power of compounding returns over a longer period of time using this longer duration float could provide a larger margin of safety with regards to the eternal nature of this float especially if capex is recurring.

 

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Yes I understand mechanically how DTLs work. And like I said, I get that it's not a true dollar for dollar liability from a valuation standpoint. My point was that in the case of PP&E DTL, the economics are totally different from insurance float. But articles I've read seem to cheer them as if they were the same, which is what confuses me.

 

In you're example in order to get the 1.2mm DTL, you have to pay 10mm for the equipment. But to get 1.2mm of insurance float you don't have to pay anything. So insurance float can generate net profit, absent any underwriting profit, whereas DTLs are a negative carry (opportunity cost on the 10mm outflow to buy the asset minus interest earned on the DTL is a negative number).

 

Obviously the equipment earns money, but this seems irrelevant from the standpoint of the economics of the float.

 

Again, one form (insurance) produces net economic benefit all by itself, the other does not (DTL). I just see good tax planning which everyone uses and anyone would expect from Buffett.

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Yes I understand mechanically how DTLs work. And like I said, I get that it's not a true dollar for dollar liability from a valuation standpoint. My point was that in the case of PP&E DTL, the economics are totally different from insurance float. But articles I've read seem to cheer them as if they were the same, which is what confuses me.

 

In you're example in order to get the 1.2mm DTL, you have to pay 10mm for the equipment. But to get 1.2mm of insurance float you don't have to pay anything. So insurance float can generate net profit, absent any underwriting profit, whereas DTLs are a negative carry (opportunity cost on the 10mm outflow to buy the asset minus interest earned on the DTL is a negative number).

 

Obviously the equipment earns money, but this seems irrelevant from the standpoint of the economics of the float.

 

Again, one form (insurance) produces net economic benefit all by itself, the other does not (DTL). I just see good tax planning which everyone uses and anyone would expect from Buffett.

 

I kinda agree. If you are valuing things from a BV perspective then obviously you need to adjust the DTLs b/c you readily admit they aren't worth face.

 

Float from insurance/DTL/etc is kinda of irrelevant when you look at project planning. Almost everyone uses some sort of cash on cash RoE as a metric for project planning and the benefits of float would be captured there.

 

There is an opportunity cost for insurance float though. You need to have X amount of equity capital per Y amount of float in order to write business. So you might want to consider that as well.

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Right - I understand what you are saying and agree.

 

I guess it would be like extending accounts payables significantly. To me it's a matter of degree. If you extend payables by months if not years, it's a source of liquidity that gives you a massive amount of flexibility. And in the hands of certain managers, that is worth much, much more.

 

For most CEOs/CFOs that aren't capital allocators, it may be more of a burden than anything to have all this extra cash lying around earning a measly return that starts to weigh down on your ROE. Like Apple, when it had all that cash, many shareholders were complaining to Tim Cook to do something with it besides investing it in money markets. But having extra cash in the hands of a great capital allocator like Buffett, I think it's worth something. How do you value that excess liquidity - do you put an expected return on? I am not sure. If the DTL proceeds are invested in the exact same way the insurance float is invested, do you discount and NPV the liability to estimate the residual equity created from investment ROE? I am not sure. Also you would then have to adjust for the underwriting ROE/profitability in the case of insurance float whereas for the DTL...is it equivalent to having a 100% combined ratio, meaning 0% underwriting profits? Not sure.

 

It's not exactly insurance float, you're right. The way I look at it is if a company like AutoZone, which I believe has 60 days payable (I think) which has been used to buy back shares aggressively (I think share count is down 50% or more in last 5 years?) and fund new store openings, this is in my opinion a form of float or just more liquidity. But the reason why it works for them is because the margins and turnover are high enough and their days receivable short enough (one week?) to pay back their vendors with new, incoming cash as the original cash paid by the vendors is long gone, used for some other (hopefully) value-creating purposes. But this extended AP in other, less crafty capital allocators would not have been as value-creating.

 

 

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Yes I understand mechanically how DTLs work. And like I said, I get that it's not a true dollar for dollar liability from a valuation standpoint. My point was that in the case of PP&E DTL, the economics are totally different from insurance float. But articles I've read seem to cheer them as if they were the same, which is what confuses me.

 

In you're example in order to get the 1.2mm DTL, you have to pay 10mm for the equipment. But to get 1.2mm of insurance float you don't have to pay anything. So insurance float can generate net profit, absent any underwriting profit, whereas DTLs are a negative carry (opportunity cost on the 10mm outflow to buy the asset minus interest earned on the DTL is a negative number).

 

Obviously the equipment earns money, but this seems irrelevant from the standpoint of the economics of the float.

 

Again, one form (insurance) produces net economic benefit all by itself, the other does not (DTL). I just see good tax planning which everyone uses and anyone would expect from Buffett.

 

I kinda agree. If you are valuing things from a BV perspective then obviously you need to adjust the DTLs b/c you readily admit they aren't worth face.

 

Float from insurance/DTL/etc is kinda of irrelevant when you look at project planning. Almost everyone uses some sort of cash on cash RoE as a metric for project planning and the benefits of float would be captured there.

 

There is an opportunity cost for insurance float though. You need to have X amount of equity capital per Y amount of float in order to write business. So you might want to consider that as well.

Yes agreed.

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So, for those wanting to look at the first 1965 10-K, I finally found it and have attached it as an appendix to the back of this file. The 10-K starts on page 17: https://www.scmessina.com/wp-content/uploads/2015/04/Analysis-of-the-1965-BRK-Shareholder-Letter_vfc.pdf

 

Thanks for your analysis and 10K. It's interesting to see what a basket case BRK was when Buffett took over. No wonder some of his partners did not buy into BRK.

 

I like to look back and wonder if I could have bought or held BRK through all its travails. It seems easy with 20/20 vision of the past. But boy it would have been difficult to hold at certain points in company's history...

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Jurgis-

 

Agreed. The cynical part of me says it was on purpose. That is, to drive the stock price down so Buffett could buy more stock back for his own sake at lower prices or to buy the shares of his LPs that were cashing out.

 

The optimist in me says it was an honest mistake. It's probably a little of both. I think Buffett is a contradiction on many levels.

 

For instance, to say he had the emotional temperament to buy safe, compounding cash flows is true. But, it would be inaccurate to attribute 100% of that behavior to his own amazing self-control. He had to buy these stocks within a very defined funding platform that we call the insurance company - with the eyes of regulators and the double-edged sword of leverage always peering down on him. I understand even then many of us with our margin leverage still act stupidly in our portfolios, but to say he was exercising self-control in a vacuum is absolutely incorrect.

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I saw some posts on here looking for old BRK 10-Ks. I couldn't find any online or on the message boards, so I had to go digging for them. Over the past few months I've tracked them down from various archives. The 1965 10-K was the hardest for me to ...

 

So much for Buffett saying his secretary should pay lower taxes than he does...

 

 

 

 

 

 

Well, what a coincidence. I just posted this (below) to an old thread here.  Anyway, following that quip about Buffett's secretary, I think you really need to watch this. 

 

 

 

 

Skip to 9 minute mark to here him talk about taxing the rich...

 

 

Leon Cooperman Says Omega Has Bought Google Shares

 

Leon Cooperman, founder of Omega Advisors, talks about Federal Reserve policy, financial markets and his hedge fund's investment in Google Inc. Cooperman also discusses leveraged-buyout funds, the oil market and the record and philanthropy of Warren Buffett. He speaks with Erik Schatzker and Stephanie Ruhle on the sidelines of the Skybridge SALT Conference in Las Vegas on Bloomberg Television's "Market Makers." (Source: Bloomberg)

 

http://www.bloomberg.com/news/videos/2015-05-07/leon-cooperman-says-omega-has-bought-google-shares

 

 

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