Semper Augustus on General Reinsurance – The Pivot

[james22]

All credit to miLucky for picking up on this.

 

The Berkshire Chairman’s letter in the following year’s 2016 annual report made this comment about the General Re purchase:

 

Unfortunately, I followed the GEICO purchase by foolishly using Berkshire stock – a boatload of stock – to buy General Reinsurance in late 1998. After some early problems, General Re has become a fine insurance operation that we prize. It was, nevertheless, a terrible mistake on my part to issue 272,200 shares of Berkshire in buying General Re, an act that increased our outstanding shares by a whopping 21.8%. My error caused Berkshire shareholders to give far more than they received (a practice that – despite the Biblical endorsement – is far from blessed when you are buying businesses).

 

Here I defend my initial summary.

 

• It was precisely the use of the “boatload” of Berkshire’s shares in the purchase of General Re that was so seminal and materially beneficial to Berkshire over the subsequent twenty years.

 

• Yes, those shares would now be worth $83 billion at year-end 2018. But it was the purchase of General Re’s investment assets, namely its 90% allocation to fixed-income, that marked Berkshire’s pivot away from a massively overvalued stock market, from its own massively overvalued stock portfolio, which alone was 15% larger than Berkshire’s entire book value, and from its business concentration in property casualty insurance and reinsurance.

 

• You might question the last part of that – the move from insurance, given that General Re, the acquiree, was, in fact, a reinsurer.

 

• Yes, but it wasn’t so much the insurance operation that was attractive – it was the ability to purchase a $25 billion investment portfolio, overwhelmingly bonds, using a stock trading at three times book value when fair value was half as much.

 

• It was the ability to shrink a stock portfolio from 115% of book value to only 69% and to do so by paying no capital gains taxes, then at a 35% corporate rate.

 

• Did management at Berkshire anticipate two decades of subpar stock market returns? Did they recognize that at three times book they possessed overvalued currency?

 

• An acknowledgment of that would suggest perhaps that Berkshire took advantage of General Re, and Berkshire would never utter that.

 

https://boards.fool.com/21419-semper-augustus-recap-and-patience-34208583.aspx?sort=postdate

 

More at the link.

[Dynamic]

When I read this years Semper Augustus letter, I was again very impressed. That guy dives deep into the minutiae of the accounts and comes back up with some real nuggets of clarity. Well worth re-reading the last three annual letters, actually for Berkshire insights alone.

[aws]

I've had the same thoughts when looking back at what happened in the late 90s, long before I was a shareholder.  At the time of the Gen Re merger Berkshire was trading at something like 2x book value, and almost half of the book value was made up of KO shares which were themselves overvalued.  Issuing stock at that time was definitely not a mistake.  The mistake was more likely failing to repurchase stock in the subsequent years at a much bigger discount to offset what was issued.

[gfp]

Issuing stock at that time was definitely not a mistake.  The mistake was more likely failing to repurchase stock in the subsequent years at a much bigger discount to offset what was issued.

 

bingo!