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Tilson bullish on Berkshire


Santayana
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I think Tilson overvalues Berkshire.  He double counts the insurance business by counting the value of investments and the operating income from the insurance businesses.  Also, he acts like a 10x multiple is conservative...but its a multiple on pre-tax income.  That is the equivalent of a 15x P/E multiple.

 

I think he was trying to make valuation based on a multiple of pretax earnings because he views BRK's growth coming from growing operating earnings- so he added earnings of investments (I think) to earnings of operating companies.

 

I agree 10x multiple is not conservative.

 

I liked WEB's estimate of IV = 8 x pre tax income of operating companies + market value of investments. Just an estimate because estimate could be off if investments are overvalued by markets.

 

BRK seems like good value to me so Tilson could be wrong.

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I think Tilson overvalues Berkshire.  He double counts the insurance business by counting the value of investments and the operating income from the insurance businesses.  Also, he acts like a 10x multiple is conservative...but its a multiple on pre-tax income.  That is the equivalent of a 15x P/E multiple.

 

I will never be the first to defend Tilson, but in this situation he is right - pre tax earnings do NOT include insurance earnings. Look at any of Buffett's letters - he tracks non-insurance EBT and investments both on a per share basis. Tilson adds zero originality to the analysis, he just copies Buffett.

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I think Tilson overvalues Berkshire.  He double counts the insurance business by counting the value of investments and the operating income from the insurance businesses.  Also, he acts like a 10x multiple is conservative...but its a multiple on pre-tax income.  That is the equivalent of a 15x P/E multiple.

 

I will never be the first to defend Tilson, but in this situation he is right - pre tax earnings do NOT include insurance earnings. Look at any of Buffett's letters - he tracks non-insurance EBT and investments both on a per share basis. Tilson adds zero originality to the analysis, he just copies Buffett.

 

Actually if you look at Tilson's slides he does use a portion of the insurance earnings (see note on slide 15).  He includes "half of the $2 billion of annual profit over the past nine years." 

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I think Tilson overvalues Berkshire.  He double counts the insurance business by counting the value of investments and the operating income from the insurance businesses.  Also, he acts like a 10x multiple is conservative...but its a multiple on pre-tax income.  That is the equivalent of a 15x P/E multiple.

 

I will never be the first to defend Tilson, but in this situation he is right - pre tax earnings do NOT include insurance earnings. Look at any of Buffett's letters - he tracks non-insurance EBT and investments both on a per share basis. Tilson adds zero originality to the analysis, he just copies Buffett.

 

yeah...i know that they insurance earnings are not included in the operating income section in buffett's letters.  However, Buffett is doing it for a reason.  Tilson thinks he can value Berkshire better than Buffett can?  You can't give benefit to the assets of an insurer, give benefit to the earnings of an insurer, and ignore the liabilities of an insurer. 

 

In fact, just giving benefit to the investments, while ignoring the earnings/liabilities, would lead to overvaluation of most insurers.  Even if the average insurer did earn a 100 combined ratio (which they don't), it is still assuming risk to get the float.  The investments don't come free.  A 100 combined ratio on average still means a big loss in a year with a Katrina.  Why take on the risk for free?  Most insurers are worth less than their investment portfolios.

 

Furthermore, because insurers like fairfax & brk are corporations that pay taxes, their portfolios are definitely not worth face value.  Income earned earned off their portfolios will all be taxed twice, once at the corporate level, and again when they are paid in dividends to you. 

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by the way...just to show how ridiculous the notion of including investments at face is...look at it for fairfax.  That would imply a 1125/share value, without giving any credit to operating earnings. 

 

I'm not going to quibble over the precise value of Fairfax, but I know with certainty it is less than 3.65x tangible book. 

 

Finally, just to be clear, I hold Berkshire and think that it is a good value.  But I think it might be more like a very safe 85 cent dollar, rather than the 65 cent dollar tilson claims it to be. 

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None of these analyses give a penny of value to the embedded put at an increasing strike price on average quarter by quarter.  Whenever BRK trades close to 110% of BV as it does now, the value of that perpetual put will add at least  20% to 30% to the value of holding the stock.

 

If one were of a mind to use margin,  BRK could be levered up now very likely with less risk than holding a spider without margin.

 

Andy, now's your big chance!  8)

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My bad - you guys are right, Tilson does double count. He's even more of an idiot than I thought.

 

Further - on page 19 he says that BRK generates $12 billion of free cash flow, which assumes the $3.1 billion "Change in Insurance Reserves/Liabs." is actually sustainable cash flow.....very deceiving.

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None of these analyses give a penny of value to the embedded put at an increasing strike price on average quarter by quarter.  Whenever BRK trades close to 110% of BV as it does now, the value of that perpetual put will add at least  20% to 30% to the value of holding the stock.

 

If one were of a mind to use margin,  BRK could be levered up now very likely with less risk than holding a spider without margin.

 

Andy, now's your big chance!  8)

 

One small caveat to this though is that Buffett has not committed to buying at 110%.  He may, he may not.  I think he's clarified that a couple times.  In particularly weak markets he may have better opportunities and he doesn't want traders to think he'll always be there to buy at 110%. 

 

With that said, it does seem likely that buying at these levels should result in investment returns at least equal to the growth in BV.  But it's not quite riskless.

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by the way...just to show how ridiculous the notion of including investments at face is...look at it for fairfax.  That would imply a 1125/share value [...]

 

However, Fairfax has a third source of funding for the investments i.e. interest bearing debt that needs to be accounted for.

 

Best,

Ragu

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My bad - you guys are right, Tilson does double count. He's even more of an idiot than I thought.

 

Further - on page 19 he says that BRK generates $12 billion of free cash flow, which assumes the $3.1 billion "Change in Insurance Reserves/Liabs." is actually sustainable cash flow.....very deceiving.

 

yeah...hes either an idiot or intentionally deceiving.  operating cashflow for an insurance company is usually meaningless, unless you calculate some hypothetical "investment in statutory reserves" to subtract, similar to capex for a manufacturer.  For an insurer (not that berkshire is 100% insurance), none of that cashflow is distributable to shareholders...its all required to meet statutory reserves. 

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None of these analyses give a penny of value to the embedded put at an increasing strike price on average quarter by quarter.  Whenever BRK trades close to 110% of BV as it does now, the value of that perpetual put will add at least  20% to 30% to the value of holding the stock.

 

If one were of a mind to use margin,  BRK could be levered up now very likely with less risk than holding a spider without margin.

 

Andy, now's your big chance!  8)

 

One small caveat to this though is that Buffett has not committed to buying at 110%.  He may, he may not.  I think he's clarified that a couple times.  In particularly weak markets he may have better opportunities and he doesn't want traders to think he'll always be there to buy at 110%. 

 

With that said, it does seem likely that buying at these levels should result in investment returns at least equal to the growth in BV.  But it's not quite riskless.

 

Completely agree.  :)

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None of these analyses give a penny of value to the embedded put at an increasing strike price on average quarter by quarter.  Whenever BRK trades close to 110% of BV as it does now, the value of that perpetual put will add at least  20% to 30% to the value of holding the stock.

 

If one were of a mind to use margin,  BRK could be levered up now very likely with less risk than holding a spider without margin.

 

Andy, now's your big chance!  8)

 

One small caveat to this though is that Buffett has not committed to buying at 110%.  He may, he may not.  I think he's clarified that a couple times.  In particularly weak markets he may have better opportunities and he doesn't want traders to think he'll always be there to buy at 110%. 

 

With that said, it does seem likely that buying at these levels should result in investment returns at least equal to the growth in BV.  But it's not quite riskless.

 

Completely agree.  :)

 

Furthermore, while this "put" provides some technical support, it is of no real fundamental value. 

 

Would fairfax have bought its CDS on MBIA from MBIA?  No.  Why?  Because such a contract would inherently be worthless.  Buying a put contract on goldman sachs with goldman sachs as the counterparty would similarly be of little value. 

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None of these analyses give a penny of value to the embedded put at an increasing strike price on average quarter by quarter.  Whenever BRK trades close to 110% of BV as it does now, the value of that perpetual put will add at least  20% to 30% to the value of holding the stock.

 

If one were of a mind to use margin,  BRK could be levered up now very likely with less risk than holding a spider without margin.

 

Andy, now's your big chance!  8)

 

One small caveat to this though is that Buffett has not committed to buying at 110%.  He may, he may not.  I think he's clarified that a couple times.  In particularly weak markets he may have better opportunities and he doesn't want traders to think he'll always be there to buy at 110%. 

 

With that said, it does seem likely that buying at these levels should result in investment returns at least equal to the growth in BV.  But it's not quite riskless.

 

Completely agree.  :)

 

Furthermore, while this "put" provides some technical support, it is of no real fundamental value. 

 

Would fairfax have bought its CDS on MBIA from MBIA?  No.  Why?  Because such a contract would inherently be worthless.  Buying a put contract on goldman sachs with goldman sachs as the counterparty would similarly be of little value.

 

This isn't a contract.  It's better.  It's a commitment that will enhance long term shareholders' value more than a contract that might bind at the wrong time.  This commitment to buy back shares aggressively below 110% of BV, unless that would stress the company financially or prevent seizing even better opportunities, is in perfect alignment with long term shareholders, including the Gates Foundation that is required regularly to sell a small percentage of shares, regardless of price.

 

BRK has been a prolific FCF generator, even during the financial crisis.  That's what gives value to the commitment.

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so if this isn't the way to value berkshire, what is?

 

(1) In the past, Buffett himself has said that an insurance business that shows an underwriting profit on average, over time is worth its investments. Add to that a multiple of 10 of the pre-tax operating earnings (outside of insurance) and you have intrinsic value.

 

The multiple of 10 pre-tax is like 15 post-tax, the average of the S&P 500 over time. Tilson adds underwriting profit to the pre-tax operating earnings in method (1). Probably too liberal.

 

(2) He has also said that value can be gotten by using the right side of the balance sheet. All capital that is costless is akin to equity and therefore of value. So, Berkshire's float, its deferred tax liabilities associated with its investments, and its common equity are all costless over time and therefore considered a measure of intrinsic value.

 

Either way, you come up with the same number at the end of 2011. Under (1) 168,266 and under (2) 168,003

 

That's a 70 cent dollar.

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by the way...just to show how ridiculous the notion of including investments at face is...look at it for fairfax.  That would imply a 1125/share value [...]

 

However, Fairfax has a third source of funding for the investments i.e. interest bearing debt that needs to be accounted for.

 

Best,

Ragu

 

Also, Fairfax's cost of float is nowhere near costless. By my calculation, cost of float at Fairfax has averaged 9% since 1998. It has been 4%, on average, over the last 5 years and 8% in 2011 alone. Fairfax is a long way away from being worth its net investments (i.e. investments less debt and preferred equity).

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If Berkshire's quality businesses aren't worth 15 times earnings, then I wonder about the market valuation of many other companies. I don't think 10x pre-tax is that far of a stretch and we should also remember that no value is given to, for instance, higher earnings from improved housing.

 

Tilson has given a high estimate of IV, but it's not like he is off 20%. I think you can say with a lot of confidence that BRK is at least worth $150,000 / A-share, possibly 10% more.

 

I also still believe people are undervaluing the possible long term value of Buffett's deals like BAC in the next 5-10 years. Buffett has been saying that his performance will revert to the mean since his partnership years but I still believe there will be some more great years ahead. No 10% outperformance, but no sloppy 'average economy growth rate' yet either.

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Would fairfax have bought its CDS on MBIA from MBIA?  No.  Why?  Because such a contract would inherently be worthless.  Buying a put contract on goldman sachs with goldman sachs as the counterparty would similarly be of little value.

 

So Goldman could offer default protection on itself and collect riskless profit?  Not in practice.  The only way this would work is a jump-to-default (overnight credit event) with no recovery.  The market prices in an extremely low probability of this happening to a diversified firm without correlated risk.  These contracts do have fundamental value and they are frequently traded as such because collateral is posted daily and the contracts are liquid enough to be assigned to many other counterparties.

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These contracts do have fundamental value and they are frequently traded as such because collateral is posted daily and the contracts are liquid enough to be assigned to many other counterparties.

 

??? What relevancy does that have?  Berkshire does not post collateral daily to its shareholders. 

 

In practice, the stock has not and will not trade as if there is an embedded put.  During times of crisis (financial or cat-insurance related), Berkshire runs the risk of losses (just as its peers), and the stock will fall. 

 

Fundamentally, this "put," as it was stated, has no value (but may offer technical support).  If a mega-cat event (9.0 earthquake on sanfran, cat 5 hurricane on new york) happens, Berkshire will have 10's of billions in losses, the stock will fall with the rest of the industry, and buffett won't buy back a dime of stock in order to remain financially sound. 

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(2) He has also said that value can be gotten by using the right side of the balance sheet. All capital that is costless is akin to equity and therefore of value. So, Berkshire's float, its deferred tax liabilities associated with its investments, and its common equity are all costless over time and therefore considered a measure of intrinsic value.

 

Either way, you come up with the same number at the end of 2011. Under (1) 168,266 and under (2) 168,003

 

That's a 70 cent dollar.

 

I would argue the liabilities are not completely costless.  On average, yes, they are.  But if someone told you if you to take a bet, where if you roll dice and get snake eyes twice in a row, you owe $1 million; but if you don't row snake eyes twice in a row, you receive $772, would you do it?  The offer has an expected value of 0 (same concept as an insurer with average CR of 100), but that doesn't mean the payout will be 0 on any given roll.

 

Insurers face large tail liability.  Do not take that risk on for free.  By adding in the full value of float liabilities (or taking the full value of investments), you are taking the risk on for free.

 

 

EDIT

For the record, I would think the value of berkshire is somewhere near 150k, similarly to tombgrt.  This would imply about a 10x multiple on op-earnings (calculated by buffett, not tilson, and a 20% haircut to investments (to account for tail risk & tax inefficiency).

 

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These contracts do have fundamental value and they are frequently traded as such because collateral is posted daily and the contracts are liquid enough to be assigned to many other counterparties.

 

??? What relevancy does that have?  Berkshire does not post collateral daily to its shareholders. 

 

In practice, the stock has not and will not trade as if there is an embedded put.  During times of crisis (financial or cat-insurance related), Berkshire runs the risk of losses (just as its peers), and the stock will fall. 

 

Fundamentally, this "put," as it was stated, has no value (but may offer technical support).  If a mega-cat event (9.0 earthquake on sanfran, cat 5 hurricane on new york) happens, Berkshire will have 10's of billions in losses, the stock will fall with the rest of the industry, and buffett won't buy back a dime of stock in order to remain financially sound.

 

I agree that BRK doesn't trade as if it has an embedded put.  I like this.  :)

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