Warren Buffett’s latest portfolio moves: the 4Q14 13-f

Investment managers subject to SEC regulation (meaning basically everyone other than hedge funds) must file a quarterly report with the agency detailing significant changes in their portfolios.  It’s called a 13-f.  Today Berkshire Hathaway filed its 13-f for 4Q14.  I can’t find it yet on the Edgar website, but there has been plenty of media coverage.

Mr. Buffett has built up his media and industrial holdings, as well as adding to his IBM.  The more interesting aspect of the report is that it shows him selling off major energy holdings–ExxonMobil, which he had acquired about two years ago, and ConocoPhillips, which he had been selling for some time.  Neither has worked out well.

There’s also a smaller sale of shares in oilfield services firm National Oilwell Varco and a buy of tar sands miner Suncor–both presumably moves made by one of the two prospective heirs working as portfolio managers at the firm (whose portfolios are much smaller than Buffett’s.  Buffett has told investors to figure smaller buys and sells are theirs.)

Three observations:

–the Buffett moves would have been exciting–maybe even daring–in 1980.  Today, they seem more like changing exhibits in a museum.

–if I were interested in Energy and thought it more likely that oil prices would rise than fall, I’d be selling XOM, too.  After all, it’s one of the lowest beta (that is, least sensitive to oil price changes) members of the sector.

But I’d be buying shale oil and tar sands companies that have solid operations and that have been trampled on Wall Street in the rush to the door of the past half-year or so.  That doesn’t appear to be Mr. Buffett’s strategy, however.  His idea seems to be to cut his losses and shift to areas like Consumer discretionary. (A more aggressive stance would be to increase energy holdings by buying the high beta stocks now, with the intention of paring back later by selling things like XOM as prices begin to rise.)  NOTE:  I’m not recommending that anyone actually do this stuff.  I’m just commenting on what the holdings changes imply about what Mr. Buffett’s strategy must be.

–early in my career, I interviewed for a job (which I didn’t get) with a CIO who was building a research department for a new venture.  I was a candidate because I was, at the time, an expert on natural resources.   The CIO said the thought there were three key positions any research department must fill:  technology, finance and natural resources.  All require specialized knowledge.    I’d toss healthcare into the ring, as well.  I’d also observe that stock performance in these more technical areas is influenced much less by the companies’ financial statements than is the case with standard industrial or consumer names.

Mr. Buffett is an expert on financials–he runs a gigantic insurance company, after all.  On tech and resources, not so much, in my opinion.  Financials are the second-largest sector in the S&P 500, making up 16% of the total.  Tech makes up 19.5%; Energy is 8.3%; Healthcare 14.9%.  The latter three total 42.7% of the index.  As a portfolio manager, it’s hard enough to beat the index in the first place.  Being weak in two-fifths of it makes the task even harder.

Buffett, Duracell and Proctor and Gamble (PG)

Warren Buffett’s company, Berkshire Hathaway (BRK), is buying Duracell from PG for $2.9 billion.

The deal is a little more complex than that, though:

structure:  PG will inject $1.8 billion in cash into Duracell prior to the sale.  It will then swap the enlarged company for BRK’s 52.8 million share holding in PG.  This makes the headline number for the deal $4.7 billion.

a win-win

PG has been interested for years in offloading Duracell, which it acquired through its purchase of Gillette in 2005.  Duracell has gone ex growth, as today’s mobile devices like smartphones use rechargeable batteries, not disposables.  Complicating the issue is the fact that Duracell is on the books at the price Gillette paid for it in the 1980s.  So a sale for cash would presumably trigger a big capital gains tax.

With this deal, PG gets rid of a no-growth brand that no trade buyers were beating down the door to get.  It avoids taxes.  It accomplishes a share buyback at the same time and takes out a large seller whose activity would depress the stock price, to boot.  So, for PG the deal is a big winner.

BRK offloads its entire holding in PG at once.  I estimate the task would take three months in the open market, during which time PG shares would doubtless be depressed as the news hit Wall Street’s trading floors.  BRK also avoids taxes on a position that’s on its books at the cost of Gillette convertible bonds it bought in 1989.

On the surface, it appears that BRK doesn’t make out so well.  It has aguably swapped a slow-growth dog for money plus a no-growth cat.  But let’s look at the numbers.

Let’s say sale of the PG shares in the open market would bring in $4.7 billion but trigger taxes due of $1.2 billion (a number I just made up).  So the net to it is $3.5 billion.  By doing this deal instead, BRK gets $1.8 million in cash plus 100% ownership of a company that generated $400 million+ in cash over the past year.  This means BRK only needs Duracell to stay afloat for four more years to recover the price it’s paying.  In addition, PG disappears from the portfolio everyone watches (as a 100% holding, Duracell never makes it in). Looks like a good deal.

what catches my eye

I hadn’t realized before, but I’ve read in the Financial Times and the Wall Street Journal that this is the third such deal BRK has done in the past year.  This looks a lot to me like portfolio housecleaning.

Warren Buffett’s trademark has long been to buy consumer-oriented stocks with strong brand names, superior products and excellent distribution networks.  All are “moats” that defend against competition.  However, all these competitive advantages are being steadily eroded by generational and technological change.

It looks to me like a big (and overdue) strategy shift may be underway at BRK–one that the company, understandably, wants to keep under wraps for as long as possible.

 

 

Tesco, Coke and IBM, three Buffett blowups

Warren Buffett of Berkshire Hathaway fame is perhaps the best-known equity investor in the United States.

What made his reputation is that Buffett was the first to understand the investment value of intangible assets like brand names, distribution networks, training that develops a distinctive corporate culture.

Take a soft drinks company (I’m thinking Coca-Cola (KO), but don’t want to dig the actual numbers out of past annual reports).  Such a company doubtless has a secret formula for making tasty drinks.  More important, it controls a wide distribution network that has agreements that allow it to deliver products directly to supermarkets and stacks them on shelves.  The company has also surely developed distinctive packaging and has spent, say, 10% of pretax income on advertising and other marketing in each of the past twenty (or more) years to make its name an icon.  (My quick Google search says KO spent $4 billion on worldwide marketing in 2010.  Think about twenty years of spending like that!!!)

Presumably if we wanted to compete with KO, we would have to spend on advertising and distribution, as well.  Maybe all the best warehouse locations are already taken.  Maybe the best distributors already have exclusive relationships with KO.  Maybe supermarkets won’t make shelf space available (why should they?).  And then there’s having to advertise enough to rise above the din KO is already creating.

 

What Buffett saw before his rivals of the 1960s was that none of this positive stuff appears as an asset on the balance sheet.  Advertising, training, distribution payments only appear on the financials as expenses, lowering current income, and, in consequence, the company’s net worth, even though they’re powerful competitive weapons and formidable barriers to entry into the industry by newcomers.

Because investors of his day were focused almost totally on book value–and because this spending depressed book value–they found these brand icons unattractive.  Buffett had the field to himself for a while, and made a mint.

 

This week two of Mr.Buffett’s biggest holdings, IBM and KO, have blown up.  They’re not the first.  Tesco, the UK supermarket operator, another firm right in the Buffett wheelhouse, also recently fell apart.

what I find interesting

Every professional investor makes lots of mistakes, and all of the time.  My first boss used to say that it takes three good stocks to make up for one mistake.  Therefore, she concluded, a portfolio manager has to spend the majority of his attention on finding potential blowups in his portfolio and getting rid of them before the worst news struck.  So mistakes are in themselves part of the territory.

Schadenfreude isn’t it, either.

Rather, I think

1.  Mr. Buffett’s recent bad luck illustrates that in an Internet world structural change is taking place at a much more rapid pace than even investing legends understand

2.  others have (long since, in my view) caught up with Mr. Buffett’s thinking.  Brand icons now trade at premium prices, not discounts, making them more vulnerable to bad news, and

3.  I sense a counterculture, Millennials vs. Baby Boom element in this relative performance, one that I believe is just in its infancy.

 

 

 

Warren Buffett and IBM + Intel

Warren Buffett on TV

Warren Buffett, an iconic stock market investor, announced two days ago on television that he has acquired a 5.5% interest in IBM, now worth about $12 billion.  He apparently began accumulating the stock–the 65 million or so shares he holds amounts to about two weeks’ trading volume–in March.

why the buy is notable

The announcement is notable in a few respects–two small ones and one large.

Let’s get the small fry out of the way first:

1.  No one in his right mind goes on TV and announces he owns a ton of a given stock unless he’s finished buying.  The implicit message is “Feel free to ride on my coattails (and raise the value of my stock) if you wish.”

2.  Portfolio investors are required to disclose their holdings in a public filing (a 13-f) with the SEC each quarter.  According to Dealbook in the New York Times, a portfolio manager can request that the SEC keep secret the names of stocks the manager is continuing to buy.   (I didn’t know about this provision, despite being in the business for over a quarter-century.  Shame on me.  I bet I’m not alone, though.)  Dealbook says that’s what Buffett did in March and the SEC said okay

Now the BIG one:

3.  The purchase represents Buffett’s first significant foray into the technology industry, a place he had previously shunned for lack of little investment appeal.  His explanation for the about-face?  …the world has changed, so he’s changing with it.

Actually, though, I don’t think IBM shows that he’s changed that much.  Buffett has also acquired a relatively small stake in INTC, which I think IS an eye-opener.  He isn’t trying to keep that one out of his 13-f filings, however.  I think this means one of his assistants really wanted to buy it and Buffett is simply watching to see how the stock turns out.  So I think it’s more a test of the assistant than a vote of confidence in INTC.

Buffett as icon

Buffett has an important place in portfolio investment history.  It comes from his being the first, a half-century ago, to understand the implications of an accounting paradox.

Long before anyone else, he realized that continuous spending on advertising to establish a brand name had an enduring positive value, even though this activity appeared in the firm’s financial statements only as a negative–as expense.  (Pick a consumer-oriented company and look at the advertising expense.  It’s mind-bogglingly high today–and it used to be a lot higher.)  Similarly, developing a strong distribution network of competent sales and delivery people also has an enduring value, even though the only reflection of this in financial statements is in (higher than normal) salary expense.

Together, a strong brand name and a top-notch distribution system form a powerful–if invisible–barrier to competitors entering a market.  They also offer the opportunity for operating leverage if the firm can push a wider variety of branded products through its network.

So while his Graham and Dodd competitors were looking for nameless/faceless companies that were piling up lots of working capital and had tons of plant and equipment, Buffett was snapping up branded firms that served recurring needs in service areas like newspapers and insurance, and strong brands like Coca-Cola…at bargain basement prices.  Geico is probably his most famous current holding.

As everyone knows, he made a fortune, both for himself and for his clients.

my (more or less random) thoughts

IBM has a powerful brand name and distribution network.  The industry it operates in aside, the purchase looks to me like vintage Buffett.

I don’t think the Buffett magic works as well as it once did, for two reasons:

–once the investment industry became aware of Buffett’s superior results, everyone studied his methods carefully and began to imitate them.  By the time I entered the business in the late 1970s the value of intangibles and of service firms was already beginning to become conventional wisdom. So Buffett’s edge gradually disappeared.

–the internet happened.  Getting distribution no longer requires years of heavy advertising expenditure; it takes good public relations and web design.

Buffett has transformed himself, consciously or not, into his own brand name.  For the performance of Berkshire Hathaway stock, the mystique of the “Sage of Omaha” is at least as important as perceived investment results.

Why IBM and not AAPL?

To my mind, INTC is the much more uncharacteristic purchase.  It’s still very cheap, I think (remember, I own the stock).  But it’s a capital intensive, research and development dependent, manufacturer of (arguably) business cycle sensitive, high-priced stuff.  It faces substantial competition from ARMH.  In other words, it’s just about everything Buffett has not wanted in a company.