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Author: CatcherintheRye Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 214615  
Subject: What to do with $2.5b?? Date: 11/16/2000 6:01 PM
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OK, so BRK has amassed between $2-3 billion in cash on retroactive insurance deals over past and coming quarter(s).

And yes, it needs to be invested at possibly a risk-free + rate to match huge and long term liabilities. Not an issue barring systemic risk on the portfolio, which frankly, remains an issue in my simple mind.

But what if, carefully managed, these funds are also available for acquisition? Not talking SAFECO, personal lines insurance but something more extravagent/long-tailed.

Rumors such as Swiss Re and Employers Re have been out ther for so long they no longer command attention from anyone.

The risk appetite has changed measurably. Have you noted?

I have to think there is a broader, strategic play at hand. Thoughts? Anyone?

Grateful & appreciative,
catcher

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Author: EliasFardo Big red star, 1000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38090 of 214615
Subject: Re: What to do with $2.5b?? Date: 11/16/2000 11:02 PM
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I have to think there is a broader, strategic play at hand. Thoughts? Anyone?

Catcher,

I believe that there is a broader, strategic play at hand with Berkshire, but it is not necessarily limited to retro contracts or the purchase of another long-tail insurance concern. The shift that I see is a company making itself into more of an operating enterprise, and less of an investment vehicle. The reason for this is simple: if Buffett wants to generate 15% average increases in book value per share, he cannot do so with his present mix of assets.

I estimate that a more normalized, after tax annual operating income sans capital gains for Berkshire is about $2 billion. This assumes a combined ratio of 103 for General Re, no underwriting gain or loss from the other insurance operations, and a profit contribution from the financial products business that is substantially lower than the current amount.

For book value to grow 15% this year, it would need to increase by about $8.7 billion. So, if in more normal times, only $2 billion could come from operations, the equity securities must contribute realized and unrealized gains after tax considerations of about $6.7 billion. Based on the current amount of equity securities, these securities must appreciate at a rate of about 26% to generate enough to bring the total increase in book value to 15%. This 26% annual appreciate rate is a very high hurdle.

The reason that Berkshire Hathaway has been able to increase its book value at a high rate during the last ten years is because it had a stock market wind at its back. At the end of 1989, book value per share represented by after tax appreciation in securities was $2,043. At the end of 1999, book value per share represented by after tax appreciation in securities was $11,570. If you believe the Buffett article in Fortune, the next ten years will not allow Berkshire to grow its unrealized appreciation per share by more than a five fold amount. So where will the 15% annual average gain in book value come from?

It will come from operating companies: insurance companies, candy companies, furniture companies and anything else that catches Buffett's fancy. During the last few years there has been an explosion of acquisition activity at Berkshire. The General Re purchase alone would make it notable, but we have also purchased aviation companies, furniture companies, insurance companies, and jewelry companies. One of the largest, noninsurance businesses at Berkshire, the furniture business, has been significantly expanded with 3 purchases in just the last year. Another of the largest noninsurance businesses at Berkshire, the aviation services concern, has been purchased in just the last few years. And what will be the largest noninsurance business of all at Berkshire, the construction materials business, consisting of Justin, Shaw and Benjamin Moore, has been arranged in only the last few months.

The bonds are the problem. So, the pattern I see is the recognition that to generate 15% annual increases in book value, much needs to be done. This can happen in three ways. One way is to increase the leverage on the balance sheet by writing more insurance, the large retro deals are an excellent example of this. Another way is to redeploy assets into higher yielding concerns. Selling bonds to buy Shaw, or Justin or Benjamin Moore is an example of this. The last way is a given. The earnings of the operating companies can be improved through new products, new markets, price increases etc. So, aside from greater profitability of existing enterprises, to increase book value the huge amount of bonds on the books of Berkshire needs to either be (1) used to buy higher income generating businesses, or (2) substantially increased with increased leverage in the insurance business, or (3) both.

I believe the answer is in (3) above and we have been seeing its implementation for the last 2 years.

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Author: loverpickle Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38102 of 214615
Subject: Re: What to do with $2.5b?? Date: 11/17/2000 9:01 AM
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Elias,

Thanks for the great post. You seem to have a real knack for cutting through the clutter and focusing on the big picture. I think you've got the future of Berkshire pegged, at least for the next few years.

It seems we are becoming more GE-like with our collection of different operating companies, which should please Woozler imensly. Where is Woozler, BTW? Hope he didn't get run over by a SnowCat or anything......

Bill

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Author: brk40 Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38104 of 214615
Subject: Re: What to do with $2.5b?? Date: 11/17/2000 9:36 AM
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Elias: Would be so kind as to explain how you determined the book value per share represented by after tax appreciation in securities was $11,570 at year end 1999? Thanks in advance. Cliff

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Author: mohonri Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38112 of 214615
Subject: Re: What to do with $2.5b?? Date: 11/17/2000 4:46 PM
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Elias,

I doubt we will see a significant increase in leverage at BRK, that's not the management style as I understand it.

IMHO we will see more buying of businesses, and strengthening of existing businesses as you mentioned.

On the other hand,one of the best things that could happen is for the market to go down alot so WEB could use all his cash to buy stocks cheap. Thats one of the things I love about BRK, it's good news if the market goes down.

Mohonri

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