Author Topic: Munger on Deferred Tax Liabilities and Intrinsic Value  (Read 8666 times)

racemize

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Munger on Deferred Tax Liabilities and Intrinsic Value
« on: September 28, 2012, 08:17:31 AM »
So, I've been reading Munger's Wesco letters (they are quite repetitive).  However, while reading, I found the following section pretty interesting:

Consolidated Balance Sheet and Related Discussion

As indicated in the accompanying financial statemtents, Wesco's net worth increased, as accountants compute it under their conventions, to $2.22 billion ($312 per Wesco share) at yearend 1998 from $1.76 billion ($248 per Wesco share) at yearend 1997.

The $459.5 million increase in reported net worth in 1998 was the result of three factors: (1) $395.8 million resulting from continued net appreciation of investments after provision for future taxes on capital gains; plus (2) $71.8 million from 1998 net income; less (3) $8.1 million in dividends paid.

The foregoing $312-per-share book value approximates liquidation value assuming that all Wesco's non-security assets would liquidate, after taxes, at book value.  Probably, this assumption is too conservative.  But our computation of liquidation value is unlikely to be too low by more than two or three dollars per Wesco share, because (1) the liquidation value of Wesco's consolidated real estate holdings (where interesting potential now lies almost entirely in Wesco's equity in its office property in Pasadena) containing only 125,000 net rentable square feet, and (2) unrealized appreciation in other assets (primarily Precision Steel) cannot be large enough, in relation to Wesco's overall size, to change very much the overall computation of after-tax liquidation value.

Of course, so long as Wesco does not liquidate, and does not sell any appreciated assets, it has, in effect, an interest-free "loan" from the government equal to its deferred income taxes on the unrealized gains, subtracted in determining its net worth.  This interest free "loan" from the government is at this moment working for Wesco shareholders and amounted to about $127 per share at yearend 1998.

However, some day, perhaps soon, major parts of the interest-free "loan" must be paid as assets are sold.  Therefore, Wesco's shareholders have no perpetual advantage creating value for them of $127 per Wesco share.  Instead, the present value of Wesco's shareholders' advantage must logically be much lower than $127 per Wesco share.  In the writer's judgment, the value of Wesco's advantage from its temporary, interest-free "loan" was probably about $30 per Wesco share at yearend 1998.

After the value of the advantage inhering in the interest-free "loan" is estimated, a reasonable approximation can be made of Wesco's intrinsic value per share.  This approximation is made by simply adding (1) the value of the advantage from the interest-free "loan" per Wesco share and (2) liquidating value per Wesco share.  Others may think differently, but the foregoing approach seems reasonable to the writer as a way of estimating intrinsic value per Wesco share.


It immediately struck me that such an evaluation could easily be applied to Berkshire, although Berkshire at this point is much more complex than Wesco was then.  Turns out, someone had already done the analysis for 2011 and 2012:

http://seekingalpha.com/article/282116-berkshire-hathaway-worth-its-salt
http://seekingalpha.com/article/740931-berkshire-hathaway-worth-its-salt-2012-update

(As a side note, I had trouble following Dan Braham's line of thinking on this evaluation in the comments of the first article)


This evaluation contrasts from the "investments per share" and "earnings from owned companies" approach, which I believe was advocated by Buffett more recently.


twacowfca

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Re: Munger on Deferred Tax Liabilities and Intrinsic Value
« Reply #1 on: September 28, 2012, 09:00:34 AM »
So, I've been reading Munger's Wesco letters (they are quite repetitive).  However, while reading, I found the following section pretty interesting:

Consolidated Balance Sheet and Related Discussion

As indicated in the accompanying financial statemtents, Wesco's net worth increased, as accountants compute it under their conventions, to $2.22 billion ($312 per Wesco share) at yearend 1998 from $1.76 billion ($248 per Wesco share) at yearend 1997.

The $459.5 million increase in reported net worth in 1998 was the result of three factors: (1) $395.8 million resulting from continued net appreciation of investments after provision for future taxes on capital gains; plus (2) $71.8 million from 1998 net income; less (3) $8.1 million in dividends paid.

The foregoing $312-per-share book value approximates liquidation value assuming that all Wesco's non-security assets would liquidate, after taxes, at book value.  Probably, this assumption is too conservative.  But our computation of liquidation value is unlikely to be too low by more than two or three dollars per Wesco share, because (1) the liquidation value of Wesco's consolidated real estate holdings (where interesting potential now lies almost entirely in Wesco's equity in its office property in Pasadena) containing only 125,000 net rentable square feet, and (2) unrealized appreciation in other assets (primarily Precision Steel) cannot be large enough, in relation to Wesco's overall size, to change very much the overall computation of after-tax liquidation value.

Of course, so long as Wesco does not liquidate, and does not sell any appreciated assets, it has, in effect, an interest-free "loan" from the government equal to its deferred income taxes on the unrealized gains, subtracted in determining its net worth.  This interest free "loan" from the government is at this moment working for Wesco shareholders and amounted to about $127 per share at yearend 1998.

However, some day, perhaps soon, major parts of the interest-free "loan" must be paid as assets are sold.  Therefore, Wesco's shareholders have no perpetual advantage creating value for them of $127 per Wesco share.  Instead, the present value of Wesco's shareholders' advantage must logically be much lower than $127 per Wesco share.  In the writer's judgment, the value of Wesco's advantage from its temporary, interest-free "loan" was probably about $30 per Wesco share at yearend 1998.

After the value of the advantage inhering in the interest-free "loan" is estimated, a reasonable approximation can be made of Wesco's intrinsic value per share.  This approximation is made by simply adding (1) the value of the advantage from the interest-free "loan" per Wesco share and (2) liquidating value per Wesco share.  Others may think differently, but the foregoing approach seems reasonable to the writer as a way of estimating intrinsic value per Wesco share.


It immediately struck me that such an evaluation could easily be applied to Berkshire, although Berkshire at this point is much more complex than Wesco was then.  Turns out, someone had already done the analysis for 2011 and 2012:

http://seekingalpha.com/article/282116-berkshire-hathaway-worth-its-salt
http://seekingalpha.com/article/740931-berkshire-hathaway-worth-its-salt-2012-update

(As a side note, I had trouble following Dan Braham's line of thinking on this evaluation in the comments of the first article)


This evaluation contrasts from the "investments per share" and "earnings from owned companies" approach, which I believe was advocated by Buffett more recently.

Intrinsic value related to what a private buyer would pay for Wesco (BRK was the only possible buyer then) would not assign much of of a premium to BV for things such as some value in the deferred taxes.  However for BRK, Warren has stated that float should be worth more than equity if it is perpetual ( or very long term defacto without declining ).  The same argument would apply to a certain percentage of deferred taxes that could be considered very long term.

These balance sheet valuations still miss the most important consideration: that Warren and his successors and the managers of the wonderful businesses he has acquired will very likely continue to employ BRK's assets and certain "liabilities" at high rates of return.

ajc

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Re: Munger on Deferred Tax Liabilities and Intrinsic Value
« Reply #2 on: August 15, 2014, 02:44:53 PM »

How Buffett Is Changing The Future Of Berkshire's Float From Insurance To Deferred Tax Liabilities

http://seekingalpha.com/article/2428045-how-buffett-is-changing-the-future-of-berkshires-float-from-insurance-to-uncle-sam



randomep

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Re: Munger on Deferred Tax Liabilities and Intrinsic Value
« Reply #3 on: August 15, 2014, 02:56:48 PM »

here Munger has quantified (even though it is just an estimate) the value of the $127 of deferred tax liability to be $30. For our personal finances the same logic should apply. I don't know his logic but one can use his methods to estimate the value of one's holdings when one does not sell a stock in a non-tax sheltered brokerage account.  I have always been looking for a way to weight the cost of keeping a stock and the benefit of the tax-deferred liability.

longinvestor

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Re: Munger on Deferred Tax Liabilities and Intrinsic Value
« Reply #4 on: August 18, 2014, 10:56:26 AM »

How Buffett Is Changing The Future Of Berkshire's Float From Insurance To Deferred Tax Liabilities

http://seekingalpha.com/article/2428045-how-buffett-is-changing-the-future-of-berkshires-float-from-insurance-to-uncle-sam

Thanks for posting. Well reasoned analysis that explains perfectly the push to invest capital into very long lived assets. It also corroborates well with the capital investment priorities laid out in last year's AR, which relegates the search for elephant deals to an occasional priority. With $11B of capital going into BNI and BHE this year alone, the elephants are in the room! 

The depreciation tables hint at what kind of investments are most likely; Railroad tracks and transmission lines(grid) are 80 to 100 years while locomotives, power generating equipment are 30 odd years. Is railroad electrification coming? Diesel fuel cost at BNI was around $3 B last year. They are piloting natural gas locomotives. The utility and the railway can agree on a 100 year supply contract with much of the energy coming from the Sun and Wind ;)

« Last Edit: August 18, 2014, 11:48:32 AM by longinvestor »

ajc

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Changing Berkshire's Float From Insurance To Deferred Tax Liabilities
« Reply #5 on: August 18, 2014, 01:22:42 PM »


How Buffett Is Changing The Future Of Berkshire's Float From Insurance To Deferred Tax Liabilities

http://seekingalpha.com/article/2428045-how-buffett-is-changing-the-future-of-berkshires-float-from-insurance-to-uncle-sam

Thanks for posting. Well reasoned analysis that explains perfectly the push to invest capital into very long lived assets. It also corroborates well with the capital investment priorities laid out in last year's AR, which relegates the search for elephant deals to an occasional priority. With $11B of capital going into BNI and BHE this year alone, the elephants are in the room! 

The depreciation tables hint at what kind of investments are most likely; Railroad tracks and transmission lines(grid) are 80 to 100 years while locomotives, power generating equipment are 30 odd years. Is railroad electrification coming? Diesel fuel cost at BNI was around $3 B last year. They are piloting natural gas locomotives. The utility and the railway can agree on a 100 year supply contract with much of the energy coming from the Sun and Wind ;)


I agree. It's funny that with all the attention Berkshire gets, until now there seems to have been relatively little focus on this area. Soon though, it'll be a bigger float generator than their insurance operations.

Even with those businesses in the room (walking, talking and looking like elephants), the recognition of their fundamental economic characteristics has been slow to follow. It's an unusual and interesting situation.



longinvestor

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Re: Changing Berkshire's Float From Insurance To Deferred Tax Liabilities
« Reply #6 on: August 19, 2014, 06:42:27 AM »


How Buffett Is Changing The Future Of Berkshire's Float From Insurance To Deferred Tax Liabilities

http://seekingalpha.com/article/2428045-how-buffett-is-changing-the-future-of-berkshires-float-from-insurance-to-uncle-sam

Thanks for posting. Well reasoned analysis that explains perfectly the push to invest capital into very long lived assets. It also corroborates well with the capital investment priorities laid out in last year's AR, which relegates the search for elephant deals to an occasional priority. With $11B of capital going into BNI and BHE this year alone, the elephants are in the room! 

The depreciation tables hint at what kind of investments are most likely; Railroad tracks and transmission lines(grid) are 80 to 100 years while locomotives, power generating equipment are 30 odd years. Is railroad electrification coming? Diesel fuel cost at BNI was around $3 B last year. They are piloting natural gas locomotives. The utility and the railway can agree on a 100 year supply contract with much of the energy coming from the Sun and Wind ;)


I agree. It's funny that with all the attention Berkshire gets, until now there seems to have been relatively little focus on this area. Soon though, it'll be a bigger float generator than their insurance operations.

Even with those businesses in the room (walking, talking and looking like elephants), the recognition of their fundamental economic characteristics has been slow to follow. It's an unusual and interesting situation.
Also to note, the $11 Billion capital does not include the tuck in acquisitions. Like Transalta and NV Energy.