Buffett buybacks: Could Berkshire tender stock?

[alwaysinvert]

I wrote a blog post speculating about this. I'll paste it here but if you want to read it in a better format here's the link: http://vardeinvesteraren.nu/vardeinvestering/buffett-buybacks-could-berkshire-tender-stock/

Two weeks ago Berkshire Hathaway removed their set buyback level of 1.2x book value. The stock reacted by trading up 5% the following session. However, I think the momentousness of this action is heavily underappreciated by the market. In my view this is a far bigger step than when the original buyback policy of 1.1x book (later revised upwards) was instituted.

The reason why I think this is a watershed moment lies in the answer to this question: why wasn’t the book multiple just once again raised? Let me try and answer that question in a roundabout way.

If you have followed Berkshire for some time you’ll know that the former policies, perhaps unwittingly, established soft floors to the stock trading, such that Buffett hardly managed to do any buybacks at all. That was probably mostly OK for Buffett and worked out pretty well for the Gates foundation, in that they got a ”guaranteed” buying price in the market. Buffett didn’t really want to repurchase Berkshire shares if he had other alternatives; in the past he has looked at it as taking slight advantage of his less sophisticated partners (the selling shareholders) while also having superior information. This issue is of course also a big reason why he vowed not to make any repurchases prior to the release of the Q2 report on August 3.

Another raise of the buyback level to say 1.3x book would likely also establish a floor. Keeping in mind the tax cut and the heightened importance of the operating businesses inside Berkshire, such a move would make perfect sense as a signal of what is now considered ”below intrinsic value, conservatively determined”. However, what’s slightly different this time is that Berkshire is sitting on an ever-growing pile of cash, now safely over $100 billion (Buffett still wants to keep around $20 billion cash as a cushion no matter what), while its investment universe is dwindling fast.

The last ”elephant” Buffett shot was Precision Castparts three (!) years ago. He would need three more acquisitions (!!) of that size to move most of the cash that he already has. And another one in a year again, probably. Not very likely to happen in today’s market.

In light of all that, this is basically Buffett admitting defeat. He just can’t allocate all that capital within the company anymore. Knowing how much he abhors taxes, the natural second choice then is of course share repurchases, rather than dividends. In short, I think the inherent ambiguity of the new policy is a deliberate feature – he really wants to buy back stocks this time.

But how will the buybacks be executed? If done over the market he’ll have to move lots of volume and will risk the price moving away from him as soon as the market gets clued in to the magnitude of what is happening. Dribbling ”a mere” couple of billions in buybacks per year will not make much of a difference, so the purchases are going to have to be very aggressive and represent a sizable portion of the trading each day to even stand a chance at paring down the cash pile.

Warren

A tender offer?

An alternative to this – that I have never seen mentioned anywhere else – could be if Berkshire made a tender offer for some amount of the shares. As some of you may know Buffett’s big idol among corporate leaders, Henry Singleton, utilized buyback tenders to great effect, retiring 90% of the shares outstanding of Teledyne in about a decade. The thought of making a tender offer to Berkshire shareholders has most certainly entered both Buffett’s and Munger’s minds more than once. Curiously, I have never heard them consider this action out loud in public. When you think all the questions have been asked at the shareholder meetings…

The big issue with a tender is of course the tradeoff between the acceptance rate and the premium offered.. Would people not just think Buffett was making an offer that was easy to resist? Well, if contrasted favorably with the former buyback level, some amount of private shareholders could probably be persuaded. A PR campaign with a CNBC guest spot by Buffett might also help with that.

There are also lots of big funds and other institutions who hold Berkshire stock and they might take the offer as an easy way to reallocate parts of their position with less friction involved. Correctly structured, the offer could also make the weak hands sell the stocks to arbitrageurs, thus securing even higher acceptance. One shouldn’t underappriecate how enticing a premium can be to stockholders, whether they are Buffett groupies or not. Making a big enough splash with the tender size should ready investors for this to have a one-off character (an argument Bufett time and time again has made against dividends is that when instituted, the owners expect it to be ongoing), thus feeding expectations that the stock price will subside back to lower levels again once the tender is done and dusted, prompting higher acceptance.

Another thing in favor of a tender offer is a fairness argument. As opposed to market buybacks, there is nothing sneaky about a tender offer. We know that Buffett cares about such things, but I dare not say how important this consideration could be. Conceivably more so if the plan is to retire a huge amount of shares, as opposed to in the past.

Last but not least, the combined daily average trading volume of A and B shares amounts to almost $900 million per Yahoo finance. That is, for Berskhire to deploy $100 billion at current prices they would have to be the sole buyer of shares for 111 straight trading days. Of course, that is a literal impossibility, but you clearly see how far the timeline is drawn out by using any reasonable but still aggressive assumption such as 20% of the average volume. The simple fact is that it is nigh impossible for Berkshire to put a really big dent in their cash pile with running buybacks. Additionally, in the pursuit of shares at a fast enough clip, the share price is extremely likely to enjoy a good ride.

For further evidence, consider Apple’s behemoth buyback program of $100 billion, which it manages with a clip of roughly $20 billion per quarter. That’s with a daily average stock trading volume of $4.6 billion (Yahoo), which makes their buyback roughly 7% of daily volume. Apple could conceivably buy back way more way faster than that with a cash balance o $250 billion. Perhaps their reasons not to include that it would move the price too much.

While I think the tender scenario for Berkshire is far above a non-zero percent possibility, a regular, but sizable, buyback is probably still the safest assumption to make. However, a market buyback strategy won’t likely solve the issue of the accumulated cash balance.

An asymmetric situation

No matter what avenue of buying back shares that is chosen, it will be done in size and with relative swiftness. The Q2 report will likely show that Berkshire trades just above 1.3x book at current market prices of just shy of $200 for the B-shares. I will not go into a big valuation exercise here (there are lots of them out there for those so inclined), but suffice to say that I view this as cheap, perhaps very cheap, and see it as unlikely that the stock will move much lower from here, bar unfortunate deaths, a super cat or some macro event affecting all market prices.

I also harbor a great suspicion that Buffett is now actually willing to buy back shares a bit above current levels. In some way or other he is likely to, by sheer necessity, affect the stock price in the coming months. An additional slight upside for the B shares is that the tiny discount that has opened up against the A shares (presumably in part due to technical selling pressure from the Gates foundation), may start closing again when a huge entirely economically motivated buyer enters the market.

My good friend David suggested that the rather muted response to the buyback policy change could depend on the extreme size of Berkshire. ”Who is going to move that much stock in a controlled company in response to such a vague policy change?” Be that as it may, it is a rather scintillating thought that an inefficiency could be because of huge size, rather than in spite of it. No matter if that hypothesis is correct, an agile mind is important in all markets.

Disclaimer: Long BRK

[sleepydragon]

Is it possible for a company to remove itself from S&p 500? Say, Berkshire do a reverse split of B shares or merge B shares back to A shares,, thus perhaps disqualify itself.  Then Berkshire structures a deal to buy back all the shares that index tracking funds are holding.

[LC]

I don;'t think so. S&P includes them based on market cap. Only way to do so would be to de-list.

[Dynamic]

I think the buyback, assuming there's no tender offer or large block purchase, is likely to merely keep the cash growth in check, perhaps stopping cash from exceeding float and maintaining that low-risk uncallable leverage. I wouldn't be surprised to see Berkshire take 5 to 10 years to gradually reduce the cash balance towards $20bn through buying a small fraction of daily volume. In reality, there may well be a modest bear market in 2-5 years, allowing Berkshire to make some meaningful acquisitions or other sensible capital allocations, which could put a sizeable chunk of its cash to work.

[gfp]

The Gates foundation and various Buffett family foundations are more likely sources of large blocks than S&P index funds.  But I suspect Berkshire will primarily just repurchase shares in the open market - they do have a half trillion dollar market cap and the B's are fairly liquid.  Occasionally a large shareholder will die or otherwise make a large block available - similar to the only large repurchase accomplished so far.  If other companies can do it through open market purchases, so can BRK.

We've seen the daily liquidity increase from Gates foundation selling in their filing.

I doubt Berkshire cash levels will ever get below $40 billion again.

[longinvestor]

The more I think about it, the more likely scenario is that “nothing has changed“ with regards to their buyback posture. It’s still intended for the long term, still a pressure relief valve for the next guy and very much  “conservatively calculated”. The biggest signal Buffett maybe sending is that BV is not their yardstick longer term. Per share Earnings is. The fixation with the BV multiple ended, it would not allow them to buy well over $100 B worth which’s what they need to do over the next decade.

[alwaysinvert]

But I suspect Berkshire will primarily just repurchase shares in the open market - they do have a half trillion dollar market cap and the B's are fairly liquid.

Did you read my basic calculations about an open market buyback? The B shares don't seem all that liquid for their purposes from what I can tell, but I could be wrong.

it would not allow them to buy well over $100 B worth which’s what they need to do over the next decade.

They'd need way, way more than that over the next decade, barring any mega-merger. It's not hard to see them earning north of $300b with already $100b+ in cash.

[gfp]

I hadn't read that far but now I have.  It's not a lot of daily volume, but there are several selling shareholders also constrained by the low turnover, so there is a lot of room for average daily volume to increase.  Whether or not there are direct block transfers between the Gates Foundation and Berkshire, both can increase the ADV over time.  You are right though - it will be very difficult to make a material dent in either share count or cash levels without a tender (and a tender seems unlikely).

But I suspect Berkshire will primarily just repurchase shares in the open market - they do have a half trillion dollar market cap and the B's are fairly liquid.

Did you read my basic calculations about an open market buyback? The B shares don't seem all that liquid for their purposes from what I can tell, but I could be wrong.

it would not allow them to buy well over $100 B worth which’s what they need to do over the next decade.

They'd need way, way more than that over the next decade, barring any mega-merger. It's not hard to see them earning north of $300b with already $100b+ in cash.

[John Hjorth]

Here I'm reposting some basic Berkshire figures [from some of my earlier posts, updated with 2017 figures] - from a birds perspective - related to the topic, just to bring specific data into the discussion. I think they are handy to have here:

Some numbers for the last ten years:
 
 Year - Cash YE [incl. T-Bills] - Equity YE [USD M]:
 
 2007 -   44,329 - 120,733
 2008 -   25,539 - 109,267
 2009 -   30,558 - 135,785
 2010 -   38,227 - 162,934
 2011 -   37,299 - 164,850
 2012 -   46,992 - 187,647
 2013 -   48,186 - 221,890
 2014 -   60,033 - 240,170
 2015 -   67,161 - 255,550
 2016 -   86,370 - 282,070
 2017 - 115,954 - 348,296 [2017 tax cut effect [net] +28,200]
 
 Average shares outstanding YE2007 : 1,545,751 [A eq.]
 Average shares outstanding YE2017 : 1,644,615 [A eq.]

Cash flow from operating activities full years this century [USD B]:
 
 2000:      2.947
 2001:      6.574
 2002:    11.135
 2003:      8.438
 2004:      7.405
 2005:      9.446
 2006:    10.195
 2007:    12.550
 2008:    11.252
 2009:    15.846
 2010:    17.895
 2011:    20.476
 2012:    20.950
 2013:    27.704
 2014:    32.010
 2015:    31.491
 2016:    32.525
2017:    45.776

Total:  324.615 [<- ~USD 325 B!]

Float YE 2000 : USD 27.9 B
Float YE 2017: USD 114.0 B

[Increase in float is included in cash flow from operating activities.]

[SwedishValue]

Thanks John Hjorth, really helpful post for perspective.

CNBC posted this. Guess we will know soon. I checked precious releases bad they have been both fridays and saturdays, so if there is anything to read into the postponement it should be that it might be a postponement for a reason? 

https://www.cnbc.com/2018/08/03/buffetts-berkshire-could-reveal-share-buy-back-plan-saturday.html