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Friday, May 04, 2007

Berkshire Hathaway Q1

10-Q for the period ending March 31, 2007

Here's my quick opinion: looks good, I think they'll survive as a going concern for a while.

$46 billion in cash, perhaps $15 billion is needed for operations, leaving $31 billion ready for opportunity with lots more streaming in. Don't underestimate the value of that. Read the book The Black Swan, there are convincing and simple reasons the future is likely to be more unpredictable than the past [and this trend has been going on for a long time, and in hindsight we don't realize how unpredictable it was]. Luck favors those prepared for it.

I see a huge jump in receivables which, if I understand Item 2 in Management's Discussion, is due to the Equitas deal.
Invested assets at March 31, 2007 exclude approximately $6.9 billion of investments received in April 2007 in connection with the Equitas reinsurance transaction. The estimated fair value of these investments was included in receivables in the accompanying Consolidated Balance Sheet as of March 31, 2007.
Insurance premium revenue is more than double Q1 2006 due to Equitas, but that's deceptive since the associated losses also increased a huge amount. But it's still a significant increase in operating earnings in insurance (22% if my calculations are correct).

Utility revenues are up over 50% from Q1 2006. That's a segment I like to see growing a lot, given what I know about Berkshire. They're currently doing $2.4 billion in construction for regulated utilities. In the notes, much of the revenue increase came from adding PacifiCorp. 23% increase in utilities operating earnings from last year's Q1.

Finance revenues are up something like 40%. Operating profit in finance increased about 14%.

Net income per share is up 12% from last year's Q1.

Always look at the movement of cash in the business
Operations spun off $4.6 billion dollars (way up from the $2.4 billion last year).

Fixed maturity securities (bonds, debt, stuff like that): Berkshire bought $1.5 billion in fixed maturity securities but sold off and/or allowed to mature $5.6 billion. So there's been a noticable shift out of this stuff.

Stocks: Bought $5.3 billion in stock. Sold only $400 million. So there's also a shift into stocks [Berkshire is always trying to shift cash into somewhere, but only when it makes sense].

Acquisitions: $870 million this quarter. Obviously that's going to be a lumpy and opportunistic category ($5.5 billion last year's Q1).

The utilities borrowed roughly a net $700 million.

The main story I see in the cash flow is selling bonds, buying some stocks, and cash increasing by $2.2 billion due to operations spitting out more than investments can use [I could easily see Buffett allocating the entire free cash in a matter of hours if the price is right, so Berkshire holders have about a 10+ year option on any fabulous large opportunities that may show up... and the cash will not be squandered].

I think Berkshire paid $870 million for TTI.

On average, Berkshire's current stock investments have been roughly a two-bagger. That's not a useful measure except as a lower limit on how well Berkshire is doing in that area.

Berkshire is essentially borrowing $18 billion from the government by deferring taxes (probably mostly capital gains on investments).

The IRS is trying to get Berkshire to pay more tax based on the timing of insurance things, but Berkshire is appealing it. Regardless, Berkshire shows it in the financial statements based on the standard accounting formulas. The amount is currently $857 million.

28,710 "A" shares were converted into "B" shares during the quarter, leaving about 1.1 million "A" shares and 13.6 million "B" shares.

Investment gains decreased by about $1.9 billion this quarter.

I skipped over the General Re legal part.

Segment Revenues
GEICO: up (8.3% increase in premiums earned)

Gen Re: up but that's probably meaningless. Property/casualty normal business is down and they're doing it on purpose to avoid unprofitable business (that's been the plan and it's good)

Berkshire Hathaway Re: up by a factor of 8 due to Equitas. Actual premiums written this quarter were down 41% due to crappy pricing that Berkshire wants no part of. Another sign of a heating economy.

McLane: up 8%, both price increases and new customers

MidAmerican: up 18% due partly to colder weather than 2006, but still some expansion

Shaw: down 11% due to 12% drop in carpet sales, all due to the housing slowdown. No big deal, Shaw is still doing well.

Other (bricks, paint, shoes, underwear, etc): up 23%, but mostly due to acqusitions. Building products down 9%.

Services (jets, ice cream, newpapers, kitchen tools, sheesh): up 28%

Total (excluding BH Re's lumpy increase): up about 11%

Segment Earnings
GEICO: down (on purpose, they lowered rates in some markets presumably to widen the moat... it's the Ray Kroc garden hose thing) and will continue down. They value the float and the market share with GEICO.

Gen Re: down due to property/casualty swinging way down to a loss due to Euro storms while life/health is up

Berkshire Hathaway Re: massively higher due to Equitas

McLane: up 5% but gross margins are down very slightly which must be carefully controlled for a low-margin business like that. Other expenses were down, however.

MidAmerican: up

Shaw: down 41% due to the housing slowdown, but they're still earning $91 million! Stick in your eye, doomsayers.

Other: up 36% due to acquisitions

Services: up 128%! mostly due to NetJets, thankfully (a fast growing business that people like to think about rather than Dairy Queens which are typically dirty and not at all glamorous... although money doesn't stink as they say in Russia). Acquisitions also helped.

Keep in mind that insurance earnings are largely guesswork (and it really depends on who is doing the guessing), but showing any real long term profit is gravy since the real benefit is the float.

Buffett doubled his money on junk bonds. All the other fixed maturity securities did about what you'd expect.

Berkshire has $1.8 billion in mortgage backed securities.

The real estate brokerage business is not doing all that badly considering it was winter and the expected unexpected real estate downturn

The natural gas pipelines look like a cash cow, but that was during winter when they make their money.

NetJets revenue for the quarter increased by $300 million over 2006's Q1. They earned a profit of $36 million thanks to increased prices and a better mix of planes. 14% more jets.

The glorified-mobile-home revenues are down slightly, but profits are good.

The famous foreign currency hedge took a tiny hit this quarter.

The SQUARZ warrants expire this month... has it been that long? The warrants are each now $2,192 in the money, so all the warrants together are worth $8.1 million associated with Berkshire's borrowing of $334 million. There was a warrant premium payable to Berkshire (the negative interest rate) at essentially 0.75% per year? If I have this right, the lenders paid Berkshire around $2.5 million and the warrants they hold are worth $8.1 million. Berkshire essentially borrowed $334 million for four years at a cost of only $5.6 million. Buffett wins. Is anyone surprised?

If I had to disappear for 10 or 20 years and had to park my money somewhere, I'd probably put a large part of it in Berkshire Hathaway. I understand the business enough to have a good idea of how it will behave going forward. I figure it will take at least two more generations of management before they would even begin to do any stupid things. And Berkshire would be a great deal more difficult to destroy than most other businesses. The corporate culture is about as good as it gets, and I've seen first hand how much that impacts operations, even far from HQ. The businesses are mostly excellent. Buffett has made a lot of decisions that add value without it being immediately apparent, so it's better than it looks. The structure of everything is carefully crafted for exactly what I would want as an owner. Buffett and Munger spent decades figuring it out and setting it up very well.

The business is not insanely cheap, but I believe it's clearly worth more than the market is paying for it.

Reading The Black Swan now, it confirms the way I look at businesses: looking for reasons not to invest based on characteristics I understand. But based on the what the book says, I should reject that confirmation, burn the book, stomp on the ashes, and continue writing my anti-resume.

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