Warren Buffett’s Still Got It

I attended last weekend’s 2019 Berkshire Hathaway Annual Shareholder meeting. During the well-known portion of the day when Charlie Munger and Warren Buffett field questions from shareholders, I was disheartened by the sheer number of questions that not so subtly asked Munger and Buffett about their deaths (questions they’ve been receiving for three decades now, or over half of a typical American’s working career), the underperformance of some particular Berkshire subsidiary against a competitor, and complaints about Berkshire Hathaway’s $110 billion cash hoard.

You would swear that Berkshire’s cash pile is burning a hole in some of these shareholder’s pockets.

What Buffett has made clear throughout his management of Berkshire Hathaway is that he does not care about Berkshire’s outperformance against the S&P 500 Index over a particular period, but rather, that he grows Berkshire’s “intrinsic value” at the highest rate possible and hopefully this will exceed the performance of the S&P 500 over long periods of time. But it is intelligent day-to-day decision making for the business, rather than worry about the day-to-day fluctuation in the stock price, that has driven Buffett’s and by extension Berkshire’s uncommon success.

You know what I found crazy through all of this?

Within the week prior to the meeting, Warren Buffett executed a deal that proved investors remain better off sticking with him than anybody else. I’m referring, of course, to Berkshire Hathaway’s extension of $10 billion to Occidental Petroleum so that it could purchase Anadarko Petroleum.

Now, I don’t talk about Occidental on the website ever because I was terribly put off by the $1.2 billion in stock compensation that Ray Irani received between 1994 and 2012 as CEO of Occidental. I can stomach extreme pay for founders, and I can tolerate investing in a business with high stock compensation if the growth (adjusted for dilution) justifies it, but the Occidental Board’s justification of Irani’s greed made me not only eliminate Occidental as an investment on the stock dilution grounds, but I also omitted it on the basis that I question the other decisions that the management and board make on a day-to-day basis if they are the type of people that can indulge in those kinds of pay plans.

But that is a separate matter from Buffett’s investment. Warren Buffett gave Occidental $10 billion exchange for $800 million in preferred stock dividends that are payable in $200 million installments every 90 days for the next ten years. A guaranteed 8% return from 2019 through 2029 is quite nice, and may even continue beyond that as the preferred stock continues until Occidental redeems it (the terms of the issuance make it unredeemable for the first ten years).

Oh, and the cherry on top? Buffett can spend $5 billion buying up to 80 million shares of Occidental at a price of $62.50. Like the preferred stock, Buffett does not have to make this decision for 10 years, plus he gets until a year after the redemption after this occurs to make his decision.

80 million shares of Occidental amounts to roughly 10% of the entire company. If the stock is at, say, $130 in 2030, Buffett is looking at laying down $5 billion to turn into $10.4 billion. That is an instant $5.4 billion in profit that comes with the benefit of being guaranteed/known at the point of purchase–i.e. To whatever extent Occidental trades at $62.50 or higher in 2030 (due to minimum one year add-on period to exercise warrants) or later, Berkshire creates an instant profit for itself. To whatever extent Occidental trades at $62.50 or below in that time frame, Berkshire can satisfy itself with the 8% return.

Those are incredible terms. And Buffett will still have $100 billion to deploy (that is now replenishing itself at $100 million per day shipped to accounts that he controls from his headquarters on Farnam Street). Nike’s market cap, for reference, is $105 billion right now. He could sit still for a year or two, issue a little bit of Berkshire stock, and make a mostly cash offer for the company and add substantial ballast to Berkshire’s cash-generating engine.

It’s incredible. The man has compounded wealth at 19% for over half-a-century. Despite this track record, he has his abilities questioned as he faces the limitations inherent in Berkshire’s massive size and impatient investors can’t appreciate Berkshire’s conservatism with its cash position. Amidst this backdrop, he is deploying $10 billion in a minimal-risk manner to earn 8% dividends and create an option for a lot of wealth to spring forward in the event that the oil production in the Permian Basin takes off with higher oil prices.

Heads, Berkshire wins billions of instant profits, tails, Berkshire gets $800 million annual dividends. Yeah, I’d say Warren Buffett has still got it.

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