While Berkshire Hathaway's (BRK.A/BRK.B) annual meeting is always entertaining, it hasn't typically been a big source of meaningful insights into the firm's operations. We can say that it has been an opportunity for shareholders to see and hear Warren Buffett and Charlie Munger respond to the questions a panel of journalists and financial analysts fire at them, as well as from the shareholders themselves. That said, between the pre- and postmeeting interviews the two men conduct, and the comments they make during the question-and-answer segment, we are always able to come away with a few nuggets of information that help to shape our thinking about Berkshire's operations, especially in relation to capital allocation and investments, and this year's meeting was no exception.
Berkshire faces a bevy of questions at this year's annual meeting. For several years now, the main focus of Berkshire Hathaway's annual meeting has been the question-and-answer segment that Buffett and Munger hold. The two men field questions from a trio of financial journalists, a trio of financial analysts, and from shareholders in attendance. This format supplanted the more traditional method of just taking questions from shareholders, and, in our view, has added a lot more value as it has helped to focus a substantial portion of the question-and-answer segment on more company-specific topics.
Berkshire's excess cash should be thought of as dry powder. Berkshire's sizable cash position continues to grow through the normal course of its business, and despite making investments and funding acquisitions over the course of the past two years, the firm still closed out 2012 and 2013 with more than $45 billion in cash and cash equivalents on its books. Buffett likes to keep $20 billion on hand as a backstop for the insurance business, which we believe is prudent, so the firm's excess cash balances have been north of $25 billion the past two years.
Critics and we have been among them have been quick to point out that keeping such large cash balances on hand, in the hopes that Berkshire will eventually be able to bag a large ‘elephant’, is counterproductive in a period of historically low interest rates. While the company does have a share repurchase program in place that could soak up some of this cash, neither of Berkshire's share classes have reached levels that would satisfy the repurchase criteria that Buffett has put in place and are unlikely to do so in the near term. This has typically led us to the conclusion that absent any other productive investment opportunities that the firm should be returning cash to shareholders by paying a dividend—even if it is only a one-time dividend.
Buffett's resistance to Berkshire paying a dividend is fairly well-known. He dedicated three of 24 pages in last year's annual letter to shareholders laying out the reasons the firm would not pay a dividend as long as he's running the show, and was forthright in his opposition to a shareholder proposal this year that suggested that the company consider "paying a meaningful annual dividend" as Berkshire already "has more money than it needs and since the owners, unlike Warren, are not multibillionaires."
Berkshire is suffering from a lack of sizable investment ideas. Acquisitions have historically been a major part of Berkshire's business and value creation, a trend that we expect to continue. Buffett has been fairly explicit over the years about his acquisition criteria, noting once again in this year's annual letter to shareholders that he and Munger are eager to hear from businesses that: 1) would be large enough to be meaningful (with the threshold being $75 million of pretax earnings or, at the very least, an ability to be folded into one of your existing units); 2) have demonstrated consistent earning power; 3) are earning good returns on equity while employing little or no debt; 4) already have good management in place; 5) are simple businesses; and, 6) are reasonably priced. Buffett has also been clear about his preference for direct ownership of businesses; however, he has been willing to own parts of businesses that meet his investment criteria via holdings in common stocks.
Over the past year and a half, Berkshire has been fairly active on the acquisition front. The company partnered with 3G Capital in February 2013 to acquire Heinz in a deal that had Berkshire buying up half the equity of the packaged foods firm for $4.25 billion and investing $8 billion in Heinz 9% preferred stock.
On top of that, MidAmerican Energy not only acquired NV Energy in a $5.6 billion deal at the end of last year, but recently made a $2.9 billion bid for AltaLink, the largest transmission company in Alberta, and is likely to do even more deals going forward. Aside from this, there has been a lot of bolt-on acquisition activity from Berkshire's other subsidiaries, which initiated 25 deals during 2013 for a total cost of $3.1 billion. On top of that, the firm paid out $3.5 billion last year to round out its stakes in Marmon and Iscar.
Although most of these deals are expected to be beneficial to Berkshire, given that they deploy capital in activities that fit with existing businesses and end up being managed by existing managers, they've done little to decrease the company's large cash balances. With the markets trading at/near all-time highs, the valuations for most firms at elevated levels, and the company doing little to move the needle with these kind of deals, we have to wonder when Buffett will ever bag the elephant he's been looking for since closing out the Burlington Northern deal just over four years ago. While we have questioned the logic of sitting on $25 billion in excess cash (earning next to nothing in an environment of historically low interest rates), Buffett and Munger seemed to dismiss the notion that Berkshire should target a larger collection of smaller companies that are growing faster, and could do so for a longer period of time, rather than looking to bag a big elephant that has in all likelihood already reached maturity.
While Buffett has admitted that these two things are not mutually exclusive—that pursuing a large deal doesn't preclude Berkshire from going after smaller deals—he would much rather bag an elephant with the cash that the company has on hand. He believes that Berkshire's universe of competitors for these types of deals has diminished—as private-equity firms seems to be more focused on buying smaller firms, swapping their holdings among themselves, or partnering up with firms like Berkshire to do bigger deals—the opportunity set has never been better for the firm to pursue much larger deals. Buffett even surprised us over the weekend, when he noted that the level of dry powder Berkshire has to do a large deal could be enhanced by selling securities in its equity portfolio, raising questions about the sanctity of legacy holdings like Wells Fargo (WFC), Coca-Cola (KO), American Express (AXP), IBM (IBM) and Procter & Gamble (PG).
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