asd Berkshire Hathaway The Ultimate Conglomerate Discount
January 1999 BRKA0120 AS
Alice Schroeder (212) 713-4977 Gregory Lapin (212) 713-4980
asd Berkshire Hathaway: The Ultimate Conglomerate Discount We have initiated research coverage on Berkshire Hathaway Inc. with an Attractive rating. Berkshire Hathaway is a company that often appears to receive the ultimate conglomerate discount: Investors overlook the company’s successful operating businesses, valuing the company as a closed-end fund. In this report, we present three alternative ways to value Berkshire Hathaway that suggest that a premium to book value is appropriate, as for any operating enterprise with a long history of consistent profitable growth. Since its early days, Berkshire’s first-choice use of capital has been to own 100% of an operating business it finds attractive, rather than to own only part of such a company through a public equity investment. Today, we view the company as primarily an operating company that also has a sizeable investment portfolio. •
Berkshire Hathaway directly employs 45,000 people around the world, in businesses ranging from aircraft fractional ownership sales to vacuum cleaner manufacturing.
Berkshire’s 1997 pro forma operating revenues of $17.4 billion would rank 75th in the Fortune 500. Its operating earnings of $1.518 billion, excluding investment gains, would rank 54th.
Berkshire is primarily a property-casualty insurer. Seventy-nine percent of both its $18.6 billion total pro forma revenues and its $1.5 billion operating earnings are derived from insurance.
Berkshire’s insurance operations are the fourth largest in the U.S. based on premiums, the largest based on surplus and the second largest based on market capitalization. By themselves, the insurance operations would rank 100th in the Fortune 500 based on 1997 pro forma revenues and 67th based on 1997 earnings.
Berkshire’s noninsurance operations, by themselves, and excluding all earnings from dividends and interest, would rank 391st in the Fortune 500 based on 1997 pro forma revenues and 243rd based on 1997 earnings.
In this report, we review Berkshire’s business from four different perspectives—based on the sources of its market capitalization; from an operating segment perspective; as a capital allocating machine; and as an acquirer, manager and builder of well-run businesses with a “virtuous circle” of competitive advantages. As a stock, BRK’s performance has been superb. It has underperformed the S&P 500 in only four of the past 33 years. The compounding effect of this outperformance has been even more impressive: $10,000 invested in BRK in 1965 would have been worth $51 million on December 31, 1998, compared to $132,990 for the S&P. Our valuation work reviews Berkshire’s valuation extensively using three methods—a “float-based” valuation, a book value-based valuation and an earnings-based valuation. We have provided sensitivity information so that readers can adjust our assumptions if they so choose. We believe that the intrinsic value of BRK today, using conservative assumptions, is $91,000-97,000 per share. Valuing the equity securities in Berkshire’s portfolio at a significant discount to their market valuations would reduce this number to $67,000-92,000 (depending on the degree of discount). Therefore, we view BRK’s price as including a significant margin of safety at its current valuation. Finally, in this report, we discuss the operating businesses of Berkshire in some detail, particularly the insurance businesses, which we believe are more difficult for investors to understand. We also review the aviation businesses, including the recently acquired Executive Jet, which we expect will be the other key driver of Berkshire’s growth.
asd Table of Contents Page Our Approach to Following the Stock.......................................