Not only has Warren Buffett’s Berkshire Hathaway once again made all the sceptics look very wrong with a sharp ride up the surging financial markets in the September quarter, but he’s also surprised by revealing plans to borrow up to $US8 billion to finance part of the cash component of the huge takeover offer for the Burlington Northern railway company.
Berkshire said Saturday morning (Australian time) that third quarter profit more than doubled to more than $US3 billion as it benefited from the recovery in the value of its huge equity investments and financial derivatives exposures.
Some of the company’s insurance businesses also were boosted by a lack of major catastrophes such as hurricanes during the quarter.
Third-quarter net income came in at $US3.24 billion, compared with $US1.06 billion a year earlier when results were hammered by the start of the final round (as yet) of the credit crunch and the deepening recession.
Berkshire’s earnings were even higher than third-quarter profits at Goldman Sachs, Wall Street’s most profitable bank and one of Mr Buffett’s newer holdings.
Operating earnings, which exclude investment and derivative gains and losses, were $US2.06 billion in the latest period. A year ago, Berkshire generated operating earnings of $US2.07 billion.
Berkshire reported a book value of $US81,247 per Class A equivalent share at the end of September. That was up 15.2% from the end of 2008 and up 10.1% from the end of the second quarter, the company noted. Book value is an important measure of companies, especially those such as Berkshire which drive much of their value from accumulating assets of different earnings potential.
Shares of Wells Fargo & Co, a big bank, and American Express Co, were two large Berkshire holdings to rise in the third quarter, up 16% and 46% respectively.
US Bancorp is another big holding and its shares also outperformed the 15% rise in the Standard & Poor’s 500 index in the quarter.
That rise in the market naturally lifted the value of many of Berkshire’s equity investments.
A big reason for the gain though was a huge rebound in the value of a series of financial derivatives which had been losers in 2008 and in early 2009.
But this time Berkshire reported derivatives gains of $US1.13 billion during the latest quarter, a $US2 billion plus turnaround from the loss of $US819 billion reported in the same quarter of 2008.
The company said the gains in the latest period mainly came from credit-default contracts the group wrote, and also from long-term put option contracts Berkshire wrote on major equity-market indexes, such as the S&P 500.
Most of these agreements were set up before the financial crisis in 2008.
The contracts don’t mature for 15 to 20 years, and Berkshire doesn’t have to post collateral to its counterparties.
The company also got billions of dollars up front for taking on these risks, and that’s money Buffett has been investing in deals such as buying high yielding debt/equity like securities in General Electric, Goldman Sachs, Tiffany’s, Swiss Re, etc.
These are paying 5% to 12% and Buffet’s $US5 billion of Goldman securities (convertibles) is now worth $US7 billion. Others have risen in value.
All up around $US23 billion has been invested in these companies, earning more than $US2 billion a year in interest income for his insurance companies, instead of being invested in government securities and generating at most around $500 million annually, depending on the maturity of the bonds.
But it’s the Burlington Northern Santa Fe Corp, at $US44 billion, Berkshire’s largest ever investment, that continues to attract attention.
After the deal was announced, Standard & Poor’s said it may cut Berkshire’s AAA ratings on concern the deal will use up a chunk of its large cash hoard.
Berkshire said Friday that it had $23.84 billion in cash at the end of September. However, roughly 60% of the $26 billion purchase price for Burlington will be paid in cash.
So it was a major surprise that in a regulatory filing late Friday, Berkshire said it now "expects to fund about 50% of the total cash consideration of approximately $US16 billion with internally generated cash and the remainder with borrowings expected to be repaid over a three-year period".
Buffett is famous for shunning debt and paying cash (the share component of the offer is the first time he has offered Berkshire paper in a decade).
The fact that he had less cash than the $US26 billion needed to make it an all cash deal, explains the borrowings, which will boost the leverage in Berkshire. It also explains the need to issue paper to entice smaller Burlington shareholders to remain with the group as shareholders in Berkshire (and why he’s splitting the Berkshire B class shares 50 times as well).
Assuming no other changes, Berkshire will be left with cash of around $14-$US15 billion once the Burlington deal is done.
Berkshire’s insurance businesses generating underwriting profit of $US363 million in the third quarter, up from $US81 million a year earlier.
Low interest rates continue to depress returns inside the insurers who invest their surplus cash in high grade bonds and securities.
Revenue rose 7.1% to $US29.9 billion, with insurance operations posting a 5.5% rise and utilities a 15% fall.
Finance and financial products operations posted positive revenue of $US2.87 billion, compared with a $US5 million loss.
Investment earnings in the insurance operations rose 21% to $US976 million.
Berkshire Hathaway Reinsurance Group made an underwriting profit of $US167 million in the third
