Warren Buffett just loves cash – as much as possible because he believes he can use it far more productively than anyone else.
And he has the track record to justify that belief, using the enormous cash flows thrown off by his core insurance companies over the decades to build an empire worth $US770 billion.
Berkshire shares are up 14% in March – well ahead of the wider US market’s 5.4% gain – and they have outperformed the market as a whole since July last year.
Buffett this week revealed the spending of billions more to continue the love affair with insurers and their huge cash flows and the leftover money (floats in business jargon) that can be redeployed into other investments and go on financing the growth of his massive empire.
Berkshire is buying New York-based Alleghany Corp for $US11.6 billion – there is a 25-day period to allow Alleghany to field rival, higher offers. (Berkshire will not match or top those, leaving Alleghany almost certain to accept the Buffett offer.)
That will add up to $US30 billion in new cash, cash flows and investments to Berkshire’s $US450 billion plus of cash and investments – the float of $US146 billion and more than $US300 billion in stockmarket investment that includes major shareholdings in Apple, Bank America, Coca Cola and Amex.
And because Berkshire holds so much cash, when the deal comes to be settled it will be with one huge cash transfer – no debt, no fees to banks and investment advisors.
Buffett says Alleghany will be managed independently as part of Berkshire’s massive insurance business, the largest in the world, meaning its cash will in accounting terms be separate, but in reality become part of the float and the investment portfolio.
In reality Berkshire’s huge insurance business (which includes its giant reinsurance operation) is just one gigantic cash gathering and investing business which also pays claims.
The number 2 US car insurer – Geico – was the first major investment of Buffett in the 1960’s when he was remaking Berkshire Hathaway from being a failed textile company into an investment conglomerate. He has gone on to add giants like General Re and National Indemnity
He has gone on to build a major global position in insurance of all forms – and his key executive, Ajit Jain invented the enormously profitable so-called super-catastrophe type of insurance which has enabled insurers and other companies to hedge or protect their businesses in the event of a major event – say massive floods, tropical storm, earthquake or fire.
Berkshire owns a small stake in Insurance Australia Group – Australia’s biggest general insurer with which Berkshire has a 20% quota share deal which effectively allows Buffett to control IAG through controlling 20% of its premium income and paying 20% of its claim costs.
In his latest shareholder letter, Buffett explained the attraction of insurance (again)
“The insurance business is made to order for Berkshire. The product will never be obsolete, and sales volume will generally increase along with both economic growth and inflation.
“Also, integrity and capital will forever be important. Our company can and will behave well.
“There are, of course, other insurers with excellent business models and prospects. Replication of Berkshire’s operation, however, would be almost impossible,” Buffett wrote.
Now Berkshire is one of the largest insurers in the world and its group of reinsurance have the greatest capacity in this key market that is being buffeted by the impact of climate change and the rising cost of natural disasters.
Over the course of this year quite a few hidden costs from the war in Ukraine have emerged, especially for companies that have leased and insured more than 700 passenger and cargo jets in Russia, as well as the hundreds of companies that have closed or ended involvement in the Russian economy.
The insurance business typically generates around 20% of Berkshire’s annual operational earnings and will get a small boost from the latest acquisition. But more importantly the insurance businesses generate most of the $US146 billion in its cash float and keep replenishing it year after year.
Buffett this year undertook to always have $US30 billion in cash in Berkshire’s accounts at all times – that too will come from the float and cash generation of the insurance businesses which he said in his latest letter
“I believe that it is likely – but far from assured – that Berkshire’s float can be maintained without our incurring a long-term underwriting loss. I am certain, however, that there will be some years when we experience such losses, perhaps involving very large sums.”
Alleghany is the owner of reinsurer Transatlantic Holdings which would expand Berkshire’s large portfolio of insurers, which includes auto insurer Geico, reinsurer General Re, National Indemnity as well as a unit that insures against major catastrophes and unusual risks.
So it’s no wonder this deal was snapped up by Buffett when you look at the latest numbers for Alleghany – of the company’s total assets of $US32.2 billion at December 31, the company has cash and invested assets totalling $US22.85 billion.
In other words, the cash being bought was almost double the $US11.6 billion cost for the whole company!
Alleghany had net premium income of $US7.15 billion (that’s essentially cash coming in the door), and net earnings (not including mark to market gains in the year) of around $US530 million.
Dividends to shareholders totalled $US627.36 million, which will no longer be paid, so that’s more cash staying in Berkshire.
Included in the assets being acquired is more than $US30 billion cash of one form or another. Claims will continue to be paid, but they will come from the returns the huge cash pile generates.
Depending on other investments and share buybacks this year Alleghany’s cash could boost Berkshire’s cash float by to around $US170 billion when the deal is done in the 4th quarter (Just in time to get the growing benefit of rising interest rates, courtesy of the Fed).
While the acquisition is one of the five largest in Berkshire’s history it would reunite Buffett with Joseph Brandon, who led General Re from 2001 to 2008 and became Alleghany’s CEO in December.
General Re is one of the key businesses for Berkshire, along with National Indemnity – both are massive re-insurers of global scale. Along with Geico they are the cash generating hearts of Buffett’s empire.
It would also end Buffett’s six-year drought of large acquisitions and help him to deploy some of the $US146.7 billion of cash and equivalents his conglomerate had at the end of last year.
And besides the cash float and the $US300 billion plus investment portfolio, Buffett pointed out in his February shareholder letter that Berkshire is the single largest private owner of infrastructure assets in the US – $US158 billion at the end of 2021.
That position has been finances by the huge cash flows running through the empire.
The $US11.6 billion cost of Alleghany is dwarfed by the $US27.1 billion spent by Buffett on buybacks of Berkshire shares (and over $US51 billion in just over 3 years). That, though, is an investment in insurance as well as direct buys like the latest deal.
Interestingly, Buffett has spent $US6.4 billion building a significant stake in occidental Petroleum this year.
Buffett owned Occidental shares after helping finance its $US37 billion takeover of rival oil and gas group, Andarko in mid-2019.
Berkshire took $US10 billion in warrants which were paying a high rate of interest (over $US600 million a year) but then sold its ordinary shares in 2020 and sat out until late January this year when it then started rebuilding its stake.
Shares of Occidental have jumped nearly 150% since early February. That price increase has brought Occidental shares to a point just over where Berkshire holds warrants to buy another 83.9 million shares for just over $US59.62 each
Added to the ordinary shares bought last month, the warrants, full converted would give Berkshire a controlling minority stake of 22% of Occidental.
Looked at in another way, it is just cash as well as a leveraged punt from a strong initial position on the short-term price of oil post the Ukraine invasion.
In agreeing to pay $US848.02 in cash for each Alleghany share, a 25% premium over the last pre-bid share price, Berkshire and Buffett is spending what seems a lot of money, but in reality, it is a sure bet on the continuing primacy of cash and the reassurance (doubtful at times) that insurance in its various forms gives individuals, corporates and others.
