The trading world trembled after the bell yesterday with the disclosure that Berkshire Hathaway (BRK) Chairman and CEO Warren Buffett has stage 1 prostate cancer. Berkshire's A and B class shares immediately dropped after regular trading on the cancer headline. The shares recovered most of the drop after details revealed that the illness isn't life-threatening and that Buffett intends to conduct business as usual.
Predictably, the news revived the constant debate on Berkshire Hathaway's succession plan and on precisely how much of a Buffett Premium is built into BRK shares. In the attached clip I discuss with my Yahoo! Finance colleague, Aaron Task of The Daily Ticker, why most of this conversation is misguided and what investors should be focused on.
The real issue isn't whether or not Berkshire "needs" to disclose the identity of Buffett's successor. As Task notes, there isn't necessarily going to be a single go-to replacement for Buffett—there are hints that Buffett's role will be divided amongst several people. The logic of such a split would be not just that Buffett is irreplaceable but that Berkshire is a diversified company.
Buffett disclosed a form of cancer generally thought not to be life-threatening in a timely, honest manner. Most investors can only dream of such responsibility to shareholders.
What scared the market, and what Buffett will bring to the table for as long as he lives, was the possibility of the loss of his personal brand. Buffett is to investing what Michael Jordan is to shoes: the name alone brings immeasurable value.
The reason the stock dropped on the news is best illustrated by 3 deals Buffett has made since 2008, none of which would have been available to any other investor on earth. During the depths of the financial crisis, Buffett put $5 billion and $3 billion into Goldman Sachs (GS) and General Electric (GE), respectively. Both investments were hailed, at the time, as "votes on America" and amounted to endorsement deals.
Buffett's investment in Goldman gave Berkshire a potential 10% stake in Goldman via "perpetually preferred" shares and paid a 10% yield. In the first quarter of last year Goldman bought back the shares, giving Berkshire a $1.7 billion net profit on a 2.5 year investment.
The GE deal pays Buffett $300 million a year, also 10%. Similarly, an investment in Breakout sponsor Bank of America (BAC) pays BRK $300 million and gives it a 10-year warrant with rights to purchase BAC shares.
These were good deals for the companies in question. They were a great deal for Berkshire Hathaway, as no one but Buffett would have carried clout sufficient enough to make said vote of confidence worth a dime. No other investor would have been able to get similar terms from any of the companies in question.
That's $600 million a year in dividends and $1.7 billion in gains that have been racked up since the fall of 2008, due entirely to the reputation of Warren Buffett. Those numbers don't include scores of other deals available to Berkshire solely because of Buffett's value-adding brand.
No succession plan in the world will be able to overcome the loss of the Buffett brand. Placing a value on the Buffett premium starts with trying to calculate the loss of future earnings for Berkshire Hathaway. The company currently trades at a roughly 20% premium to its book value of roughly $170 billion.
Investors in BRK should assume the Buffett premium at somewhere between zero and well over $40 billion and realize there isn't a single thing Berkshire Hathaway will be able to do to offset his loss, either now or after the fact.