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Berkshire Hathaway Inc. Message Board

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  • Novalis_97 Novalis_97 Jul 5, 1998 3:01 AM Flag

    Need some advise

    Each General Re share can be traded in for either
    0.0035 BRK Class A shares or 0.105 BRK Class B shares.
    These exchange ratios are set in stone, even if the
    price of Class A or Class B shares tanks in the future.
    Right now, BRK Class B shares are $2,588 per share.
    0.105 of $2,588 is $271.74. This is above General Re's
    current share price of $256. So you could easily make a
    guaranteed $15-16 per General Re share by buying General Re
    shares right now and waiting for the merger to be
    finalized in the fourth quarter. You could make more than
    $15-16 per share if BRK Class B shares continue to rise
    for the rest of the year. For instance, if Class B
    shares hit $3,000 a share in the fourth quarter (and if
    you bought General Re now at $256 per share), then
    each General Re share would be valued at $3,000 *
    0.105 = $315 per share -- but you'd have only paid $256
    for it.

    Buffett obviously believes General Re
    is undervalued, despite reports in the media that he
    is paying a "premium" for General Re. While it's
    true that paying 0.105 a BRK B share for a General Re
    share results in Buffett's paying around $270-275 for
    each General Re share, which was selling at around
    $225 before the merger announcement, Buffett is still
    paying only $20-22 billion for $24 billion in General
    Re's "float." It's like Buffett is paying out $20-22
    billion but getting $24 billion automatically in return
    -- a profit of $2-4 billion that he can immediately
    pocket. It's not everyday someone just gives you $2-4
    billion for free. To Buffett, being able to use money is
    as good as the money itself. In no time, Buffett
    will be able to use that float to generate 24% annual
    returns as he's been doing for the last 40 years. I
    personally am buying American Express big-time because
    Buffett recently petitioned and received permission from
    the Federal Reserve to increase his AXP stake from
    10.6% to an astonishing 17%.

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    • I think I understand float, but some of your math
      makes me think, maybe not. So help me:

      assume you have just two items on the balance sheet -
      $20 billion in cash (float) and $18 billion in
      obligations to policyholders. I say the equity is $2 billion
      and you had better not get excited about buying $20
      billion in float for "only" $15 billion. There are simply
      cheaper ways to get the money to use for

      Not that this is what is being done with BRK and
      General Re, just that you can't take the amount of the
      float in isolation.

      If there is anyone out
      there with a good accounting background who has
      crunched the numbers on this merger, I'm sure your
      analysis would be welcomed on this board.

      • 2 Replies to ftex
      • I think your comments on float are appropriate.
        There are people, including myself, who add back the
        float when valuing BRK. Buffett does so also. However,
        to simply say "float is the same as equity" is to
        make a mistake. For instance, if the combined ratio of
        an insurance company is above 100, then the float is
        being acquired in the presence of an underwiting loss.
        Meaning that there is a cost to the acquisition of the
        float and therefore the float is not like equity at
        all. The insurance business of BRK generates a
        combined ratio of less than 100 and therefore does not
        burden the acquisition of the float with a cost. But
        even that is simplified. I may be more than willing to
        acquire float while running a combined ratio of 105 if
        the underlying liability need not be paid for 10
        years. I may not be willing at all to acquire float
        while running a combined ratio of 101 if the underlying
        liability need be paid a month from next Tuesday. So in
        your example, to determine if the $15 billion is a
        good or poor price, one would need to factor in the
        life of the float and the combined ratio incurred to
        replinish the $20 billion of float.

        It is a small
        part of the insurance business of Berkshire, but
        Buffett buys float all the time. Go to the middle of the
        third paragraph on page 43 of the annual report to the
        sentence that starts with "Other property and casualty
        reinsurance contracts..." and read through all of the fourth
        paragraph. He sells insurance ( buys float ) at underwriting
        losses while computing the time value of money for the
        float. If he could give some examples of how they price
        those contracts, I think we would get a real education
        in the value of float.

      • An insurance company's "float" is the premiums
        from its policyholders that it invests in stocks and
        bonds for its own profit. Buffett's insurance companies
        are very selective when it comes to providing
        coverage and, consequently, Buffett is free to invest the
        money he hardly ever has to pay out. Gen Re's portfolio
        of investments, its float, is $24 billion, but
        Buffett's only paying $20-22 billion for it, and he knows
        he can basically spend that money any way he wishes
        without ever having to pay much of it out in claims. This
        is the reason he was more willing to use BRK stock
        to buy Gen Re and not cash. He reasoned he was
        getting $24 billion in intrinsic value, which he can
        immediately turn around and use to buy more American Express
        and other companies, but paying out only $20-22
        billion of intrinsic value in the form of BRK stock.

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