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Berkshire Takes on Short Sellers With Bet on Furniture Retailer

Jarrell Dillard, Katherine Chiglinsky and Anisha Sircar

(Bloomberg) -- Berkshire Hathaway Inc.’s new wager on furniture retailer RH has Warren Buffett’s company in a place it rarely finds itself: invested in a heavily shorted stock.RH is the most popular short in the home-furnishing retail sector with 37% of the shares available to trade on loan to bears, according to data from financial analytics firm S3 Partners. The disclosure last week that Berkshire bought 1.2 million shares in the third quarter sent RH soaring to a fresh record. The rally hasn’t shaken the faith of short sellers, who profit when the price of a stock falls. Short interest in RH has barely changed since Berkshire revealed its purchase.

The retailer formerly known as Restoration Hardware has a couple of traits that undoubtedly appealed to Berkshire. For one, Buffett likes to stick to areas he knows best when selecting stocks. Berkshire counts at least four furniture retailers among its portfolio of companies, including Nebraska Furniture Mart which has a sprawling 80-acre campus in Buffett’s hometown of Omaha, Nebraska.

“They have a certain limited circle of competence and within that circle of competence is furniture stores,” said David Kass, a professor of finance at the University of Maryland’s Robert H. Smith School of Business.

Berkshire’s Bet

RH, known for luxe decor like sofas that can cost more than $5,000, also has an appetite to repurchase its own stock. The billionaire investor and his business partner, Charlie Munger, “rejoice” when managers buy back stock and boost Berkshire’s stake, Buffett said in his annual shareholder letter this year. Since 2017, RH has repurchased about 60% of its previously outstanding stock, it said in September.

The relatively small size of Berkshire’s stake in RH, which totaled $206 million at the end of the third quarter compared to Berkshire’s $56 billion bet on Apple Inc., likely indicates it was made by one of Buffett’s two investing deputies, Todd Combs or Ted Weschler, according to Kass. Berkshire didn’t respond to messages seeking comment on which investment manager purchased the stake.

Whoever made the RH bet likely perceived the stock as under-priced at the time of purchase, even if it was high on an absolute basis, according to Kass. And Berkshire hasn’t shied away from buying stocks at relatively high levels. One of the deputies has spent the past year snapping up Amazon.com Inc. shares, which now trade around $1,745 and more than 80 times estimated profits.“Maybe they saw a certain growth opportunity here that other analysts are missing,” said Kass. “Much of their investment career is to try to find those rare under-priced opportunities where they expect to outperform the market.”

Bear Case

Short sellers are no doubt attracted to the rapid advance of RH shares. The Tracy, California-based company has gained more than six-fold since 2017 as Chief Executive Officer Gary Friedman managed to re-ignite revenue growth by drawing more customers to its brick-and-mortar stores at a time when consumer purchases are increasingly being made online.

That strategy is probably at the heart of the RH short thesis as Friedman has “gone against the grain with building big stores,” said John Baugh, an analyst at Stifel Nicolaus & Co., who has a buy rating on the stock.

Baugh thinks RH’s push to become more of a destination is the right move, one that will continue to drive traffic with high-end furniture that people feel the need to see in person and touch. While 9 of the 22 analysts tracked by Bloomberg that cover RH have buy ratings, the majority are neutral.

Anthony Chukumba, a Loop Capital Markets analyst, downgraded the stock to hold from buy on Thursday on concerns about valuation. He sees the upside potential and downside risks as fairly balanced at current levels. Still, Chukumba remains positive on RH’s fundamental performance, which he said has been aided by the introduction of a customer membership program.

Hennessy Investment Funds, which owns more than $18 million in RH shares, expects Friedman’s strategy to continue to improve financial results.

RH’s “earnings trajectory has been very good,” said portfolio manager Ryan Kelley. “I think they still have a lot more they can do to fortify their position.”

For Berkshire, so far the bet has been a good one, assuming it hasn’t sold the stock. Even if Berkshire bought at the highest point in the third quarter, RH shares have gained 13% since then.

To contact the reporters on this story: Jarrell Dillard in New York at jdillard11@bloomberg.net;Katherine Chiglinsky in New York at kchiglinsky@bloomberg.net;Anisha Sircar in New York at asircar@bloomberg.net

To contact the editors responsible for this story: Catherine Larkin at clarkin4@bloomberg.net, Larry Reibstein, Jeran Wittenstein

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