Buyback Gives Buffett Weapon Against Slump

By Andrew Frye - Sep 27, 2011 5:13 AM GMT+0700

Berkshire Hathaway Inc. (BRK/A)’s Warren Buffett, who invested more than $15 billion in a month at the depths of the 2008 credit crunch, is now prepared to spend cash on his own firm in a market slump.

Berkshire announced a buyback program yesterday that gives Buffett, 81, the authority to make his first share repurchases in four decades. Buffett, the chief executive officer since 1970, in February touted Berkshire’s capacity to “play offense” in a crisis. He may have $20 billion at his disposal to buy shares if markets decline, said David Rolfe, chief investment officer of Berkshire investor Wedgewood Partners Inc.

“He’s laid the groundwork to swing big and hard if you wake up some morning and something nasty is going on,” said Rolfe. “He’s going to be on the phone with his broker saying, ‘Buy the shares.’”

The Dow Jones Industrial Average posted its biggest weekly drop since 2008 in the five days ended Sept. 23 amid concerns that the European sovereign debt crisis would pressure worldwide economic growth. Class A shares of Omaha, Nebraska-based Berkshire, which slipped below $100,000 in New York trading on Sept. 22 for the first time since January 2009, traded at the lowest price-to-book ratio this quarter since at least 1990.

Berkshire Class B shares jumped $5.72, or 8.6 percent, to $72.09 yesterday in New York Stock Exchange composite trading, the second-biggest gain the Standard & Poor’s 500 Index, which rose 2.3 percent. The buyback is “unexpectedly positive news” and could total about $15 billion, Jay Gelb, an analyst with Barclays Plc, said in a research report.

‘Not a Dime’

Buffett previously preferred to use the firm’s profits to buy companies and securities issued by other firms. “Not a dime of cash” has been spent on buybacks or dividends in four decades, the billionaire told investors in his annual letter, published on Feb. 26. Buffett invested $5 billion in Goldman Sachs Group Inc. and $3 billion in General Electric Co. in 2008 when the Lehman Brothers Holdings Inc. failure cut companies off from traditional sources of funding.

“During the episodes of financial chaos that occasionally erupt in our economy, we will be equipped both financially and emotionally to play offense while others scramble for survival,” Buffett said in the letter, which accompanied Berkshire’s 2010 annual report. “That’s what allowed us to invest $15.6 billion in 25 days of panic following the Lehman bankruptcy.”

Earnings from Berkshire’s businesses have grown to about $1 billion a month, and finding uses for that cash has become more difficult, Buffett said in April. Last year, Buffett bought the 78 percent of railroad Burlington Northern Santa Fe that his firm didn’t already own in a $26.5 billion deal, funded partly by issuing Berkshire stock. In 2000, Buffett told investors he was willing to repurchase shares at or below the market price.

Book Value

Berkshire will buy back Class A and Class B shares for as much as 110 percent of book value, a measure of assets minus liabilities, and refrain from any repurchase that would push cash holdings below $20 billion, the company said yesterday in a statement. Berkshire had about $47.9 billion in cash as of June 30. The stock traded at an average of more than 1.5 times book value since the end of 1999, according to data compiled by Bloomberg.

The disclosure of Berkshire’s stock-purchase criteria may aid the company in outperforming the broader market when equities slump, giving Buffett an edge the next time he considers issuing shares to fund an acquisition, said Buffett biographer Alice Schroeder.

‘A Floor’

“If people know they’ve got a buyer at 110 percent of book, who would sell it for less than that?” said Schroeder, author of “The Snowball: Warren Buffett and the Business of Life,” and a Bloomberg View columnist. “It puts a floor on the stock and keeps it at a price that is attractive. And it enables them to have an acquisition currency.”

Berkshire traded at about 1.1 times the June 30 book value after yesterday’s gain. Declines this quarter in stock holdings in Wells Fargo & Co. and American Express Co. have pressured Berkshire’s book value since June 30. Buffett’s firm may report third-quarter data in November.

Buffett didn’t respond to a request for an interview e- mailed to an assistant.

Buffett invited shareholders in 2000 to submit offers to sell blocks of stock back to Berkshire. In his annual letter that year, Buffett said he “missed some opportunities” by not repurchasing shares when Berkshire fell, and he instructed potential sellers to contact his broker.

Munger’s Wish

Berkshire’s advance in B shares yesterday, the biggest since a 9.4 percent gain on Aug. 9, contrasts with a decline that Buffett has said he would expect if the company eventually declares a dividend. A dividend, Buffett told shareholders at Berkshire’s annual meeting in April, will be an admission that the company can’t fully invest profits.

“I think that some of you will live to see a Berkshire dividend, but I hope I don’t,” Berkshire Vice Chairman Charles Munger, 87, said at a conference in Pasadena, California in July in response to a question from an audience member. “You’re saying, ‘Do you predict failure?’ And I suppose I do.”

Class A shares surged 8.1 percent yesterday to $108,449, the biggest jump since 2009.

To contact the reporter on this story: Andrew Frye in New York at afrye@bloomberg.net

To contact the editor responsible for this story: Dan Kraut at dkraut2@bloomberg.net