The Buffett

 
 


  • Warren Buffett Stock - Investment Details since 1967

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      Period 10

    2. ISCAR
    3. Richline group
    4. TTI
    5. History of LLOYD's EQUITAS
    6. How was Equitas transaction accounted for?
    7. Marmon
    8. Buffett's words of wisdom - Classification of business into - "The Great, the good and the gruesome"
    9. A great missed opportunity
    10. Berkshire's overall cost for Mid-American Energy and its return
    11. Case study - Why Berkshire's pristine credit is so valuable - A look at Berkshire's tax exempt bond insurance business.
    12. Investment in Wrigley, Goldman Sachs and GE
    13. Dow Preferred stock
    14. Conoco Philips' biggest loss of Buffett's investment career
    15. Why regulatory effectiveness is just a ploy
    16. Berkshire's derivative contracts
    17. Why Berkshire invested in Energy and railroad business
    18. Berkshire's entry in commercial mortgage
    19. Berkshire's investments 2006-2011
    20. ISCAR - Berkshire's first acquisition outside USA : On October 25, 2005 - Buffett received a 1?page letter from Eitan Wertheimer, Chairman of ISCAR He was unknown to Buffett.. The letter began, "I am writing to introduce you to ISCAR" and proceeded to describe a cutting tool business carried on in 61 countries. Then Eitan wrote, "We have for some time considered the issues of generational transfer and ownership that are typical for large family enterprises, and have given much thought to ISCAR's future. Our conclusion is that Berkshire Hathaway would be the ideal home for ISCAR. We believe that ISCAR would continue to thrive as a part of your portfolio of businesses." Overall, Eitan's letter made the quality of the company and the character of its management leap off the page. It also made Buffett want to learn more, and in November, Eitan, Jacob and ISCAR's CFO, Danny Goldman, came to Omaha. A few hours with them convinced Buffett that if Berkshire were to make a deal, they would be teaming up with extraordinarily talented managers who could be trusted to run the business after a sale with all of the energy and dedication that they had exhibited previously. However, having never bought a business based outside of the U.S. (though Berkshire had bought a number of foreign stocks), Buffett needed to get educated on some tax and jurisdictional matters. With that task completed, Berkshire purchased 80% of ISCAR for $4 billion. The remaining 20% stayed in the hands of the Wertheimer family, making it their valued partner.

      RICHLINE GROUP: It's the only business that Buffett bought for Berkshire that was a kind of a startup. In fact it was formed by the capital pumped by Berkshire. In 2006 while Buffett was attending a lunch meeting for Ben Bridge Jewelers. There he met Dennis Ulrich, owner of a company that manufactured gold jewelry. In 2007 Dennis sent a proposal to Buffett to build a Jewelry supply business. Buffett liked the proposal and made a deal and simultaneously bought a supplier of equal size. The new company formed was named Richline group.

      TTI: John Roach who had introduced Buffett to Justin Industries in 2000, again paid visit to him in 2006. This time he brought along Paul Andrews, Jr., owner of about 80% of TTI, a Fort Worth distributor of electronic components. Over a 35-year period, Paul built TTI from $112,000 of sales to $1.3 billion. In 2006 Paul was 64 and not long ago he happened to witness how disruptive the death of a founder can be both to a private company's employees and the owner's family. What starts out as disruptive, furthermore, often evolves into destructive. In 2005, therefore, Paul began to think about selling TTI. His goal was to put his business in the hands of an owner he had carefully chosen, rather than allowing a trust officer or lawyer to conduct an auction after his death. Paul rejected the idea of a "strategic" buyer, knowing that in the pursuit of "synergies", an owner of that type would be apt to dismantle what he had so carefully built, a move that would uproot hundreds of his associates (and perhaps wound TTI's business in the process). He also ruled out a private equity firm, which would very likely load the company with debt and then flip it as soon as possible. That left Berkshire. Paul and Buffett met on the morning of November 15th and made a deal before lunch. Later he wrote to Buffett: "After our meeting, I am confident that Berkshire is the right owner for TTI...I am proud of our past and excited about our future."

      History of LLOYD'S EQUITAS 1688, when Edward Lloyd opened a small coffee house in London. Though no Starbucks, his shop was destined to achieve worldwide fame because of the commercial activities of its clientele ship-owners, merchants and venturesome British capitalists. As these parties sipped Edward's brew, they began to write contracts transferring the risk of a disaster at sea from the owners of ships and their cargo to the capitalists, who wagered that a given voyage would be completed without incident. These capitalists eventually became known as underwriters at Lloyd's. Though many people believe Lloyd's to be an insurance company that is not the case. It is instead a place where many member-insurers transact business, just as they did centuries ago. Over time, the underwriters solicited passive investors to join in syndicates. Additionally, the business broadened beyond marine risks into every imaginable form of insurance, including exotic coverage that spread the fame of Lloyd's far and wide. The underwriters left the coffee house, found grander quarters and formalized some rules of association. And those persons who passively backed the underwriters became known as "names". Eventually, the names came to include many thousands of people from around the world, who joined expecting to pick up some extra change without effort or serious risk.

      Three hundred years of retained cufflinks acted as a powerful sedative to the names poised to sign up, and then came asbestos. When its prospective costs were added to the tidal wave of environmental and product claims that surfaced in the 1980s, Lloyd's began to implode. Policies written decades earlier ?and largely forgotten about ?were developing huge losses. No one could intelligently estimate their total, but it was certain to be many tens of billions of dollars. The specter of unending and unlimited losses terrified existing names and scared away prospects. Many names opted for bankruptcy; some even chose suicide.

      From this shambles, there came a desperate effort to resuscitate Lloyd's. In 1996, the powers that be at the institution allotted ?1.1 billion to a new company, Equitas, and made it responsible for paying all claims on policies written before 1993. In effect, this plan pooled the misery of the many syndicates in trouble. Of course, the money allotted could prove to be insufficient ?and if that happened, the names remained liable for the shortfall. But the new plan, by concentrating all of the liabilities in one place, had the advantage of eliminating much of the costly intramural squabbling that went on among syndicates. Moreover, the pooling allowed claims evaluation, negotiation and litigation to be handled more intelligently than had been the case previously.

      Berkshire's involvement with Equitas From the start, many people predicted Equitas would eventually fail. But as Buffett and Ajit reviewed the facts in the spring of 2006 ?13 years after the last exposed policy had been written and after the payment of ?1.3 billion in claims ?they concluded that the patient was likely to survive. And so they decided to offer a huge reinsurance policy to Equitas. Because plenty of imponderables continued to exist, Berkshire could not provide Equitas, and its 27,972 names, unlimited protection. But instead, agreed upon a contract. Which overall stated that if Equitas paid Berkshire $7.12 billion then in return Berkshire would accept liability for all of its future claims and expenses up to $13.9 billion. Thus the names received a huge ?and almost certainly sufficient ?amount of future protection against unpleasant surprises.

      HOW WAS THE EQUITAS TRANSACTION ACCOUNTED FOR, AND ITS IMPACT TO BERKSHIRE'S BOTTOMLINE? Accounting for Retroactive insurance could be complicated. So Buffett described in his 2006 shareholder letter a simpler way of assessing the economics of the transaction. The best way for shareholders to understand it, therefore, is to know the debits and credits involved with it. The major debits will be to Cash and Investments, Reinsurance Recoverable, and Deferred Charges for Reinsurance Assumed ("DCRA"-The major credit will be to Reserve for Losses and Loss Adjustment Expense. No profit or loss will be recorded at the inception of the transaction, but underwriting losses will thereafter be incurred annually as the DCRA asset is amortized downward. The amount of the annual amortization charge will be primarily determined by how Berkshire's end-of-the-year estimates as to the timing and amount of future loss payments compare to the estimates made at the beginning of the year. Eventually, when the last claim has been paid, the DCRA account will be reduced to zero. That could be as long as 50 years down the line.

      What's important to remember is that retroactive insurance contracts always produce underwriting losses for Berkshire. Whether these losses are worth experiencing depends on whether the cash they have received produces investment income that exceeds the losses. As of 2006 DCRA charges have annually delivered $300 million or so of underwriting losses, which have been more than offset by the income Berkshire realized through use of the cash they received as a premium. Absent new retroactive contracts, the amount of the annual charge would normally decline over time. After the Equitas transaction, however, the annual DCRA cost would initially increase to about $450 million a year. This means that Berkshire's other insurance operations must generate at least that much underwriting gain for their overall float to be cost-free.

      Marmon The seeds of this transaction were planted in 1954. That fall, only three months into a new job, Buffett was sent by his employers, Ben Graham and Jerry Newman, to a shareholders?meeting of Rockwood Chocolate in Brooklyn. A young fellow had recently taken control of this company, a manufacturer of assorted cocoa-based items. He had then initiated a one-of-a-kind tender, offering 80 pounds of cocoa beans for each share of Rockwood stock. Buffett described this transaction in a section of the 1988 annual report that explained arbitrage. Jay Pritzker was the business genius behind that tax-efficient idea, the possibilities for which had escaped all the other experts, including Ben Graham. At the meeting, Jay was friendly and gave Buffett an education on the 1954 tax code. He came away very impressed.

      Thereafter, Buffett avidly followed Jay's business dealings, which were many and brilliant. Jay's valued partner was his brother, Bob, who for nearly 50 years ran Marmon Group, the home for most of the Pritzker businesses. Jay died in 1999, and Bob retired early in 2002. Around then, the Pritzker family decided to gradually sell or reorganize certain of its holdings, including Marmon, a company operating 125 businesses, managed through nine sectors. Marmon's largest operation is Union Tank Car, which together with a Canadian counterpart owns 94,000 rail cars that are leased to various shippers. The original cost of this fleet is $5.1 billion. In 2006 Marmon had $7 billion in sales and about 20,000 employees.

      In 2007 Berkshire bought 60% of Marmon and agreed to acquire virtually all of the balance within six years. Berkshire's initial outlay was $4.5 billion, and the price of their later purchases was based on a formula tied to earnings. Berkshire arrived at the price using only Marmon's financial statements, employing no advisors and engaging in no nit-picking. Marmon's CEO, Frank Ptak, worked closely with a long-time associate, John Nichols. John was formerly the highly successful CEO of Illinois Tool Works (ITW), where he teamed with Frank to run a mix of industrial businesses. Little Trivia behind this deal: Byron Trott of Goldman Sachs, who had been praised by Buffett before facilitated the Marmon transaction. The deal was code named "Indy 500" by Goldman Sachs, because, Marmon entered the auto business in 1902 and exited it in 1933. Along the way it manufactured the Wasp, a car that won the first Indianapolis 500 race, held in 1911.

      Buffett's words of wisdom - Classification of business into - "The Great, the good and the gruesome" Following is a very valuable piece of business literature that appeared in 2007 shareholder's letter which can be useful to any investor who is trying to analyze a business.

      Buffett and Munger look at businesses that have the following traits :
      1. Business that they understand.
      2) That have Favorable long-term economics.
      3) Have able and trustworthy management.
      4) Are selling at a discount.

      A truly great business must have an enduring "moat" that protects excellent returns on invested capital. The dynamics of capitalism guarantee that competitors will repeatedly assault any business castle that is earning high returns. Therefore a formidable barrier such as a company's being the low cost producer (GEICO, Costco) or possessing a powerful world-wide brand (Coca-Cola, Gillette, American Express) is essential for sustained success. Business history is filled with "Roman Candles" companies whose moats proved illusory and were soon crossed. Because of the above criteria Buffett rules out companies in industries prone to rapid and continuous change. He feels that the businesses in such kind of industries have to continuously re-invent themselves to preserve the moat. He hesitates to invest in businesses that are very much dependent on its CEO's business instincts. For instance, a medical partnership led by your area's premier brain surgeon may enjoy outsized and growing earnings, but that tells little about its future. The partnership's moat will go when the surgeon goes. You can count, though, on the moat of the Mayo Clinic to endure, even though you can't name its CEO.

      So what attracts Buffett???....He looks for Long-term competitive advantage in a stable industry and If that comes with rapid organic growth then its still better. See's Candy is a prototype of a great business. The boxed-chocolates industry in which it operates is unexciting: Per-capita consumption in the U.S. is extremely low and doesn't grow. Many once-important brands have disappeared, and only three companies have earned more than token profits over the last forty years. See's, though it obtains the bulk of its revenues from only a few states, accounts for nearly half of the entire industry's earnings. At See's, annual sales were 16 million pounds of candy when Blue Chip Stamps purchased the company in 1972. By 2007 See's sold 31 million pounds, a growth rate of only 2% annually. Yet its durable competitive advantage, built by the See's family over a 50-year period, and strengthened subsequently by Chuck Huggins and Brad Kinstler, has produced extraordinary results for Berkshire. Berkshire bought See's for $25 million when its sales were $30 million and pre-tax earnings were less than $5 million. The capital then required to conduct the business was $8 million. (Modest seasonal debt was also needed for a few months each year.) Consequently, the company was earning 60% pre-tax on invested capital. Two factors helped to minimize the funds required for operations. First, the product was sold for cash, and that eliminated accounts receivable. Second, the production and distribution cycle was short, which minimized inventories. In 2007 See's sales were $383 million, and pre-tax profits were $82 million. The capital required to run the business is $40 million. This means Berkshire had to just reinvest only $32 million since 1972 to handle the modest physical growth ?and somewhat immodest financial growth ?of the business. In the meantime pre-tax earnings have totaled $1.35 billion. All of that, except for the $32 million, has been sent to Berkshire (or, in the early years, to Blue Chip). After paying corporate taxes on the profits, Berkshire used the rest to buy other attractive businesses.

      Unfortunately there aren't many companies like See's in Corporate America. So let's turn to the second category, i.e. good, but far from sensational. An example is Flight Safety. It's a business with a great moat and delivers high value to its customers. Because of this it can command high pricing power. But, this business requires a significant reinvestment of earnings if it is to grow. Berkshire bought FlightSafety in 1996.In 2007 its pre-tax operating earnings were $111 million, and its net investment in fixed assets was $570 million. Since its purchase, depreciation charges totaled $923 million. But capital expenditures h totaled $1.635 billion. Its fixed assets, after depreciation, amount to $1.079 billion. Pre-tax operating earnings in 2007 were $270 million, a gain of $159 million since 1996. That gain gave Berkshire a good, but far from See's like, return on its incremental investment of $509 million. Consequently, if measured only by economic returns, FlightSafety is an excellent but not extraordinary business. Its put-up-more-to-earn-more experience is that faced by most corporations. For example, Berkshire's large investment in regulated utilities falls squarely in this category. Berkshire will earn considerably more money in this business in future, but will have to invest many billions to make it.

      Looking at the last type of business i.e. what is termed as worst sort of business. It grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down. The airline industry's demand for capital ever since that first flight has been insatiable. Investors have poured money into a bottomless pit, attracted by growth when they should have been repelled by it. Berkshire bought U.S. Air preferred stock in 1989. As the ink was drying on its check, the company went into a tailspin, and before long its preferred dividend was no longer being paid. But Berkshire then got very lucky. In one of the recurrent, but always misguided, bursts of optimism for airlines, they were actually able to sell there shares in 1998 for a hefty gain. In the decade following its sale, the company went bankrupt. Twice.

      To sum up, think of three types of "savings accounts". The great one pays an extraordinarily high interest rate that will rise as the years pass. The good one pays an attractive rate of interest that will be earned also on deposits that are added. Finally, the gruesome account both pays an inadequate interest rate and requires you to keep adding money at those disappointing returns.

      A great missed opportunity Ironically at the time of See's Purchase in 1972, Buffett got a similar offer from his longtime friend Tom Murphy who was then running Cap cities broadcasting. He was offering Dallas-Fort worth NBC station for $35 million. But Buffett ignored the offer. In 2006, the station earned $73 million pre-tax, bringing its total earnings since 1972 to at least $1 billion ?almost all available to its owner for other purposes. By 2006 the property had a capital value of about $800 million.

      Berkshire agreed to purchase 35,464,337 shares of MidAmerican at $35.05 per share in 1999, a year in which its per-share earnings were $2.59. Later on, in 2002, Berkshire purchased 6,700,000 shares at $60 to help finance the acquisition of a pipeline. Lastly, in 2006, when MidAmerican bought PacifiCorp, which was financed by Berkshire's purchase of 23,268,793 shares at $145 per share. In 2007, MidAmerican earned $15.78 per share. However, 77 of that was non-recurring, a reduction in deferred tax at its British utility, resulting from a lowering of the U.K. corporate tax rate. Thus its normalized earnings was $15.01 per share.

      CASE STUDY - Why Berkshire's pristine credit is so valuable - A look at Berkshire's Tax exempt bond insurance - In 2008 Berkshire Hathaway Assurance Company ("BHAC" became an insurer of the tax-exempt bonds issued by states, cities and other local entities. BHAC insures these securities for issuers both at the time their bonds are sold to the public (primary transactions) and later, when the bonds are already owned by investors (secondary transactions). By yearend 2007, the half dozen or so companies that had been the major players in this business had all fallen into big trouble. Early in the year, Berkshire offered to assume all of the insurance issued on tax-exempts that was on the books of the three largest monolines for 1.5% rate. Overall guarantees were for about $822 billion of bonds. If Berkshire's offer had been accepted, they would have been required to pay any losses suffered by investors who owned these bonds ?a guarantee stretching for 40 years in some cases.

      The monolines summarily rejected Berkshire's offer, in some cases appending an insult or two. In the end, though, the turndowns proved to be very good news for Berkshire, because it became apparent that Buffett had severely underpriced its offer.

      Here's where the story gets interesting. Finally Berkshire wrote about $15.6 billion of insurance in the secondary market. About 77% of this business was on bonds that were already insured, largely by the three aforementioned monolines. In these agreements, Berkshire had to pay for defaults only if the original insurer was financially unable to do so. Berkshire wrote this "second-to-pay" insurance for rates averaging 3.3%. That's right; Berkshire was been paid far more for becoming the second to pay than the 1.5% it would have earlier charged to be the first to pay. In one extreme case, they actually agreed to be fourth to pay, nonetheless receiving about three times the 1% premium charged by the monoline that remains first to pay. In other words, three other monolines had to first go broke before Berkshire need to write a check. Two of the three monolines to which Berkshire made its initial bulk offer later raised substantial capital. This, of course, directly helped Berkshire, since it makes it less likely that Berkshire will have to pay, at least in the near term, any claims on its second-to-pay insurance because these two monolines fail. In addition to its book of secondary business, Berkshire also wrote $3.7 billion of primary business for a premium of $96 million. In primary business, Berkshire is first to pay if the issuer gets in trouble. Berkshire has a great many more multiples of capital behind the insurance it writes than does any other monoline. Consequently, its guarantee is far more valuable than monoline's. This explains why many sophisticated investors bought second-to-pay insurance from Berkshire even though they were already insured by another monoline. BHAC not only became the insurer of preference, but in many cases the sole insurer acceptable to bondholders.

      Investment in WRIGLEY, GOLDMAN SACHS, GE and Swiss Re On October 6, 2008, Berkshire acquired $4.4 billion par amount of 11.45% subordinated notes due 2018 of Wrigley ("Wrigley Notes") and $2.1 billion of preferred stock of Wrigley ("Wrigley Preferred") The Wrigley Notes and Wrigley Preferred were acquired in connection with Mars, Incorporated's acquisition of Wrigley. Berkshire may not transfer, sell or assign the Wrigley Notes or Wrigley Preferred to third parties. Berkshire has classified the Wrigley Notes as "held-to-maturity" and accordingly is carrying the Wrigley Notes at cost. Dividends are payable on the Wrigley Preferred at a rate of 5% per annum. The Wrigley Preferred is subject to certain put and call arrangements in 2016 and annually beginning in 2021. The redemption amount of the Wrigley Preferred is based upon the future earnings of Wrigley.

      On October 1, 2008, Berkshire acquired 50,000 shares of 10% Cumulative Perpetual Preferred Stock of GS (GS Preferred) and Warrants to purchase 43,478,260 shares of common stock of GS (GS Warrants) for an aggregate cost of $5 billion. The GS Preferred may be redeemed at any time by GS at a price of $110,000 per share ($5.5 billion in aggregate). The GS Warrants expire in 2013 and can be exercised for an aggregate cost of $5 billion ($115/share).

      On October 16, 2008, Berkshire acquired 30,000 shares of 10% Cumulative Perpetual Preferred Stock of GE (GE Preferred) and Warrants to purchase 134,831,460 shares of common stock of GE (GE Warrants) for an aggregate cost of $3 billion.

      In 2009, Berkshire also acquired a 12% convertible perpetual capital instrument issued by Swiss Re at a cost of $2.7 billion. The instrument had a face amount of 3 billion Swiss Francs. In 2011 Swiss Re, Goldman Sachs and General Electric paid Berkshire an aggregate of $12.8 billion to redeem securities that were producing about $1.2 billion of pre-tax earnings for Berkshire.

      Dow Preferred stock Berkshire acquired 3,000,000 shares of Series A Cumulative Convertible Perpetual Preferred Stock of Dow (Dow Preferred) in 2009 for a cost of $3 billion. Under certain conditions, each share of the Dow Preferred was convertible into 24.201 shares of Dow common stock. Beginning in April 2014, if Dow's common stock price exceeds $53.72 per share for any 20 trading days in a consecutive 30-day window, Dow, at its option, at any time, in whole or in part, may convert the Dow Preferred into Dow common stock at the then applicable conversion rate. The Dow Preferred is entitled to dividends at a rate of 8.5% per annum.

      CONOCO PHILLIPS ?Biggest loss of Buffett's investment career. Buffett made a huge investment in Conoco Phillips in 2008 by buying 5.7% of the company's stock for $7,008 million. By year end of 2008 it was at $4,398 million, a decline of 37%. The stock declined mainly because the price oil had retreated from its peak of more than $100 / barrel to almost $40 / barrel. Berkshire sold more than half of its position in the company in 2009, incurring a loss of over $1,500 million. This was the biggest realized loss in dollar terms in Buffett's career.

      Did Buffett give up on Conoco Phillips too soon???... Berkshire's total cost of acquiring 84.8million shares was $7bn. Thus Berkshire paid on an average $82.35/share. As of Mar-1-2012, shares of Conoco Phillips had almost doubled from the lows of $37 in 2009 to $77. Valuing the company at around $100bn.

      WHY REGULATORY EFFECTIVENESS IS JUST A PLOY? In describing Derivatives and its perils, Buffett is very critical about the politician's solution that increased transparency could solve the problems. Following is a great case study explained by Buffett in his 2008 letter.

      "For a case study on regulatory effectiveness, let's look harder at the Freddie and Fannie example. These giant institutions were created by Congress, which retained control over them, dictating what they could and could not do. To aid its oversight, Congress created OFHEO in 1992, admonishing it to make sure the two behemoths were behaving themselves. With that move, Fannie and Freddie became the most intensely-regulated companies of which I am aware, as measured by manpower assigned to the task. On June 15, 2003, OFHEO (whose annual reports are available on the Internet) sent its 2002 report to Congress specifically to its four bosses in the Senate and House, among them none other than Messrs. Sarbanes and Oxley. The report's 127 pages included a self-congratulatory cover-line: "celebrating 10 Years of Excellence". The transmittal letter and report were delivered nine days after the CEO and CFO of Freddie had resigned in disgrace and the COO had been fired. No mention of their departures was made in the letter, even while the report concluded, as it always did, that "both Enterprises were financially sound and well managed". In truth, both enterprises had engaged in massive accounting shenanigans for some time. Finally, in 2006,OFHEO issued a 340-page scathing chronicle of the sins of Fannie that, more or less, blamed the fiasco on every party but, you guessed it. Congress and OFHEO."

      Berkshire's derivative contracts Berkshire's derivative contracts fall into four categories. The first is the equity put portfolio. In this contract, Berkshire has to make a fixed payment to the counterparty in a future date between 2018 to 2024 based on the index figures. To illustrate, Berkshire might sell a $1 billion 15-year put contract on the S&P 500 when that index is at, say, 1300. If the index is at 1170 (down 10%) on the day of maturity, Berkshire would pay $100 million. If it is above 1300, then Berkshire owes nothing. For Berkshire to lose $1 billion, the index would have to go to zero. In the meantime, the sale of the put would have delivered them a premium ?perhaps $100 million to$150 million ?that they would be free to invest as they wish. By the end of 2008 Berkshire had written contracts with notional value of $37.1 billion and had collected a premium of $4.9 billion for it. The contracts were set to expire between September-9, 2019 and Jan-24, 2028. For Berkshire to pay the full amount of $37.1 billion, all those indices have to go to zero by that date.

      In 2010 at the instigation of counterparty, Berkshire unwound eight contracts, all of them due between 2021 and 2028. Berkshire had originally received $647 million as premium for them. For unwinding it had to pay back $425 million. Consequently Berkshire realized a gain of $222 million and also had interest-free and unrestricted use of that $647 million for about 3 years. Now Berkshire is left with 39 equity put contracts for which they have received a premium of $4.2 billion. The future of these contracts is, of course, uncertain. But here is one perspective on them. If the prices of the relevant indices are the same at the contract expiration dates as these prices were on December 31, 2010, and foreign exchange rates are unchanged, Berkshire would owe $3.8 billion on expirations occurring from 2018 to 2026. You can call this amount "Settlement value". On Berkshire's yearend balance sheet, however, they carried the liability for those remaining equity puts at $6.7 billion. In other words, if the prices of the relevant indices remain unchanged from that date, they will record a $2.9 billion gain in the years to come, that being the difference between the liability figure of $6.7 billion and the settlement value of $3.8 billion. There is a high possibility that equity prices will very likely increase and that Berkshire's liability will fall significantly between 2010 and settlement date. If so, Berkshire's gain from 2010 will be even greater. But that, of course, is far from a sure thing. What is sure is that Berkshire have the use of the remaining "float" of $4.2 billion for an average of about 10 more years. (Neither this float nor that arising from the high-yield contracts is included in the insurance float figure of $66 billion.)

      The second category concerns derivatives requiring Berkshire to pay when credit losses occur at companies that are included in various high-yield indices. Its standard contract covers a five-year period and involves 100 companies. We modestly expanded our position last year in this category. But, of course, the contracts on the books at the end of 2007 moved one year closer to their maturity. Overall, our contracts now have an average life of 2.33 years, with the first expiration due to occur on September 20, 2009 and the last on December 20, 2013. By yearend Berkshire had received premiums of $3.4 billion on these contracts and paid losses of $542 million. Using mark-to-market principles, they also set up a liability for future losses that at yearend totaled $3.0 billion. Thus by Dec,31-2008 had recorded a loss of about $100 million, derived from their $3.5 billion total in paid and estimated future losses minus the $3.4 billion of premiums they received.

      Third category is credit default swaps. In 2008 Berkshire began to write credit default swaps on individual companies. They had $4billion worth of contracts and had received premium of $93 million. This had covered 42 corporations. The fourth category is the Tax exempt Bond insurance contracts that are similar to those written by BHAC but are structured as derivatives. The only meaningful difference between the two contracts is that mark-to-market accounting is required for derivatives whereas standard accrual accounting is required at BHAC.

      CHANGES IN DERIVATIVE RULES THAT AFFECT BERKSHIRE : As of 2011 Berkshire has a very minor collateral requirements, the rules have changed for new positions. Consequently, Berkshire will not be initiating any major derivatives positions. Because it does not prefer contracts of any type that could require the instant posting of collateral. The possibility of some sudden and huge posting requirement ?arising from an out-of-the-blue event such as a worldwide financial panic or massive terrorist attack ?is inconsistent with its primary objectives of redundant liquidity and unquestioned financial strength.

      BUT BERKSHIRE HAS ALREADY MILKED A CONSIDERABLE PROFIT - Its insurance-like derivatives contracts, whereby it pays if various issues included in high-yield bond indices default, are coming to a close. The contracts that most exposed it to losses have already expired, and the remainder will terminate soon. In 2011, Berkshire paid out $86 million on two losses, bringing its total payments to $2.6 billion. Its almost certain to realize a final underwriting profit? on its derivative portfolio because the premiums it received were $3.4 billion, and its future losses are apt to be minor. In addition, Berkshire has enjoyed about $2 billion of float over the five-year life of these contracts. This successful result during a time of great credit stress underscores the importance of obtaining a premium that is commensurate with the risk.

      BUFFETT'S MISTAKE THAT COST GEICO $44 million. Buffett floated an idea of entering credit card business which exclusively catered to GEICO's customers. He assumed that as its customers are risk averse so they would use credit in a responsible way. But he was wrong. Along with customers who had good credit, Berkshire also got the "lemons of the business". Berkshire ended up losing $6million and ended up selling its portfolio of $98 million for $53 million. He was warned by GEICO's managers about this venture. Buffett had thought he was older and wise, But it appears he was just older.

      Why Berkshire invested in Energy and railroad business Following is a very interesting explanation given by Buffett in his 2009 shareholder's letter as to why Berkshire made huge investments in Mid-American Energy and BNSF.

      "Our BNSF operation, it should be noted, has certain important economic characteristics that resemble those of our electric utilities. In both cases we provide fundamental services that are, and will remain, essential to the economic well-being of our customers, the communities we serve, and indeed the nation. Both will require heavy investment that greatly exceeds depreciation allowances for decades to come. Both must also plan far ahead to satisfy demand that is expected to outstrip the needs of the past. Finally, both require wise regulators who will provide certainty about allowable returns so that we can confidently make the huge investments required to maintain, replace and expand the plant. We see a "Social compact" existing between the public and our railroad business, just as is the case with our utilities. If either side shirks its obligations, both sides will inevitably suffer. Therefore, both parties to the compact should ?and we believe will ?understand the benefit of behaving in a way that encourages good behavior by the other. It is inconceivable that our country will realize anything close to its full economic potential without its possessing first-class electricity and railroad systems. We will do our part to see that they exist."

      BERKSHIRE'S ENTRY IN COMMERCIAL MORTGAGE: In 2009 Berkshire again tied up with Leucadia. This time they formed the company Berkadia commercial mortgage and bought Capmark, a company that had $235 billion portfolio of commercial mortgages. The first time Berkshire had tied with Leucadia was to buy Finova.

    Berkshire Hathaway's investments 2006-2011 (All numbers in millions) except no of shares
    2006
    Shares Company Cost Market
    151,610,700 American Express Company 1,287 $9,198
    43,854,200 Anheuser-Busch cos Inc 1,761 1,792
    200,000,000 The Coca Cola Company 1,299 9,650
    17,938,100 Conoco Phillips 1,066 1,291
    21,334,900 Johnson&Johnson 1,250 1,409
    6,708,760 M&T Bank 103 820
    24,000,000 Moody's corp 499 3,315
    2,338,961,000 Petro China 488 3,313
    3,486,006 POSCO 572 1,158
    100,000,000 P&G 940 6,427
    229,707,000 Tesco 1,340 1,820
    31,033,800 US Bancorp 969 1,123
    17,072,192 USG 536 936
    19,944,300 Walmart 942 921
    218,169,300 Wells Fargo & Company 3,697 7,758
    1,727,765 The Washington post co 11 1,288
    1,724,200 White Mountain insurance 369 999
    Others 5,866 8,315
    Total Common Stocks $22,995 $61,533


    2007
    Shares Company Cost Market
    151,610,700 American Express Company 1,287 $7,887
    35,563,200 Anheuser-Busch cos Inc 1,718 1,861
    60,828,818 Burlington Nothern Santa Fe 4,731 5,063
    200,000,000 The Coca Cola Company 1,299 12,274
    17,508,700 Conoco Phillips 1,039 1,546
    64,271,948 Johnson&Johnson 3,943 4,287
    124,393,800 Kraft Foods inc 4,152 4,059
    48,000,000 Moody's corp 499 1,714
    3,486,006 POSCO 572 2,136
    101,472,000 P&G 1,030 7,450
    17,170,953 Sanofi-Aventis 1,466 1,575
    227,307,000 Tesco 1,326 2,156
    75,176,026 US Bancorp 2,417 2,386
    17,072,192 USG 536 611
    19,944,300 Walmart 942 948
    218,169,300 Wells Fargo & Company 6,677 9,160
    1,727,765 The Washington post co 11 1,367
    1,724,200 White Mountain insurance 369 886
    Others 5,238 7,633
    Total Common Stocks $39,252 $74,999


    2008
    Shares Company Cost Market
    151,610,700 American Express Company 1,287 $2,812
    200,000,000 The Coca Cola Company 1,299 9,054
    84,896,273 ConocoPhillips 7,008 4,398
    30,009,591 Johnson&Johnson 1,847 1,795
    130,272,500 Kraft Foods inc 4,330 3,498
    3,947,550 POSCO 768 1,191
    91,941,010 P&G 643 5,684
    17,170,953 Sanofi-Aventis 1,827 1,404
    11,262,000 Swiss Re 773 530
    227,307,000 Tesco 1,326 1,193
    75,145,426 US Bancorp 2,337 1,879
    19,944,300 Walmart 942 1,118
    1,727,765 The Washington post co 11 674
    218,169,300 Wells Fargo & Company 6,702 8,973
    Others 6,035 4,870
    Total Common Stocks $37,135 $49,073


    2009
    Shares Company Cost Market
    151,610,700 American Express Company 1,287 $6,143
    225,000,000 BYD Company LTD 232 1,986
    200,000,000 The Coca Cola Company 1,299 11,400
    37,711,330 ConocoPhillips 2,741 1,926
    28,530,467 Johnson&Johnson 1,724 1,838
    130,272,500 Kraft Foods inc 4,330 3,541
    3,947,550 POSCO 768 2,092
    83,128,411 P&G 533 5,040
    25,108,967 Sanofi-Aventis 2,027 1,979
    34,247,373 Tesco 1,367 1,620
    76,633,426 US Bancorp 2,371 1,725
    39,037,142 Walmart 1,893 2,087
    334,235,585 Wells Fargo & Company 7,394 9,021
    Others 6,680 8,636
    Total Common Stocks $34,646 $59,034


    2010
    Shares Company Cost Market
    151,610,700 American Express Company 1,287 $6,507
    225,000,000 BYD Company LTD 232 1,182
    200,000,000 The Coca Cola Company 1,299 13,154
    29,109,637 ConocoPhillips 2,028 1,982
    45,022,563 Johnson&Johnson 2,749 2,785
    97,214,584 Kraft Foods inc 3,207 3,063
    19,259,600 Munich Re 2,896 2,924
    3,947,550 POSCO 768 1,706
    72,391,036 P&G 464 4,657
    25,848,838 Sanofi-Aventis 2,060 1,656
    242,163,773 Tesco 1,414 1,608
    78,060,769 US Bancorp 2,401 2,105
    39,037,142 Walmart 1,893 2,105
    358,936,125 Wells Fargo & Company 8,015 11,123
    Others 3,020 4,956
    Total Common Stocks $33,733 $61,513


    2011
    Shares Company Cost Market
    151,610,700 American Express Company 1,287 $7,151
    200,000,000 The Coca Cola Company 1,299 13,994
    29,109,637 ConocoPhillips 2,027 2,121
    63,905,931 IBM 10,856 11,751
    31,416,127 Johnson&Johnson 1,880 2,060
    79,034,713 Kraft Foods inc 2,589 2,953
    20,060,390 Munich Re 2,990 2,464
    3,947,550 POSCO 768 1,301
    72,391,036 P&G 464 4,829
    25,848,838 Sanofi-Aventis 2,055 1,900
    291,577,428 Tesco 1,719 1,827
    78,060,769 US Bancorp 2,401 2,112
    39,037,142 Walmart 1,893 2,333
    400,015,828 Wells Fargo & Company 9,086 11,024
    Others 6,895 9,171
    Total Common Stocks $48,209 $76,991


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