Berkshire Hathaway will hold its 2020 Annual Shareholders Meeting on Saturday, May 2 at 3:45 pm central time, as previously scheduled. However, due to the current pandemic, shareholders will not be allowed to attend in person. The only managers who will be present will be Chairman and CEO Warren Buffett and Vice Chairman Greg Abel. The annual meeting will be webcast on Yahoo! with a pre-meeting show beginning at 3:00 pm central time.
Most annual meetings of public companies do not offer much insight into the business and managers do not typically allot time to answer many shareholder questions. Berkshire’s meetings have always been different due to the length of the unscripted question and answer session which typically goes on for five hours. In recent years, the Q&A has rotated between questions asked directly by shareholders and questions from a panel of three journalists and three analysts. Shareholders are selected to ask questions at a number of microphones based on a random lottery.
This year’s meeting will be abbreviated with considerably less time for questions and no direct shareholder questions will be permitted. However, Becky Quick of CNBC will select a number of questions submitted by shareholders. It is not clear how many shareholder questions will be asked or for how long. Presumably, the questions that will be selected will be those that pertain most directly to Berkshire Hathaway and the current economic environment.
I attended Berkshire’s annual meetings almost every year from 2001 to 2011, but I have not attended in many years. Although I never asked a question at a microphone, I have submitted questions to the journalists which were selected for the Q&A.
There’s obviously no shortage of questions to ask this year given the unprecedented economic environment due to the pandemic shutdowns, so I have submitted three questions to the journalists for consideration. The questions appear below along with some additional commentary regarding why I decided to submit them.
Berkshire’s Minimum Cash Position
Berkshire’s policy regarding share repurchases has indicated that no repurchases will occur if they would reduce consolidated cash, cash equivalents, and U.S. Treasury bills below $20 billion. Recently, Charlie Munger, in an interview with the Wall Street Journal, indicated a potentially more conservative posture when he said “We just want to get through the typhoon, and we’d rather come out of it with a whole lot of liquidity.” Does Berkshire still have a policy of maintaining at least a minimum of $20 billion of cash or has this figure gone up due to the pandemic?
Last week, I posted an article examining how much of Berkshire’s $125 billion of cash equivalents and U.S. Treasury bills is truly “deployable”, whether for repurchases, business acquisitions, or purchase of marketable securities. It seems likely that Berkshire’s current minimum significantly exceeds the $20 billion that has been mentioned in the past, most recently in the 2019 annual report.
The question of how much of Berkshire’s cash is truly deployable versus a necessary permanent presence on the balance sheet is important for many reasons. In many shareholder letters, Warren Buffett has indicated that Berkshire’s diverse array of operating companies are a source of cash flow that’s uncorrelated with potential insurance liabilities. The presence of the operating companies, coupled with Berkshire’s conservative posture with respect to maintenance of a large cash balance, would free the company to pursue business acquisitions with the bulk of the cash on the balance sheet. If business acquisitions are not available, then repurchases could be an option, especially at recent prices.
In his recent Wall Street Journal interview, Charlie Munger said that Berkshire is managed to keep it “safe for people who have 90% of their net worth invested in it.” This implies a level of conservatism far exceeding the norm and is not unwelcome news for shareholders who are concentrated in Berkshire. However, conservatism comes at a potential cost. If a larger percentage of the cash hoard is not deployable, then the firepower for potential acquisitions is reduced along with upside potential.
Pandemic Insurance Exposure
In a 2009 interview, Mr. Buffett indicated that Berkshire Hathaway would be willing to write insurance coverage for pandemics at the right price, including a potential pandemic that would increase U.S. mortality by 25 percent in 2010, which would have been equivalent to 600,000 additional deaths. Has Berkshire written any pandemic specific coverage over the past decade and, if so, how do the cumulative premiums earned over the past decade compare to potential liabilities related to the current COVID-19 pandemic? Additionally, is Berkshire confident that policies that explicitly exclude pandemic coverage will hold up in court if lawsuits are brought claiming that pandemic exclusions are invalid?
Warren Buffett and Ajit Jain were clearly aware of the potential for devastating pandemics as early as 2009 when he made the above referenced comments in an interview. Additionally, Bill Gates has been on Berkshire’s board for many years and he has been well aware of the potential for a catastrophic pandemic which was the subject of a speech 2015.
If Berkshire Hathaway wrote specific coverage for business interruption or other lines specifically for pandemic coverage, the losses due to COVID-19 might be substantial. Berkshire’s first quarter report will come out shortly before the annual meeting and should shed some light on this. However, perhaps the better question is whether cumulative premiums over a long period of time offset the current year liabilities. The nature of insuring for rare occurrences is that in most years writing the coverage will be very profitable. In the few years when the insured catastrophe occurs, losses will be heavy. The net profitability of such insurance over very long periods of time will determine if entering into that business was worthwhile.
The question of pandemic related business interruption claims was discussed in a recent issue of the Rational Reflections newsletter. The legal system is difficult to predict but it seems like pandemic exclusions should withstand legal challenge. It is one thing for Berkshire to take losses on coverage it wrote specific to pandemics and quite another to take losses on policies which excluded pandemics.
Government Competition as a Capital Provider
In recent weeks, the Federal government has created a number of programs to provide distressed companies with liquidity to weather COVID-19 related difficulties, especially the government ordered shutdowns. In addition to programs designed to aid small and medium sized businesses, the government has offered aid to specific industries such as the airlines. In Charlie Munger’s recent interview with the Wall Street Journal, he indicated that Berkshire’s phones were “not ringing off the hook”, meaning that few companies were approaching Berkshire for investments. Given Berkshire’s activity during the 2008-09 financial crisis, many shareholders were hoping that the company’s large cash balance would facilitate opportunistic investments during the next crisis. Have the government’s programs, on favorable terms, effectively crowded Berkshire out of the market for “rescuing” distressed companies?
The airline bailouts include direct grants to support payroll, which do not require repayment, as well as unsecured loans. The terms are far more favorable than would be available in the private market. For example, American Airlines will receive $5.8 billion in aid from the Federal government of which 70 percent represent payroll support grants that will not have to be repaid. Of the $1.7 billion that will have to be repaid, the interest rate for the first five years is only one percent! Granted, the airline has issued warrants to the government which make the financing potentially dilutive to shareholders, but this is still very cheap money.
There is no reason to believe that Warren Buffett would have been interested in providing financing to American Airlines or to any other airline, despite the fact that Berkshire had equity stakes in four airlines at the end of 2019 (click here for a table showing these holdings). But obviously, even if he had some interest in the idea, there is no way that he would have been willing to offer financing on the terms given by the government.
The question extends far beyond the airlines. The large array of government programs pumping liquidity into the system might be justifiable based on the extraordinary disruption of COVID-19. But whether justifiable or not, the effect on Berkshire’s opportunity set is going to be negative since Buffett will no doubt demand a return commensurate with the high risk of the current environment. On the other hand, one can argue that without the presence of this government support, the widespread business failures that would occur could severely damage Berkshire’s existing business interests.
Disclosure: Individuals associated with The Rational Walk LLC own shares of Berkshire Hathaway.