AIG (stock)

The insurance giant at the brink of bankruptcyIn 2008, AIG was at the brink of bankruptcy. Its derivatives-trading subsidiary AIG Financial Products. AIG FP, as it's called, merits only a mere paragraph in the nine-page description of the company's businesses in its most recent annual report. But it's a huge player in the new and mysterious business of credit-default swaps (CDS). And as we all know CDS turned upside during the Global Financial Crisis, resulting in AIG FP losing more than $10 billion in 2007 and $14.7 billion in first six months of 2008. Compounding to the losses, its credit rating was cut and AIG had to fork over $13 billion in collateral to buyers of its swaps. The consensus then was that the company only could survive another day or two.

US government bailoutGiven the size and the reach of AIG, the US government had to bail out AIG, thereby abruptly reversing the their previous hardline position of letting Lehman Brothers fall. To save AIG, the US government eventually had to pledge US$182 billion, although only US$67.8 billion was eventually disbursed. US government ended up owning over 80% of AIG.

Recovering IconAfter US government bailout, which wiped out existing shareholders, AIG was under intense scrutiny. With its furture uncertain, AIG would become a great investment:
- Trades at less than one‐half tangible book value*
- “De‐risked” balance sheet1
- Shareholder equity‐to‐assets ratio of 15%*
- Repurchasing common stock
- Leader in global property and casualty insurance
- Dominant U.S. life insurance and retirement services provider
- 86 million customer and client relationships worldwide

Motivated sellerBy mid 2012, AIG had stablized but the US government was also eager to reduce its AIG shares, thereby creating an overhang in AIG's stock price. In dec 2012, US government completed the share of its AIG shares at US$ 32.50 per share.

FairholmeBruce Berkowitz's Fairholme Fund grabbed the opportunity to invest in AIG. Berkowitz began purchasing in the first quarter of 2010, when the price dropped to US$24 per share on average. That year, AIG's book value was US$94.94. He then more than doubled the stake in 2011, at an average price of US$31 per share. The book value in 2011 was US$53.46. Fairholme still holds its stake in AIG and Bruce Berkowitz is looking for AIG to recover to at least tangible value and for the price to exceed their estimate of intrinsic value.

Coca-Cola (stock)

Coca Cola - a once in a lifetime opportunityWarren Buffett first encountered Coca Cola in 1936. As a 6 years old then, he bought Cokes at bulk price (6 for 25cents) and resold around the neighborhood for 5 cents each. He joked that he was well aware of the consumer attractiveness and the commercial possibilities of the product, but it wasn't 52 years later, in 1989, that he bought his stake in Coca Cola. Fast forward to 24 years later, Warren Buffett owns 400 million shares of Coca-Cola at a cost of 1.299 billion. Meanwhile the stock has paid a average dividend of 3%, repurchased its stocks and had 4 stock splits (1990,1992,1996 and 2012).

What triggered Warren Buffett to buy CokeNotably, Coca-Cola had a new CEO in 1981 (Roberto Goizueta) and under his leadership overseas sales exploded. According to other articles, in 1988, at the point of Warren Buffett's purchase, overall sentiment was not positive; Coca-Cola had reported earnings down 2 percent from previous year. Many analysts were of the view that other beverage companies would take away its market share. Plus the stock was trading at 14-19x P/E.

However, Warren Buffet saw Coca-Cola differently. "Buy commodity, sell brands" has long been a formula for business success. Coca-Cola had mind share, particularly its association with heroics, the Olympics and Music. Furthermore, Coca-cola is always building infrastructure in some country. Overall its moat keeps widening. Warren Buffett's assessment that Coca-Cola will transform from a country champion to a World champion was right on the dot.

Why Warren Buffett continue to hold his stake in CokeIn 1988 Warren Buffet acquired 46.7 million shares of coke at cost of $1,023,920,000 or at $21.93 per share. In 1989, his stake would have already doubled. Over the next 24 years, coke gave compounded return of 9-11%. But because Coke is a dividend stock and there is also stock repurchase and stock splits, Warren Buffett's yield to cost is extremely high.

His overall cost in coke stake is only $3.27 per share ($1.299 bn / 400 mn shares). The 2012 dividend was $1.3 per share (~3% at current price). Hence the yield to cost is a staggering 40%!!! ($1.3 / $3.27). In other words, he gets back 40% of his capital on dividend alone! Another perspective is to view Coke stock as a bond that pays coupon of 40% and may even increase further.

GEICO (stock)

GEICO, a 48 bagger on initial investment of $46 millionGEICO is one of Warren Buffett's top investment, notable in the return and also the transformative nature of the business during the course of his ownership. Warren Buffett's interest in GEICO dates back to 1951 when, at only 21 years old, he used up 65% of his net worth to purchase shares of GEICO. A year later he sold out, to buy cheaper security (P/E 1x). However, he bought GEICO again in 1976 when the company was in distressed, accumlating with a fully converted cost base of $1.31 per share. He will subsequently declared it as a holding that Berkshire will never sell and Berkshire acquired the remaining stake in 1995.

Low cost auto insurerGEICO is a low cost auto insurer. It bypasses commissioned insurance salesmen and sell low cost auto insurance through the mail at discounts of 30%-40% directly to Federal, State and Municipal government employees and certain categories of enlisted military officers.
The Company’s low cost advantage in their core automobile insurance offering would persist and endure for decades to come. GEICO’s underwriting and loss adjustment expenses typically amounted to just 25% of premiums – at times 10-15 percentage points lower than their competitors, including such direct insurance writes as Allstate and State Farm.
With the company's significant low-cost advantage, plus the emerging post-world war II automobile boom, the company would go on to consistenly post underwriting profit for the next 35 years in a row.

Many shall be restored that now are fallen and many shall fall that now are in honorBy the 1970s, the government begun to legislate mandated price reductions. Faced with new regulations and infrlation, the GEICO's executive made a series of egregious pricing errors extending its clientele to higher risk categories. This began a stream of significant losses. In 1975, GEICO lost $126 million and bankruptcy was a real risk. GEICO's shares, which had traded as high as $61 in 1972, were down to just under $5. By 1976, the stock was a little more than $2 per share. The existing CEO was booted and GEICO broad of directors hired a new head as chairman, president and CEO.

Invest with a catalystThe new CEO was extremely sucessful in turning the situation around. Within a year, GEICO returned to profitability. In the following year, GEICO declared a dividend. Warren Buffett arranged to meet with the CEO and was so impressed that the started buying GEICO stock the next morning at $2.125. He subsequently increased his stake through more open market purchase and converitable preferred stock. Overall, his fully converted cost basis was just $1.31 per share.

GEICO Timeline
· Founded in 1936 in San Antonio by Leo and Lillian Goodwin.
· $100,000 in seed capital.
· $25,000 by the Goodwin’s and $75,000 by the Rhea family.
· Typical auto policy $27.50.
· 1937: 3,700 policies with $104,000 in premiums.
· 1937: Company relocated in Washington, D.C.
· 1940: Company books first underwriting profit. 25,000 polices in force.
· 1941: Hail storm in D.C. cements Company’s service reputation.
· 1940-1974: 35 consecutive years of profits.
Graham-Newman Timeline
· 1948: Members of Rhea want to sell their portion of Company.
· 1948: Graham-Newman buys 50% of GEICO for $712,000. Benjamin Graham becomes Chairman of the Board.
· 1948: SEC finally approves the purchase via a distribution to Graham-Newman’s partners/shareholders.
· 1948: Original OTC distribution $27 for one share.
· 1950: GEICO licensed in 15 states. 144,000 policies in force. $8 million in premiums.
· 1958: Triples addressable market by soliciting non-government professionals.
· 1958: Leo Goodwin retires. Replaced by Lorimer Davidson. $10,000 invested in GEICO had grown to $475,000.
· 1965: Graham retires from GEICO board.
· 1971: Jerry Newman retires from GEICO board and Warren Buffett nominated to replace Newman on the board.
· 1972: Graham-Newman’s original $712,000 investment worth over $400,000,000 – or more than all of Graham-Newman partnership profits combined!
Warren Buffett Timeline
· 1950: While studying under Graham at Columbia University, Buffett discovers that Graham is Chairman of GEICO.
· 1951: Buffett travels to GEICO in D.C. on a Saturday and gets a daylong insurance tutorial from Lorimer “Davy” Davidson.
· 1951: Upon graduation, Buffett moves back to Omaha and joins his father’s brokerage firm. He spends most of his time hawking GEICO to family and friends.
· 1951: Buffett invests over 50% of his net worth in GEICO (350 shares @ $29 3/8). GEICO closes at $37 ½ at year-end.
· Buffett writes “The Security I Like Best” in The Commercial and Financial Chronicle on December 6, 1951
· 1952: Buffett sells his GEICO stock at $43 5/8 to purchase Western Insurance Securities at 1X earnings.
· Buffett’s original $10,282 investment in GEICO would grow to $1.3 million over the next 20 years.
Berkshire Hathaway Timeline – Part I
· 1974: Cracks emerge in GEICO due to unbridled go-go growth.
· 1974: No-fault insurance, inflation and poor underwriting leaves GEICO woefully under reserved.
· 1975: $124 million in losses.
· 1975: Buffett’s warnings in a personal visit to CEO Gidden go unheeded.
· 1976: $40 million in losses first half of the year.
· 1976: Stock falls from high of $61 in 1972, to $42 in 1974 to $2 in the spring of 1976. Gidden out. Jack Byrne from Travelers in.
· 1976: Byrne fires 50% of employees, raises rates by 40% and tells N.J. insurance commissioner to “go impregnate yourself.”
· 1976: Buffett lurking in the wings asks Kay Graham of WaPo to broker a meeting with Byrne. Byrne says “Buffett who?” and refuses meeting. Davy Davidson calls Byrne and reads him the riot act for refusing meeting. Buffett and Byrne meet late into the night and morning discussing GEICO at Graham’s Georgetown estate.
· 1976: Buffett begins buying GEICO stock the very next morning. First trade 500,000 shares at 2 1/8. Buffett’s all-in investment would come to $19 million in a convertible preferred, plus $4.1 million @ $2.55 per share. Buffett’s fully converted cost-basis was approx. $1.31 per share.
· 1977: Byrne returns GEICO back to profitability.
Berkshire Hathaway Timeline – Part II
· 1980: Buffett sizes up Berkshire’s GEICO investment to $45 million – or 33% of GEICO.
· 1981: GEICO 31% of Berkshire’s equity portfolio.
· 1982: Berkshire’s 35% “look-through” ownership of $250 million in GEICO’s annual insurance premiums greater than own direct insurance premiums.
· 1984: Berkshire’s 36% “look-through” ownership of $320 million in GEICO’s annual insurance premiums double Berkshire’s own direct insurance premiums.
· 1985: GEICO investment ($596 million) 50% of Berkshire’s equity portfolio – a peak.
· 1984: Cumulative GEICO dividends $180 million.
· 1987: Buffett’s Chairman’s Letter names GEICO (and Cap Cities/ABC and WaPo) “permanent holdings.”
· 1990: GEICO investment worth $1,044,625,000.
Berkshire Hathaway Timeline – Part III
· 1994: GEICO investment worth $1,678,250,000.
· 1994: Buffett initiates formal merger and acquisition discussions with GEICO.
· 1994: Buffett proposes Berkshire-GEICO stock swap. GEICO balks.
· 1995: Buffett proposes new issue of Berkshire preferred as acquisition currency. GEICO balks. GEICO wants all-cash deal $70. Buffett does not have the cash.
· 1995: On August 1, Disney announces their acquisition of Cap Cities/ABC. Buffett’s Cap Cities/ABC investment of $345 million now worth nearly $2.5 billion.
· 1995: On August 25, Buffett announces Berkshire’s acquisition of the remaining 49% of GEICO for $2.3 billion.
· From the real panic low’s set in the spring of 1976 of $2.25, by the fall of 1995, GEICO’s stock had soared to over $300 (split-adjusted).
· 1996: GEICO’s best year of policy growth (+10%) in 20 years.
· 1999: Buffett and Tony Nicely increase marketing budget to $242 million from $33 million in 1995. New auto policy growth of 1.65 million. Policies in force +4.3 million.
· 1996-2012: Market share up 4X to 9.6%. Annual auto premiums up 5X to $17 billion. Ad spending +$1 billion from $33 million. Cumulative underwriting profits since 1995 +10 billion. Float up 4X to $12 billion. Conservative valuation of GEICO $15 billion.



 

American Express (stock)

Growing company in distressedIn 1964, the “salad oil scandal,” where a vegetable oil company obtained massive loans through falsified collateral, rocked American Express, which had provided warehouses and vouched for the company’s inventory. This event ended up costing the company approximately $58 million and much of its reputation. In the period after the scandal broke, investors couldn’t sell AXP shares fast enough, and the stock lost 50 percent of its value in a short time, falling to $35 per share. Buffett, however, saw this moment of panic for just what it was – a drawback for an otherwise very stable company with long-term growth potential. Buffett observed people beginning to use credit cards in their daily transactions, and recognized AXP’s potential to become an American blue chip. The Berkshire Hathaway CEO purchased shares with a cost basis of $1.28 billion. As of December 31, 2009, the company’s 151.6 billion shares are worth more than $5 billion, an unrealized gain of $3.7 billion and an increase of 290 percent. Berkshire Hathaway currently owns 12.7 percent of American Express.

Adding to positionIn his 1997 shareholder's letter, Warren buffet shared that he was thinking of selling American Express. "Our Percs were due to convert into common stock in August 1994, and in the month before I was mulling whether to sell upon conversion. On ereason to hold was Amex's outstanding CEO, Harvey Colub, who seemed likely to maximize whatever potential the company had. But the size of that potential was in question: Amex faced relentless competiion from a multitude of card issers, led by Visa. Weighing the arguments, I leaned towards sale.

Friends in the right circle"Here's where I got lucky. During that month of decision, I played golf at Prouts Neck, Maine with Frank Olson, CEO of Hertz. Frank is a brilliant manager, with intimate knowledge of the card business. So from the first tee on I was quizzing him about the industry. By the time we reached the second green, Frank had convinced me that Amex's corporate card was a terrific franchise, and I had decided not to sell. On the back nine I turned buyer, and in a fwe months Berkshire owned 10% of the company."

Washington Public Power Supply Systems (WPPSS) (High yield bond)

Favorable risk return ratioIn Warren Buffet's 1984 shareholder's letter he shared: "From October 1983 through Jun 1984, Berkshire's subsidaries continuously purchased large quantities of bonds of Projects 1,2,and 3 of Washington Public Power Supply System (WPPSS). This is the same entity that on July 1983 defauled on $2.2billion of bonds issued to finance partial construction of now-abandoned Projects 4 and 5. While there are material differences in the obligators, promises, and propertoes underlying the two categories of bonds, the problems of 4 and 5 have cast a major coulb over Projects 1, 2, and 3 and might possibly cause serious problems for the latter issues. In addition, there have been a multitude of problems related directly to Projects 1, 2 and 3 that could weaken of destroy an otherwise strong credit position arising from guarantees by Bonneville Power Administration."

Despite the negatives, Charlie and I judged the risks at the time we purchased the bonds and at the prices Berkshire paid to be considerably more than compensated for by prospect of profit.

Coupon Rate was more attractive on a comparative basis to operating businessWe extend this business valuation approach even to bond purchases such as WPPSS. We compare the $139 million cost of the investment in WPPSS to a similar $139 million investment in an operating business. In the case of WPPSS, the "business" contractually earns $22.7 million after tax (via the interest paid on the bond) and those earnings are available to us currently in cash. We are unable to buy operating businesses with economics close to these. Only a relatively few businesses earn the 16.3% after tax on unleveraged capital that our WPPSS investment does and those businesses, when available for purchase, sell at large premiums to that cpaital.

In the average negotiated business transaction, unleveraged corporate earnings of $22.7 million after-tax (equivalent to about $45 million pre-tax) migh command a price of $250 - $300 million (or something more) [note: 5-6x EBIT]. For a business that we udnerstand well and strongly like, we will gladly pay that much, But it is double the price we paid to realize the same earnings from WPPSS bonds.

Estimated RiskHowever, in the case of WPPSS, there is what we view to be a very slight risk that the "business" could be worth nothing within a year or two. There also is the risk that interest payments might be interrupted for a considerable period of time. Furthermore, the most that the "business" could be worth is about the $205 million face value of the bonds that we own, an amount only 48% higher than the price we paid.

Thrilling ResultsBerkshire held the bonds into the early 1990's and received a 16% tax-free return. In addition, the bonds were eventually redeemed at par for a capital gain of 100%, which would have brought the total return to something just short of 30% per year

RJR Nabisco (High yield bond)

Out of favored There was a lot of junk bonds being sold in the 1980's. Buffett observed that "mountains of junk bonds were being sold by those who didn't care to those who didn't think". Problems started cropping up in the later 1980's with firms that were financed using junk bonds. Companies started defaulting on their bonds and by 1989, junk bonds were largely out of favor in the market.

The junk bond that stood outAs the junk bond market unravelled, Buffett noticed that RJR Nabisco's bonds were declining with others in the market. Unlike many other companies that had issued high yield bonds at the time, RJR Nabisco was meeting its financial obligations. Buffett thought that RJR's bonds were being overly punished in the markets. RJR was selling parts of its business and was successfully lowering its debt-to-capital ratio, thereby reducing its financial risk.

Warren Buffet was also very familiar with the cigarette business. In 1987, Buffett famously stated, "I'll tell you why I like the cigarette business. It costs a penny to make. Sell it for a dollar. It's addictive. And there's fantastic brand loyalty."

Thrilling result
In 1989 and 1990 Warren Buffett bought $440 million in RJR Nabisco bonds at a discount that produced a current yield of 16%. In early 1991, RJR Nabisco announced it was retiring its high-yield bonds and Berkshire turned a profit of $150 million on the investment. Total net return is estimated at 31%

Berkshire (stock)

Buffett had noticed a trading pattern in Berkshire’s stock; when the company would sell off an underperforming mill, it would use the proceeds to buy back stock, which would temporarily boost the stock price. Buffett’s strategy was to buy Berkshire stock each time it sold a mill and then sell the company its stock back in the share repurchase for a small, tidy profit.

But then ego got in the way.  Buffett and Berkshire’s CEO had a gentleman’s agreement on a tender offer price.  But when the office offer arrived in the mail, Buffett noticed that the CEO’s offer price was 1/8 of a point lower than they had agreed previously.

In an interview with CNBC, Warren Buffet shared: "So I started buying the stock (Berkshire). And in 1964, we had quite a bit of stock. And I went back and visited the management, Mr. (Seabury) Stanton. And he looked at me and he said, 'Mr. Buffett. We've just sold some mills. We got some excess money. We're gonna have a tender offer. And at what price will you tender your stock?' And I said, '$11.50.' And he said, 'Do you promise me that you'll tender it $11.50?' And I said, 'Mr. Stanton, you have my word that if you do it here in the near future, that I will sell my stock at $11.50.'

I went back to Omaha. And a few weeks later, I opened the mail and here it is: a tender offer from Berkshire Hathaway- that's from 1964. And if you look carefully, you'll see the price is $11 and three-eighths. He chiseled me for an eighth. And if that letter had come through with $11 and a half, I would have tendered my stock. But this made me mad. So I went out and started buying the stock, and I bought control of the company, and fired Mr. Stanton. Now, that sounds like a great little morality tale at this point. But the truth is that I had now committed a major amount of money to a terrible business."