Berkshire Hathaway (BRK.B) recently disclosed stakes in ConocoPhillips (COP), General Electric (GE), and United Parcel Service (UPS).
The GE and UPS purchases were made during the first quarter of 2006. Berkshire acquired the first half of its $1 billion stake in ConocoPhillips during the fourth quarter of 2005 and the second half in the first quarter of this year.
The company reduced its stake in H&R; Block (HRB), Home Depot (HD), Iron Mountain (IRM), Lexmark (LXK), Sealed Air (SEE), and ServiceMaster (SVM).
During the first quarter of 2006, Berkshire increased its holdings in Wells Fargo (WFC) and American Standard (ASD).
Most reports in the financial news media will probably focus on the ConocoPhillips stake and engage in speculation over what it says about Buffett’s short-term view of the energy sector in general and the price of crude oil in particular. The purchase is also likely to lead to confusion, because Buffett had said he would like to put more of Berkshire’s cash to use in the energy sector. It’s unlikely he meant big oil.
Superficially, banking appears to be a commodity business. In fact, it appears to be a particularly poor commodity business, because capacity is not constrained by the need to invest in a substantial physical infrastructure. True, whatever investments are made in tangible assets are usually intended as a means to acquire more intangible assets; however, a branch is hardly comparable to an oil well.
A bank’s ability to lend money (and thus produce income) is not completely and inextricably linked to the size of its deposits. In other words, loans are the result of both a bank’s capacity to lend money and its willingness to lend money.
It’s hard to find a parallel in tangible commodity businesses. Theoretically, this should make little difference in the long run. However, the lack of physical supply constraints in the market for loans creates the possibility for large, industry-wide mistakes. Pricing in such an industry can get very weak at times.
There’s one catch here. The underlying assumption whenever the commodity business label is used is that both the demand for a product and the supply of that product are general in nature. They can’t be specific, because that would destroy the involuntary nature of pricing within the industry.
For example, if all pineapples were unbranded, identically tasting fruits the demand side of the business would meet the requirement for a commodity business. However, if most pineapples take eighteen months to grow, but there is one magical plantation where the fruit develops fully in just three months, the supply side of the business does not meet the requirement for a true commodity business. The magical pineapple plantation would produce six times as much fruit per acre and thus the plantation owner would be able to undercut his competitor’s prices. He would earn extraordinary profits, because the return on capital in his business would be much higher than that of the industry as a whole.
What does this fairy tale have to do with banking? It suggests extraordinary profits can come from having “sticky” customers or lower costs. The lower costs needn’t be the result of lower marginal inputs. The magical pineapple plantation turned the crop over faster; it didn’t need access to below market prices for any of its inputs.
The same is true of a grocery store. Two stores that buy and sell cans of soup at the same exact prices may have very different returns on capital, if one of the stores turns over its inventory more quickly, because the fixed costs will be spread over a larger number of sales.
How does this relate to banking? While a quick turnover (or some other form of operational efficiency) is the most common reason for one firm’s unusual profitability in a commodity type business, there are other ways to earn extraordinary profits. Some of them are conceptually quite similar to …
Gannon On Investing’s contributing writer, Mike Price, reviews Robert P. Miles’ Warren Buffett Wealth. Mike also outlines his own still evolving, Buffett-inspired investment philosophy. The juxtaposition of the investment philosophies of Warren Buffett and Lou Simpson (along with Mike’s own philosophy) provides food for thought. The common thread is a principled, qualitative, and (above all else) focused approach to investing.
In some future posts, you will see links to content provided by The Wall Street Transcript. At their site, you will find a large collection of interviews with executives, money managers, and analysts. The Wall Street Transcript kindly offered to provide me with access to this material on the condition that I link to the source cited.
I have been planning to increase the amount of company specific content on the blog. The partnership with The Wall Street Transcript will greatly facilitate the development of such content.
I’ve included The Wall Street Transcript and its free annual reports service, EasyReports.net, in the Value Investing Directory. Both are excellent resources. They would be worthy of inclusion even if this blog was not associated with them in any way.
One of my favorite blogs, Value Discipline, recently announced a similar arrangement with The Wall Street Transcript. Rick regularly posts on specific companies, so I’m sure Value Discipline will put the partnership to good use.…
In some future posts, you will see links to content provided by The Wall Street Transcript. At their site, you will find a large collection of interviews with executives, money managers, and analysts. The Wall Street Transcript kindly offered to provide me with access to this material on the condition that I link to the source cited.
I have been planning to increase the amount of company specific content on the blog. The partnership with The Wall Street Transcript will greatly facilitate the development of such content.
I’ve included The Wall Street Transcript and its free annual reports service, EasyReports.net, in the Value Investing Directory. Both are excellent resources. They would be worthy of inclusion even if this blog was not associated with them in any way.
One of my favorite blogs, Value Discipline, recently announced a similar arrangement with The Wall Street Transcript. Rick regularly posts on specific companies, so I’m sure Value Discipline will put the partnership to good use.…
The April Issue of the quarterly newsletter has finally been mailed out. I was very pleased with the printing job done by the second print shop. I will continue to use them. In the future, the newsletter should arrive on or about the 15th of the month.
I’ve also updated the newsletter section of the website. You can now purchase the July Issue. If anyone is still interested in purchasing the April Issue (for immediate delivery), please send me an email – I have a few extra copies.
All subscribers should have already received a PDF for the first quarter. If you purchased the April Issue and did not receive a PDF, please send me an email and I will provide the PDF at once.
For the quarter ended March 31st, Overstock.com (OSTK) reported a net loss of $15.9 million or ($0.82) per share. Total revenue increased by 8.62% to $180.2 million from $165.9 million. The company reported gross profit of $25.2 million; gross profit had been $24.8 million in the year ago period. Gross margins dropped from 14.9% in the year ago period to 14.0% in the first quarter of 2006.
Analysts had much higher expectations. As a result, shares of OSTK are down a little over 7% today. I had expected slightly higher revenue growth coupled with slightly lower gross margins. Overstock’s gross profit for the quarter exceeded my expectations, but not by a meaningful amount. More importantly, gross margins held up well, and are still in the high range of the 12-15% range I believe represents the company’s highest sustainable gross margins.
Overstock consumed a fair amount of cash during the quarter. Cash and securities fell from $112 million to $52 million during the period. Meanwhile, current liabilities were at $94 million at the end of the first quarter. Overstock had current liabilities of $155 million at the end of 2005.
The difference between Overstock’s performance in the first quarter of this year and its performance in the first quarter of last year was primarily attributable to higher technology expenses.
Patrick Byrne wrote:
We lost $15.9 million in Q1. I anticipate Q2 will look about the same, before we start climbing out of this hole in the second half of 2006. Our theme for this year is to slow growth during the first half of the year so we can work on improving internal business processes in preparation for stronger performance in Q4 and beyond. We continue to anticipate things will look better in Q3, and to be out of the ditch by Q4. Nothing that has happened recently suggests to me that we should change course.
We ended Q1 with $52 million in cash and marketable securities, including $20 million of borrowings on our inventory lines. We have an additional $30 million of availability on our lines, and are continuing to reduce inventory to turn it back into cash.
In summary, I’m committed to stay the course: slowing growth while we improve our systems and enhance the service we provide to our customers. Unfortunately, Q2 will be another disappointing quarter at the bottom line; then the tide should start coming back in by Q3 and we should be afloat in Q4.
I agree with that conclusion. When I first looked at the original $37 offer, I thought it wouldn’t be particularly attractive as anything but an arbitrage commitment (in other words: if a deal couldn’t be worked out, there was no value in Engelhard).
Since then, the market price of Engelhard (EC) shares has not provided a good spread. In fact, if you look at a chart, you’ll see that the consensus has been that BASF (BF) was being a little cheap here. Shares of Engelhard have traded above the BASF offer, so there was zero opportunity for an arbitrage commitment based on public information (i.e., the announced BASF bid).
If you wanted to play the BASF offer, you had to engage in speculation. Only a higher bid would provide a profit if you were to buy shares at the market price.
Unfortunately, this is a contested takeover, not a bidding war. While buying above the announced tender offer is always a speculation, doing so when there isn’t another bidder is far riskier.
There’s the risk that the potential acquirer will walk away without a deal that would allow you to tender all of your shares. There’s also the risk that some adverse development will permit the acquirer to do a friendly deal below the expected offer. Finally, there’s the risk that a deal will be done along the lines of the already announced offer. If you were to buy shares in the market above the offer price, you would incur a small loss when the target’s board agreed to the previously proposed terms.
If no agreement was ever reached, you’d have two possible problems. The first is that you might not want to sell your shares when it became clear the potential acquirer was backing off, because there could be a lot of other sellers at that moment. Some owners of the target’s shares might be unwilling or unable to hold their shares for long after it was clear there wouldn’t be a deal, because they don’t want to be involved in a general investment. These investors only want to hold shares of a target or potential target; they don’t want to hold a stock that will rise and fall along with the general market.
The other possible problem with these contested situations is that the target’s board might do damage to the long-term health of the company. In this case, I’m not convinced the board is dead set against a deal. They may just be holding out for a bit more money.
Of course, Engelhard may still be wrong to engage in this recapitalization, because BASF won’t bite. However, I think the situation at Engelhard is a bit different from one where the board …
Journal Communications (JRN) announced it plans to spin-off its telecom business. Shareholders of JRN will receive shares representing 100% ownership in Norlight Telecommunications.
This is a positive development for Journal Communications. It makes an already attractive stock even more attractive. Shares of Journal Communications were up about 6% on the news. The current share price still represents something on the order of a 33-50% discount to Journal’s break-up value.
I don’t expect the company will sell or spin-off any of its other assets. Journal owns a major daily newspaper (The Milwaukee Journal Sentinel), a collection of community newspapers, over three dozen radio stations, over half a dozen television stations, and the aforementioned telecom business. At a minimum, these properties are worth somewhere between $15 a share and $18 a share. JRN currently trades at less than $12 a share.
The company says the Norlight spin-off will likely take place in about six months. Ultimately, I expect the two securities (combined) will trade above the current market price for shares of JRN. However, the size and nature of the business being spun off may result in a lot of indiscriminate selling. Follow the news on this for more details about the planned spin-off.
Shares of JRN are attractive right now. Although I wouldn’t want to own the telecom business, the spin-off may actually make shares of Norlight attractive as well, because I doubt many holders of JRN will want to keep their Norlight shares.
My advice would be to buy shares of Journal Communications now and follow the spin-off to see if there is an opportunity to buy shares of Norlight for less than they’re worth. But, don’t wait to buy shares of JRN, because you can get the media properties at a discount by buying now.
Also, if you currently own shares of JRN or plan to buy shares of JRN such that you will receive a distribution of Norlight shares, I would strongly suggest you do not immediately sell your Norlight shares even if you have no interest in owning the telecom business.
You should probably decide on a certain amount of time during which you will not sell your Norlight shares for any reason. If you don’t insist on this kind of discipline, you’ll likely be selling at the same time as many other investors who received shares in the spin-off. Alternatively, you could just do the homework and figure out what Norlight is worth. There should be plenty of information forthcoming in the months ahead. This is a story you’ll want to watch.
(Note: Journal has not yet announced the record date or the distribution date.)
New Jersey based chemicals company Engelhard Corporation (EC) has announced a recapitalization plan in response to the unsolicited offer made by rival BASF (BF). The shareholder response to BASF’s tender offer had been very limited. BASF originally offered $37 a share. That bid was later raised to $38 a share.
This morning Engelhard announced it will repurchase 26 million shares at $45 a share. This is about 20% of the shares outstanding. The company also announced certain “incremental cost savings”. All of this seems to be the result of a plan to study alternatives to the BASF bid. Additional Information
The company’s preliminary proxy materials to be filed today with the Securities and Exchange Commission (SEC) – and the self-tender offer materials to be filed with the SEC and distributed to shareholders — set out in greater detail the reasons for the belief that the recapitalization plan represents the best value-creation alternative for Engelhard shareholders…Additional material on the plan is also available on www.engelhard.com.
Engelhard is increasing its board from 6 members to 9 members. The increase is related to the BASF bid and the reorganization plan.
Shares of Engelhard closed at $38.30. They were at $38.65 in pre-market trading. Other Details
The self-tender offer is expected to commence during the week of May 1, 2006 and expire at a date following the Annual Meeting of Shareholders set for June 2, 2006. If, following the Annual Meeting, individuals nominated by BASF constitute a majority of the Engelhard board, the board will have the ability to withdraw the self-tender offer. Closing of the self-tender offer would also be subject to the Engelhard board not recommending acceptance of an amended offer that BASF may choose to make as well as to receipt of financing and other customary conditions.
Note: Please research this matter before taking any action. The information provided above is not sufficient to make an informed investment decision.
I would suggest you start by visiting Engelhard’s website and reviewing any SEC filings. This post was written in the early morning; new information may have become available after it was written.…
