Ahead for Berkshire Hathaway: Utility-Like Returns?

Warren Buffett's 2009 Annual Letter

Investors who expect Berkshire Hathaway's future performance to match its historic returns are guaranteed to be disappointed.

So who is the author of the above quote (paraphrase actually)?

Some money manager or securities analyst trying to making their "bones" with a rare "sell" call on Berkshire Hathaway? (Full disclosure: Berkshire is the ultimate parent company of Edina Realty, which I suppose would make Buffett my boss if I weren't an independent contractor).

A competitor, perhaps?

Try Buffett himself.

Blunting the sting at least a little bit: Buffett makes the same warning every year, noting that "the law of large numbers" -- which certainly applies to multi-hundred billion behemoths like Berkshire Hathaway -- makes it increasingly difficult to rack up market-beating performance, year after year.

Different this Time

And yet, careful readers of Buffett's letters through the years will discern a true watershed in this year's annual letter:

Berkshire Hathaway is slowing turning itself into a utility.

As such, its returns going forward are sure to be more utility-like: stable and solid, to be sure, but lower -- and subject to government approval (sufferance?)

Again, the words come straight from the . . . er, horse's mouth:

Permitting and construction periods for generation and major transmission facilities stretch way out, so it is incumbent on us to be far-sighted. We, in turn, look to our utilities’ regulators (acting on behalf of our customers) to allow us an appropriate return on the huge amounts of capital we must deploy to meet future needs. We shouldn’t expect our regulators to live up to their end of the bargain unless we live up to ours.

--Warren Buffet, 2009 Annual Letter to Shareholders

In fact, the following passage clearly seems addressed not to shareholders, but to Berkshire's regulators, who increasingly hold sway over the company's future performance:

With few exceptions, our regulators have promptly allowed us to earn a fair return on the ever increasing sums of capital we must invest. Going forward, we will do whatever it takes to serve our territories in the manner they expect. We believe that, in turn, we will be allowed the return we deserve on the funds we invest.

--Warren Buffett

So what is the template for future Berkshire investments and acquisitions?

More companies like capital-intensive -- and regulated utility -- Burlington Northern Santa Fe.

"Ever Increasing Sums of Capital"

As Buffett acknowledges, this historic shift to capital-intensive, regulated industries (albeit monopolies, to be sure) is a function of decades of compounding returns at 20%-plus. No doubt more corporations wish they had this problem.

Yet it violates one of Buffett's two heretofore cardinal investing maxims: 1) only invest in businesses you understand; and 2) avoid capital-intensive businesses.

The reason to avoid capital-intensive businesses is that they act like an anchor on investment returns; even Buffett acknowledges as much:

The best businesses by far for owners continue to be those that have high returns on capital and that require little incremental investment to grow.

That's still good advice for investors -- advice they eschew at the expense of their future returns.

Heir Apparent

The other under remarked tidbit in this year's annual letter is that Buffett clearly has anointed a successor: David Sokol, the co-head of Berkshire's Mid-American Energy subsidiary.

Sokol has been temporarily dispatched to stop the hemorrhaging at subsidiary NetJets, an aviation operation that offers fractional ownership of jets.

This represents a signal departure for Buffett, who famously leaves incumbent management alone.

Sokol's "special assignment" is a tacit nod that he's being groomed for more and bigger assignments prospectively. And who knows their way around regulated utilities -- the parent company's future -- better than the guy who successfully shepherded Mid-American for 15 years?

Lastly, no Warren Buffett letter is complete without one great, homespun quote.

Here is my candidate for this year's:

"Sing a country song in reverse, and you will quickly recover your car, house, and wife."

Buffett's Negotiating Secrets

Berkshire '09 Annual Letter -- Part Two

For investors, perhaps the most tantalizing -- and useful -- part of Warren Buffett's 2009 letter to shareholders is a little tidbit that's appended to the end.

Actually, it's a solicitation, addressed to perhaps a few hundred people in the world.

Who? People who run or have large minority stakes in a specific kind of company. One that Buffett might want to buy next.

Specifically, the desired company should have: a market value of $5 billion to $20 billion, ballpark; top-flight management in place; and be able to earn more than $75 million annually pre-tax, through "thick and thicker," as Buffett might put it.

Buffett also stipulates two negotiating prerequisites: 1) the Seller must have a firm selling price -- and be able to deliver it (thus, no consultants or other go-between's; only principals need respond); and 2) there must be no other suitors -- no auctions.

Buffett's Negotiating Secrets

What can Buyers learn from Buffett? Three things:

One. Never negotiate against yourself.

That's what you do when you open negotiations by announcing what you're willing to pay -- as opposed to insisting that the Seller announce its selling price (and indeed, commit to being sold).

Two. Never negotiate against other would-be suitors. That's what an auction is.

Buffett doesn't do auctions because he knows that a skillfully run auction will raise the price (savvy home sellers and their Realtors know that, too!).

One of two things happens in an auction (at least when the prize is gold, not dross).

Either you prevail, in which case you'll likely have overpaid.

Or you lose, in which case, you'll just have helped drive up the price the winning bidder paid.

No thanks.

So why would a choice, up-and-coming company -- and Buffett doesn't covet any other kind -- pass up the opportunity to "play the field?"

Several reasons, actually.

Berkshire Hathaway is like a beneficent -- and distant -- ruler. A very rich and patient ruler, with an unusual commitment to building long-term value and actually investing and creating capital, not sucking it out.

For an ambitious and capable manager, there are worse places to be than part of Berkshire Hathaway's corporate fold.

Oh . . . and negotiations will be simple, quick, and painless (Buffett doesn't do hostile deals). And cheap! (remember, no go-between's). That's actually Lesson #3 -- "keep it simple and friendly" -- for anyone who is counting.

"We can promise complete confidentiality and a very fast answer — customarily within five minutes — as to whether we’re interested," Buffett promises.

I'll bet Buffett gets two corporate takers by this July 1 -- three if the market's down significantly before then (Berkshire's pretty good shelter in a storm).

Warren Buffett's Crystal Ball -- & Rearview Mirror

Memorable Quotes from
Berkshire's '09 Annual Letter

In 75% of [the last 44 years], the S&P stocks recorded a gain. I would guess that a roughly similar percentage of years will be positive in the next 44. But neither Charlie Munger, my partner in running Berkshire, nor I can predict the winning and losing years in advance. (In our usual opinionated view, we don’t think anyone else can either.) We’re certain, for example, that the economy will be in shambles throughout 2009 – and, for that matter, probably well beyond – but that conclusion does not tell us whether the stock market will rise or fall.

--Warren Buffett, 2008 Berkshire Hathaway Annual Report

Substitute "housing market" for "stock market," and you've got a pretty good long-term outlook . . .

If you've never read one of Buffett's letters, I highly recommend it; they're probably the closest thing capitalism has to Mao's "Little Red Book."

At least in my view, here are the most memorable quotes from this year's letter (last year's top line was an instant -- and much quoted -- classic: 'you don't know who's swimming naked until the tide goes out'):

"Putting people into homes, though a desirable goal, shouldn’t be our country’s primary objective. Keeping them in their homes should be the ambition."

"At the moment, it is much better to be a financial cripple with a government guarantee than a Gibraltar without one."

"Beware the investment activity that produces applause; the great moves are usually greeted by yawns."

"When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000's. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary."

"Participants [in derivatives contracts] seeking to dodge troubles face the same problem as someone seeking to avoid venereal disease: It’s not just whom you sleep with, but also whom they are sleeping with."

*Through its subsidiary, MidAmerican Energy, Berkshire Hathaway is the ultimate parent company of Edina Realty.