Bill Ackman said he invested in Berkshire Hathaway Inc. because he believes it will continue to generate significant returns even after Warren Buffett is no longer running the company.
Ackman said in a letter to investors Thursday that he believed the company was trading at one of the widest discounts to its intrinsic value at a time when its subsidiaries are poised to benefit from managerial and organizational changes.
“Berkshire is often described in the media as akin to an investment fund, leaving many with the impression that Berkshire’s shareholder returns are dependent on Warren Buffett’s extraordinary stock-picking ability,” Ackman said in the letter. “While this depiction of Berkshire was a better reflection of its reality in its earlier years, it no longer reflects the company’s current reality.”
Ackman said Buffett, 88, has designed the company in a way that will allow it to continue to succeed decades after he leaves. He said Berkshire should continue to generate high returns for shareholders even if its earnings from its large cash holdings and marketable securities portfolio are similar to that of the broader market.
“While Mr. Buffett has long been one of most high-profile and closely followed investors in the world, we believe that Berkshire Hathaway’s undervaluation is partially explained by the fact that it is one of the least followed and misunderstood mega-cap companies,” Ackman said.
$696 Million Stake
Ackman disclosed his Berkshire holdings in a regulatory filing Wednesday. His Pershing Square Capital Management held 3.51 million Class B shares as of June 30, a stake valued at about $696 million based on Thursday’s closing price. Ackman said Thursday that Berkshire was trading at 12 times his earnings per share estimate over the next year.
Buffett has acknowledged the shift that Ackman’s Pershing highlights in its letter. Buffett said in his annual letter to shareholders in February that it was time to abandon the practice of prominently featuring the change in book value because the metric “lost the relevance it once had.” Berkshire, Buffett said, has shifted from a company with assets concentrated in stocks to one holding a wide array of operating businesses.
Ackman said Berkshire’s primary asset is the world’s largest insurance business, which he said accounted for about half of its intrinsic value. That business, which includes Geico, has benefited from its scale, and has been able to grow at a higher rate and lower cost than its competitors. For more than a decade, Buffett has grown the float of the business on average by 8% a year, while achieving a negative 2% average cost of the float due to its profitable underwriting, according to Ackman.
“While Mr. Buffett is best known as a great investor, he should perhaps also be considered the world’s greatest insurance company architect and CEO because the returns Berkshire has achieved on investment would not be nearly as good without the material benefits it has realized by financing these investments with low-cost insurance float,” he said.
Berkshire’s non-insurance businesses, including the Burlington Northern Santa Fe railroad and aerospace parts manufacturer Precision Castparts, have helped drive earnings as well.
Ackman said Berkshire should use some of its $100 billion in excess cash on new businesses or share buybacks. Berkshire’s board loosened its buyback policy last year, allowing Buffett and longtime business partner Charlie Munger to repurchase shares when the pair believed they had fallen below their intrinsic value. That has led to $3.4 billion in buybacks since the change.
Ackman said that elevation of Ajit Jain, who now oversees all the insurers, and Greg Abel, who has responsibility for the non-insurance businesses, will help enhance operational performance.
“If Berkshire can improve its operations and intelligently deploy a substantial portion of its excess capital over time, we estimate that the company’s earnings per share should grow at a mid-teens’ compounded annual rate over the intermediate term,” he said.
Pershing Square had about $8.4 billion in assets under management at the end of July, according to its website. The firm said it returned roughly 49% on its investments this year through Aug. 13.
Ackman also discussed his rationale for exiting investments in Automatic Data Processing Inc. and United Technologies Corp. for the first time.
He said he expected the returns at ADP to be more modest going forward, noting the investment had returned about 64%.
Pershing sold out of United Technologies because of its “value-destructive” merger with Raytheon Co. in June after only a 3% gain.
“Although we could have run a campaign to block the transaction over the next six or more months, our loss of confidence in management would have also required us to engage in a more comprehensive battle to replace the company’s leadership, and perhaps a portion of the board, in order to be comfortable with the company’s future,” Ackman said.