Berkshire Hathaway Shareholder Letter 1999
BERKSHIRE HATHAWAY INC.
To the Shareholders of Berkshire Hathaway Inc.:
Our gain in net worth during 1999
was $358 million, which increased the per-share book value of both
our Class A and Class B stock by 0.5%. Over the last 35 years (that
is, since present management took over) per-share book value has
grown from $19 to $37,987, a rate of 24.0% compounded annually.*
* All figures used in this report apply
to Berkshire's A shares, the successor to the only stock that the company
had outstanding before 1996. The B shares have an economic interest
equal to 1/30th that of the A.
The numbers on the facing page show
just how poor our 1999 record was. We had the worst absolute performance
of my tenure and, compared to the S&P, the worst relative performance
as well. Relative results are what concern us: Over time, bad relative
numbers will produce unsatisfactory absolute results.
Even Inspector Clouseau could find
last year's guilty party: your Chairman. My performance reminds
me of the quarterback whose report card showed four Fs and a D but
who nonetheless had an understanding coach. "Son," he drawled, "I
think you're spending too much time on that one subject."
My "one subject" is capital allocation,
and my grade for 1999 most assuredly is a D. What most hurt us during
the year was the inferior performance of Berkshire's equity portfolio
-- and responsibility for that portfolio, leaving aside the small
piece of it run by Lou Simpson of GEICO, is entirely mine. Several
of our largest investees badly lagged the market in 1999 because
they've had disappointing operating results. We still like these
businesses and are content to have major investments in them. But
their stumbles damaged our performance last year, and it's no sure
thing that they will quickly regain their stride.
The fallout from our weak results
in 1999 was a more-than-commensurate drop in our stock price. In
1998, to go back a bit, the stock outperformed the business. Last
year the business did much better than the stock, a divergence that
has continued to the date of this letter. Over time, of course,
the performance of the stock must roughly match the performance
of the business.
Despite our poor showing last year,
Charlie Munger, Berkshire's Vice Chairman and my partner, and I
expect that the gain in Berkshire's intrinsic value over the next
decade will modestly exceed the gain from owning the S&P. We
can't guarantee that, of course. But we are willing to back our
conviction with our own money. To repeat a fact you've heard before,
well over 99% of my net worth resides in Berkshire. Neither my wife
nor I have ever sold a share of Berkshire and -- unless our checks
stop clearing -- we have no intention of doing so.
Please note that I spoke of hoping
to beat the S&P "modestly." For Berkshire, truly large superiorities
over that index are a thing of the past. They existed then because
we could buy both businesses and stocks at far more attractive prices
than we can now, and also because we then had a much smaller capital
base, a situation that allowed us to consider a much wider range
of investment opportunities than are available to us today.
Our optimism about Berkshire's performance
is also tempered by the expectation -- indeed, in our minds, the
virtual certainty -- that the S&P will do far less well in the
next decade or two than it has done since 1982. A recent article
in Fortune expressed my views as to why this is inevitable, and
I'm enclosing a copy with this report.
Our goal is to run our present businesses
well -- a task made easy because of the outstanding managers we
have in place -- and to acquire additional businesses having economic
characteristics and managers comparable to those we already own.
We made important progress in this respect during 1999 by acquiring
Jordan's Furniture and contracting to buy a major portion of MidAmerican
Energy. We will talk more about these companies later in the report
but let me emphasize one point here: We bought both for cash, issuing
no Berkshire shares. Deals of that kind aren't always possible,
but that is the method of acquisition that Charlie and I vastly
prefer.
Guides to Intrinsic Value
I often talk in
these pages about intrinsic value, a key, though far from precise,
measurement we utilize in our acquisitions of businesses and common
stocks. (For an extensive discussion of this, and other investment
and accounting terms and concepts, please refer to our Owner's Manual
on pages 55 - 62. Intrinsic value is discussed on page 60.)
In our last four reports, we have
furnished you a table that we regard as useful in estimating Berkshire's
intrinsic value. In the updated version of that table, which follows,
we trace two key components of value. The first column lists our
per-share ownership of investments (including cash and equivalents
but excluding assets held in our financial products operation) and
the second column shows our per-share earnings from Berkshire's
operating businesses before taxes and purchase-accounting adjustments
(discussed on page 61), but after all interest and corporate expenses.
The second column excludes all dividends, interest and
capital gains that we realized from the investments presented in
the first column. In effect, the columns show how Berkshire would
look if it were split into two parts, with one entity holding our
investments and the other operating all of our businesses and bearing
all corporate costs.
Pre-tax Earnings
(Loss) Per Share
Investments
With All Income from
Year
Per Share
Investments Excluded
1969
...........................................................................
$ 45
$ 4.39
1979
...........................................................................
577
13.07
1989
...........................................................................
7,200
108.86
1999
...........................................................................
47,339
(458.55)
Here are the growth rates of the two segments by decade:
Pre-tax Earnings Per Share
Investments
With All Income from
Decade Ending
Per Share
Investments Excluded
1979
.............................................
29.0%
11.5%
1989
.............................................
28.7%
23.6%
1999
.............................................
20.7%
N.A.
Annual Growth Rate, 1969-1999 .................
25.4%
N.A.
In 1999, our per-share investments
changed very little, but our operating earnings, affected by negatives
that overwhelmed some strong positives, fell apart. Most of our
operating managers deserve a grade of A for delivering fine results
and for having widened the difference between the intrinsic value
of their businesses and the value at which these are carried on
our balance sheet. But, offsetting this, we had a huge -- and, I
believe, aberrational -- underwriting loss at General Re. Additionally,
GEICO's underwriting profit fell, as we had predicted it would.
GEICO's overall performance, though, was terrific, outstripping
my ambitious goals.
We do not expect our underwriting
earnings to improve in any dramatic way this year. Though GEICO's
intrinsic value should grow by a highly satisfying amount, its underwriting
performance is almost certain to weaken. That's because auto insurers,
as a group, will do worse in 2000, and because we will materially
increase our marketing expenditures. At General Re, we are raising
rates and, if there is no mega-catastrophe in 2000, the company's
underwriting loss should fall considerably. It takes some time,
however, for the full effect of rate increases to kick in, and General
Re is therefore likely to have another unsatisfactory underwriting
year.
You should be aware that one item
regularly working to widen the amount by which intrinsic value exceeds
book value is the annual charge against income we take for amortization
of goodwill -- an amount now running about $500 million. This charge
reduces the amount of goodwill we show as an asset and likewise
the amount that is included in our book value. This is an accounting
matter having nothing to do with true economic goodwill, which increases
in most years. But even if economic goodwill were to remain constant,
the annual amortization charge would persistently widen the gap
between intrinsic value and book value.
Though we can't give you a precise
figure for Berkshire's intrinsic value, or even an approximation,
Charlie and I can assure you that it far exceeds our $57.8 billion
book value. Businesses such as See's and Buffalo News are now worth
fifteen to twenty times the value at which they are carried on our
books. Our goal is to continually widen this spread at all subsidiaries.
A Managerial Story You Will Never Read Elsewhere
Berkshire's collection of managers
is unusual in several important ways. As one example, a very high percentage
of these men and women are independently wealthy, having made fortunes
in the businesses that they run. They work neither because they
need the money nor because they are contractually obligated to --
we have no contracts at Berkshire. Rather, they work long and hard
because they love their businesses. And I use the word "their" advisedly,
since these managers are truly in charge -- there are no show-and-tell
presentations in Omaha, no budgets to be approved by headquarters,
no dictums issued about capital expenditures. We simply ask our
managers to run their companies as if these are the sole asset of
their families and will remain so for the next century.
Charlie and I try to behave with
our managers just as we attempt to behave with Berkshire's shareholders,
treating both groups as we would wish to be treated if our positions
were reversed. Though "working" means nothing to me financially,
I love doing it at Berkshire for some simple reasons: It gives me
a sense of achievement, a freedom to act as I see fit and an opportunity
to interact daily with people I like and trust. Why should our managers
-- accomplished artists at what they do -- see things differently?
In their relations with Berkshire,
our managers often appear to be hewing to President Kennedy's charge,
"Ask not what your country can do for you; ask what you can do for
your country." Here's a remarkable story from last year: It's about
R. C. Willey, Utah's dominant home furnishing business, which Berkshire
purchased from Bill Child and his family in 1995. Bill and most
of his managers are Mormons, and for this reason R. C. Willey's
stores have never operated on Sunday. This is a difficult way to
do business: Sunday is the favorite shopping day for many customers.
Bill, nonetheless, stuck to his principles -- and while doing so
built his business from $250,000 of annual sales in 1954, when he
took over, to $342 million in 1999.
Bill felt that R. C. Willey could
operate successfully in markets outside of Utah and in 1997 suggested
that we open a store in Boise. I was highly skeptical about taking
a no-Sunday policy into a new territory where we would be up against
entrenched rivals open seven days a week. Nevertheless, this was
Bill's business to run. So, despite my reservations, I told him
to follow both his business judgment and his religious convictions.
Bill then insisted on a truly extraordinary
proposition: He would personally buy the land and build the store
-- for about $9 million as it turned out -- and would sell it to
us at his cost if it proved to be successful. On the other hand,
if sales fell short of his expectations, we could exit the business
without paying Bill a cent. This outcome, of course, would leave
him with a huge investment in an empty building. I told him that
I appreciated his offer but felt that if Berkshire was going to
get the upside it should also take the downside. Bill said nothing
doing: If there was to be failure because of his religious beliefs,
he wanted to take the blow personally.
The store opened last August and
immediately became a huge success. Bill thereupon turned the property
over to us -- including some extra land that had appreciated significantly
-- and we wrote him a check for his cost. And get this: Bill
refused to take a dime of interest on the capital he had tied up
over the two years.
If a manager has behaved similarly
at some other public corporation, I haven't heard about it. You
can understand why the opportunity to partner with people like Bill
Child causes me to tap dance to work every morning.
* * * * * * * * * * * *
A footnote: After our "soft" opening
in August, we had a grand opening of the Boise store about a month
later. Naturally, I went there to cut the ribbon (your Chairman,
I wish to emphasize, is good for something). In my talk
I told the crowd how sales had far exceeded expectations, making
us, by a considerable margin, the largest home furnishings store
in Idaho. Then, as the speech progressed, my memory miraculously
began to improve. By the end of my talk, it all had come back to
me: Opening a store in Boise had been my idea.
The Economics of Property/Casualty Insurance
Our main business -- though
we have others of great importance -- is insurance. To understand
Berkshire, therefore, it is necessary that you understand how to
evaluate an insurance company. The key determinants are: (1) the
amount of float that the business generates; (2) its cost; and (3)
most critical of all, the long-term outlook for both of these factors.
To begin with, float is money we
hold but don't own. In an insurance operation, float arises because
premiums are received before losses are paid, an interval that sometimes
extends over many years. During that time, the insurer invests the
money. This pleasant activity typically carries with it a downside:
The premiums that an insurer takes in usually do not cover the losses
and expenses it eventually must pay. That leaves it running an "underwriting
loss," which is the cost of float. An insurance business has value
if its cost of float over time is less than the cost the company
would otherwise incur to obtain funds. But the business is a lemon
if its cost of float is higher than market rates for money.
A caution is appropriate here: Because
loss costs must be estimated, insurers have enormous latitude in
figuring their underwriting results, and that makes it very difficult
for investors to calculate a company's true cost of float. Errors
of estimation, usually innocent but sometimes not, can be huge.
The consequences of these miscalculations flow directly into earnings.
An experienced observer can usually detect large-scale errors in
reserving, but the general public can typically do no more than
accept what's presented, and at times I have been amazed by the
numbers that big-name auditors have implicitly blessed. In 1999
a number of insurers announced reserve adjustments that made a mockery
of the "earnings" that investors had relied on earlier when making
their buy and sell decisions. At Berkshire, we strive to be conservative
and consistent in our reserving. Even so, we warn you that an unpleasant
surprise is always possible.
The table that follows shows (at
intervals) the float generated by the various segments of Berkshire's
insurance operations since we entered the business 33 years ago
upon acquiring National Indemnity Company (whose traditional lines
are included in the segment "Other Primary"). For the table we have
calculated our float -- which we generate in large amounts relative
to our premium volume -- by adding net loss reserves, loss adjustment
reserves, funds held under reinsurance assumed and unearned premium
reserves, and then subtracting agents balances, prepaid acquisition
costs, prepaid taxes and deferred charges applicable to assumed
reinsurance. (Got that?)
Yearend
Float (in $ millions)
Year
GEICO
General Re
Other
Reinsurance
Other
Primary
Total
1967
20
20
1977
40
131
171
1987
701
807
1,508
1997
2,917
4,014
455
7,386
1998
3,125
14,909
4,305
415
22,754
1999
3,444
15,166
6,285
403
25,298
Growth of float is important -- but
its cost is what's vital. Over the years we have usually recorded
only a small underwriting loss -- which means our cost of float
was correspondingly low -- or actually had an underwriting profit,
which means we were being paid for holding other people's
money. Indeed, our cumulative result through 1998 was an underwriting
profit. In 1999, however, we incurred a $1.4 billion underwriting
loss that left us with float cost of 5.8%. One mildly mitigating
factor: We enthusiastically welcomed $400 million of the loss because
it stems from business that will deliver us exceptional float over
the next decade. The balance of the loss, however, was decidedly
unwelcome, and our overall result must be judged extremely poor.
Absent a mega-catastrophe, we expect float cost to fall in 2000,
but any decline will be tempered by our aggressive plans for GEICO,
which we will discuss later.
There are a number of people
who deserve credit for manufacturing so much "no-cost" float over
the years. Foremost is Ajit Jain. It's simply impossible to overstate
Ajit's value to Berkshire: He has from scratch built an outstanding
reinsurance business, which during his tenure has earned an underwriting
profit and now holds $6.3 billion of float.
In Ajit, we have an underwriter
equipped with the intelligence to properly rate most risks; the
realism to forget about those he can't evaluate; the courage to
write huge policies when the premium is appropriate; and the discipline
to reject even the smallest risk when the premium is inadequate.
It is rare to find a person possessing any one of these talents.
For one person to have them all is remarkable.
Since Ajit specializes in super-cat
reinsurance, a line in which losses are infrequent but extremely
large when they occur, his business is sure to be far more volatile
than most insurance operations. To date, we have benefitted from
good luck on this volatile book. Even so, Ajit's achievements are
truly extraordinary.
In a smaller but nevertheless important
way, our "other primary" insurance operation has also added to Berkshire's
intrinsic value. This collection of insurers has delivered a $192
million underwriting profit over the past five years while supplying
us with the float shown in the table. In the insurance world, results
like this are uncommon, and for their feat we thank Rod Eldred,
Brad Kinstler, John Kizer, Don Towle and Don Wurster.
As I mentioned earlier, the
General Re operation had an exceptionally poor underwriting year
in 1999 (though investment income left the company well in the black).
Our business was extremely underpriced, both domestically and internationally,
a condition that is improving but not yet corrected. Over time,
however, the company should develop a growing amount of low-cost
float. At both General Re and its Cologne subsidiary, incentive
compensation plans are now directly tied to the variables of float
growth and cost of float, the same variables that determine value
for owners.
Even though a reinsurer may
have a tightly focused and rational compensation system, it cannot
count on every year coming up roses. Reinsurance is a highly volatile
business, and neither General Re nor Ajit's operation is immune
to bad pricing behavior in the industry. But General Re has the
distribution, the underwriting skills, the culture, and -- with
Berkshire's backing -- the financial clout to become the world's
most profitable reinsurance company. Getting there will take time,
energy and discipline, but we have no doubt that Ron Ferguson and
his crew can make it happen.
GEICO (1-800-847-7536 or GEICO.com)
GEICO made exceptional progress
in 1999. The reasons are simple: We have a terrific business idea
being implemented by an extraordinary manager, Tony Nicely. When
Berkshire purchased GEICO at the beginning of 1996, we handed the
keys to Tony and asked him to run the operation exactly as if he
owned 100% of it. He has done the rest. Take a look at his scorecard:
New Auto
Auto Policies
Years
Policies(1)(2)
In-Force(1)
1993
346,882
2,011,055
1994
384,217
2,147,549
1995
443,539
2,310,037
1996
592,300
2,543,699
1997
868,430
2,949,439
1998
1,249,875
3,562,644
1999
1,648,095
4,328,900 (1) “Voluntary” only; excludes assigned risks and the like. (2) Revised to exclude policies moved from one GEICO company to another.
In 1995, GEICO spent $33 million
on marketing and had 652 telephone counselors. Last year the company
spent $242 million, and the counselor count grew to 2,631. And we
are just starting: The pace will step up materially in 2000. Indeed,
we would happily commit $1 billion annually to marketing if we knew
we could handle the business smoothly and if we expected the last
dollar spent to produce new business at an attractive cost.
Currently two trends are affecting
acquisition costs. The bad news is that it has become more expensive
to develop inquiries. Media rates have risen, and we are also seeing
diminishing returns -- that is, as both we and our competitors step
up advertising, inquiries per ad fall for all of us. These negatives
are partly offset, however, by the fact that our closure ratio --
the percentage of inquiries converted to sales -- has steadily improved.
Overall, we believe that our cost of new business, though definitely
rising, is well below that of the industry. Of even greater importance,
our operating costs for renewal business are the lowest among broad-based
national auto insurers. Both of these major competitive advantages
are sustainable. Others may copy our model, but
they will be unable to replicate our economics.
The table above makes it appear
that GEICO's retention of policyholders is falling, but for two
reasons appearances are in this case deceiving. First, in the last
few years our business mix has moved away from "preferred" policyholders,
for whom industrywide retention rates are high, toward "standard"
and "non-standard" policyholders for whom retention rates are much
lower. (Despite the nomenclature, the three classes have similar
profit prospects.) Second, retention rates for relatively new policyholders
are always lower than those for long-time customers -- and because
of our accelerated growth, our policyholder ranks now include an
increased proportion of new customers. Adjusted for these two factors,
our retention rate has changed hardly at all.
We told you last year that underwriting
margins for both GEICO and the industry would fall in 1999, and
they did. We make a similar prediction for 2000. A few years ago
margins got too wide, having enjoyed the effects of an unusual and
unexpected decrease in the frequency and severity of accidents.
The industry responded by reducing rates -- but now is having to
contend with an increase in loss costs. We would not be surprised
to see the margins of auto insurers deteriorate by around three
percentage points in 2000.
Two negatives besides worsening
frequency and severity will hurt the industry this year. First,
rate increases go into effect only slowly, both because of regulatory
delay and because insurance contracts must run their course before
new rates can be put in. Second, reported earnings of many auto
insurers have benefitted in the last few years from reserve releases,
made possible because the companies overestimated their loss costs
in still-earlier years. This reservoir of redundant reserves has
now largely dried up, and future boosts to earnings from this source
will be minor at best.
In compensating its associates --
from Tony on down -- GEICO continues to use two variables, and only
two, in determining what bonuses and profit-sharing contributions
will be: 1) its percentage growth in policyholders and 2) the earnings
of its "seasoned" business, meaning policies that have been with
us for more than a year. We did outstandingly well on both fronts
during 1999 and therefore made a profit-sharing payment of 28.4%
of salary (in total, $113.3 million) to the great majority of our
associates. Tony and I love writing those checks.
At Berkshire, we want to have compensation
policies that are both easy to understand and in sync with what
we wish our associates to accomplish. Writing new business is expensive
(and, as mentioned, getting more expensive). If we were to include
those costs in our calculation of bonuses -- as managements did
before our arrival at GEICO -- we would be penalizing our associates
for garnering new policies, even though these are very much in Berkshire's
interest. So, in effect, we say to our associates that we will foot
the bill for new business. Indeed, because percentage growth in
policyholders is part of our compensation scheme, we reward
our associates for producing this initially-unprofitable business.
And then we reward them additionally for holding down costs on our
seasoned business.
Despite the extensive advertising
we do, our best source of new business is word-of-mouth recommendations
from existing policyholders, who on the whole are pleased with our
prices and service. An article published last year by Kiplinger's
Personal Finance Magazine gives a good picture of
where we stand in customer satisfaction: The magazine's survey of
20 state insurance departments showed that GEICO's complaint ratio
was well below the ratio for most of its major competitors.
Our strong referral business means
that we probably could maintain our policy count by spending as
little as $50 million annually on advertising. That's a guess, of
course, and we will never know whether it is accurate because Tony's
foot is going to stay on the advertising pedal (and my foot will
be on his). Nevertheless, I want to emphasize that a major percentage
of the $300-$350 million we will spend in 2000 on advertising, as
well as large additional costs we will incur for sales counselors,
communications and facilities, are optional outlays we choose to
make so that we can both achieve significant growth and extend and
solidify the promise of the GEICO brand in the minds of Americans.
Personally, I think these expenditures
are the best investment Berkshire can make. Through its advertising,
GEICO is acquiring a direct relationship with a huge number of households
that, on average, will send us $1,100 year after year. That makes
us -- among all companies, selling whatever kind of product -- one
of the country's leading direct merchandisers. Also, as we build
our long-term relationships with more and more families, cash is
pouring in rather than going out (no Internet economics here). Last
year, as GEICO increased its customer base by 766,256, it gained
$590 million of cash from operating earnings and the increase in
float.
In the past three years, we have
increased our market share in personal auto insurance from 2.7%
to 4.1%. But we rightfully belong in many more households -- maybe
even yours. Give us a call and find out. About 40% of those people
checking our rates find that they can save money by doing business
with us. The proportion is not 100% because insurers differ in their
underwriting judgments, with some giving more credit than we do
to drivers who live in certain geographic areas or work at certain
occupations. Our closure rate indicates, however, that we more frequently
offer the low price than does any other national carrier selling
insurance to all comers. Furthermore, in 40 states we can offer
a special discount -- usually 8% -- to our shareholders. Just be
sure to identify yourself as a Berkshire owner so that our sales
counselor can make the appropriate adjustment.
* * * * * * * * * * * *
It's with sadness that I report
to you that Lorimer Davidson, GEICO's former Chairman, died last
November, a few days after his 97th birthday. For GEICO,
Davy was a business giant who moved the company up to the big leagues.
For me, he was a friend, teacher and hero. I have told you of his
lifelong kindnesses to me in past reports. Clearly, my life would
have developed far differently had he not been a part of it. Tony,
Lou Simpson and I visited Davy in August and marveled at his mental
alertness -- particularly in all matters regarding GEICO. He was
the company's number one supporter right up to the end, and we will
forever miss him.
Aviation Services
Our two aviation services companies
-- FlightSafety International ("FSI") and Executive Jet Aviation
("EJA") -- are both runaway leaders in their field. EJA, which sells
and manages the fractional ownership of jet aircraft, through its
NetJets® program, is larger than its next two competitors combined.
FSI trains pilots (as well as other transportation professionals)
and is five times or so the size of its nearest competitor.
Another common characteristic of
the companies is that they are still managed by their founding entrepreneurs.
Al Ueltschi started FSI in 1951 with $10,000, and Rich Santulli
invented the fractional-ownership industry in 1986. These men are
both remarkable managers who have no financial need to work but
thrive on helping their companies grow and excel.
Though these two businesses have
leadership positions that are similar, they differ in their economic
characteristics. FSI must lay out huge amounts of capital. A single
flight simulator can cost as much as $15 million -- and we have
222. Only one person at a time, furthermore, can be trained in a
simulator, which means that the capital investment per dollar of
revenue at FSI is exceptionally high. Operating margins must therefore
also be high, if we are to earn a reasonable return on capital.
Last year we made capital expenditures of $215 million at FSI and
FlightSafety Boeing, its 50%-owned affiliate.
At EJA, in contrast, the customer
owns the equipment, though we, of course, must invest in a core
fleet of our own planes to ensure outstanding service. For example,
the Sunday after Thanksgiving, EJA's busiest day of the year, strains
our resources since fractions of 169 planes are owned by 1,412 customers,
many of whom are bent on flying home between 3 and 6 p.m. On that
day, and certain others, we need a supply of company-owned aircraft
to make sure all parties get where they want, when they want.
Still, most of the planes
we fly are owned by customers, which means that modest pre-tax margins
in this business can produce good returns on equity. Currently,
our customers own planes worth over $2 billion, and in addition
we have $4.2 billion of planes on order. Indeed, the limiting factor
in our business right now is the availability of planes. We now
are taking delivery of about 8% of all business jets manufactured
in the world, and we wish we could get a bigger share than that.
Though EJA was supply-constrained in 1999, its recurring revenues
-- monthly management fees plus hourly flight fees -- increased
46%.
The fractional-ownership industry
is still in its infancy. EJA is now building critical mass in Europe,
and over time we will expand around the world. Doing that will be
expensive -- very expensive -- but we will spend what it takes.
Scale is vital to both us and our customers: The company with the
most planes in the air worldwide will be able to offer its customers
the best service. "Buy a fraction, get a fleet" has real meaning
at EJA.
EJA enjoys another important advantage
in that its two largest competitors are both subsidiaries of aircraft
manufacturers and sell only the aircraft their parents make. Though
these are fine planes, these competitors are severely limited in
the cabin styles and mission capabilities they can offer. EJA, in
contrast, offers a wide array of planes from five suppliers. Consequently,
we can give the customer whatever he needs to buy -- rather
than his getting what the competitor's parent needs to sell.
Last year in this report, I described
my family's delight with the one-quarter (200 flight hours annually)
of a Hawker 1000 that we had owned since 1995. I got so pumped up
by my own prose that shortly thereafter I signed up for one-sixteenth
of a Cessna V Ultra as well. Now my annual outlays at EJA and Borsheim's,
combined, total ten times my salary. Think of this as a rough guideline
for your own expenditures with us.
During the past year, two of Berkshire's
outside directors have also signed on with EJA. (Maybe we're paying
them too much.) You should be aware that they and I are charged
exactly the same price for planes and service as is any other customer:
EJA follows a "most favored nations" policy, with no one getting
a special deal.
And now, brace yourself. Last year,
EJA passed the ultimate test: Charlie signed up. No other
endorsement could speak more eloquently to the value of the EJA
service. Give us a call at 1-800-848-6436 and ask for our "white
paper" on fractional ownership.
Acquisitions of 1999
At both GEICO and Executive Jet,
our best source of new customers is the happy ones we already have.
Indeed, about 65% of our new owners of aircraft come as referrals
from current owners who have fallen in love with the service.
Our acquisitions usually develop
in the same way. At other companies, executives may devote themselves
to pursuing acquisition possibilities with investment bankers, utilizing
an auction process that has become standardized. In this exercise
the bankers prepare a "book" that makes me think of the Superman
comics of my youth. In the Wall Street version, a formerly mild-mannered
company emerges from the investment banker's phone booth able to
leap over competitors in a single bound and with earnings moving
faster than a speeding bullet. Titillated by the book's description
of the acquiree's powers, acquisition-hungry CEOs -- Lois Lanes
all, beneath their cool exteriors -- promptly swoon.
What's particularly entertaining
in these books is the precision with which earnings are projected
for many years ahead. If you ask the author-banker, however, what
his own firm will earn next month, he will go into a protective
crouch and tell you that business and markets are far too uncertain
for him to venture a forecast.
Here's one story I can't resist
relating: In 1985, a major investment banking house undertook to
sell Scott Fetzer, offering it widely -- but with no success. Upon
reading of this strikeout, I wrote Ralph Schey, then and now Scott
Fetzer's CEO, expressing an interest in buying the business. I had
never met Ralph, but within a week we had a deal. Unfortunately,
Scott Fetzer's letter of engagement with the banking firm provided
it a $2.5 million fee upon sale, even if it had nothing to do with
finding the buyer. I guess the lead banker felt he should do something
for his payment, so he graciously offered us a copy of the book
on Scott Fetzer that his firm had prepared. With his customary tact,
Charlie responded: "I'll pay $2.5 million not to read it."
At Berkshire, our carefully-crafted
acquisition strategy is simply to wait for the phone to ring. Happily,
it sometimes does so, usually because a manager who sold to us earlier
has recommended to a friend that he think about following suit.
Which brings us to the furniture
business. Two years ago I recounted how the acquisition of Nebraska
Furniture Mart in 1983 and my subsequent association with the Blumkin
family led to follow-on transactions with R. C. Willey (1995) and
Star Furniture (1997). For me, these relationships have all been
terrific. Not only did Berkshire acquire three outstanding retailers;
these deals also allowed me to become friends with some of the finest
people you will ever meet.
Naturally, I have persistently asked
the Blumkins, Bill Child and Melvyn Wolff whether there are any
more out there like you. Their invariable answer was the Tatelman
brothers of New England and their remarkable furniture business,
Jordan's.
I met Barry and Eliot Tatelman last
year and we soon signed an agreement for Berkshire to acquire the
company. Like our three previous furniture acquisitions, this business
had long been in the family -- in this case since 1927, when Barry
and Eliot's grandfather began operations in a Boston suburb. Under
the brothers' management, Jordan's has grown ever more dominant
in its region, becoming the largest furniture retailer in New Hampshire
as well as Massachusetts.
The Tatelmans don't just sell furniture
or manage stores. They also present customers with a dazzling entertainment
experience called "shoppertainment." A family visiting a store can
have a terrific time, while concurrently viewing an extraordinary
selection of merchandise. The business results are also extraordinary:
Jordan's has the highest sales per square foot of any major furniture
operation in the country. I urge you to visit one of their stores
if you are in the Boston area -- particularly the one at Natick,
which is Jordan's newest. Bring money.
Barry and Eliot are classy people
-- just like their counterparts at Berkshire's three other furniture
operations. When they sold to us, they elected to give each of their
employees at least 50� for every hour that he or she had worked for
Jordan's. This payment added up to $9 million, which came from the
Tatelmans' own pockets, not from Berkshire's. And Barry and Eliot
were thrilled to write the checks.
Each of our furniture operations
is number one in its territory. We now sell more furniture than
anyone else in Massachusetts, New Hampshire, Texas, Nebraska, Utah
and Idaho. Last year Star's Melvyn Wolff and his sister, Shirley
Toomim, scored two major successes: a move into San Antonio and
a significant enlargement of Star's store in Austin.
There's no operation in the furniture
retailing business remotely like the one assembled by Berkshire.
It's fun for me and profitable for you. W. C. Fields once said,
"It was a woman who drove me to drink, but unfortunately I never
had the chance to thank her." I don't want to make that mistake.
My thanks go to Louie, Ron and Irv Blumkin for getting me started
in the furniture business and for unerringly guiding me as we have
assembled the group we now have.
* * * * * * * * * * * *
Now, for our second acquisition
deal: It came to us through my good friend, Walter Scott, Jr., chairman
of Level 3 Communications and a director of Berkshire. Walter has
many other business connections as well, and one of them is with
MidAmerican Energy, a utility company in which he has substantial
holdings and on whose board he sits. At a conference in California
that we both attended last September, Walter casually asked me whether
Berkshire might be interested in making a large investment in MidAmerican,
and from the start the idea of being in partnership with Walter
struck me as a good one. Upon returning to Omaha, I read some of
MidAmerican's public reports and had two short meetings with Walter
and David Sokol, MidAmerican's talented and entrepreneurial CEO.
I then said that, at an appropriate price, we would indeed like
to make a deal.
Acquisitions in the electric utility
industry are complicated by a variety of regulations including the
Public Utility Holding Company Act of 1935. Therefore, we had to
structure a transaction that would avoid Berkshire gaining voting
control. Instead we are purchasing an 11% fixed-income security,
along with a combination of common stock and exchangeable preferred
that will give Berkshire just under 10% of the voting power of MidAmerican
but about 76% of the equity interest. All told, our investment will
be about $2 billion.
Walter characteristically backed
up his convictions with real money: He and his family will buy more
MidAmerican stock for cash when the transaction closes, bringing
their total investment to about $280 million. Walter will also be
the controlling shareholder of the company, and I can't think of
a better person to hold that post.
Though there are many regulatory
constraints in the utility industry, it's possible that we will
make additional commitments in the field. If we do, the amounts
involved could be large.
Acquisition Accounting
Once again, I would like to make
some comments about accounting, in this case about its application
to acquisitions. This is currently a very contentious topic and,
before the dust settles, Congress may even intervene (a truly terrible
idea).
When a company is acquired, generally
accepted accounting principles ("GAAP") currently condone two very
different ways of recording the transaction: "purchase" and "pooling."
In a pooling, stock must be the currency; in a purchase, payment
can be made in either cash or stock. Whatever the currency, managements
usually detest purchase accounting because it almost always requires
that a "goodwill" account be established and subsequently written
off -- a process that saddles earnings with a large annual charge
that normally persists for decades. In contrast, pooling avoids
a goodwill account, which is why managements love it.
Now, the Financial Accounting Standards
Board ("FASB") has proposed an end to pooling, and many CEOs are
girding for battle. It will be an important fight, so we'll venture
some opinions. To begin with, we agree with the many managers who
argue that goodwill amortization charges are usually spurious. You'll
find my thinking about this in the appendix to our 1983 annual report,
which is available on our website, and in the Owner's Manual on
pages 55 - 62.
For accounting rules to mandate
amortization that will, in the usual case, conflict with reality
is deeply troublesome: Most accounting charges relate to
what's going on, even if they don't precisely measure it. As an
example, depreciation charges can't with precision calibrate the
decline in value that physical assets suffer, but these charges
do at least describe something that is truly occurring: Physical
assets invariably deteriorate. Correspondingly, obsolescence charges
for inventories, bad debt charges for receivables and accruals for
warranties are among the charges that reflect true costs. The annual
charges for these expenses can't be exactly measured, but the necessity
for estimating them is obvious.
In contrast, economic goodwill does
not, in many cases, diminish. Indeed, in a great many instances
-- perhaps most -- it actually grows in value over time. In character,
economic goodwill is much like land: The value of both assets is
sure to fluctuate, but the direction in which value is going to
go is in no way ordained. At See's, for example, economic goodwill
has grown, in an irregular but very substantial manner, for 78 years.
And, if we run the business right, growth of that kind will probably
continue for at least another 78 years.
To escape from the fiction of goodwill
charges, managers embrace the fiction of pooling. This accounting
convention is grounded in the poetic notion that when two rivers
merge their streams become indistinguishable. Under this concept,
a company that has been merged into a larger enterprise has not
been "purchased" (even though it will often have received a large
"sell-out" premium). Consequently, no goodwill is created, and those
pesky subsequent charges to earnings are eliminated. Instead, the
accounting for the ongoing entity is handled as if the businesses
had forever been one unit.
So much for poetry. The reality
of merging is usually far different: There is indisputably an acquirer
and an acquiree, and the latter has been "purchased," no matter
how the deal has been structured. If you think otherwise, just ask
employees severed from their jobs which company was the conqueror
and which was the conquered. You will find no confusion. So on this
point the FASB is correct: In most mergers, a purchase has been
made. Yes, there are some true "mergers of equals," but they are
few and far between.
Charlie and I believe there's a
reality-based approach that should both satisfy the FASB, which
correctly wishes to record a purchase, and meet the objections of
managements to nonsensical charges for diminution of goodwill. We
would first have the acquiring company record its purchase price
-- whether paid in stock or cash -- at fair value. In most cases,
this procedure would create a large asset representing economic
goodwill. We would then leave this asset on the books, not requiring
its amortization. Later, if the economic goodwill became impaired,
as it sometimes would, it would be written down just as would any
other asset judged to be impaired.
If our proposed rule were to be
adopted, it should be applied retroactively so that acquisition
accounting would be consistent throughout America -- a far cry from
what exists today. One prediction: If this plan were to take effect,
managements would structure acquisitions more sensibly, deciding
whether to use cash or stock based on the real consequences for
their shareholders rather than on the unreal consequences for their
reported earnings.
* * * * * * * * * * * *
In our purchase of Jordan's, we
followed a procedure that will maximize the cash produced for our
shareholders but minimize the earnings we report to you. Berkshire
purchased assets for cash, an approach that on our tax returns permits
us to amortize the resulting goodwill over a 15-year period. Obviously,
this tax deduction materially increases the amount of cash delivered
by the business. In contrast, when stock, rather than assets, is
purchased for cash, the resulting writeoffs of goodwill are not
tax-deductible. The economic difference between these two approaches
is substantial.
From the economic standpoint of
the acquiring company, the worst deal of all is a stock-for-stock
acquisition. Here, a huge price is often paid without there being
any step-up in the tax basis of either the stock of the acquiree
or its assets. If the acquired entity is subsequently sold, its
owner may owe a large capital gains tax (at a 35% or greater rate),
even though the sale may truly be producing a major economic loss.
We have made some deals at Berkshire
that used far-from-optimal tax structures. These deals occurred
because the sellers insisted on a given structure and because, overall,
we still felt the acquisition made sense. We have never done an
inefficiently-structured deal, however, in order to make our figures
look better.
Sources of Reported Earnings
The table that follows shows the
main sources of Berkshire's reported earnings. In this presentation,
purchase-accounting adjustments are not assigned to the specific
businesses to which they apply, but are instead aggregated and shown
separately. This procedure lets you view the earnings of our businesses
as they would have been reported had we not purchased them. For
the reasons discussed on page 61, this form of presentation seems
to us to be more useful to investors and managers than one utilizing
generally accepted accounting principles (GAAP), which require purchase-premiums
to be charged off business-by-business. The total earnings we show
in the table are, of course, identical to the GAAP total in our
audited financial statements.
(in millions)
Berkshire's Share
of Net Earnings
(after taxes and
Pre-Tax Earnings
minority interests)
1999
1998
1999
1998
Operating Earnings:
Insurance Group:
Underwriting -- Reinsurance
....................
$(1,440)
$(21)
$(927)
$(14)
Underwriting -- GEICO
..........................
24
269
16
175
Underwriting -- Other
Primary .................
22
17
14
10
Net Investment Income
............................
2,482
974
1,764
731
Buffalo News ...........................................
55
53
34
32
Finance and Financial
Products Businesses
125
205
86
133
Flight Services .........................................
225
181
(1)
132
110
(1)
Home Furnishings ....................................
79
(2)
72
46
(2)
41
International Dairy
Queen ........................
56
58
35
35
Jewelry ...................................................
51
39
31
23
Scott Fetzer (excluding
finance operation)
147
137
92
85
See's Candies .........................................
74
62
46
40
Shoe Group ............................................
17
33
11
23
Purchase-Accounting
Adjustments .........
(739)
(123)
(648)
(118)
Interest Expense
(3) ...............................
(109)
(100)
(70)
(63)
Shareholder-Designated
Contributions ....
(17)
(17)
(11)
(11)
Other ......................................................
33
60
(4)
20
45
(4)
Operating Earnings ....................................
1,085
1,899
671
1,277
Capital Gains from Investments .................
1,365
2,415
886
1,553
Total Earnings - All Entities .......................
$2,450
$4,314
$1,557
$ 2,830
=====
=====
=====
=====
(1) Includes Executive Jet from August 7, 1998.
(3)
Excludes interest expense of Finance Businesses.
(2) Includes Jordan's Furniture from November 13, 1999.
(4) Includes General Re operations for
ten days in 1998.
Almost all of our manufacturing,
retailing and service businesses had excellent results in 1999.
The exception was Dexter Shoe, and there the shortfall did not occur
because of managerial problems: In skills, energy and devotion to
their work, the Dexter executives are every bit the equal of our
other managers. But we manufacture shoes primarily in the U.S.,
and it has become extremely difficult for domestic producers to
compete effectively. In 1999, approximately 93% of the 1.3 billion
pairs of shoes purchased in this country came from abroad, where
extremely low-cost labor is the rule.
Counting both Dexter and H. H. Brown,
we are currently the leading domestic manufacturer of shoes, and
we are likely to continue to be. We have loyal, highly-skilled workers
in our U.S. plants, and we want to retain every job here that we
can. Nevertheless, in order to remain viable, we are sourcing more
of our output internationally. In doing that, we have incurred significant
severance and relocation costs that are included in the earnings
we show in the table.
A few years back, Helzberg's, our
200-store jewelry operation, needed to make operating adjustments
to restore margins to appropriate levels. Under Jeff Comment's leadership,
the job was done and profits have dramatically rebounded. In the
shoe business, where we have Harold Alfond, Peter Lunder, Frank
Rooney and Jim Issler in charge, I believe we will see a similar
improvement over the next few years.
See's Candies deserves a special
comment, given that it achieved a record operating margin of 24%
last year. Since we bought See's for $25 million in 1972, it has
earned $857 million pre-tax. And, despite its growth, the business
has required very little additional capital. Give the credit for
this performance to Chuck Huggins. Charlie and I put him in charge
the day of our purchase, and his fanatical insistence on both product
quality and friendly service has rewarded customers, employees and
owners.
Chuck gets better every year. When
he took charge of See's at age 46, the company's pre-tax profit,
expressed in millions, was about 10% of his age. Today he's 74,
and the ratio has increased to 100%. Having discovered this mathematical
relationship -- let's call it Huggins' Law -- Charlie and I now
become giddy at the mere thought of Chuck's birthday.
* * * * * * * * * * * *
Additional information about our
various businesses is given on pages 39 - 54, where you will also
find our segment earnings reported on a GAAP basis. In addition,
on pages 63 - 69, we have rearranged Berkshire's financial data
into four segments on a non-GAAP basis, a presentation that corresponds
to the way Charlie and I think about the company.
Look-Through Earnings
Reported earnings are an inadequate
measure of economic progress at Berkshire, in part because the numbers
shown in the table presented earlier include only the dividends
we receive from investees -- though these dividends typically represent
only a small fraction of the earnings attributable to our ownership.
Not that we mind this division of money, since on balance we regard
the undistributed earnings of investees as more valuable to us than
the portion paid out. The reason for our thinking is simple: Our
investees often have the opportunity to reinvest earnings at high
rates of return. So why should we want them paid out?
To depict something closer to economic
reality at Berkshire than reported earnings, though, we employ the
concept of "look-through" earnings. As we calculate these, they
consist of: (1) the operating earnings reported in the previous
section, plus; (2) our share of the retained operating earnings
of major investees that, under GAAP accounting, are not reflected
in our profits, less; (3) an allowance for the tax that would be
paid by Berkshire if these retained earnings of investees had instead
been distributed to us. When tabulating "operating earnings" here,
we exclude purchase-accounting adjustments as well as capital gains
and other major non-recurring items.
The following table sets forth our
1999 look-through earnings, though I warn you that the figures can
be no more than approximate, since they are based on a number of
judgment calls. (The dividends paid to us by these investees have
been included in the operating earnings itemized on page 13, mostly
under "Insurance Group: Net Investment Income.")
Berkshire's Approximate
Berkshire's Share of Undistributed
Berkshire's Major Investees
Ownership at Yearend(1)
Operating Earnings (in millions)(2)
American Express Company ...........
11.3%
$228
The Coca-Cola Company ...............
8.1%
144
Freddie Mac ..................................
8.6%
127
The Gillette Company ....................
9.0%
53
M&T Bank ...................................
6.5%
17
The Washington Post Company .....
18.3%
30
Wells Fargo & Company ...............
3.6%
108
Berkshire's share of undistributed earnings
of major investees
707
Hypothetical tax on these undistributed
investee earnings(3)
(99)
Reported operating earnings of Berkshire
1,318
Total look-through
earnings of Berkshire
$ 1,926
=====
(1) Does not include shares allocable to minority interests
(2) Calculated on average ownership for the year
(3) The tax rate used is 14%, which is the rate Berkshire pays on
the dividends it receives
Investments
Below we present our common stock
investments. Those that had a market value of more than $750 million
at the end of 1999 are itemized.
12/31/99
Shares
Company
Cost*
Market
(dollars in millions)
50,536,900
American Express Company .......
$1,470
$ 8,402
200,000,000
The Coca-Cola Company ........
1,299
11,650
59,559,300
Freddie Mac ................
294
2,803
96,000,000
The Gillette Company ..........
600
3,954
1,727,765
The Washington Post Company .......
11
960
59,136,680
Wells Fargo & Company ........
349
2,391
Others ......................
4,180
6,848
Total Common Stocks .............
$8,203
$37,008
=====
======
* Represents tax-basis cost which, in aggregate, is $691 million less
than GAAP cost.
We made few portfolio changes in
1999. As I mentioned earlier, several of the companies in which
we have large investments had disappointing business results last
year. Nevertheless, we believe these companies have important competitive
advantages that will endure over time. This attribute, which makes
for good long-term investment results, is one Charlie and I occasionally
believe we can identify. More often, however, we can't -- not at
least with a high degree of conviction. This explains, by the way,
why we don't own stocks of tech companies, even though we share
the general view that our society will be transformed by their products
and services. Our problem -- which we can't solve by studying up
-- is that we have no insights into which participants in the tech
field possess a truly durable competitive advantage.
Our lack of tech insights, we should
add, does not distress us. After all, there are a great many business
areas in which Charlie and I have no special capital-allocation
expertise. For instance, we bring nothing to the table when it comes
to evaluating patents, manufacturing processes or geological prospects.
So we simply don't get into judgments in those fields.
If we have a strength, it is in
recognizing when we are operating well within our circle of competence
and when we are approaching the perimeter. Predicting the long-term
economics of companies that operate in fast-changing industries
is simply far beyond our perimeter. If others claim predictive skill
in those industries -- and seem to have their claims validated by
the behavior of the stock market -- we neither envy nor emulate
them. Instead, we just stick with what we understand. If we stray,
we will have done so inadvertently, not because we got restless
and substituted hope for rationality. Fortunately, it's almost certain
there will be opportunities from time to time for Berkshire to do
well within the circle we've staked out.
Right now, the prices of the fine
businesses we already own are just not that attractive. In other
words, we feel much better about the businesses than their stocks.
That's why we haven't added to our present holdings. Nevertheless,
we haven't yet scaled back our portfolio in a major way: If the
choice is between a questionable business at a comfortable price
or a comfortable business at a questionable price, we much prefer
the latter. What really gets our attention, however, is a comfortable
business at a comfortable price.
Our reservations about the prices
of securities we own apply also to the general level of equity prices.
We have never attempted to forecast what the stock market is going
to do in the next month or the next year, and we are not trying
to do that now. But, as I point out in the enclosed article, equity
investors currently seem wildly optimistic in their expectations
about future returns.
We see the growth in corporate profits
as being largely tied to the business done in the country (GDP),
and we see GDP growing at a real rate of about 3%. In addition,
we have hypothesized 2% inflation. Charlie and I have no particular
conviction about the accuracy of 2%. However, it's the market's
view: Treasury Inflation-Protected Securities (TIPS) yield about
two percentage points less than the standard treasury bond, and
if you believe inflation rates are going to be higher than that,
you can profit by simply buying TIPS and shorting Governments.
If profits do indeed grow along
with GDP, at about a 5% rate, the valuation placed on American business
is unlikely to climb by much more than that. Add in something for
dividends, and you emerge with returns from equities that are dramatically
less than most investors have either experienced in the past or
expect in the future. If investor expectations become more realistic
-- and they almost certainly will -- the market adjustment is apt
to be severe, particularly in sectors in which speculation has been
concentrated.
Berkshire will someday have opportunities
to deploy major amounts of cash in equity markets -- we are confident
of that. But, as the song goes, "Who knows where or when?" Meanwhile,
if anyone starts explaining to you what is going on in the truly-manic
portions of this "enchanted" market, you might remember still another
line of song: "Fools give you reasons, wise men never try."
Share Repurchases
Recently, a number of shareholders
have suggested to us that Berkshire repurchase its shares. Usually
the requests were rationally based, but a few leaned on spurious
logic.
There is only one combination of
facts that makes it advisable for a company to repurchase its shares:
First, the company has available funds -- cash plus sensible borrowing
capacity -- beyond the near-term needs of the business and, second,
finds its stock selling in the market below its intrinsic value,
conservatively-calculated. To this we add a caveat: Shareholders
should have been supplied all the information they need for estimating
that value. Otherwise, insiders could take advantage of their uninformed
partners and buy out their interests at a fraction of true worth.
We have, on rare occasions, seen that happen. Usually, of course,
chicanery is employed to drive stock prices up, not down.
The business "needs" that I speak
of are of two kinds: First, expenditures that a company must make
to maintain its competitive position (e.g., the remodeling of stores
at Helzberg's) and, second, optional outlays, aimed at business
growth, that management expects will produce more than a dollar
of value for each dollar spent (R. C. Willey's expansion into Idaho).
When available funds exceed needs
of those kinds, a company with a growth-oriented shareholder population
can buy new businesses or repurchase shares. If a company's stock
is selling well below intrinsic value, repurchases usually make
the most sense. In the mid-1970s, the wisdom of making these was
virtually screaming at managements, but few responded. In most cases,
those that did made their owners much wealthier than if alternative
courses of action had been pursued. Indeed, during the 1970s (and, spasmodically, for some years
thereafter) we searched for companies that were large repurchasers of
their shares. This often was a tipoff that the company was both undervalued
and run by a shareholder-oriented management.
That day is past. Now, repurchases
are all the rage, but are all too often made for an unstated and,
in our view, ignoble reason: to pump or support the stock price.
The shareholder who chooses to sell today, of course, is benefitted
by any buyer, whatever his origin or motives. But the continuing
shareholder is penalized by repurchases above intrinsic value. Buying
dollar bills for $1.10 is not good business for those who stick
around.
Charlie and I admit that we feel
confident in estimating intrinsic value for only a portion of traded
equities and then only when we employ a range of values, rather
than some pseudo-precise figure. Nevertheless, it appears to us
that many companies now making repurchases are overpaying departing
shareholders at the expense of those who stay. In defense of those
companies, I would say that it is natural for CEOs to be optimistic
about their own businesses. They also know a whole lot more about
them than I do. However, I can't help but feel that too often today's
repurchases are dictated by management's desire to "show confidence"
or be in fashion rather than by a desire to enhance per-share value.
Sometimes, too, companies say they
are repurchasing shares to offset the shares issued when stock options
granted at much lower prices are exercised. This "buy high, sell
low" strategy is one many unfortunate investors have employed --
but never intentionally! Managements, however, seem to follow this
perverse activity very cheerfully.
Of course, both option grants and
repurchases may make sense -- but if that's the case, it's not because
the two activities are logically related. Rationally, a company's
decision to repurchase shares or to issue them should stand on its
own feet. Just because stock has been issued to satisfy options
-- or for any other reason -- does not mean that stock should be
repurchased at a price above intrinsic value. Correspondingly, a
stock that sells well below intrinsic value should be repurchased
whether or not stock has previously been issued (or may be because
of outstanding options).
You should be aware that, at certain
times in the past, I have erred in not making repurchases.
My appraisal of Berkshire's value was then too conservative or I
was too enthused about some alternative use of funds. We have therefore
missed some opportunities -- though Berkshire's trading volume at
these points was too light for us to have done much buying, which
means that the gain in our per-share value would have been minimal.
(A repurchase of, say, 2% of a company's shares at a 25% discount
from per-share intrinsic value produces only a �% gain in that value
at most -- and even less if the funds could alternatively have been
deployed in value-building moves.)
Some of the letters we've received
clearly imply that the writer is unconcerned about intrinsic value
considerations but instead wants us to trumpet an intention to repurchase
so that the stock will rise (or quit going down). If the writer
wants to sell tomorrow, his thinking makes sense -- for him! --
but if he intends to hold, he should instead hope the stock falls
and trades in enough volume for us to buy a lot of it. That's the
only way a repurchase program can have any real benefit for a continuing
shareholder.
We will not repurchase shares unless
we believe Berkshire stock is selling well below intrinsic value,
conservatively calculated. Nor will we attempt to talk the stock
up or down. (Neither publicly or privately have I ever told anyone
to buy or sell Berkshire shares.) Instead we will give all shareholders
-- and potential shareholders -- the same valuation-related information
we would wish to have if our positions were reversed.
Recently, when the A shares fell
below $45,000, we considered making repurchases. We decided, however,
to delay buying, if indeed we elect to do any, until shareholders
have had the chance to review this report. If we do find that repurchases
make sense, we will only rarely place bids on the New York Stock
Exchange ("NYSE"). Instead, we will respond to offers made directly
to us at or below the NYSE bid. If you wish to offer stock, have
your broker call Mark Millard at 402-346-1400. When a trade occurs,
the broker can either record it in the "third market" or on the
NYSE. We will favor purchase of the B shares if they are selling
at more than a 2% discount to the A. We will not engage in transactions
involving fewer than 10 shares of A or 50 shares of B.
Please be clear about one point:
We will never make purchases with the intention of stemming
a decline in Berkshire's price. Rather we will make them if and
when we believe that they represent an attractive use of the Company's
money. At best, repurchases are likely to have only a very minor
effect on the future rate of gain in our stock's intrinsic value.
Shareholder-Designated Contributions
About 97.3% of all eligible shares
participated in Berkshire's 1999 shareholder-designated contributions
program, with contributions totaling $17.2 million. A full description
of the program appears on pages 70 - 71.
Cumulatively, over the 19 years
of the program, Berkshire has made contributions of $147 million
pursuant to the instructions of our shareholders. The rest of Berkshire's
giving is done by our subsidiaries, which stick to the philanthropic
patterns that prevailed before they were acquired (except that their
former owners themselves take on the responsibility for their personal
charities). In aggregate, our subsidiaries made contributions of
$13.8 million in 1999, including in-kind donations of $2.5 million.
To participate in future programs,
you must own Class A shares that are registered in the name of the
actual owner, not the nominee name of a broker, bank or depository.
Shares not so registered on August 31, 2000, will be ineligible
for the 2000 program. When you get the contributions form from us,
return it promptly so that it does not get put aside or forgotten.
Designations received after the due date will not be honored.
The Annual Meeting
This year's Woodstock
Weekend for Capitalists will follow a format slightly different
from that of recent years. We need to make a change because the
Aksarben Coliseum, which served us well the past three years, is
gradually being closed down. Therefore, we are relocating to the
Civic Auditorium (which is on Capitol Avenue between 18th
and 19th, behind the Doubletree Hotel), the only other
facility in Omaha offering the space we require.
The Civic, however, is located in
downtown Omaha, and we would create a parking and traffic nightmare
if we were to meet there on a weekday. We will, therefore, convene
on Saturday, April 29, with the doors opening at 7 a.m., the movie
beginning at 8:30 and the meeting itself commencing at 9:30. As
in the past, we will run until 3:30 with a short break at noon for
food, which will be available at the Civic's concession stands.
An attachment to the proxy material
that is enclosed with this report explains how you can obtain the
credential you will need for admission to the meeting and other
events. As for plane, hotel and car reservations, we have again
signed up American Express (800-799-6634) to give you special help.
In our normal fashion, we will run buses from the larger hotels
to the meeting. After the meeting, the buses will make trips back
to the hotels and to Nebraska Furniture Mart, Borsheim's and the
airport. Even so, you are likely to find a car useful.
We have scheduled the meeting in
2002 and 2003 on the customary first Saturday in May. In 2001, however,
the Civic is already booked on that Saturday, so we will meet on
April 28. The Civic should fit our needs well on any weekend, since
there will then be more than ample parking in nearby lots and garages
as well as on streets. We will also be able to greatly enlarge the
space we give exhibitors. So, overcoming my normal commercial reticence,
I will see that you have a wide display of Berkshire products at
the Civic that you can purchase. As a benchmark, in 1999
shareholders bought 3,059 pounds of See's candy, $16,155 of World
Book Products, 1,928 pairs of Dexter shoes, 895 sets of Quikut knives,
1,752 golf balls with the Berkshire Hathaway logo and 3,446 items
of Berkshire apparel. I know you can do better.
Last year, we also initiated the
sale of at least eight fractions of Executive Jet aircraft. We will
again have an array of models at the Omaha airport for your inspection
on Saturday and Sunday. Ask an EJA representative at the Civic about
viewing any of these planes.
Dairy Queen will also be on hand
at the Civic and again will donate all proceeds to the Children's
Miracle Network. Last year we sold 4,586 Dilly® bars, fudge
bars and vanilla/orange bars. Additionally, GEICO will have a booth
that will be staffed by a number of our top counselors from around
the country, all of them ready to supply you with auto insurance
quotes. In most cases, GEICO will be able to offer you a special
shareholder's discount. Bring the details of your existing insurance,
and check out whether we can save you some money.
Finally, Ajit Jain and his associates
will be on hand to offer both no-commission annuities and a liability
policy with jumbo limits of a size rarely available elsewhere. Talk
to Ajit and learn how to protect yourself and your family against
a $10 million judgment.
NFM's newly remodeled complex, located
on a 75-acre site on 72nd Street between Dodge and Pacific,
is open from 10 a.m. to 9 p.m. on weekdays and 10 a.m. to 6 p.m.
on Saturdays and Sundays. This operation offers an unrivaled breadth
of merchandise -- furniture, electronics, appliances, carpets and
computers -- all at can't-be-beat prices. In 1999 NFM did more than
$300 million of business at its 72nd Street location,
which in a metropolitan area of 675,000 is an absolute miracle.
During the Thursday, April 27 to Monday, May 1 period, any shareholder
presenting his or her meeting credential will receive a discount
that is customarily given only to employees. We have offered this
break to shareholders the last couple of years, and sales have been
amazing. In last year's five-day "Berkshire Weekend," NFM's volume
was $7.98 million, an increase of 26% from 1998 and 51% from 1997.
Borsheim's -- the largest jewelry
store in the country except for Tiffany's Manhattan store -- will
have two shareholder-only events. The first will be a champagne
and dessert party from 6 p.m.-10 p.m. on Friday, April 28. The second,
the main gala, will be from 9 a.m. to 6 p.m. on Sunday, April 30.
On that day, Charlie and I will be on hand to sign sales tickets.
Shareholder prices will be available Thursday through Monday, so
if you wish to avoid the largest crowds, which will form on Friday
evening and Sunday, come at other times and identify yourself as
a shareholder. On Saturday, we will be open until 7 p.m. Borsheim's
operates on a gross margin that is fully twenty percentage points
below that of its major rivals, so be prepared to be blown away
by both our prices and selection.
In the mall outside of Borsheim's,
we will again have Bob Hamman -- the best bridge player the game
has ever seen -- available to play with our shareholders on Sunday.
We will also have a few other experts playing at additional tables.
In 1999, we had more demand than tables, but we will cure that problem
this year.
Patrick Wolff, twice US chess champion,
will again be in the mall playing blindfolded against all comers.
He tells me that he has never tried to play more than four games
simultaneously while handicapped this way but might try to bump
that limit to five or six this year. If you're a chess fan, take
Patrick on -- but be sure to check his blindfold before your first
move.
Gorat's -- my favorite steakhouse
-- will again be open exclusively for Berkshire shareholders on
Sunday, April 30, and will be serving from 4 p.m. until about midnight.
Please remember that you can't come to Gorat's on Sunday without
a reservation. To make one, call 402-551-3733 on April 3 (but
not before). If Sunday is sold out, try Gorat's on one of the
other evenings you will be in town. I make a "quality check" of
Gorat's about once a week and can report that their rare T-bone
(with a double order of hash browns) is still unequaled throughout
the country.
The usual baseball game will be
held at Rosenblatt Stadium at 7 p.m. on Saturday night. This year
the Omaha Golden Spikes will play the Iowa Cubs. Come early, because
that's when the real action takes place. Those who attended last
year saw your Chairman pitch to Ernie Banks.
This encounter proved to be the
titanic duel that the sports world had long awaited. After the first
few pitches -- which were not my best, but when have I ever thrown
my best? -- I fired a brushback at Ernie just to let him know who
was in command. Ernie charged the mound, and I charged the plate.
But a clash was avoided because we became exhausted before reaching
each other.
Ernie was dissatisfied with his
performance last year and has been studying the game films all winter.
As you may know, Ernie had 512 home runs in his career as a Cub.
Now that he has spotted telltale weaknesses in my delivery, he expects
to get #513 on April 29. I, however, have learned new ways to disguise
my "flutterball." Come and watch this matchup.
I should add that I have extracted
a promise from Ernie that he will not hit a "come-backer" at me
since I would never be able to duck in time to avoid it. My reflexes
are like Woody Allen's, who said his were so slow that he was once
hit by a car being pushed by two guys.
Our proxy statement contains instructions
about obtaining tickets to the game and also a large quantity of
other information that should help you enjoy your visit in Omaha.
Join us at the Capitalist Caper on Capitol Avenue.
March 1, 2000
Warren E. BuffettChairman of the Board