Did you ever hear the saying “when a pendulum swings too far one way, it then swings too far the other”?. This is your textbook example. Tonight Fitch has downgraded Berkshire Hathaway (BRK.A)
Below is the action from Fitch (hat tip to Zero Hedge for finding it).
BUT, to find out what this is really all about one need only read one paragraph in the whole document (click image to open larger).
As you read the document, the reasoning is …bizarre, for lack of a better word.
Berkshire was downgraded because:
1- There can be no AAA rated “holdings companies of financial oriented enterprises”.
2- Warren Buffett is old (they actually take pain to say “this is not age related”) Well, what else could it be? Berkshire’s corporate structure has not changed in 44 years and in reality, Berkshire now has a succession plan in place that was not there 4 years ago so the “risk” for anything other than age is less. But, Fitch says having the arguably the single best capital allocator in history at the helm is “too risky”. They would apparently prefer two mediocre ones?
3- Actually, there is no #3, just those two….
Here is what it is NOT due to:
1- Equity Index Puts
2- Derivative Contracts
3- Equity investment losses in 2008
4- Operating businesses
5- Insurance results
In other words, some legitimate reasons one would think a downgrade might be warranted.
After years of lumping BBB- mortgages together and then telling people they are now AAA and selling them as such only to watch them behave like, well CCC loans, Fitch is now telling us no AAA will be given to Co’s. with “financial oriented enterprises”. Let’s not forget, Fitch at one time told us AIG (AIG) was a AAA company. So, you know, we should take what they say “to the bank”.
For those who do not know about AIG, they are this cute little company that almost brought down the entire US financial system last year. It’s bailout will eventually cost US taxpayers well in excess of $100 billion. But, hey, they had a much younger guy running things over there so AAA was entirely warranted.
It matters not that Berkshire maintains at .25 debt to equity. It matters not that the roughly $9 billion in notes downgraded Warren could write a check for tomorrow and pay off without any impairment in Berkshire operations. It matter not also that Berkshire’s insurance operation generate $35 billion of float for Warren to invest for free……free….
Nope, we now have blanket rules at Fitch..
This decision flies in the face of all reason, logic and is not in the least based on operating results at Berkshire. It makes no sense…
Well, given what the ratings agencies have done for the last decade, I guess them making yet another decision that undermines the investing community’s faith in anything they say does make perfect sense… BRK Downgrade
So, just in case you have been in a cave this am, GE (GE) had it’s credit rating cut.
General Electric lost its coveted triple-A credit rating from Standard and Poor’s on Thursday, as the credit-rating agency downgraded G.E’s long-term debt one notch, to AA+. GE had held the rating for 50 years
S&P said the outlook for G.E. was stable, meaning that further downgrades to its debt rating are unlikely in the next six months to two years.
The S&P analyst who wrote the report says:
GE issued the following statement which said in part,”Standard & Poor’s (S&P) today announced a single-notch downgrade of General Electric Company’s and General Electric Capital Corporation’s (GECC) long-term ratings from AAA to AA+, with a “stable” outlook. The ratings downgrade does not affect GE’s and GECC’s short-term funding ratings of A-1+, which was affirmed by S&P.
The action follows a thorough review of GE’s portfolio by S&P. GECC is one of the only financial services companies in the world with a rating as high as AA+. S&P defines a company with this rating as having a “very strong capacity to meet its financial commitments.” Also, S&P’s “stable” outlook means the rating is unlikely to change in the next six months to two years. GE does not anticipate any significant operational or funding impacts from this change.”
So, what to think. More important than the cuts is the “stable” rating. This downgrade is more bark than bite. There is no material change to operations from it and there is zero effect on its short term borrowing.
Just a week ago with shares at $6 I pondered picking some up but was waiting for a bit more clarity before doing so. It is looking like sitting on my hands may have been a mistake. Shares are up a cool 50% since then. Now, I have not lost any money (in fact my existing GE holdings are enjoying the ride) but have not picked any additional up either.
What to do, what to do, what to do. I resist the urge to buy anything after a 50% run and a 10% market rally, both of what we have just had. We will settle a bit and big run are almost always followed by pullbacks and then I will pick up more. I don’t think I will ever get the $6 price a gain but I think I’ll do much better than then near $10 today.
GE is still a great long term play, I’m just holding out for an even better price
JP Morgan’s (JPM) CEO talks about banking, mark-to-market accounting, compensation and regulation.
The speech:
Dimon is right when he talks about mark-to-market accounting. It is a good idea taken to the extreme and that always ends up being a bad idea. It’s widespread use for all assets type will (has) lead to insane valuation volatility. That leads to people like Berkshire’s (BRK.A) Warren Buffett liking it due to the “opportunity it presents us”. Meaning, mark-to-market produces the extreme pricing inefficiency Buffett enjoys so much.
That cannot be the goal of the system of any accounting methodology. It ought to seek to find the true value of the asset, not simply discount it to whatever the lowest seller will let something go for in times of distress. It, in its essence, is lazy accounting.
Dow Chemical Co. (DOW) the largest U.S. chemical maker, is in talks to revive a basic-plastics joint venture with Kuwait that the country’s Petrochemicals Industries Co. abandoned last year. “We are definitely in discussions,” Chief Executive Officer Andrew Liveris said today in a telephone interview. “I want to downplay expectations because of what happened last time.”
Kuwait’s cancellation of the K-Dow Petrochemical venture in December deprived Dow of $9 billion it planned to use for its acquisition of Rohm & Haas Co. That left Liveris seeking to amend financing and obtain new terms for the $16.5 billion purchase, which was agreed upon March 9.
Dow, based in Midland, Michigan, also is talking with two “very interested” parties about buying a stake in the basic- plastics unit, Liveris said. The likelihood of reaching a new deal with Kuwait is “low,” he said. “I have learned that unless the money is in the bank, OK, I am not going to promise it,” Liveris said.
Bidding War
Liveris said he didn’t include a clause in the Rohm & Haas merger agreement that would have let Dow out of the deal if the Kuwait venture failed because no one anticipated the financial collapse that occurred after the agreement was signed July 10. Dow won the Rohm & Haas auction with a $78 a share bid, topping BASF AG’s $75 offer.
“Even if you wanted a financing out, you wouldn’t have won Rohm & Haas’s bid because BASF would have won it,” Liveris said. Kuwait canceled the K-Dow venture on Dec. 28 after opposition lawmakers pressured the government to scrap the deal, which they said was overvalued amid falling oil prices. The cancellation prompted Standard & Poor’s and Moody’s Investors Service to cut Dow’s credit ratings.
Dow plans to sell $4 billion of assets this year as part of a plan to repay as much as $10 billion in short-term loans for the Rohm & Haas purchase, which closes April 1, and to maintain investment-grade credit ratings. A deal to sell Rohm & Haas’s Morton Salt unit, the biggest U.S. salt producer, for at least $1.5 billion will be announced this month, Liveris said.
“We are moving on that one very fast,” Liveris said. “Given what we achieved in five days recently, I would consider it almost wimpy of us not to achieve it in 20 days.”
‘Serious Bidders’
Dow will narrow six “serious bidders” for Morton Salt to three, possibly selecting one for exclusive negotiations, by this weekend, he said.
The value of Dow AgroSciences, which makes pesticides and develops genetically modified seeds, isn’t appreciated by investors, Liveris said. The unit “clearly” is worth more than the $5 billion to $8 billion that some analysts have estimated, he said. The company doesn’t immediately plan to sell the business, Liveris told investors on a March 9 conference call.
Asset sales are part of efforts to improve Dow’s balance sheet so another dividend cut “should never be necessary,” Liveris said. Dow slashed its dividend 64 percent on Feb. 12, the first reduction in company history, to save $1 billion a year, after Liveris promised not to cut the payments.
“After the events of the last three months, it would be terrible of me to say never again,” Liveris said.
So, where are we? There is some math here that does not quite add up and for shareholders that seems to be a good thing. Dow in its presentation yesterday said it would sell the $4.3 billion in assets to pay off the credit line in one year. If the get $1.5 for Morton Salt, that leaves $2.8 billion in asset sales. The commodity business that was originally valued at $9 billion (Dow’s 1/2) is worth less in this environment, but not almost 70% less.
I am saying here than Liveris has got burned big time over the past year. One would expect anyone who has that happen to swinging the pendulum to the other side and become so conservative that any estimate given is a real low ball figure.
On another note, analysts estimate the value of Dow Ag at $5 billion to $8 billion. Five billion dollars equals the current market cap of the whole company. Essentially buyers today pay for Dow Ag and get the specialty chemical business, the commodity chemical business and the rest of the company for free. Not a bad deal.
Nothing to so with investing but this is a book every parent of a teenager ought to be sure they read….
Premise From the Editor:
Adam Shepard graduated from college in the summer of 2006 feeling disillusioned by the apathy he saw around him and incensed after reading Barbara Ehrenreich’s famous works Nickel and Dimed and Bait and Switch—books that gave him a feeling of hopelessness over the state of the working class in America. Eager to see if he could make something out of nothing, he set out to prove wrong Ehrenreich’s theory that those who start at the bottom stay at the bottom, and to see if the American Dream can still be a reality.
Shepard’s plan was simple. Carrying only a sleeping bag, the clothes on his back, and $25 in cash, and restricted from using previous contacts or relying on his college education, he set out for a randomly selected city with one objective: work his way out of homelessness and into a life that would give him the opportunity for success. His goal was to have, after one year, $2,500, a working automobile, and a furnished apartment.
But from the start, things didn’t go as smoothly as Shepard had planned. Working his way up from a Charleston, South Carolina homeless shelter proved to be more difficult than he anticipated, with pressure to take low-paying, exploitive jobs from labor companies, and a job market that didn’t respond with enthusiasm to homeless applicants. Shepard even began donating plasma to make fast cash. To his surprise, he found himself depending most on fellow shelter residents for inspiration and advice.
Earnest, passionate, and hard to put down, Scratch Beginnings is a story that will not only inspire readers, but will also remind them that success can come to anyone who is willing to work hard—and that America is still one of the most hopeful and inspiring countries in the world.
As he looked back on his time, Shepard came to the conclusion that it was possible, no matter what “bad luck” one has experienced to not only survive but prosper in America. Notice he did not say it was “easy”. If one has a vision and was disciplined there were avenues available to make it out of even homelessness. Too often those stuck there without getting out for years were the results of drugs, lack of discipline or even a certain acceptance of the situation.
Shepard takes no grievance with those who accept their plight. In fact he takes careful pains to note that he saw happiness and despair both from those in the shelter and those living in the million dollars homes he moved furniture too and from. He says, “adversity attacks at every level” and those able to deal with it succeed.
Happiness, Shepard concludes knows no class or economic barriers. It is working towards something better and achieving it.
Towards the end Shepard says “More than anything else over the course of the year I grew to appreciate, more than ever before, that we live in the greatest country in the world. America is more fertile and full of more opportunity that any other country in the world.”
An interesting point on how investor sentiment has always overshot to the downside.
“Davidson” comments on the following chart”
Here is the SP500 from Dec ’27 to Dec ’49. The P/E and EPS are included. The change in psychology from Sept 1929 to June 1931 was much greater than the $1.60 per share to ~$0.50 per share earnings drop. Psychology has always had an enormous effect on market prices and true Value Investors utilize this knowledge to their advantage. Most available data bases do not go back beyond the 1960’s as the data reliability is not guaranteed.
(This chart is constructed from data extracted from older SP500 sources and likely does not conform to modern accounting standards. The relative perspective is useful just the same.)
From 1929 to 1931, the S&P Earnings dropped 37% yet the value of the S&P dropped 85%. Simply said this means investors were over twice as pessimistic about US business then what the reality of them actually was.
Another interesting point is the 1931-36 recovery. Note the PE skyrocket up ahead of the market. It is clear investor sentiment turned positive BEFORE the actual earnings of the S&P did. Notice from the chart earnings stays flat until essentially 1934 while the market has a massive rally. So, great you say, what does it all mean?
It means the market bottoms before earnings do and then rallies before they rebound due to sentiment. So, then, where are we now with sentiment? I am using modern numbers because to the best of my knowledge there are no “sentiment” readings from the 1930’s other than market results (if anyone knows that there are, please let educate me).
We are now more negative than the last two recessions (with reason). Those low readings eventually gave way to the 1990’s and 2002-2008 bull markets.
We can go back to a post I did last week regarding cash vs. the S&P. It shows just how pessimistic people are. Money sitting in the bank right now in Treasuries in earning essentially nothing. This, for the majority of people is preferable to the “expected” losses they assume in the market. It also is tremendous fuel for the fire once that sentiment changes and, yes it will. The current situation is not even as bad as 1980-81 much less 1929-31. The US economy and the market both came back from those periods and will again.
Now, the trillion dollar question is “when?” Again, I do not make “bottom” calls but I feel there is a large swath of the market trading at “eventual destruction” valuations. I also know people are of the mindset the world, while not quite ending is racing towards depression. With the ammunition sitting there to buy equities present, when the depression does not occur people will tired rather rapidly of earning nothing on cash in the bank or in US Treasuries and will want a higher return in the market from equities again.
As part of today’s agreement, Rohm and Haas’s two largest shareholders have agreed to purchase $2.5 billion in face value of perpetual preferred equity issued by Dow. In addition, one of the shareholders, the Haas Family Trusts has agreed that at Dow’s option, they will make an investment in an additional $500 million of Dow’s equity. These equity investments substantially reduce the debt financing required to fund the acquisition, Dow has restructured the transaction to essentially pay the equivalent of $63 per share in cash, and $15 per share in face value of preferred equity securities. To fund the acquisition of Rohm and Haas, Dow will use the proceeds from the equity issuances to reduce the amount it would otherwise be required to draw down from the $12.5 billion bridge loan, which was renegotiated last week to provide a one-year extension on $8 billion of the total loan. The financing for the acquisition also includes equity investments of $3 billion by Berkshire Hathaway and $1 billion by the Kuwait Investment Authority (KIA) in the form of convertible preferred equity.
Acquisition Delivers Significant Cost and Revenue Synergy Opportunities
Dow plans to achieve its long-term goals for the Rohm and Haas acquisition with a carefully conceived path forward built upon the cornerstones of financial discipline and operational excellence. Dow has put into place an even more aggressive plan to realize combined synergies of $1.3 billion, up from $910 million, as originally outlined. With a long history of operational excellence, Dow has a demonstrated willingness to make the decisions necessary to maintain and improve financial performance. Cost savings will come from increased purchasing power for raw materials for the combined company; manufacturing and supply chain work process improvements; office consolidations and the elimination of redundant corporate overhead for shared services and governance.
Finally, as part of the Company’s plans to improve its financial position, Dow has commenced an aggressive asset divestment program involving a number of Dow and Rohm and Haas business units expected to yield approximately $4 billion including:
1. Dow’s 45 percent stake in Total Raffinaderij Nederland NV (TRN), the Dutch petroleum refining partnership with Total Group. The sale process is underway;
2. Some of Dow’s equity stakes in its olefins and derivatives business in SE Asia. Preliminary discussions with the relevant parties have already begun;
3. Morton Salt, a division of Rohm and Haas, contingent upon the closing of the proposed acquisition of Rohm and Haas by Dow. Interested parties have submitted bids, and Dow will evaluate these bids as appropriate over the course of the coming weeks to determine timing of the sale process.
Divestments from this program, in addition to the increased equity financing will essentially address the cash shortfall created by the failure of the K-Dow transaction to close as scheduled.
For those who do not want to go through the whole presentation, here is the slide that answers most people questions, the financing and the bridge loan:
So, where are we?
Dow is offically no longer a commodity chemical company after April 1. 70% of 2008 EBITDA will be from specialty products. This will cause immediate PE expansion from high single digits that commodity producers tend to have the mid to high teens the specialty ones enjoy to to their more consistent earnings. Dow will be cash flow positive in 2009 and have the term loan used to settle the transaction paid off withing the year.
Interestingly enough, only $4.3 billion of the loan reduction will come from asset sales. Remember Dow was looking at $9.5 billion from the Kuwait JV that Kuwait bailed on essentially at the signing. Let’s also not forget that Dow is entering arbitration with Kuwait over damages in the case. Dow has said in the past they are owed the $2.5 billion breakup fee in the deal. There is also a scenario is which Kuwait decides to renter talks with Dow for some of the businesses they were originally suppose to buy. Neither of these scenario’s are baked into current projections yet are very real possibilities.
But lets look around. Negativity is everywhere. Few would question the operational ability of the combined entity and the global powerhouse it now is. But, management at Dow does have a real credibility problem. For the price paid for this deal, to the failed Kuwait JV and the dividend cut, investors are left wondering “what’s next?”.
That is going to be a bit of a cloud over the company until they can report some positive news. We need some unexpected good news, not bad. Yes, I know that Rohm & Haas is a one of a kind company and that Dow’s was not even the highest offer in the auction for it. Yes, I know Dow had no control over the Kuwait decision. Yes, I know that the dividend cut had to happen and were it not for the Kuwait decision, would not have happened. I know all this and all of it is true.
Knowing that does not change perception, it helps us rationalize the bad news. We need something to happen we do not expect that is good. I want to hear they win in arbitration and are awarded $1 billion plus. I want to hear the global de-stocking that happened in Q3 is over and orders and pricing are firming at a faster than expected pace. I want to hear that Kuwait has come back to the table or Sabic (Saudi Basic Industries) want the commodity business and the proceeds are far more than currently projected. I want to hear that because of any of these the dividend is going to be partially restored. We see the projection for debt reduction, come back to us in 6 months and tell us you are ahead of pace paying off the bridge loan.
Any of these will tell investors that the rationalizing the bad news was not insane but logical and that the events that happened could not be avoided. More bad news tells us that perhaps management is not taking into account various alternative scenarios when planning or if they are, not putting enough stock in them possibly happening and not preparing appropriately for them.
I see one of two books being written about Dow CEO Andrew Liveris down the road. One is about how the global slowdown forced a poorly planned merger on the company and eventually cost him his career. The other is a book about how he deftly managed the company through the worse economic conditions in over 80 years, completed the merger and created the world’s preeminent specialty chemical company accomplishing the vison he had when he took it over. Either one could be written now. We are at the proverbial fork in the road.
As you read the document, the reasoning is …bizarre, for lack of a better word..gif)
