I recently had a chance to talk with Warren Buffett biographer Alice Schroeder, author of The Snowball: Warren Buffett and the Business of Life. Schroeder spent fifteen years on Wall Street and was voted top-ranked analyst in the Institutional Investor All-America Research team for her property-casualty insurance research. In this first of five installments, Schroeder talks about Berkshire Hathaway
Mac: Now Alice, Warren Buffett, of course, has said that investors should be greedy when others are fearful. Any chance that we might see Buffett invest in BP?
Alice: I think it is unlikely for a couple of reasons. One is that in distress situations, he has a very decided preference for not buying equity, but buying preferential securities where he has got the first preference and everyone else is subordinated to him in some way, or nearly everybody. Here, the people who are owed the claims for the damage have preference over everyone else and so I don't think he can get a high enough return or yield to compensate for the fact that at the end of the day it could be a long time before you get paid back if you lend money to BP or take a preferred from them. The other reason, and this is very worth pointing out, is he has said before that with energy he would rather own the commodity outright than own an energy producer because you don't take all the risk of the management, and as we have seen here, the mismanagement. So I doubt it, I doubt he would do that.
Mac: What do you think the biggest misconception is about BP's financial state?
Alice: Well BP has talked a lot about its financial strength, about the fact that it had all of these lines of credit and borrowing capability and its strong cash flows. And as it has turned out, you can only borrow when you don't need to, as we have seen many times over the past few years. And all of BP's free cash flows were committed to paying dividends, so what they have had to do is take one of the four options that are very unpleasant and they are having to do all of them: cut the dividends, sell assets in a fire sale, cut capital expenditures and lastly, borrow at a time when their credit worthiness is considered to be questionable.
Mac: And Alice, BP has agreed to put $20 billion aside in escrow, but that could just be the beginning. How much could the tab get?
Alice: I learned after 9/11 that estimating these kinds of things is almost impossible to do initially, even though you have to make some kind of estimate. It is going to be in the tens of billions, but the upper limit has been said to be $100 billion. Nobody knows. It depends on whether there could be long-term health effects from this. It depends on whether the business interruption that is caused by it ends up being extremely high and a lot of it depends on what happens with the courts and Congress and what is worked out. I think it will be negotiated, in the end.
Mac: Does BP survive as a stand-alone company?
Alice: I do believe BP will survive because BP has a lot of earnings power, and it is going to be put to work one way or another, to pay to clean up this spill and to pay the people who need it. Then beyond that, it is a viable business. So the question is really not whether it will survive, but who will supervise it as it is being used to earn money to pay all of these different constituencies and stakeholders.
In our next article, Alice completes this sentence: "The most overrated thing about Warren Buffett's success is _________."