Explaining Berkshire's Mysterious Buyback

Not since the $9 billion acquisition of oil additive company Lubrizol in March 2011 have Warren Buffett and Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) made an "elephant" purchase, and even that wasn't a very big elephant.

Wednesday marked another 10-digit purchase for Berkshire, which was preceded by a halt in trading. But this one wasn't quite the elephant investors were expecting. In a rare move for the investing luminary, the company bought back $1.2  billion worth of its class A shares -- the second buyback in company history, and much larger than the first buyback of $68  million. Let's take a look at what this means for Berkshire Hathaway and its investors.

That was odd
At 9:40 a.m. on Wednesday, Berkshire Hathaway trading was halted by the SEC pending a news announcement. Immediately, the move seemed odd given that the company probably could have made the announcement 15 minutes earlier before market opened and allowed enough time for investors to digest the information. It seemed the only reason to halt trading would be for a pretty major announcement, possibly related to Buffett's health, his position in the company, or maybe some gigantic acquisition that would rattle the foundation of the Earth.

After a small waiting period, it was announced that Berkshire had decided to buy a chunk of Class A shares of its own stock that were recently made available in an estate sale of a longtime shareholder.

Wait, that's what all of the fuss was about?

It was a very strange way of announcing a buyback, which has been on Buffett's radar for some time. The Berkshire chief had said multiple times that he would begin aggressively buying back stock if the stock traded at 1.1 times book or below. That's where Wednesday's move differs from the plan. Berkshire bought the shares for $131 ,000 per share, which represents a relatively chunky premium given that today's book value is around $112,000. Why would Buffett all of a sudden reverse course on his 1.1 times book rule? That seems very un-Buffett-y of him.

What does it mean?
An easy conclusion would be that Buffett is so confident in the future profit power of Berkshire (which we, of course, know to be true) that he is willing to pay up for the strength of his own business. It is still odd, though, because for much of 2012, Berkshire was trading as low as 1.12 times book value. This would have been a much more attractive entry point for a buyback.

Could this be a favor to the "longtime shareholder" who is most likely an old friend of the Buffett family? 2013 is right around the corner, and that estate tax would likely eat into the billion dollars of Berkshire stock. But is this any more characteristic of a pragmatic Buffett?

I think that neither of these elements were the impetus behind the impromptu self-shopping spree. Sure, Buffett is comfortable in the earnings power of all of the companies under the Berkshire umbrella (except maybe BYD), but he was so, so clear about the point at which he would pull the trigger on a buyback that it is just too uncharacteristic for him to wake up one day and increase that purchase price by 7%-8%.

And while I'm sure it is nothing short of a giant sigh of relief for the estate holders to unload that huge chunk of stock before the clock strikes midnight on January 1, that also seems a bit beyond Buffett's philosophies of what is fair and right regarding the actions of a public company.

This could be going out on a limb, but perhaps this was a quick and harmless way of getting hold of a huge amount of stock in one purchase. Given the liquidity of the stock (Class A shares trading at fewer than 1,000  shares per day), it would take quite a while to get a hold of 9,200 shares. And as soon as Berkshire started buying, everyone else would load in as well, removing even more of a price advantage. Since these estate shares were not on the open market, Buffett could swoop in and buy them all at once, without budging the market and igniting a frenzy.

Again, this is one analyst's guess, and there probably are very few people who know with certainty what happened on Wednesday outside of Omaha, Neb.

As for current investors, your Class A shares are worth more than they were earlier this week. Berkshire Hathaway remains a world-class company to own, whether you are a B class or an A class shareholder. So Happy Hanukkah to those whose shares grew up a little bit this week.

More Berkshire Analysis from The Motley Fool 
Warren Buffett's long track record of success has made him one of the best investors of all time. With Buffett at the helm, Berkshire Hathaway has grown book value per share at a compounded annual rate of 19.8% for nearly 50 years! Despite an incredible historical track record, investors have to understand the key issues to watch moving forward. To help investors, the Fool's resident Berkshire Hathaway expert Joe Magyer has created this premium research report on the company. Inside you'll receive ongoing updates as key news hits, as well as reasons to both buy and sell the stock. Claim a copy by clicking here now.


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Comments from our Foolish Readers

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  • Report this Comment On December 13, 2012, at 2:52 AM, Kafue wrote:

    Immediately, the moved seemed odd ..."

    Nearly as odd as this sentence.

  • Report this Comment On December 13, 2012, at 3:01 AM, Kafue wrote:

    "... made available in an estate sale of a longtime shareholder."

    "Could this be a favor to the "longtime shareholder" who is most likely an old friend ..."

    To an old friend who is dead? Unusual way to do favors.

    "...everyone else would load in as well ..."

    Load in???

    "As for current investors, your Class A shares are worth more than they were earlier this week."

    You thing buying back Class A shares only affects their value and not the Class B shares?

    Seriously who wrote this?

  • Report this Comment On December 13, 2012, at 9:28 AM, financegrl0483 wrote:

    insightful article. always happy to see a good berkshire hathaway article.

  • Report this Comment On December 14, 2012, at 8:18 AM, Kafue wrote:

    "And while I'm sure it is nothing short of a giant sigh of relief for the estate holders to unload that huge chunk of stock before the clock strikes midnight on January 1 ..."

    What exactly is the tax benefit? The inheitance already took place. That can't be shifted to next year and has nothing to do with the sale of the stock.

    The stock inheritated at the time of death is valued at it's fair value at the time of death, so the estate is starting from that point, not whatever price the decedant paid for the stock.

    Can anyone at Motley Fool explain what this sigh of relief is about?

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