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Berkshire Hathaway
General Re

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By bvalue
May 18, 2001

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The 2001 first quarter report has some good news with General Re's cost of float now under 3.0% as announced at the AGM by Warren.

I think this is a good time to review how important the General Re purchase was for BRK beyond the acquisition of a solid company with a good track record. Though I don't like to think of Buffett as a market timer � its hard not to think that his timing of the General Re purchase was lucky if not prescient. I believe General Re helped Buffett navigate through what he foresaw was going to be a probable decline in the market price of Coke, and to a lesser extent Gillette. This was a pretty serious problem. To understand the potential impact of this problem � let's look at BRK's balance sheet at that time � June 30, 1998.

Back then, BRK controlled some $54B of investment assets. Of this $54B, about $42B was invested in common stocks with $22B of that in two stocks (KO, G). Buffett probably knew his stocks were selling at prices well above intrinsic value (KO was at $85, G at $59) but didn't want to sell/couldn't sell. More importantly, the KO and G investments at $22B represented a whopping 62% of shareholder equity ($37B).

Let's project what might have happened if Buffett didn't buy General Re. At the end of Q1, 2001 the market value of KO and G was now $12B � a haircut of over $10B! Let's assume all other investments earned 10% (pretty aggressive given market declines in 1999 and 2000 in the kind of stocks that Buffett invests in). Total investments ex KO, G were $54B less $22B = $32B. Over the two years, I estimate 10% investing return on $32B would be worth about $7B.

So over all, Buffett would see a pre-tax gain of $7B offset by a decline of $10B in KO, G for an overall net decline of $3B. Net of deferred taxes, we're talking a $2B decline in shareholder equity. Book value would therefore decline from $37B in 1998 to $35B today � a decline of 6%.

Instead, he solved the problem by buying General Re. After the merger, the $42B in common stocks was part of a combined $79B investment portfolio. In one fell swoop, Buffett reduced BRK's stocks as a % from 80% to 60%. He lowered his relative exposure to stocks without having to sell some of them and pay taxes.

More importantly, with General Re, book value over the same time frame went from $57B to $58.3B -- an increase of 1.7%. While 1.7% growth over two years is nothing to write home about, it's a lot better than a decline of 6%. In fact, I think its pretty good given the issues involved in BRK re-setting itself (weathering a $10B decline in KO and G and working through the larger-than-expected underwriting losses at General Re).

BRK got through this tough period, kept its Book Value growing, and now stands with its major equity holdings selling at prices closer to intrinsic value and GenRe once again generating increased levels of float at very reasonable cost (2-3%).

Well done, Warren.