Warren Buffett turned Berkshire Hathaway (BRK.A 0.14%) (BRK.B 0.16%) from a tiny textile mill into a conglomerate of operating businesses and investments that the market now values at more than $500 billion. But at the age of 86, the reality is that Berkshire Hathaway will have to appoint a new chief executive sooner rather than later.
Likely picks? Insurance wiz Ajit Jain and energy mastermind Greg Abel, both of whom Berkshire added to its board of directors on Wednesday. Many see these two men as the front-runners for the top spot of Berkshire Hathaway's chief executive, and for good reasons.
Jain as the main man
Ajit Jain seems like a natural fit for the role of Berkshire Hathaway's chief. Insurance is arguably the most important business in the Berkshire Hathaway umbrella, generating roughly one-fourth of Berkshire's earnings power, while providing valuable "float" that helps finance its increasingly capital-intensive business units.
Insurance is a business unlike most others. It's fair to say that Berkshire Hathaway's insurers make their money placing billion-dollar bets, most recently working a $10 billion deal with AIG to help it contain some of its risks in its insurance portfolio. These kind of big deals, managed poorly, would quickly lead Berkshire Hathaway to ruins.
Buffett writes highly of Jain in many of his annual letters to shareholders. In 1999, for instance, he wrote the following:
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.
Not much has changed since then. Berkshire Hathaway Reinsurance has been an incredibly well-run company, generating a boatload of underwriting profits with investment gains on top.
Having someone who spends their time thinking more about risk than rewards may be an advantage to a conservatively run business like Berkshire Hathaway. But at 66 years old, Jain may be contemplating his own retirement from the company, and I suspect Berkshire would prefer to push off another executive transition for as long as possible.
Abel is able
As head of Berkshire Hathaway Energy, Abel's best asset is his experience as an acquirer and manager of operating businesses. Abel joined Berkshire in 2000, when the Omaha conglomerate bought majority ownership of MidAmerican Energy, which has served as a platform for numerous acquisitions, large and small, in the nearly 18 years since.
Its growth can be readily observed from the changes in Berkshire's balance sheet over the years. Berkshire Hathaway reported $11.9 billion of energy-related property, plant, and equipment in 2005, a proxy for its capital invested in the business. Its investments have since grown to nearly $65 billion, net of depreciation, driven by organic capital investments and a thirst for mergers and acquisitions. Taken together with its railroad, BNSF, Berkshire Hathaway as a whole has become much more capital intensive over the last decade.
If you think about the single most-important thing that Berkshire Hathaway does, it's deploying capital in its existing businesses, and expanding them with smart acquisitions that can be integrated into its existing portfolio. In that sense, Abel gets the edge, given that acquisitions are something that he has done day in, and day out, since joining the company.
Berkshire Hathaway's next executive will have big shoes to fill. When Buffett hands over the throne, he's handing over day-to-day responsibilities, but also the reins to a company that has $90 billion of surplus cash in excess of a $20 billion rainy-day fund for insurance losses. Buffett's right-hand man, Charlie Munger, believes that stockpile could be used to finance the acquisition of a company worth as much as $150 billion.
Considering that Berkshire could reliably generate about $20 billion of earnings each year, the investments that Berkshire Hathaway makes over the next ten years could very easily make up more of the company's earnings power in 2028 than all of the acquisitions Buffett approved over the 53 years leading up to today. For this reason, it's my view that the conglomerate's most-active acquirer, Greg Abel, is the most likely to take Buffett's place as Berkshire's next CEO.