Earlier today, Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B), the insurance and industrial conglomerate led by Warren Buffett, announced that it has agreed to repurchase $1.2 billion of its own stock. While trading in its shares were momentarily halted pending the announcement, they have since responded in kind and are currently up by 2.3%. Aside from today's reaction, what does this mean for Berkshire's shareholders going forward?
What's the significance of today's buyback?
At first glance, it's tempting to assume that the decision will have no residual significance. According to the company's press release (link opens PDF), Berkshire is merely acting as the counterparty to the "estate of a longtime shareholder." If you read a bit further between the lines, it's likely that the estate decided to sell before tax rates increase next year courtesy of the fiscal cliff or a resulting compromise thereto. If this were all there was to it, I'd say the market's reaction amounts to much ado about nothing.
As you might have guessed, however, there's more to this story. As the press release goes on to note: "The Board of Directors authorized this purchase coincident with raising the price limit for repurchases to 120% of book value." In other words, shareholders can assume that Berkshire has an ongoing buyback program that will kick in any time its shares fall below 120% times book. This effectively creates a floor for its stock.
While setting such a floor isn't unheard of at Berkshire, as it had done something similar at the end of last year, both the size of the buyback and the level at which the floor is now set is noteworthy. Last September, Berkshire announced that it would repurchase shares if its stock fell below a similarly predetermined level. Yet, in the four months after the announcement, it only repurchased $67.5 million of its own stock -- a far cry from today's $1.2 billion.
Additionally, the previous floor was set at 110% times book value -- again, a non-negligible deviation from today's 120%. According to the company's press release (link opens PDF) at the time: "In the opinion of our Board and management, the underlying businesses of Berkshire are worth considerably more than this amount, though any such estimate is necessarily imprecise. If we are correct in our opinion, repurchases will enhance the per-share intrinsic value of Berkshire shares, benefiting shareholders who retain their interest."
Why this buyback is "weird"
While the higher floor is unquestionably welcome news to Berkshire shareholders, it's nevertheless led some commentators to call "foul." Reuters blogger Felix Salmon noted two, what he calls, "weird" aspects of the move. First, referring to the company's decision to halt trading in its stock as opposed to simply announce the decision before the market opened, Salmon observed that "the way the announcement came out seems incredibly shambolic."
And second, despite announcing the original buyback over a year ago, this is the first time that Berkshire has actually used the authority in a significant way -- for a company of Berkshire's size, the aforementioned $67.5 million buyback is akin to a rounding error. Salmon believes this is evidence that Berkshire was merely trying to support its short-term stock price from being hit by a large, one-time liquidation.
With these factors in mind, Salmon views the buyback as a favor for "an old friend of Warren's" as opposed to a prudent investment decision aimed at increasing long-term value.
The Foolish bottom line
At the end of the day, as Salmon pointed out, it's fair to say that there are some outstanding issues surrounding Berkshire's decision. At the same time, Buffett remains one of, if not the greatest, long-term investor of all times -- most recently making prudent and lucrative bets in now-recovering financial firms like Goldman Sachs (NYSE:GS) and Bank of America (NYSE:BAC). It's for this reason investors would probably be wise to continue erring in his favor as opposed to against it.