A Look at Buffett's Heir
One disagreement between us and Todd Combs: his failure to own Berkshire Hathaway itself.
Many money-management firms operate largely on a star system, although they go to great lengths to deny it. As in other star-obsessed industries, such as entertainment and professional sports, truly superior talent is rare. The gap between superstar investors and average money managers is wide, and those who possess special gifts are remarkablywell compensated.
That isn't to say that assembling a gifted team and developing sound investing disciplines don't matter -- they're often critical to success. But the nature of the investment business is such that it's difficult for something as clumsy as a committee to deal with issues that require quick and decisive action. The buck usually stops at the desk of one person, maybe two -- and the entire world can see the results of his or her decisions in objective performance figures. In such a system, it's no surprise that superstars stand out.
Surprise choice. All of which helps explain the buzz after Warren Buffett hired Castle Point Capital's Todd Combs late last year to manage at least a portion of Berkshire Hathaway's investment portfolio. Who is Combs? What has he done? How will he handle the impossible task of filling the shoes of Buffett, the most acclaimed investor of our time?
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We have no insight on any of that. We do hold Buffett's decision-making prowess in high regard, and we see no reason to question it in this case. However, we did take a gander at the latest Form 13F that Castle Point filed with the Securities and Exchange Commission, detailing the firm's holdings as of September 30. Most of the stocks he held were financials, the five largest of which were U.S. Bancorp (symbol USB), a large Berkshire holding as well; MasterCard (MA); RenaissanceRe (RNR); Chubb (CB); and Western Union (WU). Only two of his holdings -- JPMorgan Chase (JPM) and CIT Group (CIT) -- overlap with our present portfolio.
CIT, a major lender to small and midsize businesses, emerged from bankruptcy in December 2009. Under new CEO John Thain, the company has made significant progress in focusing its business strategy and shoring up its balance sheet. The stock has responded -- it climbed 50%, to $48, over the past year through January 7 -- but we believe there's still major upside potential.
CIT's primary challenge is to lower its too-high cost of financing. We believe the company, which is based in New York City, will be able to reduce its borrowing costs by refinancing its existing high-cost obligations, using cash to buy back debt, and generating increased low-cost deposits from its bank subsidiary. If the company captures the financing-cost savings we believe are possible, we think it could earn about $5 per share. If the stock traded at 12 to 14 times earnings, a valuation we consider reasonable, it would sell for $60 to $70 per share. Even more intriguing is the possibility that a healthy bank might buy CIT. Such an acquirer could achieve enormous earnings improvement if it brought its much-lower borrowing costs to CIT's business model.
One noticeable disagreement between us and Combs: his failure to own Berkshire Hathaway (BRK-B) itself. Over the past two years, Berkshire, under Buffett's direction, has aggressively deployed some of its long-hoarded cash into terrific businesses, such as Burlington Northern Santa Fe, at excellent prices. Thanks to strong stock-market performance, we estimate that the value of Berkshire's investment portfolio jumped to $59 per B share by the end of 2010. Further, we believe Berkshire's operating businesses are worth another $48 per share (a figure we derive by applying a multiple of ten to estimated 2010 pretax profits of $4.80 per share). The resulting $107 in estimated value per share is 34% above Berkshire's January 7 close of $80. Known as a quick study, Combs likely has a clearer view of Berkshire's value today.
Columnists Whitney Tilson and John Heins co-edit Value Investor Insight and SuperInvestor Insight.
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