Here’s a story that points out that the percentage of shares sold short has quintupled after the BNI deal. There are many “mainstream”, “make-sense” reasons as to why this might be:

1) Berkshire could lose its AAA credit rating due to reduced cash levels (S&P, Fitch and insurance specialist A.M. Best have placed Berkshire on “watch”);

2) It was an oversized, expensive deal that dilutes shareholders;

3) Buffett and Munger aren’t getting any younger…

Well, here’s another: it’s a simple merger “arbitrage” opportunity created by the deal’s structure.

As described in the official press release and better explained in the conference call (on page 6, question number 4), the deal is a share exchange where each BNI share is worth approximately US$ 100 in Berkshire shares IF Berkshire’s share price at the time of the exchange is set between US$ 80,000 and US$ 125,000. This means that within this range of Berkshire Hathaway prices, a shareholder of BNI would get MORE Berkshire shares as the price approaches US$ 80,000 (below this number it doesn’t matter, since the exchange ratio is fixed). So BNI holders have an incentive to short BRK/B and pocket the difference when the deal closes – at which time they’ll hold an excess of Berkshire at attractive prices…

Of course, there are two things that could go very wrong for shorts:

1) As speculated here and in some research we’ve read, BRK/B shares post-split could be included in the S&P 500 index – with the huge sums of money invested in S&P 500-pegged funds, the buying volume could (and usually does) mean a 3-4% increase when the index change is made public.

2) Buffett could announce a share buyback program if Berskhire approaches the lower limit – while he has never done that, and his available cash is relatively depleted after the deal, Berkshire generates some US$ 10bi per year and his credit is still good…

That’s all beside the point. Much more interestingly: what does this deal say about Berkshire’s sharpness in deal-making? Are they losing their edge? We won’t even judge the deal’s merit (cheap, decent or overpriced). We’re just wondering whether the fact that Buffett appears to have created a less-than-ideal deal structure is reason for concern.

Finally, we’d point out that in the unfortunate case that either Mr. Buffett or Mr. Munger dies any time soon, or if the price formation is really altered by this “arbitrage”, there could be an interesting opportunity to buy Berkshire shares. We’re talking about a company with quality assets whose culture will outlive the two, and a company whose current “bets” on inflation, energy, transportation and USA recovery (and related financial market bets, e.g. the famous S&P 500 put) represent a very interesting long-term play. We wouldn’t bet against this – and certainly not against Buffett.

LINKS:

Has Buffett lost his mind? – Dec. 8th article on the Lonely Value Investor blog pointing to the original article (link below) and to a Bruce Greenwald interview blasting the deal as “insanity” (read his answer to the 2nd question). Bruce Greenwald is the Columbia University value investing dean.

Berkshire + Burlington, a Nov. 4th rant in the Lonely Value Investor blog. Not judging merit in this piece, it does link to 3 bearish pieces in “serious” publications such as Barron’s (subscription required), Bloomberg (by none other than Alice “Snowball” Schroeder) and TheStreet.com.

Buffett says Burlington ‘not a bargain’ – Nov. 14th article on Bloomberg quoting a Charlie Rose interview. The full interview transcript can be found here, and as usual it’s quite interesting. The part on Burlington starts after a bit of an introduction, but it’s near the top.

During the meeting, we decided to experiment with live meeting “tweets”, so to speak. Read on for our main highlights and real-time posts during the meeting, in descending chronological order.

Main highlights:

They seem to be very positive on China. Munger was astonishingly upbeat on BYD, citing the CEO as a major Genius, and that you’ve got to be mad or stupid to bet against him.

Munger also said that if he was younger and starting a fund management business, he’d use the ideas of the guys he respected the most as a starting point and them do his research on them.

When asked why not appoint a CEO and tutor him, Buffett said that his daily activity comprises of reading a lot (5 newspapers: NYT, WSJ, FT, Washington Post and the local newspaper) and that he saw no point in having someone seating by his side while he reads.

The idea of having the 3 journalists selecting the best questions “out of the thousands” sent in advance by email worked well. Those were by far the best questions.

Buffett and Munger answer what they want. Sometimes the explicitly say they won’t answer, sometimes they simply ignore it and keep talking about what they want.

The question we’d like to ask Mr. Buffett (and probably will try to) is: “How do you establish the limits of your ‘circle of competence’?” After all, this is a guy who’s been in stocks and outright business ownership all over the world (Korean basket, Israeli tool manufacturing, Chinese oil, battery and car manufactury), commodities (paladium, silver, oil…), currencies (even the Real!), bonds (from investment grade to junk), convertibles, derivatives…

Real-time “tweets”

15:00 fake shareholder question from a man who was a Buffett relative (we only found out later) set up the guy’s marriage proposal right there and then.

She said yes.

On that note the meeting was over, and we take our cue and sign off as well. Cheers!

14:56 historical perspective from Charlie: “I never saw anything like 1973, 74. I knew it was my time. I just didn’t have any money then…” (laughter)

14:48 Best unanswered question: “how would you interview a candidate for a senior spot at a Berkshire subsidiary”?

14:22 On compensation/ incentives for a capital-intensive business: “you must include a cost of capital adjustment”. Then on compensation in general, he said that Boards don’t set compensation plans – in his 40-yr experience in 19 boards, it’s the CEO who does it. He chooses the compensation committee…

13:50 From the optimism camp: “There’s always something wrong with the world. Unfortunately it’s the only one we’ve got. In the 20th century there were 20 or so crisis and the world kept on growing. (Buffett) Then Munger later quipped: “I find myself cheerful on the economy”.

13:40 On General Re: “I don’t think that pointing out shortfalls, even if I was the one making mistakes, is a good practice when we’re trying to attract other good managers and business owners.”

13:25 Buffett: when Munger really wants me to do something, he says: “in the end you’ll see things my way, because you’re smart and I’m right”.

13:11 Spotted Bill Ackman in the crowd, coming back from lunch (late).

13:00 back from lunch

12:10 Lunch break

11:44 Retail and real estate set to suffer a long time. In that line, shopping centers will have vacancies that are tough to fill while capacity can’t be withdrawn. In his manufacturing operations, however tough their future looks, at least Buffett understands the “math” of future investments and returns.

11:04 Munger: the number one no-brainer infrastructure investment in the US is the power grid. MidAmerican is very well positioned.

10:36 Great one on sucession, in this case Ajit Jain’s: “Can’t replace Ajit, won’t try it. Therefore, will limit the substitute’s authority/ risk limits. We will never assign someone tasks beyond his/her capabilities”.

10:34 Buffett said he loved a question once by a Chicago U student: “what are we learning that’s the most wrong?”

10:27 More on sucession: Munger says J&J is his benchmark on training internal CEO candidates. Most BRK-like, decentralized, people learn on the job. No “crowned princes” hanging around the CEO, quips Buffett.

10:16 On sucession: While there will be just ONE CEO, we’re testing 4 CIO candidates. We may bring them all in, or one and then two to the Board, whatever. Interesting… But how would BRK avoid an unhealthy competition? More: “if I die today, new CEO is named right away, but the CIO in a month or so”.

10:03 WB: If you buy shares in a company, don’t expect to change how things get done there. Point: buy into good management.

9:52 Buffett: government did the best it could, but surely decisions made in emergency mode may not be optimal. Recommended Jamie Dimon’s letter for the clarity on what caused the crisis. Look for a future post about “great moments in annual reports”.

9:42 Unusual start: Slide showing a Bloomberg deal slip where BRK sold 5mm USD in Treasuries on Dec. 19th ’08 where the buyer would make 90 bucks on those 5mm in 4months. Buffett’s point is that 2008 extraordinary and that should be considered during the meeting.

9:25 Hilarious vid on 2008 “poor” results causing Warren to be downgraded to mattress salesman at NFM – Charlie is the delivery boy

8:24 Settled in, bought some books, waiting on the video. Number of TV crews covering the event at least 3x larger than in 2005. Had never seen the arena so crowded – there’s people in the balcony behind the podium!

7:15 We’re in, crowded as expected, visiting the exhibition!