Subject: Bear Thoughts

Date: Thu, 24 June 1999 12:42 PM EDT

From: Texirish

Whitney Tilson wrote: "I think it might be a useful exercise for the participants of the board to take off their yellow I LOVE BRK hats (for an instant anyway) and do their best to come up with the best arguments against BRK."

I think Whitney made an excellent suggestion. But, it is clear that we have difficulty taking off our I LOVE BRK hats long enough to respond.

I am basically in the same camp as Neuroberk described in his "Why BRK?" post. I am still very comfortable with BRK as my long term core holding, considering both the downside protection built into the Berkshire cash generation machine as well as the long-term upside potential. I also trust WEB's investment decisions more than my own.

Still, I think that Whitney's suggestion deserves our thoughtful consideration. If we can't visualize the downside factors for BRK, can we really say we understand the upside?

It might be helpful to break the suggestion into two parts:

1. What are the conditions that make today a difficult business climate for Berkshire?

2. What are the factors that make it difficult for Mr. Market to recognize Berkshire's true worth?

I offer some thought below on these topics, as a starting place for others to either improve upon or challenge. (However, I will warn those who have read this far that a long post follows.)

WEB gives his managers high praise for performing well under difficult business conditions. I think we owe WEB and CM the same praise. Consider some of the following :

1. The size anchor for Berkshire becomes larger every day. Minimum investment targets are already at $500 million, significantly limiting the opportunity field. The increased size following the General Re acquisition dilutes the near-term impacts of Geico and Executive Jet, as well as the other fully owned businesses.

2. The U.S. stock market, especially in the large cap companies, does not offer the margin of safety that WEB requires. This, combined with his philosophy of limiting investments to those businesses whose future he can forecast with reasonable assurance, makes investing BRK's large available capital in the equity markets very difficult today. Privately owned businesses can be expected to be fully priced, so that time will be required for the

advantages offered by Berkshire ownership to develop and become apparent to the public.

3. The reinsurance business climate is poor today, due to excess capital. This reduces Berkshire's competitive advantage of being "Fort Knox."

4. The shaky state of most of the world's economies outside of the U.S. has a major impact on both Berkshire's equity holdings (e.g. KO, G) as well as the international reinsurance business.

I remain encouraged that WEB and CM do not think the situation is so unpromising that they must resort to repurchasing BRK stock today. Still, I am not anticipating any dynamic growth in Berkshire's stock price until the investment and reinsurance business climates improve.

What WEB and CM really need is a period of "bad news" on several fronts. The U.S. economy needs to undergo sufficient trauma that the confidence of equity investors will be shaken, and Mr. Market will overreact downward. The reinsurance business needs to encounter sufficient disasters (sad to say because of the human impacts) so that excess capacity will dry up and premium margins will improves. However, such events will further depress BRK's

stock price in the near term, although they will greatly improve long-term prospects.

Beyond these macro economic items, there is also the issue of Mr. Market fairly valuing BRK.

WEB has stated that BRK has been somewhat undervalued for much of its history. There are factors which can, I believe, exacerbate this situation in the future.

1. Berkshire is more difficult to understand today. Until recent years, publicly owned companies made up the bulk of BRK's worth, with these being valued by Mr. Market. BRK was, and usually still is, viewed as a closed-end mutual fund, selling at a "Buffett premium" over its portfolio. This premium really consisted of (a) the value of future float growth, (b) leverage from deferred taxes and float, and (c) undervaluing the wholly owned

businesses - in my opinion.

But the acquisitions of Geico, Dairy Queen, Flight Safety, Executive Jet, and General Re have transformed Berkshire. Now it is truly an operating company consisting of two major parts. The first is insurance operations that have the advantage of being able to invest in equities. The second is a wonderful collection of wholly owned businesses.

However, this makes Berkshire much harder to understand for the average investor. Even Alice Schroeder's report requires careful study by a sophisticated investor to decipher. Today, she is a lone voice in the wilderness. So, the "as KO goes, so goes BRK" viewpoint continues to exist.

2. Mutual fund managers have almost no incentive to invest in BRK. If it does well, they look bad by comparison. If it does poorly, their income suffers versus the "go-go" manager. Berkshire is managed on a long-term basis, while mutual funds are evaluated on short term performance.

3. Stockbrokers have no incentive to recommend BRK. They can't make money on the small volumes and they don't really worry about their customers making money.

4. WEB's investment philosophy is not in vogue. Day traders and momentum investors today find nothing sexy in Buffett's long-term growth, preservation of capital, margin of safety investment philosophy. Many view him as being outdated in the New Information age.

5. Concerns about General Re's derivatives business and the impacts of Y2K problems on insurance companies can be legitimate near-term concerns.

6. BRK's stock prices - for both A and B shares - are a barrier to entry for the average investor. They also make the stock relatively illiquid - keeping it from being included in the S&P 500.

7. Concern about WEB's and CM's mortality continues, in spite of their assurances that management succession is in good hands. In truth, they will be difficult to replace.

I'm sure others can add to this list.

I believe that these items can have two significant impacts on BRK's near-term stock performance.

1. BRK will become more of a "show-me" stock. Investors will wait for earnings results and improved investment performance before rewarding BRK's performance.

2. Investors will not really appreciate BRK's combination of safety of principal plus long-term growth until a major stock market downturn causes them to again value such a combination.

WTilson proposed a scenario under which the stock market advances, but BRK underperforms because Buffett is not investing in the New Era stocks. He then states:

(under WTilson's scenario) …… I suspect BRK will prove to be a mediocre investment (say, 6-10% annual appreciation, when the stock market could compound at 15% annually under the best-case scenario I outlined above). 6-10% annual gains is not a doomsday scenario--in fact, there are few stocks that have such a rosy downside--but none of us are holding BRK for this kind of gain.

For my part, I am prepared to accept 6-10% annual gains for a few years until business and stock market conditions change. Buffett and Munger may, once again, surprise me on the upside. However, it will truly be due to their investment genius rather than favorable tailwinds, and they will deserve high praise.

I can develop counter arguments to the above, as can others. I believe such discussion will add to the educational value of this board.

Tex