Kass vs. Buffett

 | May 02, 2013 | 9:00 AM EDT
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This weekend, our own Doug Kass is going to stare down Warren Buffett and present the bear case at Berkshire Hathaway's (BRK.A, BRK.B) annual shareholders meeting. Or as I like to call it, the Most Interesting Man in the World vs. The Oracle of Omaha.

Kass's personality is so magnetic, he is unable to carry credit cards. His charm is so contagious, vaccines were created for it. But even these attributes, he will have his work cut out for him. Although I do not know the exact argument Kass will make, I can suggest a few.

I'll begin by dispensing with the obvious. I don't think Kass will mention valuation of the stock or Buffett's age. Those aren't great reasons to short the stock. I also don't think Kass will make the "needs to do another huge deal to move the needle" argument. Although, with an estimated $174 billion in revenue for fiscal 2013, it's true that the company has to bag a really big elephant to grow the company. But I don't think Doug will go down that road.

I think Kass can legitimately mention that many of Berkshire's most profitable deals are unlikely to be repeated. Eight companies that Berkshire invested in 2009 received $133 billion in bailout money from the Fed. That's risk-free investing at its finest.

Buffett's $5 billion investment in Goldman Sachs (GS) in 2008 turned out to be hugely profitable. Buffett reached an agreement to exchange his warrants in Goldman for shares in the company, making Berkshire a $1.4 billion profit. Who does that? Who gets access to that kind of sweetheart deal? Not I.

In fact, as I recall, doesn't everybody who's in trouble come around for some Berkshire bailout cash? Solomon Brothers did in 1991. Buffett's $700 million investment in the firm magically turned into $1.7 billion a few years later when Solomon was sold to Travelers (TRV) for $9 billion. Offloading a bankrupt bond-trading firm for $9 billion is not too shabby. He almost did it with Long-Term Capital Management, too. Buffett gave them an hour to accept a lowball offer. They didn't take the bait and Wall Street ended up rescuing Long Term Capital.

But if you really want to short the stock, why not ask Buffett why his insurance companies are more profitable than any other insurance company. Berkshire's insurance operations seem to be very lucky to me. Last year was the 10th consecutive year of profitable underwriting. Buffett likes to point out that State Farm Insurance had an underwriting loss for eight of the last 11 years. Buffett will tell you it's because Berkshire's insurance operations are run by smart people, but come on. In the 2012 annual report, Buffett writes that Berkshire's Reinsurance Group's CEO Ajit Jain has exposed Berkshire to less risk than the industry, but manages to have $35 billion of float left over. (Float is insurance lingo for money left over after claims are paid.) How can the company operate at the scale it does, take less risk than the average insurance company and dish out incredible profits?

GEICO experienced its single greatest loss in the history of the company when Hurricane Sandy claimed over 46,000 cars. Sandy was three times more costly than Hurricane Katrina, yet GEICO managed an underwriting profit of $680 million. And GEICO's profit would have been even larger if it wasn't for an accounting change that cost the company another $410 million. How's that? In the last three years, Berkshire's insurance revenue is up 17%. Finance and financial product revenue did even better. That category is up 19%. I wasn't aware the insurance business was a growth business.

I'm no expert on insurance accounting, but why doesn't anybody wonder about these things? Maybe Doug will ask. While I'm interested in Doug's short thesis on Berkshire, I admit I'm even interested in his Kentucky Derby picks.

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