Description

How can anyone recommend shorting Berkshire? We have a thesis that Berkshire subsidiaries (in general) are not being managed well. We came to this conclusion from two decades of owning the stock personally compared to owning Progressive in our fund (see our PGR write-up here on VIC, which should have won the contest... if only I could write better). We contend that the model that worked so well for most of Buffett's career is not working today. We also contend that he's unlikely to change his stripes (he is 94, after all).

Before I go further, let me make it clear that without Buffett, I wouldn't be where I am today. I am one of those that had the experience of reading Buffett's shareholder letters in college and it made complete sense to me. I was hooked, and I made my career by essentially following Buffett's investing principles. Essentially, I owe my career to Buffett/Munger and I am forever grateful.

That said, there are some important management problems at Berkshire that threaten the health of the overall business over time. At current prices, investors are assuming a fairly bright future for the operating businesses. I contend that Geico is in trouble, and that Burlington Northern is perhaps the worst managed railroad in N America (though NSC is in the conversation).

Let's go back to 2019 (I chose this year to get pre-COVID numbers and also some time -- our thesis will take time to play out so any year is not representative... we need larger time increments). Geico doesn't report PIF data, but revenues (NPE) in the first half of 2019 were $17,491. Compare that to Progressive (where I'm using auto only), where NPE was $14,458. In the first half of 2019, Progressive auto premiums were 83% of Geico's auto biz.

In 2024 (through six months), Geico NPE was $20,703 compared to $27,853 for Progressive. In five years, Progressive goes from 83% of Geico NPE to 135% of Geico NPE. Todd Combs became CEO of Geico in January 2020. To be clear, I'm not blaming Todd... he was dealt a really bad hand and may not have known that when he took the job (or didn't have a choice but to take the job). At the beginning, Todd was an interim CEO. Interesting that they have not been able to find a high-quality insurance CEO that is willing to take the job. We have some ideas why that might be the case. If you want to go down a rabbit hole, spend some time reading what Geico employees think of the place these days. Yikes.

In the past few years, Berkshire has been getting absolutely crushed by Progressive. In fact, if you read a couple of my messages in my PGR write-up, I made the case that I can't think of a strategic decision in slower-moving industries, like the one Geico made in the last few years. Our thesis is that Geico fashioned themselves as the low-cost, no-frills auto insurer and thus made it very difficult internally to pivot to a different world. What is that world? It is driven by technology. Progressive has a massive lead in understanding risk and thus pricing. A couple of years ago, Geico suddenly realized that they didn't have pricing right and decided to give a huge chunk of business to Progressive (I'm simplifying here... attempting to get the 2nd grade book report tag).

At the last annual meeting, Ajit Jain made the claim that Berkshire could catch up with Progressive in a couple of years. I contend that it is highly unlikely that they'll ever catch Progressive. Some of it is cultural. When you build your identity on lowest cost, you are unwilling to invest in technology that does not have an obvious, immediate payoff. Geico's technology is a joke, and it would take billions to fix it even if it is possible (ie--can they hire the right people?). Would Todd Combs be willing to walk into Warren's office and explain that the Geico expense ratio needs to rise by at least 5 points (probably considerably more) for several years in an ATTEMPT to catch Geico? I doubt it.

Let's look at another important subsidiary -- Burlington Northern. Their closest comp is Union Pacific so we'll compare the two. In the first half of 2019, BNSF posted revenues of $11,655 with EBIT of $3,973. Five years later, revenues are lower at BNSF ($11,361) and EBIT is lower ($3,543). Not so for UNP -- they posted first half 2019 revenues of $10,980 with EBIT of $4,220. This year so far, UNP revenues are $12,038 with EBIT of $4,772.

It doesn't seem like much, but the difference between BNSF and UNP in 2019 and the difference today is huge. 

Our contention is that the low-cost culture of Berkshire worked great for a long time. It remains a viable strategy for a wide variety of companies, but not for some of Berkshire's big subsidiaries. They have underinvested in their operating infrastructure and are paying the price in the marketplace. As a result, they are unable to attract the best management and have put themselves on a slippery slope. So long as Warren is CEO, it is hard to imagine this changing. 

We have done some interviews and spent time studying some of their smaller subsidiaries and found similar problems. They don't move the needle by themselves, but it is indicative of the current culture throughout the company.

We also happen to think that Apple is overvalued, but we won't debate that in this write-up.

I acknowledge that we could be wrong here. It is possible that Progressive and the railroad competitors are over-investing and thus setting themselves up for lower returns in the future. I think that is highly unlikely, though time will tell. The story among various BRK subsidiaries lines up too much and operating performance has degraded over time throughout the company. That said, we'll keep an eye on datapoints that would suggest our thesis is wrong (we'll see it in auto insurance first... we understand that situation best).

Regarding valuation -- I'm not going to go into much detail about valuation in this write-up. Berkshire is very clearly on the high end of its historical valuation range. I suspect we'll see that Buffett isn't buying too much BRK stock this quarter. Our thesis really isn't driven by current valuation and something changing soon. Rather, it's driven by what we perceive is a slowly deteriorating business relative to market perception. This will play out over years.

One last thing -- we're not actually short the stock in our fund. We have sold calls at current prices (and higher prices) that will make us short at expiration if the stock is at this level or higher.

Catalyst

Operating metrics will continue to deteriorate relative to the competition.