Industrials

Tara Lachapelle is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

To invest in Berkshire Hathaway Inc. means to give Warren Buffett the benefit of the doubt. That's both the beauty and potential drawback of the $392 billion company. 

Take this section of Buffett's annual letter to shareholders in February discussing certain adjustments made to operating expenses within Berkshire's manufacturing division, which comprises the recently acquired Precision Castparts business:

"We present the data in this manner because Charlie (Munger) and I believe the adjusted numbers more accurately reflect the true economic expenses and profits of the businesses aggregated in the table than do GAAP figures. I won’t explain all of the adjustments -- some are tiny and arcane -- but serious investors should understand the disparate nature of intangible assets. Some truly deplete in value over time, while others in no way lose value."

The U.S. Securities and Exchange Commission wasn't satisfied with this "just-trust-me" precept and sent a letter to Berkshire on Sept. 8 asking for clarification on two things: how the unit's net earnings were impacted by such adjustments, and why $17 billion of its customer relationships and trade names can be determined to have indefinite lives.

So as not to bore you with the accounting details, here's the short version of the Oct. 6 response from Berkshire CFO Marc Hamburg, which was released Monday along with the SEC's initial query: First, the acquisition accounting expenses were considered corporate expenses. And second, as a components maker for the "oligopoly" that is the aerospace industry, Precision Castparts' customers aren't going anywhere for the foreseeable future, meaning they shouldn't lose value and will continue contributing to the business's cash flow indefinitely. 

Fair enough. No juicy impropriety here, and in fact the SEC said in an Oct. 21 response that it had completed its review of the matter. However, it does shine a light on an issue that will most certainly become a point of contention when Buffett, 86, is no longer running the conglomerate.

Getting Bigger
...which makes Berkshire Hathaway that much harder to sift through
Source: Bloomberg

Let's face it, Buffett -- for mostly good reason -- isn't always held to the same standard as other CEOs because of his celebrity and track record. A lot of the time we're taking his word for it because his word has been good.

Berkshire is one of the few large public companies that still doesn't hold quarterly earnings calls with analysts, which as Gadfly's Brooke Sutherland pointed out this week, makes it rather old-timey. There's only the annual letter and big shareholder meeting down in Omaha, Nebraska, where you can catch Buffett playing ping-pong, strumming a ukulele and gulping down a Cherry Coke, all of which plays into the folksy persona that adds to his aura of trustworthiness.

That's in spite of the transparency shortcomings in Berkshire's financials. For example, look at all the individual companies that fall under Berkshire's manufacturing division:

How many of those does Berkshire break out quarterly results for? None. The closest you get are revenue and pre-tax earnings for three high-level groups within manufacturing: industrial products, building products and consumer products. And this division accounted for 20 percent of Berkshire's trailing 12-month revenue and about a quarter of pre-tax income.

Warren's World
Here's the company's revenue split, which aside from the insurance businesses and regional utilities, doesn't get a whole lot more granular than this:
Source: Bloomberg

Then there's analyst coverage of Berkshire. Only five analysts from the sell side formally cover the company, according to data compiled by Bloomberg. Notably, the other companies they cover are either in the insurance or financial-services industries -- not industrials, railroads, energy, or any of the other range of businesses Berkshire has collected over the years. And as fine analysts as they may be, Berkshire shareholders rely little on sell-side research because there's not much more to glean than what's in Buffett's remarks and Berkshire's prepared statements. Plus, has Berkshire's stock gone anywhere but up? (It's surged 10 percent this month alone as part of the post-election rally in U.S.  stocks.)

Buffett's possible successors -- Ajit Jain and Greg Abel top the list -- will have to answer to investors in a way that Buffett has never needed to, and potentially even more than a typical S&P 500 CEO. In an age of shareholder activism and a corporate mantra of "less is more," Berkshire, without its beloved pitchman, may be forced to justify its sprawling existence or at least provide more detail about the vast operations. 

It's easy for shareholders to put their faith in the world's second-richest man and a company he built up over the past 51 years. The next Berkshire CEO will have to gain their trust and be more accessible, or else shareholders might challenge him. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Tara Lachapelle in New York at tlachapelle@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net