The Sage Of Omaha Is Looking A Little Vulnerable

Warren E. Buffett seems willing to fess up to his errors. In Berkshire Hathaway Inc.'s 1994 annual report, he blames sloppy analysis, hubris, and the lure of owning a senior security for his ill-starred move into USAir Inc. preferred stock six years ago. But what about his stake in Salomon Inc.?

No mea culpa has been issued yet, despite Salomon's current misfortunes. If Salomon bounces back, Buffett's $1 billion-plus investment in common and preferred stock could be a big success. If Salomon's performance remains bleak, however, Buffett could be more vulnerable to serious losses than many observers realize. Neither Buffett nor a Berkshire spokesman would comment.

CONSOLATION PRIZE. At the moment, Buffett's stake is underwater. Between November, 1993, and December, 1994, Berkshire Hathaway acquired 6.63 million shares of Salomon common stock for $324 million. As of Apr. 19, the position was worth $227 million, a paper loss of $97 million. Berkshire's 700,000 preferred shares, purchased for $700 million in 1987, have recently lost ground as well. At yearend 1994, the company valued those shares at a $35 million profit, down from a $175 million profit carried on its books a year earlier. The aggregate paper loss for Berkshire's investment in Salomon: $62 million.

Berkshire retains a consolation prize, though: Its 9% dividend on the preferred produces $63 million annually. The $457 million collected through 1994 amounts to a reasonably competitive return. But it's well below Buffett's customary stellar results from such common stocks as Coca-Cola, Gillette, and Geico. For Buffett, perhaps the biggest price of his involvement at Salomon so far is the opportunity cost--it has tied up his capital and time.

Salomon will face a moment of truth on Oct. 31, when 140,000 of Buffett's preferred shares must be converted into either $140 million in cash or common stock held in Salomon's treasury at $38 a share. The rest of Berkshire's preferred stake is due to be converted in additional 140,000-share blocks over the next four years.

EMPEROR'S THUMB. Buffett's next move could have a significant impact on Salomon. "It's going to be like the Roman Empire: thumbs up or thumbs down," explains Bruce Berkowitz, a portfolio manager at Smith Barney Investment Advisors who holds stock in both Salomon and Berkshire. If Salomon stock is selling at $38 or more at the end of October, Buffett will almost certainly opt for stock. That would be very bullish news for the firm, sending the message that the Omaha investor is hanging in there. And that's the outcome that some Berkshire holders fully anticipate, especially those who are convinced that Salomon stock is poised for recovery: "It's a wonderful buy. We're accumulating it," says Jack Byrne, chairman of Fund American Enterprises Inc. in Norwich, Vt. Dwayne O. Andreas, a Salomon director and a close associate of Buffett's, acquired 100,000 shares at $33.68 in mid-March for a beneficial trust.

But if the stock languishes in the mid-30s or below, especially for several years, the outlook for Salomon might be ominous. Buffett would be under pressure to convert the preferred stock to cash. That would deplete Salomon's capital, further depress Salomon's stock (including Buffett's own common holdings), and send what might be seen as a very different message about his feelings toward Salomon. Buffett's 1994 annual letter to shareholders is silent on the subject.

Buffett, though, is known for taking the long view. He has held on to his Salomon stake even though the stock has been on a veritable roller-coaster ride for the past decade. Berkshire bought its preferred stake just weeks before the 1987 market crash halved the investment-banking company's common stock, from roughly $33 a share to less than $17. By 1991, Salomon stock had battled its way back to the mid-30s, but then news of the company's U.S. Treasury bid violations sent shares plunging again.

After that nasty surprise, Buffett became deeply involved in the firm--so deeply that some observers suggest he might accept Salomon stock in exchange for his preferred stock, even if it is selling below $38 a share and would compound his short-term paper loss. Buffett preaches the value of hanging on to subpar businesses as long as they generate cash and field a solid management team. Yet Buffett is not known for giving away money, and he must act in the best interest of Berkshire shareholders.

Berkshire's Salomon investment looks a lot better than his USAir stake, which the company wrote down to 25 cents on the dollar last year. But there's no question that Buffett's Wall Street adventure has further sullied the Sage of Omaha's golden touch.

Before it's here, it's on the Bloomberg Terminal.