Case Analysis: Warren Buffett and Berkshire Hathaway’s acquisition of GEICO| By: Maryam Abathi, Jesper Eriksson, Andrew Klotz, Lorenzo Manera, Stanislav Sobolev, | |
Financial Management Case Analysis at Hult International Business School 2012-2013|
A) What is the possible meaning of the changes in stock price for GEICO and Berkshire Hathaway on the day of the acquisition announcement? Specifically, what does the $718 million gain in Berkshire’s market value of equity imply about the intrinsic value of GEICO?
Valuation of GEICO
Warren Buffet bought the company of GEICO for 70$ per share, which he estimated to an appropriate price for the purchase of the company. Warren Buffet is focused on the future cash flow that GEICO may generate, and use this to value the company before a purchase of stocks. The acquisition of GEICO shows that Warren Buffet had a big confidence in the company, which he also mentions in the note: * Seven largest auto insurer.
* Extraordinary senior managers that may provide additional depth to Berkshire Hathaway’s senior management bench *the lowest-cost insurance provider in the industry.
Warren Buffet believed that GEICO was undervalued on the stock market and that they were stronger than what the current stock price said. He had also had his eyes on the company since as early as 1951, when he made his first investment in the company. GEICO was a company that Buffett were comfortable with and which he had followed closely for over four decades, which follows his investment philosophy to aim for long-term investments. With the insight in the company and the way that GEICO performed businesses compared to other insurance companies it had performed very well previously. NYTimes reported on the 26th of August, 1995 that “Geico, the country's sixth-largest car insurer, has been a solidly profitable company in recent years with a good record for low losses and low expenses in comparison with others in its business. These results have been possible because the company bypasses agents, selling directly to the consumer, concentrating on low-risk drivers.” Baltimore sun reported on the same day regarding GEICO “In the years since, Geico has become known as an extremely picky underwriter, undercutting competitors for the business of drivers with clean records but demanding far higher premiums from customers who have had even one driving violation. It also has among the lowest administrative costs in the insurance business because it sells most policies over the phone without using insurance agents.” The intrinsic value of the company was higher than the book value that had deteriorated due to inflation and costs. Los Angeles Times also mention in their article the day after the announcement from Buffett that analysts speculated in that by acquiring GEICO, Buffett tried to groom a successor. Warren Buffett, 65 years at this time, tried to find a stable management team for Berkshire Hathaway in case of that he would have to step down. The acquisition of GEICO was thereby not just an investment in a company that made good profits, but also an investment for Berkshire Hathaway to remain stable in the future with a good management team. According to the Autobiography about Warren Buffett, “The Snowball”, the payment for the stocks in GEICO was done in shares in Berkshire Hathaway. Instead of lowering the capital that Berkshire Hathaway had in direct cash, and paying with shares of his own company, there was no direct negative cash flow out from Berkshire Hathaway. (Page 747) Walt Disney Company:
Walt Disney Company announced three weeks before the Buffett announcement that they intended to acquire the stocks in Capital Cities/ABC for $19 Billion dollars. With the 13% ownership of the Capital Cities/ABC, the result was going to be a gain of approximately $2 billion dollars for Berkshire Hathaway that they then would be able to reinvest. The capital gain on the...