Some Thoughts on Warren Buffett's Cash Problem

(GuruFocus) Warren Buffett's Berkshire Hathaway is currently sitting on a record amount of cash.

According to the company's most recent financial statements, for the third quarter of 2019, Berkshire had just under $71.1 billion in cash and cash equivalents at the end of September, as well as $53.4 billion in short-term investments in U.S. treasury bills. In total, this gives a figure of $124.5 billion in cash and short-term investments.

If you add in the conglomerate's investments in other fixed maturity securities, the overall resources available for acquisitions jumps by $19.2 billion.

At the end of September, Berkshire owned an additional $3.8 billion in U.S. Treasury, U.S. government corporations and agency fixed maturity securities, $8 billion in foreign government debt and $6.3 billion in corporate bonds. The group also owned several hundred millions worth of municipal debt and mortgage-backed securities.

As it is highly likely that Berkshire would be able to find a buyer for these securities if it really wanted to unlock a significant amount of cash, it seems sensible to include these in the overall cash calculation.

That being said, Buffett has declared on multiple occasions that he likes to keep around $20 billion worth of cash on hand to cover any unforeseen insurance liabilities. So, of the possible total of $143.7 billion, the amount of free cash Berkshire has for spending is around $123.7 billion.

There has been plenty of speculation as to where the Oracle of Omaha will eventually decide to deploy this capital. Over the past few years, Buffett has avoided doing any substantial deals because he has been unable to find any companies that seem attractive in the current market environment, although he did commit $10 billion to Occidental Petroleum last year.

As a Berkshire shareholder, I have nothing against Buffett's accumulation of cash, but I am curious as to the level at which the cash pile will become too much.

Buffett has said in the past that he does not like to hold too much cash. In his 1998 letter to shareholders, he wrote:

"At year-end, we held more than $15 billion in cash equivalents (including high-grade securities due in less than one year). Cash never makes us happy. But it's better to have the money burning a hole in Berkshire's pocket than resting comfortably in someone else's. Charlie and I will continue our search for large equity investments or, better yet, a really major business acquisition that would absorb our liquid assets. Currently, however, we see nothing on the horizon."

As he is acutely aware, that's with cash earning less than 2% right now. Berkshire's cash mountain is weighing on its returns. However, if Buffett if can deploy his capital at the right time, he should be able to make up for this lost performance. After all, he has followed this playbook since the late 1950s.

Nevertheless, Berkshire now has more cash than ever before, and the bigger the conglomerate's cash mountain becomes, the harder it is going to be to deploy.

Over the past few decades, size has become a problem for Berkshire. This is something the Oracle of Omaha has discussed on multiple occasions. The group has to do big deals now to move the needle on returns, and there just aren't that many $10 billion-plus deals going around.

A market downturn might throw lots of opportunities for Berkshire to take advantage of like it did in the financial crisis. The problem here is that the company can only do so many deals at once.

In 2008-2009, Berkshire completed a handful of deals. These included $6.5 billion of debt and preferred stock to Wrigley, $3 billion of perpetual preferred stock to Dow Chemical, CHF3 billion Swiss Francs (approximately $3.08 billion) in a convertible preferred security issue by Swiss Re, $3 billion in General Electric stock carrying a dividend yield of 10% and $5 billion of preferred stock in Goldman Sachs. That's around $17.5 billion in total, which was a lot for the company back then.

Today the company is a lot bigger, and its cash pile is growing much faster. It ended 2018 with free cash (excluding long-term fixed maturity securities and the insurance cushion) of around $109 billion.

That means the group has accumulated the same amount of cash as it deployed in the financial crisis in less than 12 months. When you look at these figures, it starts to become clear that cash could become a problem for Berkshire.

These are just some thoughts on the problem that the Oracle of Omaha faces today. Having a lot of cash has always served him well, and I don't think this is going to change anytime soon. Still, if cash continues to accumulate at Berkshire at the rate it has been for the past five years, it could become a problem, and Buffett might have to make some hard choices.


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