Wesco Financial Corporation held its 2010 annual meeting in Pasadena, California on May 5. Wesco Financial is a 80.1 percent owned subsidiary of Berkshire Hathaway. While the Berkshire Hathaway annual meeting attracted approximately 37,000 attendees on May 1, the Wesco meeting is a much lower key event. The main attraction is the opportunity to listen to Charlie Munger’s views on business, the economy, and a variety of other topics.
Will Wesco Become a Wholly Owned Berkshire Subsidiary?
According to a 8-K SEC report filed today, Mr. Munger had the following to say about the possibility of Berkshire eventually acquiring the remaining 19.9 percent interest in Wesco:
At the Company’s Annual Meeting of Shareholders, the Company’s Chairman and Chief Executive Officer, Charles T. Munger, who is also vice-chairman of Berkshire Hathaway Inc. (“Berkshire”), which owns 80.1% of the Company’s outstanding stock, said that it would be logical for the Company to ultimately become wholly owned by Berkshire. Mr. Munger cautioned, however, that such a combination transaction, to the extent it would involve stock consideration, would only make sense if there was an appropriate relationship between the relative values and prices of Berkshire’s stock and the Company’s stock, and that such a relationship does not currently exist. Mr. Munger did not state any particular time frame for such a transaction. No combination transaction of any kind has been proposed or presented to the Company. The Company’s Board of Directors has not discussed or considered any such transaction and neither has Berkshire’s Board of Directors.
This statement is interesting primarily because it contains a reference to the relative valuation between the common stock prices of Wesco and Berkshire and suggests that the companies are currently trading at different levels relative to intrinsic value.
Valuation of Berkshire vs. Wesco
Reflecting on Mr. Munger’s statement, the desire to have both Berkshire and Wesco trade at similar levels relative to their respective intrinsic values makes perfect sense given the desire of management to treat all parties to the transaction fairly. To the extent that Berkshire stock is used to compensate Wesco shareholders, each side should receive as much intrinsic value as they are giving up.
Does Mr. Munger’s statement tell us anything regarding his view of whether Berkshire or Wesco currently represents the better bargain at current prices? Examining the price to book value ratio of each company is admittedly a simplistic and crude approach but nonetheless is interesting to consider.
Both Berkshire and Wesco are expected to file first quarter results tomorrow (May 7), but for now, let us consider December 31, 2009 reported book value. Berkshire had a book value of $84,487 per Class A share while Wesco had a book value of $358 per share. On May 5, Berkshire closed at $114,950 and Wesco closed at $369.25. This gave Berkshire a price/book ratio of 1.36 while Wesco’s price/book ratio was lower at 1.03.
Does this mean that Mr. Munger is saying that Berkshire’s share price is overvalued compared to Wesco? The answer hinges on the following statement that appeared in Mr. Munger’s 2009 letter to Wesco shareholders (a similar statement has appeared in his past letters as well):
We repeat our standard warning. Business and human quality in place at Wesco continues to be not nearly as good, all factors considered, as that in place at Berkshire Hathaway. Wesco is not an equally-good-but-smaller version of Berkshire Hathaway, better because its small size makes growth easier. Instead, each dollar of book value at Wesco continues plainly to provide much less intrinsic value than a similar dollar of book value at Berkshire Hathaway. Moreover, the quality disparity in book value’s intrinsic merits has, in recent years, continued to widen in favor of Berkshire Hathaway.
In Mr. Munger’s opinion, each dollar of book value at Berkshire is worth far more than each dollar of book value at Wesco. How much more? He does not give us a specific figure. However, we do know that the current difference in valuation is not acceptable to consider a stock based transaction in which Wesco would become a wholly owned Berkshire subsidiary.
This brings up the question of whether the price/book value gap would have to widen or narrow in order to make Mr. Munger feel that the appropriate relative value exists. It is highly doubtful that he believes that the price/book value gap would have to narrow given the strong wording that clearly states that Wesco is much less valuable compared to book value relative to Berkshire. This would lead one to believe that Mr. Munger thinks that Berkshire is undervalued relative to Wesco, even with Wesco trading not far above book value.
Can We Draw Conclusions Regarding Berkshire’s Valuation?
Taking this a step further, can we draw any conclusions regarding Mr. Munger’s thoughts on Berkshire’s intrinsic value relative to its current quotation? It would seem that Mr. Munger has to consider Wesco to have an intrinsic value of at least book value or he would be compelled to write down the goodwill component of Wesco’s book value accordingly. If we are correct in concluding that he believes that Berkshire is undervalued relative to Wesco and that he does not believe Wesco is worth less than book value, it then follows that Berkshire must be undervalued at today’s quotation.
Granted, this intellectual exercise makes a number of assumptions and Mr. Munger did not directly say what his views are regarding either Wesco or Berkshire’s current valuation. However, it is rare enough to read any comments from Mr. Buffett or Mr. Munger that even peripherally address valuation so some attempt to parse the statement’s meaning seems warranted.
Disclosure: The author owns shares of Berkshire Hathaway. No direct ownership of Wesco shares.