Berkshire net sinks; Buffett says economy in shambles

NEW YORK Sat Feb 28, 2009 4:24pm EST

Warren Buffett, CEO of Berkshire Hathaway, takes part in a conversation on leadership and the economy at The Women's Conference 2008 in Long Beach, California October 22, 2008. REUTERS/Mario Anzuoni

Warren Buffett, CEO of Berkshire Hathaway, takes part in a conversation on leadership and the economy at The Women's Conference 2008 in Long Beach, California October 22, 2008.

Credit: Reuters/Mario Anzuoni

NEW YORK (Reuters) - Berkshire Hathaway Inc, Warren Buffett's insurance and investment company, barely broke even in the fourth quarter because of losses on derivatives contracts tied to the stock market.

Profit fell 96 percent, the fifth straight quarterly decline, and Berkshire's net worth tumbled $10.9 billion in the year's final three months. Net worth per share fell 9.6 percent in 2008, only the second decline since Buffett began running Berkshire in 1965. It fell 6.2 percent in 2001.

In his eagerly anticipated annual letter to Berkshire shareholders, Buffett also offered a gloomy economic outlook, saying "the economy will be in shambles throughout 2009 -- and for that matter, probably well beyond."

Still, despite what he called "paralyzing fear" resulting from the credit crisis and falling housing and stock prices, he remained optimistic about American resilience, and praised government efforts to avoid a "cataclysmic" breakdown in the financial system.

"Though the path has not been smooth, our economic system has worked extraordinarily well over time," he said. "It has unleashed human potential as no other system has, and it will continue to do so. America's best days lie ahead.

Berkshire generates about half its results from insurance, including auto insurer Geico Corp, but operates more than 70 businesses that offer such things as carpeting, ice cream, paint, real estate services and underwear.

Buffett is one of the world's most-admired investors, and Forbes magazine last year called him the second-richest American.

Quarterly net income for Omaha, Nebraska-based Berkshire sank to $117 million, or $76 per Class A share, from $2.95 billion, or $1,904, a year earlier. Revenue fell 12 percent to $24.59 billion.

Excluding $3.25 billion of investment losses, more than double the previous nine months combined, operating profit rose 43 percent to $3.37 billion, or $2,175 per Class A share, from $2.35 billion, or $1,518.

The amount in part reflected underwriting gains at Berkshire Hathaway Reinsurance Group, and investment gains and a termination fee related to an aborted effort to buy Constellation Energy Group Inc.

"They are doing better than many rivals in a very difficult investment and operating environment," said Bill Bergman, senior equity analyst at Morningstar Inc in Chicago. "We had a 5-star rating, the highest we have, on Berkshire, and after reading the letter I feel better than I did yesterday."

Buffett said insurance and utility results helped offset his mistakes, including a decision to buy shares of oil company ConocoPhillips when oil and gas prices were near their peak. He said his "terrible timing" cost Berkshire "several billion dollars." Buffett said he has also lost most of a $244 million investment in shares of two Irish banks.

Berkshire's book value, or assets minus liabilities, fell to $109.27 billion at year end from $120.16 billion at the end of September, and from $120.73 billion at the end of 2007.

DERIVATIVE LOSSES

Results were battered by $4.61 billion of pretax losses on about 251 derivative contracts largely tied to the longer-term performance of four stock market indexes and the credit quality of higher-risk "junk" bonds.

A deteriorating economy and tight credit led to steep declines in stock prices and an increase in junk bond defaults, resulting in losses for Berkshire.

While the losses exist on paper, accounting rules require Berkshire to report them with earnings.

Buffett revealed for the first time which stock indexes he has been using: the Standard & Poor's 500, Britain's FTSE 100, Europe's Euro Stoxx 50, and the Nikkei 225 in Japan.

In his letter, Buffett said he believed each contract that Berkshire owns was "mispriced" at the outset, and that the ups and downs "neither cheer nor bother" him.

Berkshire nevertheless got billions of dollars of upfront payments from parties on the other side of the contracts, which the company can invest as it wishes. This, he has said, makes the contracts different from the "financial weapons of mass destruction" that he has called other derivatives.

"The income statement understates the benefits Buffett gets by putting the upfront premiums to work," said Thomas Russo, a partner at Gardner Russo & Gardner in Lancaster, Pennsylvania, whose largest investment is Berkshire stock.

Berkshire ended the year with $25.54 billion of cash, down from $44.33 billion a year earlier. It said it made roughly $6 billion of acquisitions in 2008, and spent $14.5 billion on fixed-income securities from General Electric Co, Goldman Sachs Group Inc and chewing gum maker Wm Wrigley Jr Co. Buffett sold some stocks to fund the latter purchases.

For all of 2008, profit at Berkshire fell 62 percent to a six-year low of $4.99 billion, or $3,224 per share, from $13.21 billion, or $8,548. Revenue fell 9 percent to $107.8 billion.

Berkshire Class A shares closed Friday at $78,600 on the New York Stock Exchange. They have fallen 44 percent since the end of February 2008, while the Standard & Poor's 500 has dropped 45 percent.

(Reporting by Jonathan Stempel; editing by Vicki Allen and Mohammad Zargham)

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