NEW YORK Investors are wondering if Warren Buffett has lost his touch.
They are bailing out of Berkshire Hathaway Inc (BRKa.N) (BRKb.N) stock and have lost some confidence that the insurance and investment company, run by one of the world's most admired investors since 1965, can pay its debts.
Berkshire stock has lost close to half its value since hitting a record high last December, as the company struggles with lower returns at its insurance businesses, the declining value of its stock holdings, and paper losses on derivative contracts.
Meanwhile, the cost of protecting Berkshire's "triple-A" rated debt has soared to a level more befitting a "triple-B" or even a junk-rated company.
Omaha, Nebraska-based Berkshire has nearly 80 businesses -- from car insurance to carpeting, clothing, food, kitchen utensils, and manufactured housing -- and owns tens of billions of dollars of stock.
Buffett's empire is diversified enough so that at any given moment many parts are unlikely to run on all cylinders.
"Everything you're seeing that affects other companies is eventually going to catch up with Berkshire," said Vahan Janjigian, author of the 2008 book "Even Buffett Isn't Perfect." "I'm not saying Berkshire is not well-run, but that even well-run companies will be hit in a severe recession."
Buffett, 78, was not available for comment.
Berkshire Class A shares fell as low as $74,100 a share on Thursday, their lowest level since August 2003.
That's down 51 percent from their record $151,650 set last December 11. It's also down 34 percent since Berkshire said on November 7 that lower insurance returns as well as investment losses led to a 77 percent drop in third-quarter profit, the fourth straight quarterly decline. Operating earnings were down 18 percent. Berkshire ended September with $33.37 billion in cash.
"We're buying Berkshire like crazy. It was our largest position, and we have made it much larger in the last two weeks," said Whitney Tilson, managing partner at T2 Partners LLC, a hedge fund firm.
"Investors are looking at the derivative exposure, seeing Berkshire marking losses, and it reminds them of AIG and other companies whose derivative exposures got them into trouble," he added. "They are coming to the insane conclusion that Berkshire faces similar risks."
He referred to American International Group Inc (AIG.N), which got a $152 billion government bailout.
In Thursday afternoon trading, the shares were down $2,760, or 3.3 percent, to $81,240 a share on the New York Stock Exchange. The cost of protecting $10 million of Berkshire debt against default for five years rose to $490,000 annually on Thursday from $294,000 a week ago and $31,000 at the start of 2008, according to Markit.
"We're in an unusual time," said Peter Schiff, editor of Schiff's Insurance Observer. "It's like comparing a person having trouble making mortgage payments with a billionaire. The financial crisis affects them, but not in the same way."
Berkshire could have to pay as much as $37.04 billion between 2019 and 2027 under some derivative contracts if the Standard & Poor's 500 index .SPX and three other stock indexes are lower than when Berkshire entered the contracts. It obtained about $4.85 billion of premiums upfront.
At September 30, Berkshire had written down $6.73 billion on the contracts. Losses have almost certainly mounted since then. In October alone, Berkshire shareholder equity fell $9 billion, or 7.5 percent.
Buffett has said he expects the contracts to be profitable, distinguishing them from the "financial weapons of mass destruction" that he labeled other derivatives.
Berkshire also ended September with $10.78 billion in potential liabilities tied to various credit events, such as junk bond defaults, up from $4.66 billion at year-end 2007.
Moody's Investors Service said the global junk bond default rate could rise to 10.4 percent by the end of 2009 from 2.8 percent in October. With a typical junk bond yielding more than 20 percent, new financing is essentially nonexistent.
"Based on his 50-year track record selling insurance, I have a great deal of confidence he is selling these at the right price," Tilson said. "The critical thing is he does not have to post cash collateral until there are actual defaults."
A credit rating downgrade would likely not be material. Berkshire would have to post "nominal" additional collateral on derivatives of "far below 1 percent of assets" if Berkshire lost its "triple-A" ratings, Buffett's assistant, Jackie Wilson, said. It was posting no such collateral as of Sept 30, when Berkshire assets totaled $281.7 billion.
EQUITY HOLDINGS DECLINE
Berkshire has other exposures to falling markets.
It ended September with $76 billion in stock investments, including multibillion dollar stakes in American Express Co (AXP.N), Coca-Cola Co (KO.N), ConocoPhillips (COP.N), Procter & Gamble Co (PG.N) and Wells Fargo & Co (WFC.N). Shares in all have fallen this quarter.
And investors have shrugged off Berkshire's investment of $8 billion in General Electric Co (GE.N) and Goldman Sachs Group Inc (GS.N) preferred shares, with their 10 percent dividend yields. Shares of both have fallen, rendering Buffett's warrants to buy common shares worthless for the time being.
Buffett has been out of step with the markets before. After missing the late 1990s tech bubble, he gave himself a "D" for capital allocation in 1999, when Berkshire's book value barely budged, and the S&P 500, including dividends, rose 21 percent. Berkshire fared better in six of the subsequent eight years.
"Earnings of Berkshire's operating businesses will undoubtedly decline given the worldwide economic downturn," T2 Partners' Tilson said. "However, these businesses remain enormously profitable, and will almost certainly continue to be."
Schiff, of the Insurance Observer, expects Buffett will actually find new opportunities to win business or make acquisitions, in part because many insurance rivals are scrambling for capital. Several are applying to become bank holding companies to be eligible for the government's $700 billion financial rescue.
"When insurers lose capital, you're going to be more conservative with how much business you write," Schiff said. "Berkshire doesn't have this problem because its balance sheet is so strong. What they own may be worth less, but they get more opportunities to buy things at cheap prices."
(Additional reporting by Dena Aubin, Karen Brettell and Ciara Linnane; editing by Jeffrey Benkoe)