Stephen’s Posterous

The Financial Times reported that Byron Trott, a former Goldman Sachs banker, and frequent financial adviser to Warren Buffett, has raised more than $2bn in capital for his investment firm.

The fundraising success highlights the spotlight that has accompanied Mr. Trott's role as Warren Buffett's preferred and trusted investment banker.

BDT Capital Partners, the venture Mr. Trott founded earlier this year to invest in and advise family-run and entrepreneurial businesses, continues to seek additional commitments. The firm has also begun to add senior dealmakers including Don McLellan, former head of mergers and acquisitions at Motorola.

Mr. Trott worked for Goldman Sachs for 27 years and headed the firm's Chicago office before launching on his own. He has been singled-out repeatedly by Mr. Buffett for his skill in either advising Berkshire or bringing deals to his attention. Berkshire Hathaway holds a modest partnership interest in BDT.

Mr. Trott's departure from Goldman Sachs and BDT's Buffettesque investment strategy has driven speculation that he may be among those Mr. Buffett is considering as his successor as Berkshire's chief investment officer.

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Though it's the largest packaged-food manufacturer in America, Kraft Foods (ticker: KFT) doesn't seem to get much respect from investors. The company boasts brands that are entrenched in American culture, from Nabisco crackers and Oreo cookies to Maxwell House coffee and Oscar Mayer processed meats.

For years Kraft was beleaguered by a bureaucratic operating structure and a stagnant pipeline. Many attribute these flaws to the corporate culture at former parent Altria Group (MO). Kraft went public in 2001 and Altria fully divested its stake in 2007. Kraft has been undertaking a massive turnaround to revamp its pipeline and create a more nimble corporate structure.

However, these gains have been offset by the run-up in the costs of the food maker's raw ingredients in the previous two years. And if that weren't bad enough, Kraft's move to raise prices to offset those costs hit store shelves as the economic situation significantly deteriorated in the second half of 2008.

As a result, Kraft shares have fallen 27% over the past 12 months to $22.87. By contrast, brand-name peers Kellogg (K) and General Mills (GIS) are down 25% and 19%, respectively in the past year.

Although it shares have underperformed its leading competitors, Kraft is a more compelling defensive play than the competition for one major reason: It carries a 5.2% dividend yield that is nearly twice the yield offered by the 10-year Treasury. As cash flow improves, Kraft could raise this payout. The yields at Kellogg and General Mills are in the mid-3% range.

Kraft "offers an appealing total return potential" with shares priced at around $20-$22, says Alan B. Lancz, president of Toledo, Ohio-based investment money-management firm Alan B. Lancz & Associates. The stock is trading "at a historic low, the yield is at a historic high and the expectations are low," he adds.

The stock is trading 12.1 times forward earnings estimates. Its norm is 14.5-16.5 times. Lancz has been shifting to a more defensive portfolio after successfully playing the rally in more cyclical names in recent months. He is expecting a slow, prolonged recovery and Kraft "is definitely more defensive" in this environment.

It doesn't hurt that Warren Buffett's Berkshire Hathaway (BRKA) is Kraft's largest shareholder, owning a 9.4% stake at the end of 2008. But you don't have to drink the Kool-Aid, which by the way is a Kraft product, to see the upside potential in the company's shares. Kraft has been making strides under its three-year turnaround plan started in 2007, which includes cutting costs, divesting assets such as Post cereals and creating synergies from acquisitions (of biscuit maker LU in Europe).

Notably, Kraft has carved out 20 business units with decentralized decision making. "We've taken off their shackles by blowing up the bureaucratic matrix," Chief Executive Officer Irene Rosenfeld said at a consumer conference earlier this year. Alexia Howard, an analyst at Sanford C. Bernstein, says the pipeline is starting to improve after it "was starved for years under Altria."

She names Kraft as her top pick in 2009 with an Outperform rating and $34 price target, pegging it as "a margin recovery story."

A recovery in operating margins, which had fallen from 21% in 2002 to 12.5% last year, along with the 230 basis-point improvement in gross margins in the fourth quarter excluding the impact of commodity hedging losses shows that Kraft is "already starting to see a turnaround," she adds. This turnaround will take time. Lower commodity costs will help ease margin pressure, particularly for dairy products.

Meanwhile, Kraft has talked candidly about its challenges. The company expects to earn $1.88 in 2009, in line with 2008 results, after taking into account a 40-cent headwind from a stronger U.S. dollar and pension costs. Nearly 60% of Kraft's sales are from the U.S., 25% from Europe and the rest from other regions.

The company's sales volume fell 5.2% in the fourth quarter of 2008 (from a year earlier), and management projected further declines in the first quarter of 2009, which will be reported in May, but these weak numbers are misleading. More than half of the fourth-quarter drop in the sales volume was due to a deliberate move by the company to get rid of underperforming brands.

Higher supermarket prices as Kraft passed on commodity prices have hurt sales volumes more than cash-strapped consumers trading down from premium priced goods to private-label alternatives, Howard notes.

Private-label products have a 21% share in categories where Kraft brands hold a No. 1 or 2 market share by a wide margin, compared to the industry average of 20%. Kraft is benefiting a bit from consumers trading down from premium products, says IBISworld industry research analyst George Van Horn. For instance, Maxwell House coffee gained market share for the first time since Kraft started tracking this data more than a decade ago.

About 40% of Kraft's U.S. sales are from products that have triple the market share as their next competitors, and 50% of its global sales are from products that have twice the market share of their largest competitors, says Howard.  Kraft has nine brands that each generate more than $1 billion in annual revenue and at least 50 brands each raking in greater than a $100 million a year.

The company has been strengthening its relationship with its major customers, Carrefour, Tesco and Wal-Mart Stores, and sharing marketing costs. As stores reduce inventory and cut shelf space, it is the middling players between Kraft and private-labels that are getting cut, notes Howard.

Kraft's turnaround won't be an overnight sensation. But until then, an attractive valuation and fat dividend will feed investors looking for a tasty return.

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Byron Trott, a long-time Goldman Sachs banker and a trusted adviser to Berkshire Hathaway’s Warren Buffett, is leaving the company to start his own investment fund with backing from the billionaire.

The new venture, BDT Capital Partners, will invest in and advise family-run and entrepreneurial businesses. Berkshire will hold a “modest partnership interest” in the firm, an assistant for Mr Buffett said.

Mr Trott’s departure ends a 27-year association with the bank that culminated with his appointment as head of the Chicago office, and raises questions on whether Goldman will retain its enviable position as adviser of choice to one of the world’s richest and respected investors. He has been singled out repeatedly by Mr Buffett for his skill in either advising Berkshire or bringing deals to his attention.

“I should add that Byron has now been instrumental in three Berkshire acquisitions,” Mr Buffett wrote in his 2003 letter to Berkshire shareholders. “He understands Berkshire far better than any investment banker with whom we have talked and – it hurts me to say this – earns his fee. I’m looking forward to deal number four (as, I am sure, is he).” Mr Trott also came to Mr Buffett with an offer to buy preferred shares in Goldman itself. Berkshire invested $5bn in the bank in September.

Berkshire said it would maintain a close association with both Goldman and Mr Trott, who becomes the latest senior Wall Street executive to leave their employer as the financial services industry wades through its steepest downturn in generations. Jon Winkelried, Goldman’s co-president, Morgan Stanley’s Bob Scully and Merrill Lynch’s Greg Fleming are among those to exit since the onset of the crisis.

A person familiar with Mr Trott’s thinking said the scrutiny that Goldman endured in recent months as one of the most visible institutions in an industry beset by the financial crisis and political backlash did not play a role in the timing of his departure. Nevertheless, Goldman executives had hoped to keep Mr Trott, one of their brightest stars.

Mr Trott, who also serves as vice-chairman of investment banking, had weighed forming his own fund for several years, and wanted to begin the venture with enough of a time horizon to see BDT’s investments blossom, the person said. He relied heavily on the counsel of his frequent client, Mr Buffett, who himself prefers to invest in family businesses, people familiar with the matter said.

When Mr Buffett restricted certain Goldman executives from selling their shares in the firm as part of his investment agreement, he did not include Mr Trott on the list.

Separately, JPMorgan Chase began another round of planned redundancies in its investment bank. The job cuts, which are part of efforts to reduce the 28,000-strong workforce of the investment banking division by around 2,000 people by the end of the year, are believed to have come in the prime brokerage division, among others.

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In his letter last week to Berkshire Hathaway (BRKA) shareholders, Warren Buffett took himself to task for more than quadrupling the firm's stake in energy giant ConocoPhillips (COP) last year.

"The terrible timing of my purchase has cost Berkshire several billion dollars," Buffett wrote. Buffett may have got the timing wrong, but it might be wise to take his advice also contained in the annual letter: "Whether we're talking about socks or stocks, I like buying quality merchandise when it is marked down."

Right now, shares of ConocoPhillips, hovering near their five-year low, are an attractive way to play an eventual rebound in crude-oil and natural-gas prices. The company's above-average exposure to natural gas compared to its peers could drive returns in an economic recovery that would also boost the lagging commodity.

The stock is trading at a sharp discount based on several valuation metrics. Shares are valued at 0.6 times book value whereas Exxon Mobil (XOM) and Chevron (CVX) are trading at 2.6 and 1.4 times, respectively.

The dividend, yielding 5%, offers stable returns in this volatile market. Lee Delaporte, director of research at Dreman Value Management, says ConocoPhillips is his firm's largest holding for a very simple reason: It is a large, diversified energy company that is also "one of the cheapest in the energy space."

"I think from a long-term perspective that I'm going to get a better return over time in a ConocoPhillips" as the valuation gap narrows, Delaporte says.

"ConocoPhillips shares outperformed the major integrated companies every single year from 2003 through 2007 and by a wide margin, not by one or two points," says Fadel Gheit, managing director at Oppenheimer. That stellar track record came to an abrupt end in 2008: ConocoPhillips fell 41%, versus the major integrated group's 30% decline and the Standard & Poor's 500 index's 39% drop during the year.

Gheit, who also was optimistic about ConocoPhillips and other integrated oil companies early last year, admits, "Warren Buffet and I made a mistake. I never thought that [oil and natural-gas] prices would collapse the way that they did and stay the way they did, but obviously you live and learn."

A rebound in oil to at least $55 a barrel and natural gas to $6 per million British thermal unit "will make this stock very cheap," Gheit says. The market is valuing ConocoPhillips' oil reserves at $9.46 a barrel versus the group average of $11.11.

ConocoPhillips stock typically trades at a discount to its peers. That's because the company has a history of making untimely acquisitions at the top of the market. In the fourth quarter, the company took a whopping $34 billion write-down largely for its acquisition of Burlington Resources in 2005 and a 20% stake in Russian oil giant Lukoil in 2007.

This is a noncash accounting charge, but "the slate's been cleaned and when gas prices recover, it's going to be positive for them," says Dreman's Delaporte. Even so, the company built its way into the group of major integrated oil companies and commands an impressive reserve base with attractive long-term growth opportunities, such as developing liquefied natural-gas facilities in the Middle East.

ConocoPhillips has cut spending and halted its stock repurchases so that it can essentially live off of cash flow. The company ended 2008 with $755 million in cash compared to $35 billion at Exxon and $24 billion at Chevron.

As the "junior member of the elite club," Gheit notes that ConocoPhillips is more susceptible to shocks -- such as Venezuela's move to nationalize reserves in 2007. Its large exposure to volatile natural gas (40% of production) has been a drag in the downturn, but the upside potential from here is significant.

Oil and natural-gas futures fell 70% from last July's peak to trough a few months later, but the 9% rebound in natural-gas prices has lagged the 33% recovery in oil, says Gheit. "I think oil prices will go higher and gas will be catching up." This would also improve margins. ConocoPhillips' profits fell to $8 a barrel of oil equivalent in the fourth quarter from $24.40 in the third quarter, wrote Barclays Capital analyst Paul Cheng in a Jan. 29 report.

Earnings are expected to drop from $10.66 in 2008 to $4.03 in 2009 before climbing to $6.03 in 2010, according to Thomson Reuters.

Margins for producing gasoline and other oil products have improved as refiners slashed production to match demand. So this refining component "will be helpful in this particular period rather than be hurtful," says Carlton Neel, portfolio manager at Virtus Investment Partners/Zweig Advisers. Refining and marketing operations make up about 20%-25% of revenues.

The company is holding an analyst meeting on March 11. At its current price, we suspect that Warren Buffett's excitement for the stock could be rekindled.

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Berkshire Hathaway shares lost more than 30% in 2008, and more since. Meanwhile the value of the company's portfolio fell just 10%. The Sage of Omaha doesn't focus on the share price. But he says risks, formerly under appreciated in the investment world, are now being overpriced. As that corrects, shares of the billionaire's investment company could benefit.

Buffett admits he "did some dumb things", most notably buying billions of dollars of ConocoPhillips stock when energy prices were near their peaks.

Even so, the per share book value, or assets minus liabilities, of Berkshire's holdings fell a smidgeon less than 10% in 2008, against a 37% loss on the S&P 500 index and a near 20% fall for the average hedge fund. In that context, the Nebraskan investor's worst performance since 1965 - and only his second annual decline in book value - doesn't look so bad.

Berkshire shares tell a different story. At the end of 2007, they traded at a premium to book value of more than 80%. By the end of last year, the premium had shrunk to less than 40%. Now, it's only just more than 10% based on the year-end book value, admittedly now too high. The shares are off almost 50% from their late 2007 peak.

Of course, the gloominess of the economic outlook is a real concern. Buffett sees the economy in a shambles through 2009 and probably beyond. That affects both Berkshire's own businesses and those of companies whose stock it owns. But other potential worries look less rational.

One centres on derivatives. Berkshire has written put options on global stock indexes and various derivatives on corporate credit. These have generated $13bn-odd of paper losses between them, so far. Yet not only is Buffett's record comforting as to the eventual outcomes, the exposure is scaled to Berkshire's capacity - unlike, say, that of the flailing American International Group. An improbable total loss on the credit derivatives, for instance, would absorb only half Berkshire's cash on hand.

Meanwhile, Buffett's company has one of the strongest balance sheets in the US, which he calls it Gibraltar-like. As shown by his investments in the stock or debt of companies as diverse as Goldman Sachs, Harley Davidson, General Electric, Swiss Re and Tiffany, he is finding opportunity amid the carnage.

A fearful market could be focusing too much on the unhappy keywords attached to Berkshire: finance, derivatives, investments and insurance, to name a few. When irrational fears start to subside, the Buffett premium could return. While it might be damped by the fact that the 78-year old isn't mortal, that could still help Berkshire stock even before the underlying investments turn around.

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The first step in addressing a problem is to admit that you have one. By cutting its quarterly dividend, General Electric has put its foot forward. The road to recovery, however, remains long and tortuous.

Investors had ample warning: GE said the payout for the second half of 2009 was under review back on Feb. 6. Even before then, the stock's double-digit yield was a flashing signal that a cut was likely. Friday's announcement prompted another sharp fall in GE's share price. However, it also answers a big question that was hanging over the stock, which could tempt in some buyers.

Beginning in the second half of the year, the quarterly payment will drop to 10 cents from 31 cents. That will conserve $13.3 billion by the end of 2010, which is almost a year's worth of operating cash flow from GE's industrial business. Meanwhile, the new dividend yield of 4.7% remains attractive, and looks more sustainable.

Cutting the dividend isn't a silver bullet, however. GE's triple-A credit rating remains under review and still looks likely to be cut. It has demonstrated prudence, which should please the likes of Moody's, not to mention politicians, who might wonder why a company benefiting from government debt guarantees was still being so generous to shareholders.

The saving in 2009 will be just $4.2 billion. That is handy, but not enough to fully assuage fears of bigger write-downs in the finance business or a weaker performance in the industrial business.

Moving to a more defensive posture was long overdue and is welcome. But the unavoidable consequence is to stoke fears that the outlook for GE's businesses continues to deteriorate.

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Berkshire Hathaway, the holding company led by famed investor Warren Buffett, reported its worst year ever in 2008.

The company's net fell to $4.99 billion from $13.21 billion in 2007. Berkshire said its book value per share declined 9.6% -- a performance far better than the S&P 500-stock index but only the second negative year suffered by the company since Mr. Buffett took over in 1965.

Berkshire predicted the economy "will be in shambles throughout 2009 -- and, for that matter, probably well beyond." Still, Mr. Buffett struck an upbeat note in his letter to shareholders. The chairman detailed the current woes of the financial system, saying we should "never forget that our country has faced far worse travails in the past. ... Without fail, however, we've overcome them."

The market tsunami was expected to wreak havoc on Berkshire holdings such as Coca-Cola, U.S. Bancorp, Wells Fargo, Moody's and Washington Post, among others. It was also a challenging year for Berkshire's insurance companies. It was the second costliest hurricane season on record, with damage estimated at $54 billion, according to the National Climatic Data Center. In 2005, storms including Hurricane Katrina caused $128 billion in damage, resulting in more than $3 billion of losses for Berkshire.

Still, its decline far outpaced the Standard & Poor's 500-stock index, which fell 37% in 2008, including dividends. Through 2007, Berkshire's book value per share averaged an annual rise of 21.1% over more than four decades, compared with the 10.3% rise of the S&P 500. Source.

Berkshire Hathaway Shareholder Letter 2008

It's been a challenging year at Berkshire Hathaway. While Chief Executive Warren Buffett has made a slew of savvy preferred stock and corporate-bond investments, the company's famed portfolio of stocks has been slammed in the ongoing bear market.

So far this year, Berkshire's class A shares have slumped 20% to $77,500, near the lowest level in five years and just over half the stock's peak reached in late 2007.

The investment company's woes come in spite of recent investments outside the common stock market. For example, the company has bought $2.6 billion of convertible securities from Swiss Re that pay a 12% interest rate. Berkshire also has bought a series of bond issues from the likes of Vulcan Materials, Harley Davidson, Tiffany and Sealed Air that pay 10% or more.

Berkshire's problems these days clearly stem from its equity portfolio, which could be down more than 25% in 2009, based on our calculation of the performance through yesterday of Berkshire's 17 largest investments, which historically have accounted for over 85% of the portfolio.

Wells Fargo has been the biggest disaster, as Berkshire's holding of 290 million shares as of Dec. 31, 2009, has lost more than half its value as Wells Fargo dropped to $12 from $29 on Dec. 31. That alone has cost Berkshire over $5 billion. Other losers include American Express, U.S. Bancorp, Procter & Gamble and ConocoPhillips.

Coca-Cola, Berkshire's largest holding at $8.5 billion, has held up relatively well, declining about 5% year-to-date, versus a drop of 17% in the Standard & Poor's 500 index. The total stock portfolio now may have dropped below $45 billion, down from $76 billion on Sept. 30.

Wall Street is eagerly awaiting Berkshire's fourth-quarter earnings release, which is expected late Friday, February 27, 2009, and the company's annual report on Saturday, February 28, 2009. The annual will contain Buffett's widely read shareholder letter, as well as more detailed disclosure on the $37 billion of long-dated equity puts on U.S. and major foreign stock markets that Berkshire had sold as of Sept. 30.

The rising value of those puts and the resulting losses on that derivative position have weighed on Berkshire shares partly because it's not easy to gauge the value of the puts, which have an average maturity of 13 years and can only be exercised at maturity.

The customized puts, which aren't traded on any exchange, had suffered a loss of $1.7 billion in the first nine months of 2008. Additional losses since then could top $5 billion. Berkshire also has suffered unspecified losses on some $10 billion of credit derivatives linked to junk bonds given that market's fall since Sept. 30.

Investors typically value Berkshire based on book value and earnings. Based on both measures, the stock looks attractive. We estimate that Berkshire's current book value is in a range of $62,000 to $65,000 a share, down from more than $77,000 on Sept. 30 and roughly $71,500 on Oct. 31.

This suggests that Berkshire now trades for about 1.2 times book value, below its average of 1.5 times book in the past decade. Berkshire's market value now is $118 billion. Based on third-quarter results, Berkshire's operating profits are running at an after-tax annual rate of about $5,300 per share. This means Berkshire trades for a relatively reasonable 14 times estimated '09 earnings.

Berkshire's results this year likely will be depressed by the economy since some of the company's wholly owned businesses are involved in retailing, building materials and manufacturing. Berkshire, however, will be helped by its new high-yielding investments, including the total of $8 billion of 10% preferred stock that it purchased from Goldman Sachs and General Electric in the fall.

Investors will be going through the '08 annual Saturday and focusing on year-end book value, which may have stood around $70,000 a share; the equity derivatives loss in the fourth quarter and guidance about how to value those puts, as well as Berkshire's cash position.

The company had nearly $28 billion of cash at its insurance units on Sept. 30, but that position fell in October as Berkshire bought $5 billion of Goldman preferred, $3 billion of GE preferred and $6.5 billion of Wrigley debt and preferred stemming from its buyout by Mars. Cash may have dropped to the $10 billion to $15 billion range at year end.

The declining cash position may have been a reason that Berkshire sold over half its equity holding in Johnson & Johnson in the fourth quarter, raising almost $2 billion. Berkshire is on the hook to purchase $3 billion of convertible preferred stock of Dow Chemical if it goes through with its deal to buy Rohm & Haas.

Berkshire has taken some lumps this year, but it remains a financial powerhouse at a time when credit is dear and investment opportunities are plentiful. This plays to Buffett's strength, although he probably wishes he had invested less in 2008 and had more cash to invest now.

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Warren Buffett's Berkshire Hathaway bought $250 million of debt from jewelry giant Tiffany & Co. The debt sports a yield of 10%, according to Tiffany’s filing with the Securities and Exchange Commission. Half of the notes are redeemable in eight years, the other half is redeemable in 10 years. New York-based Tiffany said it will use the proceeds to refinance existing debt and for general corporate purposes.

The investment is the latest in a series of deals in which Berkshire has scooped up securities with yields of 10% or more as the cash-rich firm takes advantage of cash-starved companies. In late September, Berkshire bought $5 billion of Goldman Sachs Group preferred stock yielding 10%. It has also purchased high-yielding debt or preferred stock from General Electric, Swiss Re, Harley Davidson and a handful of other companies.

It’s an intriguing strategy for Mr. Buffett. A number of analysts and Buffett watchers have questioned whether the investor has lost his mojo amid the latest market mayhem. Berkshire’s stock lost 32% in 2008, hurt by large holdings such as Coca-Cola and Burlington Northern Sante Fe.

But with the market in such turmoil, it’s hard to argue with investments that lock up a 10% yield or more over the next decade, Mr. Buffett’s legions of supporters say. Investors now eagerly await Berkshire’s quarterly filing of its holdings, expected some time in the next several days.

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