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Is Buffett Fed Up With 'God's Work'?

Nov 18, 2015

In this issue:
» L&T - Case of diworsification?
» Is the exit of FIIs a worry?
» Dwindling market caps of large pharma companies
» ....and more!
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Tanushree Banerjee, Co-Head of Research

Remember Goldman Sachs CEO Lloyd Blankfein's famous proclamation exactly six years back? In November 2009, Blankfein had declared that he was doing 'God's work'!

'We are very important,' he added. 'We help companies to grow by helping them to raise capital. Companies that grow create wealth. This, in turn, allows people to have jobs that create more growth and more wealth. It's a virtuous cycle,' he told London's Sunday Times.

Well, maybe Blankfein was not blatantly lying.

A couple of decades back, the business of investment banking did create a virtuous cycle. But here was good reason for it...

The firms were structured as partnerships. Meaning investment bankers risked their own money when they helped companies raise capital. Meaning they were cautious and prudent.

But that was more than a generation ago.

Blankfein had forgotten that, ever since the investment banks became universal banks, they had license to lend other people's money.

By 2007, as the housing bubble was ready to burst, Goldman was selling mortgage securities to clients based on the bets of speculative hedge funds!

And if it weren't for Warren Buffett's bailout of the bank during the peak of the 2008 crisis, Goldman Sachs would have been the next Lehman Brothers.

Buffett's stiff bargain with Goldman Sachs for the purchase of the latter's warrants yielded good returns...to begin with.

Within a year, the investment had outperformed the S&P index by a handsome 66%.

Mind you, the investment bank had average return ratios upwards of 20% until the 2008 crisis. So, valuations aside, Buffett had enough reason to take his stake in Goldman.

Since then, Goldman Sachs' returns have fallen to less than 10%. The bank still helps companies raise money (more cautiously now, we hope). And it still sells mortgages. But neither venture is as remunerative as it was a decade back.

So we were not surprised to read that Berkshire Hathaway trimmed its stake in Goldman Sachs by 13% in the past quarter. What we couldn't believe, however, were the reasons given for doing so.

The official explanation was that Berkshire had to raise cash. After all, its latest acquisition, aerospace-equipment-maker Precision Castparts, was a big-ticket deal.

But with over US$60 billion in cash on its balance sheet, one wonders why the sale was so urgent.

Further, we wonder why it took Buffett six long years to get fed up with 'God's work'.

No doubt, the shrewd investor has already made his billions in the deal. But with the declining fundamentals, he is now looking for greener pastures.

We never believed that the investment in Goldman Sachs fit the 'Buffett-would-buy criteria', not even in 2008. We secretly hoped that, sooner rather than later, Buffett would get rid of the mistake. Better late than never!

As Buffett looks for more-responsible companies to fit his value-investing metrics, he may eventually consider some Indian ones.

Radhika has been working on two Buffett-would-buy portfolios since 2009. Both have handsomely outperformed the benchmark Indian indices. Perhaps now is the time to see if any of them should find a place in your portfolio too.

Do you think Buffett should have exited from the investment in Goldman Sachs long back? Let us know your comments or share your views in the Equitymaster Club .

1.50

Since we are at Buffett would buy companies, let's talk about one such great company, which despite its virtues, has not found its way to our Buffett portfolios yet.

Engineering major L&T is a solid bluechip. However, we have for long had one major grouse with it. It is not very good at sticking to its core business of providing engineering services. This business is asset light, and highly profitable - even more so due to the company's prowess in it. But instead of restricting itself to what it is best at, the company has habitually gone out and put capital into other areas.

Take its infrastructure investments subsidiary for example - L&T Infrastructure Development Projects Ltd (L&T IDPL). This subsidiary takes up equity stakes in the projects it is involved with. Not only does this expose the company to risks associated with the project, the investments in the projects have also been bringing down the company's return on capital. While L&T's investments in the technology and power sectors are performing well, its large investments in road projects and the much-delayed Hyderabad Metro rail network are proving detrimental to returns.

In our meeting with the company a while back, it maintained that its intention in these projects is to develop them, commission them, and then churn them at good valuations. They do not intend to operate the projects through their life of say 20-25 years. However, we are of the opinion that in trying to do so, the company cannot escape exposure to the risks (execution and otherwise) that these large projects come with. Various such risks have already been rearing their heads on some of these projects. Thus exiting these at lucrative valuations will not always be an easy game to play for L&T.

2.45 Chart of the day

Foreign institutional investors' (FIIs) activity is driven by a slew of factors. This includes the economic fundamentals and various global macro factors. On the domestic front, poor earnings, political scenario, slower reforms momentum and on the global front factors such as Fed decision on increase in interest rates, depreciating currencies of emerging markets and commodity slump have been the key events that has let to recent sell off.

It also imperative to note Indian markets rallied considerably during fiscal 2015, and so a price correction thereafter is only natural. Ultimately, what will lead to a sustainable stock market rally is the reform story playing out and translating into increased earnings for corporates.

The money coming from FIIs, can get sucked out anytime leading to collapse in the markets. Especially if and when the US Fed announces the rate hike. For serious long-term Indian investors who focus on business fundamentals, such events can throw up great long-term investing opportunities. They just need to keep stock valuations in perspective.

Sale of FII stake in Indian companies
3.30

The recent regulatory headwinds have wiped off billions from the market caps of the India's leading pharma companies. As reported in Mint, India's top 5 Pharma companies have lost around Rs 1 trillion worth market caps due to USFDA regulatory issues.

The sharp correction in the stock price is largely as investors see biggest risk in the time taken to clear these issues. The point here is while these companies have spent millions of dollars for developing robust pipelines to launch in future, but the issues at the facility delays such launches. Consequently, the companies tend to lose some key opportunities due to regulatory challenges in their plants.

We have seen that happening in the case of Ranbaxy (acquired by Sun Pharma recently). The company has lost substantial sales on the back of these issues. Not only that, since 2008 the issues remain unresolved. Take the other such case of Wockhardt, the company's two plants have been under USFDA ban since 2013, and yet very little development seen on this front too. This company too has built pipeline of several niche opportunities but again the company could not launch due to regulatory qualms. The time taken by the companies to come out of regulatory issues is something to do with the management's ability too.

Managing the US FDA compliance issues is largely dependent on quality of management of the pharma companies. The managements which have been largely meeting the compliance norms will be lesser impacted than the once whose issues are deep rooted. The regulatory risks cannot be avoided, but can be mitigated if managements take enough steps to meet US FDA norms. Take the example of Glenmark Pharma. This company does not have any negative observation pending from the USFDA. For, the companies which are already undergoing through these issues, the management's capability to avoid or come out of these issues will be the game changer.

4.45

At the time of writing, the Indian markets were trading in the red. The BSE Sensex was trading lower by about 329 points. Losses were seen in commodity, IT and banking stocks while select power and pharma stocks were eliciting investor interest. The midcap and smallcap indices were also trading lower.

4.50 Today's Investing mantra

"The book value deserves at least a fleeting glance by the public before it buys or sells shares in a business undertaking. In any particular case the message that the book value conveys may well prove to be inconsequential and unworthy of attention. But this testimony should be examined before it is rejected." - Benjamin Graham

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee (Research Analyst) and Bhavita Nagrani (Research Analyst).

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3 Responses to "Is Buffett Fed Up With 'God's Work'?"

Krishna Kumar

Nov 19, 2015

You may not be aware that some of these projects will not come to L&T unless it finances them . Hence they have to risk in financing projects. There is low entry barrier in EPC projects . Many smaller players can do these projects as well as L&T or in fact better. L&T manages competition by funding these projects

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Gopalan

Nov 18, 2015

This is a comment on the US FDA regulations and some high ranking Indian pharma cos. Would be grateful if EquityMaster can research or if already researched, to let the readers know that if US FDA disapproves products how come Same products are let into the Indian market ? Have we become a third rate banana republic? Wonder why this is not coming to the forE. I think responsible and mature organisations like EquityMaster should take this up.

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Haresh Shahani

Nov 18, 2015

I think the following statement in your article is incorrect "And if it weren't for Warren Buffett's bailout of the bank during the peak of the 2008 crisis, Goldman Sachs would have been the next Lehman Brothers." Goldman Sachs was nowhere near going bankrupt even during the peak of the crisis, and they did not need Warren Buffet's money to stay afloat. What they needed at that time was a vote of confidence from Buffet, because the market gives so much importance to Warren Buffet's opinion. He was offered a deal that would not be offered to anyone else by Goldman and he just took it. Warren Buffet himself said at that time that his phone was ringing off the hook with CEO's of all big companies begging him to make a token investment in their firms, just so that the market would be assured that their firm was in good financial health.

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