Buffett’s Wrong-Way $2 Billion Bet

Posted On Jun 1, 2018 By Dave Gonigam

  • A rare Buffett blunder: What went wrong?
  • Unemployment rate falls — which is even better news than you’d think
  • Tariff impact: Manufacturers face soaring costs, consumers next
  • Despite eurozone drama, Rickards says euro is safe
  • Europe cracks down on Google, Google emerges stronger
  • Many readers write: At what age are you taking Social Security?

“Some of the reported details are not correct but it’s true that Berkshire had discussions with Uber,” Warren Buffett told CNBC this week.

According to several news outlets, Buffett was ready to sink $3 billion into Uber, but the talks fell apart. Exactly why is still a matter of speculation.

For all we know, Buffett came to the same conclusion as a couple of financial renegades we spotlighted last year. After examining Uber’s publicly available numbers, one of them calculated that 61% of each fare is effectively subsidized by the endless quantity of cash that gullible venture capitalists keep sinking into the company. The other analyst straight-up called Uber a “Ponzi scheme.”

Or maybe it’s Uber’s debt load?

Debt was the undoing of a deal that went down as one of Buffett’s rare blunders — an episode worth revisiting because it’s instructive.

Our income maven Zach Scheidt tees up the story: “In 2007, Buffett joined a group of private equity heavy hitters — TPG Capital, KKR & Co. and Goldman Sachs — to help acquire a Texas electricity provider called TXU Energy.

“At the time, the company was the largest coal power plant operator in Texas. The business had been around for over 100 years and was one of the most profitable utility operators in the country. People always need electricity, so TXU seemed like a good, safe bet.

“The transaction was a leveraged buyout (LBO), meaning it was funded with cash and debt. As part of the deal, the company changed its name to Energy Future Holdings. The final price tag came out to be $44 billion — making it the largest LBO in history at the time.”

Buffett bought a massive $2 billion of that debt, expecting to collect steady interest payments. Alas, by 2014 the company became the biggest bankruptcy ever by a nonfinancial firm.

Along the way, the shale energy revolution had kicked into high gear. Suddenly natural gas was cheap and plentiful. As the price of electricity fell, so did the firm’s revenues. Worse, the cost of operating those coal-fired power plants did not fall.

Absent the debt load, the company probably would have muddled through. “Before the deal,” says Zach, “the company had paid only $830 million in annual interest on its debts. Following the LBO, its annual interest expense was $4.3 billion.”

Yeah, that’ll leave a mark.

“The LBO had quintupled the company’s interest payouts — just as the company’s revenues were plummeting,” Zach goes on.

“The combined losses of KKR, TPG, Goldman Sachs and, of course, Warren Buffett’s Berkshire Hathaway totaled billions of dollars.”

Fast-forward to the present… and the firm’s assets came out of bankruptcy as two separate companies — one of which Zach finds very attractive. “Companies often emerge from bankruptcy with cleaned-up balance sheets and a fresh start.”

But here’s the thing: He’s not recommending shares of that company. Instead, he’s recommending something he calls an “Alpha contract.”

This powerful instrument can “lock in” guaranteed payments totaling tens of thousands of dollars — using just four clicks of a mouse.

Zach’s publisher shows you how it works when you follow this link. Don’t put off doing so — the link goes dead at midnight tonight.

The Dow’s yo-yo this week — down Tuesday on Italy worries, up Wednesday as those worries receded, down yesterday on trade-war jitters — is up today with the latest unemployment numbers.

The Bureau of Labor Statistics conjured 223,000 new jobs for May — more than even the most optimistic guess among dozens of economists polled by Econoday. The official unemployment rate inched down to 3.8%, the lowest since April 2000.

Even the real-world unemployment rate from Shadow Government Statistics is now its lowest since late 2009 at 21.4%.

With the official unemployment rate moving down, we’ve dodged another bullet. For now.

Last month, Bloomberg columnist Stephen Mihm pointed out how a recession typically sets in only four months after the unemployment rate hits bottom. Well, that’s the average of the 10 recessions since 1950, anyway. The longest span was 10 months.

The April unemployment rate of 3.9% marked a new low for the current economic cycle — until the May number of 3.8% today. Whew — we bought ourselves another month!

Anyway, the Dow is up 200 points as we write, back above 24,600. Both Treasuries and gold are selling off; the Midas metal’s latest excursion above $1,300 lasted only three days.

There’s one other economic number of note today, and that’s the ISM Manufacturing Index. At 58.7 the number is strong (anything above 50 indicates a growing factory sector).

The “internals” of the ISM number are a mixed bag. New orders are super-strong at 63.7… but the prices-paid component is too strong at 79.5. In other words, manufacturers are paying through the nose for raw materials.

Sooner or later, those costs will be passed along to you and me as consumers.

To no small extent, those rising costs are a function of the Trump administration’s tariffs. Yesterday, Commerce Secretary Wilbur Ross once again tried to downplay the impact, telling CNBC the tariffs will amount to a “trivial increase” in U.S. consumer prices. Unlike in his previous media appearances this year, he did not trot out any props to make his point…

man

Ross on CNBC three months ago (Is that a tall-boy can of Bud?)

According to the U.S. Chamber of Commerce, American steel prices are up 40% since the first of the year… and they’re now 50% higher than prices for Chinese and European steel. The additional tariffs kicking in today will double the volume of metals imports subject to tariffs.

It’s going to be more than just soup and beer cans…

“I’ll say what I said in 2010, 2011, 2012, 2013, 2014 and 2015: No one is leaving the euro,” Jim Rickards tweets from Tokyo.

The latest news from Italy: The powers that be will allow two populist parties to form a coalition government after all. The parties came together on a platform of tax cuts and welfare spending that’s liable to run afoul of the European Union’s budget-control guidelines.

Meanwhile, there’s fresh drama in another of the “PIIGS” countries that were the cause of so much hand-wringing a few years ago. Spain’s Prime Minister Mariano Rajoy has been forced out amid a corruption scandal. (Good riddance: Rajoy is the one who sent jack-booted government thugs into Catalonia last year to crack people’s heads for merely voting in an independence referendum he disapproved of.)

But Europe’s power elite will hold the euro together, one way or another. As Jim’s said for years, the euro is not an economic project, it’s a political one aimed at binding its member states closer together. It’s a project with roots dating to the old European Coal and Steel Community of the 1950s, formed by European leaders of the day determined never again to go to war with each other.

Despite alarmist headlines, the number of nations trading in euros has grown in recent years from 16 to 19. “No one’s getting kicked out,” says Jim. “The euro is rock-solid.”

From the Department of Predictable But Unintended Consequences: Europe’s push for online “privacy protections” is only making Google stronger.

A week ago today, the European Union imposed a raft of new regulations. Maybe you noticed as a bunch of tech companies sent you emails updating their global privacy policies. Eurocrats figured they were going to show up the likes of Google and Facebook.

Now The Wall Street Journal reports the law “is drawing advertising money toward Google’s online-ad services and away from competitors that are straining to show they’re complying with the sweeping regulation.” That’s because according to the early data, Google “is gathering individuals’ consent for targeted advertising at far higher rates than many competing online-ad services.”

Oy… Once again we see how regulations have the effect of making entrenched incumbents even more entrenched because smaller competitors don’t have the money or manpower to comply. It’s how the too-big-to-fail banks from a decade ago are even bigger now…

And now a sampling of the massive response we got from our inquiry on Wednesday: At what age do you plan to (or did you) start collecting Social Security?

“I turned 62 in February of 2017,” a reader writes, “and after running the numbers decided to collect immediately. Like so many others I know, it seemed like the only ‘sure thing‘ with the state of the country’s financial health (or lack thereof)!”

“I am now 67,” says another, “and I started taking SS at 66, which was the earliest I could actually net something, since I still work full time. Doing the breakeven was the ‘closer’ (somewhere around 80), but since I paid into the system for close to 50 years, I wanted to get something before it shut down.”

“Waiting until 70 and it’s coming fast,” says a third, mindful of that extra 8% a year. “I will be 67 in a few months.”

“Originally I thought I would take my benefits a few years ago at 62 but due to some good fortune in my business, I will likely wait until sometime next year,” a reader writes.

“I turn 65 in about six months and look forward to ditching part of the huge monthly health care premiums when I transition over to Medicare. As a point of reference, my wife (58, but don’t tell her I told you!) and I are both self-employed and we currently pay $1,600/month total for higher-deductible, more restricted coverage than what we paid $450/month for total prior to the ACA kicking in.

“The lower Medicare premiums will almost feel like I am getting an increase in my Social Security benefits. Whoo-hoo!

“Love The 5!”

The 5: Just remember you might be subject to higher Medicare Part B premiums if you’re not collecting Social Security, depending on the inflation rate. Yeah, it’s complicated…

“I’m 65, forcibly retired at 56, and when I turned 62 I grabbed the payments as soon as possible. 

“The ‘breakeven’ arithmetic on payments beginning at age 62 versus 66 (in my case) was simple, but the decision was based more on gut and faith than math. I have more faith in my own questionable health than I do that of the SSA, let alone the Federal Reserve-driven monetary system, to maintain any integrity by the time I turn 78–79 (if I make it that far). My brother-in-law (two years older than me) made the same decision.

“Another friend is 66 and still working in her position of the past 26 years and is looking forward to maximizing her bonus for deferring her payments.

“What I wish I had learned before making the choice is that returning to the workforce during the 62–66ish window can compromise (read reduce) all benefits (and yes, I choke on the word given contributions paid) going forward.”

The 5: Yes, that’s a painful lesson learned by many people pushed out of the workforce earlier than they expected — either because an employer kicked them to the curb or because of health issues.

Yes, you can pay back all the benefits you’ve collected within 12 months and not suffer the penalty… but few people have the ready cash to pull that off.

Speaking of regrets…

“Back when I was 62 I also believed that SS would be defunct before I died so I took it and ran.

“Well, now I am ‘older and wiser,’ heh. Because of several incompetent investment managers, at 85 I am struggling to survive on $1,020 a month. So soon old and so late smart.”

“I am 92 years old,” writes our final correspondent, “and have not accepted and do not intend to accept the so-called ‘Social Security.’

“We all know the money has all been spent. How can I expect to spend it again?

“As an American citizen I have already received whatever may have been the result of its expenditure. Now, to cover broken promises, Social Security payments must be taken by force of law from my fellow citizen’s income.”

The 5: That’s a brutal but not inaccurate way of looking at it. All the revenue theoretically set aside for Social Security? Congress already went and spent it on food stamps and F-15s.

As the former U.S. comptroller general David Walker once said, the Social Security trust fund “can’t be trusted, and isn’t funded.”

Have a good weekend,

David Gonigam

Dave Gonigam

The 5 Min. Forecast

P.S. Last chance: If the stock market’s action these last few months leaves you feeling skittish, you should check out the “Alpha contracts” championed by one of our publishers.

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