Berkshire Hathaway just announced its latest acquisition plan: a bid to acquire the insurer Alleghany for $11.6 billion. This is an interesting buy because we can analyze a lot about Warren Buffett’s approach to takeovers. It can also tell us something about current market valuations and the economic situation.

Let’s take a closer look at the acquisition and what we can learn from it.

“Buy What You Know”

Insurers — and Alleghany in particular — are very familiar territory for Berkshire CEO Warren Buffett. He has been running and optimizing insurance operations for decades. Notably, he acquired National Indemnity in 1966, GEICO in 1996, and General Re in 1998.

Speaking of General Re, it was headed (under the Berkshire umbrella) from 2001 to 2008 by Joseph Brandon, who is also the current leader of Alleghany.

Joseph Brandon very deliberately molded Alleghany into what has been described as a “mini Berkshire”. The company has used its profits to acquire a portfolio of non-insurance companies, slowly turning it into a Berkshire-stye conglomerate. These businesses will now also be integrated into Berkshire Hathaway.

Alleghany’s self-description could be straight from Buffett himself:

Conservatism dominates our management philosophy. We shun investment fads and fashions in favor of acquiring relatively few interests in fundamental financial, industrial and other companies that offer the potential to deliver long-term value to our investors.

The connection with Joseph Brandon shows us how deep the understanding of Alleghany goes for Buffett. He could have bought any insurance company, but chose a very trusted company with a compatible culture.

Commenting on the offer, Buffett said: “Berkshire will be the perfect permanent home for Alleghany, a company I’ve been watching closely for 60 years”. I guess it’s a nice bonus to bring home tried and true talent like 62-year-old Joseph Brandon. In fact, Brandon may eventually oversee all of Berkshire’s insurance business.

The acquisition price is slightly above book value, but only a small portion of Berkshire’s $146 billion in cash was still used, leaving enough for other acquisitions. In his latest letter, Buffett said that internal growth seems more attractive and that “we are not very excited in the stock markets”. Alleghany has 25 days to find an even better offer, but Buffett generally refuses to engage in bidding wars.

Funnily enough, the acquisition price is rumored to be $850/share, but instead went with the odd $848.02/share to remove Goldman Sachs’ fees for advising Alleghany on the subject. Buffett allegedly refused to pay the banker’s fees for the takeover.

Alleghany the insurer

Alleghany’s insurance business is very similar to the other insurance businesses already owned by Berkshire Hathaway. Well run, profitable, with growing market share and book value, and a bit boring.

Alleghany has potentially hidden in the same way as the other insurance companies that have gathered in Berkshire Hathaway: the float.

Insurers receive money for the insurance contract first and must put that money aside to cover claims when they arise later in the future. This stock of cash, or float, can be invested to generate greater returns. Alleghany’s float is worth about $22.8 billion.

Currently only 16% of this float is invested in securities for legal reasons, the rest mainly in cash and bonds. The integration into Berkshire Hathaway should allow this money to be used for more productive purchases in the future.

The sale of the bonds should also help Alleghany avoid risks of rising interest rates. With Buffett’s experience of different economic cycles, we can assume that he has the foresight to manage the potentially changing economic conditions and adapt to rising inflation and interest rates.

Alleghany the conglomerate

The portion of Alleghany that invests in non-insurance companies is called Alleghany Capital and generated $3.7 billion in revenue in 2021. The largest investments representing 3/4 of the division’s revenues are:

AFCO SteelJazwares (the 7th largest toy maker in the US)IPS, a design and engineering company focused on pharmaceutical and biotechnology factories.

The rest of the businesses owned by Alleghany are also a diverse group, including hotel management, trailers, plastic parts manufacturing, precision cutting, and funeral products. This nicely reflects Berkshire’s very diverse portfolio and investment strategy. They are also all either very niche markets or rather ‘boring’ sectors. They also offer a good and stable return on equity (ROE).

The timing

An interesting coincidence is Buffett’s previous purchases of insurers similar to Alleghany. Berkshire bought both National Indemnity (in 1966) and General Re (in 1998) during periods of high stock market valuations. In such an environment, Buffett struggles to find quality stocks available at desirable prices. That problem is compounded today by the sheer size of Berkshire Hathaway. At the same time, pressure is mounting on Buffett to do something with the staggering amount of cash piling up in Berkshire’s coffers.

The Alleghany acquisition is probably a good way to do something, but still collect more dry powder for future opportunities at better prices. Alleghany Capital’s earnings, as well as the company’s float, will provide more capital to invest than its $11.6 billion acquisition cost.

Overall, the Alleghany acquisition isn’t surprising or unusual for Buffett. The float will be used to fund further investments later, as before for GEICO and General Re. The acquisition itself is justified by a good price for a great company, quality management and a lack of other low-cost opportunities in a relatively expensive market.

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