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Schumer’s Op-Ed Off Base……Way Off

Dear Charles, this isn’t the best answer, it was the easiest.

Here is Senator Charles Schumer’s WSJ Op-Ed today.

Here is the key point in it:

The administration’s initial approach to the crisis was to propose buying troubled assets from banks. But direct capital injections into financial institutions — modeled on the Depression-era agency, the Reconstruction Finance Corporation (RFC) — always offered a far better prospect of success. The RFC provided fresh capital to banks and restored confidence (and lending) to the U.S. banking system, while making a small profit.

I pointed this out on the Senate floor a few days before Mr. Paulson came to Congress to ask for authority to spend as much as $700 billion to buy up troubled assets. Later, Democratic leaders Sen. Chris Dodd, Rep. Barney Frank and I made explicit our desire to make direct infusions of capital a part of the approach to solving the crisis during our negotiations with the Treasury.

The benefits of this approach are clear, which is why so many economists, both liberal and conservative, have embraced it. More than a liquidity problem, today we face a solvency problem. History has shown that under such conditions, the most effective means to restore health to the financial system is large injections of capital — which only the government has the wherewithal to make.

Capital infusions are also far more efficient than purchasing assets. Banks can lend much more if their capital bases are restored, and when they dispose of their troubled assets, private markets, not the government, will fix the price.

There is little question that making the government a major investor in American banks raises thorny questions, especially about the role of the public sector in private markets. So let me be clear — this is a temporary solution to an unprecedented crisis, and the government’s role must be limited.

However, that does not mean the government should simply make investments with no or minimal restrictions. We must operate in the same way any significant investor operates in these situations — when Warren Buffett invested in Goldman Sachs and General Electric in recent weeks, he demanded strict, but not onerous terms. The government must be similarly protective of taxpayer interests, without involving itself in daily operational decision making. I believe there are a series of steps and principles, both carrots and sticks, that must be applied if Treasury embraces this approach.

The government should encourage widespread acceptance of capital injections, and mandate it where there are clear systemic risks.

Direct injections of capital will encourage all institutions to lend again. But because depositors and creditors may interpret an injection of government capital as a sign of weakness, we need to start by persuading a substantial cross section of major banks, even those in relatively good health, to accept capital. Widespread bank participation will reduce the risk that depositors may flee or that other institutions will refuse to do business with banks that accept or request public capital.

So, what about the ratio he talks about….

Here is a good definition of the “Tier 1 Ratio
:

The Tier 1 capital ratio is the ratio of a bank’s core equity capital to its total risk-weighted assets. Risk-weighted assets are the total of all assets held by the bank which are weighted for credit risk according to a formula determined by the Regulator (usually the country’s Central Bank). Most central banks follow the Bank of International Settlements (BIS) guidelines in setting formulae for asset risk weights. Assets like cash and coins usually have zero risk weight, while debentures might have a risk weight of 100%.

A good definition of Tier I capital is that it includes equity capital and disclosed reserves, where equity capital includes instruments that can’t be redeemed at the option of the holder (meaning that the owner of the shares cannot decide on his own that he wants to withdraw the money he invested and so cannot leave the bank without the risk coverage). Reserves are, as they are held by the bank, by their nature not an amount of money on which anybody but the bank can have an influence on.

Tier 1 capital is also seen as a metric of a bank’s ability to sustain future losses.

In short, there are two ways to look at it. You either increase the equity portion of the ratio, or reduce the debt. Either improves the ratio. Now, I would argue that just raising the equity portion will not do the trick. Why? Many banks already have capital ratio’s far about the legal limit yet still are not lending. Why? The bad debts they have that still cannot be fully valued are causing the debt portion of the ratio to rise and remain unacceptably unstable.

Adding capital to the banks now does NOT “encourage them to lend”. It does assure they will not fail and does let management know it has ample capital to cover future expected losses. Neither of those “encourages lending”. Rather they encourage management to “sit pat” until they have a handle on losses and things “work themselves out”. This is opposed to them running around searching for capital injections like they are now. Removing the debt would have stabilized (even diminished) loan losses AND freed up currently reserved capital being held to cover anticipated losses. Bank management then assured of its situation, would then have begun lending.

In short, removing the bad debt would have encourage lending.

While Schumer does opportunistically mention he terms Bekshire’s (BRK.A) Warren Buffett got from Goldman Sachs (GS). He also does, I think dishonestly omit Buffett enthusiastically not only supported the original plan (buying of debt), but offered to take 1% of the assets ($7 billion dollars worth). Why? It kept the gov’t out of private business and Warren was more than confident the transaction would be profitable for the tax payers and by default, Berkshire’s shareholders.

Schumer also omits this “capital infusion plan” is essentially what the Japanese did during the 1990’s. What happened? A decade of economic malaise as banks simply sat on the money. Having the gov’t as a partner only encourages the most benign of business practices. These are not conducive to economic growth.

Why wasn’t the debt purchase plan done? Timing. It would have been very difficult and time was a factor. The setting up of auctions and the implementation of it would have been a bureaucratic nightmare. Paulson and Bernanke took the capital infusion option not because it was “the best idea”, but because it was the “best idea we can do today”.

If you read the Treasury’s term sheet and watch the Paulson video here, it is clear that Paulson does not think this idea is the best one, just the one we can do this minute.

Had the market not cratered last week, this plan would not have been unveiled.

The following bank have already agred to the program: Goldman Sachs Group Inc. (GS), Morgan Stanley (MS), J.P. Morgan Chase & Co. (JPM), Bank of America Corp. (BAC), Merrill Lynch (MER), Citigroup Inc. (C), Wells Fargo & Co. (WFC), Bank of New York Mellon (BK), and State Street Corp. (STT).

None of these banks were in danger of being below required capital ratios…

All have uncertain loan losses coming up….they still do…

What this plan did as diminish irrational fear in the market banks were going to fail. You saw that relief in yesterday’s rally. What it will not do is lead them to increase lending dramatically and that will hamper any economic recovery. That is where we sit now

I hope Schumer is as willing in the future to step up and take credit for the economic flaccidity this plan will induce just as eagerly as he was today in standing up to take credit for its implementation.


Disclosure (“none” means no position):Long WFC, C, GS, none
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Graham and Doddsville Newsletter

Here is the link for the latest issue from Columbia Business School.

Featured are Warren Buffett, Mohnish Pabrai and Bill Ackman

FULL ISSUE. PDF


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It’s Our Fault, Not Theirs

I have been reading like a fiend lately on 1929, the 60’s, late 90’s and obviously today. One theme is a constant….greed, margin, debt then a reckoning..

Each episode had its roots, not in corporate greed or lack of “regulation”, although there were certainly elements of them in each, but of the greed of the public. What follows is a basic overview of each and their similarities.

The 1920’s featured the barber and the paperboy speculating on stocks with money they did not have using margin. It was common for people to buy stock using 90% to 95% borrowed money. This rush of investor funds drove prices up to stratospheric levels. When they peaked and inevitably fell, margin calls exacerbated to fall and wiped out investors.

The 1960’s featured investors blindly throwing money into mutual funds at unprecedented rates. Again, the rush of funds drove asset levels up to untenable levels. The result was a fall in the market and investor disillusionment in stocks, a psychology that lasted until the 1980’s.

The late 1990’s again featured investors who had never thought about the stock market wildly chasing stock prices to ever higher levels. Conversation everywhere was about the latest IPO issue and newest tech stock that was rocking upward for no fundamental reason. Everyone knew someone who “hit it big” in a tech stock and people rushed to join the fray. Of course eventually the necessary funds for continued stock appreciation ran out as the economy began to slow an then stock prices began to fall. Again, as huge amounts were bought on margin in companies that had no earnings (or any prospects for them), the fall was fast and furious.

Now…one word, housing. Rather than stock prices being inflated, now it is housing and consumers borrowing far too much to purchase homes. Yes, the banks were complicit in their lax lending standards but when all is said and done, it is you who sign on the bottom line buying the 4,000 sq. ft. house with granite kitchen counters when all you really could afford was 2,000 sq. ft. and formica. The collapse in housing has caused a liquidation of the most salable asset, stocks. Investors selling stocks for liquidity and redemptions at mutual funds have cause a rush to sell and stock price collapse.

In all the above episodes there are outlying factors many of which has to do with the gov’ts response at the time, corporate scandals, accounting “issues” and others. But, the constant theme in them all and the primary reason for the inflated bubbles that then popped was the consumer and their borrowing. Without the consumer rushing blindly and without hesitation into the hot investment, the rise in prices that then collapsed would not have been possible. Whether it be margin for stocks or mortgages for houses, investors continually have borrowed to excess chasing rising prices that when they began to fall, took investors with them.

Will “we learn” and not repeat these mistake again? No. In housing perhaps as prices there ought to take a decade or more to reach prior levels and that by itself ought to dampen enthusiasm for the asset class. As for stocks? If history tell us anything, it will happen again. Here is the scenario. Burned investors will sit idly by as stocks eventually bottom and begin their ascent. Fear of a repeat will keep them out of the market initially though. Now, they have will have been hearing from various sources that they ought to be buying now but fear caused them to sell.E veryone will now know somebody will have been buying now (I am) and they will be hearing stories of the wealth it will have created or the paper lossed that were erased and turned into gains.

Like a dog looking at another dog with a bone, the one thing that is irresistible to an investor is watching another make money while they sit on the sidelines (the dog will always drop their bone for the other). Regretting they “got out of the game” they will jump back in…fast and we will start the whole dance over again.

How long will it take? Who knows. One thing is for sure. The internet is allowing information to travel at speeds measured in seconds, not days or weeks like in the past. I think that will have the effect of shortening the time between and the steepening of the ascension and descent of prices in these episodes. It also means that for the investor who can take a step back and see where we are in the cycle, there is plenty of money to be made and losses to be avoided.

Yes, there are fundamental reasons why we are where we are today but the current sell-off is just way overdone. I know people who are pulling money out of stocks “because”. That is the reason, “because”. That is just unadulterated fear and void of any rational thought. Times like this offer spectacular opportunities for those will to step in and buy. Stocks are off 40% for the year. Thinking of buying a summer home? Many such areas are selling those home 40% to 50% cheaper that they did a year ago.

There are tons of opportunities out there….if you have the patience and clarity of thought. If you think I am full of it, just listen to history’s greatest investor, Berkshire’s (BRK.A) Warren Buffett. He has always said “buy fear and sell greed”. If you think this is not fear in the market, think again. What has Warren been doing? Buying..in a big way. Buying stakes in Dow Chemical (DOW), Goldman Sachs (GS), GE (GE) and others for a cool $40 BILLION in investments..

Warren has watched his investments in Coke (KO), Wal-Mart (WMT) and Home Depot (HD) fall just like you have have. The difference is that he has not sold and cemented those losses. He has held on and will pocket the rebound in prices. He has also realized that when things are on sale, it is then the best time to be a buyer.

Here is the suggested reading list
“Once in Golconda” (1929)

“The Go-Go Years” (60’s)

“Origins of the Crash” (Late 90’s)

Mr. Market Miscalculates (today)


Disclosure (“none” means no position):Long GS, DOW, GE, None
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Buffett Sells More Puts on Burlington Northern

Just days after selling puts on 1.3 million shares of Burlington Northern (BNI), Berkshire’s (BRK.A) Warren Buffett is at it again..

This time he sold puts on Burlington Northern:
$80 strike, 1.1 million shares, expiring 12/08 for $7.03
$75 strike, 761k shares, expiring 12/08 at $5.78

1. The put options were written by National Indemnity Company (?NICO?), a subsidiary of OBH, Inc. (?OBH?). OBH is a subsidiary of Berkshire Hathaway Inc. (?Berkshire?). As OBH and Berkshire are each in the chain of ownership of NICO, each of Berkshire and OBH may be deemed presently to both beneficially own and have a pecuniary interest in all securities of Burlington Northern presently owned by NICO. Warren E. Buffett, as the controlling stockholder of Berkshire, may be deemed presently to beneficially own, but only to the extent he has a pecuniary interest in, the Burlington Northern securities presently owned by NICO. Mr. Buffett disclaims beneficial ownership of the reported securities except to the extent of his pecuniary interest therein.


Disclosure (“none” means no position):None
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Buffett Selling Puts on Burlington Northern

Berkshire’s Warren Buffett is taking advantage of the volatility out there to sell put options on Burlington Northern (BNI)

Buffett sold 12/08 puts at an $80 strike price for $7.02 each on 1.3 million shares on 10/6.

Explanation of Responses:
1. The put options were written by National Indemnity Company (?NICO?), a subsidiary of OBH, Inc. (?OBH?). OBH is a subsidiary of Berkshire Hathaway Inc (BRK.A). As OBH and Berkshire are each in the chain of ownership of NICO, each of Berkshire and OBH may be deemed presently to both beneficially own and have a pecuniary interest in all securities of Burlington Northern presently owned by NICO. Warren E. Buffett, as the controlling stockholder of Berkshire, may be deemed presently to beneficially own, but only to the extent he has a pecuniary interest in, the Burlington Northern securities presently owned by NICO. Mr. Buffet disclaims beneficial ownership of the reported securities except to the extent of his pecuniary interest therein.


FULL FILING


Disclosure (“none” means no position):None
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@ VIC: Us Value Folks Are Funny People

Some reflection on the past few days and the Value Investing Conference.

Friday the Dow hit 10,700, today it hit 9,200. People are scared. People are panicking. TV folks are ashen with fear. CNBC’s Jim Cramer is running around in a panic telling everyone to “sell everything”. Hank Paulson is on TV trying to reassure people. McCain and Obama are in a debate battling over who has the best “consumer bailout” plan.

Yet, a constant theme was observed at the Value Investing Congress. Disbelief. Not in that equity values were evaporating, but that securities people have wanted to buy reached buying targets in only a matter of days.

Bill Ackman said, “we are buying heavily”. Whitney Tilson said, “we are buying hand over fist”. Leon Cooperman said, “America is on sale”. Several money managers I spoke to, (they and their activity will remain nameless until they disclose it, it is not my place to do so) were practically laughing at the prices they were buying equities at. Despite a 14% drop in the Dow in 48 trading hours, this was a very happy group of people.

Why?

Simple. Markets were are in today happen perhaps once a century. We are in a state of almost paralyzing fear. What does Berkshire’s Warren Buffett say about fear? “Buy it”. Talk to anyone you know and they want to yank all their money out of the market. Let me ask you this. Why? Until you actually sell a stock, any loss or gain you have is only theoretical. It fluctuates day by day. Once you pull the sell trigger you then have actually lost or gain money. Why cement a loss now unless you believe the value of American business will continue to decline in perpetuity. It won’t, so if that is true, your imaginary losses today will decrease and perhaps become gains down the road.

Back to the conference….

I spoke to countless people at the conference and there were two themes…

– Nobody was selling anything…
– Everyone had bought something (including me)..

There was no signs of anxiety or panic. People were relaxed, joking and trading “can you believe “x” is selling for that?” stories.

It was my first conference and I plan on being a regular at future ones. As I think about what would make these folks (and myself) begin to attend with apprehension and be a bit nervous sitting there my mind flashed back to 1999 and 2000. Stratospheric valuations would make us value folks nervous sitting there because if history tell us anything…..there is a reckoning coming.


Disclosure (“none” means no position):None
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Wednesday’s Links

Funny, Buffett, The Crash, Cramer

– Dealbreaker just always nails ‘ole Charlie

– Who does Warren listen to?

– Didn’t think there would be any left

– Please….Please….ignore him


Disclosure (“none” means no position):
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@VIC Jeff Matthews: Evaluating GE: What Would / Did Warren Do:

After my recent purchase of GE (GE) and what Berkshire’s (BRK.a) Warren Buffett did days later, this presentation intrigued me from the day I saw it.

Runs RAM Partners LP, and is author of this NEW book:

Evaluating a Company:
– Read every report and Chairman’s letters
– Is it a good business, do I understand it, does it have a moat, does it throw off cash?
– Is management good, honest, do they manage for the long term?
– Is Board aligned with shareholders?
– What is stock worth, what is it priced at today?

Rather than seeing price first then evaluate, Buffett look at company first and figures out what he thinks it is worth.

Is a fan of CNBC’s Jim Cramer (my note…..Cramer is a fool)

GE
Does business in (in descending order of revenues) infrastructure, commercial finance, GE money, industrial, NBC universal, healthcare.

GE “core competency” is the recruiting and training of the world’s best people according to Jack Welch in 2000 Chairman’s Letter.

GE Capital’s business and ratings is stable and NOT at risk.

Bought back $25 billion in stock 2005-2007 at average price of $35. Recent offering of $3 billion was at $22.

GE has had a falling tax rate from 30% in 2000 to 15% in 2007, inflating the net earnings number.

GE Culture (+ means “good” and – means “bad”):
+ Numbers + values = good manager
– numbers – values = gone
– numbers + values = eventually gone
+ numbers – values = hardest to part with

The “lowest common denominator” of manager at GE “makes the numbers”

Institutional imperative: “Companies do stupid things because they can”. This lead GE to get into the mortgage business by pursuing this “growth” and GE caught the mortgage problem.

In short, Matthews was not very encouraged by GE. Matthews did point out accurately the pitfalls of Immelt being the “guy who followed THE GUY” who was Jack Welch. The same holds true for managers in sports or of any business.

If he was in charge of GE, he would keep Immelt there and change the board of director and alter expectations. Immelt ought to focus on core business and not worry about numbers.

Matthews thinks the GE deal was a bit of a “please do this” scenario and points out Buffett did not take a 9% stake like he did in Coke (KO) and American Express (AXP)


Disclosure (“none” means no position):Long GE, none
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@VIC Mohnish Pabrai: The Dhandho Investor, Interesting Times Interesting Opportunities

The man who paid $650,000 for lunch with Berkshire’s Warren Buffett (BRK.A) spoke to the conference.

Here is Mohnish’s Book:

Talked about Joel Greenblatt and his assertion that spinoff’s:
– Outperform market by 10% a year for 1st three years
– Largest gain is in second year

Used Marriott (MAR) / Host Marriott International (HST) as a Case Study
– Abandoned by institutions
– Too small
– Made 4x money on deal

Sonae Group (SON.LS)
– Portugal’s largest employer
– Head, Belmiro (country’s second richest person)is very highly regarded.
– Spun out Sonae Capital (SONC.LS)
– Belmiro moved from larger company to the spin company.

Sonae Capital
– 250m share outstanding
– Belmiro owns 55%
– Pabria own 7%
– 100+ real estate portfolio. Includes fitness centers, wind farms, marina, apartments etc.

Bought Troia Resort in 1997 in bankruptcy from government for nothing but the promise to develop.
– Has 1110 acres, Top 100 in World golf course, 18km beach, Roman Ruins, nature reserve and cleanest swimming water in Portugal.
– 170m Euros invested in it and now worth 500m to 1b Euros.
– One of a kind asset

Palacia Hotel
– 35m Euro investment
– Member if “Leading Hotels in the World”
– Valued at 100m Euros

Aqulaz Hotal
– 4 Star hotel
– Worth 50m Euros

Other Real Estate worth 412m Euros
Other businesses worth 250m Euros.

Total value of 1.2 to 1.8b Euros. Intrinsic value after debt subtracted equals 955m to 1.5b Euros.

Per share equals 3.82 to 6.20 value vs .69 markets price (all in Euros). In other words, you can buy a dollar bill here for 12-20 cents.

Responding to a question on FreightCar America (RAIL) that he sold. Talked about relevance of clean coal and that coal use will increase. There is a 30-40 year bulge in railcar demand. Negative is that the business it is unionized and narrow. Sold because he had a small profit and had a better opportunity and he thought the 40 year bulge may be off by 2 or 3 year. Turns out it was and the stock has dropped.

Harvest (HST) question. Has owned for 7 years, “so obviously I like it”. Owns 1/6 of company. Said right now “if you threw darts at energy companies you could probably make money”.


Disclosure (“none” means no position):None
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Warren Buffett on Charlie Rose Last Night (10/1)

Buffett talks about GE (GE), the economy and investing..


Disclosure (“none” means no position):Long GE
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Buffett and GE (video)

Here is more from Berkshire’s (BRK.A) Buffett on GE (GE)

Warren:

Here is Mornigstar’s GE and Berkshire analysts talking about the deal:


Disclosure (“none” means no position):Long GE, none
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Thursday’s Links

Fear & Greed, Governance, China, Bogle

– George over at Fat Pitch has a great post about emotion

Dow scores perfect

– Buffett takes another dip

– Some excellent advice

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Buffett Invests in GE

First Warren followed me into Dow Chemical (DOW), then Goldman Sachs (GS), and now days after my GE (GE) investment, in comes Berkshire’s (BRK.A) Warren Buffett again. No, I don’t really think he is copying me….it does give me confidence in my recent purchases though..


From Press Release

FAIRFIELD, Conn.—October 1, 2008– GE today announced plans to offer at least $12 billion of common stock to the public. The underwriters will have a 30-day option to purchase shares representing an additional 15%of the offering amount from GE to cover over allotments, if any. The offering is expected to be priced prior to tomorrow’s market open in the U.S.

In addition, GE announced that it has reached agreement to sell $3 billion of perpetual preferred stock in a private offering to Berkshire Hathaway, Inc. The perpetual preferred stock has a dividend of 10% and is callable after three years at a 10% premium. In conjunction with this offering, Berkshire Hathaway will also receive warrants to purchase $3 billion of common stock with a strike price of $22.25 per share, which is exercisable at any time for a five-year term.

Berkshire Hathaway Chairman and CEO Warren Buffett said, “GE is the symbol of American business to the world. I have been a friend and admirer of GE and its leaders for decades. They have strong global brands and businesses with which I am quite familiar. I am confident that GE will continue to be successful in the years to come.”

GE CEO Jeff Immelt said, “This action does two things for GE investors. First, it enhances our flexibility and allows us to execute on our liquidity plan even faster. Second, it gives us the opportunity to play offense in this market should conditions allow. In addition, we remain committed to the Triple A rating and in the recent market volatility, we continue to successfully meet our commercial paper needs.

“The economic environment remains volatile,” Immelt said. “However, the company’s performance remains on track with the earnings guidance we provided last week for 2008, including third quarter financial services earnings of approximately $2 billion and industrial earnings growth of between 10 and 15 percent, excluding our Consumer & Industrial business. “

Goldman, Sachs & Co. is the bookrunner for the transaction. GE expects that Banc of America Securities, LLC, Citi, Deutsche Bank Securities, J.P. Morgan and Morgan Stanley will be added as additional bookrunners. Copies of the prospectus for the offering may be obtained from Goldman, Sachs & Co., Attn: Prospectus Department, 85 Broad St., New York, NY 10004 or by faxing (212) 902-9316 or by emailing prospectus-ny@ny.email.gs.com.

A registration statement relating to these securities has been filed and is effective. This press release is neither an offer to sell, nor a solicitation of an offer to buy, nor shall there be any sale of, these securities in any state in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such state. The proposed offering will be made only by means of a prospectus.


Disclosure (“none” means no position):Long GS, Dow ,GE, none
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Dow Chemical Makes Another Acquisition & Some Thoughts on Valuation

Dow AgroSciences, a division of Dow Chemical (DOW) has now made six acquisitions in the last year to strengthen its seed business.

Dow AgroSciences LLC said today it is acquiring most of the assets of Sac City, Iowa-based Renze Hybrids Inc. for an undisclosed price. It will acquire all sales, marketing and agronomy assets related to the Renze brand as well as all soybean production assets. Renze operations manager Craig Williams will join Dow AgroSciences to lead the Renze business. The Renze family has formed a seed corn production company to provide hybrid corn for Renze.

This comes after the August deal to acquire Dairyland Seed Co. DowAg is a double digit earnings grower for Dow and the division that CEO Andrew Liveris is most excited about. Let’s look at some numbers.

Kuwait recently bought 50% of the commodity business from Dow for $9.5 billion in a deal that valued Dow at $38 billion vs today’s $28 billion market cap. Dow parlayed that investment from the low multiple commodity business into the Rohm & Hass (ROH) deal, a specialty chemical maker that commands a mid-teen earnings multiple.

ROH earned $661 million last year. At the 18 pe specialty makers are trading at (that is a discount to the 22 ROH currently trades at), that portion of Dow will be valued at $12 billion. Add in the $19 billion valuation of the commodity business and you have today’s markets cap.

That also means buyers of the stock today get the Ag business, Dow’s current specialty business and it various JV’s around the world FOR FREE. Oh yea, and a 5% dividend. Does anyone wonder now why Berkshire (BRK.A) and Warren Buffett recently became the largest shareholders?

Me either…


Disclosure (“none” means no position):Long Dow, none
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Wednesday’s Links

NFL, Labitan, Shipping, IOUSA

– Have we reached a bottom when the NFL is talking about it?

– An interview with a Buffett book author

– Everyone is hurting

– Has anyone sen this?


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