HUMMONEY - `Not Light Reading’ (Perspective)

---By Greg Lewin

Two incredibly important investment documents were made available yesterday and I urge all investors to read carefully. One is Berkshire Hathaway’s annual report, and the other is Mary Meeker’s “USA Inc.,” which can be found at www.kpcb.com/usainc. As a general rule I believe Warren Buffet and his partner Charlie Munger have dispensed more investment wisdom than all other investment commentators combined.

However, it seems in my estimation that as Berkshire’s assets have grown so too has Mr. Buffett’s ownership bias. Throughout the recent recession his public commentary has been decidedly optimistic, closer in form to cheerleading than the critical analysis we have grown accustomed to.  In his latest report to shareholders he bases his optimism on “human potential,” a quality not easily subject to measurement, yet forming the basis for his new and increased investments in the United States.  Obviously he is of the opinion that we are in procession of a uniquely large sum of this potential versus our foreign competitors. Later, as he begins to explain to the readers how he approaches investing his capital he spends time reviewing his calculation of intrinsic value, his 3 part process for investment selection, of which the third part consists, in a single word, management. We will explore this later after we review our second document, “USA Inc.”

Mary Meeker is a Wall Street trained internet analyst who built a considerable reputation during the boom years for the internet stocks. She is now a partner at a prominent private equity firm. In her current capacity she wrote an outstanding piece on our federal government’s financial position. Her approach is unique and thoughtful. In this 266-page document she attempts to take public data and evaluate our federal government in much the same way as a security analyst might evaluate a public company, examining revenues and expenses, assets and liabilities, both on and off the government’s balance sheet, in an effort to determine the fundamental worth of the US as if it were a publicly traded company. I will try to summarize some of her key financial conclusions for “USA Inc.”:

1 -   “Cash flow is deep in the red (by almost $1.3 trillion last year, or $11,000 per household) and USA Inc.’s net worth is $45 trillion in the red and deteriorating.”

2 - “Entitlement expenses amount to $16,000 per household per year, and entitlement spending far outstrips funding, by more than $1 trillion in 2010. More than 35% of the US population receives entitlement dollars or is on the government payroll.”  Note: this analysis excludes state and local government workers, who account for 15% of national employment, and large unfunded deficits and entitlements.

3 – “As a percentage of GDP, the federal government’s public debt has doubled over the last 30 years, to 53% of GDP,” including underfunded entitlements and other liabilities, “. . . gross federal debt accounted for 94% of GDP in 2010. The public debt to GDP ratio is likely to triple to 146% over the next 20 years, per CBO . . . By 2037, cumulative deficits from Social Security could add another $11.6 trillion to public debt.”

4 – “Last year’s interest bill would have been 155% (or $290 billion) higher if rates had been at their 30-year average of 6% (vs. 2% in 2010). As debt levels rise and interest rates normalize, net interest payments could grow 20% or more annually.”

5 – “By 2025, entitlements plus net interest payments will absorb all - yes, all – of USA Inc.’s revenue, per CBO.”

6 – “The low personal savings rates of average Americans – 3% of  disposable income . . .  limit flexibility, at least in the early years of any reform.”

7 – “The ‘management team’ has created incentives to spend on healthcare, housing and current consumption. At the margin, investing in productive capital, education and technology – the very tools needed to compete in the global marketplace – has stagnated.”

In conclusion she remarks, “With these trends, USA Inc. will not be immune to the sudden crises that have afflicted others with similar unfunded liabilities, leverage and productivity trends. The sovereign credit card issues in Europe suggest what might lie ahead for USA Inc. shareholders – and our children. In effect, USA Inc. is maxing out its credit card. It has fallen into a pattern of spending more than it earns and is issuing debt at nearly every turn . . . Past generations of Americans have responded to major challenges with collective sacrifice and hard work. Will ours also rise to the occasion?”

As investors we are challenged to integrate the wisdom and analysis presented in these informative documents. In my opinion the central thought behind Ms. Meeker’s facts and Mr. Buffet’s optimism is an assessment of the quality of management. In this case can one invest in a subsidiary of USA Inc., a corporation domiciled in the US who must pay taxes, employ workers and support their families, if the parent company, USA Inc., is managed by executives (our political branch) who have a terrible track record of financial performance? Furthermore, is the very structure of the organization of the company (our government) designed to allow for the very radical decisions necessary to succeed? Are incentives in place which allow for long term thinking at the expense of the short term? And have the shareholders (US citizens) put themselves in the type of position to endure short term consequences? Until some of these questions can be answered with far less speculation it would seem wise to focus a little more on the facts and a little less on the potential.

 ---The views expressed here are of the author, HUMMoney contributor Greg Lewin; currently a General Partner at TLF Capital, an investment management firm. During the past 26 years he has been a senior money manager or partner in Wall Street firms including Neuberger Berman, Charter Oak Partners and Sailfish Capital.