Berkshire Hathaway's 3rd Quarter 2007

Investment Manager's Letter October 2007

Berkshire Hathaway filed seven separate disclosures of sales of PetroChina H Shares during the third quarter. These sales will have a substantial impact on 3rd quarter earnings. As of September 30th the company had sold 1.686 billion of the H Shares. We do not have prices for all sales, but by applying the prices listed on the disclosures to all sales in the intervening time period we can come up with a pretty good guess at Berkshire Hathaway’s gain. (See table)

Berkshire Hathaway’s cost basis is about $.17 per share, so the gain realized in the third quarter was about $2.4 billion. If taxes are paid at a rate of 35% the after tax gain will be about $1.54 billion.

The latest filing dated October 13, 2007 was a 13G filed with the SEC, and it shows Berkshire Hathaway’s position by September 30 had been reduced to 653 million H Shares. This means that in the last 3 days of September they sold 495 million shares. There has been no price reported for this sale, but if we estimate the sales at a 5% discount to the market price on those days.

Disclosure Date Estimated Remaining Holdings Sales Since Previous Disclosure (Estimate in Millions)
  Percent (Millions of Shares) Shares Est. Pr Amount Cost Gain
    2,339          
07/07/07 10.96% 2,312 27 1.61 $42.74 $4.41 $38.34
08/29/07 9.72% 2,051 262 1.47 $384.59 $43.43 $341.16
09/06/07 8.93% 1,884 167 1.47 $245.02 $27.67 $217.35
09/13/07 7.99% 1,686 198 1.46 $289.56 $32.92 $256.64
09/21/07 6.97% 1,471 215 1.55 $333.58 $35.72 $297.85
09/25/07 5.44% 1,148 323 1.66 $535.87 $53.59 $482.29
09/30/07 3.10% 653 495 1.75 $865.85 $82.13 $783.72
          $2,697.22   $2,417.35

In the Second Quarter Berkshire Hathaway’s after tax net was $3.1 billion, so the PetroChina sales may well push Third Quarter bottom line to over $4.5 billion. This compares to last years $2.77 billion for the quarter, so the quarter to quarter comparison may exceed plus 60%.

Factors that may reduce these earnings gains include a negative drag from the insurance operations because insurance premiums have softened, and the fact that GEICO’s margins have been tightening. In addition, the second quarter included $319 million in derivative gains which may or may not recur. (I, as investment manager, am secretly hoping for a nice derivative gain from Warren Buffett’s pursuit of entertainment in credit default swaps) so that item could be either higher or lower.

The 13G listed no PetroChina ADRs so those were also sold in the 3rd quarter, but the ADRs were only a $100 million position and they will not change the results much. From rate of sales of H shares in last two weeks of September and the fact that we are two weeks into October it is quite likely the entire position is history.

The PetroChina stock has been rallying strongly in the last month on the increase in oil prices and speculation that mainland Chinese will be able to buy the H (Hong Kong) shares. Stocks trading on both the Hong Kong and Shanghai market trade at a higher price in Shanghai, a market that has recently become very bubbleish. I think that we can view this sale as a window into Buffett’s thinking on both the oil market and the Shanghai bubble.

Warren Buffett may be early with this sale, but hey, isn’t that what value investors do? They buy early and they sell early. Personally it looks like a good move to me, with all the speculation in the Chinese market, if Warren Buffett had waited, it might have been a lot, more difficult to get out of the position.

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