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Reuters reports that Warren Buffett, whose Berkshire Hathaway (NYSE: BRK.A) controls 19.6% of Moody's Corp. (NYSE: MCO), is saying that he thinks Moody's will be around a long time. Even though Berkshire Hathaway's $188 billion market capitalization is more than 20 times that of Moody's -- Buffett's $1.8 billion loss -- the 50% drop in the value of his 19.6% Moody's stake from its February 9, 2007 peak -- has to sting.
Moody's was already under fire over the U.S. mortgage market crisis when it took a fresh blow on Wednesday -- launching an investigation into a report that it had wrongly assigned triple-A ratings to about $4 billion of complex European debt products -- Constant Proportion Debt Obligations (CPDOs), funds that used borrowed money to bet on credit-default swaps -- and had then not downgraded them. Buffett's comment: "I don't think one day will permanently change the franchise value of Moody's."
As I posted, the ratings agencies competed for lucrative fees from investment banks that created and sold these asset-backed securities. Moody's took in $3 billion for such structured finance ratings between 2002 through 2006. The agencies that offered the best ratings won the business.
Under these conditions, it is impossible for investors to rely on the objectivity of the ratings. And yet, that is just what they did. I don't think that this way of paying ratings agencies is credible and it needs to change. However, if Buffett really believes that a franchise based on such deeply flawed incentives is valuable, then I expect him to increase his Moody's stake substantially as the stock continues to tumble.
If he does, he's buying into a company that has to repay $722 million in debt in the next year with only $340 million in cash -- a figure that's down 20% since December. And its revenues and profits have fallen 26% and 31% respectively in the last year.
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter
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