What Business Models Have Float?

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Most people know Warren Buffett as a stock picker but few understand his deep affinity for businesses that have float. Below, we will look at some businesses that have access to float.

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Sources of float: Insurance

Berkshire Hathaway uses insurance float as one of its key sources of investable funds. It’s well known that Buffett was drawn to the business of insurance for it provided a fountain of additional investable funds. These investable funds, however, belonged to insurance policyholders, not to Buffett, as these funds are claims to be paid to policyholders. These investable funds held by Berkshire can be called float, or insurance float.

Warren Buffett

Here is some commentary that Buffett has said about insurance float from the 2014 shareholder letter:

“One reason we were attracted to the property-casualty business was its financial characteristics: P/C insurers receive premiums upfront and pay claims later. In extreme cases, such as those arising from certain workers’ compensation accidents, payments can stretch over many decades. This collect-now, pay-later model leaves P/C companies holding large sums – money we call “float” – that will eventually go to others. Meanwhile, insurers get to invest this float for their benefit. Though individual policies and claims come and go, the amount of float an insurer holds usually remains fairly stable in relation to premium volume. Consequently, as our business grows, so does our float.

— Berkshire Hathaway - 2014 Letter to Shareholders

How is insurance company float calculated? Buffett delves into the calculation for insurance float as follows in the 1994 shareholder letter as follows:

“For the table, we have compiled our float – which we generate in exceptional amounts relative to our premium volume – by adding loss reserves, loss adjustment reserves, funds held under reinsurance assumed and unearned premium reserves and then subtracting agents’ balances, prepaid acquisition costs, prepaid taxes and deferred charges applicable to assumed reinsurance.

— Berkshire Hathaway - 1994 Letter to Shareholders

So we know about insurance companies as having float, but what about other types of companies with float? By float, we mean funds belonging to others that are in transition and temporarily held by the company. There are several that come to mind.

Sources of float: Bank

A bank has a source of float in the form of deposits from its customers that it can lend out to other customers or invest in securities to generate investment returns. Buffett liked banks so much that he owned through Berkshire a bank in Illinois until the U.S. government forced Berkshire to dispose of it – the U.S. government made Berkshire decided whether it was going to be in the insurance business or in the banking business. Buffett chose the former, disposing of the Illinois bank. This, however, did not preclude the ownership of minority positions in banks. One such minority position is Wells Fargo, which is one of the largest positions held by Berkshire’s insurance subsidiaries.

Sources of float: Lottery

A less intuitive business with float is the lottery. Whether states know it or not, they have a source of float when millions of tickets are bought by hopeful consumers wishing to win the state-run lottery jackpot. When the state holds the proceeds until the jackpot is paid out, either in lump sum or as an annuity, the state is holding substantial funds that really don’t belong to them. This is a form of float. Given the dire financial situations of some of these states, maybe some ought to consider conservatively investing this lottery float! Alternatively, just having the money in a savings account provides a return on the float, which adds up given the millions of lottery tickets bought.

Sources of float: Gift Cards

Another form of float comes in the form of gift cards. When the retail store GAP sells its gift cards to customers, it gets paid money upfront that GAP holds until the cards are redeemed. There is an industry term called “breakage” which actually means the percentage of gift cards (value-wise) that are never redeemed. Figures of breakage of 10% are not unheard of. With 10% breakage, this means that GAP gets paid 10% to hold these funds received from the sale of their gift cards. The duration however of these gift cards, i.e. the time from the receipt of money for the gift cards until the owner of the gift cards redeems them for value can be relatively short. Such a short time period of holding this float makes it difficult for places like the GAP or Starbucks to invest these funds into securities for any meaningful period.

Sources of float: Loyalty Programs

Blue Chip Stamps was a company that had a varied take on gift cards and loyalty programs by selling stamps to retailers. Blue Chip Stamps would then take the proceeds from retailers and hold onto them until retailers redeemed these stamps with cash from customers. Customers would select items from a catalog and submit stamps they’ve collected from retailers to “pay” for these items. When the retailers submitted these stamps, the “float” held by Blue Chip Stamps was then returned as cash. In the meantime, while Blue Chip Stamps held this float, it was able to invest these proceeds in securities such as stocks and bonds. The stock of Blue Chip Stamps used to be a core holding of Berkshire, until Berkshire eventually acquired the company in its entirety. No doubt, Blue Chip’s access to and ability to invest the float was a key point of attraction for Buffett.

Sources of float: Traveler’s Checks

American Express, which is still a core position of Berkshire Hathaway, used to have a substantial source of float in the form of traveler’s checks. The funds from the traveler’s checks were similar to funds received in exchange for gift cards. American Express held this float until the traveler’s checks were used or redeemed by customers while travelling abroad. These days traveler’s checks are rarely used.

Sources of float: Payment Processing Business

Another business that has float, albeit in extremely short duration, is the payment processing business. You can think of companies like ADP, which temporarily hold wages and salaries for its clients before paying them out. It would be difficult to invest this float however since the holding period is so short, and it would be unethical to tell workers that they were receiving less money than they were supposed to because their wages were put into some bad investments! At the same time, ADP may still reap some return from holding these funds in its checking account.

Sources of float: Subscription Businesses & Pre-Paid Contracts

There are subscription and pre-paid contract businesses like newspapers and Netflix, while not technically receiving float belonging to customers that they have to return at some point, they are receiving payment upfront for services and products that need only be funded later down the road. In the meantime these funds could be used in flexible ways to fund buybacks, purchases of securities, etc. As long as such funds are continually coming through the door to replace old funds that are being invested, these funds can operate as a form of float by providing negative working capital. Remember, negative working capital is a form of float – if you have 90 days accounts payable while accounts receivable are one week, you, in essence, are generating excess liquidity that can be used to do all sorts of wonderful things. Perhaps this is one of the reasons why Buffett loves Coca-Cola, which he has said on more than one occasion has negative working capital.

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Article by S&C Messina Capital Management

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