By Tom Bradley

One of the recent themes of this blog has been the notion that this economic crisis will cause the ‘strong to get stronger’.  Well-financed companies will have unprecedented opportunities to buy assets and attract talent through this period, and will come out of it with fewer and/or weaker competitors.  We recently wrote about Cisco (Thank You Mr. Market) to illustrate our point.

As you read Warren Buffett’s 2008 Letter to the Shareholders of Berkshire Hathaway that was published last Saturday, it is obvious that his company will be one of those players.  The company has already jumped on some new opportunities – entering the business of insuring tax-exempt bonds, buying high yielding securities from Wrigley, Goldman Sachs and General Electric – and there will be more to come.

Interestingly, financial strength has proven to be a negative in some aspects of Berkshire’s business, specifically in areas where it is competing directly with the government-subsidized (owned?) banks.  Warren explains:

"Conversely, highly-rated companies, such as Berkshire, are experiencing borrowing costs that, in relation to Treasury rates, are at record levels.  Moreover, funds are abundant for the government-guaranteed borrower but often scarce for others, no matter how creditworthy they may be.  This unprecedented "spread" in the cost of money makes it unprofitable for any lender who doesn’t enjoy government-guaranteed funds to go up against those with a favored status.  Government is determining the "haves" and "have-nots." That is why companies are rushing to convert to bank holding companies, not a course feasible for Berkshire.  Though Berkshire’s credit is pristine – we are one of only seven AAA corporations in the country – our cost of borrowing is now far higher than competitors with shaky balance sheets but government backing. At the moment, it is much better to be a financial cripple with a government guarantee than a Gibraltar without one."

In defense of my ‘strong get stronger’ thesis, I don’t think this disadvantage will be a factor in most other businesses – the cost of funding is important for all companies, but is the dominant variable in financial services.  If we again use Cisco as an example, it is unlikely that the government is going to bail out or subsidize a competitor like Nortel.  And if it does, I like Cisco’s chances even more.

In the financial sector, government-backed banks will be able to write some great business in competition with the ‘unsubsidized’ players (let’s hope they do, otherwise they’ll never dig themselves out), but their hands will be tied in so many other ways.  They won’t be able to do acquisitions and take advantage of other opportunities the way the stronger players will (think RBC, BNS and TD).