Tag Archives: Berkshire Hathaway

Buffett, Duracell and Proctor and Gamble (PG)

November 14, 2014 By in Current Market Thoughts, Portfolio management, Trading Tags: , , , , , , , , Leave a comment

Warren Buffett’s company, Berkshire Hathaway (BRK), is buying Duracell from PG for $2.9 billion.

The deal is a little more complex than that, though:

structure:  PG will inject $1.8 billion in cash into Duracell prior to the sale.  It will then swap the enlarged company for BRK’s 52.8 million share holding in PG.  This makes the headline number for the deal $4.7 billion.

a win-win

PG has been interested for years in offloading Duracell, which it acquired through its purchase of Gillette in 2005.  Duracell has gone ex growth, as today’s mobile devices like smartphones use rechargeable batteries, not disposables.  Complicating the issue is the fact that Duracell is on the books at the price Gillette paid for it in the 1980s.  So a sale for cash would presumably trigger a big capital gains tax.

With this deal, PG gets rid of a no-growth brand that no trade buyers were beating down the door to get.  It avoids taxes.  It accomplishes a share buyback at the same time and takes out a large seller whose activity would depress the stock price, to boot.  So, for PG the deal is a big winner.

BRK offloads its entire holding in PG at once.  I estimate the task would take three months in the open market, during which time PG shares would doubtless be depressed as the news hit Wall Street’s trading floors.  BRK also avoids taxes on a position that’s on its books at the cost of Gillette convertible bonds it bought in 1989.

On the surface, it appears that BRK doesn’t make out so well.  It has aguably swapped a slow-growth dog for money plus a no-growth cat.  But let’s look at the numbers.

Let’s say sale of the PG shares in the open market would bring in $4.7 billion but trigger taxes due of $1.2 billion (a number I just made up).  So the net to it is $3.5 billion.  By doing this deal instead, BRK gets $1.8 million in cash plus 100% ownership of a company that generated $400 million+ in cash over the past year.  This means BRK only needs Duracell to stay afloat for four more years to recover the price it’s paying.  In addition, PG disappears from the portfolio everyone watches (as a 100% holding, Duracell never makes it in). Looks like a good deal.

what catches my eye

I hadn’t realized before, but I’ve read in the Financial Times and the Wall Street Journal that this is the third such deal BRK has done in the past year.  This looks a lot to me like portfolio housecleaning.

Warren Buffett’s trademark has long been to buy consumer-oriented stocks with strong brand names, superior products and excellent distribution networks.  All are “moats” that defend against competition.  However, all these competitive advantages are being steadily eroded by generational and technological change.

It looks to me like a big (and overdue) strategy shift may be underway at BRK–one that the company, understandably, wants to keep under wraps for as long as possible.

 

 

Warren Buffett and IBM + Intel

November 16, 2011 By in Current Market Thoughts, Investment firms, Portfolio management Tags: , , , , , , , , , Leave a comment

Warren Buffett on TV

Warren Buffett, an iconic stock market investor, announced two days ago on television that he has acquired a 5.5% interest in IBM, now worth about $12 billion.  He apparently began accumulating the stock–the 65 million or so shares he holds amounts to about two weeks’ trading volume–in March.

why the buy is notable

The announcement is notable in a few respects–two small ones and one large.

Let’s get the small fry out of the way first:

1.  No one in his right mind goes on TV and announces he owns a ton of a given stock unless he’s finished buying.  The implicit message is “Feel free to ride on my coattails (and raise the value of my stock) if you wish.”

2.  Portfolio investors are required to disclose their holdings in a public filing (a 13-f) with the SEC each quarter.  According to Dealbook in the New York Times, a portfolio manager can request that the SEC keep secret the names of stocks the manager is continuing to buy.   (I didn’t know about this provision, despite being in the business for over a quarter-century.  Shame on me.  I bet I’m not alone, though.)  Dealbook says that’s what Buffett did in March and the SEC said okay

Now the BIG one:

3.  The purchase represents Buffett’s first significant foray into the technology industry, a place he had previously shunned for lack of little investment appeal.  His explanation for the about-face?  …the world has changed, so he’s changing with it.

Actually, though, I don’t think IBM shows that he’s changed that much.  Buffett has also acquired a relatively small stake in INTC, which I think IS an eye-opener.  He isn’t trying to keep that one out of his 13-f filings, however.  I think this means one of his assistants really wanted to buy it and Buffett is simply watching to see how the stock turns out.  So I think it’s more a test of the assistant than a vote of confidence in INTC.

Buffett as icon

Buffett has an important place in portfolio investment history.  It comes from his being the first, a half-century ago, to understand the implications of an accounting paradox.

Long before anyone else, he realized that continuous spending on advertising to establish a brand name had an enduring positive value, even though this activity appeared in the firm’s financial statements only as a negative–as expense.  (Pick a consumer-oriented company and look at the advertising expense.  It’s mind-bogglingly high today–and it used to be a lot higher.)  Similarly, developing a strong distribution network of competent sales and delivery people also has an enduring value, even though the only reflection of this in financial statements is in (higher than normal) salary expense.

Together, a strong brand name and a top-notch distribution system form a powerful–if invisible–barrier to competitors entering a market.  They also offer the opportunity for operating leverage if the firm can push a wider variety of branded products through its network.

So while his Graham and Dodd competitors were looking for nameless/faceless companies that were piling up lots of working capital and had tons of plant and equipment, Buffett was snapping up branded firms that served recurring needs in service areas like newspapers and insurance, and strong brands like Coca-Cola…at bargain basement prices.  Geico is probably his most famous current holding.

As everyone knows, he made a fortune, both for himself and for his clients.

my (more or less random) thoughts

IBM has a powerful brand name and distribution network.  The industry it operates in aside, the purchase looks to me like vintage Buffett.

I don’t think the Buffett magic works as well as it once did, for two reasons:

–once the investment industry became aware of Buffett’s superior results, everyone studied his methods carefully and began to imitate them.  By the time I entered the business in the late 1970s the value of intangibles and of service firms was already beginning to become conventional wisdom. So Buffett’s edge gradually disappeared.

–the internet happened.  Getting distribution no longer requires years of heavy advertising expenditure; it takes good public relations and web design.

Buffett has transformed himself, consciously or not, into his own brand name.  For the performance of Berkshire Hathaway stock, the mystique of the “Sage of Omaha” is at least as important as perceived investment results.

Why IBM and not AAPL?

To my mind, INTC is the much more uncharacteristic purchase.  It’s still very cheap, I think (remember, I own the stock).  But it’s a capital intensive, research and development dependent, manufacturer of (arguably) business cycle sensitive, high-priced stuff.  It faces substantial competition from ARMH.  In other words, it’s just about everything Buffett has not wanted in a company.

 

 

 

the curious case of David Sokol and Berkshire Hathaway

April 8, 2011 By in book value, Securities regulation Tags: , , , , Leave a comment

The case of David Sokol, late of Berkshire Hathaway, has been widely reported over recent days.  The facts, as I understand them, are as follows:

Sokol’s behavior…

1.  One of Warren Buffett’s chief lieutenants and touted as a potential successor to the Sage of Omaha, Mr. Sokol had the task of finding a suitable target for the merger and acquisition “elephant gun” Mr. Buffett proclaimed last year he had primed to fire.  There may have been others looking as well, but Mr. Sokol certainly was one.

2.  Mr. Sokol decided to recommend Lubrizol to Mr. Buffett as a company that Berkshire should purchase.

3.  Prior to approaching his boss, Mr. Sokol bought $9+ million in Lubrizol stock for himself.

4.  In his presentation to Mr. Buffett, Mr. Sokol mentioned his own holding, but only in passing.  He apparently did so in a way that it didn’t highlight the relevant points of how recent or how large his purchase had been.

5.  Buffett decided to buy Lubrizol.  Sokol sold his stock for a $3 million personal profit.

6.  After this became know, Sokol resigned from Berkshire.  Buffett maintains that Sokol did nothing wrong and that the resignation has nothing to do with his Lubrizol stock purchase.

7.  The SEC is now investigating Sokol, with the focus of the inquiry on whether there are other instances of the same buy-for-yourself-then-recommend behavior.

…isn’t the issue on Wall Street.  Buffett’s is.

People buy Berkshire Hathaway stock because they regard Warren Buffett as a master investor and a person of absolute integrity.  His public appearances draw immense media attention for the same reasons.  Other investors parse each sentence he pens or utters for sophisticated investment insights.  Why, then, would such a hero defend a subordinate who appears to have taken advantage of Mr. Buffett’s trust and used his corporate position for personal gain?   …especially when this conduct appears to fly in the face of the fair-play rules every investment company must follow.

why do this?

No one outside Berkshire Hathaway knows for sure.  I have two observations:

1.  Imagine what Mr. Sokol’s defense against charges of failing in his fiduciary duty to Berkshire Hathaway shareholders might be.  If it were me, I’d argue along three lines:

a) First, I would say that Sokol is an industrialist working for a conglomerate, not a portfolio manager working for a regulated securities company.  Therefore, he’s not subject to the severe controls on the latter’s activities.

b)  I’d then say that Berkshire doesn’t have adequate compliance procedures that establish and monitor standards of conduct.  As as result of this corporate failure, he was ignorant of proper procedures.

c) Then I’d try to argue that his behavior was common practice at Berkshire.

In fact, it appears Sokol is already asserting that what he did is just the same as Charlie Munger (Buffett’s long-time associate and vice-chairman of Berkshire) holding shares of Chinese battery company BYD prior to Berkshire taking a large stake.

In the press, there has been no discussion of Berkshire compliance procedures.  Yes, Buffett wrote a letter on the subject all newly hired executives are required to state that they have read–but nothing else.  No one I’m aware of has written that Berkshire implemented the kind of strict controls over, and intense scrutiny of, personal trading that is mandatory for investment companies.  Nor is there talk of periodic compliance training that is also required for professional investors.  My guess is that, while these procedures may exist in the company’s insurance subsidiaries, there’s no company-wide effort.

Also, if it is correct that the thrust of an SEC investigation of Sokol is on a pattern of behavior rather than this one incident, this suggests that points a) and b) above have merit.

To sum up, at least in the very narrow sense of “can he be convicted?”, Mr. Sokol may actually have done nothing wrong.  Unethical, maybe, but illegal, no.  So there’s little Mr. Buffett can do other than to ask for Mr. Sokol’s resignation.

Ironically, if Berkshire were a regulated investment company, it may well be that Mr. Buffett’s supervisory failure to publicize and enforce the rules would be the main actionable offense.

2.  There could be a second reason for Berkshire wanting to put this incident behind it as quickly as possible.

The shock and outrage in the investment community over the Sokol affair illustrates Wall Street’s belief about what Berkshire is:  the investment company run by one of the greatest American investors of the twentieth century.

To defend itself, Berkshire would likely have to emphasize that Berkshire is a financial services/industrial conglomerate (Geico is its best-known brand), not a regulated investment firm.

What’s so bad about that?  The stock doesn’t trade at the discount to asset value that’s characteristic of multi-industry companies, insurance firms in particular.  Berkshire trades at a substantial, though slowly shrinking, premium to book.   Defense of Berkshire’s behavior regarding Sokol might well end up being an attack on that premium as well, and accelerate its decline.