Buffett's Buyout Blues and the First LBO

On this day in economic and business history...

Warren Buffett's Berkshire Hathaway (NYSE: BRK-B  ) made what was then the largest acquisition in its history when it agreed to acquire General Re for $22 billion in a tax-free exchange of stock on June 19, 1998. The deal was unusual for Buffett: He has a known preference for all-cash transactions, and the acquisition was nearly five times larger than Berkshire's previous record buyout of Geico, completed in 1995. As a result of the deal, General Re's shareholders wound up with an 18% stake in Berkshire -- a sizable premium over the purchase price, given Berkshire's roughly $200 billion market cap at the time.

The deal turned out to be pretty good for General Re's shareholders. From the time the acquisition closed -- it was accounted as a merger for tax purposes -- to the 15th anniversary of the buyout offer, Berkshire's shares gained 173% -- more than double the return of the Dow Jones Industrial Average (DJINDICES: ^DJI  ) over the same time frame.

However, General Re became a bit of a headache for Buffett in later years, as it soon became apparent that the reinsurer had been up to some risky business. Two years after the buyout, General Re's subsidiary entered into two sham transactions with American International Group (NYSE: AIG  ) that were designed to inflate AIG's loss reserves by $500 million. Buffett, in discussing his experience with General Re post-buyout, quoted country-western musician Toby Keith in his 2002 shareholder letter: "I wish I didn't know now what I didn't know then."

The scandal ousted longtime AIG CEO Maurice "Hank" Greenberg from his post in 2005 and led to the successful prosecution of four General Re executives and one AIG executive in 2008. These five convictions were overturned in 2011 -- right around the time Berkshire found itself embroiled in another financial scandal, this one over a top Buffett lieutenant's alleged insider trading in the weeks before the company acquired Lubrizol.

Controlling communications
The first comprehensive Communications Act in the United States was signed into law on June 19, 1934. It replaced the Federal Radio Commission with the Federal Communications Commission, which was charged with "regulating interstate and foreign commerce in communication by wire and radio." This new description is broad enough to encompass television and the Internet, but as the Act was devised in an era when Americans used only telephones and radio, it was originally biased toward regulating these two forms of communication.

The FCC is the Communications Act's most visible legacy. Its history has seen several high-profile actions of lasting consequence for the American telecommunications industry. An FCC report in 1940 forced the breakup of NBC, and ABC was formed out of the split. A 1948 TV station permit "freeze" damaged ABC's growth prospects and ultimately destroyed the upstart DuMont television network, which had no choice but to pay AT&T (NYSE: T  ) for radio lines and TV cables. DuMont did not operate radio stations, so the charges were effectively discriminatory. After AT&T's divestiture, the FCC (belatedly) moved to a new regulatory goal of equality for all long-distance providers using local lines.

Since the turn of the century, the FCC has stepped up its enforcement of television-related indecency regulations, culminating in the infamous "wardrobe malfunction" and subsequent fines of the 2004 Super Bowl. The FCC has also become an important player in the Internet's network neutrality debate. It played its most visible role in a 2008 ruling against Comcast when the company attempted to throttle download access for users of file-sharing programs.

A new kind of buyout
The first leveraged buyout in American history  took place on June 19, 1964, when Rollins Broadcasting (NYSE: ROL  ) made a $62.4 million bid to acquire nationwide exterminator Orkin. Rollins was a company with $9.1 million in annual revenue and $900,000 in annual net income in fiscal 1964. The deal, later called "Jonah swallowing the whale" by BusinessWeek, saw a company put up virtually none of its own money to acquire a company with $37.3 million in annual revenue and $3 million in annual net income. Rollins/Orkin (the pairing has worked out for nearly five decades) quotes the particulars of the deal on its website:

Rollins Broadcasting borrowed $60 million, including $10 million from the sellers, and used $2.4 million of Orkin's excess cash to close the transaction. Rollins Broadcasting also borrowed $20 million, including $10 million at 4.5% interest for 15 years from the Orkin family, with payments deferred for four years. The $10 million of Rollins Broadcasting's assets helped support the transaction.

Nearly five decades later, Rollins and Orkin have shown that leveraged buyouts can be great successes when both parties have the same goals. In its most recent fiscal year, Rollins reported $1.3 billion in revenue, of which nearly $1.1 billion came from Orkin's pest control services. The combined company generated $111 million in annual revenue. On a combined basis, Rollins/Orkin has grown its revenue at an annualized rate of 7.1% and its net income by 7.3% since closing the deal. This sort of deal might have a much better reputation if only more leveraged buyouts worked out this way.

Thanks to Buffett's investing savvy, Berkshire Hathaway's book value per share has grown a mind-blowing 586,817% over the past 48 years. But with Buffett aging and Berkshire rapidly evolving, is this insurance conglomerate still a buy today? In The Motley Fool's premium report on the company, Berkshire expert Joe Magyer provides investors with key reasons to buy, as well as important risks to watch out for. Click here now for instant access to Joe's take on Berkshire!


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