April 29, 1999
The Makings of a Diversified Conglomerate
by Yi-Hsin Chang (TMF Puck)
Unlike a McDonald's, a Coca-Cola, or a General Motors, Berkshire Hathaway (NYSE: BRK.A and BRK.B) is not involved in one type of business. It's got its hands in a lot of businesses. It is involved in insurance, manufacturing, retailing, and services, and peddles everything from boxed candies, sundaes and shoes, to furniture, diamond rings, and airplanes. (See table.)
Far from its roots as a New England-based textile mill, Warren Buffett's Berkshire Hathaway is a holding company that acquires large, profitable companies irrespective of their actual lines of business. The notable exception, of course, is technology. Keeping to his rule of not investing in something he doesn't understand, Buffett has stayed away from high-tech companies.
But make no mistake about it, Berkshire is very methodical in the way it makes acquisitions and has set criteria for potential candidates. It looks for companies with at least $50 million in pre-tax earnings. The bigger the better -- something with a price tag of $5 billion to $20 billion, preferably payable in cash, not stock. It wants companies with proven and consistent earnings power and good returns on equity using little or no debt, and it will only do friendly takeovers with strong management already in place.
As Buffett puts it: "[Vice Chairman] Charlie [Munger] and I frequently get approached about acquisitions that don't come close to meeting our tests.... A line from a country song expresses our feeling about new ventures, turnarounds, or auction-like sales: 'When the phone don't ring, you'll know it's me.'"
But the phone has rung many times, and Buffett has closed many deals. His most recent and largest-ever purchase was the $22 billion acquisition of General Re Corp. completed in December 1998. General Re owns General Reinsurance Corp., the largest U.S. property-casualty reinsurer, as well as 82% of the world's oldest reinsurance company, Cologne Re. The uncharacteristic all-stock merger helped double the number of Berkshire shareholders to around 250,000.
Despite the size of the company -- it was ranked 112 in terms of 1998 revenues and 32 in terms of profits among Fortune 500 companies prior to factoring in the General Re acquisition -- Berkshire operates more as a partnership than your typical multi-billion-dollar corporation. Buffett has more than 99% of his net worth invested in the company, while Munger has about 90% or more. The two think of themselves as managing partners of the company and shareholders as owner-partners of the company.
In addition, Berkshire takes a hands-off approach when it comes to managing its various subsidiaries, hence the importance of acquiring companies with good managers. Berkshire gives each of its subsidiaries the "freedom to operate in whatever manner will best allow the company to exploit its strengths." As Buffett likes to say, "[W]e subcontract all of the heavy lifting in this business to the managers of our subsidiaries." Of Berkshire's 45,000 employees, only 12 -- yes, that's twelve -- work at the company's headquarters.
Take Nebraska Furniture Mart, the largest home furnishings store in the country, which was bought by Berkshire in 1983. Buffett decided to buy 90% of the business -- leaving 10% to founder Rose Blumkin ("Mrs. B") and family -- after concluding that he'd "rather wrestle grizzlies than compete with Mrs. B and her progeny. They buy brilliantly, they operate at expense ratios competitors don't even dream about, and they then pass on to their customers much of the savings."
Mrs. B, who was 89 years old when she struck the deal with Buffett, remained chairman of the Furniture Mart and on the sales floor seven days a week. Louie Blumkin, Mrs. B's son, was the company's president and widely regarded as one of the country's shrewdest buyers of furniture and appliances.
Incidentally, Mrs. B quit the business in May 1989 after disagreeing with her son and grandsons about the remodeling and operation of the carpet department, making her the first and only manager ever to run out on Buffett. After taking a few months off, Mrs. B opened a competing store right by the Furniture Mart, though a few years later she publicly admitted that she had been wrong and agreed to allow Berkshire to buy out her new store for $5 million.
Chairman Buffett speaks highly of all of the managers of his businesses. "Most of these managers have no need to work for a living; they show up at the ballpark because they like to hit home runs. And that's exactly what they do," Buffett brags in one of his insightful letters to shareholders. "When I call off the names of our managers... I feel the same glow that Miller Huggins must have experienced when he announced the lineup of his 1927 New York Yankees."
Buffett is also a big fan of the businesses themselves. He unabashedly does a sales pitch for just about every line of Berkshire's businesses in his annual letter to shareholders. In his latest masterpiece, he writes jokingly: "Last year I spent more than nine times my salary at Borsheim's [jewelry store] and EJA [Executive Jet Aviation]. Just think how Berkshire's business would boom if you'd only spring for a raise." (Buffett's salary? A modest $100,000 a year -- a fraction of that of most CEOs of Fortune 500 companies.)
Buffett is also big on auto insurer GEICO, of which Buffett mentor Benjamin Graham was chairman. Because of the Graham connection, Buffett decided to visit GEICO's headquarters in Washington D.C. while he was a 20-year-old student at Columbia Business School in New York, where Graham taught. He took a train down on a Saturday and found the door locked, but was able to talk to Lorimer Davidson, the financial vice president and lone executive working that day, for four hours on the ins and outs of GEICO's auto-insurance business.
Today, Buffett says of GEICO: "Combine a great idea with a great manager, and you're certain to obtain a great result.... Here's an impartial scorecard on how we shape up: In New York, our largest-volume state, the Insurance Department recently reported that GEICO's complaint ratio in 1997 was not only the lowest of the five largest auto insurers but was also less than half the average of the other four."
Other Berkshire holdings, be they wholly owned subsidiaries or large stock holdings, also reflect Buffett's tastes as well as his brand loyalty. "Regardless of price, we have no interest at all in selling any good businesses that Berkshire owns," he explains. "We are also very reluctant to sell sub-par businesses as long as we expect them to generate at least some cash and as long as we feel good about their managers and labor relations."
A long-time drinker of Pepsi, preferably spiked with cherry syrup, Buffett converted to Cherry Coke after former neighbor and then president of Coca-Cola, Don Keough, gave him samples of the new product still undergoing testing. Buffett began accumulating shares of Coke in 1988, and Berkshire now holds an 8% stake in the soft-drink giant.
Berkshire started buying shares in The Washington Post Co. in 1973 and quickly became its largest outside shareholder. As a kid growing up in D.C. while his father served in the House of Representatives, Buffett had been a paper boy for The Post. Of course, the precocious Buffett turned his paper routes into a well-oiled business -- he was making $175 a month, comparable to what many young men were earning in full-time jobs.
In outlining Berkshire's acquisition of International Dairy Queen, Buffett characteristically praised the management and added that he and Munger bring a "modicum of product expertise" to the transaction -- both had long patronized the fast-food restaurant chain. "We have put our money where our mouth is," Buffett said.
Lest you get the impression that Buffett invests solely in brands he happens to like, the most important factor to him is without question a company's financial statements. When he got a call to see if he was interested in buying See's Candy Shops, a California chocolate chain, his initial response: "The candy business. I don't think we want to be in the candy business." But after quickly looking up See's numbers, he said, "Yeah, I'd be willing to buy See's at a price." That price ended up being $25 million, at the time his largest investment by far.
There's no question that Buffett is Berkshire Hathaway, and Berkshire Hathaway is Buffett. It's his life's work. But at 68 (he'll be 69 at the end of August), Buffett realizes the importance of reassuring investors about the future of the company. In the company's Owner's Manual, he says that upon his death, his job will be divided into two positions, with one executive responsible for investments and the other for operations. The two people he would now pick to fill the positions work for Berkshire, and their names are known to Buffett's family and a few key individuals.
Buffett jokes that his commitment to Berkshire is like the "loyal Democrat in Fort Wayne who asked to be buried in Chicago so that he could stay active in the party." On a more serious note, Buffett says, "You can be equally sure that the principles we have employed to date in running Berkshire will continue to guide the managers who succeed me."
Judging by Buffett's latest letter to shareholders and recent media interviews, the Oracle of Omaha appears as nimble and sharp-witted as he was a decade or two ago. Don't be surprised to see him at Berkshire's helm for many more years to come.