After the much anticipated release of Warren Buffett's annual letter to Berkshire Hathaway (NYSE:BRKA) (NYSE:BRKB) shareholders last week, many news outlets highlighted Buffett's lamentation of failing to complete any major acquisitions in 2012. "I pursued a couple of elephants," Buffett wrote, "but came up empty-handed."
Of course, Buffett was quick to point out last month's joint acquisition of ketchup king H.J. Heinz (NYSE: HNZ), for which Berkshire put $12 billion of its hard-earned cash to work.
Antelope hunting works, too
However, if you haven't read the letter -- and read it you should -- you may have missed an important piece of the puzzle by absorbing Buffett's thoughts out of context.
Consider the following paragraph from the Oracle of Omaha on page four:
"Though I failed to land a major acquisition in 2012, the managers of our subsidiaries did far better. We had a record year for "bolt-on" purchases, spending about $2.3 billion for 26 companies that were melded into our existing businesses. These transactions were completed without Berkshire issuing any shares. Charlie and I love these acquisitions: Usually they are low-risk, burden headquarters not at all, and expand the scope of our proven managers."
On the surface, it seems remarkable Berkshire was able to absorb 26 stand-alone businesses into its existing operations without the greater market so much as batting an eye. Of course, given Berkshire's enormous market capitalization of more than $250 billion, cash on hand of $35 billion (after accounting for the Heinz deal) and growing, and the average acquiree's size of just $88 million, each of these tiny companies looks like a drop in Berkshire's mind-bogglingly large bucket.
If anything, the size of these acquisitions looks eerily similar to those typically pursued by "mini-Berkshire" and fellow financial holding company Markel (NYSE:MKL) which, as I noted last month, tends to focus on buying companies with an enterprise value of less than $300 million. When combined, however, Berkshire's minor acquisitions nearly approach the total $2.5 billion enterprise value of Markel's largest-ever purchase in competitor Alterra (NASDAQ: ALTE) late last year.
But why (else) do they matter?
From Buffett's comments, we can also see these small purchases benefit Berkshire in a number of other ways massive acquisitions cannot.
First, acquiring small companies requires taking on little risk with no burden on Berkshire's headquarters. In short, each acquisition in and of itself is small enough to be managed by existing business segment managers, and should any aspect of the integration fail, it wouldn't have a significant negative effect on overall operations.
On a related note, the integration of large companies almost certainly involves tackling messy regulatory and logistical hurdles. It's safe to assume, then, that these small businesses are comparatively easy for Berkshire to simply fold into its existing operations, thus yielding synergies which can make them even better deals than Berkshire's typically prudent managers already negotiated.
Finally, small companies offer one other significant benefit big business can't match: strength in numbers. Buffett himself once stated, "It's a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that."
It stands to reason that, much in the same way retail investors enjoy a much larger investment universe than, say, a mutual fund with billions of dollars at its disposal, there are likely hundreds of small companies for every lone elephant that meets Buffett's stringent acquisition criteria.
The hunt continues
Nonetheless, the world can't help but wonder which huge company currently sits in the crosshairs of Warren Buffett's already-loaded elephant gun. Heck, just a few weeks ago when I considered what Berkshire might buy next, the smallest of the four companies I suggested currently boasts a market capitalization of $13 billion.
I suppose, however, it should come as little surprise that Buffett sees the value in pursuing smaller game. After all, we're talking about the man who rose to fame largely for his unrivaled ability to recognize the stocks of under-appreciated businesses. By using these acquisitions to increase the scope of responsibility of Berkshire's proven managers, Buffett is also effectively working to ensure his business will continue to thrive long after he's gone.
In the end, if that's not reason enough to believe Berkshire Hathaway will continue to outperform the broader market for the foreseeable future, I don't know what is.