Thornton O'glove, an eminent financial writer, recently advanced a curious proposition: Spin off Berkshire Hathaway's (BRK.B 0.54%) (BRK.A 0.64%) subsidiaries and break Warren Buffett's company apart.
In opposing this idea, I find myself in the rather incongruous position of defending Mr O'glove's interest against his own will, as he is a shareholder of Berkshire and I am not.
The spinoff fad
In the 1960s, it was conglomeration. Today, the scale has turned full circle to the new fad of spinoffs.
A favorite among activists like Nelson Peltz and Carl Icahn, these schemes are almost always justified on the merits of "focus" and the ideal of "shareholder value."
In the case of Berkshire Hathaway, according to O'glove, not only can Berkshire's 57 individual businesses be spun off, but those businesses can be split up even further, causing a veritable chain of spin offs which will, it is presumed, make current shareholders rich.
According to this theory, it is the job of management to "unlock hidden value" by exposing its jewels to the market so value can be brought to light. In short, shareholder value is equated with a boost to the stock price. Anything that creates such a short-term gain is good; anything that prevents such gain is bad for shareholders.
Conveniently ignored is the possibility that by taking one's gains so hastily upfront, one may forgo greater gains, or incur greater risks, over time. In essence, the short-term investor, the arbitrageur, and the savvy financier are privileged at the expense of those investors who want to buy and hold.
This is not to deny the utility of spinoffs, which have their place in the strategic arsenal of any company. A spinoff is particularly apt when a company has overpaid for an acquisition in the past, and now is so bloated that it must pare itself down.
This was the case with the Marriott Corporation in the early 1990s, and it may also be the case with the various spinoffs that have been undertaken recently by pharmaceuticals like Pfizer (NYSE: PFE) and Abbott Laboratories (NYSE: ABT).
Very often, a spinoff is a sort of recompense for past mistakes, an admission by management that the assets being spun out should never have been bought in the first place. But certainly this can't be the basis on which O'glove justifies his scheme.
If it is, I wonder which of Buffett's many acquisitions he considers to have been mistaken, and deserving of separation. Granted the man has made mistakes from time to time, buying airline securities and Dexter Shoes, but even his detractors agree that as a collector of businesses he is simply unparalleled.
Why Berkshire Hathaway should remain intact
Mr. O'glove seems to believe that since there is no "synergy" between Berkshire Hathaway's various parts, no harm could come from them being split apart. But in fact, Berkshire has plenty of synergy.
There is more "synergy" at Berkshire than at many other companies where that word is constantly parroted. The synergy exists not at the operational level but at the higher level of capital allocation and management compensation.
The individual managers of Berkshire are incentivized to send cash up to Omaha, and this cash is put to work by Buffett himself. If the managers want to reinvest their excess cash, a hurdle rate of around 15% is imposed, high enough to discourage frivolity but low enough not to dampen greed.
Normally the compensation of managers is set by the board of directors, with undue influence exercised by the managers themselves, but at Berkshire that task is performed by Buffett, with the assistance of Charlie Munger. In other words, the cost of equity capital is set, not by the market, but by top management.
Finding the best option
A conglomerate like Berkshire Hathaway has the advantage of being able to move capital from business to business so that the highest risk-adjusted return can be obtained.
In some conglomerates, particularly those in Asia, the profitable division is often seen subsidizing its weaker brethren – the exact opposite of what should be done. In such cases, a spinoff would be good for shareholders, but at Berkshire, where this has never been the case, shareholders should preserve the current structure and refuse any clever scheme to create so-called value.
Consider this: If See's Candies were to be spun off from Berkshire, the shareholders may be temporarily enriched, but the management of the new company would now be compensated by a board of directors, and moreover the excess cash that it generates would have to be plowed back into its own business (or returned to shareholders) and not into a business which could earn an even higher return. How does this help the shareholder who buys and holds?
There is another, more important reason why Berkshire Hathaway as it exists today should be kept together. Berkshire is in many businesses, from insurance to fast food; but at its highest level, it is in the acquisition business.
It competes directly with the private equity funds who scour the earth for undervalued assets. In this game, Berkshire Hatahway has, in its reputation, an important competitive advantage. Because it buys to hold and eschews "restructuring," the targets come to Berkshire instead of Berkshire having to go to them. If Berkshire were to start selling off or spinning off its assets, it would lose the attraction that it holds for the seller and become just another private equity fund. Its "moat", as Buffett calls it, would narrow.
The bigger question
The larger question, of course, is whether or not any successor can possibly fill Buffett's shoes.
Thornton O'glove and company paint Buffett as an inimitable financial genius. But Buffett is much more than a financier. He is one of America's great entrepreneurs, and his genius lies not so much in his stock-picking acumen but in Berkshire Hathaway, the business he created.
A great business can survive the reign of a fool just as it can thrive from the reign of a genius. The next CEO of Berkshire need not be a genius, but he must be patient, disciplined, and have sense enough not to sell off the company's crown jewels.
