Warren Buffett was forced to defend his association with 3G Capital from the beginning of the ritual Q&A session at the Berkshire Hathaway (NYSE:BRK-B) Annual Meeting last Saturday, as a shareholder said that "he cannot make a moral case" for the Brazilian investment firm's aggressive cost-cutting programs at acquired companies. Given that Berkshire Hathaway's partnership with 3G Capital is more likely to expand than shrink over the next decade, Berkshire shareholders ought to understand its nature. In fact, 3G's methods are not inconsistent with Mr. Buffett's approach to business, which is, well, all business.
Partnering with 3G Capital, for example on the 2013 acquisition of H.J. Heinz -- and now on the merger of Heinz with Kraft (NASDAQ: KRFT) -- is a new modus operandi for Berkshire, at least on this scale. 3G Capital sources its acquisitions and is then responsible for operational oversight. Berkshire, meanwhile, acts as a passive investor, supplying the capital but ultimately reaping the rewards of 3G's operational expertise and efforts without having to pay a management fee -- the sort of partnership anyone can appreciate!
The trouble is that, to many outside observers, 3G Capital superficially resembles a "strip-'em-and-flip-'em" private equity firm that loads up acquired companies with debt and cuts costs to the bone before returning them to the public markets or selling them on to a new acquirer (often another private equity firm!). In some cases, these operators' holding periods are just a few years.
"We have no exit strategy"
That approach violates two principles on which Mr. Buffett has built Berkshire Hathaway:
- When Berkshire acquires a business, it exercises minimal oversight, leaving the existing management to exercise the sort of autonomy it enjoyed when it was independent.
- As Buffett wrote in his 2002 Shareholder Letter: "Unlike LBO operators and private equity firms, we have no 'exit' strategy -- we buy to keep."
The first point reflects the fact that, although Mr. Buffett is a businessman and an exceptional student of business, he is not interested in getting stuck in the nuts-and-bolts of a Berkshire operating business to improve it, much less turn it around (this is something he has done earlier in his career, out of necessity, including at the Buffalo News and Salomon Brothers.) Instead, he prefers to acquire well-oiled machines and let the people already running them get on with it.
"That doesn't mean I endorse it. I basically tolerate it."
However, when people he trusts and respects -- such as Jorge Lemann and his partners at 3G Capital -- are willing to roll up their sleeves and get their hands dirty on his behalf (without asking for compensation!), Buffett is certainly not opposed to the notion of cutting jobs in order to improve profitability. As he told shareholders last Saturday:
On 3G, neither I nor Charlie Munger have ever said there should be more people than are needed in a company...I tip my hat to what the 3G people have done... I hope our Berkshire companies are not being run with more people than they need, either... We do have some businesses where we probably have more people than we need, and I don't do anything about it. But that doesn't mean that I endorse it. I basically tolerate it.
As far as the second charge regarding private equity firms' timeframe goes, Buffett told CNBC on Monday:
It is true that private equity firms generally have some timetable that when they want to get out of an investment -- sometimes they get out just in a couple of years. 3G and we -- we're their partner -- has no plans to do anything but build the businesses that we've joined them with and they've showed no indication to do anything else throughout their history. They're in a retailing operation in Brazil that they went in 20 years ago. They are builders -- they are builders of efficiency as well as builders of the product... These fellows, every conversation I have with them -- they want to figure out how to make the companies bigger and more efficient over time and I've watched them do it. They're in no way private equity operators who are buying a business, getting an override for owning for a while and then selling it.
In fact, back in March, when he was discussing the merger with Kraft, Buffett went as far as to say regarding 3G Capital, "I don't think it's even proper to call them a private equity firm."
In sum, Buffett's stance appears to be that a genuine long-term owner is well within their rights (in a broad ethical sense) to make cuts, even deep cuts, at a business, because they are acting with the long-term vitality of the business in mind -- a defensible proposition, in my opinion.
The elephant hunt continues
Still, 3G Capital's involvement does raise some questions. It's an investment firm with outside investors, after all. Although I'm certain 3G Capital has a longer holding period than your run-of-the-mill private equity firm, it's difficult for me to believe that period is "forever". How do they offer their investors liquidity? Thankfully for Berkshire shareholders, that question highlights a potential source of opportunity. I can easily imagine a scenario that has Berkshire buying out 3G Capital's stake in Kraft Heinz, for example.
Either way, you can expect Berkshire to team up with 3G Capital on more acquisitions in the future. As Buffett quipped on Saturday morning in front of the Heinz stall at Omaha's CenturyLink Center: "I like big deals, but they [3G Capital] really like big deals."