Sunday, March 1, 2015

Uncle Warren Explains It All to You

Time for Daddy’s little dividend
“Sure, sure.”

— Sidney J. Mussburger, The Hudsucker Proxy

Apparently some doddering old fart in Omaha, Nebraska published a celebratory letter yesterday in connection with an obscure anniversary some of you might have heard about. Something to do with a mid-range furniture store or failed textile mill or something. Anyway, I felt compelled to read it, if only because every financial pundit in the Western Hemisphere has been recommending its salutary virtues to me with a fervor approaching the evangelical. Personally, I found it more hokey and self-congratulatory than illuminating, but then again I tend to prefer my moral fiber to come unencumbered by six cups of refined sugar and smug self satisfaction per serving. I know, I know: I am downright un-American.

If you care about the content of this man’s nattering—and the compl(i/e)mentary nattering of his partner in cast iron cheer—I would refer you to Matt Levine, who offered a very serviceable summary unburdened by the usual encomia breathlessly showered on this duo by all and sundry. He points out that the success of the business purchasing part of this entity can be neatly reduced to the skill with which the principal buys and sells said businesses, and not hands on management and supervision thereof, which said demiurge studiously avoids. This strikes me as essentially correct. He also calls attention to an aspect of the jolly old elf’s behavior that tends to be overlooked by his cheerleaders: he is a ruthless allocator of the bounteous capital at his command. Far from his image as a genial rich uncle offering cozy and undemanding shelter from the withering blasts of shareholder capitalism to skittish families and corporate management teams in search of a few shekels to renovate their yachts, Mr. Buffett drives a hard bargain going in and, in the event the bloom comes off the rose, delivers an even harder kick in the pants going out.

Warren buys cheap, and then he owns your ass in perpetuity, unless he decides to dump you. Which is just fine, by the way: it’s what his shareholders want him to do, and he has been very successful at it. It just amuses me this incontrovertible characterization seems to elude almost everybody who has gushed about him in the past.

* * *
Aaannnyhoo, Warren Buffett is a serial acquirer of companies, inter alia, and he is indisputably good at it. And this explains (if does not condone) the snarky barbs he sends my direction, railing against investment bankers, to which my response is the entire point of this peroration. Now everybody knows, your defensive correspondent included, that nobody likes investment bankers, so I do not anticipate my remarks will undermine the regard in which the Great Man is held by anybody. Nor do I begrudge a beloved financial celebrity and multibillionaire a little fun in kicking the mangy village cur everybody hates, but I do hope to persuade at least a few of you that Mr. Buffett’s critique of my industry is not disinterested.

Uncle Warren’s critiques of investment bankers are scattered throughout his missive, but probably the highest concentration is located in his section on Berkshire Hathaway as a conglomerate, starting on page 29. The money shot, so to speak, is concentrated on pages 31–32:
Berkshire has one further advantage that has become increasingly important over the years: We are now the home of choice for the owners and managers of many outstanding businesses.

Families that own successful businesses have multiple options when they contemplate sale. Frequently, the best decision is to do nothing. There are worse things in life than having a prosperous business that one understands well. But sitting tight is seldom recommended by Wall Street. (Don’t ask the barber whether you need a haircut.)

When one part of a family wishes to sell while others wish to continue, a public offering often makes sense. But, when owners wish to cash out entirely, they usually consider one of two paths.

The first is sale to a competitor who is salivating at the possibility of wringing “synergies” from the combining of the two companies. This buyer invariably contemplates getting rid of large numbers of the seller’s associates, the very people who have helped the owner build his business. A caring owner, however – and there are plenty of them – usually does not want to leave his long-time associates sadly singing the old country song: “
She got the goldmine, I got the shaft.

The second choice for sellers is the Wall Street buyer. For some years, these purchasers accurately called themselves “leveraged buyout firms.” When that term got a bad name in the early 1990s – remember RJR and
Barbarians at the Gate? – these buyers hastily relabeled themselves “private-equity.”

The name may have changed but that was all: Equity is dramatically reduced and debt is piled on in virtually all private-equity purchases. Indeed, the amount that a private-equity purchaser offers to the seller is in part determined by the buyer assessing the maximum amount of debt that can be placed on the acquired company.

Later, if things go well and equity begins to build, leveraged buy-out shops will often seek to re-leverage with new borrowings. They then typically use part of the proceeds to pay a huge dividend that drives equity sharply downward, sometimes even to a negative figure.

In truth, “equity” is a dirty word for many private-equity buyers; what they love is debt. And, because debt is currently so inexpensive, these buyers can frequently pay top dollar. Later, the business will be resold, often to another leveraged buyer. In effect, the business becomes a piece of merchandise.

Berkshire offers a third choice to the business owner who wishes to sell: a permanent home, in which the company’s people and culture will be retained (though, occasionally, management changes will be needed). Beyond that, any business we acquire dramatically increases its financial strength and ability to grow. Its days of dealing with banks and Wall Street analysts are also forever ended.

Some sellers don’t care about these matters. But, when sellers do, Berkshire does not have a lot of competition.
This really is masterful trolling. In one sequence, investment bankers, corporate acquirers, and private equity firms are all depicted by the Oracle of Omaha as modern day Snidely Whiplashes, evilly twirling their mustaches as they sell unnecessary transactions, “invariably” fire trusted and loyal employees, and repeatedly ravage the sanctity and probity of the acquired company’s balance sheet with dat ole debbil Debt. In contrast, Berkshire Hathaway is characterized as a veritable lavender-scented bosom of motherly protection and comfort.

Old Warren knows his audience, and his audience in this section is family-owned businesses or professional managers of corporate subsidiaries who aspire to get off the big company hamster wheel. The former, in particular, tend to be less sophisticated when it comes to matters financial, and hence are ripe targets for terrifying with images of slick, rapacious professional rapscallions just waiting for a chance to spring upon Aunt May and ravish her repeatedly over a cracker barrel. But of course most of it is tendentious bullshit.

* * *
I will not try your patience or mine by responding to each attack detailed above. Instead, I will only note that Warren is so eager to characterize non-conglomerate corporate acquirers and private equity firms in so unflattering a light because they are his competitors for buying companies. Likewise, he takes a swipe at my profession because our job and livelihood is attempting to get the best possible deal for our clients who are sellers. An important part of this for most sellers, of course, is maximizing the monetary value they receive for their companies, subject to other interests and constraints. And because Berkshire Hathaway brings no revenue or cost synergies to the table, unlike non-conglomerate corporate buyers, and can be disadvantaged against financial sponsor buyers due to their ability to pay with very cheap, tax deductible debt, Warren is often the least attractive buyer in terms of price offered. Not all potential sellers care only about receiving the highest possible price, but almost all of them are interested in price to some degree, so it is our duty as sell-side representatives to make this dynamic clear to our client. This, I am confident, does not please the Great Man.

This is also why Mr. Buffett refuses to participate in auctions for companies, since auctions are usually recommended and run by investment bankers for price discovery purposes and tend to result in higher realized prices than proprietary negotiations with one buyer. As a sophisticated serial acquirer of businesses, Warren would much prefer to deal with wet behind the ears families lacking professional representation, since the presence of the latter can end up making the terms he has to offer, if he can bring the seller to the finish line in the first place, much less attractive to Berkshire Hathaway and its shareholders than might otherwise happen. A professional advisor, even if her client decides he wants to join the warm embrace of Mother Buffett at a lower price than he could achieve in a more thorough market test with different kinds of buyers, can also help by pointing out potential pitfalls and precedents that might attend such a decision.

Personally, I thought two stories Mr. Buffett related at separate points in his letter were revealing in ways highly pertinent to a client considering selling his business to him. In the first, Warren proudly related how he beat down the family owners of See’s Candy in 1972 from their asking price of $30 million to $25 million. He later revealed that See’s subsequently generated over $1.9 billion in pre-tax earnings, cash flow which Warren diverted from growing the candy business to buy unrelated portfolio companies. It made me wonder what the poor saps in the See’s family did with what was left of the $25 million in cash Warren gave them after they paid taxes. I sure hope they used some of it to buy Berkshire Hathaway stock, because it’s undeniably true that BRK shareholders (including Mr. Buffett) are the only ones who got a good deal from that transaction. The second story, which represents a mirror image to See’s, is Dexter Shoe, in which Warren complained about buying a doomed shoe company for $433 million in 1993 for which he paid the owners BRK shares worth $5.7 billion today. Notwithstanding any present value advantage to a tax deferred sale of your company for Berkshire Hathaway stock instead of cash (consult your tax advisor), it’s clear the preferred currency for any seller to the Sage of Omaha should be BRK stock, since that is the one currency he prefers to keep to himself.

Anyway, Mr. Buffett is, among his other talents, a serial buyer of companies. Unlike the other big class of professional company buyers, however—private equity companies, who tolerate investment bankers because they need us to help finance and eventually sell their purchases—Mr. Buffett needs no help financing and never intends to sell the companies he buys. Accordingly, he despises investment bankers and employs his considerable folksy charm to scare potential business sellers away from using us for the plain and simple reason that we make his job harder and more expensive. For sellers of companies, investment banks level the playing field.

We all know Warren Buffett is a very clever, very successful investor. Warren Buffett hates level playing fields.

Related reading:
Warren Buffett and Charlie Munger, 2014 Annual Letter to the Shareholders of Berkshire Hathaway Inc. (February 28, 2015)
Matt Levine, Warren Buffett Explains His Cozy Embrace (Bloomberg View, February 28, 2015)

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