Tuesday, April 29, 2008

Pilgrimage, Part VII: “You Don’t Want to Let Him Down”


Noodling on a Deal, Meaningless Quarterly Numbers and One More Secret of His Success



Back in the fall of 1990, when it looked like the world was coming to an end, investment-wise, I went to a meeting in New York City for Shaw Industries.

Shaw makes carpets, which nobody wanted at the time because the American consumer was not in the mood to buy much of anything, let alone new carpeting.

Hard as it may be to recall a time when the American consumer wasn’t going “all-in” at the checkout counter, not to mention a stock market doing anything less than making new highs every day, those were dark days all around.

Saddam Hussein had occupied Kuwait, set its oil wells on fire and was threatening to send his “Elite Republican Guard” into Saudi Arabia. Given the American oil habit, of course, this would have put us at the mercy of a homicidal maniac.

Consequently, oil prices were going through the roof and pretty much everything else, including consumer confidence, was going through the floor.

Thus Shaw Industries, being a carpet-manufacturer, lost both ways: sales were going down at the same time that costs were going up—most carpets being made of nylon and polyester fibers; which are, of course, petroleum-based synthetics.

Naturally, Shaw’s stock was dropping as fast as the sales of its carpets.

And yet the company’s reaction was—to Wall Street’s Finest—a head-scratcher: Shaw was buying its own stock back, in size.

Now, that may sound entirely normal nowadays, what with companies repurchasing stock for any reason they can think of—“to offset option dilution,” “to have a more efficient capital structure” (i.e. more debt, less equity), or the general, all-purpose, “to enhance shareholder value.”

As a general rule, of course, these can all be translated into "making our investment bankers richer."

Back then, however, share buybacks were rather exotic, and usually done only when a company was being threatened with a hostile takeover from an unwanted corporate raider.

But nobody wanted to raid a company whose main product cost more and sold less.

Wall Street’s Finest wasn’t sure the share buyback was a good use of cash for a cyclical business whose future looked as dark as the petroleum-blackened horizon over Kuwait. They questioned why Shaw did not preserve the cash and wait for things to pick up.

So Bob Shaw, the company’s self-assured, strong-headed CEO came to New York to discuss with Wall Street’s Finest the state of business, which was lousy, and the seeming non sequitur of an aggressive share buyback program.

As I recall the session, Shaw and his CFO spent most of their time defending the share repurchase as a good use of corporate cash, but the analysts—who were almost uniformly negative on the stock and fully convinced the company was throwing good money after bad—didn’t like it.

They really thought he was risking the company.

After answering the same basic question asked in only slightly different ways, Shaw finally lost his temper and dropped all pretense of explaining the share buyback in rational economic terms and said:

"Look, if Wall Street is gonna throw my stock in the trash can, I'm gonna pick it up."

I thought it was as good an explanation for a company buying its stock as I've ever heard.

And Bob Shaw was soon proven smarter than all of Wall Street’s Finest put together: low-flying B-52’s bombed Saddam’s “Elite Republican Guard” back to the proverbial Stone Age while troops on the ground chased the remnants back to Baghdad.


Meanwhile, legendary Texas oil well fighter Red Adair was called in to put out the fires, and did it so quickly that oil prices collapsed, housing sales went up, Americans started buying carpets, and Shaw’s business—and the company’s stock—boomed.

Kuwait was free once again to not allow women to vote (believe it or not, women’s suffrage only became legal in Kuwait last year); and America would not be at the mercy of a homicidal maniac named Saddam Hussein controlling the world’s spare oil capacity.

Instead, his name is Vladimir Putin, the ex-KGB agent who took over Russia.

All that aside, by buying back stock aggressively in a time of near-crisis, Bob Shaw was ahead of his time, and he came out looking pretty smart, having taken heed of one of Warren Buffett’s favorite maxims, which I paraphrase from memory:

The best time to buy is when there are no other buyers.

Ten years later and almost to the day of that meeting, Bob Shaw did something else that was slightly ahead of his time: he chucked the public-company rat race and sold his company to Berkshire-Hathaway.

The way Buffett told the story in his annual shareholder letter, Shaw had visited him in the summer of 2000 to ask whether Berkshire could write an insurance policy covering the potentially unlimited asbestos liabilities of a company he was thinking about merging into Shaw Industries.

Buffett turned down the idea flat, but liked Bob Shaw enough to keep up a dialogue and ended up buying the company a few months later.

This brings us to another simple secret of Buffett's success: the self-selection process of those who want to sell to him.

If you’re a mediocre but successful-in-a-ladder-climbing-way type of CEO, it’s not going to occur to you to try to sell out to Berkshire-Hathaway for the simple reason that it’s far too lucrative—not to mention comfortable—running a public company, what with corporate jets and golden handshakes and stocks options granted by your friends on the board of directors.

And if you’re a genuinely bad, Dennis Kozlowski type of CEO—good at scamming Wall Street’s Finest with the help of creative accounting and an incompetent board, but not much else—the odds that your exit strategy involves selling out to Buffett, who can read a spreadsheet better than anyone (and faster too, for Buffett is a speed-reader with a photographic memory), is nil.

The guy, or, in the case of Cathy Tamraz, who sold corporate news distributor Business Wire to Berkshire in early 2006, woman, who wants to work for Warren Buffett is by definition, highly ethical, hardworking, and not in it strictly for the money, because the management team always stays on after selling to Berkshire-Hathaway.

(As one of those very managers would tell me during the lunch break, “Warren tells us ‘I don’t want to run your business. You run it.’”)

But how does it really work?

What really happens after the handshake agreement is made, the deal is done, the books are closed and the stock is transferred to Berkshire-Hathaway, Inc?

What happens inside the business?

Is life as grand as the nice, folksy stories in the Buffett letter to shareholders would make it seem? Do the management teams of the Berkshire-Hathaway companies—as Buffett himself likes to say he does—"Tap dance to work"?

The lunch break is coming up, and I will get a chance to find out.


One of the quaint aspects of the Berkshire-Hathaway meeting—and a reminder that this really is a shareholder’s meeting, and not a spectacle orchestrated to showcase Warren Buffett’s genius—is the fact that Buffett alone conducts the meeting.

There is no master of ceremonies, no pre-programmed light show, no voice from the speakers to tell us where we are in the session—just a man checking his watch occasionally as he sits at the small table on the stage.

He does this in an old fashion sort of way, crooking his arm enough so that the watch appears from beneath his jacket sleeve and tilting his head back to read it.

(Charlie Munger, on the other hand, moves almost not at all. He sits Sphinx-like next to his partner, a microphone before him, and looks half-asleep until he decides to add to something Buffett has said—and it becomes clear he has been thinking, not sleeping. More on this in a later installment.)

As noon approaches, Buffett crooks his arm once more, and announces that after the next question we will break for lunch.

We decide to head out a few minutes early to beat the crowd—there is only so much information you can absorb in three and a half hours, and we find ourselves very hungry, as if calories have been burned just listening.

We get a Greek salad at one of the extra stands set up around the arena (the regular Qwest Center concessions offer nothing but beef—no surprise, this being Omaha) and eat standing up at a railing overlooking the main lobby, where crowds are emerging from the arena in a steady flood.

This vantage point gives a more complete view of the Berkshire-Hathaway shareholder demographics than I had inside the arena, but everyone looks quite the same as those I observed in our upper level section: they are middle-aged to late-middle-aged, mostly couples, and virtually all white.

This last gets me thinking, and I start looking to see if—and how many—non-white faces are in the crowd. It is not many. In fact, it is so few…well, more on this, too, in a later installment.

We finish, then head down to the lower lobby, and move with the crowd flowing into the giant exhibition hall attached to the arena.

It is a vast, Costco-sized space filled with booths, temporary stores, large motorized vehicles, ice cream stands and even a bookstore: it is, in fact, a giant trade show entirely for Berkshire-Hathaway's own products.

A Fruit-of-the-Loom store, complete with racks and shelves of T-shirts and boxer shorts with Berkshire-Hathaway slogans, is on the immediate right. Inside it, on a small stage, men dressed as Fruit-of-the-Loom characters are singing “Help Me Rhonda” to enthralled children while their parents shop. We find the shelves have already been stripped of most of the normal sized merchandise, and, anyway, what remains is disappointingly cheap stuff.

Next—and at the other end of the price spectrum—a Clayton manufactured home is open for inspection, with a long line of shareholders waiting to go inside. The nearby NetJets display has a more upscale feel, as you might expect. (Shareholders with a serious interest can go to the Omaha airport and tour a collection of real NetJets).

A Dairy Queen stand is doing a land office business selling (no giveaways, even to the shareholders) chocolate covered ice cream sticks, which seems to be the most popular item in the place; at the opposite end of the popularity spectrum is a World Book Encyclopedia display, one of the few square feet of the giant hall largely devoid of people.

Nearby, Berkshire subsidiary Forest River has parked one of their campers next to an atmospheric fence and a small water-filled pool, a long line waiting to peak inside.

In the far corner of the hall, a bookstore has been constructed and filled entirely with—you guessed it—Buffett (and Munger) books. And the bookstore is packed. “Read everything you can,” Buffett has been telling his younger acolytes all morning, and it seems like every shareholder is taking him at his word.

Squeezing and pushing our way out of there we feel like one of those salmon on the Klamath River, and the exhibition is starting to wear thin.

It is then that I spy a pair of men wearing something that perks me up: instead of the large plastic “Shareholder” badge worn by everyone else in the crowd, they are wearing “Manager” badges.

We maneuver through the crowd, introduce ourselves and ask what company they manage. Then we begin to talk.

Their company, like each of the dozens represented in the exhibition hall, had been in business a long time before selling itself to Berkshire. Also, like the others, it has a good brand name, if somewhat tired and old-fashioned.

The two men are soft-spoken and friendly—in a wary sort of way. We chat about how long they'd worked at their company (a long time) and how their company came to be purchased by Berkshire (it had been public, and Berkshire bought it a number of years ago).

Then we get to what I really want to know, which is not numbers or trade secrets, but what it’s like to work for Warren Buffett.

They both smile. One says, “No quarterly nonsense, for one thing.”

The other agrees. “We don’t have to do any stupid stuff to hit numbers,” he said.

What kind of stupid stuff?” we ask.

Oh, we used to do dumb things—really dumb, expensive things.”

Channel-stuffing?” I ask. (Discounting product at the end of a quarter to book a sale.)

They both smile. “All kinds of stuff.”

We don’t pry for more specifics, because we don’t want to scare them off. Besides, they haven’t been public in many years, and we wouldn’t learn anything too useful about what their customers might be doing in the way of accepting channel-stuffs nowadays.

But they reinforce what Buffett has always preached about Wall Street’s obsession with quarterly earnings reports:

1. Public companies—except for a handful, such as the longtime Berkshire-influenced Washington Post Company—manage their business with the short-term expectations of Wall Street’s Finest in mind. And, as Bob Shaw proved, Wall Street’s Finest are not necessarily the audience you want to please when it comes to successfully managing a business.

2. Public companies that manage for quarterly earnings will engage in stupid, wasteful, and uneconomic transactions that actually detract from their long-term value.


I ask what else changed after they sold to Buffett, aside from dispensing with the quarterly earnings nonsense.

They shrug, look at each other, and say, “Nothing.”

Nothing?”

No. Nothing.”

Now, I know Buffett is a hands-off manager: he says it every chance he gets. But coming from a world in which corporate acquisitions are integrated by teams of finance, accounting, sales, legal, human resource and technology experts, I find it hard to believe that not even the accounting changes.

What about your external reporting?”

No change.”

But how do you report your numbers to Berkshire?”

They look at me as if I had asked how they get out of bed each morning. “We send them the numbers.”

Well, who talks to Buffett?”

Our CEO talks to his CFO.”

When Buffett says he doesn’t want to manage the companies he buys, he’s not kidding.

I ask about an acquisition their company made fairly recently—how it came about, who suggested it, and why Berkshire went ahead with it.

We thought it would be a good fit. We sent it to him.”

Did you meet with him to discuss it?”

Once.”

What did he ask?” I’m thinking now’s the chance to hear the juicy details about the kind of number-crunching Buffett does to convince himself to buy a billion-dollar company.

He just wanted to see us tell him in person we thought it was a good deal.”

He didn’t look at numbers?”

A lot of numbers had already gone back and forth,” they say.

So what did he say to you?”

He said ‘Okay, well Charlie and I want to noodle on this over the weekend.’” The man smiles: “He said that, he wants to ‘noodle on it.’

The other man says, “They took it from there.”

I ponder the notion that Buffett merely wanted to see the men tell him they thought the deal made sense. For some reason it makes a huge impression on me, although I will not fully comprehend its significance until the afternoon session when Buffett and Munger will respond at length to what, in retrospect, will be the best question of the day.

Meanwhile, my acquaintance asks the two men, “What’s it like not having that quarterly earnings pressure? It must be great.

It’s great,” they both agree. “But, in a way, the pressure is worse,” one says quietly.

Why?” we ask in unison.

Because,” the man says with a kind of quiet awe in his voice, “you don’t want to let him down.”


With those words in our ears we head past a Justin boot shop with salesmen dressed in cowboy hats, some gorgeous looking Western boots on display, and a lot of paunchy men trying them on. A small, dirt-floored rodeo ring is next door, unused for the moment.

We keep walking in that glazed-eyed sort of state of mind, overwhelmed by the crowds, the noise, and the booths selling GEICO insurance, Dexter shoes, See’s Candies and even Berkshire-Hathaway playing cards (Warren is the King and Charlie is the Joker), until we stumble across the most surprising display in the entire hall: Ginsu knives.

Yes. Warren Buffett owns Ginsu knives.

Actually, Warren Buffett controls Berkshire-Hathaway, which owns a conglomerate called Scott Fetzer, which owns Douglas Quikut, which manufactures Ginsu knives.

Despite the name and the old TV ads with the Japanese chef slicing a shoe, Ginsu knives have nothing to do with Japan, or Japanese culture. Never have.

“Ginsu knives” were created here in America, and they are manufactured in Walnut Ridge, Arkansas.

Whether a company can profitably manufacture knives—let alone boots, shoes, and T-shirts—in America is one of the many subtleties about Berkshire-Hathaway that I begin to think about as we head back inside the arena for the second portion of the Q&A with Warren and Charlie.

Shortly after we take our seats—a much easier task since probably a third of the crowd (and more than half of those seated in the directors and family section, including Bill Gates) will not return for the second half of the meeting—Buffett gets what I think is the best question of the day.

It comes from a young shareholder, who wants to know how Warren and Charlie decide when a person can be trusted.


To be continued…



Jeff Matthews
I Am Not Making This Up

© 2007 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

10 comments:

Anup said...

I appreciate your posting of these stories. Thank you!

Richard said...

I appreciate your efforts. Taking the time to write your impressions of the meeting is a great service.

Thank you!

Bruce said...

Jeff, Thanks for these postings. I attend these meeting every year I can. I had to miss it this year but you are giving a sterling review of the best points made. I suspect you a far more perceptive than I am which makes these articles a double bonus for me. Buffett seems to be one of those people who can look at complex problems and immediately point out the central issue, and explain it so that the rest of us understand it. Thanks again and maybe I will see you there next year.

John said...

Thanks Jeff for all the time you are putting into your reports of the meeting. Is is very much appreciated.

Phil said...

I agree. This is awesome...

Edgecliff said...

Jeff: From your very perceptive commentary my take away is that Warren Buffet is the Richard Feynman of the business world. Seems to be about 1 in a generation. I wonder who's next? PT

gsm_73 said...

Jeff thanks for the detailed posts on the meeting. I appreciate your efforts in making these entries on the meeting.

Ganesh
Dubai

Fab Five said...

Thanks Jeff for your insightful comments. Buffett is truly one in a billion.

Joe said...

Jeff,

I am not a conspiracy nut (by saying that you now think I am)I was in the silver pit when Buffett started buying silver. There were 2 explanations at the time. 1. Marc Rich* "set up" Buffett and when Buffett realized it he got out and bascially "scratched" or 2. Buffett was trying to get out of a big silver position on the books from Phibro which was owned by Salomon which was being taken over by Citi months later so Buffett used some deception (Buffett's buying) to move the silver market to get out of the old position.

Take your pick.

*Marc Rich may have also "set up" the copper trader at Sumitomo.


Great blog.

JSAL

EB said...

Your posts are much better than the dry word for word transcripts on other sites.