Wednesday, May 28, 2008

Congress Blames the Hedge Funds, Part II: Indonesia to OPEC...'See ya!'

Indonesia to Pull Out of OPEC
May 28, 2008 6:41 a.m.

JAKARTA, Indonesia -- Reduced to the status of a marginal net oil exporter, Indonesia will quit the Organization of the Petroleum Exporting Countries at the end of this year, Energy Minister Purnomo Yusgiantoro said Wednesday.

Asia's only OPEC member, Indonesia still exports natural gas, but its aging oil fields and lack of fresh investment in exploration have undermined the country as a crude producer and forced it to slash costly domestic fuel subsidies as global oil prices soar.

"Today we decided that we are pulling out from OPEC," Mr. Purnomo said. "We are an (oil) consuming country."

—The Wall Street Journal


What does the Koninklijke Nederlandsche Maatschappij tot Exploitatie van Petroleum-bronnen in NederlandschIndië have to do with the Shell Transport and Trading Company?

Both companies discovered oil in colonial Indonesia way back in the 1800s. They merged in 1907, and today you know them as Royal Dutch/Shell.

Back in the day, Indonesia was a pretty big deal when it came to world oil supply, thanks to those early oil discoveries by the Dutch and the Brits and the fact that Indonesian crude was what is known as “light and sweet,” meaning low in sulfur and easy to refine into gasoline.

Indonesia joined OPEC in 1962, two years after the Organization of Oil Exporting Countries was formed to maximize the long-term value oil for the countries that are fortunate enough to export the stuff in large quantities.

It is dropping out in 2008.

That's right: Indonesia no longer exports oil, a fact we have highlighted here in NotMakingThisUp as far back as August, 2005 [See "Instability Adds Up," August 25, 2005].

For the record, Indonesian oil production peaked in 1977 at 1.7 million barrels day, most of which was exported. The absence of 1.5 million barrels a day of light, sweet crude, much of which ended up in American cars, is the equivalent of shutting down Prudhoe Bay.

And that is a fact the geniuses in Congress might want to consider before they waste a lot more time than they usually waste—holding hearings on Roger Clemens, for example—pursuing a witch-hunt against hedge funds and commodities traders.

But, of course, since it won't help them get re-elected, they probably won’t.

Jeff Matthews
I Am Not Making This Up

© 2008 Not Making This Up LLC

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. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author.

Friday, May 23, 2008

Congress Blames the Hedge Funds—Yeah, That’s It!

I got a call from a Congressman recently.

I’d met with his staff early last year after testifying before Barney Frank’s Financial Services Committee, which was looking into hedge funds and whether the presence of so many big hedge funds was a destabilizing influence on the American economy.

[Full disclosure: I once worked for Senator Ed Brooke of Massachusetts, then under a cloud over matters arising from the fallout of his divorce—a divorce that was, as America now knows, triggered by the Senator’s affair with Barbara Walters. Barney Frank back then was the only politician with enough guts to stand by Brooke. I still like him for that.]

My colleagues and I told Frank’s committee, in essence, “No, hedge funds aren’t destabilizing—in fact they help provide liquidity.” And that’s pretty much how it worked in the ensuing credit crisis that began about three months later, although it was clear at the time that a few on the committee weren’t convinced.

Now, this particular Congressman I spoke with recently was in no way the least intelligent of the bunch asking questions in that room. (Carolyn Maloney was what might politely be termed the “least value-add,” from what we saw: she read a statement that basically indicated she wasn’t going to listen to a word of what we said, asked a question that indicated she wouldn’t know a hedge fund from a tomato, and then headed out the door for something else.)

This particular guy seemed bright and interested in what we had to say, and his call this week wasn’t completely out of the blue (I’d made friends with a staffer, who was working on energy policy). He sincerely wanted to know what I thought was driving oil prices higher.

I explained the fact that a) world oil demand is up 12 million barrels a day since 2000, and non-OPEC oil supply is up only 4 million barrels a day since 2000, and b) America decided to convert food into ethanol at the very moment that c) China's demand exploded.

That’s pretty much the whole story, but the Congressman wasn’t buying it.

What about hedge funds, he wanted to know. What about all these traders carrying all these contracts?

I asked him how they had anything to do with it.

“Well there’s so much more oil traded than really exists,” he said. “Isn’t that driving up the price?”

I explained that's pretty much the way it is with anything...stocks, bonds, oil, you name it.

He didn't believe it. Then he said Congress is considering reducing the amount of oil contracts traders can buy and sell. “Won’t that reduce the price of oil?”

I explained that maybe if Congress had taxed gasoline and funded mass transit instead of giving tax breaks for SUVs and ethanol we wouldn’t be forced to go begging the Saudis for more oil.

It went downhill from there.

I figure maybe he’s been having coffee with Carolyn Maloney.

Let's hope my Congressman isn't.

Jeff Matthews
I Am Not Making This Up

© 2008 Not Making This Up LLC

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. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author.

Wednesday, May 21, 2008

Evil Empire’s New Motto: “We’ll Pay You to Like Us”

Microsoft hopes to make gains on Google in the lucrative business of Internet search through a new service that pays consumers who buy items they find through the software company's search service, according to people familiar with the company's plan.

The software maker is rolling out a service called "Live Search cashback" that gives consumers money back on certain purchases of products found through Microsoft's Web search service, the people said.

—The Wall Street Journal

So what happens at Microsoft Board of Directors meetings, anyway?

Does Steve Ballmer PowerPoint them to death?

Do they keep a dozen Glade air fresheners on the table to mask the stench of dead products?

Or do they just lace the ice water with long-term memory loss drugs to keep directors from wondering out loud about the repeated failure of whatever new products are not sufficiently lashed to its aging operating system monopoly to keep Microsoft users just that—Microsoft users?

How else to explain the latest idea—which we are not making up—to pay cash to people not to do a search on Google?

Does anybody on Microsoft’s Board remember the “Dot-Net” initiative—the last time Microsoft was going to revolutionize the Internet?

Gates, in his role as Microsoft's chief software architect, rolled out a retooled company strategy that would integrate its software with the Internet and make it easier to swap information between computing devices.

Among the prototypes were computers that recognize voice and can answer back, a digital book and notepad that can recognize natural handwriting and connect to the Web, and cell phones that let users dictate email.

"The Internet is the starting point," said Gates, and the Web browser is the "universal canvas" upon which the information landscape will be painted.

"It's a bet-the-company thing," Gates said, speaking to several hundred analysts at the…briefing in describing the "dot-net" initiative.

That “bet-the-company thing” happened eight years ago, and as far as I can tell, my
Dell noteback does not “recognize” my voice and “answer back” when Microsoft Word mysteriously freezes and I curse it.

Maybe Carl Icahn is trying to shake up the wrong company.

Jeff Matthews
I Am Not Making This Up

© 2008 Not Making This Up LLC

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. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author.

Sunday, May 18, 2008

Throwing it All Away, Forever—But at Least They’ll Get Re-elected!

Polar Bear Decision Reached

The Interior Department is listing the polar bear as a threatened species because of declining Arctic sea ice. Scientists have projected that up to two-thirds of polar bears could disappear by mid-century because of sea-ice losses.
—May 15, 2008

Saudis Rebuff Bush on Oil

With U.S. voters seething over gas prices, Congress is considering a grab bag of ideas: Withholding arms sales to Saudi Arabia until it ramps up production by one million barrels per day; opening up the Organization of Petroleum Exporting Countries to anticollusion lawsuits in the U.S.; and tightening regulation of oil trading.
—Wall Street Journal, May 17, 2008

Ah, to be an elected official in America!

We use too little mass transit, consume too much energy, and one result is we’re helping destroy the planet. So the solution is…to threaten the Saudis and hope they give us more oil!

Forty years from now—most of you reading this will still be around to see it—the polar ice will be reduced to the point that polar bears as a species will be firmly heading towards extinction.

But gas prices right now are so high that in six months Congress might loses their jobs.

Guess who they’ll pander too?

Hint: the constituency that doesn’t vote.

Jeff Matthews
I Am Not Making This Up

© 2008 Not Making This Up LLC

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. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author.

Friday, May 16, 2008

Immelt to Wall Street's Blackjack Dealers: “Hit Me!”

GE May Shed Storied Appliance Unit

May 15, 2008; Page A1

General Electric Co. is preparing to sell or divest itself of its century-old appliances business, one of the best-known American consumer brands, as Chief Executive Jeffrey Immelt seeks to revive his weakened conglomerate.

GE could receive between $5 billion and $8 billion from a sale of the business, according to people familiar with the matter. A sale would come as the company faces pressure to trim a portfolio that ranges from credit cards to aircraft engines to television broadcasting, following a disappointing first-quarter earnings report.
—The Wall Street Journal

“Gin rummy managerial behavior (discard your least promising business at each turn) is not our style.” —Warren E. Buffett, Berkshire Hathaway “Owner’s Manual”

“Hit me!” —Jeff Immelt, GE CEO, to Wall Street Investment Banking Blackjack Dealers

Not much more than a year after GE agreed to buy oil service company Vetco Gray from a private equity group for 3.5 times the PE group’s cost; and a bit less than a year after GE backed out of a head-scratching deal to buy two of Abbott Lab’s diagnostics businesses for what looked like 25-times trailing 12-month operating income; and one month after GE reported shockingly poor earnings from one of the few AAA credits left in this world, comes the announcement of further asset-shuffling at the American business icon: the sale of the GE appliance business.

What gives?

Did Jack Welch—whose on-air rant (“Here’s the screw-up: you made a promise that you’d deliver this and you missed three weeks later…”) helped loosen the fast-shifting earth beneath his successor’s feet so quickly that Immelt is now described as “embattled”—leave so much of a mess behind him after twenty years' worth of “delivering” on promises that nobody could stop the cracks from spreading under the whole foundation?

Or is Jeff Immelt really that bad a CEO?

If we had to bet, it'd be on the former, not the latter.

Jeff Matthews
I Am Not Making This Up

© 2008 Not Making This Up LLC

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. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author.

Wednesday, May 14, 2008

Scenes from an Annual Meeting

First we go back in time, to May 3, 2008:

It is 3:30 p.m., Central Standard Time—1:30 p.m. Pacific Standard Time—and the giant exhibition hall in the Omaha Qwest Center is filled with dozens of Berkshire Hathaway companies selling their wares to thousands of Berkshire shareholders.

Nothing is free here—not the Ginzu knives or the Fruit of the Loom t-shirts with Warren and Charlie stenciled on them—except some Wrigley gum being given away to celebrate the recently-announced Berkshire-financed Wrigley buyout by Mars Company. (Thanks, Warren!)

Still, the place is packed—and not just with shareholders.

Suddenly there is a rustle of unusual activity, and Bill Gates goes by, surrounded by autograph-seekers and television cameras, smiling and looking like he has not a care in the world.

Now Sue Decker—the President of Yahoo—comes along. She is walking with her family and friends, heading over to the dirt-floored rodeo ring near the Justin Boots sales floor, where two huge long-horned steers are motionless as statues.

She is smiling, relaxed. In brief, she looks like Bill Gates, her fellow Berkshire board member, just did: on top of the world....

Sharp-eyed readers will note the time highlighted above. They will also recall what happened later that day, as reported in the Wall Street Journal:

In a subsequent telephone conversation with Mr. Ballmer, the Microsoft CEO told Mr. Yang that Microsoft was ending its pursuit of Yahoo. Mr. Ballmer sent his letter to Mr. Yang around 4 p.m. Pacific Time Saturday officially withdrawing Microsoft's offer.

If Bill Gates and Sue Decker were involved in the minute-by-minute details of Microsoft’s bid for Yahoo—and Steve Ballmer’s subsequent withdrawal of that bid, announced an hour and a half after their paths more or less crossed in the Qwest exhibition hall—it didn’t show at the Berkshire meeting.

Still, anybody who expected Microsoft to randomly jack up its offer for Yahoo just for the sake of making a few vocal Yahoo shareholders happy clearly does not understand the profound impact Warren Buffett has had on Bill Gates.

And Warren Buffett never pays up for anything.

Jeff Matthews
I Am Not Making This Up

© 2008 Not Making This Up LLC

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. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author.

Sunday, May 11, 2008

Hold the Presses: Rupert Outbid!

Cablevision Close to Newsday Deal

Tribune Co. is close to a deal to sell its Long Island newspaper Newsday to Cablevision Systems Corp. for $650 million, according to a person familiar with the situation.

If successful, the bid from the Long Island cable operator will have beat out matching $580 million offers from News Corp., which owns the New York Post and The Wall Street Journal, and New York Daily News owner Mortimer Zuckerman. News Corp. had an informal agreement for Newsday, but was unwilling to match Cablevision's offer and revoked its bid on Saturday.

—Wall Street Journal Online

Before you read this, please swallow your coffee and place the cup firmly on the counter. Then put away any sharp objects that might be nearby. Now, sit down and take a deep breath.

Rupert Murdoch has been outbid for a media property.

That’s right. The canny folks at Cablevision apparently decided that it made sense to get into a bidding war for a newspaper property. Against Rupert Murdoch. Who had synergies with his own New York Post—our newspaper of record.

And Cablevision appears to have “won” the bidding war, according to Rupert's own Wall Street Journal.

Now, we don’t know the precise revenue or cash flow figures for Newsday—it a small part of Tribune Company, which went private last year. But we do know that Tribune’s publishing revenues dropped 11% in the first quarter of 2008.

And classified ad revenue fell a bit more sharply: 27%.

So it’s a fair bet that Newsday’s numbers aren’t exactly up-and-to-the-right, like Google. Still, we’re sure the folks at Cablevision know what they’re in for: just think how they’ve elevated professional sports in New York City.

But we can’t wait to read the New York Post story on this deal first thing in the morning.

Jeff Matthews
I Am Not Making This Up

© 2008 Not Making This Up LLC

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. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author.

Friday, May 09, 2008

Berkshire Update

We here at NotMakingThisUp made it to the 2008 Berkshire meeting thanks only to the remarkable efficiency of, and we are not making this up, NetJets.

That happy ending rescued us from the normal United Airlines nightmare situation of a plane full of people which, in the pilot's words, "broke" after two hours on the runway in Chicago and returned to the gate without a Plan B in place.

The full story will be coming down the road. In the meantime, normal posting will resume here Monday.

Monday, May 05, 2008

Pilgrimage Concluded: “This is a Rational Place”

Note: Originally published June 26, 2007.


Scary-Smart, With Visions of Fatness

I always thought Warren Buffett was irreplaceable.

He seemed to be a genetic mutation of sorts—not merely a smart, self-confident, and supremely logical thinker who’d cornered the market on value-based investing, but a man with a preternatural ability to do precisely what he and his partner, Charlie Munger, seek of his eventual successor at the helm of Berkshire-Hathaway:

“We’re looking for someone who doesn’t only learn from things that have happened, but can also envision things that have never happened.”

That's how Buffett put it during the question and answer session of this year's Berkshire-Hathaway shareholder meeting, when asked about the search to replace the seemingly irreplaceable “Oracle of Omaha.”

“Many people are very smart, but they’re not wired to think about things that haven’t happened before.”

And it was precisely Buffett’s apparent ability to see the unforeseen that had caused me to finally get on a plane bound for Omaha—after years of reading his annual shareholder letters and studying the shareholder meeting transcripts that, before the internet came along, were passed like samizdat among the growing legions of Berkshire followers—to see the irreplaceable Buffett in the flesh.

I wanted to witness the Berkshire-Hathaway phenomenon just once, before his mystical powers had diminished—or worse—and the company’s leadership had passed to younger, lesser individuals.

And I’m glad I did it...manual-locking rental car and shirtless-shareholder-in-the-parking-lot notwithstanding.

My own personal apprehension of Warren Buffet’s apparent clairvoyance came nearly thirty years ago, almost the very first day I started on Wall Street.

It was 1979, not long after the Iranian revolution had triggered the second great oil shock in a decade, and I’d been hired out of college by a major Wall Street firm to be an oil analyst, albeit an extremely junior one. It was lucky timing on my part, since oil prices had recently tripled and, for reasons that now escape me, were widely expected to hit $100 a barrel in another year or two.

Practically from the day I started all anybody on Wall Street wanted to hear about was oil and oil stocks—even if the person doing the talking was an extremely junior analyst who knew next to nothing about the real world, let alone investing in general and oil stocks in particular.

Strangers asked for tips on the elevator, and I gave them. It was quite the heady experience.

Meanwhile, a heretofore successful investor out of Omaha, Nebraska had begun accumulating a large position in General Foods, the predecessor of today’s Kraft Foods and owner of such stalwart brands as Maxwell House, Birdseye, Post and Kool-Aid.

Hard as it is to imagine now, packaged food companies back then were considered slow-growing, dull businesses—victims of a decade's worth of oil shocks and wage-and-price controls. Their stocks were for value-investing chumps and coupon-clipping widows and orphans, not performance-hungry fund managers.

Given Wall Street’s infatuation with oil stocks, few people outside his then-small band of loyal followers could understand Warren Buffett’s infatuation with General Foods.

Indeed, by the time Berkshire-Hathaway had accumulated 9% of that company’s shares in a stock market that was only too glad to sell, the question around Wall Street had changed from the initial, curious “What is Buffett thinking?” to the jaded, cynical “What is Buffett thinking?”

What Buffett was thinking, I learned by reading those shareholder meeting transcripts, was “shelf space.”

General Foods’ key asset, he explained, was the supermarket shelf space commanded by its brands—Maxwell House coffee, Birdseye frozen foods and Post cereals, not to mention Kool-Aid. Since no supermarket could do without ‘em, General Foods was able to price those products high enough to earn a superior return on investment, even in an inflationary cost environment, with everybody expecting oil to go to $100 a barrel.

Of course, oil never went to $100 a barrel. It never even got to $50 at that time.

It stopped instead at about $35, because something happened that our spreadsheets—Wall Street research departments were among the first to get a new invention, the “personal computer,” which enabled us to construct wonderfully complex and totally meaningless five-year earnings forecasts—hadn’t taken into account: demand for oil dropped.

In fact, it collapsed.

And as demand collapsed, so did oil prices (eventually down to $10 a barrel). Things stopped going against packaged food companies and started going for them. With costs declining and demand rising, General Foods made a killing, thanks to all that shelf space.

By the time Wall Street got around to realizing the inherent value of “shelf space”—and people had stopped talking to me on the elevator except to tell me which floor button to push—General Foods had been acquired by Phillip Morris, to the enormous benefit of Berkshire-Hathaway’s balance sheet, Warren Buffett’s reputation, and his growing base of worshipful shareholders.

While, in retrospect, buying stock in the country’s largest packaged foods company on the cusp of the greatest consumer spending boom since World War II looks like a “no-brainer,” it was, at the time, not at all obvious.

In fact, it was entirely contrary to the previous decade’s worth of learned investment behavior. To buy General Foods in the late 1970s and early 1980s, as Buffett did, was to “envision things that have never happened.”

I began to understand why people called him the Oracle of Omaha.

Yet Buffett was no clairvoyant. He had not predicted the future. He had not foreseen the oil price collapse. He had not divined the takeover by Phillip Morris. He had not even bothered working up a five year earnings forecast on one of those new-age “personal computers.”

What he had done was much simpler, but at the same time far harder: he had correctly identified the key asset of a company, measured its worth, and judged it vastly under-priced in a stock market still looking backward at recent history, rather than forward at things that hadn’t yet happened.

The result was such a clear investment opportunity that Buffet had no need to precisely calculate the exact value of those General Food brands or to worry about how quickly he would get paid for owning 9% of their “shelf space.”

As Buffett himself said at this year’s meeting, when asked his opinion of hurdle rates and such manner of sophisticated valuation techniques,

“If somebody comes to the door, whether they weigh 300 pounds or 325 pounds, it doesn’t matter: they’re fat. We don’t need to know more.”

Yet it wasn’t until after I’d taken my seat at the Qwest Center and observed Buffett answer question after question—over thirty in the course of nearly six hours—with the firmness, confidence and constancy of a minister who has been preaching the same gospel for half a century, with only subtle adjustments to the canon, that I really grasped the full import of that central fact.

Charlie Munger corroborated the inexact nature of the Buffett method this way:

“We have no system for estimating the correct value of all businesses. We put almost all in the ‘too hard’ pile and sift through a few easy ones.”

Thus, the heart of Berkshire-Hathaway’s success is not solely the prodigious brainpower of a unique human being, it is a rational process immune to current waves of thought.

As Munger later summed it up, with characteristically profound simplicity,

“This is a very rational place.”

And since what needs replacing at the head of Berkshire-Hathaway is the extraordinarily rational behavior of an extraordinary human being, not the mystical powers of a genetic mutation, I have come to the conclusion that Warren Buffett is, in fact, replaceable.

Charlie Munger, too.

Furthermore, although the general sense on Wall Street is that, as Buffett goes, so goes Berkshire-Hathaway, Buffett and Munger will almost certainly find a capable succesor, for the two men are, not surprisingly, taking an exceedingly rational approach to the search process:

“We want to give them [several people] each a chunk of about $5 billion and have them manage it over time, as if they’re managing $100 billion. Then we’ll turn it over… We’re not looking for someone to teach, we’re looking for someone who knows how to do it.”

This is not to say “Uncle Warren,” as he is called by some of the longer-term members of the faithful, won’t be missed in his role as the colorful master of ceremonies at these annual meetings.

And it is hard to imagine anyone but Charlie Munger playing the urbane, Dean Martin-ish straight-man to Buffett’s more animated, wise-cracking Jerry Lewis. (Munger: “I don’t know anything about it.” Buffett: “Neither do I, I just took longer to say it.”)

Nor do I mean to understate the unique abilities both men possess.

First and foremost, Warren Buffet is scary-smart.

This should be obvious, but it’s easy to lose sight of, especially when the avuncular, self-deprecating “Uncle Warren” discusses both his successes—which he generally ascribes to Munger’s wise counsel or the “All-Stars” who manage the various Berkshire-Hathaway businesses—and his failures, for which he takes all the blame.

Recall Buffett’s description of Berkshire-Hathaway’s disappointing silver investment a decade ago:

“I bought too early and I sold too early. Other than that, it was a perfect trade.”

Later, he again took full responsibility when reminding his audience of Berkshire’s disastrous investment in US Air:

“I bought into a high-cost airline [US Air] thinking it was protected…but that was before Southwest [Airlines] showed up….”

Now, in the course of this brief, self-flagellating airline discussion, Buffett happened to toss off two obscure numbers: the cost-per-seat-mile of fanatically efficient Southwest Airlines (“8 cents”), and the cost-per-seat-mile of the aging, inefficient US Air (“12 cents”).

And it is no coincidence that cost-per-seat-mile is the single most important variable in the airline industry. For during the course of the day, Buffett invariably zeroed in on the most important number for whatever industry came up.

Whether it was the current circulation of the Los Angeles Times, which Buffett pegged at 800,000 during a discussion of the newspaper industry’s current problems (and which I later discovered is, in fact, precisely 815,723), or the finding costs of a particular oil company whose annual report he and Charlie had read recently, Buffett knows what to look for:

There was no discussion of finding costs in the [CEO's] letter…” he said indignantly of the oil company report, “…because of course it was a terrible figure.”

As one who started life on Wall Street as an oil analyst, I can say that “finding costs”—the money an oil company spends to discover and develop its oil reserves—is hands down the single most important indicator of an oil company’s long-term value. It beats revenues, margins, reserves, and anything else you can think of.

And, despite the fact that less than 3% of Berkshire-Hathaway's $65 billion portfolio is in U.S. oil stocks, and only one at that (Conoco Phillips), Buffett knows exactly what he's looking for when he reads their annual reports.

Thus it is that whether he’s talking about food companies or airlines or newspapers or oil companies, Buffet has clearly made it his business to identify the single most important variable for each business—and knowing those crucial variables, he can determine whether the values offered in the stock market at any given time are attractive, or not.

Without using a spreadsheet.

Still, it is not enough that Buffett himself is scary-smart: there is a reason Charlie Munger is his partner, confidant, and closest advisor.

While Munger does occasionally lapse into grumpy-old-man syndrome—he dismissed the potentially catastrophic impact of global warming by quipping “It would be more comfortable if the world was a little warmer,” and his mail-order-bride-with-AIDS crack went over like a lead balloon—he is every bit Buffett’s peer in the realm of the mind.

It is probably no coincidence that one of Berkshire-Hathaway’s least profitable investments was the aforementioned silver trade, which in fact was Buffett's idea alone.

Yet it is not merely being scary-smart, and partnering with a like-minded individual to help him keep the place "rational," that has caused Buffett to make Berkshire-Hathaway a market-beating, efficient-market theory-confounding enterprise for nearly forty years.

Being in Omaha has something to do with it too, I think.

For Omaha sits smack in the middle of the country, both geographically and metaphorically. Even with jet travel, it is not all that easy to get to for anybody, let alone an eager young investment banker trying to push a bad deal, or an extremely junior analyst passing off third-rate stock tips.

The buildings are mostly solid brick and granite: insurance companies, not investment banks, dominate what skyline there is. The streets are wide and quiet. Even the river flows relatively undisturbed, allowed to flood its banks in places.

In this quiet environment it is no wonder, I think, that the following is how Buffett described his and Charlie’s frenetic activity during the 1998 worldwide financial panic:

“We knew during the Long Term Capital Management Crisis that there would be a lot of opportunities, so we just had to read and think eight to ten hours a day.”

I can tell you that not very many people on Wall Street—or in any other financial capitol around the world—were “reading and thinking” during those fear-crazed days when a highly leveraged hedge fund nearly brought down the system.

Being thus removed from what he calls the “electronic herd,” Buffett can ignore the short-term distractions of Wall Street, and focus on the long term opportunities for his shareholders.

And by "long term" I don't mean one year or even three years:

“You need to see five to ten years out,” he told his shareholders at one point.

And those shareholders are willing to wait. After all, they have been waiting—some for as long as forty years—and they have been amply rewarded for doing so.

Being in Omaha, and having perhaps the most patient shareholder base in the world, allows Buffett to wait, and eventually act, on those visions of fatness.

Now, Warren Buffett isn’t above a little self-promotion.

That movie at the start of the morning session was nothing if not a panegyric to Warren Buffett. And he is, I am told by reporters who have dealt with him over the years, surprisingly accessible, particularly when the story in progress is not necessarily flattering, as during the AIG-General Re "finite insurance" flap of a few years back.

Furthermore, he’s a proven master at setting low expectations—something many of today’s CEOs attempt to do so that Wall Street analysts will be pleasantly, if artificially, "surprised" with the actual results:

“When you see last year’s [insurance profit],” Buffett had cautioned early in the meeting while reviewing the Berkshire-Hathaway earnings report
, “look at it as an offset to future losses.”

And when Charlie Munger later warned shareholders, “We won’t make the kind of returns on these [new investments] we made on investments 10-15 years ago,” Buffett immediately chimed in: “We won’t come close.”

Of course, both Buffett and Munger have been saying these kinds of things for ten or fifteen years, at least, and their shareholders know enough to expect more, because unlike the typical Fortune-500 CEO who attempts to raise his stock’s value by setting artificially low expectations and beating them modestly in the short-run, Buffett and Munger have been exceeding their shareholders’ expectations for decades.

It is early Sunday morning, the day after the shareholder meeting and our trip to the Nebraska Furniture Mart.

Outside it is still dark and raining. The storm clouds that had opened on our way to dinner last night were part of a heavy weather system that spawned tornadoes in Nebraska and other parts of the Midwest over night. One destroyed an entire town in Kansas, I find out after turning on the Weather Channel.

Getting home is looking tricky.

Instead of waiting for the lackadaisical hotel shuttle, I split a cab to the airport with a man who does not appear to be a member of the Berkshire-Hathaway shareholder crowd. While most of the people we saw at the Qwest Center yesterday were older, paunchy, and quite relaxed, this guy is young, fit, and quite impatient to get to the airport.

Turns out he works for Warren Buffett.

As we talk, I discover he’s with an insurance business acquired by Berkshire-Hathaway in the recent past. And while he had only first met Buffett the night before at an insurance dinner following the shareholder meeting, he knows quite a bit about Ajit Jain, Buffet’s ace “super-

cat” insurance man.

Jain handles the so-called super-catastrophic insurance policies that Berkshire-Hathaway makes a specialty of underwriting, at great profit. Mike Tyson’s life, billion-dollar Pepsi contests, earthquakes and town-destroying tornados are the stuff of Ajit Jain’s territory, and he is a legend in the business, thanks in part to Buffett’s frequent mentions in the shareholder letters, as well as his reputation as the insurer of last resort.

I ask my fellow cab-rider his impression of Jain, and he gives me the two-word answer you might have expected by now:


Then he shakes his head.
“Ajit never writes anything down. But he remembers every number you ever gave him.”

He could, of course, be describing Warren Buffett.

The trip to the airport is brief so our conversation ends quickly. He leaves for his flight, and I for mine. The sky lightens as the sun rises, and the rain mutes to a drizzle. My flight leaves on time, lifting off over the muddy river and the brown, flooded fields, up into the clouds. The trip home is smooth and without incident.

Berkshire-Hathaway without Warren Buffett will not be the same company, but that is not saying anything nobody didn't already know. Furthermore, the great investment returns of yesteryear will diminish with or without him—the law of large numbers will see to that.

I also suspect Buffett’s successor will find that the Berkshire stable of businesses—at least those outside the core insurance operations, such as Fruit of the Loom, See’s Candies and especially Nebraska Furniture Mart, from which Buffett has been draining much cash over the years—would do better over the long term as publicly traded companies in their own right.

But as Charlie Munger told shareholders, “Berkshire has a very strong culture that will continue after we are gone.”

And whatever scary-smart individual they find who fits that culture should do okay, so long as he or she maintains the key strengths of Berkshire-Hathaway, which Buffett neatly summed up near the end of the day:

We have good businesses, deal from strength, always have a loaded gun, and have the right managers and people and an owner-oriented culture.”

But whoever replaces Warren Buffett will need one more thing:

They'll need a Munger, to keep the place rational.

The End

Author's Note:

This rumination on the Berkshire-Hathaway annual meeting would not have been possible without the following:

Chris Wagner, whose plastic “Shareholder” badge—and years of prodding—actually got me inside the place.

Whitney Tilson of Value Investor Insight, whose 33 typewritten pages of Berkshire-Hathaway Annual Meeting Notes supplemented my own—oddly enough—33 handwritten pages of notes, when memory failed or my notes were incomplete. Please read his notes at

The readers of this blog, whose patience and encouraging feedback prompted a much fuller contemplation of the Berkshire-Hathaway annual meeting than I ever intended—to my own benefit, if not their own.

Jeff Matthews
I Am Not Making This Up

© 2007, 2008 NotMakingThisUp LLC

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.

Sunday, May 04, 2008

Pilgrimage, Part X: On The Cheap

Unexpired Time, Blinking Screens and What Might Have Been

Warren Buffett takes pride in his cheapness.

“My suits are expensive, they only look cheap on me,” he likes to say, being as self-deprecating as he is tight-fisted.

Cheapness defines more than his personal proclivities, however; it also defines his investment style. For not only is Buffett cheap, but, as the CEO of a deep-pocketed insurance giant named Berkshire-Hathaway, he buys entire companies cheap.

And those companies, once in the Berkshire fold, adopt his personal and professional proclivities: they spend cheap—the better to generate excess cash for the great Warren Buffett to invest…cheap.

How cheap is Warren Buffett?

In his 2006 letter to shareholders—which runs 24 pages, so seriously does he take his own advice that a CEO should communicate directly to “the people who gave him the money”—Buffett re-tells the story of Berkshire-Hathaway’s $8.6 million purchase of National Indemnity from Jack Ringwalt, 40 years ago;

“Jack was a life-time friend of mine and an excellent, but somewhat eccentric, businessman… When we were due to close the purchase at Charlie’s office, Jack was late. Finally arriving, he explained that he had been driving around looking for a parking meter with unexpired time.”

Far from being annoyed at the delay, says Buffett, he was delighted:

“That was a magic moment for me. I knew then that Jack was going to be my kind of manager.”

I suspect the “magic moments” of most public company CEOs run more towards the thrill of a successful initial public offering, or a blockbuster major mega-merger announcement, or the first time they were served a dry martini on the corporate jet—not from hearing about the search for unused time on a parking meter.

But that’s Warren Buffett. And, hey, it’s worked: he is, after all, the most successful investor in the world.

Still, is penny-pinching for the sake of penny-pinching always a good thing when it comes to running a business?

Is the CEO in the story, who drove around the block looking for unexpired time on a parking meter (and the story must be true, because from what we have seen, the streets of Omaha do have a lot of parking meters on them), the kind of CEO who’s going to maximize the value of a business not just in the short-term, but also in the very, very long term?

Some readers will, no doubt, answer with an emphatic “Yes” and quickly name a relevant example.

My own personal favorite is probably Great Lakes Chemical, the Indiana-based bromine producer that expanded and adapted over the years into a large, yet still notoriously tight-fisted specialty chemicals company.

I recall the CEO of a Great Lakes competitor telling me, with awe, about a visit to Great Lakes’ bare-bones corporate office, where the lights in the conference room were operated by an old-fashioned light timer, like the timers that control heating lamps in hotel bathrooms.

Not only did Great Lakes save money on their lighting bills, he pointed out, but “the meetings were real short,” what with executives having to get up to turn the lights back on every ten minutes or so.

Now, if you’re thinking the Great Lakes Chemical people sound like Warren Buffett’s kind of managers, you’re right. Berkshire-Hathaway bought 7% of the company in 1999—a move that paid off six years later, when Great Lakes sold out to a competitor.

Still, while the Great Lakes Chemical stock provided Warren Buffett and others with an excellent return on their investment, the Great Lakes Chemical company didn’t survive.

Could both the company and its stock have done even better if there’d been less focus on the utility bill and more focus on new growth opportunities? In the long run, is running a business on the cheap—cheapness for cheapness’ sake—a good thing or a bad thing?

That question pops into my head as we follow a long line of cars snaking into the Nebraska Furniture Mart parking lot, which is actually many parking lots of various sizes and shapes connecting the huge buildings—and by “huge” I mean airplane hanger size-huge—that comprise the Midwest’s largest home furnishings store.

The buildings are scattered in such a random fashion across 77 acres of what used to be prairie that it feels as if each time they outgrew a building, somebody decided to put up the next building right here, without much forethought as to how it all fit with any of the others.

It reminds me of nothing so much as an old-fashioned lumberyard.

We park in the general vicinity of the electronics store, which Nebraska Furniture Mart opened in 1995. Large flags on the nearby lamp-posts display various electronics brand names, simultaneously enticing shoppers into the store, as well as reminding them where they parked.

The entirely unintended effect of these flags, however, is to plainly age the place, for there is not a single new or even semi-new brands that electronics shoppers care about these days—Garmin, for example, or LG or even iPod.

Instead they are older, stodgy brands such as IBM and Hewlett Packard and Maytag and Whirlpool. Some of the brands no longer even exist in any meaningful fashion. The one near our car, for example, reads “Compaq.”

They might as well advertise Underwood Typewriters.

That out-of-dateness sets the tone for the entire place, which, while every bit as big and eye-popping as Buffett’s fond mentions in his annual shareholder letters, is fraying around the edges—like a Wal-Mart Super Center three or four years after the grand opening.

And we haven’t even gone inside yet.

Not helping matters, I will admit, is our having to go through the clumsy manual door-locking sequence of this GM rental car, nor is it a plus that when we start walking towards the main entrance we witness the oddest sight of the entire day: a middle-aged couple changing their clothes in the dubious privacy of Nebraska’s Largest Parking Lot.

I am not making that up.

The husband and wife have obviously come a long way to attend the shareholder’s meeting—their minivan is packed with gear—and they appear to be changing into more formal attire for a shareholder reception being readied under a big white tent that rises on a far corner of the Furniture Mart property.

Yet they are doing it—at least the husband is, muscle shirt and all—while standing under the flipped-up hatch of the minivan. We move on quickly, before we can see what the wife might be planning.

Once inside, the electronics store seems like an extremely huge, but extremely basic, electronics store. The prices on a few familiar items appear to be nothing very special, although we are not here to conduct an in-depth price check.

Nevertheless, the place does project a deep-discount feel that gives a shopper the impression they could do no better, and probably a whole lot worse, elsewhere.

The cash registers are busy, and easily one-third of the adult shoppers are wearing their plastic Berkshire-Hathaway “shareholder” badges. They wear the badges not out of mere habit, but because they will get a steep discount on their shopping here this weekend.

As Buffett noted in his shareholder letter with pride, Nebraska Furniture Mart generated $30 million of revenue during the 2005 shareholder meeting weekend—almost 10% of this location’s annual total sales (there are two other Marts: one in Kansas City, and another in Des Moines).

Which, I suspect, makes Berkshire-Hathaway the only public company to routinely earn a profit on its annual meeting.

Nevertheless, the merchandizing is familiar to anyone who has shopped in a Best Buy or a Frye’s—aisles of CDs, DVDs, telephone products, boom-boxes, stuff. There is a small but crowded iPod display and an empty Microsoft Zune display.

Then we reach the heart of the store, which consists of two giant, crowded aisles along which big screen televisions are displayed, floor to near-ceiling level. Given Buffett’s own innate, er, cheapness, it makes sense that Berkshire-Hathaway's own shareholders would be savvy enough to cash in their discount on the biggest dollar value item in the joint.

After all, why waste it on a DVD?

We squeeze through browsers, customers and clerks to the far end of the store and make our way back down an adjacent aisle with the computer displays—a relatively bare-bones but decent offering that includes Macs. This strikes me as fairly impressive, since Best Buy only recently got authorization from Cupertino to roll them out.

Still, the general warehouse-type aura of the store feels out-of-date, particularly now that most electronics stores are downsizing, not upsizing.

After all, an aisle or two of music CDs can be carried on an iPod these days, and Volkswagen-sized stereo systems have shrunk to the approximate width and length of a beer can.

It’s not merely that big is no longer better: big is no longer necessary at all.

Even Best Buy, which helped drive the supersizing of American electronics retailing, is cutting its prototype store size by one-third.

It is while contemplating this that I come upon something else far more unsettling at a nearby register. The Nebraska Furniture Mart computer monitor on which one of the sales people is checking something for a potential customer is an ancient, pre-Windows type of screen—the kind with block white letters and a blinking white cursor.

I haven’t seen this kind of ancient point-of-sales software in a large chain in so long I can’t remember where I last saw it. Dollar General, maybe?

Of course, not having the latest and greatest software isn’t necessarily a sign of back-office chaos. For all I know, the Nebraska Furniture Mart computer systems might offer every piece of vital information a sales person or an accounts payable staffer needs, at a keystroke.

But I doubt it.

And I doubt it even less when we move on and I see an open door to a small room, which contains a bunch of less-than-cutting-edge servers stacked on cluttered shelving. Makes me wonder not only how up-to-date this place really is, but how secure the systems might be.

Retailing has, after all, come a long way since 1983 when Buffett bought Nebraska Furniture Mart on a handshake from Rose Blumkin, the late Russian immigrant whose motto—“Sell Cheap and Tell the Truth”—could, with a minor adjustment (replace the “Sell” with “Buy”) be Buffett’s own.

And electronics retailing has come even further, what with the constant downward spiral in prices, fickle consumer tastes, accelerating product cycles and the rise in online shopping.

Disappointed and not having spent a dime, we head outside and cross a busy driveway to the Main Event—the furniture store.

It is big, cavernous and long. Very long. The longest store I have ever walked through.

Fully loaded showrooms meld into one after another—a seemingly endless display of sofas, recliners, tables, and chairs. And that’s before we even get to the lighting area, which appears to offer every fixture ever created since Thomas Edison patented the thing.

Which reminds me: here we see even more of those old-fashioned computer screens with blinking white cursors at the customer service desks.

There is no doubt the shoppers are here—whether they are University of Nebraska students getting ready for summer school or Berkshire-Hathaway shareholders loading up on discounted La-Z-Boys.

And there is no doubt the place has grown from the single-store brainchild of Rose Blumkin—“Mrs. B,” as she is reverently known—to a three-store Midwest home furnishings powerhouse.

But why, I wonder, is the Nebraska Furniture Mart not a national phenomenon?

Why, 74 years after its modest beginnings, are there only three stores in the entire United States?

"Well," you might say, "this was a family-owned Nebraska retailer in the middle of nowhere, with a limited product line and no Wall Street big shots pulling the strings—so what’s wrong with three stores and a half-billion or so in very profitable sales?"

Not a thing, certainly—except that another family-owned Nebraska retailer in the middle of nowhere, with a limited product line and no Wall Street big shots pulling the strings managed to rack up over $2 billion in very profitable sales last year, its 45th year in business.

Like Nebraska Furniture Mart, this retailer operates huge stores in out-of-the-way places (ever hear of Hamburg, Pennsylvania?) and puts the customer first.

Unlike the Mart, however, this company's stores are modern, lively and fun to shop, even if you couldn’t care less about hunting or fishing gear—which is what they sell. There's even an ice-fishing department, if you can believe it.

That company is Cabela’s.

And if a retailer of hunting and fishing gear (U.S. market size: $30 billion) could grow into a $2 billion enterprise, why—with a little more capital investment over the years—couldn’t Nebraska Furniture Mart, which sells home furnishings, for goodness sake (U.S. market size: $250 billion), be a whole lot bigger than a mere half billion or so by now?

Lest readers think I am picking unfairly on Nebraska Furniture Mart, the question also holds for See’s Candies, I think.

In 1994, See’s sold $216 million worth of chocolates and sweets, mostly in the western half of the U.S., earning $28 million after-tax.

Of that, See's spent a modest $4 million on expansion and turned in the $24 million balance to Berkshire-Hathaway for Warren Buffett to invest as he saw fit.

That same year, another west-coast company sold $284 million worth of consumables in shops mostly on the west coast, on which it earned $10 million after taxes.

Unlike See’s, however, this company was growing: it spent $136 million on expansion and didn’t pay a penny of dividends to its shareholders.

Today, See’s is still a west-coast business, with about 200 shops and, I am guessing, perhaps $500 million in sales generating as much as $75 million in cash for Berkshire-Hathaway.

That other west-coast firm, however, now has over 13,000 shops around the world, sold nearly $8 billion worth of coffee last year and generated almost $1 billion in pre-tax profits.

I am talking, of course, about Starbucks.

Both Starbucks and See's make an excellent product, have an excellent brand name and earn excellent returns on capital. The biggest difference, as far as I can see, is that one invested their capital to grow; the other invested it, well, in other companies.

I am reminded of Charlie Munger’s remark earlier today, when he said, “If a business is good, it will carry a lousy management.”

How long, I wonder, can a good business carry an owner who does not reinvest in that business?

It is a question that, until our walk through the cavernous halls of the Nebraska Furniture Mart, had not occurred to me.

Time to go. It has been a long day.

The air outside the Mart is cooling down thanks to threatening dark clouds rising up in the southern sky. We drive out of the parking lot and head back downtown. I haven’t seen or heard a thing about the outside world all day, and I’m hoping whatever those clouds are going to bring, it won't happen early tomorrow morning when my flight is scheduled to take off.

After the crowds at Mart, the hotel feels almost empty. There are some people in the bar, and a few more waiting near the main door, dressed for dinner and clearly waiting for friends or acquaintances.

I head up to my room. It’s straight out of the 1970’s—polyester bed spread with a dark, stain-hiding motif; a basic alarm clock on the night table and a shower that somehow leaks a flood into one corner of the bathroom floor unless the shower curtain is sealed with duct tape, which I don’t have.

The view out the window is to the north side of town, overlooking some construction, an office building, and, a few blocks away, a giant sign for Sol’s Pawnshop that for reasons I haven’t bothered to analyze vaguely calls to mind the giant eye in The Great Gatsby.

I suppose it has to do with the irony that such a literal sign of economic need could exist in city limits that are also home to the accumulated wealth of the greatest investor the world has, literally, ever known.

I had planned to take a walk towards Sol's with my camera after our excursion to the furniture mart, but parts of the city center do not have a particularly safe feel, and when I had asked a cop outside the Qwest Center if there was any area I particularly would not want to walk, he had nodded in the direction of Sol’s, and said, “Don’t go north.”

Instead, I pack for the morning flight and head downstairs for dinner.

We intend to walk the five or six blocks to Old Town, but after half a block, those clouds really look ready to break, so we decide to drive, even if it means the convoluted door-opening routine, which is getting tedious.

Three blocks into the drive, the clouds get purple and then black. They open up just as we find a parking spot and run inside the restaurant, feeling vindicated, having sized up the situation and, as Buffett had advised, tried to “look ahead to see danger where others don’t,” even if it merely applies to a little rain.

The restaurant is packed with shareholders, and getting a table will take too long, so we eat at the bar and review the day.

It has been far more than I bargained for.

To be concluded…

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.

Friday, May 02, 2008

Pilgrimage, Part IX: Avoiding Catastrophe; Some Bad Advice; and One Unanswerable Question

Note: This was originally published June 6, 2007. We are republishing our series on the 2007 Berkshire annual meeting as we prepare for the 2008 meeting.

Warren Buffett crooks his arm so he can check his watch one last time.

It is close to three o’clock, more than seven hours since we walked through the main doors into a jam-packed Qwest Center. The arena is now barely half-full. Even the roped-off area on the floor, where directors and their families were seated at the start of the meeting, is almost empty.

In the upper deck, where we have enjoyed the extra space left behind while most others moved closer to the stage, the cement floors beneath the stiff plastic seats are littered with Coke bottles, popcorn bags, and, of course, newspapers.

My trusty, old-fashioned steno notebook—no computers or recording devices are allowed here—is nearly full, stuffed with thirty-three pages of scrawled quotations from the two men still seated on the small stage far below.

There, Charlie Munger sits in his familiar position: arms folded, head bowed. Buffett, after checking his watch a final time, announces the session is finished.

The Berkshire-Hathaway annual shareholders’ meeting is adjourned.

Actually, only the Q&A portion of the meeting is over just now, Buffett tells us. The true business portion of the shareholder’s meeting—in which votes are counted and directors are elected—will start again, after a short break.

In fact, Buffett encourages the crowd to “stick around” for it, because, among other things, that proposed divestiture of Berkshire-Hathaway’s PetroChina holdings—which he earlier told us had been defeated 25-to-1 “even excluding my own vote”—will be debated.

It should be an interesting discussion,” he says, quite earnestly.

But we are not sticking around.

For one thing, while Buffett may be right about the PetroChina debate, the business portions of shareholder meetings are usually very dry and formal affairs—a sort of kabuki without the makeup, involving legal language, calls to order and seconds to nominations.

All that fluff, of course, is required to handle the nuts and bolts of corporate democracy—mainly shareholder votes on such fantastically boring topics as whether or not to reappoint the auditor, as well as board of director elections, which
are normally about as suspenseful as a Kennedy race in Massachusetts.

That is not to say shareholder meetings need to feature Warren Buffett and Charlie Munger sharing a small stage for five-plus hours of high-level Q&A in order to be worthwhile.

Quite the opposite.

In fact, shareholder meetings are often highly informative and well worth attending, especially for small companies that escape the attention of Wall Street’s Finest—the analysts who, for the most part, follow companies the way dogs run: in packs.

For starters, the smaller the company, the more interaction a shareholder can have with management before, during and even after the formal shareholder meeting itself.

Also, small companies tend to attract a loyal contingent of long-time investors who, like the Berkshire-Hathaway shareholders making the trek to Omaha year in and year out, faithfully appear to ask questions of their company’s stewards. And they take that opportunity very seriously.

In turn, the senior executives of those companies usually respect their shareholders’ earnestness as highly as Buffett has shown he does. During many such question and answer sessions, in fact, I have heard CEOs call on the shareholders by their first names—as, I imagine Buffett himself used to do, before he became “The Oracle of Omaha,” and the scene began to resemble an Elvis concert.

Finally, you’d be surprised how much worthwhile information a polite question from an aging retiree can elicit from a CEO.

In the weeks after returning from Omaha, for example, I will attend the shareholder meeting of a small New England-based technology company whose CEO will share with those present the kind of details on order backlogs and revenue targets that no CEO would dare speak of in the presence of Wall Street’s Finest.

He will do this not for the sake of hyping his company’s share price, but merely to explain to serious individuals who could be his grandparents how he plans to return their company to profitability.

It isn’t “The Oracle of Omaha” discoursing with pith and merit on the evils of gambling—“a tax on ignorance”—and the secret of long-term investment success—“avoiding catastrophe.”

But it is worthwhile.

Still, we are leaving the Qwest Center once and for all. Aside from the general restlessness that comes after nearly seven hours of serious concentration, and the fact that the PetroChina resolution to be debated at the business session has already lost, we have a more pressing reason.

We want to use what remains of our useful available time today to investigate one of the Berkshire-Hathaway enterprises operating right here in Omaha.

Oddly enough, I have found the last six and one half hours—from the start of the movie to Buffett’s last glimpse at his watch—less informative about the nuts and bolts of Berkshire-Hathaway itself than most annual meetings I’ve attended.

With so much high-level discourse about the state of the world—from the U.S. dollar (“It’s going down”) to the inadequacies of a portfolio theory concept known as ‘beta’ (“Beta is nice and mathematical, but it’s wrong: it is NOT a measure of risk,”)—there has been almost no discussion of the Berkshire-Hathaway businesses themselves.

The names of those businesses have been flashing all day across a bright electronic band ringing the balcony between levels of the Qwest Center arena.

They start with Acme Brick and end in XTRA Corp, and in between are familiar brands such as Benjamin Moore paints, Fruit of the Loom underwear, Dairy Queen, Johns Manville and the Nebraska Furniture Mart, along with many unfamiliar brands.

Familiar or not, we learn almost nothing new about them aside from Buffett’s comment at the start of the meeting, during the brief review of first quarter earnings report, that,

“Most of the non-insurance businesses did fine.”

He does not define “fine,” nor does he give any detail about the impact of the homebuilding downturn on Shaw Industries, Acme Brick and the other residential construction-related businesses within the Berkshire portfolio, except to say they were “hit, and in some cases hit hard” by it.

Then, with absolutely no numbers to back it up, Buffett boasts,

“Compared to other companies in the sector our managers are doing a sensational job.”

Finally, he engages in a bit of crowd-pleasing cheer-leading by concluding his quarterly review with the uplifting message that Berkshire has “the best managers, and the best shareholders, of any company.

The rest of the session has been about the dollar, the stock market versus the bond market, private equity, derivatives, currency speculation, Klamath River dams, Florida insurance regulations, railroad stocks, the virtues of See’s Candies, the intrinsic value of Berkshire-Hathaway stock and precisely what Buffett is looking for in his search for a replacement.

To this last, Buffett says he will be giving billions of dollars to several money managers and watching how they do over a period of time—no gunslingers need apply:

“We will need somebody who basically doesn’t do any dumb things, and occasionally does something [smart].”

While today was a wholly worthwhile and intensive personal immersion in the Buffett philosophy, it is a philosophy I have studied for decades, reading not only his annual shareholder letter, but also the shareholder meetings transcripts as well. Thus I find myself leaving the Qwest Center knowing very little I didn't already know about Berkshire-Hathaway itself.

I am not suggesting Buffett avoided speaking to the topic: I simply don't think anybody in the building particularly cared enough to ask.

After all, if you had a chance to ask Warren Buffett a question, you’re probably not going to ask how Fruit of the Loom is going these days.
You're going to ask about something more along the lines of Buffett's secrets to becoming a fabulous investor.

Still, it is a fact that Berkshire-Hathaway owns Fruit of the Loom, a vertically integrated apparel manufacturer with those cute ads showing, well, fruit. It is also a business that must surely be getting the daylights squeezed out of it by big customers such as Wal-Mart on one end, and low cost imports on the other.

“We do not want to buy a business with a high labor content that can be shipped from overseas,” Munger has said near the end of the afternoon session, yet Fruit of the Loom is mostly that.

We hear not a thing about it—not even an update on how Fruit of the Loom's recent acquisition of U.S.-based fleece-maker Russell Corp has helped, or hurt, its competitive position.

See’s Candies, to pick another brand name from the flashing sign ringing the arena, is certainly not a candidate for low-cost competition from China, as with Fruit of the Loom, but it must certainly be getting squeezed on the expense side of the business.

Fudge, after all, is made with sugar, coco, butter, corn syrup and lots of energy.

Yet we hear nothing about those issues, or about the company’s expansion plans, or where See's fits in a world in which giants such as Hershey and Cadbury are gobbling up the competition in order to spread rising costs over bigger volumes and move into the developing countries that are quickly evolving into seriously big markets.

See’s “international” operations consist of two stores in Hong Kong, three in Japan, and some sales in Mexico. How much future sales and profit potential might See’s—and future Berkshire-Hathaway shareholders—be missing out on by settling for life as a fabulously profitable, money-dividending, niche product?

As for Iscar Metalworking, the Israel-based company Buffett acquired last year, footage of whose human-free factory floor drew wows during the movie, there is not one word about its current business or the potential return on the $5 billion Berkshire-Hathaway plunked down for a controlling share.

If Buffett isn’t going to say anything about this, and if no shareholder is going to ask—at least, no shareholder who got in line at 1 a.m. the night before in order to get one of the precious seats at the microphones—then we’re going to have a look for ourselves at one of the most highly spoken of stars in the Berkshire firmament.

We head down escalators along with most of the others leaving the Qwest Center and walk out into the warm, humid air—the remnant of overnight storms that are due to get more serious later tonight and on into tomorrow morning, when I plan to fly home.

The rental car is hot and stuffy—and bizarrely we can’t unlock the doors using a regular old door-unlocking clicker. The driver has to use the key to unlock the driver door, and then he has to scootch over the front seat to unlock the passenger door from the inside.

I am not making this up.

General Motors, in what appears to be a last-ditch attempt to restore profitability to precisely the kind of business Warren Buffett wouldn’t touch—high labor content products made by low-cost foreign competitors—has apparently concluded that one way to solve the fact that it loses money on each car it sells is to try to discourage people from buying them in the first place.

How else to explain the fact that the passenger has to wait outside, sweating, for the driver to physically unlock his door, and then stretch across the seat to open the passenger door from the inside?

Not only that, but in order to put our gear in the back seat, we have to climb over seats to unlock the back doors from the inside.

If GM’s intent is to showcase terrible cars through their rental fleets, they are succeeding.

It actually feels like it's taking more time to get inside the stupid car than it will to drive out to the Nebraska Furniture Mart on the western outskirts of Omaha, which is where we are heading.

Eventually, we're behind the wheel and in minutes leave the modern aluminum-and-glass Qwest Center behind for the more familiar, plain-spoken look of the brick and granite high-rises in the city center.

After a few more minutes and a half-dozen traffic lights, we leave behind downtown Omaha entirely. The office buildings have given way to bars, insurance brokers, and apartment complexes.

As I look out at the cracked sidewalks and brick buildings, I wonder about the advice Buffett had given to the girl from Kentucky, who asked in a timid but clear voice “What would a ten year old do to make money?

Buffett wisely suggested she “look for what people don’t want to do for themselves,” before describing some of the many various enterprises he had tried at that age, and then concluding with a suggestion that reveals more, I think, about his age than about the real world:

“A paper route is a good idea.”

In fact, a paper route is a pretty lousy idea these days, what with the demise of afternoon newspapers, the automobile-demanding sprawl of suburbia and the decline of 1950’s style Leave It to Beaver-type neighborhoods, all which make the early-morning distribution of heavy reading materials by a 10 year-old girl on foot or by bicycle a complete non-starter.

Not to mention contract labor issues and all the potential legal liabilities that come with sending a minor out on foot into stranger’s houses.

In fact, most newspapers these days require route prospects to have a valid drivers license and insurance, and frequently hire only those 18 years or older.

Picking up on Buffett’s observation that nobody would invent the newspaper in today’s Internet economy, I would have suggested the girl find something to do with the latter, not the former.

But I am not Warren Buffett, and only one bum response out of the thirty-plus questions thrown at him is a sensational ratio for anybody of any age—especially considering that with only two exceptions Buffett answered every question at length and in varying degrees of detail.

The first exception was a question about the merits of the New York Stock Exchange merger with Euronext, which elicited a brief, non-committal answer from Buffett, followed by a classic bit of dialogue between him and his partner:

Charlie Munger: “I don’t know anything about it.”

Warren Buffett: “I don’t either, I just took longer to say it.”

The second exception was a question about healthcare. Specifically, “What can Berkshire-Hathaway do to solve the healthcare problem?” a shareholder from Salinas, California wanted to know.

This elicited the briefest responses of the day. Buffett simply shrugged and said, "It’s too tough." Munger added, “We can’t solve that one. We try to look for easy problems.”

The apartment buildings yield to grassy blocks and houses, and then the University of Nebraska campus suddenly appears on both sides of the street.

A very busy intersection signals that we are approaching our destination, and we turn off there and see in the distance a motley collection of huge buildings out of the airplane-hanger and lumber yard schools of architecture.

We follow a line of cars snaking into one of the many parking lots, find a space, go through the laborious process of manually locking every door in the car, remind ourselves that we are never buying a GM car EVER, and look for signs guiding us to the nearest entrance of the largest retail enterprise I have ever seen.

It is the Nebraska Furniture Mart, and inside its cavernous walls I will see a stunning assembly of merchandise and hordes of eager buyers, in an environment that, in certain respects, seems nearly as out of date as Buffett’s advice to the 10 year-old girl from Kentucky—“a paper route is a good idea.

I begin to wonder just how healthy these businesses we have learned almost nothing about might be.

To be continued…

Jeff Matthews
I Am Not Making This Up

© 2007, 2008 NotMakingThisUp LLC

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.

Thursday, May 01, 2008

Pilgrimage, Part VIII: Who Do You Trust?

Originally published June 1, 2007.


Body Language, "What They Laugh About," and Mail-Order Brides

I know, I know—it’s “whom do you trust?”

But that sounds a bit too snooty for this gathering of Berkshire-Hathaway owning, Warren Buffett-idolizing folk.

After all, they come from what might be called, metaphorically speaking, the solid middle of the country, even if technically speaking a large portion hail from the two coasts, not to mention many foreign countries.

They are also, almost entirely—and I mean it literally—white.

Now, that is not a premeditated observation on my part. It never crossed my mind that the racial mix of Berkshire-Hathaway shareholders would find its way into my notes—nor did I expect to find myself counting heads.

However, to not notice the few African-Americans at the Qwest Center while sitting in the arena, or standing on line for lunch, or walking around the exhibition hall, would be like going to a Yankees-Red Sox game at Yankee Stadium and not noticing the Red Sox fans: they just stand out.

And when I say the “few” African-Americans, I mean precisely eight in total: six men and two women.

You can blame what follows on the influence of listening to Warren Buffett for half a day, because Buffett has a way of putting numbers into strikingly clear perspective that's contageous, and probably poorly imitated on my part. For example, at the start of the meeting he reported on a shareholder resolution calling for Berkshire to divest its PetroChina position this way: only 1.8% of all shareholders had voted for the resolution, he said, adding,

“Even if you leave out my personal vote, it was a 25-to-1 vote in opposition.”

Consequently, I find myself examining the racial mix of the shareholder meeting in this way: having seen eight African-Americans out of the many shareholders I could see clearly enough to notice a skin color; and assuming by day’s end I will have seen one quarter of all 27,000 shareholders in attendance; I extrapolate a total of 32 African-Americans are at the Qwest Center.

Arbitrarily tripling that strikingly low number to 96 and dividing 96 by 27,000 yields an African-American shareholder constituency of 0.35% of those present—less than half of one percent.

Since African-Americans comprise approximately 13% of the United States population, their “share” of Berkshire-Hathaway stockholders is not even a tenth of their overall “share” of the US population as a whole.

But, you might ask, so what?

This is, after all, America, and nobody’s stopping anybody from buying a stock—let alone from attending an annual meeting.

Besides, you might well ask, is the Berkshire-Hathaway shareholder racial mix any different from a gathering of you snooty Wall Street hedge fund types?

In fact, the answer is no. It is not much different at all.

The disparity I’ve noticed out here in the, metaphorically-speaking, at least, middle of America, is something I’ve witnessed up close and personal for 28 years on the business end of Wall Street.

In those 28 years I have known exactly two African-American investment professionals (that does not include several others I’ve known of or admired from afar, such as John Rogers of Ariel Capital).

And of those two, one was immensely successful, the other immensely not.

The successful one was a technology analyst who worked harder than anybody else in the business and knew more about his companies—and not just about the numbers, but also about the software they sold—than any analyst on Wall Street, whatever their skin color.

His counterpart was likewise an analyst, and not only an African-American, but also a woman. And this was back in the days when there were only a handful of female analysts on Wall Street, and they were considered pioneers.

Being a woman on Wall Street is no longer a novelty, of course—close to half the analysts I know and depend on for ideas are female, although not many run hedge funds. African-American analysts—and hedge fund managers—are, still, even more scarce than female hedge-fund managers.

That successful technology analyst I mentioned went on to help run a giant software company.

What happened to his counterpart, I have no idea, but I think of her—nervously smoking (you could smoke inside office buildings in those days) as she tried to finish reports that never seemed to get done, burdened by pressures I could not even begin to imagine—as we resume our seats for the afternoon session, and I wonder whether Buffett sees an inequity when he looks out into the arena.

Probably he does not, given the lights shining on the stage, which cause him to shield his eyes whenever he looks for an individual out in the crowd—as when a question about Florida’s new insurance laws causes him to search for Joe Brandon, the CEO of General Reinsurance, to handle the question.

Still, Buffett does project a compassionate sensibility throughout the day.

In response to a question about recently announced plans to give away his fortune, Buffett dismisses the notion that his commitment to donate $37 billion worth of Berkshire-Hathaway stock to various charities is some kind of sacrifice on his part.

After all, he says, he still does exactly what he loves doing every day.

A sacrifice, he goes on, is “if someone gives up…a trip to Disneyland because they donated [to a charity]…”. He says flatly, “I haven’t given up anything.”

At another point, discussing the meltdown of the sub-prime debt market, Buffett calls the teaser rates and other no-interest loans practices that triggered the current bust “dumb lending and dumb borrowing.”

But he seems most offended by the high, hidden fees the mortgage brokers pulled out of the deals thanks to the easy available credit and the naïveté of the borrowers. The fallout, of course, will hurt those who can least afford it:

“You’ll see plenty of misery,” he says.

Charlie Munger, on the other hand, projects a colder, more aloof sensibility on stage, rarely unfolding his arms even while he makes a point by leaning slightly towards the microphone on the desk before him.

Adding his two cents to Buffett’s comments on the sub-prime debacle, Munger says that it is in the nation’s interest “to give loans to the deserving poor,”

“However, the moment you give loans to the undeserving poor or the stretched rich, it’s trouble.”

It isn’t clear to me who the “undeserving poor” might be, aside from the people who got screwed—there’s no other word for it—by their mortgage brokers.

Still, the meeting moves on, and it is later in the afternoon session Munger lets loose a quip that results in the single most uncomfortable moment of the day—and shocks a good portion of the crowd.

It occurs in response to a rather bland question regarding Buffett and Munger’s views on the usefulness of “hurdle rates.’

“Hurdle rates” are standard MBA fare—the minimum rate of return a company or an investor like Buffett requires before spending capital or buying a business. Whether it is a fixed number, such as 10%, or keyed off a company’s cost of capital, it represents a figurative “hurdle” the contemplated investment or acquisition must get over.

Hence, “hurdle rate.”

Buffett, as you might expect, does not pay much attention to such textbook notions. He re-states comments made earlier in the day that equity investments in general ought to beat the return offered by treasury bonds. But the precise calculation is one he makes very informally:

“I’ve never done a spreadsheet, except in my mind.”

Munger chimes in by saying while the notion that a potential investment ought to hit a minimum standard return “makes nothing but sense,” people make “terrible” mistakes by depending on them, since they provide an artificial notion of what is acceptable.

He advises investors to consider a wide range of investment options and “think about the returns from each” before committing money, rather than making what could be a poor or mediocre investment simply because it theoretically exceeds a given hurdle rate.

Now, while Buffett tends to be energetic and wide-ranging in his answers, Munger seems to always be formulating an amusingly sardonic, pithy summation of his view on a given topic—which he will then deliver to the obvious delight of the crowd.

Sometimes he surprises us, and gets a good laugh, with nothing more than a simple, dry, emphatic “No,” when the longer-winded Buffett asks, “Charlie, you want to add something?”

Usually, however, it is an amusing metaphor or a crisply harsh judgment, such as his simple conclusion to their discussion of why Berkshire-Hathaway does not invest in the gaming industry:

“It is a dirty business.”

So even after his unusually long dissection of “hurdle rates” as a poor substitute for using common sense, we are expecting a zinger of sorts as Munger winds up his thoughts.

This he delivers, but not quite as we expect.

Speaking of the hidden surprises that may await an investor who depends solely on “hurdle rates,” Munger says, and I quote more or less verbatim:

“It’s like the fellow who orders a mail-order bride, and it turns out she has AIDS.”

Some people laugh reflexively—this is, after all, Charlie Munger speaking, “The Joker” in the Berkshire-Hathaway deck of cards. We have become used to chuckling each time he drops a line.

But the laughs freeze and there are gasps as the crowd collectively wonders, “Did he really say that?” Then the arena goes uncomfortably silent while Charlie sits back in his chair, arms crossed, no expression on his face, and Buffett hastily calls for the next question.

The point Munger was emphasizing is now lost in the vast, darkened auditorium.

That momentarily dark mood does not, however, erase the lingering impact of what has been, for me, the most interesting answer of the day to the most interesting question of the day, from one of the many budding Buffetts in the crowd.

The young man started out by telling Buffett that, while he can research a company’s financial statements and read the analyst reports, he can't really tell much about management from the numbers or the reports.

How, he asks, does Buffett know which people he can trust? How does an investor learn who to trust?

It’s a great question, and Buffett seems stumped trying to explain it.

He talks about small investors getting taken advantage of by unscrupulous advisors, about the “good luck” he and Munger have had avoiding such scams, and how they have been about "90%" successful in finding good people.

However, while their experience has been “overwhelmingly good,” Buffett says, he and Charlie “filter out a lot of people.”

Then he describes the filtering process, and it has nothing to do with numbers. It has to do with meeting people face to face:

“People give themselves away,” Buffett says. “When they come [to meet us]—the very things they talk about…. There are a lot of clues in the things they think are important.”

What he’s talking about is “body language.”

Cops are taught to read it; reporters watch for clues in it—and Warren Buffett uses it to help him make investment decisions.

I attended a citizen’s police academy years ago, and one of the sessions was given over to interrogation techniques. I remember the Sergeant summing up how he judges when a suspect may or may not be telling the truth:

“If he looks up, that’s recall; if he looks left or right, he’s making it up.”

It's the old shifty-eyed thing, and it doesn't just apply to petty thieves; it applies to management teams, too. I’ve never understood those Barron’s interviews with money managers who go strictly by numbers. Some of them actually take pride in not meeting with management. They say it helps them avoid mistakes.

Still, Enron's numbers, which turned out to be a fiction, caused a lot of investors to make a big mistake.

That's why I can't buy something if I've never met the CEO and the CFO, and I find it especially striking that the greatest investor who ever lived is talking less about numbers and more about body language.

Munger takes it even further, noting how they quickly rule out deals that merely seem, on the surface, too easy:

“We’re deeply suspicious if it sounds too good to be true.”

He describes one such deal—an insurance company that supposedly only wrote fire insurance on underwater concrete bridges, and draws a laugh.

Buffett picks up on this—it’s not just the numbers or the body language behind the numbers that matters, he says, but how the numbers themselves are presented and the language that is used:

“They [promotors] make certain kinds of comments… What they laugh about... They say ‘it’s easy’… It’s never easy. We get suspicious very quickly [if the numbers sound too optimistic]. We rule them out 90% of the time.”

I recall the Berkshire-Hathaway manager telling us during the lunch break that Buffett wanted to see him in person—not to make a detailed presentation on the proposal, but:

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

Buffett had the numbers. But he wanted to see it in their faces.

The information load is taking a toll. As the questions get less interesting, I take a quick, head-nodding-to-the-chest kind of nap, and snap out of it, refreshed, while Buffett is answering a question about the New York Times and whether the dual-class shareholding structure of that company has something to do with its problems.

Buffett discourses on the poor economics of newspapers in an Internet age, as he has done in other forums, by asking rhetorically if anybody would choose to invent the newspaper as a form of news distribution today—costly, untimely and inflexible as it is.

The obvious answer is no.

Still, for all his hard-nosed observations about newspapers being a dying business, Buffett’s only real clunker of a piece of advice will come in response to that 10-year old girl from Kentucky mentioned previously...and it will involve newspapers.

To be continued…

Jeff Matthews
I Am Not Making This Up

© 2007, 2008 NotMakingThisUp LLC

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.