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.

Monday, April 28, 2008

Pilgrimage, Part VI: The Most Versatile Investor in the World

Note: This post, part of series on the 2007 Berkshire Hathaway annual meeting in Omaha, Nebraska, originally appeared May 22, 2007.
_______________

Mr. Matthews, I am a fan of the blog. As a college student and investor, I generally enjoy your sharp and objective insight. That said, I recently started following the news about OSTK [Overstock.com]…... your CNBC interview did not help the cause. Byrne may tell a wild story, but he clearly carried the debate….

--PadawanCowboy


Thus began the first of what would be many comments in support of Patrick Byrne, the CEO of Overstock.com, posted on this blog in the fall and winter of 2005 by an individual identifying himself as “Padawan Cowboy.”

If you haven’t heard, Patrick Byrne is a self-styled “crusader” who’s spent the better part of two years attempting to convince the world that a coalition of short-selling hedge funds, “crooked” reporters, lax SEC regulators, Israeli mobsters and others who all take their direction from a James Bond/SPECTRE-style “Sith Lord” threaten the stock market as we know it.

You might well ask why anyone would take such stuff seriously.

The answer is that Patrick Byrne is not only the CEO of a public company, but he has an interesting pedigree: his father is Jack Byrne, the legendary insurance executive who turned around GEICO for Warren Buffett and looms large in the Berkshire pantheon of Great Managers.

Patrick himself once even ran a Berkshire apparel subsidiary.

For the record, “Naked short-selling” is a term for selling a stock short without first actually borrowing the shares being sold. Now, I have worked on Wall Street almost 30 years, and aside from a case reported in the Wall Street Journal, in which a rogue employee sold short shares of small companies in Canada without borrowing the stocks—for which he was successfully prosecuted by the SEC—I have never heard of, known of, or worked with anybody—anybody—who didn’t borrow a stock before shorting it.

Never. Not once.

But now, at the Berkshire-Hathaway shareholder’s meeting, my own 28 year’s worth of experience is being put to the test by a serious, slightly breathless, man—the kind of guy you wouldn’t want to make eye contact with at Starbucks—who is asking a question as if:

1) He is about to expose the biggest scandal since Teapot Dome, and;

2) Government agents acting in cahoots with hedge funds and Byrne’s “Sith Lord” intend to cut off his microphone before he can spill the beans.

The question he asks is, what does Buffett think of the “naked short selling” problem in this country, and what can be done to protect the companies whose stocks appear on the fail-to-deliver list “for hundreds of days.”

Now, if anybody is going to be able to contradict my own measly 28 years’ worth of experience on this and any other issue, it is Warren Buffett and Charlie Munger, whose combined investment experience exceeds 120 years.

But it’s not just a matter of age and longevity that causes 27,000 individuals to troop out to the middle of the United States and sit for five or more hours listening to Buffett and Munger answer questions of all stripes—even conspiracy-theory bunk like naked shorting.

It is to witness first-hand what am I beginning to understand is one of the less heralded secrets to Buffett’s extraordinary success: the breadth of his experience and his knowledge of pretty much everything that has happened on Wall Street since World War II (and much of what happened before he started), as well as what is happening right now.

For in seeing and hearing Buffett respond to question after question, it becomes clear he is not merely the deep-value investor with an aversion to computers (except for playing online bridge) who spends his days reading annual reports and CEO letters until one day deciding to buy 7% of Coca Cola or 11% of Burlington Northern, as he has been portrayed in some of the books.

He is in fact one of the most versatile investors in the world.

“We’re not limited,” he says, when asked about the merits of alternative investment vehicles such as managed futures funds
(which he does not care for); “we buy businesses, bonds, currencies, futures….”

And he’s not kidding.

Take derivatives. During today’s meeting Buffett will repeat his past his warnings about the risks posed by the explosion of derivatives in today’s financial markets (some day we will get “a very chaotic situation” he tells us), and he will emphasize his first-hand experience with the matter by reminding shareholders that Berkshire took a $400 million loss on a derivatives portfolio that had already been marked down to what was thought to be fair value.

Yet Buffett then goes on to say quite matter-of-factly,

“We have 60 derivatives” in the Berkshire portfolio
. “And believe me,” he says, “we’ll make money on all of them.”

We believe him.

Not only does Buffett know derivatives, he also knows currencies. In response to a question about his bearish view of the US dollar, Buffett says it will continue so long as spendthrift US policies continue, and declares:

“We think the dollar will decline and we had a $21 billion bet that way, although the carry cost made it too difficult to keep…so we’ve focused on buying companies that earn money in foreign currencies.”

He then leaves his audience hanging with a terrific teaser:

“We have one currency position that will surprise you,” he says.
“We’ll tell you about it next year.”

Now, think about that statement for a minute.

Consider it from the perspective of a nervous, coffee-buzzed, chart-addled Wall Street currency trader whose position book changes by the hour, if not the minute or the second. I know just such a currency trader who opened an office in Germany in order to save the milliseconds it took to send electronic orders across the Atlantic Ocean, giving him an advantage over certain of his U.S.-based counterparts.

Yet Buffett is talking about a currency position he quite seriously expects to hold until
some time later this year.


Buffett not only knows—and does—derivatives and currencies, he also knows commodities, and a question is asked about the Great Silver Trade of ten years past, when Buffett famously bought control of 130 million ounces of silver when the stuff was going for a little more than $7 an ounce.

Current price: $13 an ounce.

Buffett ruefully acknowledges leaving money on the table:

“I bought too early, I sold too early. Other than that it was a perfect trade,” he says, getting a laugh.

Note here that Buffett uses the nominative singular pronoun “I” and not the plural “We.” Berkshire’s silver trade was Buffett’s alone—although Munger does not distance himself from the rare mistake when he concludes the matter by saying flatly:

“I think we demonstrated what we know about silver.”

Throughout the day, questions about derivatives, currencies and commodities compete with duller and more arcane issues raised by shareholders, all of which Buffett discourses on with ease and absolute knowledge.

The topics range from recent insurance legislation in Florida (and nothing is more important to Berkshire than insurance) to those electricity-generating dams on the Klamath River causing problems for Native Americans and non-native Americans alike (Buffett claims his hands are tied by the Federal Energy Regulatory Commission, which controls what happens to the dams).

And, of course, the “naked shorting” question asked by the guy-you-don’t-want-to-make-eye-contact-with-at-Starbucks.

Buffett starts his response with a sort of amused recap of the question for Munger:

“It’s about this so-called failure-to-deliver and naked shorting.”

Note the qualifier, “so-called.” Buffett—who knows more about investing than any living American—is clearly not impressed by any supposed naked shorting crisis.

With sixty years of experience in the business, he understands what anybody with even a passing familiarity with our profession knows: no borrow, no short. Whatever is causing those stocks to appear on that list of failures-to-deliver, it is not large hedge funds shorting naked.

Buffett in fact does not even have a problem with legitimate short-selling:

“I do not see the problem with shorting stocks,” he says, noting quite correctly
, “But it’s a tough way to make a living.”

In fact, recalling that Berkshire-Hathaway made good money lending shares of US Gypsum to short-sellers when it was under seige from asbestos lawsuits, before the stock went up ten-fold, Buffett says:

“If anybody wants to naked short Berkshire-Hathaway, we’ll welcome them.”

This draws an appreciative chuckle from the audience, although not, I am sure, from the questioner, who could only have been disappointed by the frank disbelief in his cause expressed by the World’s Greatest Investor.

No doubt, too, the “college student and investor” who began posting on this blog in support of Overstock.com CEO Patrick Byrne and his naked-shorting crusade under the name “Padawan Cowboy” would likewise be disappointed, especially since the evidence suggests he was not a “college student and investor” writing about Patrick Byrne.


Like Byrne's imaginary, evil, hedge fund-commanding “Sith Lord,” a “Padawan Cowboy” is also a Star Wars figure—although a more heroic, Harrison Ford-type. And it is because of that and many other giveaways in his postings that I'd bet the Byrne-defending, naked-short obsessed “Padawan Cowboy” was Byrne himself.

We will soon break for lunch and head into the giant exhibition hall adjacent to the main arena, where the Berkshire-Hathaway companies are offering products and services ranging from Net-Jets to T-shirts to the thousands of eager, souvenir-hunting shareholders.

And it is there I will have a chance to meet members of management from one of the Berkshire companies, and finally get to find out first-hand something I have long wondered: whether working for Warren is really as trouble-free as Buffett himself would like us to think.



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.

Sunday, April 27, 2008

Pilgrimage Part V: Budding Buffetts and The Best of All Worlds


Mr. McGuire: I want to say one word to you. Just one word.
Benjamin: Yes, sir.
Mr. McGuire: Are you listening?
Benjamin: Yes, I am.
Mr. McGuire: Plastics.
Benjamin: Just how do you mean that, sir?

—The Graduate



The questions are asked politely and with great respect.

Each shareholder first states his or her name and where they live, and then proceeds to ask whatever is on their mind. Those are the rules.

The rules have been provided in a pre-meeting information package that goes to each shareholder, along with the four plastic “Shareholder” badges each shareholder receives so they may take along friends or family. (I’m here courtesy of a long-time friend and Berkshire shareholder).

The information package also has other vital information, including all the weekend shareholder events at various Berkshire-owned companies, not to mention the locations of the half-dozen Dairy Queens in the area.

After identifying themselves, most of the shareholders gush thanks to Warren and Charlie for this wonderful gathering, for their willingness to share their wisdom, and for the long-term benefits they have accrued by owning Berkshire-Hathaway stock.

At this point, the questions tend to diverge: professional investors from New York City tend to ask tightly scripted questions about potential credit problems and the derivatives market, while long-time shareholders ask more loosely constructed, but further-ranging questions, including one rambling, hard-to-follow query about Charlie Munger’s view of John and Abigail Adams.

Aside from an obviously prepared-for moment when a quiet, respectful female from the Hoopa Valley Tribe asks Buffett whether he is willing to meet with tribal leaders regarding their concerns over a Berkshire subsidiary’s dams on the Klamath River—and, unscripted, breaks down, crying—they come out of left, right, and center field.

Buffett fields them all the same way: straight ahead, spending no less than five minutes on any question (except one—more on that one later). For example, he tells the Hoopa Valley Indian that his hands are tied, because, as a condition of buying the regulated energy supplier which owns the Klamath River dams, he signed an affadivit that he would do nothing to influence regulatory matters governing the dams...and he holds up the signed papers for all to see. (The gesture
falls flat; we expect him to be willing to at least listen to what they have to say).

Still, he will not blow off a question or shorten his answer regardless of how similar the question might be to one previously asked, even though many of the questions are variations on a handful of themes.

I decide this is for two reasons: first, these are shareholders asking questions, not merely Wall Street hotshots, and they have a right to be answered in the same thoughtful way they’ve asked their questions.

Furthermore, Buffett’s mind is so precise that since every question, no matter how similar it might be to one already asked, is slightly different, Buffett can draw distinctly nuanced responses each time.


Of all the general themes, the second most common comes from younger members of the audience, generally eager young males—but also a ten year old girl from Kentucky—who want to know what career advice Buffett would give them.

The first time it is asked, a seventeen year old from San Francisco, attending his “tenth consecutive meeting,” wants to know:

“What should I do to become a great investor?”

Buffett’s emphatic answer reminds me of “The Graduate,” when Mr. McGuire famously tells Dustin Hoffman’s character, Benjamin, that one word—“Plastics”—as if it is the key to the universe.

Buffett says:

“Read everything you can.”

It is advice Buffett will give in different ways throughout the morning and afternoon.

For Buffett strongly believes—and Munger later concurs—it was the reading he did in his formative years that shaped his approach to investing and prepared the groundwork for the next fifty mind-bogglingly successful years.

And he’s not kidding when he says to “read everything you can”:

“When I was ten,” he says, “I’d already read every book in the Omaha Public Library with the word ‘finance’ in the title.”

Buffett does not advise reading any particular books, nor does he steer the budding Buffetts towards any particular investment style, even though the impact of Benjamin Graham’s “The Intelligent Investor” on Buffett is widely known.

Rather, he advises reading everything possible to find the style that suits the individual:

“If it turns you on, it probably will work for you.”

Buffett also recommends investing, “on a small scale,” to learn the trade.
“Invest, don’t just read.”

Charlie Munger chimes in, suggesting a logical approach typical of almost—almost—everything Munger will say during the session (more on that later):

“Ask (yourself) ‘What do you own and why do you own it?’ and if you can’t answer that, you aren’t an investor.”

Buffett concurs, and repeats what he has told his students over the years:

“If you can’t write an essay describing ‘why I’m going to buy the entire company at the current valuation,’ you have no business buying 100 shares of stock.”


As I said, questions from budding Buffetts will prove to be the second most frequent of the day.

By far the most frequently asked questions concern Buffett’s view of the current investment environment.

The first time a variation on this theme comes up, it is asked by a Japanese investor eager to hear Buffett’s view of the current attractiveness of U.S. corporations.

Buffett replies by marveling at the fecund level of U.S. corporate profits, noting that companies are achieving “20-25% returns on tangible equity versus 4.75% bond rates,” and this is “extraordinary.”

He means that, like most things, quite literally:

“Corporate profits [measured] as a percent of Gross Domestic Product have increased from 4-6% to 8%..." He spreads his hands widely apart.
"That's a huge change [from previous business cycles].”

“What this means,” he says, bringing his hands close together, “is somebody else’s share [of GDP] is down.”

He finds this not only “extraordinary,” but unsustainable:
“[It is] the best of all worlds; and history has shown [these extremes] don’t last.”

But he does not expect things to get a lot worse any time soon. Asked about the potential for a credit crisis, he says quite simply, “The Fed doesn’t want to contract credit.”

The last real credit contraction was thirty years ago,” he notes, and says he finds it unlikely to be repeated (the 1998 Long Term Capital crisis “was a credit seize-up,” not a credit contraction, according to Buffett).

Buffett’s generally complacent view of stocks appears to stem mainly from a comparison of equity valuations versus low-yielding bonds; and his long-term preference for owning businesses rather than debt instruments will come across throughout the day, in many different ways.

“Today, if you give me a twenty year time horizon, I’d buy equities versus a 20 year bond.”

“I would not want to own a 4 ¾% bond.”

“We’re going to want to get a significantly higher return of cash on something we buy, compared to a treasury-bond.”

Shareholders trying to square Buffett’s less-than-ebullient view of the current return potential for stocks (except as compared to bonds) with the fact that he spent $5-plus billion to buy stocks in the first quarter of the current year get a typically facile, but, to the crowd, acceptable answer:

“Have we changed our standards? I don’t think so…but if you haven’t had a date in a month….” He shrugs, and the audience laughs.

Munger adds straightforwardly:
“We won’t make the kind of returns on these we made on investments 10-15 years ago.”

To which Buffett says emphatically:

“We won’t come close.”


Question answered, Buffett moves on, checking off a number on a sheet he keeps on the table before him, and calling for a question from the next microphone.

The question comes from a man who sounds a bit too breathless and a bit too serious and a bit too on edge—like the guy who appears from out of nowhere while you’re filling up your car at a gas station and tells you he lost his wallet, has no money, and needs gas to get to his mother’s house three towns away…and can you give him any money?

What the man at the microphone wants is Buffett’s view of the naked short-selling crisis supposedly sweeping through America’s financial markets.

And, while I’m a sucker for the guy at the gas station and usually give him five bucks to get him on his way, Buffett’s answer will not be exactly what this man is hoping for.

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.



Friday, April 25, 2008

Pilgrimage Part IV: What if Bob Nardelli Had Done This Once in a While?

Originally published May 14, 2007
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The contrast to most annual meetings couldn’t be greater.

Whereas except during times of crisis, the average large company annual meeting—and Berkshire-Hathaway is a large company, with almost $100 billion in revenue last year, almost three-fifths the size of GE and four-times the size of Coke—gets modest shareholder attendance and gadfly-dominated questions from the floor, the Berkshire annual meeting draws shareholders from, quite literally, around the world.

German, Australian, Swiss, Canadian and Japanese investors—not to mention those from California, New York, Connecticut, Kentucky and elsewhere—have lined up early to ask Buffett their questions.

And it’s impossible to say how many other states and countries are represented, given the fact that only slightly more than one tenth of one tenth of one percent of all those in attendance will get to ask a question before the five-and-a-half hours are up.

What we do know is that so many international shareholders have come that Warren and Charlie will host a meet-and-great with them later in the day, for more than an hour. Buffett explains that he feels if so many shareholders have come all that way to be in Omaha, he just feels he ought to thank them.

Why is it that, hearing Buffett talk this way about his shareholders, I begin thinking about Bob Nardelli?

Nardelli is, of course, the infamous ex-GE Power Systems star whose stormy tenure as CEO of Home Depot—during which time sales doubled, earnings rose almost 150%, and yet the stock price languished—ended not long after a Nixonian shareholder’s meeting at which the public company CEO did not respond to a single question from the Home Depot shareholders who dared ask one, aside from saying “Thank you.”

In true “Final Days” style, Nardelli’s Board of Directors—the folks nominally in charge of the company—did not witness the mockery of corporate governance for the simple reason that not one of them attended the meeting.

Nevertheless, after the shareholders finally revolted, that same Board of Directors later gave Nardelli a fine send-off—$210 million worth—for what, to the stock market, looked very much like failure. (See “The Tragedie of Home Depot,” January 6, 2007.)

Still, you might well ask if it is fair that the increased sales and earnings which occurred under Nardelli should be considered “failure” merely because Home Depot’s share price flat-lined during his reign of errors?

The answer, I think, is: yes, absolutely.

While stock prices in the short run are, as Buffett repeatedly tells shareholders, quite irrelevant, and one should be comfortable owning a stock without regard to near-term fluctuations, stocks can also be quite accurate leading indicators of the business itself.

And in this case, the stock market knew what Bob Nardelli did not: it knew that his militaristic, top-down, numbers-obsessed operating style—which worked quite well at GE Power Systems—was destroying what had been an egalitarian, bottoms-up, customer-obsessed culture that, prior to his tenure, had transformed a sleepy, cyclical, low-margin industry and created one of the great retail success-stories of all-time.

The failure wasn’t hard to spot: all you had to do was visit stores and ask. But Nardelli did not even listen to his own shareholders, so why should he listen to ex-store managers?

Now, I don’t particularly like thinking about Bob Nardelli, so this is unfortunate, having him come to mind right now. The shareholder questions are moving along and I want to pay attention.

But the next question is about the seemingly outrageous compensation packages offered like candy by today’s corporate Boards desperate to get the next Jack Welch, even if he turns out to be—you guessed where I was going—Bob Nardelli.

Buffett flat out does not care much for meticulously crafted compensation systems in the first place, and he states something at once obvious and profound:

“There are more problems with having the wrong manager than having the wrong compensation system.”

It is a lesson the Home Depot Board of Directors learned the hard way. Buffett riffs further on the topic, noting that despite serving on 19 corporate boards he has only been nominated to a single compensation committee:

“They’re looking for Cocker Spaniels to go on comp committees, not Dobermans.”

As for what’s to blame for outsized compensation packages, Buffett and his partner place it squarely on the public disclosure rules which, well intentioned though they might be, have the unintended consequence of fueling compensation inflation because everybody knows what everybody else earns.

The “envy” which drives the ensuing compensation one-upmanship is hard for Buffett to grasp:

“Envy—where the hell is the upside?” he asks rhetorically. “You feel miserable…but the other guy has no idea how you’re feeling.”

Noting that envy is one of the original “seven deadly sins,” Buffett picks up a chocolate candy from the See’s box on the table before him—something he will do frequently throughout the meeting, both before the lunch break and after—and declares gluttony to be a far more worthwhile sin.

While there’s no upside to envy, “there’s upside to gluttony,” he declares, happily popping the See’s in his mouth, to laughter.



One of the less-well known aspects of Buffett’s career is that he ran a hedge fund before turning Berkshire-Hathaway into his own personal investment vehicle.

And it is no wonder the model attracted him, for Buffett is a pay-for-performance kind of guy. Following the discourse on gluttony, Buffett is asked by a Swiss investor about how to cure the executive compensation arms race, and he uses the example of an oil company that benefits from a sudden rise in the price of crude oil:

“If oil goes from $30 (a barrel) to $60, it’s crazy to pay more” to the executive management team. “But if their finding costs (for oil) were lower (than the industry finding costs), I’d pay ‘em like crazy.”

It is simple, concise and clear, and hard to argue with.

I begin to wonder how Nardelli’s tenure at Home Depot—and his impact on the company itself—might have ended differently if Nardelli, and his Board of Directors, had allowed themselves to be subjected to just such an annual session in which everything was on the table?

How many ex-store managers might have given the military-obsessed Nardelli a piece of their mind—and a real-life view from the trenches—about what was happening to the stores and their customers when his efficiency experts replaced the plumbers, carpenters and electricians with junior military officers and self-checkout stands?

How many former Home Depot customers and long-suffering shareholders might have educated Nardelli, who by then was no longer eating lunch with the masses, having created an executive dining room for himself and his Team, on the distinction between running a time-and-materials factory line and a flesh-and-blood store, if they’d been allowed to ask him a question before his fellow Directors?

Is it just the GE culture that created such an out-of-touch CEO?

Or have Wall Street’s financial innovations—Mutual Funds, Exchange-Traded Funds, Hedge Funds, Funds-of-Funds—so removed the shareholders and their money from the companies they fund that management and their handpicked Boards of Directors no longer have to answer to the shareholders in the flesh and articulate why they do what they do?

Buffett, who sets his own example of a CEO’s accountability—and willingness to hear dissenting views directly—during the five-plus hours of Q&A at his meeting, doesn’t even think the CEO should let somebody else write the CEO letter for the annual report.

“If the CEO isn’t willing to talk [through a letter] directly to the people who gave him the money…I’ve got a problem with that.”


I wonder how many other CEOs even think that way?


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, April 24, 2008

Pilgrimage, Part III: When the Math Doesn’t Work

Note to readers: This was originally published May 11, 2007 as part of a series on the Berkshire Hathaway annual meeting. We republish it here as we prepare for the upcoming 2008 Berkshire Hathaway annual shareholder meeting.

We will resume regular posts, with interruptions for further commodity hoarding bulletins, following the Berkshire meeting in early May.
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The mark of an original thinker may be that you never know how they’re going to answer a question you’ve never heard them get asked.

And when the first shareholder asks Buffett about his views on the current private equity mania sweeping the world’s capital markets—specifically, “What could cause it to bust?”—I expect him to offer a pithy warning about the silliness of running with the herd and the possible future dislocations from just such a bust—dislocations he will be happy to take advantage of, given the fabulously large cash reserves at his disposal, not to mention his eye for a bargain.

As it turns out, however, Buffett doesn’t think the private equity mania is a bubble, despite, in my view, all the evidence to the contrary, what with everything from deeply cyclical semiconductor companies to fashion-dependent retailers being leveraged up with the kind of debt loads that would make Donald Trump nervous.

It isn’t really a bubble,” he says. It is a boom, certainly, and one in which Buffett sees little to gain from blindly jumping on board. “The math has to make sense to us.” Furthermore, as if all 27,000 people in attendance don't know it already, Buffett is not into flipping companies the way private equity flipped Hertz, or Burger King, or Dominos...

"We own them forever."

As to private equity not being a bubble, Buffett points out that in order for a mania like private equity to go “bust,” as the margin-fed bull market did during the 1987 crash, it must have investors who can pull their money out quickly to trigger the kind of panic selling that both causes a crash and marks its nadir.

Private equity investors, he notes, are locked in. “It takes many years for people to take their money out” of private equity funds. Thus Buffett makes the subtle distinction between a mania that might well end in disappointment for all concerned, and one likely to end in a crash.

As for the bull run of 1987, which did end in a crash, Buffett puts the blame squarely on a mania altogether different from private equity funds: it was called ‘portfolio insurance.’

For those of you too young to remember, the wonderfully-misnamed ‘portfolio insurance’ was a financial engineering tool foisted upon institutional money managers eager to participate in the bull market of that era as it gathered steam—without the commensurate downside risk—by financial consultants eager to generate outsized compensation fees.

I still recall the day I first heard the term ‘portfolio insurance’ at one of those same institutions being pitched its wonders by the very firm that had dreamed it up.

It was some time in 1984, and I was an analyst at a plain-vanilla pension-fund shop. By “plain-vanilla” I do not mean “mediocre”: we had a lot of bright people and a great framework for investing our clients’ money. We just didn’t do anything exotic or out of the ordinary.

In fact, ‘portfolio insurance’ was about the most exotic thing I recall us ever looking at. The idea seemed goofy on the face of it—somehow, by shifting money between treasury bills and index futures, an institutional money manager could supposedly ‘insure’ a portfolio against market declines of a certain size over a certain period of time.

But I was merely a lowly stock-picker, not the chief portfolio manager. In fact, the chief portfolio manager was the smartest guy I’d ever worked with up to that point, and the decision whether to even think about the concept was his.

I recall him seated at the table in the Monday morning research meeting, stroking his long sideburns and declaring he had studied the research on portfolio insurance over the weekend.

The math works,” he said.

And, yes, it did “work,” if by the definition of “work” you mean, "Completely failed to do what it was supposed to do."

For not only did ‘portfolio insurance’ end up not insuring anybody of anything, it actually triggered the panic selling that culminated in a 22.6% one-day drop on Black Monday—October 19, 1987.

Now, by that time I had moved on to help identify acquisition candidates for a large industrial company, and later joined one of the best money management firms that ever existed, before it was subsequently purchased and destroyed by a large Wall Street firm that shall remain nameless.

Consequently, I have no idea if my former shop had actually engaged in ‘portfolio insurance,’ and, if it had, whether it was still involved when the "math" stopped working on October 19 and the forced mass selling resulted in that very Black Monday.

But it is a fact that computerized selling triggered by funds engaged in ‘portfolio insurance’ turned a Fed-tightening stock market retreat into a “bust.”

And it is the beautiful simplicity by which Buffett can synthesize complex issues with comprehensible analogies that makes these meetings what they are, for here Buffett provides one: "portfolio insurance" he says, stripping a highly complex set of financial-derivatives established by quantitative models to its essence, was nothing more than a giant “stop-loss order” on the market as a whole.

Thus, institutional money managers, or the computers they relied on to ‘insure’ their portfolios, sold stocks into the decline, causing the crash.

As Buffett says, “the math has to make sense to us,” and in the case of ‘portfolio insurance’ it clearly did not.

Next up, compensation committees, executive pay, a possible credit crisis and “the best of all worlds,” along with a question from the lunatic fringe.


To be continued…

Jeff Matthews
I Am Not Making This Up


© 2007, 2008 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.



Tuesday, April 22, 2008

We Interrupt This Broadcast to Bring You…Rice-Hoarding in America



We interrupt this reprint of last year’s “Pilgrimage to Omaha” series to bring you the most interesting news story you may well read today.

It is titled “Food Rationing Confronts Breadbasket of the World,” it was written by Josh Gerstein, and it was published in the New York Sun.

Without giving away the heart of the story, if the prospect of rice-hoarding at Costco stores strikes you as something worth reading about, here’s where to go:

http://www.nysun.com/news/food-rationing-confronts-breadbasket-world


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. It is intended solely for the entertainment of the reader, and the author.

Monday, April 21, 2008

Pilgrimage Part II: The Newspaper Generation

Note: This blog was originally posted May 8, 2007, following a visit to the Berkshire Hathaway annual meeting.

Already your editor can see mistakes: "Berkshire Hathaway" is never hyphenated, as in the first paragraph below.

Nevertheless, mistakes, warts and all, we thought it worth reprinting for readers as a countdown to the 2008 meeting early May.

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What I notice while we wait for things to start at the Berkshire-Hathaway annual meeting in the Qwest Center near downtown Omaha, Nebraska is that almost every person sitting near me is reading a newspaper.

Most are reading the Omaha World-Herald, which was available free in the lobbies of the hotels, with a ‘Welcome Berkshire Shareholders’ wrapper. Others are reading the Financial Times of London, which was being given away when we came into the Qwest Center.

Or they’re reading USA Today, or the weekend Wall Street Journal.

What they are not reading is their Blackberry. Nor are they looking at their Treos or scrolling through songs on their iPods. They're not even on their cell phones.

I haven't seen this many people reading newspapers in so long that it’s a bit jarring.

Oh, come off it, you might be thinking. He’s gone off the New Economy deep end.

But I’m not being flip about this: it’s really different. It even looks different: the social and physical essence of a newspaper reader is entirely distinct from that of a Blackberry user.

To read a newspaper you have to sit up more or less straight with the page in front of you. If you wear reading glasses—which most newspaper readers do, by definition—your head tends to tilt back, away from the page. And you don’t move much, except when flipping the pages, because it takes a few minutes to read each page.

Reading a newspaper is an open, inviting, approachable kind of posture.

Now contrast that with a Blackberry user. To read a Blackberry you hunch over the screen because it’s small and you need to shut out bright light to see the contrast. Your head is bowed so you can’t see much around you. And you’re constantly clicking or scrolling to keep the sentences coming.

It is a closed, uninviting, not-very-approachable posture.

Now, I realize this meeting is taking place on a Saturday morning, and the markets are closed, so who knows how many of these newspaper-readers have left their Blackberrys back in the Doubletree, and are simply reading to kill time.

Furthermore, I can’t actually see what all the other 27,000 shareholders and their families and friends are doing. (The crowd is so big we don’t all fit in the main arena, so thousands watch on remote screens in satellite areas nearby.) Somebody somewhere in the building is, at this very moment, flicking compulsively through emails.

But the lights in the arena are dim enough so that I can see that on the floor of the arena there is only the occasional square spot of light—literally five or six—indicating a Blackberry or cell phone in use among the people in those seats, and I have not in years seen a gathering of so many individuals who appear to prefer the crinkled feel and larger typeface of a newspaper to the wireless urgency of a Blackberry, or the companionship of a cell phone.

I’ve gotten accustomed to seeing a bunch of hunched-over, head-bent, finger flicking, well-dressed Type-As—not rows full of relaxed, studious, reading-glass-wearing newspaper readers. The place just looks different.

It’s a bit of a step back in time.

So too is the day-planner handed to me by the Acme Brick Company mascot on our way into the Qwest Center.

That’s right: a paper day-planner for the year 2008, the approximate size and shape of a college exam booklet bound by a black cover with “Acme Brick Company” in embossed gold lettering.

On the inside cover is a picture of Warren Buffett holding an Acme Brick (“Since 1891”), describing how he came to buy the company nearly fifty years after buying his first and only house, which was made of—you guessed it—brick.

I took the Acme day-planner not because I will use it, but because it reminds me of the Depression-era day-planners my grandfather used to have around his house.

My grandfather was a veteran of both World Wars, a Colonel who marched at the head of the Topsfield (Massachusetts) parade each Memorial Day. The best days of his life were fighting Germans in the fields of France in 1918, and he could talk about those days like they’d happened last week. He was a war hero with a box full of medals whose significance he dismissed whenever we asked about them: “You wave a gun at a bunch of Germans and they surrender, and somebody gives you a medal, don't you know. Nothing else to it.”

Between wars he worked at the Topsfield Co-op, which prospered even throughout the Great Depression because, as he told me once with a kind of Buffett-like simplicity: “Farmers had to feed their chickens, don’t you know.”

He even built his house during the Depression: “Gave a few men some work, that did.”

His words come back to me as I flip through the Acme Brick Company day-planner, because it looks and feels like the Topsfield Co-op day-planner he used to keep by the telephone. I saved one and keep it in a fire-proof safe.

This Acme Brick day-planner is quaint and I will never use it, but I’m going to hang onto it as a keepsake of this meeting.

Meanwhile, the arena keeps filling up, with more couples finding seats around us. They are polite, expectant, and part of something bigger. One genuine cowboy walks up the steps behind his wife, holding a plastic Wal-Mart bag, looking for seats.

At 8:20 a.m. a voice announces "The movie is going to start in ten minutes," and people on the floor of the arena—who have been mingling and moving about easily—start taking their seats, while those around us take off their reading glasses and start putting away their newspapers.

At 8:25 we notice a bustle in the center aisle on the floor, a sudden activity that generates a kind of collective arm-grabbing, finger-pointing, whispering: a man in a rumpled dark suit with unruly white hair is walking casually up the aisle towards the center of the arena, led by an efficient-loooking woman.

It is The Great One. The King. The Boss. It is John, Paul, George and Ringo all in one. It’s The Chairman of the Board himself—and quite literally, too.

It’s Warren Buffett, Chairman of the Board of Berkshire-Hathaway. The Oracle of Omaha.

He sits down in a reserved row halfway up the center aisle, presumably to have a good view of the movie on the giant screens above the small stage where he and Charlie will sit and conduct the meeting. A crowd forms around his chair, and that’s when the camera flashes start going off. Polite, nicely dressed men and women approach, timidly, to snap pictures and then retreat into the crowd which is building larger.

The flashes go off rapidly now, and the crowd closes in on the man who is sitting casually, one leg over his knee, and chatting with the efficient-looking woman who led him to his seat.

Then the voice announces "The movie will start in two minutes," and suddenly young men in suits appear and start disbursing the picture-takers, but the flashes keep going off and the men in suits do their job a bit more forcefully, pointing people to their seats, and the crowd breaks up as the lights go down and the place gets dark.

Then the movie begins.

It starts with a cartoon—a fairly long one—that plays on the well-worn theme that Berkshire’s annual meeting is a Woodstock for Capitalists.

The cartoon's central premise is that two young hippies named Warren and Charlie drive their VW Wagon to a music festival where they swap their Fruit-of-the-Loom T-shirt collection for a "groovy" soft drink called Coke, of which they sell out immediately, and use that windfall to buy a van full of See’s Candies.

During the respective selling and buying of these Berkshire-owned brands, the two hippies meet a young Bill Gates talking gibberish (to them) about some new fad called computers, a singer named Janis asking if they've seen “Bobby McGee,” and a guitarist named Jimi looking for a riff to go with the lyrics of a song he has written about “Purple Haze.”

The cartoon-Charlie Munger provides the famous riff, and Jimi goes off to play it.

Now, when I was 11, my sister made me lie down on the floor with a pair of speakers on either side of my head. “Listen to this,” she said. Then she put on an album full blast.

It was Jimi Hendrix, “Are You Experienced?

I’m not going to say that album changed my life, because it didn’t. Still, I did grow up on it, particularly the very first song she exposed me to that day—namely, “Purple Haze” (coolest part, Jimi coughing just before singing the opening verse).

And I have to believe that anybody who likewise grew up on that album knows that the core demographic of the Jimi Hendrix Experience is not exactly the Berkshire Hathaway demographic I have earlier described.

The crowd gathered in this arena to listen to two thoughtful, scary-smart, elderly men expound on the meaningless of ‘beta’ in portfolio management (“It’s nonsense”) and the folly of naked-short-selling crusaders (“There are more people bull-ing stocks for phony reasons than people bear-ing stocks for phony reasons") is not exactly out of the Woodstock Nation.

This crowd is of the Elvis Generation, and the Jimi Hendrix/Woodstock cartoon is a dud that can’t end too quickly.

Fortunately, a video of ukelele-playing Warren singing “Ain’t She Sweet” with ersatz-relative Jimmy Buffett picks things up, and is followed by an interesting film visit inside the Israeli plant Warren and Charlie got with their purchase of Iscar last year (no humans in the place—not one—and night shifts can be operated online, from the plant manager’s home).

As you'd expect, there follows plenty of Berkshire company ads, including one laugh-out-loud Geico commercial with Charlie giving a very dry customer testimonial, backed by a maniacal Little Richard.

There are very bizarre moments, like the showing of the “Mean Joe Greene” Coke commercial from 1979—almost thirty years ago—for no apparent reason at all, as well as seemingly random film clips of Nebraska football highlights.

There are also very terrific moments, like the interview with Lorimar Davidson—the GEICO executive Buffett famously interviewed on a Saturday morning in Washington D.C. after a janitor let the 21 year-old Buffett into the locked and otherwise deserted building—taped the year before Davidson died.

Mostly, the movie is a visual and audio shrine to Warren Buffett and the values, both investment and otherwise, he has consistently espoused over his consistently successful investment career. When it finally ends, we get to see Buffett in the flesh.

Only it is Jimmy Buffett, the singer, who now appears on stage with a guitar, a pair of bifocals on the end of his nose and some prompt cards on the floor at his feet, and he is attempting to play “Wasting Away in Berkshire-Hathawayville” with lyrics like “Some people say that Charlie Munger’s to blame…”

(I say “attempting” because he can't read his own lyrics and has to start over at one point.)

The song finally over, Jimmy introduces the Buffett everybody has come to see and hear, along with Charlie Munger. The two men, in conservative suit and tie, emerge from a curtain behind the stage to great applause, sit down at the table, and Warren starts the meeting.

First he introduces the directors (including Bill Gates) seated in the roped-off section down front, and then reviews in a sentence or two the quarterly earnings just announced.

It is clear right away we are in for something quite unlike your standard dog-and-pony show: rather than take credit for the wonderful first quarter results, Buffett makes sure to point out that 2008 insurance profits aren't likely to stand up to their 2007 peak (“It couldn’t get any better than it was last year, from our point of view.”)

That done, he lays out the general ground rules for the questions that will be asked by the shareholders who have lined up at a dozen or so microphones around the arena. More than thirty questions will be taken in the course of the five-plus hours, from investors of all ages (including a 10 year old girl from Kentucky) and from many countries (including an American Indian tribe).

Buffett will answer them all thoughtfully and in full—rarely discoursing for less than five minutes on a topic, and sometimes as much as ten, before asking his quiet, reserved partner, “Charlie, you have anything to add?”

The first question from the first shareholder is about the Private Equity boom. More specifically, “What could cause it to bust?”

In a gruff, folksy, matter-of-fact voice, Buffett starts to speak.



To be continued…


Jeff Matthews
I Am Not Making This Up

© 2007, 2008 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.



Thursday, April 17, 2008

Pilgrimage to Omaha, Part I: This is Big

Note to Readers:

It is Spring, and our thoughts turn towards Omaha, where the 2008 Berkshire Hathaway annual meeting takes place in a few short weeks.


We thought it appropriate to prepare for Warren Buffett's annual 'Woodstock for Capitalists' by reviewing here our notes from last year's journey to the heart of Berkshire Hathaway, and back.

It is particularly relevant given the public unraveling now underway at GE, whose management has always made a point of announcing, and, until this last quarter, delivering on clearly stated revenue and growth goals so that lazy institutional investors could do less work than they otherwise might if things didn't seem quite so cut-and-dried.

Warren Buffett, knowing that things in the real world are never so cut-and-dried, has always possessed a particular aversion to (and suspicion of) stated growth goals of the GE kind. It is why he sold a large position in earnings-management-prone Freddie Mac well before the stock peaked and subsequently collapsed (although his dim view on such stuff didn't stop Coke from stuffing its Japanese subsidiary with product to make numbers while Buffett sat on that company's Board).

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In any event, what the 'Oracle' might say about the public GE spat that erupted on CNBC yesterday, the Subprime Crisis that somehow didn't "stay in subprime," and, oh, food riots, potash prices, and anything else of note, we eagerly await.
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Herewith our notes from last year's Journey. They owe much to the comments and encouragement of our readers as we published them last year. Any mistakes, errors, omissions are mine alone.

Jeff Matthews 4/17/08
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I first realize how big this is when I'm in Chicago. Specifically, at Gate G-19 in Chicago O’Hare, while trying to switch my afternoon ticket to the late-morning flight to Omaha on American.

“It’s sold out,” the lady behind the counter tells me. “All the flights to Omaha are all sold out. But you can try standby if you want…”

She hands me the standby ticket the way the guy at the 7-11 hands me the Powerball ticket—a look like, “You might as well rip it up right now, my friend.”

Yes, I buy Powerball tickets when the pot breaks $100 million. After all, where else are you going to get a shot at a hundred million bucks for one dollar?

That kind of limited thought-process is not, of course, what is compelling me to fly to Omaha for the Berkshire Hathaway annual meeting. Warren Buffett would, no doubt, toss me out of the Qwest Center if I suggested the Powerball bit.

For one thing, he’d note, the so-called hundred million dollar pot is a grossed-up number, not after-tax. For another, he'd surely point out, that hundred million is an undiscounted future income stream, not its far smaller net present value.

Finally, and most assuredly, he would remind everyone that the odds are with the seller, not the buyer. Not for nothing Berkshire Hathaway has sold insurance policies to corporations such as Pepsi sponsoring precisely the kind of impossible-to-win games of chance on which I toss away ten or twenty bucks a year.

(And Buffett will not disappoint at the annual meeting: he will call the notion that state governments encourage the growth of casino gambling “socially revolting.” More on that later.)

Still, worthless standby ticket in hand, I wait, wirelessly plugged into the world at large via my new Mac. And it is while waiting that I realize everybody else on this flight is going to the Berkshire Hathaway meeting, because they are talking about it with one another like kids going to Disney.

No, these are not the intense young high-tech Bluetooth-wearing laptop-carrying technology warriors I am used to seeing on the JFK to SFO flights; nor are they exhausted mothers and fathers juggling babies and toddlers, as you see in JFK waiting for a JetBlue flight to Orlando or West Palm.

Rather, they are men and women—older couples, mostly, as well as younger men in groups of two or three, and almost all Baby Boomers—eager to get to Omaha.

So eager, in fact, that some will be left behind despite having confirmed seats, because American Airlines appears to have been so caught off guard by its own recent prosperity that it is overselling seats even on these flights, just out of habit.

Unfortunately all the way around, when the ticket agent offers to pay people not to take this particular flight to Omaha, nobody takes her up on it.

As a result, when the doors close and my own long-shot standby ticket expires, one desperate couple and two angry men with confirmed seats watch helplessly as the flight backs slowly away from the gate and gets in line for take-off.

They stand there, the four of them, with that Anxious Ticket Holder look—leaning over the counter while two American ticket agents take turns typing on one of those Ancient Clackety Airline Keyboards and shaking their heads while carefully deploying the Standard Airline Non-Eye Contact look by which they successfully infuriate already-angry customers.

The wife of the stranded couple is so anxious to get to Omaha she suggests renting a car and driving from Chicago to Omaha (467 miles), while her husband, red-faced and exasperated, dismisses the notion and makes calls on his cell phone as if somebody besides the American ticket ladies can do something.

I chuckle inwardly, knowing I have a ticket on the next flight to Omaha.

Turns out, I thought I knew I had a ticket on the next flight to Omaha, because a couple of hours later, after standing patiently in a long line of expectant Buffett-worshipers boarding my flight to Omaha, my ticket kicks out of the bar-code scanner and the ticket agent hands it back saying, “There’s something wrong with your seat.”

Having thus been branded a Loser with a Capital L in full view of a long line of Buffetteers, I shuffle off to the desk to await my fate. Turns out there are five of us who’ve been rejected by the bar code scanner, and the talk turns to alternatives. One man has no alternatives: “My wife is on that plane, expecting me to meet her,” he says. “I’m screwed.”

Nevertheless, we all finally get new seats, although my new seat, it turns out, is exactly the same seat I’d been assigned when I got the stupid tickets three months ago. I figure American Airlines is just messing with my head, because right now they can.

But I don’t care: I’m on a plane bound for Omaha.


Omaha is a peculiarly Midwestern city: you fly over impossibly green fields marked by roads and contoured plowing patterns, then over brown fallow fields muddy from rain, then suddenly more green fields, with an occasional solitary house ringed by trees along a road, and more brown fields and more green farmland.

Then the fields come to an end at a bank of trees along a muddy river, and now you are over the river and above grass and suddenly concrete, which becomes a runway; then the plane bangs down and you’ve landed.

The jet taxis toward a low, brown building—no runways to cross, no waiting for the traffic at the gates to free up. It arrives at the gate, the door opens and you’re out onto a gangway and into a building that must have been built thirty years ago and spruced up a little over the years, with a Krispy Kreme stand and a Hudson bookstore selling, among other books, an unusually high number of biographies and hagiographies of Warren Buffett.

There is no line for cabs, and I get one without breaking my stride. It is your basic cab, windows open, hot from the mid-day sun, with sagging seats and an unsafe feel as the driver pulls away from the curb.

I had noticed a soccer ball on the front seat as I got in the back, and ask the driver about it. He is from East Africa by way of Minneapolis, and plays a lot of soccer in his spare time with friends in town. He likes Omaha: “It’s cheap here, you know.”

As we drive, his friends keep paging him on his Nextel. It isn’t official business: they're trying to get a game together, but this has been a busy day, “just like they told us it would be busy.”

There is no highway to get on—the airport is that close to the city. The city streets are wide—very wide—but not very full of cars. There’s not much action on the streets, either. No cabs idling outside restaurants, no limos waiting outside the shops, no FedEx trucks unloading. And very few pedestrians.

The buildings are a mix of old brick or granite classics and not-so-old generic office buildings. Despite the wide roads and the lack of traffic, we move slowly because the traffic lights aren’t coordinated, so you stop a lot, but eventually you get there.

“There” is the Doubletree Hotel, and it is pretty much your basic Doubletree—everything feels slightly out-dated. Still, I expect more activity, but there is only a short line at the front desk. You would not guess this is the biggest weekend in Omaha’s year.

Thanks to the crack TSA regulations safeguarding our skies, of course, I’d had to throw out the potentially dangerous tube of Crest from my overnight, so after check-in I seek out the gift shop in the lobby. It has a “Closed” sign hung over the door. The lady at the front desk says it reopens at 4:30 p.m. I don’t ask why.

That night, I meet up with an investor from California and we walk to the Old Town area for dinner. It is a quaint, busy few blocks full of bars, restaurants, odd stores and people making their plans for the next day.


The next day dawns wet and raining, and so we drive to the Qwest Center, even though it is only a few blocks away. Doors opened at 7 a.m.; we pull in by 7:45 but the main lot is full and crowds are walking from satellite parking lots that handle the overflow.

I had been told that so strong is the Buffett draw from surrounding farms and ranches that there would be pickup trucks among the Lincoln Navigators in the parking lots. I look for the pickup trucks, but I don’t see them.

The crowds are, as were those I saw waiting for our flight, mostly white (more on this later), mostly middle-to-old aged, and mostly couples, dressed casual-nice, with men in short-sleeved shirts and women in pant suits. In addition to the couples there are those young-to-middle-aged men who look like they’re going to one of the Police reunion concerts, so eager are they to hear the teachings of the Master first-hand.

A Hilton Hotel is attached to the Qwest complex, and from its doors a more prosperous, jacket-and-tie group of shareholders is walking into the arena. The Hilton, I am told, is where the Buffett elite stay, and it is impossible to book no matter how far in advance the average shareholder tries.

In fact, there is a pecking order to the entire affair that will persist all weekend, at each event: an individual’s status is determined by the length of time the person has been attending a Berkshire meeting.

This is clear the minute we enter the giant, glass-walled complex. We have no chance of getting a seat on the floor—there is a roped-off area up front for directors and their immediate families; while the remaining floor seats have long been taken by Buffett regulars who mingle comfortably by their seats like the old friends and family they probably are.

So we go up the escalators and find what looks to be good seating on the first level—but it turns out the seats are all spoken for, with hats, jackets, and newspapers placed on them, and I realize where all those people we'd seen in line at the concession stands for coffee and pastries are sitting. Then we find one of the microphone areas where shareholders may ask questions when called on by Buffett himself (no Investor Relations flak here), but those have long since been taken, too.

We finally find open seats on the upper level, a bit cramped and almost vertical, but with a good view of the small table where Buffett and Charlie Munger will sit, a bowl of See’s Candy between their microphones (more on that later), and answer questions for more than five hours (a little under three hours in the morning, a little more than two hours in the afternoon).

Then we settle back and wait, and observe the crowd. And I notice something I have not seen in years.



To be continued...



Jeff Matthews
I Am Not Making This Up

© 2007, 2008 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.



Monday, April 14, 2008

GE Surprised Itself—No Wonder it Disappointed Wall Street


The big news in our Newspaper of Record—the New York Post—is not spiraling gasoline prices (up 5% locally in the last few weeks) at home, or food riots abroad.

No, not even GE’s unprecedented, confidence-shattering earnings miss could move the saga of the Red Sox team jersey buried by a die-hard Red Sox fan and recently unearthed from the cement floor of the new Yankees Stadium, off today's front page.

We are not making that up.

Of course, “die-hard Red Sox fan” in this case may be an unfortunately loaded phrase, what with the fanatical local reaction to a bizarre and silly effort to perpetually jinx the new House That Ruth Built.

But the GE news is the real show-stopper, and it appears to have momentarily jinxed the hoped-for economic turnaround that, so far, keeps receding from the horizon like a mirage.

To grasp the shock with which GE’s news was greeted—the company is, after all, half-finance, so why should anybody have been so greatly surprised is not clear—compare GE CEO Jeff Immelt’s comments on Friday’s earnings call with his sanguine earnings preview less than four weeks earlier, during an interview on CNBC.

Excerpts from both appear courtesy of the indispensable Street Events:

Jeff Immelt, GE Chairman and CEO
March 13, 2008 CNBC


Now, look, the US consumer is in a tougher patch. But that is how we had kind of planned the Company in 2008, is assuming that the US consumer would go through a stressful year. Ultimately the US economy is so big you have to somehow protect yourself from the standpoint that some of it does bleed over into the rest of the world. But we just don't see that right now….

You know, look, I think making the stock price grow in the short term is really about I would say three things. One is, delivering financial results, hitting 10% EPS growth, getting $2.42 a share or greater, which is what we believe and what we're committed to do this year, and what we are on track to do this year.


I think in this environment, that is going to look pretty gosh-darn good.


Jeff Immelt, GE Chairman and CEO
April 11, 2008 Earnings Call


We had planned for an environment that was going to be challenging, but what I would say is kind of late in the quarter, particularly after the Bear Stearns event, we experienced an extraordinary disruption in our ability to complete asset sales and incurred marks of impairments and this was something that we clearly didn't see until the end of the quarter.

We also saw a slowdown in March in the US healthcare and C&I market, so I think what we did is try to reflect on that, not create excuses about it, but take appropriate actions. We have reviewed all the businesses in the last few weeks. We have made operational adjustments as we approach the year going forward. The Company fundamentals remain strong.


The fact that GE surprised the Street—Wall Street’s Finest get paid to look ahead, but seem frequently unable to shake off an ingrained reliance on company “guidance” for near-term forecasts—is not nearly as significant as the fact that GE surprised itself.

And if GE—a manage-by-numbers company if ever there was one—can be surprised, others will surely follow.



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. It is intended solely for the entertainment of the reader, and the author.

Saturday, April 12, 2008

Cutting Costs and Calories at Starbucks, or Trying To, Anyway



“We no longer put whipped-cream on our drinks. If you want whip, Just Ask!”

So says the colorfully-drawn sign behind the counter at this Starbucks.


And so, along with the much-promoted “Pike Place Roast” and the new paper coffee cup label colored a shade of brown that is suspiciously similar to Peet’s Coffee, Howard Schultz’s “Transformation Agenda” takes hold.

We won’t disclose the exact location in order to protect our sources on the latest doings at this struggling-to-turnaround purveyor of high-end coffee, but according to the barista behind the counter, Georgia is a test market for a “no-whip” policy the company is thinking about rolling out elsewhere.

And while it makes perfect sense, business-wise, to dispense with the automatic slathering of the stuff on otherwise perfectly fine coffee drinks, what with dairy prices having gone through the roof—along with everything else—in recent years, Georgia might not be the place to start:


“This isn’t the best market to do it,” our barista tells us. “People around here love whipped cream.”

She’s not kidding. Georgia’s adult obesity rate is 6th highest in the U.S.

Now, Starbucks isn't exactly shoving the test down its “Guests” throats. The sign is barely noticeable on the wall behind the counter, and the baristas have been prompting customers to make sure they know there’s no whip cream coming on whatever it was used to get it.

So, how’s the “no-whip” portion of the Agenda looking in Georgia?

About half the customers here still want their whipped cream.



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. It is intended solely for the entertainment of the reader, and the author.

Tuesday, April 08, 2008

‘The Undertaker’ Bares His Inner Soul


He says rock-bottom interest rates actually went against his "19th century" aversion to easy money. "My inner soul didn't feel comfortable," he says.

—Alan Greenspan, “Greenspan Goes on Defensive,” the Wall Street Journal



Are you feeling depressed?

Anxious?

Nervous about the housing market? The job market? Oil prices at all-time highs? Gasoline prices cracking $4.00 a gallon?

Can't sleep with iron ore prices going through the roof? Coking coal prices soaring? Rice-rationing triggering social unrest and mass starvation?

Then read your Wall Street Journal today—specifically “Greenspan Goes on Defensive”—and have a good laugh.

Not since Bill Clinton told the world he “did not have sex with that woman” and George Bush gave his Nixonian “mistakes were made” speech on Iraq, has a public figure of such stature tried to brazenly downplay his role in a public failing entirely of his own making.

To whit,
Alan Greenspan’s Federal Reserve’s Bubble-inducing 1% interest rate monetary policy—the fallout of which we are all dealing with today.

Here's just a sample, but you must read the entire piece for yourself:

"I was praised for things I didn't do," Mr. Greenspan said during one of three interviews at his sun-drenched office in downtown Washington, D.C. "I am now being blamed for things that I didn't do."

It is difficult to recall Mr. Greenspan ever denying whatever undue credit he was given back when his legacy was still untarnished. But now that his legacy has been not only tarnished, but bound with duct tape, he has come out swinging.

And not merely with logic and numbers.

Turns out, the man called “The Undertaker” by his role model—the androgynous, free-market, absolutist Ayn Rand—has a softer side that he never revealed to the capital markets denizens who once idolized him, until today:

He says rock-bottom interest rates actually went against his "19th century" aversion to easy money. "My inner soul didn't feel comfortable," he says.

Makes one wonder what Ayn Rand is doing right now. Rolling in her grave, perhaps?

More likely she is trying to summon the spirits with which to contact her broker, in order to buy more gold futures for her estate.



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. It is intended solely for the entertainment of the reader, and the author.