Thursday, May 21, 2009
The Best of “Woodstock for Capitalists,” Part 3: The Most Logical Answer
The Midas Touch; Good Businesses and Bad Businesses; and Moats Filling Up with Sand.
“Years ago you warned against utilities,” began the second-to-last question of the day, from a Costa Mesa, California shareholder. (Shareholders picked by lottery alternated with questions submitted to, and read by, reporters.) In light of this, the investor asked, why was Buffett was pouring so much money into the things.
She was referring to Buffett’s long-held distain for capital-heavy and government-regulated businesses, which can be traced at least as far back as John Train’s 1987 Buffett book “The Midas Touch”—possibly the first and still one of the best of the dozens of “How Warren Buffett Does It”-style books out there.
The fact that Train’s book remains remarkably current 22 years after publication is no small a testament to how little Buffett’s investment criteria have changed over the decades. In fact, half the chapter titles would fit a brand-new “How Warren Buffett Does It” book published in the year 2009—including “GEICO,” “Good Businesses,” “Bad Businesses,” and “The Margin of Safety.”
One thing that has changed in the intervening years, however, is Buffett’s perception of the value of utilities, which offer “decent” and assured returns, at the risk of government interference.
The beauty of a franchise like See's Candies, of course, is that no government regulator determines the price of a box of See’s fudge (Buffett does that himself), or the return on capital of the business (since Berkshire spends very little on See's, the return on capital is stratospheric).
But as the availability of See’s-type franchises at reasonable prices has diminished, while Berkshire’s appetite for capital deployment has grown, Buffett has happily committed capital to utilities.
“I would say the capital intensive businesses that scare me more are outside the utility business, where you pump in capital without knowing if you’ll get a return,” Buffett told the woman from Costa Mesa and the other 17,000 people in the Qwest Center arena. “We’ll probably get those returns with or without inflation,” he added.
All this assumes Berkshire maintains good relations with government regulators. And Buffett is anxious to stay on good terms with those regulators. In this year's shareholder letter, he wrote:
Our long-avowed goal is to be the “buyer of choice” for businesses – particularly those built and owned by families.…
In the regulated utility field there are no large family-owned businesses. Here, Berkshire hopes to be the “buyer of choice” of regulators. It is they, rather than selling shareholders, who judge the fitness of purchasers when transactions are proposed.
Having stated the major risk in owning a regulated utility, Buffett then provided a remarkable advertisement for the virtues of Berkshire Hathaway stewardship of a public utility:
Our two pipelines, Kern River and Northern Natural, were both acquired in 2002. A firm called Mastio regularly ranks pipelines for customer satisfaction. Among the 44 rated, Kern River came in 9th…and Northern Natural ranked 39th. There was work to do.
In Masio’s 2009 report, Kern River ranked 1st and Northern Natural 3rd. Charlie and I couldn’t be more proud of this performance. It came about because hundreds of people at each operation committed themselves to a new culture…
This is remarkable because Buffett usually talks about how hands-off Berkshire is when it comes to its acquired businesses, as he did in the 1987 letter:
With managers like ours, my partner, Charlie Munger, and I have little to do with operations. In fact, it is probably fair to say that if we did more, less would be accomplished…. Our major contribution to the operations of our subsidiaries is applause.
Buffett did something else quite unusual in this year’s letter: he bragged about putting more money into a business than that business made for Berkshire:
In 2008 alone, [Berkshire’s] MidAmerican spent $1.8 billion on wind generation.... By the way, compare that $1.8 billion to the $1.1 billion of pre-tax earnings of PacifiCorp….
In our utility business, we spend all we earn, and then some, in order to fulfill the needs of our service areas. Indeed, MidAmerican has not paid a dividend since Berkshire bought into the company in early 2000. In exchange, we have been allowed to earn a fair return on the huge sums we have invested. It’s a great partnership for all concerned.
It was the first time in 30 years worth of Buffett's annual letters Buffett boasted about spending, not saving, money...and it was, of course, quite deliberate: regulators are now reading the letter along with Berkshire shareholders.
Now, none of this means Buffett has abandoned his notions of what makes for a truly great business, and towards the end of his response at the meeting, he reverted to character:
“On balance…the best businesses are the ones that don’t require much capital and yet make good money. They’ve got some moat around them.”
To this, Charlie Munger added the coda that may explain a good deal of the recent acquisition activity at Berkshire Hathaway:
“Unfortunately a lot of moats have been filling up with sand lately—newspapers and television stations.”
Hence, Buffett’s response on the question of investing in utilities got our vote for Most Logical.
We will continue our exploration of the Best of Woodstock, with the Best Question Not on Our List, Answered…
…and Best Question Not on Our List, Avoided.
I Am Not Making This Up
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Posted by Jeff Matthews at 8:21 AM