Tuesday, February 02, 2010

What I Learned Writing a Book, Part II: The Oracle Appears, Alone…Sort Of

There is some gamesmanship going on as we enter the cozy, wood-floored Peter Kiewit concert hall here in downtown Omaha.

Of course, it’s nothing like what goes on at the Berkshire Hathaway annual meeting. At that “Woodstock for Capitalists,” as Buffett likes to call it—held not in a 2,000-seat concert hall but in a 17,000-seat arena within the Qwest Center a few blocks away—draws so many shareholders from around the world that lines begin to form, for hundreds of yards around the glass and steel complex, before the sun rises, just waiting for the doors to open.

If the annual meeting is the equivalent of a musical Woodstock, without the drugs and naked dancers, then today’s special meeting is more like one of Sting’s lute concerts. (If you never went to one of Sting’s lute concerts, you are not alone: only hardcore Sting fans went to those, and only hardcore Buffett fans are here.)

This will be, indeed, a very mellow affair.

There no camera crews from China prowling the halls for interviewees, no giant video screens hanging alongside the stage, and no young men in Dockers and button-down oxford shirts bursting inside as soon as the doors open, running down the aisles and claiming seats near the stage.

Instead, there are older couples—retirees with time to spare on a sleety, cold, blustery Wednesday morning—and professional investors (all men, most in suits and ties), all walking casually down the aisles, chatting, spotting friends, and selecting seats.

And this is where the gamesmanship comes in.

For even in this cozy concert hall, and even among these—the most serious observers of Warren Buffett and Berkshire Hathaway—there are people are looking for the best seat possible from which to watch Warren Buffett.

Several new acquaintances and I take seats in what appears to be a prime spot, a few rows from the front. The money manager seated next to me is a 20 year Berkshire veteran who had introduced himself out in the lobby—he had read “Pilgrimage to Warren Buffett’s Omaha”—and I learn he attended the last and only other special meeting in Berkshire Hathaway’s post-Buffett history: the meeting to approve the acquisition of General Re.

We talk about that meeting—made legendary when Buffett put up a life-size cut-out photograph of Charlie Munger in the seat next to his and played tape-recorded bits of Mungerisms at appropriate times—and he observes that there were far more investors at that meeting than this one.

Indeed, by my count, there are only about 150 people are here today. By contrast, there were 500 shareholders at the 1998 special meeting.

What accounts for this loss of interest—aside from the bad weather—is one subtle but distinct difference between the General Re meeting eleven years ago and this one today.

Today’s meeting is merely to approve a stock split that will enable Berkshire’s purchase of Burlington Northern railroad. Buffett’s going to buy Burlington come hell or high water, or, as Buffett once said in reference to another transaction, “even if Ben Bernanke runs off with Paris Hilton.”

The 1998 special meeting, on the other hand, was held for Berkshire shareholders to approve the company’s merger with General Re.

Now, until Burlington Northern came along a few months ago, General Re had been the biggest acquisition in Berkshire’s—and Buffett’s—history, although despite Buffett’s high hopes and effusive cheerleading at the time, it did not prove to be one of the best.

Buffett paid $22 billion for General Re, all of it in shares of Berkshire stock (hence the need for a special meeting to get shareholder approval), meaning the cost of the deal went up along with Berkshire’s stock price, even if General Re’s business did not likewise increase in value.

And for some time afterwards, that prospect did not look good. Indeed, the 1998 press release in which Buffett announced the deal reads embarrassingly wide-eyed, given what was to follow:

“But the main attraction of the merger [with General Re] is synergy, a word that heretofore has never been used in listing the reasons for a Berkshire acquisition. In this transaction, however, there are at least four areas of powerful synergy, which Charles Munger, Berkshire’s Vice Chairman, and I believe justify the premium price that Berkshire is paying…”

Not only did the synergies take longer to appear, but one of them—“removes constraints on earnings volatility”—would come to haunt Berkshire after the 9/11 terrorist attacks on the World Trade Center caused more than $2 billion worth of unanticipated “earnings volatility.”

In addition, and to Buffett’s eternal annoyance, Berkshire would later spend $400 million laboriously unwinding 23,000 derivatives contracts fermenting with General Re at the time of the acquisition.

(On the plus side, the experience of unwinding those contracts during the salad days of the early 2000s would directly lead to Buffett’s stern warnings against derivatives as a market cure-all in his 2002 shareholder letter, and help Berkshire emerge from the 2008 crisis in far better shape than its peers.)

Furthermore, Gen Re would, under Buffett’s watch, become embroiled in a scandal that would eventually entail testimony from Buffett himself; threaten the squeaky-clean image Buffett demands the Berkshire business family to maintain; and result in the conviction of several former Gen Re executives—all for entering into “sham transactions” by which Gen Re helped AIG dress up its reserves to satisfy Wall Street’s Finest.

In fact, I’ve been told—while preparing for an early-morning interview with Bloomberg TV—that a final settlement on that sordid chapter was coming, with Gen Re paying $92 million to both settle investor claims and put an end to Federal investigations into the matter.

Thus, as Berkshire closes out the final, downbeat chapter to that last previous record-setting acquisition, we Berkshire shareholders are being asked not to approve the acquisition of Burlington Northern railroad, but merely to allow a 50-for-1 stock split and the elimination of paper stock certificates for the Berkshire “B” shares.

The Berkshire “B” shares—and I’ll keep it light so our readers’ eyes don’t roll back into their heads—are simply cheaper versions of the regular Berkshire “A” shares. The “A” shares trade around $100,000 a share—yes, $100,000 per share—and most people can’t afford to buy them. So Buffett created the “B” shares at 1/30th the value of the “A” shares.

One more difference, and it’s huge: the “B” shares have fewer voting rights than the “A” shares—like 1/200th of the voting rights. This might seem to be a glaring incongruity at a company whose CEO is highly vocal about the rights of shareholders, and also highly outspoken about the irresponsibility of “lapdog” Boards of Directors, but readers of “Pilgrimage to Warren Buffett’s Omaha” know this is only one of several incongruities when it comes to the greatest investor in the world.

Before today’s meeting, the vote-deprived “B” shares sell for around $3,500 each. After the meeting, assuming we’ve approved a 50-for-1 split, they’ll sell for $70-something a piece…and they’ll be even more vote-deprived.

Instead of having 1/200th of the voting rights of an “A” share, they’ll have 1/10,000th of an “A” share vote.

We are seated, as I said, a few rows back from the stage. Our seats are, technically, “Stage Left”—i.e. to the left of center stage when facing the audience—and this is where the gamesmanship comes in.

“The speech is on the other side,” somebody says, pointing to the table onstage where Buffett will sit. It has two microphones, just like the annual meeting, and a stack of papers has been placed at the seat which is to our left as we look at the table, but which is, technically, Stage Right.

Someone else observes, “Well that’s where he always sits at the annual meeting.”

So we get up and walk through an empty row to the other side of the concert hall, and pick seats a few rows back that will presumably give us a better look at Buffett when he sits down at the microphone with the speech in front of it.

Others notice and follow our example; others notice but sit pat. After all, almost any seat in the room will provide a good view of the “Oracle of Omaha.”

I am introduced to a farmer from Iowa. He is a longtime Berkshire shareholder, and we begin talking about the harvest and the outlook for corn prices. Business has been good, he tells us, what with demand from ethanol plants and the wet November that interrupted the harvest. “I was out there yesterday and there’s a lot of corn to be harvested.”

“Isn’t this kind of late in the season?” we ask.

“It is,” he says, “it is, but—”

Our focus turns to the stage, where a woman has crossed from the wings and is arranging things on the table. She moves the speech from one microphone to the other, raising speculation of a shift in Buffett’s preferred seat.

“Maybe Charlie’s coming,” somebody says hopefully.

This bit of Kremlinology ends when Buffett himself strides in from Stage Left, smiling as the crowd begins to applaud.

He sits down on our side of the table, Stage Right—“where he always sits”—and fiddles with the microphone. There is no bowl of See’s candy, as at the annual meeting, but there are two cans of Cherry Coke within arm’s reach.

“This is a little embarrassing,” Buffett begins, in his husky, folksy voice. “When Charlie’s here we usually get about 35,000 people.”

While we’re laughing, Buffett lifts up a life-size cut-out of a youthful Charlie Munger—the same one it would appear he used at the special meeting in 1998—and places it in the other seat.

He presses a button and Charlie’s familiar, higher-pitched voice says, “I have nothing more to add.”

“It’s as good as having him here and we don’t pay him,” Buffett says.

After dispensing with the preliminaries, Buffett announces he will accept questions on the motions before us.

And there are questions.

—to be continued.

Jeff Matthews
I Am Not Making This Up

© 2009 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: 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 investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.


Mark said...

If that guy didn't know a THING about investing, he'd still be worth watching, just for the jokes... Is there a funnier well-known investor or CEO in America? How about some nominations?

Anonymous said...

Jeff, I disagree with your point about voting rights between A and B shares. Yes, B shares have 1/1500th of the voting rights - but they also have 1/1500th of the economic rights. That is to say, if i bought $10 million worth of Berkshire A shares and my friend bought $10 million worth of Berkshire B shares, we would have the exact same voting influence in the company. Am I wrong?

Jeff Matthews said...

Anonymous is right, as the post was written--if the B shares had 1/1,500th of the voting rights of the A shares, that would match their economic rights at 1/1,500th of the value of the A shares.

But that was a typo: the B shares have 1/10,000th of the voting rights. The post has been corrected.

Thanks for flagging!


AOP said...

Dear Jeff,
On a totally unrelated subject, since you are a tech marketing sales guru, in your humble opinion, how frightened is Amazon of Apple's Ipad? Thanks Art Poltrack

Anonymous said...

Jeff Matthews do you ever look at Loews?

But What do I Know? said...

You say "incongruities," I say "hypocrisy"--let's call the whole thing off. . .

I have read somewhere that Buffett said something on the order of "If we ever split the shares in Berkshire, you should sell." Is this true, or am I getting it wrong?


Jeff Matthews said...

AOP asks how scared Amazon might be of Apple's iPad. I think plenty. While the Kindle is nice for what it is--i.e.a very portable book reader--it feels old, clunky and out of date. The iPad will eventually kill off Kindles, or at least force Amazon to make them more iPhone-like.

Anonymous asks if we ever look at Loews, the Tisch-family insurance vehicle (Larry Tisch was one of the first investors to 'discover' Buffett, and also one of the first to model a business on Berkshire--i.e. use insurance cash to build a conglomerate).

The answer is 'no.' When Lowes owned Lorillard, we didn't touch it. And nowadays, if you want to own insurance you can buy an insurance company stock, and if you want to own drilling rigs, you can buy an oil service stock, and same with hotels. The conglomerate thing holds no appeal.

But What Do I Know? asks if Buffett once said 'if we ever split Berkshire stock, sell it.' I don't have that quote at hand, but it certainly reflects Buffett's long-standing bias against stock splits. (See the 1983 and 1992 shareholder letters for detailed discussions on this issue.)

But things change, and Buffett is changing, and... Well, stay tuned to Part III here.


sfgirl said...

going to get this book!

Peter said...

Hi Jeff,
I took my $3,000ish piece of art (stock certificate) off the wall and deposited it in my broker account to get the new 50 shares. Are you saying that I won't be able to get a new $75ish piece of art with these new "B" shares?

BB said...

Jeff, I really enjoy your posts. I thought I might share a small laugh I got today when I looked in and saw that according to Google Finance, Berkshire B shares have a Market Cap of 8.44 Trillion With 116 Billion Shares outstanding. We knew BRK.B would get a pop from a split, but who knew. Another great Google "Beta" program. Thanks for the great Blog.


But What do I Know? said...

Thanks for clarifying, Jeff. I will stay tuned for your next posts. . .

arel said...

The BN acquisition: A Point not considered.

No arguments with your analysis of the Berkshire acquisition of BN but there is a value in BN, especially for Berkshire that I have not seen mentioned that might cause one to view the acquisition from a different perspective.

It is especially a problem for a company the size of Berkshire which faces the difficulty of finding large scale and long term investments for future cash float and flows.

And the different perspective is:

The value of BN's "right of way" for the construction of high voltage electric lines.
This dovetails with the energy production sites and transmission and energy trading parts of Mid American Energy.
If you superimpose the map of the BN system on a map of the major sources of renewable energy (mainly wind at present) the logic of the
acquisition might appear clearer.



If, additionally you superimpose a map of MidAmerican's electric service territories it become even clearer.

One of the major roadblocks for the use of renewable energy e.g. wind energy originating in an area starting from the Dakotas and running in a line down to NW Texas, is the lack of transmission networks from the energy sources to the major population centers East and West of the line.

The ability to construct transmission lines runs into NIMBY and problems of eminent domain.

Berkshire might just have short circuited the problem of constructing transmission lines and at the same time acquired a possible long-lived toll road with a wide moat.

A second roadblock for maximizing the value of low cost energy production is the ability to store the produced energy, especially during low usage periods.
This is a problem of technology and the economics of storage.
That will be solved, though I have no idea as to When.
But then the question is one of siting of the storage facilities.
Logically, large scale storage should be close to the main transmission lines rather than locally. (economics)
So there might be another business for MidAmerican in the future

The above is pure conjecture on my part.

But any acquisition of the small North Central electrical utilities (in whose territories wind facilities are located) by MidAmerican might lend support to my conjecture.

Additional support to my conjecture would be an announcement by MidAmerican that it is building transmission lines outside of its service area but connecting the western and eastern MidAmerican service areas.

Your thoughts on the acquisition after the above??

LifeAfterMBB said...

Long time reader her Jeff,
Just saw your clip on BRK here:


You are so much more mellow that your posts here suggest:)