Monday, June 27, 2011

Munger’s Revenge, Part V: “It’s a Berkshire Type Company”


Author’s Note: we continue contrasting Warren Buffett’s commentary at the April 30, 2011 annual meeting with David Sokol’s March 31, 2011 CNBC interview, using the Lubrizol proxy as a timeline. 
  This entry starts on the date Sokol first spoke to Buffett about Lubrizol as a potential acquisition candidate—one month after he first met with Citi bankers, discussed Lubrizol and first bought shares in that stock; one week after he finished loading up on nearly $10 million worth of that stock; and around the same time he spoke to Lubrizol CEO James Hambrick about what Hambrick appears to have logically reacted to as a takeover feeler.

 January 14, 2011: Sokol finally talks to Buffett.
 Warren Buffett: “Now bear in mind his first conversation when he said he owned the stock was January 14.  In between January 14 and March 14 [when the deal was announced], Dave gave no indication he’d had any contact with Citigroup of any kind…”
 David Sokol: “Mr. Hambrick called me on the 14th, so I either called Warren just before that call or just after it.  And ah, we had a pleasant conversation.  Mr. Hambrick told me about a health issue he had recently had and talked about my son, who has a similar health issue historically.”
 [After thus diverting the issue to family health matters involving his son, presumably to dredge up sympathy among CNBC viewers, Sokol discussed the conversation with Buffett.]
 “And then I called Warren and said, ‘You know, there’s an opportunity here either for you or I to have dinner with James.  And I told Warren I purchased shares in the company.”
 Warren Buffett: “At that time when Dave called me he said nothing about contact with Citigroup or anything of the sort…and I said, I don’t know anything really about the company.  He said, ‘Well, take a look at it.  It…might fit Berkshire.’  I said ‘How come?’  He said… ‘I’ve owned it and it’s a good company.  It’s a Berkshire type company.”
 And now Buffett acknowledges a mistake: “And, you know, I obviously made a big mistake by not saying, ‘Well, when did you buy it?’  But I think if somebody says ‘I’ve owned the stock’ you know it sounds to me like they didn’t buy it the previous week.”
 Indeed, it probably never crossed Buffett’s mind that an employee of his—any employee—would have taken down millions of dollars worth of a stock he had discussed with investment bankers, however innocently Sokol might have believed that discussion to be, particularly if (as the proxy stated) Sokol had been informed on December 17 that the company’s CEO was going to discuss Berkshire’s “possible interest” with his board of directors.
 Nevertheless, the future of Berkshire Hathaway—a conglomerate now roughly the size and scope of General Electric—ought not to be tied to what might or might not cross Warren Buffett’s mind: the fact that Sokol could keep a lid on his Lubrizol purchases for as long as he did, whether or not he violated any laws, illustrates the problem.
 Buffett, however, does not view more bureaucracy as the answer: “We have 260,000 employees… At Berkshire, there are presently three people that can execute trades and then there are a few other clerical people that would see what was done….
 “If you take Berkshire at 260,000 people, you know, that’s about the number of households in greater metropolitan Omaha.  And as perfect as we like to think we are in Omaha, I will tell you there’s lots of things going on in Omaha right now as we sit here that, you know, do not match the rules….
 “The problem, obviously, with the Sokol thing is it hit very very high up, you know.”

 For his part, David Sokol played down the idea that Lubrizol was even a potential acquisition target for Berkshire Hathaway at that point:
 “And frankly, at that time, Warren was pretty cool to the idea.  He says, ‘Yeah, I know the company.  It’s interesting, but I’m not sure it economically makes sense.’ But he hadn’t looked at it for a while.  ‘But, you know what, why don’t you go ahead and have a look and see if there’s anything there.’ And subsequently [I] had dinner with James… I believe it was the 25th.”

January 19: “Members of Lubrizol’s senior management met with Citi and Evercore to discuss Mr. Hambrick’s upcoming meeting with Mr. Sokol.”
 Certainly the Lubrizol team wasn’t “cool to the idea”: they reacted as any public company would react to a potential takeover bid in the works.

January 25: “Mr. Sokol and Mr. Hambrick met in Cleveland, Ohio.  The two executives discussed their respective backgrounds and business.  Mr. Hambrick provided Mr. Sokol with an overview of Lubrizol’s corporate culture, philosophy and operations.  Mr. Hambrick also discussed Lubrizol’s overall business and past and expected financial performance….
 “Mr. Sokol indicated that he did not believe that there was any more information that Berkshire Hathaway needed at that time, but said that he would get back to Mr. Hambrick if additional meetings would be helpful….
 Buffett: “It struck me as a business I didn’t know anything about initially.  You know, you’re talking about petroleum additives… Are there competitive moats, is there ease of entry, all that sort of thing.  I did not have any understanding of that at all initially…
 “And I talked to Charlie a few days later…and Charlie says, ‘I don’t understand it either.’”
 Sokol, on CNBC: “Well, just before that dinner, he [Buffett] had sent me an email…saying, ‘The real question is…can they sustain this margin growth…that they’ve had the last couple of years?’…
 “That was the primary conversation then that I had with James [Hambrick].  And James offered that if Warren had an interest in continuing the discussion, he’d love to come and meet Warren.  And so, [I] talked to Warren the next day and from that point on I had no more conversations...”
 At this point, CNBC’s Joe Kernen interrupted Sokol: “You knew at that point you had almost 100,000 shares and the wheels were starting to turn for a possible acquisition by Berkshire.  At that point did that seem to you that this doesn’t smell right and maybe I should sell this right now before—”
 “Not at all,” Sokol said.  “Actually I think it would have been wrong for me to do anything.  Once I mentioned to Warren that James had an interest, to me then it was a Berkshire opportunity, whether Berkshire would want to do it or not was up to Berkshire…”
 Unfortunately, Kernen didn’t press the real issue—that Sokol ought to have realized that it was “a Berkshire opportunity” the minute he spoke to Citi’s investment bankers about Lubrizol back on December 13, which the Lubrizol proxy identified as the day Sokol spoke to Citi’s bankers and told them, according to the proxy, that Sokol was interested in speaking with the Lubrizol CEO “about Berkshire and Lubrizol.”

January 27: “Mr. Sokol responded to Mr. Hambrick’s offer to meet with Mr. Buffett by calling Mr. Hambrick, stating that it would be helpful for Mr. Hambrick to meet with Mr. Buffett… Mr. Sokol also said that, if Mr. Buffett wanted Berkshire Hathaway to proceed with an acquisition of Lubrizol, Mr. Buffett would have a view on what Berkshire Hathaway would be willing to pay, but that Mr. Buffett would not make an offer unless Mr. Hambrick wanted him to do so.”

January 27: “Mr. Buffett…called Evercore’s Chairman and indicated that Mr. Sokol’s feedback on his meeting with Mr. Hambrick had been very positive and that Buffett was interested in having Berkshire Hathaway acquire the outstanding shares…if it could be done at a price that made sense to Berkshire Hathaway.   Mr. Buffett also indicated that he was very interested in an opportunity to meet with Mr. Hambrick, and that, subject to the meeting, Berkshire Hathaway would be willing to make an offer at the meeting on February 8, 2011 if Lubrizol was willing to receive such an offer.”

February 8: “Mr. Hambrick met with Mr. Buffett in Omaha, Nebraska… At this meeting, Mr. Buffett responded to a question from Mr. Hamrick about price by saying that Berkshire Hathaway would like to make an offer to buy all of the outstanding shares of Company common stock for $135.00 per share in cash….”
 Buffett: “What Dave passed along to me after having that dinner with James Hambrick, and which I later confirmed in a lunch when James Hambrick came out here…I got a good understanding of industry dynamics and how the business had developed over time…
 “I looked at the question of ease of entry…I decided there’s probably a good size moat on this.  They’ve got lots and lots of patents, but more than that they have a connection with customers…
 “I felt I had an understanding of the economics of the business… I think Lubrizol will be the leading company for a very, very, very long time.  And that’s the conclusion I came to.”

March 8: “Berkshire Hathaway and Lubrizol entered into the confidentiality agreement.  Later that day, Munger Tolles [Berkshire’s law firm, and Charlie Munger’s namesake] provided Jones Day [Lubrizol’s law firm] with initial comments on the draft merger agreement….”

March 14: “Berkshire Hathaway and Lubrizol announced the signing of the merger through a joint press release.”
 Buffett: “On March 14, when the deal was announced in the morning, I got a call from John Freund…John Freund works for Citi in Chicago, and he…has handled the great majority of our business in equities for decades, and I’ve got a direct line to him…  And he called and said ‘congratulations and…that Citi’s team had worked with Dave on this acquisition, and they were proud to be part of it…
 “And this was all news to me…
 “And the next day, I had Marc Hamburg, our CFO, call Dave, and Dave readily gave him the information about when he had bought the stock and how much.”
 So far, so good, until Hamburg asks Sokol about Citi’s involvement:
 “Dave said…he thought he called a fellow there to get their phone number, which turned out to be somewhat of an understatement.”
 How much of an understand Buffett will find when he reads the “Background to the Merger” detail in the draft of the Lubrizol proxy statement…

March 18: Buffett receives Lubrizol proxy draft material, detailing Sokol stock purchases.
Buffett: “At that point…our law firm got involved…in their input to the Lubrizol lawyers as to what we had seen that was different or what we had seen that they didn’t know about that we could add…
 “And I believe he [Sokol] was interviewed at least three times about both the stock purchases, the history of things with…his relationship with Citigroup, and they were assembling this information…
 “And we decided that when we got back [from Asia] we would need to have a prompt meeting of the Berkshire Board about this matter…
 “And we got back on…Saturday the 26th, and on the 28th we were going to bring Charlie [Munger] into it before calling a board meeting…. And then, about five or so in the afternoon a letter was delivered by Dave’s assistant, which really came out of the blue…
 “He said he felt he was retiring on a high point and he gave the reasons why he was retiring... I don’t know whether the questioning the previous week had affected his attitude.  He would say not.  But in any event, we had that resignation…
 “So I drafted up a press release, which has since been the subject of at least mild criticism…”

March 30: “Berkshire Hathaway issued a press release announcing the resignation of Mr. Sokol.  The press release also indicated that Mr. Sokol purchases shares of Lubrizol common stock on December 14, 2010 and on January 5, 6 and 7, 2011. Lubrizol first learned of these share purchases and Mr. Sokol’s resignation on March 30, 2011.”

Buffett: “Now, in there was included the fact that Dave had no indication that—that Lubrizol had any interest in an approach from Berkshire and that, at least according to the final Lubrizol proxy, is not the case…. The Lubrizol proxy now says that Dave did know that Lubrizol had an interest on December 17.
 “But both in the two chances he had to review it [the March 30 press release] and then when he went on CNBC on a Thursday and talked for half an hour, he made no attempt to correct any of the facts in it.
 “Now, on Wednesday when we put out the report, we had to have a board meeting first… We also delivered—we, through our law firm, we phoned the head of enforcement division of the SEC and told them exactly the facts regarding the stock purchases and anything else that they might have cared to know.
 “So I think we acted in that case, very very promptly…
 “So from our standpoint and my standpoint, Dave was gone, minimum severance costs, minimum chances for lawsuits about compensation due to him and we had turned over some very damning evidence, in my view, to both the public and to the SEC.”

All very rational, and Warren Buffett is, if nothing else, entirely rational.  However, there is the matter of “being ruthless,” and here is where Buffett gets defensive.

 To be continued…
  
Jeff Matthews
Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”
(eBooks on Investing, 2011)    Available now at Amazon.com


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

1 comment:

Anonymous said...

I can't wait to hear the specifics of the ruthlessness that WB should have meted out on Sokol.