Wednesday, July 20, 2011

Munger’s Revenge, Concluded: The Tiger Woods Syndrome, and What Made Berkshire Hathaway as We Know It


 Well, Tiger Woods Syndrome is breaking out all over, even in Omaha, Nebraska.
 By “Tiger Woods Syndrome” we refer to what happens when the Mainstream Media has been sitting on a story it has long known of but couldn’t go with because the subject was too powerful: when the story suddenly, irrevocably blows wide open (like, oh, the guy’s wife tries to bash his head in with a golf club), well, suddenly everyone has a story to tell, and the press is happy to tell it.
And while the David Sokol Affair didn’t involve sex or golf, it did involve enough bad judgment to blow the cover off the notion that Warren Buffett’s perceived successor had everything a Berkshire shareholder could ask for, which is precisely when the knives came out here in Omaha at the Berkshire Hathaway shareholder meeting.
 Friends and financial reporters who’d been told things over the years would say quietly to us, “Don’t quote me, but…” and then tell a Sokol story (more about judgment and personality than about anything you could put down as being wrong) that had either been dismissed as just sour grapes from a Sokol competitor or had been suppressed for the same reason nobody in the Mainstream Media ever bothered to investigate Tiger Woods’ extracurricular activities: the guy was too rich and too powerful.
 And, hey, David Sokol had Warren Buffett’s blessing.
 But with Sokol gone, so is the glow—and a lot of shareholders would like to know exactly how close did Berkshire Hathaway come to putting Warren Buffett’s life’s work in the hands of a guy willing to pick off a few points in a stock ahead of his employer’s acquisition of that company?
 Unfortunately, the real answer to that question—probably a lot closer than Warren Buffett would like to admit—was never actually addressed at the Berkshire meeting, either by Buffett or Charlie Munger.
 Indeed, because of the Sokol Affair, Buffett seemed on his guard and more defensive than usual.  In contrast to last year’s defense of Berkshire’s relationship with Goldman Sachs, when Buffett came out swinging, this year he was more reflective and less direct in getting to the heart of the Sokol-related questions.
 He seemed still stunned at the whole turn of events.
 Charlie Munger, by contrast, was sharp, hard-nosed and positively voluble throughout.  Munger also got the funniest line of the day in the video within the movie that kicked things off.
 (The video—the best in years—was a laugh-out-loud takeoff on the TV show “The Office,” called “Michael’s Replacement,” in which Buffett and Munger take over at Dunder Mifflin from the clueless Michael Scott and his conspiratorial number two, Dwight Schrute.  When a jealous Dwight sizes up Munger, his replacement as Number Two, sneering, “You don’t look so tough,” Munger adjusts Dwight’s tie, leans in and says menacingly, “There are eighteen ways I could kill you.”)
 But it was in the six-hour Q&A following the movie that Munger demonstrated what has made him so valuable to Warren Buffett and to Berkshire Hathaway all these years, participating in an unprecedented number of questions, and with more substance and fewer jokes than usual.
 In fact, at one point Munger abruptly took over one of the Sokol questions from Buffett, saying sharply, “I’ll handle this,” when a shareholder suggested Lubrizol’s board of directors had violated its fiduciary duty by negotiating only with Berkshire Hathaway, and not auctioning the company.
 And whereas Buffett mainly played defense, with long-winded explanations of Sokol-related issues, Munger played offense, summing up matters crisply and, as usual, with no holds barred.


Sisters Under the Skin
 For example, after Buffett explains in long and meandering detail how he came to believe Lubrizol belonged in the Berkshire family, despite its tainted upbringing, Munger simply says,
 “You know ISCAR and Lubrizol are to some extent sisters under the skin...very small markets...fanaticism in service.  If you have any more like that, give Warren a call.”


We Own So Many Wonderful Businesses
 When Buffett wrestles with an explanation for the current valuation of Berkshire’s stock ($125,000 a share at the time of the meeting) compared to one observer’s estimated intrinsic value of $185,000 (based on the faulty premise that Berkshire’s $95,000 per share worth of investments are somehow unrelated to the insurance businesses and therefore a cash-equivalent that should be added to $90,000 per share for the businesses themselves) Munger dismisses the premise that Berkshire’s share price is tied to any break-up calculation, and instead focuses the crowd on the long-term value of Berkshire:
 “It’s terrible trouble you people have...we own so many wonderful businesses we hate to part with them.”


Europe Survived the Black Death…
 As usual, while Buffett takes the bright side of most issues in keeping with his inherent optimism in the future, Munger offers a dour, cynical view based on his broad knowledge of history and human behavior—but usually arrives in the same spot.
 Asked “How can a lousy long-term U.S. economy make you happy?” Buffett gives a long, enthusiastic, cheerleader’s answer, winding up with, “All I can tell you is...the power of capitalism is incredible.”
 
Munger, on the other hand, dryly notes:
“Europe survived the Black Death when a third of the people died, but we’re gonna move on.”
 Still, Buffett is crisper and forceful when it comes to his comfort zone: Berkshire and its legacy.  He minces no words when asked about whether, and when, Berkshire will pay a dividend.
 “There will come a time, and who knows how soon because the numbers are getting big...when a dollar only buying 90c of value...but I predict the day Berkshire declares a dividend the stock will go down because that will mean it is no longer a compounding machine...”


It Had Its Head Up Its---
 And Munger does hold back at least once in the six hours of Q&A, when they are asked about Berkshire’s position in Wells Fargo, one of the banking giants whose inherent profitability has been impaired by the Dodd-Frank legislation and the housing implosion. Buffett defends the investment without much input from Munger:
“US banking profitability will be considerably less than early part of this century; one reason is the leverage will be reduced... If you keep out of trouble on the asset side, it's a good business because credit is very cheap.  I like our positions there.”
 Yet, months later, speaking to investors in Los Angeles, Munger will say that what he admired about Wells Fargo is its management didn’t hesitate to admit “it had its head up its ass” when it came to mortgage lending.
 But Munger bit his tongue here in Omaha.


Not a Terribly Rational Thing
 Still, when he does speak here, it is just as straightforward as that observation in defense of Wells Fargo management.
 When asked about gold as an investment, for example, Buffett launches into almost a professorial discussion of investing.  “There are three categories of investment,” Buffett begins, describing currency, which depends on the behavior of monetary authorities to maintain its value; gold and other commodities that “don’t produce anything and you hope somebody will pay you more for later one,” and then assets “that make things, like a business, a farm”—which is the category Buffett and Munger have generally stuck to, with a few bets on currencies and commodities along the way.
 Munger simply says:
“Buying something that only goes up if the world goes to hell is not a terribly rational thing.”


This Attitude of Trust
 When Buffett is prodded by a shareholder about Berkshire's lack of formal compliance procedures “like most firms,” he gets defensive, first saying “I don't think most companies have them” (which is absolutely not true when it comes to financial giants like Berkshire), then dismisses the idea altogether:
“But we could have all the records in the world...they could be trading in their cousin's name.”
 Munger, on the other hand, defends Berkshire’s culture entirely:
 “If you look at the greatest institutions in the world, they trust their people...it’s so liberating...I think your best compliance cultures are the ones that have this attitude of trust.”


Glitches
 That “attitude of trust” may be Munger’s Achilles heel when it comes to BYD, the Chinese car company of which Munger was a shareholder and fan for their efforts in battery technology well before Berkshire invested in the company.
 BYD’s initials stand for “Build Your Dreams,” but the company has been accused of copying other carmaker’s designs in diplomatic cables uncovered by WikiLeaks, one of which read: “BYD seeks to ‘Build Your Dreams’—based on Someone Else’s Designs.”
 Asked by a shareholder about the company, whose earnings and share price have been under pressure, Buffett demurs, saying, “Charlie’s the BYD expert.”
 Munger begins his answer with the worst line of defense, BYD’s stock price, and then dismisses any issues with bland assurances as uncharacteristic as they are unenlightening:
 “Of course the price is still way higher than the price BRK paid… Any company that tries to move as fast...is going to have its glitches...I'm quite encouraged...”
“Glitches” is the same term Munger employed to describe the Sokol stock trading affair in the immediate aftermath of that black eye, and it may be as understated an adjective when applied to BYD as it was to Sokol’s $10 million investment in Lubrizol in the weeks preceding Berkshire’s bid for the company.
 BYD thus far has failed to produce anything like its past promises, as contained in this 2009 Reuters article:
 BYD says that its new E6 electric car due out before the end of the year will do 250 miles (400km) on a single charge.
 This is a very big number. The Tesla electric sports car does almost as much, but has little room for anything else in the car but the battery.
 The E6 is roomy with space for five passengers and a good-sized boot. The battery tucks under the back seat.
—Roger Harrabin, Reuters
 The E6 was not out “before the end of the year” 2009, nor was it out before the end of the year 2010.  And when the Wall Street Journal inquired about the delay late last year, BYD gave the paper a howler of an excuse:
 Stella Li, BYD's senior vice president and head of its U.S. operations, said the holdup was caused by BYD's efforts to make the car roomier, especially its rear-seat area that was cramped thanks to a beefy battery pack that needs to be stored under the seat.
 Ms. Li told the Journal the E6 would be ready for sale in 2012.  (We here at NotMakingThisUp would call that bluff.)


A Star Rises in the East
 But, BYD aside, Munger has few blind spots, and enough blunt assessments about the ways of the world to keep Berkshire shareholders happy…
 On why Berkshire does not trade commodities like oil:
“Oil trading worked best of all for the people who bribed Nigeria.”
 On what caused the financial collapse:
“My answer is that past panics and depressions tended to involve great waves of speculation.... I think you can confidently expect a new mess before your career is over... Part of this mess is due to our academic institutions... Finance really attracts people who should be in snake charming.”
 On the political environment in Washington:
“I remember an era when we had a bipartisan foreign policy, the Marshall plan.  Now it seems we have two parties competing to be more stupid.”
  On CEO compensation:
“I think somebody has to be an exemplar for not grabbing all you can...”
 On which asset class he would add to his ‘circle of competence’ if he were going to live another 50 years:
“It would either be tech or energy.”
 But the best line of the day—one not picked up on by everyone in the arena, so fast and subtle it was—came towards the end, on a question asked by a very sincere investor.
 “If you were to have a baby in the next 5 years,” the shareholder begins, drawing titters from the crowd, “how would you incentivize them to compete against hungrier kids from other parts of the world...”
 Munger, whose age (six years older than Buffett and now approaching 90) has always been the subject of jokes between the two men, sits up in his chair and a huge smile crosses his face at the idea of becoming a father as an octogenarian:  “A star rises in the east,” he says in an awe-struck voice, drawing broad laughter as Buffett begins his answer.

A Fortune Fairly Won and Wisely Used
 Still, it is not wisecracking that makes Charlie Munger so important to Berkshire Hathaway.  It is the genius of his recognition—forged as an attorney working with struggling companies in Los Angeles before hooking up with his fellow Omaha native in the 1960s—that buying good businesses at reasonable prices was better in the long run than buying bad businesses however cheap they appeared to be, which was how Warren Buffett came to take control of Berkshire Hathaway before Munger came along.
 It was Munger’s crucial notion about the long-term value of good businesses versus bad business (“Bad businesses throw tough decision after tough decision at you; good businesses throw cash,” was how he once put it) that led the two men to make their first acquisition together in 1972—See’s Candies, for $25 million.
 And See's was a very good business.  For one thing, it almost immediately began generating excess cash (well over a billion dollars so far) for Buffett to reinvest elsewhere.  For another, it created the template by which Berkshire would amass a collection of good companies, bought at reasonable prices, that today employee over a quarter-million people and churn out a billion dollars a month in cash.
 Asked about their legacies at the Berkshire meeting, Buffett initially wisecracks that he would like it to be “Old age,” then says he’d like to be known as a teacher.
 Munger, who has always seemed more well-rounded, if less wealthy, than his partner, sums up his answer as succinctly, and appropriately, as you’d expect:
I have an uncle with a saying: ‘A fortune fairly won and wisely used.’”
Indeed.


The End.

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


© 2011 NotMakingThisUp, LLC
                                                             
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.

4 comments:

Anonymous said...

Munger is awesome. Thanks Jeff for putting this together.

Fans of Munger can purchase a copy of the morning with charlie transcript here...

http://myinvestingnotebook.blogspot.com/2011/07/morning-with-charlie-transcript.html

Ben said...

Thanks Jeff, always enjoy reading your unbiased accounts of the Berkshire meetings. Been reading "Poor Charlie's Almanac" lately, which is a good coffee table book for those who like Munger.

jb said...

Great coverage of l'affaire Sokol. You noted that "the crowd seems a trifle thinner than last year" at Berkshire's annual meeting. Is this an indicator of the real problem? Will the next elephant in the room be the poor performance of Berkshire's stock? It closed at $113,700 on December 15, 2006. Today, July 26th, it is currently at $113,649.

So it has done nothing for 4 years and 7 months. Dead money. Will the crowd turn on Warren and Charlie and start asking them more pointedly what's going on if the price hasn't improved by next year? Or have they earned a multi-year waiver on performance? And how long a waiver do they deserve?

Jeff Matthews said...

JB asks some good questions. The answer is that the crowd has already begun to turn. Attendance was actually down 10% year over year, and that's probably not a coincidence, coming so soon after the Sokol Affair.

It's kind of like when a bad company finally really pukes a quarter and the sell-side analysts that have been defending it all the way down finally have an excuse to throw in the towel.

Not that Berkshire is bad, nor is its recent performance poor in the grand scheme of things (name one financial company that preserved value throughout the financial crisis).

But today's Berkshire is not, as we've said before, your father's Berkshire. It isn't a mutual fund run by a genius any more: it's a GDP-dependent operating company.

(Read "Secrets in Plain Sight" for more on this--it was the first book to analyze Buffett and Berkshire without blinders, both the good and the not so good.)

The Sokol Affair gave some people who hadn't really looked too closely an excuse to throw in the towel.

JM