Thursday, August 25, 2011

Buffett, Berkshire, BYD and The Greater Fool Theory in Practice


 BYD, the Chinese automaker whose name stands for “Build Your Dreams,” couldn't be more aptly named.
 A Chinese rags to riches story, its shares were given the good housekeeping seal of approval several years ago when Warren Buffett bought a 10% stake after his notoriously dour, skeptical (and brilliant) business partner, Charlie Munger, convinced Buffett that the company was not just a car company, it was an engineering marvel with a shot at world domination thanks to breakthrough battery technology.
 Here’s how Munger defended the unusual investment—unusual for Buffett, who prefers low-technology to high-technology, and closer-to-home rather than halfway around the world—at the Berkshire Hathaway annual shareholder meeting two years ago:
 “BYD, while its founder is only 43 years old, it’s not some early stage venture capital company, it’s one of the world leaders of rechargeable lithium batteries…  From a standing start of zero he created the best selling model in China.  This is not some unproven, highly speculative activity—it’s a damn miracle….”
 And Munger, whose distaste for con artists and unproven business models is as well known as his dry wit (read “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett” for some fun examples, didn’t stop with encomium for BYD—he applied it to the entire country:
 “You get a remarkable aggregation of human talent, which when unfettered by the wrong kind of government, they succeed mightily—when they came to this country as coolies, slaves, they would leave and become the most important people in the town, so these are a remarkable people.”
 Of course, Munger was speaking two years before a likewise remarkable number of Chinese scams went public in the U.S., thus paying back, it might be said, some small part of the debt owed by the American railroads to their ancestors. 
 But if Munger’s na├»ve-sounding enthusiasm was premature, it was earnest, and based in large part on the chance for BYD’s supposedly revolutionary battery technology to help solve the great problem of how to store wind and solar-powered energy so it can be used when and where it is actually needed, as opposed to the Mohave Desert:
 “These lithium batteries are a remarkable technology, we need them.   I know it looks like Warren and I have gone crazy, but I don’t think we have…
 “It may be a small company but its ambitions are large, and I don’t wanna bet against 17,000 Chinese engineers led by Wang Chuanfu I would be amazed if great things don’t happen here.”
 Now, great things did indeed happen at BYD.  In this decade alone, sales grew almost 40-fold, gross profits 20-fold, and pretax income 15-fold.
 And the share price really took off after Berkshire invested a quarter-billion U.S. dollars in the company in 2008.
 Technically, of course, it was MidAmerican Energy Holdings that acquired the stock, buying 9.89% of BYD for $8HK per share.  And in what might now look like a giant red flag for Berkshire shareholders, it was MidAmerican’s CEO at the time, David Sokol, who went to China to look the company over before Buffett approved the investment (Munger recused himself—appropriately—from the decision-making, because his family had owned BYD shares for some time, a fact Sokol later tried to use, lamely, in his own defense after making undisclosed purchases in Lubrizol shortly before Berkshire announced a deal to acquire that company).
 Unfortunately, Sokol may have done Buffett no favors in encouraging the BYD investment, for while BYD shares soared immediately after the announcement, reaching $88.40HK—10 times Berkshire’s cost—they have since returned to earth ($15.40HK last sale) after a series of missteps, including missed sales forecasts in the bread-and-butter car business, an 88.6% profit drop in the most recent half-year results, and a series of missed deadlines for delivery of the company’s revolutionary electric car.
 This last is most worrisome for Munger’s optimism, which he maintained when asked about BYD’s setbacks at the most recent Berkshire shareholder meeting:
 “Any company that tries to move as fast...is going to have its glitches...I'm quite encouraged...”
 But we would not be so sure, particularly after asking an acquaintance from a large and prosperous US-based company, which has been making car batteries for almost 100 years, about BYD’s so-called revolutionary technology.
 The acquaintance shrugged.  “We don’t know much about it.”
 “You guys make batteries.  How come don’t you know?”
 “We don’t work with them.  They make everything themselves.  Everything.  We don’t know what their technology is.”
 “Well, what do you think it is?”
 Another shrug.  “Batteries hold a charge.  It’s how you put them together that makes them better or worse.  We don’t know what they do.”
 “Well, what do you think they do?”
 He speculated that part of the answer lies in the fact that the expected life of a car battery in China is shorter than in the U.S.  “They might only get five years out of it.  We build ours to last 10 years, which means they’ll last 15.  But what they’re doing in lithium, we don’t know.”

 Thus far, the “margin of safety” by which Warren Buffett lives (read “Secrets in Plain Sight” for the meaning behind this phrase), has protected Berkshire Hathaway from an embarrassing loss on its BYD investment.
 But while speculation rages that Berkshire will up its stake in the company, the speculation is dead wrong.
 Warren Buffett is no fool: he can read a balance sheet, and he can read a cash flow statement…and he could have easily bought all the new BYD shares he wanted when the company offered them recently on the Shenzhen stock exchange, supposedly for “research and development.”
 Against all odds—the weak sales, the State Department cables describing BYD’s alleged copycat cars, and the delayed electric car introduction—the BYD offering was 21-times oversubscribed.

 The greater fool theory lives.
  

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.

Monday, August 15, 2011

Buffett Takes Off the Gloves? He’s Getting Worried.


Stop Coddling the Super-Rich

Our leaders have asked for “shared sacrifice.” But when they did the asking, they spared me. I checked with my mega-rich friends to learn what pain they were expecting. They, too, were left untouched.
While the poor and middle class fight for us in Afghanistan, and while most Americans struggle to make ends meet, we mega-rich continue to get our extraordinary tax breaks….
These and other blessings are showered upon us by legislators in Washington who feel compelled to protect us, much as if we were spotted owls or some other endangered species. It’s nice to have friends in high places….

—Warren E. Buffett, New York Times, August 12, 2011 



  Warren Buffett’s politics have always been a surprise to first-time Berkshire observers.   “How can a billionaire like that be such a liberal?” is almost always one of the questions I get after a speech, or before a speech, or during a speech, about Buffett.

 But as anybody who’s followed Berkshire for a few years knows—or who’s read “Secrets in Plain Sight—Business and Investing Secrets of Warren Buffett”— Buffett’s Democrat credentials go as far back as 1968, when he supported anti-war candidate “Clean Gene” McCarthy in the presidential primaries.
 And Buffett’s strident stance on the inequities in the U.S. tax code is nothing new: he’s been talking about the tax advantage accruing to so-called “unearned” income versus wages for years, even testifying before Congress on behalf of “fairness,” at least as he sees it.
 Still, Buffett doesn’t—as readers of “Secrets in Plain Sight” also know—mention that while running what was, for all practical purposes, a hedge fund during the late 1950s, he took advantage of an even greater disparity in the tax code (the top marginal tax rate was 91% back then)—one of those ‘Do as I say, not as I do’ aspects to the Buffett PR machine that drives some investors crazy.
 But Warren Buffett is the most successful investor of his times, possessing not only one of the most rational minds in the business but also the uncanny ability to frame the cloudiest issue in a crisp, clear frame that makes whatever he’s talking about sound, well, pretty rational.
 And while today’s op-ed piece sounds pretty rational, the more interesting aspect is that it unleashes a new aspect to Buffett’s tax “fairness” campaign: he takes off the figurative gloves and talks about what he would do if he ran the joint.
 Among these are “pare down some future promises that even a rich America can’t fulfill,” “leave rates for 99.7 percent of taxpayers unchanged,” “continue the current…reduction in the employee contribution to the payroll tax,” and “raise rates immediately on taxable income in excess of $1 million…”
 Whether Buffett’s prescription is what America needs, let alone whether it will work, we make no judgment on here.
 We’re more interested in why he’s taking off the gloves now.
 And the reason—at least based on a close reading of “Stop Coddling the Super-Rich”—is that Warren Buffett is getting worried:

Twelve members of Congress will soon take on the crucial job of rearranging our country’s finances. They’ve been instructed to devise a plan that reduces the 10-year deficit by at least $1.5 trillion. It’s vital, however, that they achieve far more than that. Americans are rapidly losing faith in the ability of Congress to deal with our country’s fiscal problems. Only action that is immediate, real and very substantial will prevent that doubt from morphing into hopelessness. That feeling can create its own reality.

 The emphasis above—“That feeling can create its own reality”—was added by your editor, but having been written by a man born ten months after the Crash of ’29 who happens to be the head of a company with 260,000 employees making everything from chocolate candy to wind farms, and who is the overseer of insurance businesses holding tens of billions of dollars of exposure to financial markets through stocks, bonds, and the same kind of derivative contacts he once called “ticking time bombs,” the words fairly jump off the page on their own.
 Sounds like Warren Buffett is getting worried.

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.

Saturday, August 13, 2011

Standard & Poor’s: Welcome to Our World!


SEC Examines S&P’s Math
Italian Town’s Prosecutors Probe S&P, Moody’s
White House Challenges S&P Decision
—The Wall Street Journal
  
 “The fact is, we didn’t need a rating agency to tell us that we need a balanced, long-term approach to deficit reduction.”
 So said President Obama the other day.
 Unfortunately, on that matter, the President is dead wrong: the fact is, we did need a rating agency to remind us that 40% of what our Federal Government spends is borrowed; that this is unsustainable; and we better do something about it before it’s too late.
 Otherwise, nobody in Washington would have paid attention to that fact until it was too late.
 But our point here is not about our Japan-style budget policies, or the 11th-hour budget deal, or dis-function in DC or even the S&P downgrade itself.
 It is about the fact that Standard & Poor’s is now being attacked—by Congresspersons who wouldn’t know a balance sheet from a tomato; by White House staffers whose paychecks and generous healthcare benefits are paid by the taxpayers S&P is looking after; and even by prosecutors in the Italian village of Trani, which, as Stacy Meichtry and Nathania Zevi of the Wall Street Journal noted, “hasn’t played much of a role in the global economy since the Crusades”—for merely evaluating what it is paid to evaluate and saying in plain English what it has concluded.
 Granted, S&P didn’t cover itself in glory during the downgrade, switching its math at the last minute and rewriting its premise to accommodate the use of a different, less-than-worst-case scenario, and thus opening itself up to political hacks eager to shoot the messenger.
 But the message is right: after all, America has, as PIMCO’s Bill Gross points out, $66 trillion worth of entitlement liabilities—and that’s present value—amounting to half a million dollars per household.
 Still, that fact won’t stop those who benefit from our lousy, unbalanced budget from screaming the loudest at the downgrade, and using every lever at their disposal—Congressional hearings; lawsuits; bought-and-paid-for “60 Minutes” so-called ‘investigative’ stories—to discredit and disable the folks at Standard & Poor’s.
 After all, this is what CEOs do when intellectually honest analysts, short-sellers and just plain folks criticize, publicly, their companies for flaky accounting, serial restructuring charges and worse.
 Which is why so few people bother any more.
 So welcome to our world, Standard & Poor’s, and keep speaking your mind.
 It may be the thing that saves us from ourselves.


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.

Wednesday, August 03, 2011

The Most Important Call of the Year: “I’ve Got All The Clarity I Need”


 We have, in the past, highlighted in these virtual pages the comments of David Farr, the outspoken and common-sense-laden CEO of Emerson Electric Co.
 Readers not familiar with Emerson should become familiar with it, for in its long history (it was founded in 1890) Emerson has outperformed its more famous relative, General Electric (founded two years later), by a wide margin…and never needing taxpayer dollars to bail itself out from bad decisions like Jack Welch’s bad decision to turn GE from a company that made stuff for Main Street to a company that ‘made the numbers’ for Wall Street, using GE Finance as a perpetual motion machine that lasted only as long as the credit cycle lasted.
 We once talked to an ex-executive at Emerson about the GE comparison.  He said to us: “You know we used to have a finance operation like GE, right?”  We said, “No, what happened to it?” He said, “We shut it down.”  We asked “Why?”  He said, “Because our CEO decided it was too risky.”  That’s the kind of CEO the ‘beat-the-numbers’ folks at GE could have used.
 In any event, Farr runs one of the most value-added earnings calls of the season, offering frank and unvarnished observations about not only Emerson’s far-flung operations, but also about the operating environment in which the company lives.
 And that environment is not getting any prettier, if yesterday’s call is any indication.  Indeed, we think yesterday’s call was the single most important this season, and perhaps this year-to-date.
 Now, for a full flavor of Farr’s comments, readers ought to get a hold of the full earnings transcript—or, better yet, listen to a replay of the call itself.
 But the heart of the call came two-thirds of the way through the Q&A, when he was asked by one of Wall Street’s Finest what triggered Emerson’s recent warning that growth was slowing, and whether it stemmed from the need for greater clarity out of Washington.
 Here’s what Farr said:

 “I just look at the order pace. I think the biggest issue that I'm watching right now is they're not really -- either in the US or Europe really addressing the gut issues. The US have enormous regulations coming at us right now.
 “There's -- the incentive to invest in the United States is negative and from my perspective.
 “People talk about ‘we want clarity’. I've got all the clarity I need. They're spending, they're regulating us, the tax rates, they're talking about raising the tax rate.
 “Our tax rate this year will be around -- in the US will be around 36%. We'll pay in US taxes this year over $500 million, actually pay the US government over $500 million, and they say they want to raise it even more. And so I'm looking at that as a -- I run a Company, I have a lot of money to invest and I look at that and I say I'm not going to invest it here and I think customers -- I think a lot of customers have the same concern.
 “And then when you have a company like Boeing, you're talking about one of the iconic US companies gets sued by the federal government. If that doesn't get your attention, nothing will. They get sued for investing $2 billion in South Carolina. Last time I saw South Carolina was a part of the United States of America and you get sued for that. I tell what you, the CEO, you get my attention.”

Let’s hope Farr’s comment get some attention where it matters.



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.

Monday, August 01, 2011

The Least Reassuring Headline You Will Read Today


The least reassuring headline you will read today—and it may not get much attention with all the budget talk going on—is from our friends at Reuters:
 White House Not Worried About Double Dip - White House economic adviser Gene Sperling said on "Fox News Sunday" he was "not worried the U.S. will have a double-dip recession" – Reuters 
 The reason this is not as reassuring a headline as it might appear is that it comes amidst an earnings season that, aside from a few leading lights (mainly in the technology field and those companies doing significant businesses in Asia), has yielded news from the ground which is not nearly so perky as the ‘30,000 foot view’ preferred by lofty economics advisors such as Mr. Sperling.
 Pepsi, for example, had the following to say recently about its U.S. business two weeks ago:
 “Of the three factors impacting North American beverages—inflation, consumer demand and pricing—the consumer demand picture is the most concerning to us at this point.  In fact, the modest pickup in total consumer sending almost all U.S. businesses saw earlier in the year has reversed in the past several months.”
 And it isn’t just North American where things are wobbly.  Newell Rubbermaid warned last week:
 “Unfortunately we are seeing a softer economy in the US and Europe than we would hope for.”
 Indeed, this morning, Armstrong World Industries added its voice to the chorus:
 “We now expect our residential and commercial end markets opportunity to be slightly lower as the domestic economic recovery appears to be delayed.”
 There are many more examples of the sudden bloom of cautious commentary from businesses.  HSBC, no slouch in the world of global banking, this morning announced plans to cut 25,000 jobs—only a few days after the FT leaked that the company was going to “trim 10,000 people.”
 One might say HSBC “beat the number”…but in a double-dip sense.


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.