I know many articles have been written about Buffett’s recent bid for BNI, but I thought I had something to add to the controversy.I was excited to hear that Buffett was going to be on Charlie Rose and talk about the BNI acquisition. However, I was disappointed by the interview with Charlie Rose, since only a short segment was devoted to discussing the BNI purchase.
Earlier that night I was listening to Alice Schroeder (the author of Snowball) Buffett’s biography, being interviewed by Tom Keane on Bloomberg radio, and something she said caught my attention. Schroeder said that one reason that Buffett bought BNI was to diversify Berkshire away from the financial and insurance services. She said that right now Berkshire Hathway’s revenue is comprised of 50% financial, and insurance services, and 50% other industries. She argued that Buffett can manage these financial services but is unsure that his successor would be able to manage these risks. Therefore, one reason for the BNI acquisition was to gear Berkshire more towards non financial services for the future
. On the surface this seems like a valid argument. The sub-prime and overall recession has proved that financial geniuses with PHDs from MIT cannot devise formulas or computer programs to manage risk. Common sense hands down beats complicated financial formulas. Risk assessors from the largest financial institutions and mortgage lenders devised sophisticated models, that supposedly were able to determine whether their loan portfolio was risky. Yet these “financial experts” miserably failed at their task. (A similar lesson should have been learned 11 years earlier from the collapse of LTCM but unfortunately was not.) Common sense tells us that someone with no income or assets will quickly default on a mortgage, and lending to borrowers like this on a mass scale could lead to huge losses for a lender, yet this common sense was ignored. Therefore, it takes someone with the skill of Buffett to manage risk in financial and insurance services to produce large profits while guarding against downside risk. This could not be guaranteed for his successor.
I decided to look at other possible acquisitions, Buffett may have pursued that could have fulfilled this goal of diversifying away from financial services. I assume Buffett’s favorite companies were his largest holdings, therefore I decided to examine the possibility of Buffett purchasing them instead of BNI.
Buffett’s largest holding is Coke. It would have made sense for Buffett to buy it since it has a huge moat, dominates its market, and has a high returns on equity( and of course is a non financial company.) Yet Coke has too large a market cap for Buffett to buy there is simply no way he had enough cash to buy the entire company.
Wells Fargo is another company Buffett loves, however it is a financial company and even at its low of $8 dollars reached in March Buffett would have had to pay far more to acquire it then he paid for BNI
American Express is a company Buffett loves and he could have afforded to purchase it when it reached its low of $10 in March, however it too is a financial company which entails the risks Buffett was trying to move away from.
Johnson and Johnson, and Proctor and Gamble
JNJ and PG are also large holdings of Buffett and are non financial companies. Yet both companies are two of the largest in the world, and way out of Buffett’s reach.
The only company that would fit on the radar is Kraft. Kraft has only a slightly higher market cap than BNI. Buffett would have likely had to pay a similar price that he had paid for BNI so it would have been a toss up between the two.Perhaps Buffett sees more of a future for BNI and that is why he did not offer to acquire Kraft. In addition, considering that Kraft is trying to make a large offer for Cadbury I doubt the Kraft management would have been interested in a takeover.
The only one of Buffett’s favorite companies that he could have bought out entirely is BNI using Schroeder’s criteria. However without getting into the whole question of whether the BNI acquisition was intelligent I have two points to make. First Buffett did not have to make one large transaction. He could have purchased smaller businesses in the non financial sector with a large moat and excellent managements. There were many companies that were selling at bargain prices throughout the past year that fits this criterion. My second problem is why Buffett waited so long to make the deal. Buffett is famous for his principle to be fearful when others are greedy and be greedy when others are fearful. Buffett offered to buy out BNI when it was at $75 a share at a 30% premium which is going to cost him $100 a share. If buffett had been greedy when others where fearful he could have purchased BNI at $65 a 30% premium when it was trading as low as $50 in March. This would have saved Berkshire shareholders billions of dollars to buy the same exact business. Of course I was a BNI shareholder until after the acquisition announcement, was very happy to sell out at $98 a share instead of $65!
Disclosure: I am long KO, PG, WFC, and AXP