Notes on the 2011 Berkshire Hathaway Annual Report, Part 3 (On Acquisitions)

Notes on the 2011 Berkshire Hathaway Annual Report, Part 3 (On Acquisitions)

Notes on the 2011 Berkshire Hathaway Annual Report, Part 3 (On Acquisitions)

Though part of a series, this post is different.  I went back through the last 35 years of shareholder letters to analyze Buffett’s approach to acquisitions.  As Charlie Munger has said, Buffett is scary smart.  I say this because he adjusted through many different eras, while running a business that was part conglomerate, part closed-end fund.

In some ways the early years were different — more arbitrage, public investments take up more time in the shareholder letter.  But what I find fascinating is that from the earliest days, it didn’t matter to Buffett whether he owned whole businesses, or parts of them.

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Part of this feeds off of Felix Salmon’s recent piece on acquisition language, where he contrasts tuck-ins and bolt-ons, correctly concluding that the difference is only one of size, even though that is an informal distinction.

But since the ’80s Buffett has always talked about acquisitions. Here’s a graph indicating Buffett’s use of the term acquisition(s):

Notes on the 2011 Berkshire Hathaway Annual Report, Part 3 (On Acquisitions)

You will note that his use of phrases like “tuck-in” and “bolt-on” occur only in the 2000s.  But the ideas were there long before that.  There were many cases in the ’90s, and to a lesser extent, the ’80s, where subsidiaries of BRK made acquisitions.  Buffett was always looking for ways to profitably deploy excess capital, and he knew that acquisitions facilitating organic growth was often far more effective than buying something totally new.  Buffett was doing tuck-in and bolt-on acquisitions for 15 years before he mentioned the terms.

Buffett always saw the public and private markets as being complementary.  He doesn’t care where he makes money; he just wants to make money.  Below there is a list of BRK acquisitions by year, with slight commentary.

One thing to understand about BRK is that full and partial ownership of private public businesses was always a part of the plan.  Growing out of a textile manufacturing business as a holding company, that should be obvious, as it should be when considering See’s Candies, BRK’s first acquisition.

Public and private, full and partial did not matter to Buffett.  He was simply interested in what could grow the intrinsic value of the the overall enterprise best, within the concept of a margin of safety.

1987-1989 was kind of an in between era for BRK, where Buffett would talk about his Sainted Seven private firms inside BRK, until he bought Borsheim’s in 1989, which gave him no good way to describe his private holdings with a simple moniker.

As it is, when he began doing more acquisitions, the 1991-1993 era included the “Shoe Group,” which was not among his finer moments.  But starting in 1995, with the purchase of the remainder of GEICO, is the start of the modern BRK.  Acquisitions become a regular part of the plan.  What makes that plain, was that post-1990 in years where BRK had no acquisitions, Buffett would discuss his theory on acquisitions for shareholders.  He did this because when there are few promising targets to invest in, it is usually a sign that valuations are stretched.

And in general, Buffett chose wisely with the private businesses.  Yes, there have been some that ended up being losers, or, not big winners, like the “Shoe Group,” and Scott & Fetzer’s untimely purchase of World Book, which was about to be obsoleted by Encarta, and then Wikipedia.

Buffett understood the need for sustainable competitive advantage.  He also knew how much he could afford to risk in acquiring private firms.  His “bite size” increased gradually until he could take down monsters like Burlington Northern.  He bought businesses that would be hard to obsolete.

One thing I found interesting about reading through the older letters of Buffett was that his ideas on acquisitions were developed early, long before BRK ceased to be predominantly a public company value investor, which is the way that many still regard BRK.

And as a result, it should be no surprise that as BRK grew, given Buffett’s desire for owning as much of great businesses as he could, that BRK became a conglomerate, albeit one dominated by its leading insurance businesses.

Though we can look at the different strategies employed by Buffett over the years, and see how some played a larger role early on like arbitrage and distressed investing, Buffett had a singular focus for the investments that offer decent returns in the size range that will make a difference for BRK investors.

Once BRK got big, that meant becoming a conglomerate, albeit a special one, was the logical outcome.  And I could be wrong, but that is the final corporate form for BRK.  There may come a day in a post-Buffett era when it may do many things, such as spin off companies, or centralize functions.  At present that won’t happen because BRK is the acquirer of choice for those that want to cash out, but don’t want the unique character of their organizations to change, which Buffett points at in the present Shareholders’ Letter as a unique competitive advantage.  BRK does not compete on price in acquisitions; it does compete by saying that unless something goes badly wrong, BRK will be more than happy to let the management do its thing.  It’s as if Buffett says, “Just make money, and send us back the excess.  If you have need of cash for promising opportunities, let us know.”

And then, it lets a thousand flowers bloom, and a thousand schools of thought contend, so long as you make money and grow the value of the business.  BRK is a unique business, and reflects the character of its founders (including Munger here).  No other large firm that I know of offers as much latitude to its operating units.

One final note: Buffett has also had a very good nose for sniffing out good insurance enterprises.  That’s the backbone of BRK.  It’s interesting to see over the years how he assembled the various pieces.  It would be interesting to see pre-1977 data on the insurance side, to look at how Buffett initially entered the insurance business, and transisted out of running a textile firm.

Tomorrow should have my final installment on BRK.  I will review the 10-K and provide commentary.

Here are the links for: Part 1 and Part 2

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.
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