Charlie Munger On Frozen Corporation
Benjamin Graham used to talk about a “frozen corporation” - A company whose charter prohibited it from ever paying out anything to its owners or ever being liquidated or sold. And Graham’s question was, “What is such an enterprise worth?”
I do think that it’s an interesting case because I think there is a class of business where the eventual “cash back” part of the equation tends to be an illusion. There are businesses like that – where you just constantly keep-pouring it in and pouring it in, but where no cash ever comes back.
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For years, I was a director of an International Harvester dealership in the Central Valley. That is a really tough business. And there’s never any cash. As the saying goes, at the end of the year, your profit is sitting out in the yard – in the form of your used equipment. And struggling with a business that never produces any cash – whether it’s winning or losing as a matter of accounting – is no fun. And I watched that being done for many years. Then I was in an electronic business where we had what I would call style changes. However, they were really technology changes. Our main product was obsolete by magnetic tape. And nobody told me that magnetic tape was going to be invented and that it was going to obsolete my main product. And I found it s a very unpleasant experience.
Charlie Munger's investment mistake
So we learned part of what we learned from unpleasant experience. And the experience Warren Buffett and I had early on in the department store business in Baltimore—we never should have bought into it. It was an investment mistake caused by youth and ignorance, although we were plenty old enough to know better. We just hadn’t learned enough from vicarious experience. But we soon realized that we had problems there that we couldn’t fix. In fact, we soon realized we had problems that nobody could fix. There’s no example in recorded history of anybody fixing the kind of problem we had in Baltimore. There were four big department store chains which sort of equally shared the market. And it just got tougher and tougher and tougher. And it demanded capital on a massive scale just to stay in the game at all.
Luckily, we were able to exit that business and get our money back. Maybe we even got 2% per annum interest. But we learned a very valuable lesson.
Charlie Munger: Thompson Publishing vs AT&T
Warren occasionally teaches that lesson in business schools. He used to show students the records of Thompson Publishing, the newspaper company, and AT&T going way back without identifying the companies. And it turns out, of course, that for 30 years the telephone company was a lousy investment for shareholders because they just kept issuing shares like crazy and throwing more capital into the business. They were able to get higher earnings only by reinvesting enormous amounts of cash. There was never any real cash to distribute to AT&T shareholders. This is going way back – before the breakup and before the last few years when they changed it into a different kind of company.
In contrast, Thompson Publishing had all of these little newspapers that just spewed out cash. They basically never had to put any cash back into the business unless they wanted to buy another newspaper. So, of course, the people who owned the stock of Thompson became enormously rich, whereas the people who owned AT&T didn’t. The difference, of course, is that one business grew like crazy without requiring more capital. And the other one grew only by requiring way more capital than the business made.
You should seek businesses that just drown in money if they just pause for breath…