Buffett’s Investment In Dempster Mill – A Cigar Butt by John Huber, Base Hit Investing
I came across a case study that discusses Dempster Mill recently. I thought I’d post a brief summary of some notes I jotted down while reading it. Dempster Mill is a company that Buffett bought in the early 1960’s when operating his partnership.
The company manufactured farm equipment, specifically windmills and water irrigation systems. It was a difficult business because the farm equipment it made was not much different than its competitors’ products, and because of these commodity-like economics, the business produced low returns on capital, and in fact struggled to break even. But despite its poor earning power, Buffett bought the stock because of the discount to its net tangible assets–a classic cigar butt.
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Here is Buffett’s introduction of Dempster Mill from his 1961 letter to partners:
“Dempster is a manufacturer of farm implements and water systems with sales in 1961 of about $9 million. Operations have produced only nominal profits in relation to invested capital during recent years. This reflected a poor management situation, along with a fairly tough industry situation. Presently, consolidated net worth (book value) is about $4.5 million, or $75 per share, consolidated working capital about $50 per share, and at yearend we valued our interest at $35 per share…”
Buffett bought this originally as a generally undervalued stock—one that he bought because it was cheap and expected to sell out at a profit at some future date. Indeed it was cheap: Buffett paid around $28 for a stock with $50 of working capital and $75 of book value. However, the stock remained cheap as the business struggled, and Buffett began buying more of it—eventually owning 70% of the company. The position represented 21% of his portfolio.
What’s interesting is that Buffett took control of the company, and expected two possible ways to profit from this investment: the company could improve its operations and achieve a higher valuation in the market, or the value of the assets could be monetized (through liquidation or asset-sales).
“Certainly, if even moderate earning power can be restored, a high valuation will be justified, and even if it cannot, Dempster should work out at a high figure.”
Buffett and Charlie Munger worked together on this investment—and they brought in their own manager in hopes of restoring the company to profitability.
The case study provides the complete story of this investment, or just read the 1961-1963 partnership letters for complete details. Snowball and The Making of An American Capitalist provide more commentary from Buffett and Munger as well.
Dempster Mill Summary
Here are some notes I jotted down as I read the case study and reread the old partnership letter:
- Buffett bought the stock of Dempster Mill extremely cheap (as low as 25% of book value)
- He was very patient, buying it in dribs and drabs over 5 years—from 1956 until 1961
- At first he was content to buy a cheap stock, but as he bought a larger stake in the company, he began taking more control of the operations
- Management paid lip service to fixing operations and cutting bloated costs
- Eventually, Buffett owned 70% of this business with low earning power and bleak prospects. He needed to turn it around in order to either sell the company or improve earnings.
- Charlie Munger, who wasn’t particularly fond of poor businesses like Dempster, recommended hiring Harry Bottle.
- Bottle was surprisingly able to turn the company around. He cut costs and liquidated assets. Bottle sold down excess inventory so Buffett could use the proceeds to invest in stocks for Dempster’s account. Bottle laid off workers, closed unprofitable branch locations. He even was able to improve business operations which led to modest sales growth, and thanks to his focus on keeping costs under control, profitability improved.
- Bottle helped Dempster gain profitability and use up its tax losses, which eventually led Buffett to want to either fold Dempster’s business into BPL partnership (to avoid the corporate double taxation) or to sell the company outright.
- The company ended up getting sold around book value for $80 per share, a nice increase from the $15-$30 per share where Buffett was buying his shares at years earlier.
My Own Comments On The Dempster Mill Investment
The investment was a big success for Buffett’s partnerships (BPL). I think the key though was not the bargain price that Buffett paid for the shares, but the fact that Harry Bottle was able to turn the company around by stabilizing sales, cutting unnecessary costs, and improving profitability. If Bottle didn’t come along, the company’s management likely would have continued down the same path, which would have led to mediocre or poor operating results, which likely wouldn’t have resulted in anywhere near the success that BPL had on this investment.
When it was all said and done, BPL had over 20% of the partnership invested in Dempster, and the stock went up nearly 3-fold from the original purchase price.
But if it weren’t for the shrewd strategies of Harry Bottle, this could have been a mediocre investment at best, and at worst, in Buffett’s postmortem words:
“If Dempster had gone down, my life and fortunes would have been a lot different from that time forward.”
The moral of the story is that Buffett invested in a cigar butt that went nowhere for years until he was able to gain control and install his own manager—who had a focus on essentially liquidating the company. If it weren’t for Bottle, the company would have almost certainly continued to destroy value.
Unlike BPL’s purchase of American Express or Disney whose intrinsic values were increasing as time went on, (and whose stock prices responded accordingly—the former went up 3x for BPL and the latter gained about 50% the year after Buffett bought it), Dempster was eroding its intrinsic value each year that it continued to exist. The best result is a quick sale or liquidation for these types of investments.
John Huber is the portfolio manager of Saber Capital Management, LLC, an investment firm that manages separate accounts for clients. Saber employs a value investing strategy with a primary goal of patiently compounding capital for the long-term.