Dale Oesterle On Buffett & Munger 20 Years Later by Lawrence Cunningham, Concurring Opinions
Editor’s Note: Dale Oesterle (Ohio State U.) contributes an extended version of his current reflections on The Buffett Essays Symposium: A 20th Anniversary Annotated Transcript, recently published by The Cunningham Group and Harriman House. Prof. Oesterle (right) participated in the 1996 symposium’s panel on takeovers and engaged in extensive colloquy with Berkshire Hathaway Vice Chairman, Charlie Munger, sitting in the front row (left).
Much has changed since my exchange with Mr. Munger in 1996. Relevant to my comment, leveraged acquisition practice, and our view of the social utility of leveraged acquisitions has changed significantly.
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First, true hostile tender offers, tender offers that close hostile, are dead. By hostile, I refer to tender offers that are made and executed (closed) without the consent of the target board of directors. An offer closes hostile when the hostile bidder, buys enough stock to replace vote out a resisting target board. Financial buyers were “raiders” funded by “LBO Funds” [Leveraged Buy-Out Funds].
We have a very infrequent current substitute in which hostile tender offers are made contingent on the success of a hostile proxy contest. But the word hostile now attaches to tender offers that are, in essence, harsh opening bargaining positions to pressure sitting boards of the target to negotiate to a friendly conclusion. These bids too are rare, however.
What now survives of the old 80s hostile acquisition is a rather timid substitute. Hedge funds buy small stock stakes so as to not trigger takeover defenses and, as “activist shareholders,” attempt to persuade a sitting board to engage in major transactions or financial reorganizations.
In most cases, the incumbent board and the new active block shareholder negotiate to some sort of compromise. Incumbent boards that refuse any and all changes face a challenge for one or two board seats and “shark attacks”, a growing group of shareholders, other hedge funds and even institutional investors, that is increasing disturbed by the board’s position. The common public attack, fueled by the same group of lawyers, politicians, and pundits that attacked raiders, now focuses on hedge funds and “activist shareholders.”
True leveraged acquisition became friendly, run by “PE [Private Equity] Funds,” and often focused on distressed companies negotiating purchases short of inevitable or impeding bankruptcy. PE Funds also attracted the scorn of the public for their often radical re-organization efforts; workers were fired, factories closed or sold, and headquarters moved.
Second, there is growing understanding, given a pile of complex financial studies, that company-level financial style acquisitions are profitable at some meta-level. Hedge Funds that do major acquisitions are now a legitimate “asset class” in the portfolios of main line institutional investors, university endowment funds, mutual funds, and insurance investments. They make money and are worth the risk; they “juice returns.”
Moreover, there is a growing awareness that acquisitions of distressed companies, saving the immense costs of bankruptcy, The evidence is everywhere. Even the federal government has become an all too common broker of workout acquisitions. Consider the 2008 deals for the sale of Chrysler and Merrill Lynch.
Using debt to buy companies is, if carefully done, a sensible strategy. Even Mr Buffet and Mr. Munger are now in the LBO business. They have teamed up with internationally known PE Fund 3G Capital to buy Kraft, Heinz, and Tim Hortons for cherished Berkshire Hathaway. Mr. Buffet’s remarks that this is not a traditional PE Fund operation because he will not sell the companies purchased are a bit hollow.
Venture Capital Funds, which are loved for their support of start-ups, are in the business of buying and, yes, selling portfolio companies. PE Funds are just late stage dealers. In any event, the 3G Capital deals are leveraged acquisitions and Mr. Buffett and Mr. Munger will reorganize and restructure the companies to grow them so as to pay off the new debt. The low cost of debt was just irresistible to these savvy stock pickers as it has been to hedge funds.
Remember Mr. Buffett does sell some losers; Berkshire Hathaway no longer owns its namesake textile factories. We must recognize that Buffett runs an obsolete business system, the old conglomerate that failed so many times in the 70s and 80s. His success with this old relic is unique and a real credit to his investment prowess. Others will not repeat it so easily and we should not encourage them to do so.
Normal professionals in the business need to sell losers and cash in winners. There is still no end to the social criticism of PE Funds but it has telling shifting and is now, in a sense, an outright admission that the financial acquisitions work. It is “profits” that are under attack; we, for example, should favor “Benefit Corporations” that forsake profits for social welfare or otherwise “Feel the Bern.”
So where are we? The point I made in my discussions with Mr. Munger still stands. We have too many laws that interfere with leveraged acquisitions. They do not stop them but they do affect how the parties split the gains of the acquisition. Target firm shareholders still take the lion’s share of the acquisitions profits. This has many effects.
The laws, for example, discourage bidders, encourage targets boards to spend substantial funds and time on discouraging acquisition offers and/ or shareholder requests, and encourages a hedge fund industry to spend funds to overcome the stubborn resistance of reluctant boards. Brokered government bailouts are made more likely. These are all social losses.
As for the new socialism in our politics? We need to better educate our high school students on the social benefits of capitalism.
Editor’s Further Note: For Cunningham’s views on some of these points, see Cunningham: Culture of autonomy makes Berkshire’s size more strength than weakness, Omaha World Herald (posted April 30, 2016) and hear Cunningham’s Keynote on Berkshire’s 50th Anniversary, Museum of American Finance (posted May 12, 2016).