The Warren Buffett You Don't Know (1 of 2)
businessweek.com
Ace stockpicker, of course--and now, an empire-builder
Warren Buffett is returning to the U.S. from Europe in a private jet. As his plane nears its destination, the flight attendant gives out landing cards and a warning to all eight passengers aboard. ''The customs inspector here is utterly humorless,'' she says, ''so no wisecracks or he will tear the plane apart from fore to aft.'' Buffett, who quips as reflexively as he breathes, takes his card without comment.
In the terminal, a surly looking man with a crewcut and a pistol on his hip sits behind a small table. Buffett hands over his passport and landing card to the inspector, who does not seem to realize that the professorial-looking 68-year-old standing before him is America's second-richest man. Or perhaps he just gets a kick out of trying to take the high and mighty down a peg. ''You left some things blank,'' the inspector says peevishly. ''Do you have $10,000?''
The question could have launched a dozen snappy retorts, but Buffett restrains himself. ''I have what I left with,'' he says carefully. The inspector furrows his brow--was that some kind of joke?--but does not press the issue. He asks Buffett if he has any anything to declare. ''I was given two books,'' Buffett says. ''Well, you have to put it down, then,'' snaps the agent, who fills in the blank himself.
Buffett shows not a flicker of annoyance at being treated like a misbehaving child. He stands mute and impassive before the inspector, who, after a few more curt remarks, can think of nothing else to do but let ''the Oracle of Omaha'' be on his way.
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Has there ever been a less pompous billionaire than Warren Edward Buffett? Hollywood might cast him in the role of an amiable teacher at a Midwestern college or a sweet-tempered, wisecracking inventor who eventually wins a Nobel prize and gets the girl besides. To hear Buffett sing his beautifully artless rendition of Ain't She Sweet to his own ukulele accompaniment is to wonder not only how such a man came to measure his net worth in billions but also whether he might not be a time-traveler from a more innocent age.
If Buffett had a business card, it would identify him as chairman and chief executive of Berkshire Hathaway Inc. (BRK.A) But he is far better known--indeed, world-famous--as the greatest stock market investor of modern times. The figures, though often cited, still astound: Had you put $10,000 into Berkshire when Buffett bought control of it in 1965, you'd have $51 million now, vs. just $497,431 if the money were invested in the Standard & Poor's 500-stock index.
The numbers don't lie, but the story they tell is out of date. Buffett has not added a major position to Berkshire's bulging stock portfolio since amassing 4.3% of McDonald's Corp. (MCD) in 1995. In the meantime, he has transformed what long has been a sideline at Berkshire--the acquisition of entire companies--into the main event. Over the past three years, Berkshire has spent $27.3 billion to buy seven companies in industries as disparate as aviation, fast food, and home furnishings. The $22 billion purchase of reinsurer General Re Corp., which closed late last year, was Buffett's largest ever.
The effect has been dramatic: In short order, Berkshire has been transformed from a closed-end fund in corporate drag to a bona fide operating company. At the start of 1996, the company's famous stock portfolio accounted for fully 76% of Berkshire's $29.9 billion in assets. But by the end of 1999's first quarter, the figure had plummeted to 32% as assets quadrupled, to $124 billion. Today, Buffett's company employs 47,566 workers, double the number in 1995.
And he isn't done yet. ''I'd love to make a $10 billion to $15 billion acquisition, and we could go bigger than that if I really like the company,'' says Buffett, who holds $15 billion in cash and is sitting on top of an additional $30 billion in unrealized gains in Berkshire's stock portfolios.
It's all there in black and white in Berkshire Hathaway's famously literate annual reports, but somehow the company's transformation has gone not just unheralded but unnoticed. Berkshire is ''possibly the most talked about and the least understood company in the world,'' contends Alice Schroeder, a PaineWebber Inc. insurance analyst who in January published one of the few comprehensive studies of the company ever undertaken by a brokerage house.
MISUNDERSTOOD. The common view is that Berkshire shares fetch a premium because of Buffett's reputation as a latter-day Midas. The ''Buffett premium'' undoubtedly is real in the sense that if the man died today, the stock would plunge tomorrow. In Schroeder's view, though, Berkshire's stock is already trading at a sizable discount to its true value, which she estimates at $91,000 to $97,000 per A share. The A shares lately have been trading at about $70,000. The basic problem, Schroeder says, is that the world continues to misperceive Berkshire as little more than the sum of the stocks it holds in its $37 billion portfolio. In other words, the market tends to overreact to news about the seven stocks that form the core of Berkshire's holdings (table). Over the past 12 months, Berkshire has fallen by about 17%, from a high of $84,000 in June, 1998. In Schroeder's view, the main cause of this decline is the plunging value of Buffett's colossal stakes in Coca-Cola Co. (KO) and Gillette Co (G).
The radical recent shift in Berkshire's corporate profile does not reflect a radical change in Buffett's thinking. In most ways, he remains true to the conservative precepts of value investing. In essence, Buffett continues to prefer today's sure thing to the next big thing, no matter how spectacular its potential. Forget Internet stocks: Buffett still will not invest in even such well-seasoned high-tech companies as Microsoft Corp. (MSFT) or Hewlett-Packard Co. (HWP) because he doesn't believe that anyone can predict how much they will earn over the next decade or two. ''I can't do it myself,'' he says. ''And if I don't know, I don't invest.''
Even in his stock-picking heyday, Buffett preferred owning businesses to passive minority investment. Until recently, though, Berkshire's acquisitions have been few and far between because Buffett insisted on buying top-quality businesses at discount prices. What has changed is that he is now willing to pay a premium for one-of-a-kind businesses.
Why this is so is not completely clear. The Buffett psyche is notoriously labyrinthine. ''I could easily spend a lot of time trying to analyze Warren if I didn't consciously try not to,'' says Olza M. Nicely, CEO of auto insurer GEICO Corp., one of Berkshire's largest subsidiaries. ''There are certain mysteries you just have to accept.''
In Buffett's view, he is putting the finishing touches on his masterpiece. ''Berkshire is my painting, so it should look the way I want it to when it's done,'' he says.
In an era in which most CEOs at least mouth the platitudes of good corporate governance and shareholder rights, Buffett, in his good-natured way, is a throwback to a time when a mogul was a mogul and did as he damn well pleased. ''Berkshire is the company I wanted to create. It's not the company Alfred P. Sloan wanted to create. It fits me,'' he says. ''I run it with our investors and managers in mind, but it is designed to fit me.'' To be blunt, Buffett stands revealed as a driven, even monomaniacal corporate empire-builder.
For all his offhand charm, Buffett is pretty much all business all the time. Aside from an addiction to luxury air travel, he is a man of simple tastes and frugal habits. He neither spends his money nor gives much of it away. Philanthropy, the renascent vogue of America's superrich, interests him peripherally at most. Buffett intends to take his fortune to the grave--and to keep adding to it until the day he dies. ''The problem I've got with doing anything else except what I'm doing is that there is nothing remotely as fun as running Berkshire,'' he says. ''I'm selfish that way.''
So far, Berkshire's legendarily devoted shareholders would not have it any other way. In May, some 15,000 of them flocked to Omaha to sit at the feet of the master during Berkshire's three-day festival of an annual meeting, which Buffett calls ''Woodstock for Capitalists.'' Of course, Buffett and his wife, Susan T. Buffett, are the largest Berkshire shareholders by far: Their 38.4% stake is worth about $40 billion.
The highest circle of management power at Berkshire has always been tight, but it has shrunk in recent years--to Buffett alone. Charles T. Munger, Buffett's longtime vice-chairman and business alter ego, continues to enliven the annual meeting by playing the part of drolly laconic sidekick to Buffett's ebullient master of ceremonies. Behind the scenes, though, his influence has waned. ''Charlie and I don't talk a lot anymore,'' acknowledges Buffett, who says he did not even bother to consult his vice-chairman before making the epochal Gen Re acquisition.
By all accounts, including their own, Munger and Buffett have not fallen out. But while Buffett is wholly devoted to building Berkshire, Munger, 75, now spends his time chairing a not-for-profit hospital and serving as a trustee of a private high school. ''Charlie is broader in his interests than I am,'' Buffett says. ''He doesn't have the same intensity for Berkshire that I have. It's not his baby.'' Munger concurs: ''Warren's whole ego is poured into Berkshire.''
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In mid-April, Buffett led a small entourage on a whirlwind European tour to promote one of Berkshire's latest acquisitions, Executive Jet Aviation. I went along for the ride (on one of EJA's Gulfstream IV-SP jets) and got an unusual chance to observe the notoriously press-shy Buffett at close range against a kaleidoscopic backdrop of private airports, luxury hotels, and banquet halls stretching from London to Frankfurt to Paris.
Buffett survived a demanding regimen of midmorning coffees, two-hour luncheons, 90-minute press conferences, and four-course banquets. ''I never get tired,'' he told reporters in London, ''except for my voice.'' Actually, Buffett was ashen with fatigue midway through the third day but soldiered gamely on, answering even the lamest questions with the same expansiveness and wit the fifth time he heard them as he did the first.
Only once did Buffett show annoyance. During a press conference at the Frankfurt airport, Richard Santulli, EJA's normally understated chief executive, let his admiration of Buffett overflow. ''People say that he's the most astute investor of the 20th century,'' he said. ''I say ever.''
Buffett, who was sitting at Santulli's side, gave a little snort. ''Why not?'' he said sourly. ''I'm sitting right here.''
Like any mogul, Buffett has his special needs. On this trip, he indulged two of them, listed here in reverse order of importance: red meat (at lunch and dinner) and Coca-Cola (all the time).
Whenever I lost track of Buffett, Coke often appeared to guide me--a carbonated version of the proverbial trail of crumbs. In London, our party went from airport to hotel in separate cars. When I arrived at the Berkeley Hotel, I did not have to wonder for long whether Buffett had preceded me. A bellhop approached with a shopping bag. ''Is this yours?'' he asked. Inside were two six-packs of Cherry Coke. Two days later, I was in the crowded lobby of the Schlosshotel Kronberg near Frankfurt, following a white-gloved waiter bearing aloft a single bottle of Coca-Cola on a silver tray.
Buffett bought Executive Jet in mid-1998 for $725 million. Although this is a pittance compared with what Berkshire paid for General Re, the EJA deal was no less a milestone in its way. EJA, which pioneered the fractional ownership of business jets, is the first true emerging-growth company that Buffett has ever owned. What's more, the very idea of investing in business aviation would have been considered downright sacrilegious throughout most of Berkshire's history.
For years, Buffett mocked corporate ownership of jets as a wasteful executive perk. But in 1986, he bought a small used plane for Berkshire, then traded up to a more expensive model a few years later. He named the jet ''The Indefensible'' and made sport of its purchase in his 1989 report to shareholders: ''Whether Berkshire will get its money's worth from the plane is an open question, but I will work at achieving some business triumph that I can (no matter how dubiously) attribute to it.''
The truth is, Buffett had fallen in love with his plane but could not yet admit it. In 1995, he was introduced to Santulli by the head of one of Berkshire's operating companies and bought a one-quarter share of a Hawker for personal use. His wife, who has become a frequent flier, called the new plane ''The Richly Deserved.'' (Not to be outdone, Buffett renamed Berkshire's jet ''The Indispensable.'') Santulli offered to sell his company to Buffett when Goldman, Sachs & Co. (GS), a founding minority investor, began pressuring him to float a public stock offering.
Executive Jet in no way resembles the sort of business on which Buffett cut his teeth as an apprentice to the late Benjamin Graham, co-author of the value-investing bible, The Intelligent Investor. Graham's method emphasized creating a ''margin of safety'' by investing only in stocks trading at two-thirds of net working capital. He called them ''cigar butts''--companies the stock market had discarded but that still held a puff or two of value to extract.
Buffett was Graham's most accomplished disciple. But as the pupil established himself, he began to feel constrained by the mentor's method. For Graham, a business was an abstraction wholly defined by a set of numbers on a page; he had no interest in its products, its management, its personality. But Buffett's boundless curiosity and enthusiasm were not satisfied by the ghoulish exercise of profiting from the last dying gasps of derelict companies. Buffett's yearnings and dissatisfactions did not begin to coalesce into an investment philosophy of his own until he met the blunt-spoken Munger in 1959. The two, closely matched in intellect and outlook, quickly became the closest of partners. Munger urged his friend to leave the cigar butts in the gutter and think of value in more expansive terms. Says Buffett: ''Charlie kept pushing me back to the idea that what we really needed to own was the wonderful business.''
Even so, it took Buffett a long time to tailor Graham's straitjacket conservatism to the more generous dimensions of his own personality. His $11 million purchase of Berkshire Hathaway in 1965 was a costly case in point. Initially, Buffett saw the floundering old-line company as a classic Graham play. But then the textile manufacturer rallied unexpectedly, and Buffett sank more money into it on the belief that this cigar butt had a future after all. It did indeed, but not in textiles.
Buffett did not come fully into his own until he and Munger collaborated on the $25 million acquisition of See's Candies in 1972. The San Francisco maker of boxed chocolates was the first business of any sort for which Buffett paid more than book value--three times book, in fact.
What, in Buffett's view, makes a business wonderful? It starts with ''a sustainable competitive advantage.'' Underline sustainable. Buffett will not invest in a business unless he feels reasonably certain how much it will earn over the next 20 to 25 years. But for all of Buffett's cerebration, he does not feel truly comfortable unless a business ties into his own everyday experience. His favorite companies tend to traffic in elementally appealing brand-name products that Buffett not only uses himself but also invests with almost totemic meaning: a bottle of Coca-Cola, a Gillette razor blade, a box of See's candy, and, yes, even a Gulfstream jet.
Buffett has always been especially partial to companies that can sustain a competitive edge without tying up much capital. Consider Scott Fetzer, which makes a variety of industrial and consumer products, including Kirby vacuum cleaners and Quikut knives. Since 1986, when Berkshire paid $315 million for Scott Fetzer, its earnings have risen by only 5.5% a year on average. Yet Buffett repeatedly has praised it as a model of capital efficiency. In 1998, Scott Fetzer netted $96.5 million after taxes on its $112 million in equity, a return on equity of 86%. This is all the more breathtaking considering that Buffett has been milking it for 13 years, extracting more than $1 billion all told.
Ever since Berkshire's 1967 acquisition of National Indemnity Co., insurance has held double appeal for Buffett. Not only does he like the economics of the business--or parts of it, anyway--but a well-run underwriter also generates a steady flow of low-cost investment dollars, or ''float,'' as a matter of course. The 1996 acquisition of GEICO, now the sixth-largest U.S. auto insurer, doubled Berkshire's float at one stroke, and the Gen Re buy nearly tripled it, to $21 billion. |
