A letter a day!

A letter a day!

Letter #49 1995

Key learnings:

1. Many times, due to high valuations quoted at the time of acquisitions, the shareholders of the acquiring company mostly face the damages.

In any case, why potential buyers even look at projections prepared by sellers baffles me. Charlie and I never give them a glance, but instead, keep in mind the story of the man with an ailing horse. Visiting the vet, he said: “Can you help me? Sometimes my horse walks just fine and sometimes he limps.” The vet’s reply was pointed: “No problem – when he’s walking fine, sell him.” In the world of mergers and acquisitions, that horse would be peddled as Secretariat.

2. Acquisition of Helzberg Diamond shop

Helzberg diamond shop was started by Barnett Helzberg, Jr., who owned four shares of Berkshire and had also been at the 1994 meeting. He pitched the company to Buffett as he wanted to free himself from the management of the company.

” We completed the Helzberg purchase in 1995 by means of a tax-free exchange of stock, the only kind of transaction that interested Barnett. Though he was certainly under no obligation to do so, Barnett shared a meaningful part of his proceeds from the sale with a large number of his associates. When someone behaves that generously, you know you are going to be treated right as a buyer.”

3. Acquisition of R.C Willey home furnishings

R.C. Willey is an amazing story. Bill(A friend of Irv from Nebraska Furniture Mart) took over the business from his father-in-law in 1954 when sales were about $250,000. From this tiny base, Bill employed Mae West’s philosophy: “It’s not what you’ve got – it’s what you do with what you’ve got.” Aided by his brother, Sheldon, Bill has built the company to its 1995 sales volume of $257 million, and it accounted for over 50% of the furniture business in Utah.

Buffett on retailing business:

“Retailing is a tough business. During my investment career, I have watched a large number of retailers enjoy terrific growth and superb returns on equity for a period, and then suddenly nosedive, often all the way into bankruptcy. This shooting-star phenomenon is far more common in retailing than it is in manufacturing or service businesses. In part, this is because a retailer must stay smart, day after day. Your competitor is always copying and then topping whatever you do. Shoppers are meanwhile beckoned in every conceivable way to try a stream of new merchants. In retailing, to coast is to fail.”

4. Purchase of 100% share of GEICO corporation

The entire story is narrated by Buffett how he came across GEICO through his teacher/mentor Mr Ben Graham. And later in 1995, went on to acquire the full company.

” GEICO, of course, must continue both to attract good policyholders and keep them happy. It must also reserve and price properly. But the ultimate key to the company’s success is its rock-bottom operating costs, which virtually no competitor can match. In 1995, moreover, Tony and his management team pushed underwriting and loss adjustment expenses down further to 23.6% of premiums, nearly one percentage point below 1994’s ratio. In business, I look for economic castles protected by unbreachable “moats.” Thanks to Tony and his management team, GEICO’s moat widened in 1995.”

5. Any company’s level of profitability is determined by three items:
   (1) what its assets earn;
   (2) what its liabilities cost;
   (3) its utilization of “leverage” – that is, the degree to which its assets are funded by liabilities rather than by equity.

6. Insurance operations

Few examples of insurance being undertaken by Berkshire Hathaway

1. The life of Mike Tyson for a sum that is large initially and that,
   fight-by-fight, gradually declines to zero over the next few years.

2. Lloyd’s against more than 225 of its “names” dying during the
   year.

3. The launch, and a year of orbit, of two Chinese
   satellites.

Buffett writes on the same :

“Berkshire is sought out for many kinds of insurance, both super-cat and large single-risk, because (1) our financial strength is unmatched, and insureds know we can and will pay our losses under the most adverse of circumstances; (2) we can supply a quote faster than anyone in the business; and (3) we will issue policies with limits larger than anyone else is prepared to write.

Most of our competitors have extensive reinsurance treaties and lay off much of their business. While this helps them avoid shock losses, it also hurts their flexibility and reaction time. As you know, Berkshire moves quickly to seize investment and acquisition opportunities; in insurance, we respond with the same exceptional speed. On another important point, large coverages don’t frighten us but, on the contrary, intensify our interest. We have offered a policy under which we could have lost $1 billion; the largest coverage that a client accepted was $400 million”

7. Exchanged cap cities shares for Disney shares plus cash.

“I first became interested in Disney in 1966, when its market valuation was less than $90 million, even though the company had earned around $21 million pre-tax in 1965 and was sitting with more cash than debt. At Disneyland, the $17 million Pirates of the Caribbean ride would soon open. Imagine my excitement – a company selling at only five times rides!

Duly impressed, Buffett Partnership Ltd. bought a significant amount of Disney stock at a split-adjusted price of 31› per share. That decision may appear brilliant, given that the stock now sells for $66. But your Chairman was up to the task of nullifying it: In 1967 I sold out at 48› per share.
Oh well – we’re happy to be once again a large owner of a business with both unique assets and outstanding management.”