Buffett Week: Some Parting Words from Warren

By Glenn Dyer | More Articles by Glenn Dyer

Warren Buffett has hopped on one of his favourite hobby horses – defending the conglomerate structure of Berkshire Hathaway.

In his latest shareholder letter Buffett repeated comments he made in defence of Berkshire Hathaway’s structure back in the 2015 letter to shareholders.

Berkshire has more than 90 businesses in its structure as well as a $US280 billion share portfolio.

It’s the world’s biggest conglomerate and according to many analysts and business ‘experts’ it’s an anachronism and should really be broken up and all that value ‘liberated’.

Forget that even after three poor years in a row, it has still doubled the yearly performance of the S&P 500 over the last 55 years.

Berkshire Hathaway has survived those 55 years and occupies key spots in some sectors – insurance, being the largest insurance group in the world and a ‘conglomerate of its own in this huge financial business.

It also owns one of the largest railways in the US, a big mobile home business, huge real estate agency and car dealerships, one of the fastest growing energy utility in the US with a plan that will end in 2030 (after 30 years work) on rewiring much of the US midwest to handle renewable energy.

Buffett created his conglomerate when they were a poplar business idea in the 1950’s and 60’s with all that talk of ‘synergy’ and the different businesses having differing exposures to the wider economy providing some sort of balance.

The inflation surge after the first two oil crises, then the recession of the 90s, then the tech wreck 20 years ago and then the GFC and finally the pandemic and its mad cap surge in megatech stocks changed investment thinking forever.

Conglomerates remain on the outer – some still exist in US and global business (popular in Italy, France and Germany), but none as large as Berkshire Hathaway and none in such a key position in markets (with a market cap approaching $US600 billion). It is also the largest shareholder in Apple, Bank fo America, Coca Cola, Amex and uS BankCorp as well as owning a swag of Kraft Heinz.

Developing economies are full of conglomerates – from China, to India, to Turkey, to South Korea, the Philippines and throughout the Middle East. It is a way for the wealthy insiders to control as much of a country’s economy as possible.

Australia has a few conglomerates – Wesfarmers is the biggest domestic example. BHP is a mining conglomerate with coal, iron ore, copper, gold, silver, nickel, potash as well as oil and gas.

Some property companies or trusts are conglomerate in style – GPT, Mirvac and Stockland all invest in different areas of property, unlike Scentre, which concentrates on shopping malls.

Warren Buffett observed in his latest investor letter the Berkshire’s imitators fade away:

“Eventually, of course, the party ends, and many business “emperors” are found to have no clothes. Financial history is replete with the names of famous conglomerateurs who were initially lionized as business geniuses by journalists, analysts and investment bankers, but whose creations ended up as business junkyards.

“Conglomerates earned their terrible reputation,” Buffett declared

“Charlie Munger, (Berkshire co-chair) and I want our conglomerate to own all or part of a diverse group of businesses with good economic characteristics and good managers. Whether Berkshire controls these businesses, however, is unimportant to us.

“It took me a while to wise up. But Charlie – and also my 20-year struggle with the textile operation I inherited at Berkshire – finally convinced me that owning a non-controlling portion of a wonderful business is more profitable, more enjoyable and far less work than struggling with 100% of a marginal enterprise.

“For those reasons, our conglomerate will remain a collection of controlled and non-controlled businesses. Charlie and I will simply deploy your capital into whatever we believe makes the most sense, based on a company’s durable competitive strengths, the capabilities and character of its management, and price.”

“Berkshire is often labeled a conglomerate, a negative term applied to holding companies that own a hodge-podge of unrelated businesses. And, yes, that describes Berkshire – but only in part. To understand how and why we differ from the prototype conglomerate, let’s review a little history.

“Over time, conglomerates have generally limited themselves to buying businesses in their entirety. That strategy, however, came with two major problems.

“One was unsolvable: Most of the truly great businesses had no interest in having anyone take them over. Consequently, deal-hungry conglomerateurs had to focus on so-so companies that lacked important and durable competitive strengths. That was not a great pond in which to fish.

“Beyond that, as conglomerateurs dipped into this universe of mediocre businesses, they often found themselves required to pay staggering “control” premiums to snare their quarry.

“Aspiring conglomerateurs knew the answer to this “overpayment” problem: They simply needed to manufacture a vastly overvalued stock of their own that could be used as a “currency” for pricey acquisitions. (“I’ll pay you $10,000 for your dog by giving you two of my $5,000 cats.”)

“Often, the tools for fostering the overvaluation of a conglomerate’s stock involved promotional techniques and “imaginative” accounting maneuvers that were, at best, deceptive and that sometimes crossed the line into fraud.

“When these tricks were “successful,” the conglomerate pushed its own stock to, say, 3x its business value in order to offer the target 2x its value.

Investing illusions can continue for a surprisingly long time. Wall Street loves the fees that deal-making generates, and the press loves the stories that colorful promoters provide. At a point, also, the soaring price of a promoted stock can itself become the “proof” that an illusion is reality.

 

Glenn Dyer

About Glenn Dyer

Glenn Dyer has been a finance journalist and TV producer for more than 40 years. He has worked at Maxwell Newton Publications, Queensland Newspapers, AAP, The Australian Financial Review, The Nine Network and Crikey.

View more articles by Glenn Dyer →