What I Learned, Part V: On Expected Returns and Diluting the Berkshire Gene Pool

“What is the expected return on capital from Burlington?” asks the shareholder from Hamburg, Germany. “And if you can’t buy more railroads would you expand into shipping?”

As Warren Buffett launches into his answer, I muse that this is not the first time a German has asked the best question at a Berkshire shareholder meeting.

In “Pilgrimage to Warren Buffett’s Omaha” (McGraw-Hill 2008) I described the one and only question that really challenged Warren Buffett throughout more than five hours on a Saturday morning two years ago—and it was asked by a shareholder from Bonn.

The fact that only one question—out of more than 50—attempted to scratch the surface of the Oracle’s brainy-but-folksy demeanor is not as striking as it might appear to those who have only seen Buffett hold court on CNBC, where he delivers opinions on everything from the inheritance tax to the environmental advantage of railroads versus trucks.

Despite the fact that the centerpiece of the annual “Woodstock for Capitalists” is a five-hour, no-holds-barred question-and-answer session with Warren Buffett and his vice-chairman, Charlie Munger, the fact is that in recent years not many shareholders asked questions even marginally related to Berkshire and its businesses.

That changed at last year’s meeting, of course, when Buffett eliminated the first-come, first-served lineup at the microphones and instead selected three financial journalists to pose questions submitted in advance by shareholders and anyone else with an internet address.

The new format eliminated the tendency of past meetings to veer towards “What Would Warren Do?”-type queries from awestruck acolytes asking Buffett advice on how to become a great investor, or what issues Buffett would tackle if elected President, or—and I am not making this up—“Do you know and believe in Jesus Christ, and do you have a personal relationship with God?” (The answer to that one is—well, buy the book and find out.)

Indeed, at the May 2008 meeting only one question related to the businesses owned by Berkshire Hathaway. It was also the only question Buffett ducked. (By contrast, he answered the “Jesus Christ” question as he answered most of the rest: straight ahead, with no irony.)

And that was too bad, because it was a great question that indirectly got to the heart of what will likely become the central issue at Berkshire Hathaway: what happens when Warren Buffett—the best capital allocator in the world—is no longer allocating capital at Berkshire.

Using Berkshire’s See’s Candies as an example, the Man from Bonn asked whether Buffett would prefer a slower-growing but higher-margin business, as See’s is, to a global but somewhat lower-margin business, as Swiss chocolate giant Lindt & Sprüngli has become.

It was (and still is) a an excellent observation: when Buffett and Munger bought See’s for $25 million in 1972, it was a small, west-coast candy company. 37 years and $1.5 billion in profits later, See’s remains a small, west-coast candy company.

While that’s good news for Berkshire shareholders—after all, Warren Buffett reinvested that $1.5 billion of cash from See’s into other high-return opportunities, to the benefit of Berkshire and its shareholders—it’s not necessarily good news for See’s Candies in a world gone global. (To see how Buffett ducked the German’s question, read “The Decline and Fall of the Sainted Seven,” Chapter 36 in “Pilgrimage.”)

The question asked today by the shareholder from Hamburg is equally good:

“What is the expected return on capital from Burlington,” he has asked, “And if you can’t buy more railroads would you expand into shipping?”

This time, Buffett does not duck it:

“I think the return will be satisfactory but not mouth-watering,” Buffett says. “It’ll be similar to our energy utilities.”

Berkshire’s utilities earn decent, regulated returns on investment—not remotely close to the See’s Candies-kinds of returns that most investors associate with Warren Buffett—but “satisfactory” nonetheless.

The reason “satisfactory but not mouth-watering” returns are appealing to a guy famed for growing Berkshire’s book value at 20% a year for 45 years is simple: the sums involved are now so vast ($43 billion, give or take, in total capital for the Burlington Northern deal), that a merely “satisfactory” return on an elephant-sized investment still means a lot of money will be coming in Berkshire’s door every year for many, many years.

And any money manager—Buffett, especially—will tell you it is far more difficult to grow large amounts of money than small. Thus, in Burlington Northern, Buffett has found precisely the kind of “elephant” he has been hunting for years.

That does not mean, however, Buffett thinks the Burlington acquisition is without risk.

By comparing the railroad business to Berkshire’s existing utilities businesses, Buffett makes an important point. For unlike See’s Candies, which sells a discretionary consumer product and therefore may raise prices or introduce new products or enter new markets at will, the railroad business is subject to significant oversight from the Feds—less so than in the past, when pricing was regulated, but still significant—much like a public utility.

Indeed, at this very moment, Jay Rockefeller’s Senate Commerce Committee is considering new rail legislation to beef up regulatory oversight and put the screws to railroads—legislation that the CEO of Union Pacific, Burlington’s chief rival in the west, complained about on his company’s recent earnings call.

And so it is that Buffett proceeds to discuss the risk this government interference poses:

“We are counting on society to behave well with us in allowing us a reasonable return on capital IF we do our job of behaving reasonably well,” he says.

Asked next what would happen if government regulation got “more intense” on railroads, Buffett says matter-of-factly:


“The governments could strangle our utilities… They have the ultimate authority…they could raise the corporate tax rate to 80% or something…

Our basic position is that if we behave well, they’ll behave well. Our utility customers oughta feel very sure that when they flick a switch the lights’ll go on,” he says, adding, “They’re gonna need the railroads in this country big time.”


Buffett’s age (he’ll be 80 in August) seems to be catching up with him: despite shielding his eyes from the glare of the spotlights, he can’t discern where the next question is coming from. He looks intently at the unused microphone near us while the shareholder asking the question is at the microphone on the other side of the concert hall:

“How would the stock split affect Berkshire’s ability to be in the S&P 500?”

It is a bit unsettling to see Buffett continue to stare at nobody, but the spotlights are bright and what the hell, this is Warren Buffett, who cares where he’s looking?

Besides, this is a question with big dollars at stake. Berkshire is not in the S&P 500 Index, despite the fact that its market value is larger by far than any other company outside the index—and bigger than most that are in it.

The reasons Berkshire has been excluded up to now are straightforward: two of the Standard & Poor’s Index Committee’s five ‘admitting criteria’ haven’t been in Berkshire’s favor since the day Buffett took control in 1965—one being trading volume and the second being the amount of stock in public hands.

Before the Burlington deal was announced in early November, a less-than-whopping 40,000 shares of Berkshire “B” shares traded on a good day, not adjusted for today’s proposed 50-for-1 stock split. And the volume in “A” shares, through which Buffett controls Berkshire, barely rounded up to a 1,000 a day prior to the announcement.

Answering the question, Buffett observes:

"We’re by far the largest co that’s not in the S&P 500… the A/B situation creates problems for us, but eventually we’ll be in the S&P 500, we’ll be so large.”

So far, so clear; but it is in discussing the effects of this dramatic change in his shareholder base (over which Buffett was once so obsessed that he used to keep track of how many shareholders lived in his own zip code) that Buffett exhibits an ability that at once makes him so remarkable, and, to some investors, so hypocritical—the ability to rationalize any particular stance at all, whenever it suits his purpose:

“If they put us in the S&P, it’s good for shareholders,” he says, because “if 6-7% of funds are in index funds it’s a block of stock that’s essentially there forever, which is EXACTLY what we’re looking for.”

Thus in one easy, plain-spoken sentence the investor who for fifty years has warned against following the herd; who has railed against diversification by serious investors (“ass-backwards,” his business partner, Charlie Munger, calls it); and who has refused to split his stock for fear of diluting the intellectual gene pool of those “quality shareholders” in the Berkshire Hathaway shareholder base, who now blithely claims that index funds—big, stupid, mechanical, massively diversified index funds—are “Forever.”

If, by “Forever,” Buffett means “So long as Berkshire’s market capitalization stays proportional to the index,” then he’s correct.

If, on the other hand, by “Forever” he means “Whatever happens to Berkshire Hathaway,” he can’t be more wrong.

After all, if Berkshire is one day hit by some strange off-the-wall disaster—an asbestos lawsuit, say, or a problem with the Berkshire derivatives portfolio—that causes its stock to get cut in half while the S&P 500 stayed steady, then those same “Forever” index funds will sell half their Berkshire so as not to be “out of balance” with the index.

And they will not think twice about it, because they are run by computers.

It is an astonishing piece of rationalization by the Oracle, even for most of the investors seated in this room, yet the prevailing reaction seems to be a shoulder-shrugging 'Warren-being-Warren'.

Buffett then rationalizes the effect on the Berkshire gene pool in an equally offhand way:

“By now our identity is pretty well known. I don’t worry about downgrading the quality of our shareholders.”

He concludes the stock-split discussion with one more remarkable statement:

"Charlie and I should have done it when we bought Gen Re.”

The final question of the day gets to something that’s been on people’s minds since Buffett first announced the Burlington deal: what kind of hidden assets he sees in the Burlington railroad balance sheet.

To be concluded….



Jeff Matthews
I Am Not Making This Up

Image of Warren Buffett and all text © 2010 NotMakingThisUp, LLC
Image of Burlington railcar from Wikipedia

The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.

What I Learned Writing a Book, Part IV: Of Colonoscopies, Cash and Cutouts

The question Buffett’s been asked is a simple one: ‘What’s the difference between Berkshire using undervalued stock to buy Burlington Northern, and Kraft using undervalued stock to buy Cadbury?’

It’s also quite a good one.

After all, Buffett has been beefing to anybody who’ll listen—and CNBC pretty much listens whenever he’s awake—about the price Kraft CEO Irene Rosenfeld is paying for Cadbury PLC, the iconic British chocolate company: in particular, the fact that much of that price will be in shares of Kraft.

Buffett’s beefing about it because Berkshire Hathaway happens to be the single largest holder of Kraft stock.

But what really gets Buffett is that Rosenfeld did an end-around the “Oracle”—imagine that!—by cutting back on the stock portion of the deal to less than 20% of shares outstanding precisely so that Buffett wouldn’t have a chance to vote against the deal, as he promised to in a highly public, early January, press release.

(Charlie Munger, seen above looking over Buffett’s shoulder, no doubt feels equally slighted.)

For the record, Rosenfeld’s Kraft is paying roughly $21 billion all-in for Cadbury. That amounts to 24-times Cadbury’s trailing annual earnings, 14.3-times Cadbury’s trailing cash operating income (what analysts call ‘EBITDA’), and 3.8-times Cadbury’s book value.

(We use trailing, money-in-the-bank numbers here. While most deals are priced on forward-looking sales and earnings forecasts, everyone at this meeting knows that investment bankers and chief financial officers can, and will, come up with whatever they need as far as futures go to justify their salaries and their bonuses. 'Garbage in, garbage out,' as Buffett himself would say.)

For all that money, Kraft is getting in Cadbury a business that generates a modest 45-50% gross margins, a paltry 12% operating margin, and throws off only enough cash from operations to cover capital expenditures. When it comes to branded consumer businesses similar to Cadbury, this lack of “free cash flow” is hard to fathom, and is sure to change under Kraft ownership.

Some—including Kraft and its advisors—have argued that Kraft is picking up an irreplaceable consumer franchise at a multiple of sales and operating cash flow that would have looked like a steal during the credit boom’s glory days.

Blackstone Group, after all, paid Cadbury-type multiples of revenue and operating cash flow for Freescale Semiconductor, a business—semiconductors, for goodness sake—that’s as cyclical, unstable and unpredictable as the chocolate company’s is non-cyclical, stable and predictable.

Oh, and the semiconductor business is low-margin and highly capital-intensive, to boot.

Nevertheless, Warren Buffett opposes the Kraft-for-Cadbury deal because, as he said during an early morning interview today, in a typically Buffettian utterance, that as Kraft’s largest shareholder “I feel poorer.”


So let’s compare what Kraft is willing to pay for Cadbury with the price Warren Buffett is willing to pay—using both cash and a slug of shares of Berkshire Hathaway—for Burlington Northern.

Burlington is a “Class 1” American railroad that was assembled through mergers at the rate of one-per-decade starting in the 1970s. Its tracks stretch from Chicago to the Gulf of Mexico and west to ports on the Pacific Ocean.

Berkshire, which already owns 22% of Burlington (most of that purchased for close to $80 a share) is paying $100 a share for the other 78% of the company. All-in, that amounts to $34 billion for the equity plus about $9 billion in Burlington debt, for a total price of roughly $43 billion.

Keep in mind, Burlington is a railroad, not a chocolate maker. While railroad operating margins in the good times can hit 23%, in the bad times they can get down to 15%, or less. Cash flows tend to be healthy, but so do capital expenditures.

Indeed, the Chief Financial Officer of CSX, one of the other three “Class 1” (it means “big”) railroads in the U.S., reflected on just that subject at an investor conference this week:

“Yes, we spend a lot of money. We always have. People are always, for some reason I’m perplexed with, [asking] why the industry spends between 15 and 17% of our revenue. It is a highly capital intensive business.”

For this cyclical, GDP-dependent railroad operator, Berkshire is paying almost 20-times trailing earnings, 9-times trailing cash operating income (EBITDA), and 2.7-times book value.

None of those numbers look like a steal.

Indeed, as Buffett himself has often pointed out, the “book value” of a consumer brand business like Cadbury is far more valuable than an industrial business, for the simple reason that the cash generated by a consumer brand doesn’t need to be invested in capital expenditures simply to keep the business going—as with a railroad.

All in all, it looks like Buffett’s Burlington investment, as he has been widely and memorably quoted, really does represent an “all-in wager on the economic future of the United States.”

As for using precious Berkshire stock in his deal, while at the same time criticizing Kraft for doing the same in their deal, Buffett’s answer here today is not so memorable:

“I’ve written the annual letter,” he says—Buffett drafts his unique, 20-page annual shareholder letter by hand; ace Fortune Magazine editor and longtime Buffett confidant Carol Loomis edits it with, I am told, a very light touch—“and I deal with this.”

He continues with a line from his earlier CNBC interview:

“Charlie and I like using stock for an acquisition about as much as we like preparing for a colonoscopy.”

It’s a great line that generates laughs and will surely be the quote of the day, as Buffett surely knows.

“We are paying $100 a share [for Burlington]…but it costs us somewhat more than that because we are using stock on the low side of its historic range of book value, as a proxy for value.”

Buffett moves his hand up and down to indicate a theoretical price range, and keeps his hand down to reflect the lower end of that range: it is the first time in years he has publicly offered an observation on the current market value of Berkshire Hathaway stock.

“So when we looked at the Burlington deal we regarded it costing us somewhat more than $100 a share because we are using stock we would not like to issue.”

Having admitted to paying with undervalued stock, Buffett rationalizes the price in two ways:

“We already owned 22.5% of Burlington... We’re getting to use $22 billion of cash advantageously, and we will get to use more cash in that business, we think advantageously… So we thought the deal was okay.”

As to why use stock at all, Buffett says, without stating this out loud, that the deal wouldn’t have happened without some stock being offered to Burlington shareholders:

“If we had to use more [Berkshire] stock, I wouldn’t have done it. They TALKED about us using more stock, but I wouldn’t have done it.”

He then takes a parting shot at Kraft, with Charlie Munger’s input:

“I wish that Kraft, looking at THEIR deal, [had considered the value of Kraft stock in their offer]. I hope they considered that when they were making their calculations…”

Charlie Munger’s voice—Buffett has been sitting next to a cutout of his partner the entire meeting—breaks in, and breaks up the 150 or so shareholders watching:

“I couldn’t agree more.”


In “Pilgrimage to Warren Buffett’s Omaha”—a hedge fund manager’s journey to the heart of Berkshire Hathaway—I noted that a remarkable number of German shareholders manage to line up first at the microphones in order to ask questions of Buffett and Munger during the Saturday question-and-answer session.

And today, the first international shareholder happens to be from—yes—Germany.

Specifically, from Hamburg, which is mainly famous as the port city where the Beatles developed their chops while playing to drunken sailors and other detritus of World War II.

And although this shareholder’s question has nothing to do with the Beatles, the second half of it does relate to Hamburg’s historic role in the Germany economy.

“What is the expected return on capital from Burlington? And if you can’t buy more railroads would you expand into shipping?”

Buffett responds, and the answer is both surprising and entirely expected.

To be continued…


Jeff Matthews
I Am Not Making This Up

Photographs and Content © 2010 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.

What I Learned Writing a Book, Part III: “He Can’t Not Answer A Question.”

Buffett runs the meeting briskly and efficiently—so much so that within minutes of his first appearance on stage we reach the guts of the thing: he offers a motion to approve the 50-for-1 stock split and elimination of paper certificates for the Berkshire “B” shares.

Now, for shareholders accustomed to the spectacle of the annual meeting, when 17,000 shareholders pack into the Qwest Center arena for the sole purpose of watching Buffett and his vice-chairman, Charlie Munger, take questions, it is an odd thing to sit in a Berkshire Hathaway meeting and hear Warren Buffett ask for a second to a motion.

And it is odder still to have shareholders respond “Second!” from the floor.

The annual meeting, or “Woodstock for Capitalists,” as Buffett likes to call it, is, after all, a highly moveable affair. Shareholders come and go as they see fit during the five-plus hours of Buffett and Munger’s question and answer session: they grab a cup of coffee to help stay alert; or they go shopping among the Berkshire booths at the nearby exhibition hall; or they skip out to take advantage of the shareholder discount at the Nebraska Furniture Mart. After all, their presence is not required.

But nobody’s moving from this meeting. This is real business.

Buffett moves quickly. The motion has been seconded, and we may now discuss it, he says. Shielding his eyes from the spotlights trained on his seat, he points out two microphones set up for the purpose—one in each aisle—and warns us that the discussion is strictly about the motion to split the stock.

This is disappointing.

Nearly everyone in this room braved the chancy odds of making Chicago airplane connections, not to mention the cold, sleety weather and slippery sidewalks outside to ask Warren Buffett some good, old-fashioned questions. There will be none of the “What should I do with my life?” type of back-and-forth that permeates the annual meeting from this crew.

I sense from those around me that every one of the individuals in this room has at least one question they’d like to ask, given the chance. My seatmates glance at one other after the no-straying-off-topic admonishment.

“Well he can’t not answer a question,” somebody says hopefully.

But it does not look good: there is one lone shareholder standing at the microphone placed in the aisle near us. This is a far cry from the dozens of hopefuls that line up at each of the thirteen microphones placed in the Qwest Center for the Buffett and Munger Q&A session at the annual meeting.

Buffett—who has trouble seeing through the glare of spotlights which microphone the question is coming from: the one in the aisle to his left, or the one in the aisle to his right—is told there is a question, and he calls on the one brave shareholder

The shareholder is from Princeton, New Jersey (the same protocol as that which governs the annual meeting is in place here: shareholders state their name and where they’re from before asking their question), and he begins by pointing out that the proposed stock split will occur whether or not the Burlington Northern acquisition goes through.

So, he asks, “what is the benefit to vote for the split even if the deal doesn’t go through?”

It’s a good, reasonable question, and Buffett drops all pretence of keeping things brief by starting a classicly Buffettian answer—long and rambling, but to the point.

“Burlington has 250,000 shareholders,” Buffett says, warming-up to the topic. Paying part of the price with Berkshire stock “enables Burlington shareholders to get a more tax-efficient transaction.”

This is true: shares sold for cash in a takeover trigger capital gains tax, but shares swapped for stock trigger no taxable event. Thus, most individual investors—and individuals monitor their after-tax returns far more carefully than mutual fund managers—prefer stock swaps to all-cash tenders. Buffett wants to accommodate those Burlington shareholders looking to avoid a tax hit.

Now, it is precisely this kind of matter-of-fact maneuvering around the U.S. tax code that drives a healthy slice of investors crazy when it comes to Warren Buffett.

Buffett is a master of such maneuvers, going back to his early days running a hedge fund (yes, Warren Buffett ran what amounted to a hedge fund: see the chapter titled “Beyond Buffett” in “Pilgrimage to Warren Buffett’s Omaha”.) And for years he benefitted mightily from same the tax-advantaged carried interest provisions of private partnerships which he now criticizes.

(His type-written letters to his limited partners from those years, which are available on the internet, are worth every bit as much to read as his annual Berkshire “Chairman’s Letter.”)

And if there is one thing I have learned writing a book about Warren Buffett and his company—or, more precisely, while giving speeches about the book itself—it is that in almost every crowd there is at least one investor who actually despises Warren Buffett.

I’ve learned to spot them quickly.

They tend to sit in an uptight position, with arms and legs crossed, making a tight face. When question time comes around they inevitably raise their hand aggressively and ask in a louder-than-normal voice how it is that Warren Buffett gets off blabbing about taxes when he, Warren Buffett, ran a hedge fund for years; or when he, Warren Buffett is avoiding the inheritance tax by giving away his stock to his billionaire friend, Bill Gates; or when he, Warren Buffett, could just pay higher taxes if he wanted to….

Buffett himself has been asked these questions over the years, of course: he merely responds, quite rationally but, to his critics, quite lamely, that the laws are the laws, and he obeys those laws.

Thus it is that if the Burlington Northern Board of Directors wants part of the purchase consideration from Berkshire to be stock, both in order to avoid capital gains taxes on a good portion of their shareholders’ profits and to benefit from future growth in Berkshire Hathaway (although Buffett does not mention the second part of that rationale here today), well, Buffett is going to accommodate them.

The stock split is necessary, he explains, because Burlington Northern shareholders would need to own more than $3,000 worth of Burlington stock to convert to Berkshire, since the current price of Berkshire “B” shares is over $3,000.

And if he must split his own company’s high-priced stock so that small investors in Burlington may get the same tax advantages as large investors who will choose to sell out for stock rather than cash, then Buffett is perfectly willing to do it:

“We want to earn the reputation of treating every shareholder equally and with respect,” he says. “To not offer people with less than $3,000 of Burlington Northern the same as those with more, we felt it was the wrong way to go…”

As for his own well-known, and long-voiced, opposition to splitting Berkshire’s stock, Buffett explains his change of mind this way:

“I worried in the past that people would be enticed by the stock price. I’m less worried about that.” He adds ruefully, “in fact our recent record will help with that.”

This generates laughter and is precisely the kind of self-deprecating remark by which Buffett diffuses even mildly contentious questions—and it works here today: he calls for the next question.

The shareholder moves his question gingerly outside the realm of stock splits: “Why Burlington Northern, and not Union Pacific?” he asks.

“They’re both wonderful railroads,” Buffett responds, in his usually tactful manner. (Unless the subject is greedy investment bankers, remorseless mortgage brokers or Greek-alphabet-pushing academics, Buffett follows the Dale Carnegie rule of not to criticize, condemn or complain.)

“And there’s no way one will do better or worse…their fates are locked,” he says.

Then, getting to the heart of the question, Buffett says, “I like the western railroads a little better. If you look out 10 or 15 or 20 years, the West will grow a little faster.”

Clearly, he is looking to China and India as engines of worldwide growth.

The next shareholder asks how he will handle the annual meeting when its shareholder attendance—already north of 30,000—is inflated by some portion of those 250,000 Burlington Northern shareholders to whom he will be giving stock.

Buffett smiles and says, “Maybe if Charlie stays home we’ll only have a hundred people.”

There are now shareholders at each of the two microphones, and their questions contain no pretense of staying on the subject of the stock split. In fact, it is the next question, from a local Omaha shareholder, that is most clearly on everyone’s mind: it is about the Kraft bid for Cadbury.

And while Buffett has already this morning been asked a variation on the same question by the Buffett-friendly CNBC anchor Becky Quick, it is here among his most serious admirers that Buffett won’t be able to glibly toss off an amusing response to his favorite talking head.

Buffett, the shareholder notes, has complained about Kraft using “undervalued stock” to buy Cadbury, yet Buffett is using his owned undervalued stock to buy Burlington Northern.

“What are the differences using undervalued Berkshire stock to buy Burlington Northern?” he asks.

Buffett begins to speak, and we listen.


—To be continued...

Jeff Matthews
I Am Not Making This Up

Photograph and Content © 2009 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.

What I Learned Writing a Book, Part II: The Oracle Appears, Alone…Sort Of

There is some gamesmanship going on as we enter the cozy, wood-floored Peter Kiewit concert hall here in downtown Omaha.

Of course, it’s nothing like what goes on at the Berkshire Hathaway annual meeting. So many shareholders from around the world attend that “Woodstock for Capitalists,” as Buffett likes to call it—held not in a 2,000-seat concert hall but in a 17,000-seat arena within the Qwest Center a few blocks away—they form lines stretching hundreds of yards around the glass and steel complex, before the sun rises, just waiting for the doors to open.

If the annual meeting is the equivalent of a musical Woodstock, without the drugs and naked dancers, then today’s special meeting is more like one of Sting’s lute concerts. (If you never attended one of Sting’s lute concerts, you are not alone: only hardcore Sting fans went to those, and only hardcore Buffett fans are here.)

This will be, indeed, a very mellow affair: there no camera crews from China prowling the halls for interviewees; no giant video screens hanging alongside the stage; and no young men in Dockers and button-down oxford shirts bursting inside as soon as the doors open, running down the aisles and claiming seats near the stage.

Instead, there are older couples—retirees with time to spare on a sleety, cold, blustery Wednesday morning—and professional investors (nearly all men, most in suits and ties), walking casually down the aisles, chatting, spotting friends, and selecting seats.

And this is where the gamesmanship comes in.

For even in this cozy concert hall, and even among these—the most serious observers of Warren Buffett and Berkshire Hathaway—there are people are looking for the best seat possible from which to watch Warren Buffett.

Several new acquaintances and I take seats in what appears to be a prime spot, a few rows from the front. The money manager seated next to me is a 20 year Berkshire veteran who had introduced himself out in the lobby—he had read “Pilgrimage to Warren Buffett’s Omaha”—before telling me about the last and only other special meeting in Berkshire Hathaway’s post-Buffett history, which he also attended: the meeting to approve the acquisition of General Re.

We talk about that meeting—made legendary when Buffett put up a life-size cut-out photograph of Charlie Munger in the seat next to his and played tape-recorded bits of Mungerisms at appropriate times—and he observes that there were far more investors at that meeting than this one.

Indeed, by my count, there are only about 150 people are here today. By contrast, there were 500 shareholders at the 1998 special meeting.

What accounts for this loss of interest—aside from the bad weather—is one subtle but distinct difference between the General Re meeting eleven years ago and this one today: today’s meeting is merely to approve a stock split that will enable Berkshire’s purchase of Burlington Northern railroad. Buffett’s going to buy Burlington come hell or high water, or, as Buffett once said in reference to another transaction, “even if Ben Bernanke runs off with Paris Hilton.”

The 1998 special meeting, on the other hand, was required to attain the approval of Berkshire shareholders for the company’s merger with General Re.

Now, until Burlington Northern came along a few months ago, General Re had been the biggest acquisition in Berkshire’s—and Buffett’s—history, and despite the Oracle’s high hopes and effusive cheerleading at the time, it did not prove to be one of the best.

Buffett paid $22 billion for General Re, all of it in shares of Berkshire stock (hence the need for a special meeting to get shareholder approval), meaning the cost of the deal went up along with Berkshire’s stock price, even if General Re’s business did not likewise increase in value.

And for some time afterwards, the prospects for General Re did not look good.

Indeed, the 1998 press release in which Buffett announced the deal reads embarrassingly wide-eyed, given what was to follow:

“But the main attraction of the merger [with General Re] is synergy, a word that heretofore has never been used in listing the reasons for a Berkshire acquisition. In this transaction, however, there are at least four areas of powerful synergy, which Charles Munger, Berkshire’s Vice Chairman, and I believe justify the premium price that Berkshire is paying…”

What followed those words were years of aggravation. Not only did the synergies heralded by Buffett in the press release take longer to appear, but one of them—“removes constraints on earnings volatility”—would come to haunt Berkshire after the 9/11 terrorist attacks on the World Trade Center caused more than $2 billion worth of unanticipated “earnings volatility.”

In addition, and to Buffett’s eternal annoyance, Berkshire would later spend $400 million laboriously unwinding 23,000 derivatives contracts fermenting with General Re at the time of the acquisition.

On the plus side, of course, the experience of unwinding those contracts during the salad days of the early 2000s would directly lead to Buffett’s stern warnings against derivatives as a market cure-all in his 2002 shareholder letter, and help Berkshire emerge from the 2008 crisis in far better shape than its peers.

Most unfortunately, however, is that General Re was to become, under Buffett’s watch, embroiled in a scandal that would eventually entail testimony from Buffett himself; threaten the squeaky-clean image Buffett demands the Berkshire business family to maintain; and result in the conviction of several former Gen Re executives—all for entering into “sham transactions” by which Gen Re helped AIG dress up its reserves to satisfy Wall Street’s Finest.

In fact, I’ve been told earlier this morning—while preparing for an interview on Bloomberg TV—that a final settlement of that sordid chapter was coming, with Gen Re paying $92 million to both settle investor claims and put an end to Federal investigations into the matter.

Thus, as Berkshire closes out the final, downbeat chapter to that last previous record-setting acquisition, we Berkshire shareholders are being asked not to approve the acquisition of Burlington Northern railroad, but merely to allow a 50-for-1 stock split and the elimination of paper stock certificates for the Berkshire “B” shares.

The Berkshire “B” shares—and I’ll keep it light so our readers’ eyes don’t roll back into their heads—are simply cheaper versions of the regular Berkshire “A” shares. The “A” shares trade around $100,000 a share—yes, $100,000 per share—and most people can’t afford to buy them. So Buffett created the “B” shares which possess 1/30th the value of the “A” shares.

They also possess one more difference, and it’s a huge one: the “B” shares have fewer voting rights than the “A” shares, but not 1/30th the voting rights.

They have 1/200th of the voting rights.

Now, before today’s meeting, the vote-deprived “B” shares were selling for around $3,500 each. After the meeting, and assuming we’ve approved a 50-for-1 split, they’ll sell for $70-something a piece…and they’ll be even more vote-deprived.

Instead of having 1/200th of the voting rights of an “A” share, they’ll have 1/10,000th of an “A” share vote.

This disparity might seem to be a glaring incongruity at a company whose CEO is highly vocal about the rights of shareholders, and who is highly outspoken about the irresponsibility of “lapdog” Boards of Directors...but readers of “Pilgrimage to Warren Buffett’s Omaha” know this is only one of several incongruities when it comes to the greatest investor in the world.


Voting rights aside, we are seated, as I said, a few rows back from the stage. Our seats are, technically, “Stage Left”—i.e. to the left of center stage when facing the audience—and this is where the gamesmanship comes in.

“The speech is on the other side,” somebody says, pointing to the table onstage where Buffett will sit. It has two microphones, just like the annual meeting, and a stack of papers has been placed at the seat which is to our left as we look at the table, but which is, technically, Stage Right.

Someone else observes, “Well that is where he always sits at the annual meeting....”

So we get up and walk through an empty row to the other side of the concert hall, and pick seats a few rows back that will presumably give us a better look at Buffett when he sits down at the microphone with the speech in front of it.

Others notice and follow our example; others notice but stay put. After all, almost any seat in this room will provide a good view of the “Oracle of Omaha.”

I am introduced to a farmer from Iowa. He is a longtime Berkshire shareholder, and we begin talking about the harvest and the outlook for corn prices. Business has been good, he tells us, what with rising demand from ethanol plants and a wet November that interrupted the harvest.

“I was out there yesterday and there’s a lot of corn to be harvested,” he says.

“Isn’t this kind of late in the season?” we ask.

“It is,” he says, “it is, but—”

Our focus turns to the stage, where a woman has crossed from the wings and is arranging things on the table. She moves the speech from one microphone to the other, non-Buffett seat, raising speculation of a shift in Buffett’s preferred seat from stage-right to stage-lift.

“Or maybe Charlie’s coming,” somebody says hopefully.

This bit of Kremlinology ends when Buffett himself strides in from Stage Left, smiling as the crowd begins to applaud.

He sits down on our side of the table, Stage Right—“where he always sits”—and fiddles with the microphone. There is no bowl of See’s candy, as at the annual meeting, but there are two cans of Cherry Coke within arm’s reach.

“This is a little embarrassing,” Buffett begins, in his husky, folksy voice. “When Charlie’s here we usually get about 35,000 people.”

While we’re laughing, Buffett lifts up a life-size cut-out of a youthful Charlie Munger—the same one it would appear he used at the special meeting in 1998—and places it in the other seat.

He presses a button and Charlie’s familiar, higher-pitched voice says, “I have nothing more to add.”

“It’s as good as having him here and we don’t pay him,” Buffett says.

After dispensing with the preliminaries, Buffett announces he will accept questions on the motions before us.

And there are questions.


—to be continued.


Jeff Matthews
Pilgrimage to Omaha


All images and text © 2010 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.

What I Learned Writing a Book about Warren Buffett: Part I

The Mini-Meeting: January 20, 2010, 8:30 a.m.

The most surprising thing about this “mini” Berkshire Hathaway shareholder meeting is the intimacy.

Leaving a raw winter’s morning outside and entering the warm confines of downtown Omaha’s Holland Performing Arts Center, named after Dick Holland, an early Buffett investor (circa 1958) and advertising executive—Buffett would grill him for information before buying shares of advertising agencies in the 1970s—there are no crowds, no lines, and no spectacle.

There are, in fact, only a handful of shareholders in the lobby.

Some have come by cab directly from the airport—they are East-Coasters, for the most part, and wear suits and ties beneath wool overcoats—while others have driven in from the snowy neighborhoods west of downtown Omaha, wearing parkas or jackets and boots. All are chatting quietly or milling around outside the doors to the 2,000-seat Peter Kiewit concert hall, where the meeting will start in about an hour.

Indeed, so laid back, so folksy and so accessible is this meeting that the casual observer can see Mid-American Energy CEO David Sokol, Warren Buffett’s heir-apparent (at least, for now: more on this later), chatting it up with a few long-time Berkshire investors from the New York City area.

And there is Mark Hamburg, the Berkshire CFO—head down and papers in hand, moving among shareholders and staff members—but looking more like a harried mid-level accountant for the local electric utility than the CFO of one of the largest companies on earth who happens to be orchestrating a special meeting that will help create more shareholders for that company than its CEO ever cared to have.

Even the CEO himself, Warren Buffett, can be glimpsed in between several moveable screens that wall off a portion of the lobby from us, the shareholders.

Inside that space Buffett is meeting the press, but if you stand in the right spot you can see him talking animatedly with a half-dozen reporters (all male, for some reason) about the Kraft deal (Kraft has announced an end-around plan in its efforts to buy Cadbury which neuters Buffett, its biggest shareholder, and he is angry), about the Obama tax proposals (the President, whose candidacy Buffett vocally supported, is lashing out at banks, and Buffett is uneasy), and about the economy (stabilized, according to Buffett, but not zooming ahead) while photographers move around him like he is Brangelina, their cameras snapping only a couple feet from his head.

Paparazzi aside, this must be very much like a Berkshire annual meeting back in the days before Buffett created the “Class B” shares and let the riff-raff in.

Ah, but one other difference is now noticeable: a tall, well dressed, man—easily 6’ 4”—stands calmly and discretely nearby, on our side of the screens. While he makes no move to restrict the few curious bystanders edging towards the break in the panels to watch Buffett, we all can see the coiled wire rising from the collar of his dark business suit to a piece of plastic in his ear: he is a bodyguard. So despite the easy casualness of it all, nobody ventures too close to listen to the “Oracle of Omaha.”

Suddenly a woman’s disembodied voice calls out sharply from behind the screens: “Okay, now we’ll do broadcast.”

“Great,” Buffett says in his husky voice, sounding oddly happy about the change despite the fact that he—a billionaire for whom time and money are inextricably linked—is being made to schlep from one group of reporters to another. For a man rooted in the deep-seated sexism of the 1950’s (he once posed his Board of Directors, males and females, among the silicone-enhanced staffers of a Hooters restaurant for the annual Berkshire Christmas card), it seems that Becky Quick and Betty Liu are more fun to talk to than a bunch of middle-aged men.

And thus the band of reporters surrounding him disperses, and Buffett moves away from the crack in the partition to an unseen seat in front of unseen television cameras. The few curious onlookers disperse, and the bodyguard relaxes.

It’s time to go inside the concert hall.

But this modest effort requires proving one’s status as a Berkshire shareholder in good standing, and thus credentials are being checked by two friendly women seated behind a table—a setup more like the raffle table at a church pot luck supper than the gatekeeper to a shareholder meeting for one of the world’s largest companies.

Fortunately I’ve brought a copy of my brokerage statement—the prospectus did say ownership was required—and am soon handed a movie theater-style ticket to the meeting (no large plastic “Shareholder” badges here, as at the annual meeting).

Next to me, however, is a couple from suburban Omaha who, despite having braved the rotten weather, which is just cold enough to have turned the sidewalks around this building to a sheet of ice, brought nothing to show the ladies.

The couple protests—nicely: this is Omaha, not Manhattan—that they had no idea they’d have to show proof of ownership, and while I don’t wait around to hear what happens, I can’t imagine they won’t get in: “Woodstock for Capitalists” this is not. It’s more like an old Allman Brothers concert at the Fillmore East, though decidedly upscale, and without the chemistry experiments in the bathrooms, if you get my drift.


Thus it is that I have journeyed again to the heart of Berkshire Hathaway—downtown Omaha, Nebraska—this time on an icy, overcast day, and taking a chance that the so-called Oracle of this very Midwestern city will take questions above and beyond the stated purpose of a simple, straightforward shareholder meeting: to approve a 50-for-1 stock split in the Berkshire ‘B’ shares. (For reasons why Warren Buffett is, in reality, no ‘Oracle’—world’s great investor, yes; Oracle, no—pick up a copy of “Pilgrimage to Warren Buffett’s Omaha at Amazon.com.”)

And it will prove worth the trip.

No, Charlie Munger—Berkshire Hathaway’s acerbic Vice-Chairman and the business partner without whom Warren Buffett would not have created Berkshire as we know it—is not in attendance, although Buffett will make up for Munger’s absence in a particularly Buffett-like manner.

Nor will attendance approach the 30,000-plus faithful that will likely cram into the nearby Qwest Center arena for the annual meeting come May 1.

Nor will Buffett take questions for anything close to the 5-plus hours he does each year.

But there will be a few goodies, including the fact that not a single “What should I do with my life?”-type questions will be asked by the more informed shareholders who bothered to come, which means that we will learn a few things about the Burlington Northern acquisition, and why it is that Kraft’s issuance of under-valued stock bothers Buffett mightily even though the reason we are having a shareholder meeting is to approve a stock split to facilitate an acquisition by Warren Buffett using his own under-valued stock.

Stay tuned.

Jeff Matthews
Pilgrimage to Omaha

© 2010 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.

The Pilgrimage to Omaha Interview with Alice Schroeder

Editor’s Note:

We had the opportunity to interview author Alice Schroeder as the paperbook version of her best-selling, and eye-opening, "The Snowball: Warren Buffett and the Business of Life" was hitting stores. We emailed more than a dozen questions to Alice, including a few that might have been uncomfortable, but, we thought, worthwhile. Alice answered them all.

Our questions are in plain typeface; Ms. Schroeder’s responses are italicized in bold.

For her thoughts on brilliant people, costly aspirations and codependency, as well as working against actuarial tables, sources fearing retaliation and when “he stopped speaking to me,” not to mention the next CEO’s biggest challenge, Charlie’s dictionary entry, “a major case of monkey mind” and other unique insights into Warren Buffett and the future of Berkshire Hathaway, read on! —JM

Jeff Matthews: First of all, Alice, congratulations on having written a book—that isn’t easy. Second, congratulations on the book being successful enough to warrant a paperback—that isn’t as common as it used to be.

Alice Schroeder: Thank you very much. And congratulations on your very successful book.

JM: Thank you. What was the worst part—not the hardest, but the worst—about writing the book in the first place?

AS: Wow, we are really launching right in here. Okay, the worst part was living with fear. Nearly all writers live with a fear of being judged that increases as the book draws closer to its publication date. I did live with that fear, yet it was far outweighed by my fear of the consequences of publishing this book. I wrestled with that daily for years.

Eventually, I could judge the truth of my writing by my feelings. If it made me feel weak, even nauseous to write something, that was good. It meant that I’d succeeded in subduing the fear monster with my blow dart just long enough to pen it on the page. I never reread The Snowball if I can help it. The fear monster glares at me from its captivity inside the book. Better to just shut the covers and leave it there.

JM: Understood. What was the best part of writing “The Snowball”?

AS: There’s no one best part. You can’t imagine how grateful I feel to have had this opportunity. I have never learned so much about so many topics so fast. Warren is a great teacher. Simply by observing him and his world you absorb a whole new culture, as an anthropologist would. I got to spend time with a whole cast of other interesting, brilliant people. Imagine being able to talk to Bill Gates for hours. He’s a great teacher, too.

I researched all sorts of unusual topics that would never have crossed my desk otherwise. The history of desegregation in Washington, D.C. How a slaughterhouse was organized in 1940s Omaha. The history of Las Vegas. I learned to write narrative nonfiction. Some days the words well up inside you and you know they are coming from somewhere outside yourself. To experience that sense of grace is why writers write. This experience changed my life in so many ways that I can’t recount them in a paragraph.

JM: So what, if anything, did you regret about the book once it was published?

AS: According to both my agent and editor, every writer sees the flaws in their book, real and imagined, as soon as they open the covers. And it’s true.

JM: You bet. Now, the new, paperback version of “Snowball” is shorter, but I honestly couldn’t identify major chunks that you removed—and that is no easy feat. What did you remove and who decided what to take out?

AS: I did the cutting myself, which was essential, and removed words, phrases, and sentences to condense stories when possible rather than wholesale cutting. I had to make some tough decisions.

One story that was hard to cut, for example, was the story of Warren’s silver investment in the chapter “Semicolon.” He had bought almost a third of the world’s silver supply. He wanted to go to London to visit the silver, and pictured himself in the vault, enjoying the feeling of being surrounded by all those silver bars. What an image.

JM: Yes it is. Now, a question about the title…not about “The Snowball” part, which some Buffettologists thought was odd given that the snowball metaphor is one of his least well known—but about the “Warren Buffett and the Business of Life” part.

As your book points out, his wife left him—physically, at least—after 25 years, and his children, in their formative years, appear to have occupied his mind less than 10-Ks and 10-Qs.

Indeed, subheadings in your book’s index under “Warren Buffett” include ‘attention-seeking,’ ‘emotional frugality,’ and ‘focus, total absorption and obsession.’Isn’t one subtext of your book that WB failed where it really matters in the “business of life?”

AS: We read biographies of eminent subjects to learn from their lives, for better or worse. These are people who have succeeded and failed on a grand scale, and the lessons they impart are magnified accordingly. Warren’s life is so instructive – the Inner Scorecard, his way of dealing with people, how he taught himself to think about risk, about time, about responsibility. When I started working on the book it felt like getting a post-graduate degree in life. I wanted to give those lessons to the reader.

As for the business of life in the title, the point is that business is inseparable from life. Most of the investing books focus on financial success as an isolated goal. Yet his business life can’t be understood outside the context of his personal life. Warren’s story is a living illustration that aspirations to be as successful as him have a cost. Until I got to observe him closely I didn’t realize how single-minded he is. People who want to invest like Warren Buffett ought to understand what this would mean to their lives.

Lastly, readers might be interested to know that a professional indexer creates the index. This is a real job – indexer -- I am not making this up. Other terms she chose: complex personality, honesty, sense of rectitude, sentimentality, showmanship, personal growth after Susie’s death.

JM: You interviewed a lot of people for your book. First, what was your relationship with Susan T. Buffett, and how comfortable were you interviewing her?

AS: I met Susie the day I first interviewed Warren as an analyst. The first five years we barely knew each other. It wasn’t until the book got going that we started getting acquainted. Susie’s very comfortable to be around. One time she took me down to Glide Memorial Church to see the gospel choir rehearse, and we had dinner with the Reverend Cecil Williams and his wife, Janice Mirikitani. I’ve had a couple of meals with Susie, and her eating habits were nearly as appalling as Warren’s, incidentally.

As you would expect from reading The Snowball, when I was interviewing Susie, she didn’t want to talk about herself, but was forthcoming about Warren. She was diagnosed with cancer six months after I started working on the project, which limited the interviews we were able to do. That was too bad. She was a wise woman.

JM: Who was most fun to interview?

AS: Warren, of course. He’s nonstop funny as well as always teaching you things. Among the rest, my favorites, hands down, were the older people. The actuarial tables were not working in my favor, with so many people of Warren’s generation and older to interview, so I started with the oldest first – those over age ninety – and worked my way down. We so rarely spend generous amounts of time with our elders. I was able to do it often and at length. It was a privilege to spend so many hours among people who had accumulated such a great store of wisdom.

JM: Who gave you the most insightful view of Buffett?

AS: Warren, by letting me spend so much time observing him and talking to him. My observations of him became the litmus test against which I measured everyone else’s statements. Beyond that, his sisters, Doris and Bertie, who have known him longer than anyone. Charlie Munger. His kids. Sharon Osberg. Don Graham. A few others that I’d prefer not to name.

JM: Speaking of those last, in your acknowledgements you cite “those who asked not to be named”: what, in general, did those who didn’t want to be named have in common?

AS: They wanted the truth to be told, and were afraid of retaliation if they were named.

JM: Wow. Okay. One final question along this line: there’s a quote late in the book (Page 694 in the paperback), about how Buffett held off on endorsing Obama “until it became irrelevant.” You write:As one observer put it, “Warren only ever wants to back winners. Your real friends are the people who are there for you even though it might cost them something.”

That sounds remarkably catty for a true friend of Buffett to say. Buffett is a guy who won’t sell the Buffalo News even knowing its value is going to zero and who almost never fires a CEO, even if the business is underperforming. I suspect it was said by a political acquaintance.

Am I wrong about that, and do you agree “he only ever wants to back winners”?

AS: To help and endorse and support your friends when they are in need is different than making business decisions about underperforming assets and people. The quote you refer to came from a close friend of his who has no involvement in politics, and is simply one of the people who have been hurt. I would describe it as a wounded, not catty statement.

Remember, we’re speaking of the man who wouldn’t help his sister when she nearly went bankrupt, who wouldn’t help his daughter when she was pregnant (and they are not the sources of this quote). By the way, as you can tell from The Snowball, people who’ve been hurt by Warren almost always rise above it, and still love him in the end.

JM: You became the first major Wall Street analyst to cover Berkshire Hathaway after Buffett merged with Gen Re. You gained enough of Buffett’s respect that he regularly appeared at your famous (among Buffettologists) Friday night dinner in Omaha during the annual meetings, and ultimately gave you his blessing to write what was perceived to be his one and only authorized biography.

How did your own personal view of Buffett change from the first time you met him to the day “Snowball” was published—and how about as of today?

AS: If I could make one small adjustment to your introduction, Warren cooperated with me for The Snowball, but it was not an authorized biography. The latter means the subject has editorial control over the book. When I knew Warren as an analyst he was an awe-inspiring, almost infallible-seeming figure. Fortunately he didn’t care about the stock’s rating, and I believe he might even have been perversely pleased had I put a sell rating on it, so that he could show off how little he cared and make a point about Wall Street. (I didn’t, and it would have been a mistake to do that during the time I followed BRK).

Once I got to know him better he became real, fallible, even fragile. His achievements actually seem more impressive to me with hindsight. To start out in life with a family like his and accomplish what he has done is, in my opinion, a greater feat than the public generally gives him credit for. Whereas the hero-worship of Warren Buffett has been overdone, his real accomplishments are underappreciated.

Today, he seems the same person as when I finished the book. The test of whether you’ve done good research is how well you can predict and, more important, explain your subject’s behavior. Warren rarely surprises me, and I nearly always understand his motives.

JM: You wrote extensively—I'd guess too extensively for most Buffettologists, not to mention for Buffett himself, if the rumors are true—of his personal life. In fact, you named his first wife’s lover. Having been a Wall Street analyst and having written a book about Warren Buffett, I know it is not easy to write something unflattering about a person you both like and admire.

How hard was it to physically put those words down in a book that would be read by WB, not to mention his best friends and family?Also, where did the worst reaction come from, and do you think you could have or should have done anything differently?

AS: It’s strange that this is a controversy. A biography includes the details of the personal relationships that influenced the breakdown of the subject’s marriage. That goes without saying. You can’t really understand Warren Buffett without this information. And of course I didn’t want to hurt Warren. I care about him as a human being. It was hard to know that he was going to be hurt and that I would be the instrument of his pain.

But let us turn this around a bit. Warren knew my work as an analyst. He knew that I was dogged about research and that I had a history of writing things that were true even if they upset people. He chose me for this project anyway. He may have thought, who knows what. That in exchange for such complete cooperation, I would owe him the loyalty of writing the version he wanted. As many people would. Nonetheless, he knew what he was getting when he chose me. That was not an accident.

He immediately began shoveling biographical material of an intensely personal nature at me. Until that point I had no idea of the situation I was walking into. Once I started to understand, it became my responsibility to do corroborative research. The choice was to tell the truth, which would hurt Warren, anger other people, and expose me to vindictiveness, or to lie, which would violate the reader’s trust and my integrity. I had to work myself up over and over to find the courage to tell the truth. From time to time, I talked to Warren, and my agent talked to Warren, to let him know that he wasn’t going to like, or even necessarily agree with, some aspects of the book. He continued to cooperate with me throughout. Warren read the book in July 2008, right before it went to the printer.

Afterwards, we continued to have a perfectly friendly relationship, right up until the week The Snowball was published. It was only then that he stopped speaking to me. Under the circumstances, someone might deduce that other people’s reactions influenced him, although there’s no way to know for sure. I wouldn’t do anything differently with hindsight. This was an important book that needed to be written. I made a considered judgment based on the readers’ needs, and have tried to set my own feelings aside.

JM: The results speak for themselves, I’d say. Now, moving beyond the personal, while researching “Pilgrimage to Warren Buffett’s Omaha,” my thought process on Berkshire changed: I went in thinking Buffett the Investor could be replaced by an equally rational investor, while Buffett the Manager could be replaced by anyone who merely left the Berkshire companies alone.

However, I came out thinking Buffett the Investor may not need to be replaced—because the investment portfolio is so minor relative to the businesses Berkshire now owns—while Buffett the Manager can’t be replaced for the simple reason that nearly all those Berkshire companies are run by individuals who sold to Warren Buffett, not to Howard Buffett and the Board of Directors. Furthermore, it seems unlikely that families who might want to sell to Warren Buffett would feel comfortable selling to a David Sokol on anything like the terms Buffett would get.

What's your take?

AS: Allocating Berkshire’s capital (as opposed to investing in stocks) is going to be the CEO’s biggest challenge. The Berkshire companies throw off a lot of cash. Even after the company declares a dividend, as it almost certainly will, there is still the capital management question.

Warren has a term, the Institutional Imperative, to describe the empire-building and other foolishness that leads to overpriced acquisitions, underutilized capital, stock repurchased above its intrinsic value, stock issued below its intrinsic value, and all the other failures of capital management that companies are so prone to commit. CEOs are rewarded in all sorts of ways for creating bigger companies, not more profitable companies. That’s putting aside all the risk that goes with running a big insurance business and the other financial exposures that Berkshire’s balance sheet includes.

Then there is the Buffett charm you describe, which has brought the company such good acquisition opportunities. How do you replace that? Capital management is the biggest risk shareholders face. Warren’s not replaceable as a manager, in my opinion, because he’s created a company that’s an expression of his personality. Even so, Berkshire can evolve to become a more conventional yet still successful company without losing its essence if Warren’s successor does a good job. I am not in the camp that believes it must be broken up. That’s conceivable, but not necessary. The most critical issue is choosing good operating managers. Undoubtedly many of those who are running the businesses now will retire when Warren leaves. They have hand-picked their successors without much, if any, oversight from Warren. The next CEO will need to approach the turnover as an opportunity, not a problem, if he wants to succeed. It is, for example, an opportunity to improve diversity in Berkshire’s leadership.

JM: Good points, all. Now, you are not a Berkshire shareholder: why?

AS: I thought it would be a conflict of interest to own BRK while writing the book, and didn’t want to have to deal with that. Plenty of people who write about him do own the stock, which I’m not criticizing. Whether someone can manage a conflict of interest is purely a personal thing. But you can also see, collectively, how it influences the gestalt. The tone of writing on Buffett as a whole is largely set by the way so many authors are financially invested in him. If all these people have gotten rich or are getting rich or hope to get rich because of Warren Buffett, how objective can they be?

Journalists and analysts disclose whether they own a stock, but interestingly, they aren’t ever asked to disclose whether the investment is material to their net worth. After the book was published and I’d said my piece, I did buy some BRK. It’s not significant to my net worth.

JM: I meet an inordinate number of people who have personally met Buffett and/or Munger in one way or another—finance (Buffett), real estate (Munger), charity (Munger), and education (Munger also)—and I've heard some great stories.You must hear things all the time: what’s a favorite story, or a favorite interaction of your own with them, that you didn’t include in the book?

AS: Warren is not so good with anything visual. Once we were talking on the phone after I had known him for years and he had seen me on many occasions. As a sort of joke, I asked him what color my hair was. He paused for quite a long time, and then said, “Not black.”

JM: Perfect. Of course, Charlie Munger is as important to the Berkshire model as Buffett himself. My own feeling is that Munger has had a better-rounded life than Buffett—and yet he comes across to strangers as impossibly arrogant.What's your take on Charlie?

AS: It’s hard to sum up Charlie in a couple of sentences or a paragraph. He’s quite humble in his genuine respect for the achievements of others, as long as they equal or exceed his own intelligence, in his opinion. He is so ungodly judgmental that some people find him insufferable, yet his fundamental kindness shines through.

Politically … if you look up “politically incorrect” in the dictionary you’ll find a picture of Charlie there instead of a definition. That’s part of why Charlie is refreshing to be around, though. He’s always himself. There is not a phony cell in his body. Your time will not be wasted talking to Charlie. Usually he’s got something very interesting and insightful to say. It’s better to listen when you’re around Charlie than to try to talk. The phenomenon I wrote about in the book, about him turning his head off when other people are talking, is very much in evidence at times. He’s really a treasure. I enjoyed interviewing Charlie immensely.

JM: I bet. Now, back to Warren.

There’s a single sentence in your book (page 650) that blew my mind. It puts Buffett in focus like nothing else I’ve read, but I’m not sure if you meant it the way it’s written.

The setting is this: Susan T. Buffett, his first wife, has had a brain hemorrhage in Sun Valley; Buffett is distraught and at her side in the hospital; and their two younger children have traveled a long distance to get there. When his son and daughter arrive at the hospital, you quote Buffett telling them nothing about their mother, her condition, or what exactly happened. Instead, you have him saying, "I've been here 5 hours."

Is it really all about him?

AS: Well, I guess the best way to answer that is to say that a trained psychologist or psychotherapist would have a field day reading The Snowball. I’m not qualified to diagnose psychological conditions. But my observation was that Warren knows himself pretty well. He’s intentionally arranged his life so that things center around him. He’s got his own means of reciprocating and being loyal to people, yet at the same time is not the least ashamed to say that he feels needier than others. He’s so open about his self-orientation that it’s quite disarming, even part of his charm.

He seeks out people who are comfortable with one-sided relationships, and once said that he felt he served Susie and Astrid by being a “taker,” because they loved to “give.” I thought that was pretty astute of him. He’s got a knack of making codependency work for the people involved, which is why people love him even after they get hurt.

JM: Buffett is known as a guy who “tap-dances to work,” and is so comfortable in his rational approach to the market that he could turn things off and nap whenever he needed to. When did he start taking sleeping pills?

AS: Warren is not a big self-medicator, unless you count work, sugar and caffeine. He loves going to work. It really is the highlight of his day. Work is his stress-reliever. He told me he’s never been a great sleeper, and I’m sure that’s true. He goes through withdrawal from work, and he can’t play bridge in his sleep. He’s got a major case of monkey mind, as the Buddhists would say.

My recollection is that he first started using Ambien for jet lag. If he uses it for insomnia, who cares? He’s certainly no Michael Jackson. Probably at least half the people reading this take Ambien or something similar from time to time.

JM: True. Of course, Buffett is, we know, astonishingly intelligent—and not just about investments. For example, he saved Salomon from extinction; turned around the Buffalo News during a very difficult time; and gave excellent advice to Kay Graham—as you write in your book—that helped her save the Washington Post during a crisis early in her tenure running that company.

So how does he sit on the board of Coke while its CEO starts promising growth targets—which Buffett hates—that leads to channel-stuffing and an SEC investigation?Does he really hate confrontation that much? Or can he simply rationalize his way out of anything?

AS: Warren is pretty good at rationalizing what he needs to if there is money to be made, and he really does hate confrontation. This is mostly about something else, though. You will notice a seeming passivity when he sits on a board that is similar to his reluctance to direct his own managers. (This trait is almost always taken at face value as being one of his strengths, by the way, rather than being studied for the lessons it yields as both a strength and a weakness. But I digress.)

Warren divides the world into matters for which he has assumed personal responsibility and everything else that is not about him. Where he’s taken responsibility and will be judged for it, he’s uncompromising with himself, and even a micromanager. Otherwise, he “abdicates,” to use Tom Murphy’s term.

With both the operating managers and the CEOs of the companies who’s boards he’s sat on, the point at which he takes action is when the damage done by others could reflect on his reputation. The best example is Coca-Cola. He was passive until the crisis, then took on a role so active it shocked people.

JM: Understood. In the paperback “Snowball,” which is updated to cover the financial crisis, you make the excellent point that Buffett's derivatives position handcuffed him during the market collapse last year.

But instead of taking sides on whether Buffett should or shouldn’t have sold puts with $37 billion in notional value on the market near the peak, let's invert the question in a manner of speaking, as Charlie Munger likes to do, and look at the sale of puts this way: What does it mean that he did it?

Does it mean that he had become as complacent as everyone else, despite years of warning about “ticking time bombs” and “financial weapons of mass destruction”?

AS: I don’t think he was complacent. Warren views derivatives as being fraught with credit risk. He structured these, and other deals, to protect the company from the capital calls that such risk entails. The decisions he made were excellent in that sense. They are the reason why Berkshire is still standing, financially healthy and why it did not require a bailout. It’s dicey to second-guess an investor as successful as Warren Buffett. Chances are he will be proved right on those puts and they’ll be profitable.

I do think Warren, in his focus on the long-term, missed how much the short-term volatility of the market would affect others’ perceptions of Berkshire’s day-to-day financial strength. Berkshire had an awful lot of market exposure going into the crisis, and unfortunately, during the bloodbath, it didn’t look like the Ft. Knox of capital to the rating agencies.

JM: Okay. And last but not least—you. You describe yourself as “a full-time writer.” What’s next?

AS: I’m working on another book, subject undisclosed except that it’s not a biography. I have been approached to write a biography by several other well-known people, but said no. Right now my interests lie elsewhere.

I’m also writing a column on general topics for Bloomberg, roughly once a month, which has been incredibly enjoyable. Occasionally I’m also writing other short pieces, for example, like this, or for The Motley Fool or Huffington Post. You can find these at my website, www.aliceschroeder.com.

JM: Excellent, Alice. On behalf of our loyal and thoughtful readers, I thank you very much and wish you good luck.


Jeff Matthews
Pilgrimage to Omaha

© 2009 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.

Why Buffett Finished Off Burlington: It’s the Inventories, Stupid

Everybody has an opinion on whether we’re going to have a V-shaped, U-shaped, W-shaped or L-shaped recovery (what happens in China: do they have sinographic recoveries?).

But the issue that will determine the near-term course of the economy is simple enough, and has nothing to do with letters or ideographs or even giant red dog bones: it’s the inventories, stupid.

And inventories are probably as low as they are ever going to go.

Here’s how the CFO of 3M put it on their October 22 earnings call:

Heading into 2009, in the face of such a significant economic collapse, we set very aggressive cash flow targets for each of our businesses. Ground leaders and their teams have responded with great results. Third quarter free cash flow is $1.6 billion, up $769 million versus last year's third quarter. This represents a 97% year-on-year increase. The improvement was driven by many factors, but most notably by lower capital expenditures, improving that working capital, lower cash tax payments and also reduced cash pension contributions. Net working capital declined by $415 million year-on-year, with inventory down $443 million....

Lest anyone think we cherry-picked a particular industrial conglomerate in the form of the famous Post-It notes maker, we did not. Pick any company in the same SIC code as 3M and you ’ll hear pretty much the exact same story.

And it is not just old-line conglomerates that have brought inventories down to can’t-go-lower levels.

Bob Wachob, the CEO of Rogers Corporation, which makes, to be technical about it, stuff that goes into cellphones, told listeners last week that his company’s hi-tech customers have not much in the way of surplus inventory:

Our customers are continuing to order with a request for extremely short lead times. That is a good indication they don't have any inventory.

As for Rogers’ own inventories, Wachob said, without mincing words:

I think we are as low as we can go without impacting our customers.

Even a homebuilder as bruised and battered as Beazer has begun running low in inventory at the very moment orders are increasing, as reported earlier today:

As of September 30, we had only 270 unsold finished homes and 417 unsold homes under construction representing declines of 34% and 27% respectively from year-ago levels. With a cautiously optimistic outlook, we do not contemplate further significant reductions in our unsold home inventory levels but rather the resumption of more normal seasonal patterns.

Net new home orders of 1012 for the quarter represented an increase of 2.4% year-over-year.

Most striking of all, however—just as far as being emphatic about it goes—was Jeff Siegel, the CEO of Lifetime Brands, a kitchenware maker that sells to the Bed, Bath and Beyonds of the world, when he was asked by one of Wall Street’s Finest to size up the inventory reduction at that firm’s major customers:

It's shocking. Honestly, it's sometimes a shocking number. And I don't -- I can't get at the numbers by retailer, but we do get it from -- like one retailer we're down about 6% on point of sale at one retailer. Our inventories are down over 30%.

In other words, while sales of Lifetime’s products at this unnamed retailer are running 6% below last year, inventories of those same products at that same retailer are down by one-third.

The response to Siegel’s comment from the member of Wall Street’s Finest who asked the provocative question?

“Wow.”

Wow indeed.

So what happens when somebody actually needs to order a pallet of new flexible circuits for a rush order of cell phones, or an extra gross of Post-It notes not available on the loading dock, or a set of kitchen knives not sitting in the warehouse…or, heaven forbid, a whole new house?

Now, we’re well aware that Warren Buffett doesn’t make short-term bets on markets or economies.

But given the fact that he stands at the center of an economic supply chain that stretches from a candy maker in South San Francisco to a high-tech machine tooling supplier in Israel, we think it’s no wonder Warren Buffett decided the time was right to buy the rest of Burlington Northern.

There’s going to be a lot of—to be technical again—stuff that will need to be getting moved around in the next twelve months.

It’s the inventories, and Buffett isn’t stupid.

Jeff Matthews
I Am Not Making This Up

© 2009 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews.
Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.