Berkshire Hathaway of the Internet
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A few challenges with the trying to replicate the Berkshire model on the internet:
##Lower cost of Capital (Float): One of the unsaid rules of BK is that their cost of capital is cheaper than most operating companies because of thier insurance float (Ajit Jain, General RE, GEICO etc). So, they can take an existing business & assume absolutely no changes to their changes & still make better ROI because their capital structure is more efficient. It is a different matter that they take portfolio companies like BNSF & use float to expand their capital projections (this is like making a private investment vs a public investment. From the BK 2015 Letter on how capex is linked to float:
After a poor performance in 2014, our BNSF railroad dramatically improved its service to customers last year. To attain that result, we invested about $5.8 billion during the year in capital expenditures, a sum far and away the record for any American railroad and nearly three times our annual depreciation charge. It was money well spent. BNSF is the largest of our “Powerhouse Five,” a group that also includes Berkshire Hathaway Energy, Marmon, Lubrizol and IMC. Combined, these companies — our five most profitable non-insurance businesses — earned $13.1 billion in 2015, an increase of $650 million over 2014.*
##Bullet proof Revenue (Moat): One of the operating assumptions behind BK's acquisition is that the business does well regardless of management. Therefore, if the revenue assumptions hold (i.e. this is the moat part of the strategy)- then the float kicks in & does magic.
However, the challenge with using a BK model in tech i.e. acquiring companies & being hands off without PRODUCT ENERGY- the products atrophy & revenues goes. The reason that BK hates tech is because there is moats are hard to sustain & it is too competitive.
I am looking at Tiny's portfolio: http://www.tiny.website/ & I am hard pressed to think of any product that has moat. I would suspect that once the founder leaves in almost all of these cases, the products will atrophy.
Is that the case? I am currently reading the collection of Warren Buffets' Annual Letters to the Shareholders (https://www.amazon.com/Berkshire-Hathaway-Letters-Shareholde...) and in every letter, he attributes a significant part of the success of their companies to good management.
I knew nothing about the management of Moody's. The - I've also said many times in reports and elsewhere that when a management with reputation for brilliance gets hooked up with a business with a reputation for bad economics, it's the reputation of the business that remains intact.
If you've got a good enough business, if you have a monopoly newspaper, if you have a network television station - I'm talking of the past - you know, your idiot nephew could run it. And if you've got a really good business, it doesn't make any difference.
http://www.businessinsider.com/warren-buffett-good-business-...
It may be possible to build a BK of the internet but it's not easy to imagine how.
A BK of the internet would buy ugly tech companies, turn them around, and sell them. Buffett is definitely not the only guy in that business, but he's probably been the most successful. An internet version of that would have to really really understand technology and the markets driving it, along with understanding the modern financial system and sources of capital (to finance buying the companies). It is kind of a weird combination.
However, I do think we're going to start seeing waves of consolidation in tech, and maybe some interesting turnarounds.
And network effects. That was true with most of the OS providers since the OS was an independent component, and obviously matters for some of the modern bigcos (Facebook, Amazon to some extent [third party sellers], Ebay).
I think we can all agree thats about as similar as it gets to Berkshire Hathaway, and what the author is doing is not really that unique or similar.
I view the article as nothing more than a way to get press and hope to try and improve the author's deal flow in case anyone who reads the article is interested in selling their business, and if I had to guess the author got at least a few leads from it.
Also worth looking at is the relative contribution of these kinds of acquisitions to BRK's overall performance. Simply put, it's not Borsheim's and See's Candy that give BRK.A a $425B market cap. There's an enormous portfolio of high-ticket investments --- many of them in gigantic public companies --- that dwarf these mom-and-pop acquisitions. Even among the wholly owned subsidiaries, and even in the smaller "Manufacturing and Retail" segment, contributions are dominated by very large companies like Clayton Homes.
Noted below in the thread, the "powerhouse five" of Berkshire's portfolio: BNSF Railroads, IMC (one of the largest metalworking companies in the world), Lubrizol, Berkshire Energy, and Marmon (one of the largest home builders in the US). I doubt very much the acquisition of any of these companies followed the casual pattern listed in the post. Some of them weren't even acquired all at once.
Finally: having twice been involved in the sale of a company I was a principal at, the acquisition process was pretty unlike the breakdown this person provided. It was somewhere in between what he reports Buffett's process to be and what he claims the normal process is. The actual decision --- getting to an MOU with a notional price --- was reasonably informal and didn't take up much time. Certainly nobody did a road show. The rest of the process was legal, and I very much doubt Berkshire avoids much of that work either.
But your focus on the "powerhouse five" over See's Candy's is backwards. The powerhouse 5 are all very new acquisitions, and were purchased in part because See's candies was so amazingly successful as an investment.
In 2011, Buffett said that See's had directly earned $1.65B for Berkshire since it's acquisition. Those earnings were reinvested in Berkshire, so over the years they've probably added as much as $10B to Berkshire's value. That's enough to have enabled the purchase of one of the "power house 5" by itself.
Another measure of Mr. Buffett’s firepower: Berkshire Hathaway’s insurance float, paid in premiums that can be invested until claims have to be paid. Float was about $89 billion on March 31 2016, compared to about $88 billion at the end of 2015. http://blogs.wsj.com/cfo/2016/05/09/at-berkshire-hathaway-ca...
Second, market cap is actually $420B, but Buffett was talking about value, and BRK value is much higher, certainly over $500B.
But this is the way I see it. Berkshire could easily sell $90B in ten year bonds for some low rate, let's say for 4%. Those bonds are better than float in some ways? one is it's easier to use more if the proceeds to buy long term investments, much of float has to be tied up in safe and liquid investments approved by regulators such as short term bonds. So the long term returns should be higher using borrowing vs. float.
The counter is that float is free, often better than free the way Berkshire insurance ops are run. Let's assume BRK averages being paid 1% a year to hold the float, that makes the cost advantage to float 5% a year. If he can earn 2% more a year because of the fewer restrictions on what he uses borrowing for over float, the net difference per year would 3%, or less than $3B a year, or less than 1% a year in additional investment returns.
Now that's a significant benefit but far from a huge edge. It also might easily be less than that. One reason I might be wrong is "why not both?" If float doesn't preclude debt, then the float benefits stand alone, and could easily be worth $6B-$9B a year, and that's a pretty big benefit (2-3% a year).
But I don't believe both can be done because all that float requires WEB to hold dry powder against unforeseen mega-losses. If he maxes out BRK borrowing and his insurance subs suffer massive losses, he can only raise money through a horribly priced secondary or forced asset sakes and he'd never allow himself to be backed into that corner.
That's not exactly what he is saying nor what he means. Both are risky assets. A 100% owned business you deeply understand is still a very risky asset. On its own. I agree with aeden's comment that diversification is one of the main reasons to sell.
The other good reason to sell...you get cash! Sure some of the cash will "probably" go to a diversified stock portfolio but some of it will be spent on cool stuff. You can't use stocks to buy your dream vacation home or donate money to charity for it to be spent on medical research. Cash is also the reason to sell.
Lastly, people die. A business founder must sell the business or give it to someone else at some point in one way or another or it will be done for him or her.
My understanding is that many businesses cannot support providing the Government with amount of cash necessary pay the tax, or the net reduction in income makes running the business not worthwhile.
Note how the letter is worded to carefully state that the family members will still have some ownership and management will be maintained. While this is certainly wise acquisition tactic, it is also very appealing to a seller who is on the margin and primarily selling to avoid the death tax.
(If you are thinking, "but the inheritor will still have to pay the tax on the cash," you are correct, but paying tax on cash still provides immediate payback with what is left over, whereas running or even just owning a business or any investment asset for 10+ years and getting zero or close to zero is not going to be desirable to a great many people.)
Now I think he's wrong about this. Rockefeller had a roughly ten times greater share of our nations wealth as Gates or Buffett ever had. And somehow our democracy survived and flourished, because inheritances typically get split up among children, grand-children and eventually hundreds of great-grand kids and great-great grand kids, and predominantly those descendants dissipate the wealth because they don't have the same drive or abilities as the wealth creator.
And lots of that money ends up in charities before it's all gone.
I specifically discussed sellers who are on the margin. While it can be difficult to know exactly how many of these are, I'm willing to bet this would result in a very real and measurable reduction in investment opportunity for Berkshire. If it were 10 businesses in a year at Buffet's stated minimum of $10 million annual net profit, then that would represent $80 million in annual revenue for Berkshire.
In the world of big business, famous personalities, and politics, my position is to assume the worst case scenario, which is that the only reason someone like Buffet supports the death tax is because he profits from it. In this case, it is not a coincidence.
If you always assume some extreme in the absence of evidence your assumptions are probably not going to be very accurate.
There's a bunch of evidence Buffett is not like that.
First, Buffett's minimum pretax profit hurdle for potential acquisitions is $75M a year, not $10M. Those people tend to have the best legal help possible to avoid/minimize estate tax.
Your opinions on mon-profit entities is anecdotal at best, all that matters for the purpose of the question at hand is how Buffets charitable contributions work and you haven't spent an iota of time learning about them, not that it stops your pontificating.
I disagree with Buffett on estate tax, but that doesn't make me blindly question his motives. There is a whole world out there full of people who may surprise you if you take off your political blinders.
The person running it is getting to retirement and the kids aren't that in to taking over, or some of the kids would rather have the cash - often the case in Buffett's purchases
You want to cash in and do something else eg. Paul Graham selling Viaweb and ending up with this YC stuff
Maybe diversification
Maybe you have VC like investors who want/need to monetize
I imagine you know your way around Buffett's annual letters well. Any other favorite portions you might particularly recommend?
They're worth taking your time with, especially once the thing gathers pace.
Partnership letters 1959 - 1975 https://www.rbcpa.com/WEB_letters/WEB_Letters_pre_berkshire....
Berkshire letters http://www.berkshirehathaway.com/letters/letters.html
There are little nuggets of wisdom everywhere.
> There is often a sound reason to sell but, if the transaction is a fair one, the reason is not so that the seller can become wealthier.
It's a challenging statement in a world where pre-revenue startups can sell for $xM, and instructive about how the rest of the world works.
So I don't really see the challenge. Pre-revenue just means higher risk and a bigger discount.
Ah, the zero-sum game deception. That only works in the short term, else the world economies wouldn't be able to support a population that is double what it was 30 or 40 years ago.
That doesn't mean I disagree with the statement that capital assets are not valued purely on future earnings.
This is very unusual. Typically stocks in the same industry are highly correlated.
A company with negative growth rates still has a value (not sure what negative interest means in this context). An example is liquidations, which can be very profitable investments.
"A stock's present value is also based on it's likely future value, which is in turn based on market forces and geopolitic". The more I read your post the more I think you confuse price and value.
Lets say I find a stock trading at 5x earnings, with a good moat, and earnings growing at only 5% a year, so it obviously looks like a bargain.
But lets also assume I have a magic ball that can tell me a stocks future, and it says this company will never trade for anything but 5x earnings. I'm still buying it, not only am I getting a 20% a year return on my investment (as my imputed share of profits), but that return is going to grow over time. At some point they will either buy back stock, increasing my share of their profits, or pay me my profits in dividends.
In the meantime I can let the value grow, even in this "slow growth" business.
But it will have a future value based on the potential future future future cash flows.
Sometimes you can have a startup you're [i]not[/i] obviously poised to make significantly money with which poses a threat to a major player's significant revenue stream, or has IP or eyeballs they value. This seems to be the case for a surprisingly high proportion of tech acquisitions.
If you should decide to do business with Berkshire [...] There would be no brokers involved.
then the article is saying that's the usual process to avoid.
However, to paraphrase something I read from a sailor, "every regulation in the Navy is written in the blood of your predecessors". If you do 10 deals, one might wipe out any upside from the other 9, even if you got more upside by negotiating a better valuation, and having a faster turnaround and lower cost of doing business. And of course, if a buyer got the reputation of not doing due diligence, it would attract all the problematic companies.
There is a reason behind every "annoying" stage, and those reasons collectively explain why the entire industry is made of buyers that follow those stages.
Since he runs 10 businesses, it is probable that the author has other ways of doing the work. He will keep track of most of the promising names in his industry, he will have a network of insiders to keep him appraised of the real story in those companies (although never officially), and he will know when the timing is ripe. His good relationship with his existing bankers means financing will be quick and standardised already, his back office experienced and streamlined. His experience tells him how you can play with what numbers to present a rosier picture than the reality, as well as how much to offer to get a founder to come to a quick decision. Unless he decides to go buy palm oil crushing plants in Indonesia, it might work out quite well.
1) In the words of Buffet, "there would be no chance that a deal would be announced and that the buyer would then back off or start suggesting adjustments (with apologies, of course, and with an explanation that banks, lawyers, boards of directors, etc. were to be blamed)" [https://news.ycombinator.com/item?id=13906176]. Most of such re-negotiations can only be explained by screw ups in the decision making process or dishonesty of the acquirer trying to squeeze more from the tired owners.
2) Not screwing with the acquired businesses: they buy companies because they know their owner-managers are what made these companies successful, so it would be a stupid decision to replace them or change their operations.
I remember a famous fund launch recently and I was about to pitch them but then read up the main partner's comment history and realised his demonstrated character and worldview did not match the (excellent) marketing. That was enough to put me off even just getting in touch. Being upfront that you play like everybody else might be a better strategy (prisoner's dilemma version: "like all the other funds, we assume defect-defect; we won't try and get you to cooperate so we can defect quietly"). In other words a standard negotiation with both sides having written in guarantees to protect themselves from worst case scenarios.
On 2), every investor claims they will be hands off and trust owner-operators. However, not only is this rarely the case in practice (why else are board seats so important?), many funds explicitly argue synergy as a competitive advantage with their limited partners and the community. E.g. they get you the C-levels you're missing, an experienced marketing and finance team from their network, help you find clients, investors... and if things go badly, they eject you and put in one of their turnaround names. How can you know ahead of time? You can't, so you assume a defector. As for Buffett, he did step in to run Salomon Brothers when things went south.
I think you're right here, and the reason Berkshire Hathaway can get away with this type of strategy at this point is because it's large enough and diversified enough that it can assume that risk. A tiny company, I would think, would be in much less a position to do so.
1) Sometimes a small error can actually turn into a huge red flag because it exposes a pattern of fraud. But this is extremely rare. It's hard to fake more than a fraction of your cash flows.
Real risks of acquisitions aren't the cash flows, it's the former partner who sues (and wins) because of an undisclosed agreement, or the undisclosed IP lawsuit, or bad contract provisions with their key landlord/distributor/etc.
2) It's ass-covering. Acquisitions are done by teams, with consultants, etc, and no-one wants to have a finger pointed at them if it goes wrong. So they do due diligence to ridiculous levels.
3) It's billable hours. Same reason as 2), consultants are happy to ring up more hours for the dumbest of reasons if you will pay them for it.
For acquisitions I think two key skills are needed.
1) Ability to recognize what businesses have a significant moat.
2) Ability to weed out the honest/ethical owners from the bullshit artists.
These are two skills Warren seems to have in spades. But even he makes mistakes. Dexter Shoes went out of business after he paid BRK stock that would be worth $14B in todays price. You and I both can scratch our heads and ask what "moat" did he ever see there.
When you can be really confident in the moat, the ethics of the owner becomes more of a redundancy. Once you own the business and find the moat not as strong as you thought, you then sure don't want to find that the owner hid other big problems from you.
Whether a business made $1M or $950K shouldn't make a big difference in your decision. Whether that $950k-$1M is repeatable and will grow is a hundred times more important.
Likewise with internet stuff what counts is whether you bought facebook or friendster. The accounting minutiae not so much.
There’s an interesting video about how Magnus Carlsen makes his chess moves. He makes the next move in seconds and then thinks if it’s the right move, ref: https://www.youtube.com/watch?v=PZFS0kewLRQ -- And maybe Buffet does a similar thing, he can look at balance sheets and quickly decide if it's a business worth buying or not.
Numerous writers in different fields have debunked this myth. Starting with Taylor in organization theory [1]
It is the process that matters, not some undefined 'talent'
Processes are ante into the game, great process and lousy leadership will fail.
Many, many, more.
In the entirety of all global business today, there are only a few dozen conglomerates large enough to make either the US or global equivalent of the Fortune 500 in terms of sales.
The majority of those conglomerates exist not due to a special process or skill, instead they exist due to vast amounts of time and wannabe empire building managements (eg General Electric).
GM was a classic example of that wannabe empire building. They tried to build a conglomerate and it went poorly. They acquired companies like Hughes and EDS.
More often you get outcomes like GE's empire building which nearly bankrupted the company and required a bailout to keep them from collapse. Sony is another classic example of a failed attempt at a conglomerate empire.
First there aren't many $500B conglomerates to start with, and not with BRK's returns.
Second, there is almost certainly not another conglomerate even a tenth the size with such a tiny executive staff. He's got only 24 people total at the corporate headquarters, and their role is mainly just doing the tax returns. He has more than a hundred businesses reporting directly to him.
It might be the least duplicatable process in the world.
Buffett's talent - capital allocation - is what provided the capital to begin building the foundations of the conglomerate in the first place. He stacked a large amount of capital up from the wildly successful Buffett Partnerships, long before he had any supposed process in place in regards to what has made Berkshire successful.
Berkshire debunks organizational theory because it's organization structure has been fabulously successful and no one else has been able to copy it.
I didn't know it was sold and can't seem to find an announcement anywhere?
I agree that they are vague, but that's sort of their personal business. I don't think they owe anyone that information.
One of the reasons BH has an advantage is their insurance business, which throws off large amounts of investible capital. He talks about how special and important the insurance businesses are in his annual letters. They make it easier for Buffet to be patient or to handle bad deals.
Does Tiny have access to this, or something like it? Maybe existing SaaS products that have very high gross margins?
He has to keep money ready to repay float when insurance subs need it, or regulators would shut them down. So it can't be directly invested in long term equities.
Any investor who wanted to ape Warren could borrow against 20% of their portfolio and achieve a similar "advantage". You shouldn't borrow more because one day the market will drop 50% and you could have your entire portfolio liquidated at the worst possible time.
And obviously borrowing doesn't help if you aren't a skilled investor, if you are paying 7% to try to earn 8% the extra return isn't worth the risk. But if you are the next Buffett with the skill to average over 30% a year for your first decade with a smaller portfolio, it's a reasonable strategy.
I get it that there are a number of steps needed to buy a business, but this isn't exactly buying a chocolate bar from the supermarket where all we need to check is the "best before" date has not passed.
Proper, thorough, due diligence takes time, and knowing how much you are paying for a business versus how much you are handing over for goodwill (which is far from guaranteed) is hard, let alone being able to understand cultural fit, internal politics, market forces and the myriad of other internal and external factors that all influence a business on a daily basis.
Warren Buffet apparently does it quickly (I didn't check beyond the claim in this article), but he has a talent for it, and I will guess a fairly large research team that are fully prepared and informed before they approach a prospective target.
Comparing Warrent Buffets approach to this service to me comes off like a very well-intentioned but frankly naive initiative.
Of course, if the author is planning to buy businesses at a massive discount to what they are truly worth then he indeed can probably skip some of the diligence - but that's a pretty poor outcome for the seller.
Buffet has 24 total people at corporate, mostly finance people working on tax returns and a CFO obviously. Warren evaluates the business, values it, makes the offer, and relies on his CFO I believe to do basic due diligence and close the deal.
But the key value Warren relies on is "moat" and that's a hard one to quantify for many tech businesses. Warren can buy a chain of furniture store because he thinks they are run well, efficiently but most importantly have a strong moat because of a great brand and locations in their market. So he can be confident the business will be around in decades.
Will a web development company be? Will the web be? Those are harder questions and make applying Buffett's techniques far harder in this market, even if author had similar skills to Buffett, which is also very unlikely.
I don't think this yet qualifies as the Buffet of Baud. But I admire the excellent marketing.
They rarely buy "growth companies". Those are speculative investments.
>> They are fiduciaries managing money for huge institutional investors.
Most of the due diligence is the intermediary covering their ass. In fact, a huge institutional investor is also an intermediary for a bunch of other people and they like to cover their ass. It's all about minimizing risk of getting sued by someone.
That said, it should be noted that WB doesn't like tech companies and invests in very few. He likes businesses that have steady cash flow, containable costs, and reliable yield/growth. This isn't tech.
Just a side note, the above likely referenced this Wikipedia page[1], but it misses that MiTek, which is listed on that page, represents holdings of another 20 companies that aren't on that page. I didn't research if other BRK company are also holding companies.
I currently consult for two companies, a PaaS company and a CRM/SaaS company. Both were recently purchased by MiTek and focus on the Builder Industry. They both continue to operate independently as do the other companies held by MiTek. This follows the traditional BRK business approach to keep the existing management and corporate culture in place of the acquired company.
Prior to that acquisition I thought the BRK team was not tech savvy. I can tell you first hand (at least when it comes to the MiTek team) that is not the case.
[1]https://en.wikipedia.org/wiki/List_of_assets_owned_by_Berksh...
Berkshire recently bought Apple stock but I believe that was done by two young investment managers he lets manage smaller parts of the Berkshire portfolio.
Buffett is clearly more tech savvy than he lets on, but his objection to tech investments is he doesn't think he can identify durable competitive advantages there. It's certainly harder.
In other words, I really didn't even notice them. To me, at least, they certainly weren't a distraction at all; in fact, just 30 seconds after closing out that tab I didn't recall seeing them in the first place.