In his annual letter to Berkshire Hathaway’s shareholders, Buffett said that financial history is replete with the names of famous conglomerateurs who were initially lionised as business geniuses by journalists, analysts and investment bankers, but whose creations ended up as business junkyards.
Buffett said in his and Charlie Munger’s 20-year struggle with the textile operation finally convinced him that owning a non-controlling portion of a wonderful business is more profitable, more enjoyable and far less work than struggling with 100 per cent of a marginal enterprise.
Berkshire as conglomerate
Buffett said that conglomerate is a negative term applied to holding companies that own a hodge-podge of unrelated businesses.
“And, yes, that describes Berkshire – but only in part,” he argued, while insisting that Omaha-based company differs from prototype conglomerate.
Buffett said conglomerates have generally over time limited themselves to buying businesses in their entirety.
That strategy, however, came with two major problems.
“One was unsolvable: Most of the truly great businesses had no interest in having anyone take them over. Consequently, deal-hungry conglomerateurs had to focus on so-so companies that lacked important and durable competitive strengths. That was not a great pond in which to fish,” he said.
Beyond that, as conglomerateurs dipped into this universe of mediocre businesses, they often found themselves required to pay staggering “control” premiums to snare their quarry, Buffett said.
“Aspiring conglomerateurs knew the answer to this overpayment problem: They simply needed to manufacture a vastly overvalued stock of their own that could be used as a “currency” for pricey acquisitions. (“I’ll pay you $10,000 for your dog by giving you two of my $5,000 cats.),” he said.
Often, the tools for fostering the overvaluation of a conglomerate’s stock involved promotional techniques and “imaginative” accounting maneuvers that were, at best, deceptive and that sometimes crossed the line into fraud, Buffett said.
When these tricks were “successful,” he said, the conglomerate pushed its own stock to, say, three times its business value in order to offer the target two times its value.
Buffett said investing illusions can continue for a surprisingly long time.
Wall Street loves the fees that deal-making generates, and the press loves the stories that colorful promoters provide. At a point, also, the soaring price of a promoted stock can itself become the “proof” that an illusion is reality,” he said.
Eventually, of course, the party ends, and many business “emperors” are found to have no clothes.
Buffett said his conglomerate owns all or part of a diverse group of businesses with good economic characteristics and good managers.
Whether Berkshire controls these businesses, however, is unimportant, he said.
“For those reasons, our conglomerate will remain a collection of controlled and non-controlled businesses. Charlie and I will simply deploy your capital into whatever we believe makes the most sense, based on a company’s durable competitive strengths, the capabilities and character of its management, and price,” Buffett said.