Can Berkshire Keep it Together Without Buffett?

By Phil Cutajar - May 8, 2012 | Tickers: AAPL, BRK-B, BRK-A | 0 Comments

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81 year old Warren Buffett, known to many as the Oracle of Omaha, was recently diagnosed with prostate cancer. Fortunately Buffett’s doctors caught the disease early. The 5-year survival rates for patients with prostate cancer in local or regional stage are nearly 100% according to the National Cancer Institute (NCI).  But the recent public disclosure of his health condition, together with Buffett’s advanced age, reopens the question of succession.

Succession Secrecy

Berkshire Hathaway (NYSE: BRK-A), (NYSE: BRK-B) has disclosed very few details publicly about plans for succession, just as Apple (NASDAQ: AAPL) did concerning succession of the late Steve Jobs. The succession secrecy has led to public speculation and a proposal submitted by the AFL-CIO asking whether Berkshire should disclose more specifics about its succession plans. Unlike Apple, Berkshire’s succession plans are difficult to predict. In Apple’s case the consensus candidate to replace the CEO was an obvious choice; Tim Cook had been the interim CEO at Apple during Steve Jobs’ medical leaves, and had been the COO of the company since 2005. Although Steve Jobs was truly irreplaceable, Cook was well prepared by the time Steve Jobs resigned, and Apple didn’t skip a beat when the time came.

What is Berkshire doing to prepare for Buffett’s succession? Buffett, who currently serves as both chairman and CEO of Berkshire, told shareholders in this year's annual letter to shareholders that the board had already picked his successor and even identified two backup candidates just in case. But no names have been disclosed. Buffett’s right-hand man and longtime business partner at Berkshire is vice chairman Charlie Munger, but at 88 years of age Munger is an unlikely successor. In public comments Buffett has hinted Berkshire may decide to split the chairman and CEO jobs, and suggested his son Howard, already serving on the board, might be a good candidate for the non-executive chairman position.  But the likely successor to the CEO position is still quite elusive.  

Buffett’s legacy

Warren Buffett’s involvement in Berkshire Hathaway began 50 years ago when he started buying shares in what was then a textile company. Within 2 or 3 years Buffett had acquired enough stock to become majority stock holder and took control of the company. By 1967 Buffett began diversifying into insurance and other industries, and by 1985 Berkshire was completely out of textiles. With Buffett at the helm, the Berkshire empire grew so vast it is now rated the eighth largest public company in the world according to Forbes Global 2000 list, with a market cap of approximately $200 billion.

 At most recent count, Berkshire Hathaway had majority ownership in over 45 companies, many of which are 100% owned, including familiar brands such as GEICO Insurance, General Re, Dairy Queen, Fruit of the Loom, Benjamin Moore, NetJets and Burlington Northern Santa Fe.  

Berkshire’s investment portfolio consisted of 34 positions as of December 31^st, 2011. Berkshire’s top-15 holdings by market value are;

Berkshire also has stock in well known companies such as Visa, Mastercard, CVS Caremark, Intel, General Dynamics, General Electric and several others. In addition to this extensive portfolio of companies and investments, Berkshire has an estimated $38 billion in cash on hand.

Buffett is irreplaceable

Buffett’s wisdom and mastery of the markets has paid investors in Berkshire Hathaway handsomely. Berkshire’s compound annual growth rate (CAGR) since 1989 is estimated to be 14.9%, versus 6.8% for the S&P 500 (source: Covestor Blog). Such a phenomenal track record will be difficult, if not impossible, for Buffett’s successor to reproduce.

Buffett is known to be hands-on in many of the strategic and operational decisions. Buffett himself has said that one of his most important jobs as CEO is to manage risk and protect Berkshire from catastrophic problems. In public statements Buffett has said the Berkshire board won’t choose a CEO who doesn’t possess the proper skills to manage the complicated insurance and derivative transactions Berkshire likes to participate in, adding “We’re not going to have an arts major in charge of Berkshire.” One could easily say that Buffett is one of a kind and equally as irreplaceable as Steve Jobs was to Apple. Is there one man within the Berkshire Hathaway domain who can do what Buffett does?

Perhaps the reason why there isn't one obvious successor to Buffett is because there may not be just one, but several. Following David Sokol’s messy departure last year over the Lubrizol debacle, maybe the best strategy is not to find a successor to Buffett, but instead to split Berkshire up into multiple parts and appoint CEOs to each corresponding unit.

Sum of its parts

The senior leaders in the Berkshire enterprise include Ajit Jain, the head of Berkshire’s reinsurance operations, and a veteran of Berkshire since 1986; Tad Montross, chief executive of General Re and head of Berkshire’s insurance business; and Matthew Rose, the accomplished chief executive of the railroad unit Burlington Northern Santa Fe. No doubt every one of these successful men were drawn to Berkshire and stayed on board because of the man himself. Once Buffett moves on,  choosing one of these three to succeed Buffett could leave two of them disappointed. Since all of them are already wealthy and accomplished, retaining the two not chosen for the job could be a problem for the new CEO. Instead, why not retain them all as CEOs over their respective domains and offer shares in each of their individual units, or perhaps an exchange traded note (ETN) inclusive of all the units.

If Berkshire were to follow such a strategy, existing Berkshire shares could be swapped at equivalent value for units in the new consolidated ETN, and the number of units in the individual businesses could be decided based on the actual value of the new conglomerates formed from the split of Berkshire. Similarly, the $38 billion in cash could be divided up proportionally or used as a line of credit to the individual business units. I know this is an oversimplification of a monumental and highly complex strategy, but I am compelled to believe the fantastic success of Buffett and Munger will likely never be reproduced given Berkshire’s current scale. Splitting up the company into more agile and focused business units seems logical, and the successors leading the business units could have a better chance of success without the weight of the entire Berkshire superstructure.

Although Buffett claims the board has identified his successor, I would not be surprised if the successor is in fact a team rather than an individual. As talented as the likely successors are, it would be difficult to pick just one and expect Berkshire to continue to outperform as it has for the past 50 years.

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