Warren Buffett Plays the Float with Blue Chip Stamps and Private Jets...and Wins!
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There would not seem to be that much in common between licking Blue Chip Stamps and leasing private jets, but both have been investments that Warren Buffett has made for the portfolio of Berkshire Hathaway (NYSE:BRK-A) that have resulted in him becoming one of the world's wealthiest men while greatly enriching the shareholders of the company. Understanding the appeal of each greatly explains the recent buy of 63 newspapers by Buffett from Media General (NYSE: MEG) and the purchase of The Waco-Tribune on June 22, 2012.
Blue Chip Stamps were an old school loyalty program. When customers bought goods, they would be given a certain number of stamps depending on the size of the purchase. The stamps would then be licked or otherwise moistened and stuck on the page of a book. When enough had been saved and accumulated, they would be exchanged for various items, ranging from lawn furniture to kitchen ware. The cost of the stamp loyalty program, needless to say, was factored into the price of the goods sold: nothing for free in this world!
Warren Buffett begain buying into Blue Chip Stamps in 1970. Berkshire Hathaway's ownership rose from 36.5% in 1977 to 60% in 1970, culminating with a stock swap merger in 1983. In his shareholder letter of 2006, Buffett wrote that when Blue Chip Stamps had 1970 sales of $126 million, about 60 billion of the "stamps were licked by savers, pasted into books, and taken to Blue Chip redemption stores." He also penned that, "When I was told that even certain brothels and mortuaries gave stamps to their patrons, I felt I had finally found a sure thing."
In the Berkshire Hathaway portfolio is also NetJets, which offers the fractional ownership and leasing of private jets. After being a NetJets customer for three years, Buffett acquired NetJets for Berkshire Hathaway in 1998. Despite The Great Recession, the business outlook for NetJets is so promising that it just placed a $9.6 billion order for 425 new planes from Bombarier (TSX:BBD.B) and Cessna.
The Blue Chip Stamps loyalty program and leasing or owning a fraction of a private jet all operate on the same economic principle of the time value of money with the enduring financial model of "playing the float." When buying a fraction of a private jet or a punch bowl that results in the awarding of stamps in a loyalty program, the customer is paying up front. Before the fully filled stamp book is redeemed for patio furniture or the private jet flown to St. Barts, the money is paid well in advance.
The business then "plays the float" and invests the money. Profits are earned when the investment income and the initial payment exceed the cost of the patio furniture and the total expenses of buying and operating a private jet for charter. This is the time value of money that supports the entire insurance industry. When someone like Warren Buffett is doing the investing, "playing the float" can be very lucrative.
There is another rule of investing at play with Blue Chip Stamps and private jet leasing. In the Richard Ford novel, Wildlife, Warren Miller, the wealthy businessman in a town in Montana, observed that, "You get rich from other people's mistakes."
Buffett has prospered from this as many never redeemed their Blue Chip Stamps, although they were paid for in the price of the goods rung up at the checkout counter. The same goes for the fractional ownership and leasing of private jets. While the fractional ownership or rental period is fully paid for up front, often times it is not utilized and expires unused. People pay for insurance they never have to, or want to, redeem. And during all of that time, Warren Buffett is earning investment income for the shareholders of Berkshire Hathaway.
The same economic and financial tenets hold true with newspapers. Customers pay for a subscription in advance. If it is for a year, there are twelve months and counting down of "playing the float" before the paper has to be delivered.
Classified advertising, particularly on-line will be especially rewarding for Buffett. The second biggest expense, about 20%, for a newspaper is the print. A digital ad redirects that money from newspaper pulp to investing. In addition, ads are paid for advance. If classified space is bought for a month and the item sold in a couple of days, the seller made a mistake in paying for over three weeks of advertising that were not needed and will not be used. Again, "playing the float" results in greater returns here as does gaining from the mistakes of others. Owning more than 60 newspapers will allow Warren Buffett tremendous pricing power and synergies for these activities. As the newspapers bought by Buffett are the only ones in the area, there will be attendant monopoly benefits.
Whether it is loyalty club stamps, newspapers, insurance, or private jet leasing, it will always be the time value of money, no matter the investment. Intrinsic and inherent in this is "playing the float" so as to maximize the investment returns from the cash flow. And for the denouement, there is "get(ting) rich from other people's mistakes" when the stamps are never redeemed, the private jet never flown, the newspaper ad never used, and the insurance coverage never needed. Nobody profits from this better than The Oracle of Omaha.
Fool blogger Jonathan Yates does not own any of the stocks mentioned in this article.