How Berkshire Hathaway Got Bigger by Getting Better (Part Five)
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In the fourth part of an ongoing saga loosely based on a story inspired by Chick-fil-A founder Truett Cathy I went through the seventh principle from Warren Buffett’s “Owner’s Manual” for Berkshire Hathaway (NYSE: BRK-B) shareholders. If you haven’t heard the story yet, back in the 1980’s when a Boston Chicken (now Boston Market) had just finished raising capital to expand; the management at Chick-fil-A spent a long time discussing how they too could get bigger in order to fend off this threat. After hearing enough talk about getting bigger, Cathy pounded the table and said, “I am sick and tired of listening to you talk about how we can get bigger. If we get better, our customers will demand we get bigger.” The eighth principle that we’ll be reviewing builds upon the foundations laid in principle seven as violating companies tend to strive to get bigger no matter the cost, instead of concentrating on becoming better.
“A managerial “wish list” will not be filled at shareholder expense. We will not diversify by purchasing entire businesses at control prices that ignore long-term economic consequences to our shareholders. We will only do with your money what we would do with our own, weighing fully the values you can obtain by diversifying your own portfolios through direct purchases in the stock market.”
It seems like daily we either see a deal announced or a rumored deal that’s in the works from companies whose only real goal is to get bigger. You’ll hear these companies making bold proclamations of the synergies the deal will provide which will lead to increased value for both sets of shareholders. As time goes by these synergies fail to materialize and value was destroyed.
Buffett’s not against making a deal, but it has to be the right deal for shareholders. He went on to elaborate on this principle by saying, “Charlie and I are interested only in acquisitions that we believe will raise the per-share intrinsic value of Berkshire’s stock. The size of our paychecks or our offices will never be related to the size of Berkshire’s balance sheet.” Unfortunately for investors, most management teams don’t feel the same way. If there was one story that came out of the financial crisis that drove both investors and the average American to the point of protestation it was the stories of over-the-top executive compensation. Management teams at Wall Street’s biggest banks went on empire building sprees which grew their companies bigger, to the point that some have been deemed “too big to fail.”
I’ll be among the first to admit, acquisitions are rather exciting, especially when it involves a company in my portfolio. There is just something about seeing your investment’s value pop that bring thoughts of a better future. Often those gains are short lived, as over time the promised synergies that were to lead to increased shareholder value just never seem to materialize because of something beyond management’s control.
Deals can and do work out well for the acquirer, if the price is right for the opportunity that the acquired business brings to the table. Buffett mentions that he’s only interested in acquisitions that add to the per-share intrinsic value of the stock. Most management teams have no idea what their stock should be worth, only that it should be worth more so that their options are also worth more. The management teams that do know what their stock is worth manage the company accordingly.
These same management teams will know when it’s best to use cash, stock or debt to acquire another business. One of the best in my mind is the team at Brookfield Asset Management (NYSE: BAM). If you head over to their investor page they’ll come right out and tell you they think the company is worth $42.35 per share of intrinsic value. The team continues to work to increase that number, and they’ve made a number of value enhancing moves over the years.
Knowing that their own shares are undervalued they’ve looked at outside the box ways to raise capital in order to continue to acquire value enhancing businesses. A few years back they spun out Brookfield Infrastructure Partners (NYSE: BIP) as a platform to own and grow their infrastructure business. They used shares of BIP to first take a recapitalization stake in and subsequently acquire Prime Infrastructure. Shares of that business have risen steadily over the years as the market is beginning to recognize the value they have created.
Another team that’s done a great job at acquiring smartly is Linn Energy (NASDAQ: LINE). Twice over the past year they have acquired a billion dollars’ worth of oil and gas properties from BP (NYSE: BP). To pay for their Deep Horizon oil spill, BP has been selling off assets to raise billions and Linn has seized on these opportunities to make deals that are immediately accretive to their unit holders. Over the past two and a half years the management team has screened at 425 opportunities, bid on 83 of them for $23.6 billion and closed 29 acquisitions for $5.7 billion. They’ll only close on a deal if it’s going to benefit unit holders with immediate cash flow per unit accretion and have upside for future value extraction.
Not all deal making is bad for shareholders as a wise management team can create value by being selective and keeping their shareholder interests at the forefront. The best management teams are the ones that know exactly what their business is worth, and work at making the business better by acquiring the right pieces and value enhancing prices. Over time this discipline will ensure the business does grow bigger.
In part six we’ll look at how Berkshire reviews their results to ensure that they are really producing better results than their investors could do on their own.
latimerburned owns shares of Brookfield Asset Management and Linn Energy, LLC and has a diagonal call on Berkshire Hathaway. The Motley Fool owns shares of Brookfield Infrastructure Partners and Berkshire Hathaway. Motley Fool newsletter services recommend Berkshire Hathaway, Brookfield Asset Management, and Brookfield Infrastructure Partners. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.