In Buffett’s 1992 shareholder letter(all content in italics in this article), Buffett detailed how Berkshire (tickers: BRK.A and BRK.B) viewed corporate mergers and acquisitions.
Like looking for a spouse
Of all our activities at Berkshire, the most exhilarating for Charlie and me is the acquisition of a business with excellent economic characteristics and a management that we like, trust and admire. Such acquisitions are not easy to make but we look for them constantly. In the search, we adopt the same
attitude one might find appropriate in looking for a spouse: It pays to be active, interested and open-minded, but it does not pay to be in a hurry.
Is a typical institutional imperative
In the past, I’ve observed that many acquisition-hungry managers were apparently mesmerized by their childhood reading of the story about the frog-kissing princess. Remembering her success, they pay dearly for the right to kiss corporate toads, expecting wondrous transfigurations. Initially, disappointing results only deepen their desire to round up new toads. (“Fanaticism,” said Santyana, “consists of redoubling your effort when you’ve forgotten your aim.”) Ultimately, even the most optimistic manager must face reality. Standing knee-deep in unresponsive toads, he then announces an enormous “restructuring” charge. In this corporate equivalent of a Head Start program, the CEO receives the education but the stockholders pay the tuition.
In my early days as a manager I, too, dated a few toads. They were cheap dates – I’ve never been much of a sport – but my results matched those of acquirers who courted higher-priced toads. I kissed and they croaked.
This is why Buffett wrote in his 1997 shareholder letter: “In some mergers there truly are major synergies — though oftentimes the acquirer pays too much to obtain them — but at other times the cost and revenue benefits that are projected prove illusory. Of one thing, however, be certain: If a CEO is enthused about a particularly foolish acquisition, both his internal staff and his outside advisors will come up with whatever projections are needed to justify his stance. Only in fairy tales are emperors told that they are naked.”
For a detailed description of the unspoken rules of the enterprise, I suggest you refer to my previous blog post “Institutional imperative – the good, bad, and ugly“
Lesson learned
After several failures of this type, I finally remembered some useful advice I once got from a golf pro (who, like all pros who have had anything to do with my game, wishes to remain anonymous). Said the pro: “Practice doesn’t make perfect; practice makes permanent.” And thereafter I revised my strategy and tried to buy good businesses at fair prices rather than fair businesses at good prices.
Berkshire’s creteria for mergers and acquisitions
Berkshire’s acquisition criteria are described on page 23. Beyond purchases made by the parent company, however, our subsidiaries sometimes make small “add-on” acquisitions that extend their product lines or distribution capabilities. In this manner, we enlarge the domain of managers we already know to be outstanding – and that’s a low-risk and high-return proposition.
Buffett also mentioned in his 1997 shareholder letter: “The reasoning that Berkshire applies to the merger of public companies should be the calculus for all buyers. Paying a takeover premium does not make sense for any acquirer unless a) its stock is overvalued relative to the acquiree’s or b) the two enterprises will earn more combined than they would separately. Predictably, acquirers normally hew to the second argument because very few are willing to acknowledge that their stock is overvalued. However, voracious buyers — the ones that issue shares as fast as they can print them — are tacitly conceding that point. (Often, also, they are running Wall Street’s version of a chain-letter scheme.)”
For more than a decade since 1982, Buffett has released Berkshire’s acquisition criteria every year. For a detailed description of Berkshire’s acquisition criteria, I suggest you refer to my previous blog post “Buffett’s M&A criteria”.
Related articles
- “Why most mergers and acquisitions end in failure?“
- “How Buffett Views Mergers and Acquisitions“
- “Buffett’s Acquisition Criteria“
- “Berkshire’s acquisition model“
- “Why Buffett prefers minority stake to entire company?“
- “Institutional imperative – the good, bad, and ugly“
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