In Berkshire’s (ticker: BRK.A and BRK.B) shareholder letter in 1995, Buffett fully explained Berkshire’s acquisition model in detail:
Minority or full ownership
Charlie Munger, Berkshire’s Vice Chairman and my partner, and I want to build a collection of companies – both wholly- and partly-owned – that have excellent economic characteristics and that are run by outstanding managers. Our favorite acquisition is the negotiated transaction that allows us to purchase 100% of such a business at a fair price. But we are almost as happy when the stock market offers us the chance to buy a modest percentage of an outstanding business at a pro-rata price well below what it would take to buy 100%. This double-barrelled approach – purchases of entire businesses through negotiation or purchases of part-interests through the stock market – gives us an important advantage over capital-allocators who stick to a single course.
Two characteristics of Berkshire
We proceed with two advantages: First, our operating managers are outstanding and, in most cases, have an unusually strong attachment to Berkshire. Second, Charlie and I have had considerable experience in allocating capital and try to go at that job rationally and objectively. The giant disadvantage we face is size: In the early years, we needed only good ideas, but now we need good big ideas. Unfortunately, the difficulty of finding these grows in direct proportion to our financial success, a problem that increasingly erodes our strengths.
Seller is in a good position
In any case, why potential buyers even look at projections prepared by sellers baffles me. Charlie and I never give them a glance, but instead keep in mind the story of the man with an ailing horse. Visiting the vet, he said: “Can you help me? Sometimes my horse walks just fine and sometimes he limps.” The vet’s reply was pointed: “No problem – when he’s walking fine, sell him.” In the world of mergers and acquisitions, that horse would be peddled as Secretariat.
we face the inherent problem that the seller of a business practically always knows far more about it than the buyer and also picks the time of sale – a time when the business is likely to be walking “just fine.”
Berkshire has several advantages
Even so, we do have a few advantages, perhaps the greatest being that we don’t have a strategic plan. Thus we feel no need to proceed in an ordained direction (a course leading almost invariably to silly purchase prices) but can instead simply decide what makes sense for our owners.
In making acquisitions, we have a further advantage: As payment, we can offer sellers a stock backed by an extraordinary collection of outstanding businesses. An individual or a family wishing to dispose of a single fine business, but also wishing to defer personal taxes indefinitely, is apt to find Berkshire stock a particularly comfortable holding.
Note: Please note–This so-called advantage, Buffett has a lot of regrets, because he regrets using Berkshire’s stock to pay for mergers and acquisitions in the early years, because after long-term compound interest, the Berkshire’s stock paid at that time is getting more and more valuable.
Note: In the 2016 shareholder letter, Buffett complained: “Unfortunately, I followed the GEICO purchase by foolishly using Berkshire stock – a boatload of
stock – to buy General Reinsurance in late 1998. After some early problems, General Re has become a fine insurance operation that we prize. It was, nevertheless, a terrible mistake on my part to issue 272,200 shares of
Berkshire in buying General Re, an act that increased our outstanding shares by a whopping 21.8%. My error caused Berkshire shareholders to give far more than they received (a practice that – despite the Biblical endorsement – is far from blessed when you are buying businesses).”
Beyond that, sellers sometimes care about placing their companies in a corporate home that will both endure and provide pleasant, productive working conditions for their managers. Here again, Berkshire offers something special. Our managers operate with extraordinary autonomy. Additionally, our ownership structure enables sellers to know that when I say we are buying to keep, the promise means something. For our part, we like dealing with owners who care what happens to their companies and people. A buyer is likely to find fewer unpleasant surprises dealing with that type of seller than with one simply auctioning off his business.
Related articles
- “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“
- “Why most mergers and acquisitions end in failure?“
- “Advantages of controlled business“
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