I wanted to see that little piece of paper that said I was the owner of Cities Service Company, and I felt that the managers were there to do as I and a few other co-owners said. And I felt that if anybody wanted to buy that company, they should come to me.24
As an adult, he had felt the same way. If the manager at See’s got an offer and didn’t tell him about it, Buffett would have felt “a little put out.” Someone had to make the decision on whether to sell—it had to be the shareholders. It was their capital. It could not be the CEOs—the Bergeracs of the world—any more than the guy behind the counter at See’s.
Nor could he deny that shareholders were benefiting from takeovers. Buffett himself had reaped an immense profit in General Foods. What’s more, he said, “because my mother isn’t here tonight, I’ll even confess to you that I have been an arbitrageur.”§ So he was profiting from deals in that respect, as well. And Buffett, in the past, had scorned “entrenched” CEOs in terms not dissimilar from the raiders’.
Yet now that the raiders were in the ascendant, he was deeply troubled. CEOs were now his peers—in many cases, his friends. At a visceral level, he was uneasy with the raiders’ confrontational style. But his concerns went deeper.
I had this idea that some sort of economic Darwinism would work and that if offers were made, it was the invisible hand working and that it would improve the breed of managers. And then over the years I’ve been troubled by two things I’ve observed—and I don’t know exactly where this leads me—I’ll just tell you what bothers me. The first thing is that over a good many [years] the very best-managed companies I know of have very frequently sold in the market at substantial discounts from what they were worth that day.…
Takeovers, in theory, were a curative, the system’s method of pruning corporate deadwood. In the neat economic model, assets flowed to the highest bidder because, by definition, the high bidder was the one who could put them to best use.
But the stock market was not always neat. Shares of even very good companies, such as Cap Cities, occasionally could be had for a song. A raider could gobble them up—not because Murphy and Burke were managerial deadwood, but because their stocks were subject to the depressive fits of Mr. Market. Even Boone Pickens, in a too-candid moment, blamed the oil takeovers on the simple fact that it was cheaper to drill for oil “on the floor of the New York Stock Exchange” than in the ground.25 One day it was oil; the next it was something else. To Buffett, it was not corporate Darwinism but corporate roulette. It could not be good for the Tom Murphys of the world to be replaced by asset shufflers.
His other troubling observation was that takeovers were distorting prices. Businessmen, like politicians and anyone else, spent other people’s money more freely than their own. CEOs—quite a few confided in Buffett—purchased better aircraft on the company’s tab, and they ate at better restaurants.
And I also notice that when they eat companies, they behave a little differently with the shareholders’ money than they would with their own.
A raider with access to somebody else’s dough would pay a lot more than a company was worth. And Wall Street’s soaring appetite for junk bonds was providing a vast supply of easy money. Junk bonds had become a kind of “phony currency” (phony because bond buyers were thoughtlessly, and naïvely, financing borrowers beyond their means). Whoever could borrow the most was winding up with the store. To Buffett, this was truly vexing. The trouble with debt was that it worked too well; people got hooked and carried it too far. And he allowed that the new borrowers would repeat this pattern. “I personally think, before it’s all over, junk bonds will live up to their name.”
For 1985, this was strong talk. Junk bonds were thriving, and defaults had been rare. Investors were or would soon be lining up for such surefire credits as Allied Stores, Continental Airlines, Macy, and Trump’s Castle (and many more that later would file for bankruptcy).
Michael Bradley, a University of Michigan finance and law professor at the Columbia seminar, protested. “I am troubled by the use of the pejorative term junk to describe these high-yield securities.” Bradley argued that the risks on such bonds were offset by their (high) interest rates, just as was true on a triple-A bond. There was no such thing as a bad bond.
In a theoretical sense, Buffett agreed. The previous year, Berkshire had made a lot of money buying the (then cheap) bonds of a highly troubled creditor, Washington Public Power Supply System. Bankrupt credits often were attractive on a price-to-value basis; Michael Milken, Drexel’s junk-bond impresario, had gotten his start trading just such “fallen angels.” Junk bonds of recent vintage had the crucial distinction of not having yet fallen: they were weak credits issued at par (full price), with a long way to fall and little upside.
Buffett, continuing in his “pejorative” vein, pointed out that the issuers of those junk bonds were raking in very fat fees, as were the deal promoters. To him, the takeover game resembled an addiction, and Wall Street was pushing junk-bond “needles” to keep the Street in a stupor. “It won’t die out without a big bang,” Buffett predicted. “There’s too much money in it.”
All this was very much on Buffett’s mind in January 1986, just after the Cap Cities merger closed, when he made a surprise showing at the annual retreat for Cap Cities’ managers in Phoenix. Noting that many big investors were reexamining their loyalties “every hour on the hour depending on the stock price,” Buffett pledged that his investment in Cap Cities would follow him to the grave—and, in fact, a bit beyond the grave.
I get asked what happens if I get hit by a truck. I usually say I feel sorry for the truck. I have it arranged so that not a share of Berkshire Hathaway stock needs to be sold on my death and [so] the behavior will conform to the promises I have made.26
Buffett’s “promises” were designed to thwart any possible designs of a Perelman, Pickens, or Kravis. He not only gave Murphy and Burke the proxy power over his Cap Cities stock, he also gave Cap Cities the legal authority over Berkshire’s freedom to sell. Buffett wouldn’t even be free to change his mind.
Buffett tried to rationalize this unusual setup on economic grounds. He made the point that Murphy would be able to focus on the business without worrying about a raid. But Buffett was personally, as well as professionally, motivated. Murphy, with whom Buffett spoke virtually every week, was a close friend. In this investment, the “personal equation” was just as important. Buffett remarked to an interviewer:
I will be in Cap Cities as long as I live. It’s like if you have a kid that has problems—it’s not something we’re going to sell in five years. We’re partners in it.27
The deal did have problems, even before it closed. Television ad sales collapsed, and ABC went into free fall. The network finished third in the ratings, in both prime-time programming and news. Then it faced losses on baseball, football, the Winter Olympics, and two ill-conceived dramatic specials. And its costs were out of control.
A friend of Buffett’s said, “I don’t think Warren had any idea of the extravagance, of how poorly managed ABC was.” Peter Buffett recalls his dad’s reviewing expenses and flipping out over a $60,000 florist charge. Burke got a similar shock when he walked into the stylishly appointed ABC building before the closing: the walls had been stripped bare of their Jackson Pollock and Willem de Kooning paintings—which had been sold to pad the network’s year-end results.28
In the first year after the sale, a projected network profit of $130 million melted into a $70 million loss. It would have been far worse had Murphy and Burke not taken a scalpel to costs. On Murphy’s first visit to Los Angeles, the entertainment division sent a white stretch limo for him. Thereafter, Murphy took cabs.29 At the New York headquarters, the private dining room was closed. Months later, Murphy and Burke sold the whole building to a Japanese speculator (for a record $365 per square foot). They also laid off fifteen hundred employees.
Buffett lent an ear, but did not intrude. One time, he was in New York when ABC was renegotiating
rights to Monday Night Football. Burke figured ABC would lose $40 million on it. But having already cut back on glamour events, including sports, he didn’t want to lose the National Football League’s showcase. “Warren stumbled in,” Burke recalled, “and it was obvious he thought we should hold the line.” Buffett didn’t say much; he merely looked, in Burke’s words, “like he smelled an odor.” Only as they were waiting for the NFL to call back and finalize the deal did Buffett speak up. “Well,” he said glumly, “maybe they’ll lose our phone number.” (They didn’t. Losses on the contract were even worse than expected.)
Murphy and Burke were able to cut costs significantly. However, the entire media business was becoming more competitive, due to a plethora of new outlets in both television and print. The three major networks were gradually losing viewers to cable and home video. One time, as Buffett and Murphy were watching Monday Night Football on a large-screen TV, Buffett exclaimed, “Isn’t that a great picture?” Murphy allowed, “I liked it better on an eight-inch black-and-white screen when there were only three networks.”30
Buffett, needless to say, would have been happier with one network. But despite turning bearish on media ahead of the pack,31 he made no attempt to get out. A couple of years after the merger, Walter Annenberg flew to Omaha to get Buffett’s opinion on whether to sell his magazine empire to Rupert Murdoch. Buffett advised him that media, though still a good business, was weakening. Annenberg got out at the top, but Buffett made no attempt to lighten up on his own holdings.
In Burke’s view, Buffett paid a price for it. Cap Cities’ stock soared to 630—at which point, Burke maintained, Buffett had to know it was overpriced. “He could have sold,” Burke said. Within a year, the stock had plunged to 360.
One of the best young money managers thought Buffett had sort of lost it. “Warren has had three careers,” this investor-critic explained. “In the old days, he was a scavenger. He looked for value. Then it got hard to find stuff and he became a franchise investor; he bought great businesses at reasonable prices. And then he said, ‘I can no longer find good businesses at even acceptable prices, and I will take advantage of my size and teach the world a lesson about long-term investing.’ We think he screwed up. It’s stupid.”
Buffett and Munger doubted that they could have done better trying to dance in and out.32 For one thing, a buy-and-hold investor put off the tax man—over time, a very big saving.‖ For another, their long-term approach created opportunities: a Mrs. B or Ralph Schey was more inclined to sell to an owner such as Buffett. And, knowing that divorce was not an option, Buffett was a bit—quite a bit—more circumspect in choosing a partner. To the extent that he, or any investor, is not thinking about how and when he will get out, he will be more selective on the way in. As in a marriage, this is apt to lead to better results.
But the reason for Buffett’s policy, “stupid” or not, was that selling left him hollow, whereas staying with “Murph” he found infinitely satisfying. As he expressed it to Business Week, selling a familiar stock was “like dumping your wife when she gets old.”33 This was a strong comment from a guy who, in fact, had refused to dump his wife after she had moved out on him. Buffett revisited this metaphor in one of his letters: here, selling a good stock was like marrying for money—a mistake in most cases, “insanity if one is already rich.”34
Buy-and-hold did have a financial logic, but at Buffett’s extreme it can only be seen, as he put it, as a “quirk” of character, appealing for “a mixture of personal and financial considerations.”35 He liked to keep things—stocks, “pals,” anything that lent a sense of permanence. To turn around and sell because someone offered “2× or 3×” was “kind of crazy.”36 Any other investor, such as his young critic, would have deemed that Buffett was the crazy one. But Buffett had always craved, and had always felt enriched by, continuity: to work with the same people, to own the same stocks, to be in the same businesses. Hanging on was a metaphor for his life.
Buffett carried his avoidance of debt to a similar—highly personal—extreme. In 1986, Exxon, which enjoyed a triple-A credit rating, had four times as much equity as debt. Berkshire had twenty-five times, a ratio that would have put a Puritan to sleep.37 But then, debt could lead to the supreme discontinuity, one perhaps more painful than “dumping your wife”—losing control of Berkshire. As Buffett explained in Phoenix, debt was the financial temptress, the fatal “weak link”:
It’s a very sad thing. You can have somebody whose aggregate performance is terrific, but if they have a weakness, maybe it’s with alcohol, maybe it’s susceptibility to taking a little easy money, it’s the weak link that snaps you. And frequently, in the financial markets, the weak link is borrowed money.38
This prejudice for what was enduring, enlightened by a sense of history, drove Buffett’s critique of the LBO promoters. From the moment a deal was hatched, these escape artists had in mind an “exit strategy”—a “quaint term,” he called it, for the deal-maker’s eagerness to flip his creation to the first willing sucker (usually the public).39 Since Buffett defined investing as an attempt to profit from the results of the enterprise, as distinct from the price action,40 the LBO artists did not really qualify as “investors.” They merely transferred assets from one pocket to the next. They did not “create” value, which Buffett defined as adding to the sum of socially useful or desirable products and services. Most often, their profits stemmed merely from the huge tax savings that derived from converting equity to debt (interest payments being deductible).
Buffett disapproved, both because the raiders’ bounty seemed undeserved and because society was the poorer for the loss of tax dollars. Embedded in his critique was a strongly conservative bias that Mrs. B’s sort of work was more useful to society than what went on at Merrill Lynch—that creating pies was more useful than slicing pies. The LBOs, he argued (at another Cap Cities retreat), did not “make the steaks taste better”; they didn’t “make the clothes warmer or last longer”:
Now when you read about Boone Pickens and Jimmy Goldsmith and the crew, they talk about creating value for shareholders. They aren’t creating value—they are transferring it from society to shareholders. That may be a good or bad thing but it isn’t creating value—it’s not like Henry Ford developing the car or Ray Kroc figuring out how to deliver hamburgers better than anyone else.… In the last few years … one [company] after another has been transformed by people who have understood this game. That means that every citizen owes a touch more of what is needed to pay for all the goods and services that the government provides.41
At Cap Cities/ABC, Buffett was trying to re-create a world where people would not be thinking about “exit strategies.” Following the deal, ABC, once the rockiest of the networks, became the most stable one financially, and a consistently strong player in daytime soaps, evening news, and prime time. By contrast, CBS and NBC struggled with repeated management shake-ups and continuing doubts about the commitment of their respective owners, Larry Tisch and General Electric. In Burke’s view, Buffett’s investment provided a margin of comfort, without which “we would have felt differently,” particularly during the industry’s severe recession. The company would have been more leveraged and less able to maneuver. Possibly, it would have met a fate similar to Time’s. In the event, Murphy and Burke continued to wring out superior profits, and Buffett’s faith in them was vindicated by a spectacular rebound in Cap Cities’ stock.
* Buffett’s friend Bill Ruane took his Post board seat. The merger required Cap Cities to divest its cable systems; they were sold, at Buffett’s prompting, to the Post.
† The prices do not reflect a ten-for-one split in 1994.
‡ The warrants enabled each holder of ten ABC shares to buy one share of Cap Cities at $250. Initially valued at $30, the warrants later soared to a peak price of $207.75.
§ Buffett limited arbitrage to companies that had agreed to merge. Classic “risk arbitrageurs,” such as Boesky, speculated on rumored deals and helpe
d to put targets in play.
‖ Buffett did sell stocks, of course, but usually after long holding periods. Berkshire’s investments in three select stocks—Cap Cities, the Post, and GEICO—and its wholly owned businesses, such as See’s Candy, were deemed by Buffett to be “permanent.”
Chapter 15
PUBLIC AND PRIVATE
By the time of the Cap Cities deal, Buffett had a following. There were fifty Buffett-made millionaires in Omaha and hundreds elsewhere around the United States.1 When he showed up at Columbia Business School to speak on investing, two hundred fans were turned away. Forbes called him a “folk hero.”2 There was a dog in Kansas City named Warren and another in New York answering to “Buffy.” William Oberndorf, a Stanford business student, saw Buffett once, turned down a job at McKinsey & Co., and made a watershed decision to enter investing. Christopher Stavrou, a money manager, christened his son Alexander Warren. Then there was Douglas Strang, an Omaha stockbroker who idolized Buffett but had never met him. When his wife, Marsha, went into labor, Douglas reached for a copy of The Money Masters and read aloud to her from the chapter about Buffett, as though his wisdom might explain the cosmic mysteries of their daughter’s birth.3
By early 1986, Berkshire had broken $3,000 a share. In the twenty-one years that Buffett had been turning the veritable dross of a textile mill into gold, the stock had multiplied 167 times; meanwhile, the Dow had merely doubled. On Wall Street, Buffett was regarded with awe. When he told David Maxwell, chairman of Fanny Mae, that he had invested in his company, Maxwell felt an urge to rush to the window and shout, “Warren Buffett’s buying our stock!” Forbes unashamedly asked, “He doesn’t walk on water?”4 Headline writers dubbed him a “Midas,” a “wizard,” the “sage of Omaha,” and (the alliterative favorite) the “oracle of Omaha.”
Buffett Page 33