In a sure sign that greed had overtaken fear, investment banks had plunged into “merchant banking,” not only brokering LBOs but buying companies themselves, with their own capital at risk. In another sign, John Gutfreund, the traditionalist at Salomon Brothers, had jumped into the game. This gave Buffett and Munger a window seat on the later stages of the deal era.
The two played the good-cop/bad-cop bit to perfection. When a deal was proposed, Buffett, the “good” director, would diplomatically question Salomon’s bankers. Munger would try to rip the deal to shreds. Of one proposal to buy a chain of gasoline stations, which never made it past the board, a senior executive said Buffett and Munger “tore the presentation apart.”
Michael Zimmerman, the head of merchant banking at Salomon, said, “Warren’s attitude was, if it didn’t make sense to do a deal with equity it didn’t make sense to do it with debt.” Buffett’s point was that the bankers should focus on finding good businesses, rather than on balance sheet reengineering. But by no means did he oppose every deal.
In October 1988, on a Sunday evening, Buffett, who was at home in Omaha, got a call from Gutfreund. The latter was at his Fifth Avenue apartment with a group of Salomon bankers. The previous Wednesday, F. Ross Johnson, the swashbuckling boss of RJR Nabisco, the maker of Winston and Salem cigarettes, Ritz crackers, and Oreo cookies, had proposed to take his company private. Johnson’s banker was Shearson Lehman Hutton, a subsidiary of American Express. No sooner had this giant LBO been hatched than every other house on Wall Street started scheming for a piece of the action. Now, Salomon Brothers was mulling a competitive bid. The group at Gutfreund’s wanted to know: would Buffett, as a Salomon director and big shareholder, give his blessing? And secondly, would Berkshire put up $100 million of its own and join the deal as a general partner?1
Unbeknownst to the bankers, Buffett had placed an order for RJR Nabisco shares in the past few days, on the heels of Ross Johnson’s announcement.2 And, of course, Buffett had owned the stock in the early eighties. When Jay Higgins, Salomon’s top investment banker, started to explain the company’s merits, Buffett’s Midwestern twang crackled over the speakerphone.
“Don’t tell me about the economics—I know they’re great. You make a product for a penny, you sell it for a dollar, and you sell it to addicts. And it has tremendous brand loyalty.”3
Buffett and Munger had once come close to buying Conwood Co., a Memphis-based chewing-tobacco maker. But they didn’t want to be principals in tobacco, they had decided. Such thoughts were on Buffett’s mind as he talked to the bankers.
“The product—it’s got some problems,” he continued wryly. “I don’t think I’d want it on my tombstone that I was a partner in it.” But Salomon could go ahead without Buffett.
The next day, Kohlberg Kravis Roberts launched a bid of its own. Then Salomon joined forces with the Shearson-Ross Johnson team, and a bidding war the likes of which Wall Street had never seen burst into the open. The mother of deals was at hand, and the merger fever, which had been so long in building, rose to a climax. Now that the fever was at its apogee, no price was too much to pay for an Oreo.
At the eleventh hour, KKR sweetened its bid by promising that sometime after the deal had closed, it would “reset” the interest rate on the junk bonds it sold to finance the LBO. The worse that RJR Nabisco fared, the higher the rate that it would pay. (Imagine buying a house with a “reset” mortgage: lose your job and the interest rate doubles.) It is hardly a secret why KKR agreed to such a deal. Regardless of how its investors fared, KKR would immediately pocket $75 million in fees.4
Gutfreund had a chance to match the KKR “reset,” but to his credit he refused. It cost his side the deal.5
Once KKR had it locked up, Buffett bought more RJR Nabisco—a short-term arbitrage (a bet that the deal would fly). Berkshire would make a fast $64 million on it.6 Given Buffett’s well-known criticisms, it seemed, to some, hypocritical of him. It did not seem that way to Buffett. Once a deal was on the table, he analyzed the risks and rewards with his usual indifference to anything but profit and loss. He also made arbitrage profits on Beatrice, Federated Department Stores, Kraft, Interco, Southland, and other deal stocks.7
But Buffett, who had learned arbitrage from Ben Graham, deviated from Wall Street’s arbitrageurs in one Graham-like respect. As the action got hotter, Buffett was less eager to go along. Years earlier, at the Columbia seminar on takeovers, he had warned that bankers using phony currency would one day push the bidding to unsound levels. After the $25 billion RJR Nabisco deal, he judged that this was a prophecy no more.
Deal-makers were financing LBOs with “zero-coupon bonds,” a type of funny money that enabled buyers to borrow huge sums and defer their interest payments (and reality) for years. Given the ease with which such scrip was printed—and the willingness of investors to suspend disbelief—it is hardly surprising that deal prices had made for the stratosphere. Quoting Buffett:
Some extraordinary excesses have developed in the takeover field. As Dorothy says: “Toto, I have a feeling we’re not in Kansas any more.”8
Buffett wrote that in February 1989, just as the RJR Nabisco deal was closing. He had made his profit; now he wanted nothing more of arbitrage. The deals were too unsafe.
Considering Berkshire’s good results in 1988, you might expect us to pile into arbitrage during 1989. Instead, we expect to be on the sidelines.9
With the stock market soaring, Buffett (who was just buying his last Coca-Cola shares) was on the sidelines there, too. But he needed someplace to put his cash. And this had become a much tougher problem with Berkshire’s greater size. Ever since the early years of the Buffett Partnership, Buffett had been prophesying the day when the law of averages would finally catch him—prophesying it, yet somehow putting it off. But as he warned his stockholders, “A high growth rate eventually forges its own anchor.”10 To have any chance of continuing his gravity-defying act he had to put his money to work.
Such a compulsion to invest can be dangerous. It has been wittily defined as rhinophobia, an investors’ disease meaning “the dread of ever having any cash.”* Buffett admitted to such feelings; having cash around was “an enormous temptation.”
There is an itch that comes about, and I get it, I confess. There is an itch to do things, particularly when you haven’t done anything in a while.12
In the second half of 1989, Buffett did something. In a sudden spurt, he fashioned three big deals—with Gillette, USAir, and Champion International—totaling $1.3 billion. As a group, they were below his par. While Gillette, the world’s dominant razor blade seller, was a typical Buffett investment, USAir and paper producer Champion were capital-intensive cash absorbers and not at all the stuff of his past success. (Champion had something in common with his failures, though. Buffett thought it might be an inflation hedge.)13
In each case, Berkshire bought a new convertible preferred stock, just as it had with Salomon Brothers. Save for Gillette, a consumer-brand company in the mold of Coca-Cola, Buffett did not have a strong opinion on the companies’ prospects.14 That is why he structured them as convertibles (with fixed dividends). Indeed, he admitted, rather gloomily, “If I had four more Coca-Colas to buy, I wouldn’t be buying these.”15
The threat of takeovers, once again, was behind these deals. Gillette had been stalked by Ronald Perelman; USAir had been put in play by Michael Steinhardt, a New York money manager; and Champion was thought to be a target. “When you’ve got an able management,” Buffett told the Washington Post, “they should have time to play out their hand.”16 Now each of those companies would have Buffett as its protective “gorilla.” In return, Berkshire would get a fixed coupon, on average 9 percent, and an option to convert to common stock (a “lottery ticket”) if the shares should rise.
But Buffett’s latest moves were unpopular. At Cap Cities, Buffett had bought the common stock, as anyone could, but in the new deals, he had negotiated a special security, available only to him. Li
nda Sandler, writing in the Wall Street Journal, charged that Buffett was pocketing rich coupons for Berkshire in return for safekeeping the other CEOs’ jobs:
Many Wall Street investors say Mr. Buffett’s special deals amount to a kind of gentlemanly protection game. In the old days, these investors say, corporate raiders such as Saul Steinberg got paid “greenmail” to go away. But Mr. Buffett is getting “whitemail” to stick around and hold management’s hand.17
Such sweetheart deals with the CEOs, so the argument ran, were depriving the stockholders of the freedom to sell out in takeovers. According to Forbes,
Buffett gets a special deal, but so does management.… Put differently, how much does Warren Buffett charge for takeover protection?18
Buffett, of course, was not responsible to the shareholders of Gillette, USAir, and Champion. He was supposed to make good deals for Berkshire. But moralists get judged by tougher standards, and Buffett, suddenly on the defensive, seemed anxious to defend the high ground. In a letter to his holders after the “whitemail” deals, he argued:
… the other shareholders of each investee will profit over the years ahead from our preferred-stock purchase. The help will come from the fact that each company now has a major, stable, and interested shareholder.…19
The trouble with this argument is that it assumes that every CEO—or every CEO that Buffett likes—will be deserving of protection, and will deal fairly with the inherent conflict of interest. But not every CEO is a Tom Murphy. Buffett himself, at the Columbia seminar, had argued that as imperfect as the takeover process may be, ultimately, the decision had to be up to the folks who owned the “little piece[s] of paper”—the stockholders.
Champion was a particularly dubious case. Andrew Sigler, its CEO, was a vocal critic of takeovers and an active member of Business Roundtable, a lobbying group for big business. At Champion, he had poured money into the company’s mills but failed to deliver for his shareholders. Over the previous decade, a great one for stocks in general, Champion’s had risen by an abysmal 3 percent a year. Even among other paper companies, its return ranked as one of the poorest.20
The only person with much to show for Sigler’s poor record was Andrew Sigler. In 1989, a lackluster year, Sigler paid himself an $800,000 salary, plus “incentive compensation” of $425,000. In addition, he took advantage of Champion’s depressed stock price to award himself options on 31,000 shares. The next year, Champion’s earnings fell by half. Sigler upped his take to $1.2 million, plus $28,000 so he wouldn’t have to pay for his personal tax adviser, plus options on 47,000 more shares.
Buffett, of course, had been a fierce critic of options,21 particularly when doled out to poorly performing CEOs. If anyone had been desirous of taking over Champion, it’s hard to see why Buffett would have wanted to stop them.
The managements of Gillette and USAir were a different story. USAir was building a national system with hubs in middle-market cities, but had yet to consolidate. It seemed to have the sort of strategy that warrants time and a little “protection.” Gillette, quite simply, was minting money.
Although Buffett’s terms were richer than what an ordinary Joe could have gotten on open-market issues,22 the deals were not as sweet as his critics claimed. Berkshire was locked into each security for a decade, which on Wall Street is an eternity and then some. Indeed, most money managers would have rejected Buffett’s “sweetheart” arrangements.
Nonetheless, the deals had an unwholesome aspect. They had an odor of insidership—of Buffett’s standing too close to his pals in corporate boardrooms. It may be no coincidence that he bought a swankier corporate jet that year, for $6.7 million. In his annual letter, Buffett went to lengths to poke fun at himself for this singular perk (without alluding to his exceptionally modest $100,000-a-year salary). He noted that if the cost of replacing his plane continued to rise “at the now-established rate of 100% compounded annually, it will not be long before Berkshire’s entire net worth is consumed by its jet.”23 But the jet, which he wittily dubbed the Indefensible, underscored the fact that he was spending more time out of town and in very elite company.
By the late eighties, down-home Warren Buffett seemed to know everyone. He would jet out of town to a board meeting, or the Super Bowl, or a party where he might run into Paul Newman or Senator Edward Kennedy.24 He played bridge with the Corporate America team, a celebrity CEO group, including a match against members of Parliament at Old Battersea, the splendid seventeenth-century London home of Malcolm Forbes. When Buffett was asked, during a talk, what financial advice he might give to the President, he could respond that, as a matter of a fact, he had been to a dinner with President Bush the previous Saturday.25
Warren’s wife insisted that it was time for him to get some “decent clothes,” as she told their daughter. When the elder Susie was in Omaha, the two women dragged Warren to a store and fitted him into a $1,500 Zegna suit. The Italian-made Zegnas became his uniform—a fetish like his Cherry Cokes and his jet. (But he refused a salesman’s entreaty to order them custom-made, preferring to drop into Zegna’s New York branch sans appointment and buy a bunch at a time off the rack.)26
His new circle was astonishingly wide. In Boston, he would hobnob with the likes of John Kenneth Galbraith and Globe editor Thomas Winship. Winship said, “Warren’s a great collector of friends”—an interesting comment about a guy who collected and hung on to stocks. Buffett had a gang in Washington, and another in California. Susie and he would visit the Big Apple with a sort of “program,” as one friend put it, to squeeze everybody in. “They are not like other people,” she noted.
Buffett’s inner circle—a group that included Graham, Loomis, Murphy, Munger, and Ruane—was as before. But his friends in Omaha, such as Dick Holland, noticed that he wasn’t around as much. Verne McKenzie estimated that his boss was out of town one or two days a week.
So uncontemporary in other respects, Buffett jetted from coast to coast like one of the glitterati. He dined at the Oscars with Dolly Parton.27 He flew into Martha’s Vineyard for a gathering at Kay Graham’s with the likes of Nancy Reagan and 60 Minutes correspondent Mike Wallace.28 Another time, he picked up his wife and swooped into Walter Annenberg’s Palm Springs, California, estate, abloom in the desert with silver-leafed tamarisk trees and sculpted shrubs. Sam Walton came, too.
Buffett was popular in this crowd because he seemed to be unaffected by his money. He still spoke in homey expressions that vaguely recalled the 1930s (“I’m on the wire” instead of “I’m on the phone”). At the 1988 Winter Olympics in Calgary—where he was a guest of Murphy and of ABC—Buffett ducked an invitation for lunch by the pristine Lake Louise to hole up in town and work. At the Olympics, Agnes Nixon, a soap opera creator for ABC, met Buffett and decided he was “the reincarnation of Will Rogers.” She invited him to New York to do a cameo on Loving, a daytime soap opera. After the taping, Buffett, Nixon, and others from ABC went out to dinner at Bravo Gianni, an East Side northern Italian restaurant. As they were leaving, Nixon noticed that John Kluge, another billionaire, was exiting, too. Kluge ducked into a waiting limousine while Buffett stepped off the sidewalk and hailed a cab.29
Buffett liked to portray himself as a sort of provisional traveler in high society. He was full of stories that accented his supposed innocence, such as one regarding a dinner party at which he found himself seated next to Carolyne Roehm, the socialite designer, then married to Henry Kravis. Roehm said, “Can you cut my meat for me?” Buffett didn’t know if this was a new form of upper-class affectation or—worse—a come-on. He ignored her the entire evening—until, to his horror, as her barely nibbled roast was carried away, he saw that she had a cast on her wrist.30
He liked his homespun image and seemed uncomfortable with the reality that he now was something of a celebrity. After Buffett appeared in an episode of television’s Lifestyles of the Rich and Famous, he was so embarrassed that he told people that the producers had spliced it together without his having known about
it. But that was untrue. In fact, Buffett had donned a microphone and been formally interviewed.31
In 1989, Buffett also was in the news in Omaha. Mrs. B—the carpet woman—was stripped of her authority in carpets by her grandsons Ronald and Irvin, who by now were running the Furniture Mart. She quit the store in a rage, denounced Buffett for selling her out, and publicly called her grandsons “Hitlers.”32
In Omaha, the spat got the sort of attention elsewhere reserved for Charles and Princess Di. Mrs. B accused her grandsons of being spoiled ingrates who wasted their time in “meetings” and lived like “millionaires.” Besides, she added poignantly, “It hurts when you’re a nobody.”33
The ninety-five-year-old dynamo spent a few months at home. Then she opened a new store, “Mrs. B’s Warehouse,” adjacent to the Furniture Mart—now her blood rival.
“It breaks my heart,” Mrs. B remarked one Sunday, motoring past a sea of carpets in her new store. She added that she now was working “for spite.”
Buffett felt terrible about it. He took two dozen pink roses to Mrs. B on her birthday to try to patch it up. But as a business matter, he backed his management. Reporting on the unhappy affair to shareholders, he praised Louie, Mrs. B’s son, as well as Ron and Irv, as “outstanding merchants.”
Mrs. B probably has made more smart business decisions than any living American, but in this particular case I believe the other members of the family were entirely correct: Over the past three years, while the store’s other departments increased sales by 24%, carpet sales declined.…34
Nonetheless, one has the sense that if Buffett had been in Mrs. B’s shoes, he would have wanted to go out the same way, kicking and screaming—and that at some level he admired her for it. Shortly after her break, he spoke about her with considerable empathy:
She hasn’t lost her marbles in any way, shape or form. She happens to be—improperly, in my view—very negative on a couple of the grandchildren that work in the store. Every now and then they want to take a day off with their families. Believe me, they are marvelous guys, but they can’t work as hard as Mrs. B did.… It’s a human tragedy in the sense that she couldn’t have a better family than she had. But they had it easier than she did—nothing you can do about it.35
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