By Jeff Bailey
Steven Davidoff's column in the New York Times is a constant source of insight for investors, and in a recent column he takes on what seems a tired topic - whither Berkshire Hathaway (BRK.B) when Warren Buffett departs? - and makes it a compelling read by focusing on Buffett's deal-making, not his stock picking.
Will Berkshire get sweet terms on big acquisitions and investments when Buffett, a charmer and the name other business people most want to drop ("Warren was telling me the other day . . ."), has retired or otherwise passed on? Buffett is 82.
Buffett's stock-picking prowess has more frequently been the skill observers fear losing at Berkshire. But there are reasons that facet of his management is less important than it once was. First, Berkshire's value is increasingly based on its operating companies and less on its investment portfolio.
Berkshire's top-five industrial operations (BNSF, Iscar, Lubrizol, Marmon and MidAmerican Energy), for instance, brought in more than $10 billion in combined pre-tax profit in 2012. Its proportionate share of (after-tax) profits at its top-four stock holdings, meanwhile, (as of December 31, 2012, 13.7% of American Express (AXP), 8.9% of Coca-Cola (KO), 6.0% of International Business Machines (IBM) and 8.7% of Wells Fargo (WFC) ) would have been $3.9 billion, Buffett relates in his latest letter to Berkshire shareholders. Nice, but not as big a deal as the owned-and-operated stuff (though, there is price appreciation in the stocks, too, in most years).
What's more, Buffett mightn't be irreplaceable as a stock picker. So far, his two hired hands, Todd Combs and Ted Weschler, are smoking the market and smoking the boss. "It 2012, each outperformed the S&P 500 by double-digit margins," Buffett writes. "They left me in the dust as well."
Where Buffett has really shined of late is in deal making, Davidoff points out. Other business people like to sell their companies to him, like to get him to invest in their companies enough to offer him favorable terms, and he seems able to avoid the irksome bidding process that causes acquisition prices to rise for many other big investors.
Heinz (HNZ), Davidoff mentions, didn't shop itself around before agreeing to the Berkshire/3G deal for $28 billion. On top of $4 billion or so in common equity Berkshire put in to buy Heinz, it also agreed to invest another $8 billion in preferred stock, and got a 9% interest rate on the position (and a huge slug of warrants to buy common).
Anyone offer you 9% lately? "3G could have found cheaper financing," Davidoff mentions, calling the terms Buffett negotiated "out of whack."
Lubrizol and BNSF also sold to Berkshire without shopping themselves around.
And Goldman Sachs (GS), General Electric (GE) and Bank of America (BAC), during the depths of the financial crisis, paid huge premiums to the market rate to entice Buffett to buy their preferred shares. The premium, it seems, was in return for Buffett attesting to their ability to survive. They didn't so much need the money as they needed for financial market to know that Buffett had put some of his at (not much) risk.
Buffett didn't have this magic tough with other business people in 1965, when he took control of Berkshire, but has achieved it through decades of admirable results and no small amount of careful and seemingly-reluctant self-promotion. He is unfailingly self-critical and praises his subordinates (often CEOs of companies he acquired who chose to stay on) to the skies, qualities other business people like (even if so few of them exhibit these qualities themselves).
It's doubtful Buffett's successor will immediately be accorded the same affection, and Davidoff believes that will reduce Berkshire's deal-making advantages: "Even though Mr. Buffett has hired and groomed other executives, he is a true star, and he cannot just create or transmit those qualities, which are the very ones that get those great deals."
There are plenty of other reasons Berkshire will miss Buffett when he departs. Will a board chaired by his son, Howard Buffett, a loquacious Illinois farmer, be as attractive a panel to serve on as Berkshire's is now? Will Warren Buffett's successor be able, in overseeing operating businesses, to attain his combination of hands-off management and intuitive understanding of risk? Will Ajit Jain, Berkshire reinsurance wizard, want to stick around without his old friend for companionship?
Jeff Bailey, The Editor of YCharts, is a former reporter, editor and columnist at the Wall Street Journal and New York Times. He can be reached at email@example.com.