But the GM holding remains a puzzling news story for investors, one that still has many followers of Warren Buffett and Berkshire Hathaway scratching their heads and asking questions.
Who Dunnit? And the Larger Questions
At the outset, readers should note the GM stake is below the 300 million dollar threshold that generally triggers Buffett's personal investment selection. This has been discussed in numerous reports including one in USA Today and a WSJ piece indicating the stake is the likely work of Berkshire deputies (e.g., Todd Combs or Ted Weschler).
Berkshire Hathaway has long had investment decisions made by those besides Warren Buffett and Charlie Munger, most notably Lou Simpson, the longtime head of Geico investments. But interestingly, at least one Morningstar analyst notes neither Combs or Weschler have demonstrated a background in auto sector investments, so the pick is "anybody's guess".
But the stock is now a Berkshire Hathaway holding, so the larger questions are now about the merits of the investment and whether it fits (or doesn't fit) into Berkshire Hathaway's holdings and investment strategy.
Does GM Fit the Berkshire Hathaway Profile?
A glance at Berkshire's holdings reveal the new GM stake does not share a great deal in common with most of the other investments.
In its recent 13-F statement, Berkshire Hathaway also disclosed a stake in Viacom (NYSE:VIA) that squares with its past and present media holdings; and the recent newspaper purchases (from Media General), and the announcement of more to come, fit dead center into what Buffett calls his "circle of competence", with a long history in the newspaper industry including The Washington Post Company (WPO), the Buffalo Evening News, and even Buffett's youth as a top notch paperboy and circulation manager.
Amid the Berkshire Hathaway's holdings we see banks, credit cards, media/entertainment, leading retailers, and strong consumer brands. These are mostly the classics franchises with moats and stable (increasing) earnings.
Then we find the world's 2nd largest automaker (by sales), still relatively fresh out of bankruptcy. This is a capital intensive, cyclical manufacturing business in a highly competitive environment, sticking out like the proverbial sore thumb.
Kissing Frogs & Succession
One possible theory on the GM holding may be found in a lesser known book about Warren Buffett, The Warren Buffet CEO by Robert Miles (2002). While less popular than the bestselling biographical works, this book details Buffett's leadership and management style at Berkshire Hathaway. The theme is empowerment and freeing people to make decisions. The result is highly autonomous managers with long term perspectives. It could be Buffett must empower a potential successor to "kiss a few frogs" or, better yet, prove their acumen and gain experience to help prepare for the top spot(s) in the near future?
As the Berkshire Hathaway 2011 annual letter to shareholders states:
"As 2011 started, Todd Combs joined us as an investment manager, and shortly after year end Ted Weschler came aboard. Both of these men have outstanding investment skills and a deep commitment to Berkshire. Each will be handling a few billion dollars in 2012, but they have the brains, judgment and character to manage our entire portfolio when Charlie and I are no longer running Berkshire."
But putting a couple of hundred million at stake might be a bit of a costly succession plan. And no one knows more about opportunity costs and the importance of careful stock selection than Warren Buffett, an investor keen on "waiting for the right pitch" and using a "punch card" analogy, noting investors should only make a limited number of carefully selected investments in their lifetime. Hence there may be some juxtaposing of Warren Buffett's management style and his investment philosophy at work in the incongruous GM holding.
Regardless, investors have to wonder about the merits of GM and where it fits (or doesn't fit) into the Berkshire Hathaway philosophy. Moreover, the stake came from Berkshire Hathaway's people, its system and culture, so it may also be telling as a harbinger of the investment philosophy of potential successors and the direction of future investments. The pick may ultimately tell investors as much about Berkshire's future as it does about the merits of GM as an investment.
Ten Point Test Drive of The General Motors Selection
Here are ten questions prompted by the GM stake, along with some analysis comparing the investment to past and present Berkshire Hathaway investments and principles.
1) Buying Businesses versus Investments and Arbitrage?
While Warren Buffett is best known for long term investments (with the ideal holding period being "forever") in companies with a "franchise" or "moat" giving them a competitive advantage, his firm also has a long history of exploiting market opportunities.
Berkshire has large, very long-term positions in firms like Coca Cola (NYSE:KO), Wells Fargo (NYSE:WFC), Proctor and Gamble (NYSE:PG) and more. It has bought many other companies outright--Geico, Sees Candy, Benjamin Moore, Dairy Queen, etc. These are examples of Berkshire "buying businesses", all or in part, for the long haul. But Berkshire Hathaway also has made shorter term "investments" and engaged in arbitrage since its founding, often taking advantage of "Mr. Market's" depressive episodes when a stock is undervalued or a rate of return well worth the risk. At present, the GM stake appears to be more of an investment rather than the permanent buying of a business for many of the reasons that follow.
2) The Size of the Stake? The GM position represents a small portion of General Motors and also of Berkshire Hathaway's assets. The company is not a top ten institutional holder. It is also not in the top 15 Berkshire holdings by value. If Berkshire were looking to "buy" a business, it would need a more significant stake to both own a meaningful portion of that company and to have that investment move the needle of Berkshire's returns.
3) Why Capital Intensive Manufacturing With Complex Labor Relations? Berkshire Hathaway has generally avoided large scale, capital-intensive operations with complex labor relations, especially those with no major advantage over competitors. And, as one of the world's largest automakers, General Motors is ripe with capital needs and potential labor issues. Warren Buffett learned hard lessons about costly plants and equipment in past enterprises (like the namesake textile mill) and about labor strife with the Buffalo Evening News and bit of both in the early Dempster Mill Manufacturing debacle. Buffett evidenced a sage distrust of the auto sector when he shorted automaker Kaiser-Frazier in 1949-1950.
4) Where are the Steady, Increasing Cash Flows? Buffett has steered Berkshire to prefer stocks with predictable, almost bond-like streams of income. Autos are cyclical stocks, and are very dependent on the economic cycle. Another famous example of a Bershire Hathaway cyclical bust has been in airlines (Buffett calls himself a recovering air-aholic for this bad investment). The boom and bust cycles of autos make them unlikely as a candidate for a long term holding.
5) Strong Franchise & Brand? Part of the Berkshire Hathaway formula has been to identify companies with a competitive advantage that allows them to generate predictable, increasing free cash flows that are then reinvested (plowed back) into the company and allowed to compound. Ideal companies for this type of formula have been those with steady, loyal consumers like insurance, banks, financial services, soda, and candies. In particular, those firms with very strong brands have been a part of this strategy. However, GM does not have a brand in the top ten most valuable car brands according to one source. The current General Motors CEO, arguably, is in the process of rebuilding their iconic brands. But at present Buick's strength in China as a luxury brand is probably the closest approximation to a customer preference giving pricing power on a large scale. To build its brands, GM will need to repeatedly exceed expectations for consumers; these are often measured through third-party reviews and based on cost of ownership (Edmunds); reliability, fit and finish, etc (Consumer Reports); and safety (Insurance Institute for Highway Safety).
6) Bullish on Autos? US Consumer? Both?:A parallel thesis on the GM stake might be that it is simply a part of Berkshire's larger bets on North American consumer spending, right in tandem with the increased positions in Wal-Mart (NYSE:WMT) and Dollar General (NYSE:DG). Autos, after all, are one of the largest consumer purchases. However, USA Today notes the latest data may indicate Toyota (NYSE:TM) , Honda (NYSE:HMC) , and Volkswagen (OTCPK:VLKAF) are the likely beneficiaries of pent up demand and improved consumer sentiment in the US. While a recent Businessweek piece on the General Motors stake cites some merits for the auto market, investors could also see Berkshire's ownership of Chevy and GMC as "of a piece" with their construction niche (with existing companies such as Johns Manville's, Benjamin Moore, Shaw and Acme). Sales of full size trucks and vans are often indicators of the construction market in the US. And with GMC Sierra, Chevy Silverado, and commercial vans, Berkshire has an even bigger footprint in the US residential construction market should the market improve. Also, General Motors may even part of future Berkshire strategy of looking beyond US consumer altogether.
7) China: Buick Country? In the Snowball, the most detailed of the Warren Buffett biographies, we find an uncanny understanding of the history of the US auto industry: "[t]here were two thousand auto companies . . . only three companies survived. And at one time or another, all three were selling at less than book value" (p. 18). The tremendous innovation from horses to autos has been a boon for society but a tremendous bust for investors, Buffett explains. But is the past prologue for the next societies moving from horse to auto?
As GM has lost market share in North America, it has gained market share in China (and also South Korea) according to a Reuters article. GM had a leading 13.6% market share in 2011 China up from 12.7% in 2010 and expects further gains for 2012. Also, GM has partnered with SAIC Motors; it predicts Shanghai GM to increase sales 5-10% annually. There is some precedent for China exposure (think: electric car maker BYD and Petro China). Buick has retained brand leadership in China, with the Buick Excelle the #1 selling passenger car in 2011 (and the Chevy Cruze a respectable #3). GM has an early lead in the market, with car sales in China now eclipsing those in the US. Buffett is a sort of capitalist folk hero in China, and he has dabbled in China before. With GM, Berkshire get a top Chinese auto maker with the certainty of US management and share ownership. So Berkshire's first investment in Detroit since the Ambassador Bridge may have more to do with Shanghai than Michigan.
8) Value Play? At this writing, GM stock has a 6.75 P/E with a strong cash position, having jettisoned liabilities in their restructuring. Is this a classic value play, with the going concern selling at a discount and offering a margin of safety, largely due to the negative reaction to the past bankruptcy and government ownership? The record profits and some maverick moves (stopping Facebook and Superbowl ads) could mean business as usual is over at GM and there is a new focus on products and profits. Longtime Berkshire followers know Geico was in trouble and a turn around in the mid 1970's when Berkshire bought in; and American Express (NYSE:AXP) was embroiled in the 1960's salad oil scandal when Buffett gobbled up shares. He saw through near term problems to longer term potential.
9) Widening Circle of Competence? Recent investments have shown signals of a "next era" for Berkshire Hathaway. The firm no longer avoids technology like the plague with stakes, for instance, in Intel (NASDAQ:INTC) and IBM IBM. It may now be taking a few more swings at cyclical stocks at the right price as well. A global focus is also present, with China clearly on the radar at Berkshire, and GM fits as a China play. Also, if we frame pickup trucks (GM strength in North America) in terms of construction exposure, then the investment only nudges the circle of competence of Berkshire's building and remodeling products by now including the trucks that move the workers, tools and materials.
10) BOTTOM LINE: Berkshire Hathaway is likely taking this cyclical stock for a test drive to tap rising consumer demand for autos at home and abroad as well as an improving construction and housing market; however, GM does not fit the profile of a permanent Berkshire Hathaway holding, so the stake will likely be traded in for a more lucrative investment vehicle at the right point in the economic cycle.
Disclosure: I am long PG.
Additional disclosure: I own all stocks mentioned through index funds and ETFs with many stocks mentioned as top ten holdings in said funds.