“Long live the new boss. Same as the old boss.”
That old adage came to mind last week when I read of the latest internal moves at Berkshire Hathaway (BRK.A) (BRK.B). The company announced on January 10th that CEO Warren Buffett had named two senior executives, Ajit Jain and Greg Abel, to the board of directors. Each was also given the status of vice chairman and increased autonomy in their respective business units.
The move appears to signal the latest evolution of Buffett’s thinking regarding the eventual ascension of a new chief executive. While Buffett has stated that he has no plans of retiring, he appears to at last be bowing to the reality that his advancing age (he is now 87) demands a plan of succession be put in place. A disordered or chaotic period after his sudden demise or incapacitation could cause irreparable damage to the reputation of one of the most respected companies in the world.
Clearly, Buffett has no intention of leaving the future leadership of the vast empire he has built over many decades to the vicissitudes of fate, but he has resisted the calls to anoint a successor. But with the elevation of Jain and Abel, we are perhaps witnessing the final test of the two people likeliest to be tapped by the Oracle of Omaha to lead Berkshire in his stead.
Let’s take a look at these two men, and what the eventual changing of the guard will mean for Berkshire investors.
Meet The Heirs Apparent
Ajit Jain, aged 66, is the head of Berkshire’s reinsurance business. He has been with Berkshire since 1986 and has been discussed as a potential Buffett successor for more than a decade. Jain has done remarkable work in that business unit, generating hundreds of millions of dollars in annual profits and providing Buffett billions in investable float over the years. It is easy to see why he might be a popular candidate to succeed Buffett, given his successful management of a complex business unit, and the supreme importance of the insurance business to Berkshire’s financial health and investing muscle.
Greg Abel, aged 55, has a somewhat less classically “Berkshireian” pedigree. He joined the Berkshire family in 1999 when the company acquired MidAmerican Energy, the energy company he had been working for. In 2008, Abel was appointed chief executive of MidAmerican, which was renamed Berkshire Hathaway Energy in 2014. As head of the energy division, Abel runs a business generating billions of dollars in profits every year for the parent company. Energy infrastructure has been an important part of the Berkshire portfolio, and Abel has managed it ably, even during the energy price volatility of recent years.
Both Jain and Abel have been in the mix as potential Buffett successors for some time. In his 2014 letter to shareholders, Buffett intimated that he had a successor in mind, stating that he had the “right person to succeed me as CEO. A successor ready to assume the job the day after I die or step down. In certain important respects, this person will do a better job than I am doing.”
Before the note was issued, all the smart money would have pegged Jain as the unnamed “right person.” However, in the same letter, Charlie Munger, Buffett’s long-time business partner and the second most influential individual at Berkshire, also addressed the issue of succession, naming both Jain and Abel:
But, under this Buffett-soon-leaves assumption, his successors would not be “of only moderate ability.” For instance, Ajit Jain and Greg Abel are proven performers who would probably be under-described as “world-class.” “World-leading” would be the description I would choose. In some important ways, each is a better business executive than Buffett. And I believe neither Jain nor Abel would (1) leave Berkshire, no matter what someone else offered or (2) desire much change in the Berkshire system.
Munger’s comments caused quite a stir at the time, since most Berkshire-watchers saw Jain as Buffett’s hand-picked heir. Adding Abel into the mix caused a swirl of speculation, one that has been reinvigorated by their joint elevation to the highest echelon of the business.
Proving Their Mettle
Ajit Jain and Greg Abel have both been with Berkshire for a long time, though in different sections of the business. Each has distinguished himself leading complex business units and is rightfully considered a potential successor to the Oracle. Buffett clearly intends to put them through their paces before he announces a final decision.
Jain is now Vice Chairman of Insurance Operations while Abel is Vice Chairman of Non-Insurance Operations. Each has their own set of expertise, but their new roles will give them considerably more authority over a wider range of business units. These units will now be reporting to either Jain or Abel, instead of directly to Buffett. This gives the would-be Buffett successors exposure to the wider universe of Berkshire’s operations, as well as testing their ability to lead and make competent decisions in areas not exclusively within their traditional expertise.
While it is clearly a contest, Buffett has made it clear that it will be a civilized affair, noting that, “They know each other well, they like each other well, they both have their areas of specialty.”
There is always the chance that Buffett, or the board, might choose to create a dual structure, with neither man rising to the status of sole CEO. But for now, the likely outcome looks to be that one or the other of them will get the top job.
As to the question of which of them it will be, it is hard to say who will win out. In terms of making Berkshire money and time in the company, Jain undoubtedly wins in the comparative. Yet there is also a serious question of longevity. Buffett has stated the preference that the next CEO be young enough to hold the reins for a long time.
Since he is not going away any time soon, and could be at the helm for five years or more, Jain’s age starts to look like a liability. At 66, Jain is getting on in years. Abel is no spring chicken, but he is a decade younger than his rival. The longer Buffett holds on, the likelier it is that the younger man will get the nod.
Replacing The Indispensable Man
Last month, I wrote about another massive and sprawling conglomerate that may face challenges in the years ahead as it expands further and further from its core business. Amazon (AMZN), like Berkshire, has a founder-CEO who has constructed the business to suit his way of doing business and to conform with his long-term strategic vision. Jeff Bezos is not going anywhere, so Amazon’s leadership issues are a long way off, if they ever materialize. Berkshire, on the other hand, faces the issue imminently.
Even the best succession plans can blow up and the most well-groomed heirs can prove wanting. Jack Welch built General Electric (GE) into a vast diversified empire, but his hand-picked successors failed miserably in upholding his legacy. Now the company faces the prospect of an ignominious breakup, as the unwieldy divisions fail to achieve the synergy Welch had once extracted with such skill.
In the case of Berkshire, a sprawling diversified empire unlike virtually anything else in the business world, the individual talent of Warren Buffett cannot be downplayed. He has proven over many decades a nigh-unique grasp of financial markets and expertise in identifying and acquiring exceptional businesses.
In his absence, even the best prepared heir might find the task of governing Buffett’s empire an overwhelming task. That is especially true given the sheer size of Berkshire. Growth has been achieved through creative identification of new opportunities and laser-focused attention to the bottom line. Berkshire without Buffett’s “secret sauce” or special insight might find the next phase of growth a steeper challenge.
Who Rules The Kingdom
As with many monarchies, in which he who wears the crown often does not wield the power, so too can businesses find power held and exercised by individuals other than the chief executive. In the case of Berkshire, it is evident that no one will rule with the same degree of authority that Buffett has enjoyed. Whether Jain or Abel ascend to the top job, the other will still be indispensable in managing his side of the business – and will wield power within the board and in the c-suite that no executives have enjoyed in the Buffett era.
There will be other power centers to contend with as well, with Buffett’s investment deputies Todd Combs and Ted Weschler likely to share the role of chief investment officer and Howard Buffett, Warren’s son, set to become non-executive chairman of the board with the mandate to help preserve Berkshire’s corporate culture after the departure of the man who made it.
While shared power and responsibility may provide a better division of labor and talent, and provide for a long and prosperous future, it could also lead eventually to turf wars and contests for power. With all the contenders for senior roles in the post-Buffett era insiders, the chances of a serious dustup are low – at first, anyway. But the threat of instability in the absence of an overriding power in the center, as Buffett has always been, is very real.
Any succession carries major risks for the future. In the case of a vast and complex corporate empire like Berkshire Hathaway, those risks are magnified significantly. After Buffett’s departure, we should expect an orderly transition of nominal authority, but the risks of instability or conflict will be ever on investors’ minds as they watch the succession unfold and the new normal, whatever that is, eventually takes hold.
Investors currently holding Berkshire shares should be prepared for some volatility in the quarters after Buffett's departure. With a succession carried off as smoothly, or almost as smoothly, as Buffett has promised, short-term volatility should transition back to the general trend.
Over the long run, Berkshire may begin to face issues of valuation stretch. Berkshire's B-class shares are currently trading at a price-to-earnings ratio of 27.8, well above its 5-year average of 16.8. That is symptomatic in part of the secular market climb in recent years. Berkshire has sustained strong earnings growth for decades and can continue to do so in the absence of Buffett. But if the new leadership has difficulty matching or nearing historical performance, then the valuation may begin to slip.
Investors must also consider the special significance of Buffett himself and how much of an impact he has had on the stability and strength of Berkshire's stock performance. He is one of the most widely respected and revered individuals in finance, and that patina of invulnerability has undoubtedly added some juice to Berkshire's price. How much of that will diminish in his absence is very difficult to say, as it is a wholly immeasurable intangible asset.
Future uncertainty makes Berkshire a somewhat less ironclad, though still arguably extremely safe and worthwhile, investment. Investors who have bought and held it on autopilot should pay closer attention over the next few years and during the dicey quarters and years post-transition.
While greater vigilance is called for, a loss of trust in Berkshire's ability to perform is not. It is dangerous to bet against the Oracle of Omaha – even when he’s gone.