Manager Watch (continued)

The large stream of cash is a manifestation of Buffet’s continuing success in fostering and institutionalizing a culture…across all of Berkshire’s many businesses… focused on improving operations and producing long-term gains in intrinsic business value. With $31 billion of cash on hand at year-end 2003, Buffet is patiently waiting to deploy that cash toward the purchase of companies that meet his time-tested criteria for success: companies with favorable competitive positions, able and honest management, and a sensible purchase price. Recently, Buffet has found it more advantageous to execute this strategy by purchasing entire businesses rather than fractional stakes in publicly traded companies. But if stocks become cheaper than entire businesses, Buffet promises to “buy them aggressively”. One consequence of the focus on entire businesses is that Berkshire’s public equity holdings now account for a much lower percentage of the company’s net worth (114% in the 1980s versus 50% in 2003). Movements in the general stock markets now have less direct impact on Berkshire.

So what’s Buffet been buying? Two of the most recent purchases were Clayton Homes, a leader in the manufactured housing industry, and McLane, a distribution company that was spun off from Wal-Mart. Buffet has also nibbled around in fixed income, selectively buying junk bonds when the price is right, and interestingly, engaging in what he terms “opportunistic strategies in fixed income securities” using borrowed money, which sounds to us like leveraged fixed-income arbitrage. With bearish views of the dollar, which Buffett outlined last November in an article in Fortune, Warren entered the foreign currency market for the first time in 2002. He expanded those positions substantially in 2003. Buffett is betting big against the dollar, a view we are not uncomfortable sharing, to help hedge Berkshire’s cash position, and to reap substantial rewards if he is right on the dollar’s direction. In these respects, by using classic hedges of fixed income arbitrage and global macro strategies, Buffett is borrowing from the toolkit of “absolute return” managers (see 4th Quarter, 2003 Commentary).

Why We Like This Manager

We continue to think that Warren Buffett and Charlie Munger are two of the smartest, most rational, and most disciplined allocators of capital anywhere. We are very confident they will continue to deploy capital wisely in opportunities that grow shareholder value and lead to attractive compounding in Berkshire’s stock price. We won’t be at all surprised to see Berkshire continue to outperform the S&P 500 over time. Buffett and Munger expect it. We are reasonably confident as well; but there are risks.

Buffet’s success at installing and infusing all of Berkshire’s subsidiary companies with owner-oriented compensation systems and cultural norms, plus a “let’s make Warren proud” motivational focus, ensures that building shareholder value remains the raison d’être at Berkshire. Finally, Berkshire remains a very tax efficient investment structure
with all returns provided to shareholders in the form of capital gains (or losses) and then only at sale. Consequently, so long as Warren Buffett remains actively involved at Berkshire, which, happily, he plans to do indefinitely, we intend to remain shareholders of this unique investment vehicle.

But what if Warren does not remain active or gets hit by the proverbial bus? Would Berkshire remain as attractive an investment without him? A great deal of attention has been focused on this succession question and we struggle with it ourselves. Buffett himself has even chimed in announcing in the 2003 shareholder letter that his successor(s) will come from four internal candidates, and that his role will be split in two with one person serving as CEO of Berkshire’s many operating businesses, and another person serving as Chief Investment Officer. Happily, Berkshire has some splendid managerial talent and a wonderful collection of businesses, many with strong competitive advantages that should make Berkshire a solid, perhaps a superb, investment for years to come. Nevertheless, in our view, it’s very hard to believe Berkshire could be as good without the Oracle of Omaha as with him.

You can’t easily replace his combination of talents – a mathematical wizard with a near photographic memory, possessing encyclopedic knowledge of thousands of companies with the discipline, experience, and independent judgment to have consistently made many more good or great investment decisions than bad. The sheer scope of Buffett’s “comfort zone” is pretty amazing—from purchasing entire firms after one conversation and a handshake, to opportunistically investing in currencies, commodities, and junk bonds, to engaging in many forms of arbitrage, to fearlessly making outsized bets in individual companies; he has done it all. Add to that Buffet’s managerial skills that have motivated so many talented executives to continue working for him long after they were rich enough to retire and you have one of the most difficult to replace business talents on the planet. Lastly, Buffet’s personal network and early…and sometimes exclusive…access to attractive opportunities based on his star power and reputation may be completely irreplaceable.

Consequently, while we would not rush to sell right away if something happened to Buffett, it’s hard to imagine we could remain as durably committed from that point as we are now.
 

_