Learning from Warren Buffett Shareholders Letter - Year 1981 - Master Class on Acquisition.
5th September 2024
Learning from Warren Buffett Shareholders Letters – Year 1981 – Master Class on Acquisition.
Dear Investors,
Namaste! We will learn from 1981 letter. We often hear about take over and acquisition. Today let us learn from Master how to do it?
Master starts with NON-CONTROLLED Businesses: -
Our non-controlled business interests have more favourable underlying economic characteristics than our controlled businesses. That’s understandable; the area of choice has been far wider. Small portions
of exceptionally good businesses are usually available in the securities markets at reasonable prices. But such businesses are available for purchase in their entirety only rarely, and then almost always at high prices.
Master now goes to CONTROLLED Businesses: -
As our history indicates, we are comfortable both with total ownership of businesses and with marketable securities representing small portions of businesses. (His objective is to make money, not to control the businesses).
Our acquisition decisions will be aimed at maximizing real economic benefits, not at maximizing either managerial domain or reported numbers for accounting purposes.
(He doesn’t want to acquire just to control some companies or to show more sales).
Regardless of the impact upon immediately reportable earnings, we would rather buy 10% of Wonderful Business T at X per share than 100% of T at 2X per share. Most corporate managers prefer just the reverse, and have no shortage of stated rationales for their behaviour.
(He once again makes his goals clear).
Motivating factor for acquisition by major corporations: - ( Reality of TAKEOVER)
However, we suspect three motivations - usually unspoken - to be, singly or in combination, the important ones in most high-premium takeovers:
(1) Leaders, business or otherwise, seldom are deficient in animal spirits and often relish increased activity and challenge. At Berkshire, the corporate pulse never beats faster than when an acquisition is in prospect.
(2) Most organizations, business or otherwise, measure themselves, are measured by others, and compensate their managers far more by the yardstick of size than by any other yardstick.
(Ask a Fortune 500 manager where his corporation stands on that famous list and, invariably, the number responded will be from the list ranked by size of sales; he may well not even know where his corporation places on the list Fortune just as faithfully compiles ranking the same 500 corporations by profitability.)
(ADANI was higher in Fortune list in late 2022 compared to AMBANI. But Ambani was much ahead in profitability!! )
(3) Many managements apparently were overexposed in impressionable childhood years to the story in which the imprisoned handsome prince is released from a toad’s body by a kiss from a beautiful princess. Consequently, they are certain their managerial kiss will do wonders for the profitability of Company T(arget).
Such optimism is essential. Absent that rosy view, why else should the shareholders of Company A(cquisitor) want to own an interest in T at the 2X takeover cost rather than at the X market price they would pay if they made direct purchases on their own?
In other words, investors can always buy toads at the going price for toads. If investors instead bankroll princesses who wish to pay double for the right to kiss the toad, those kisses had better pack some real dynamite. We’ve observed many kisses but very few miracles. Nevertheless, many managerial princesses remain serenely confident about the future potency of their kisses - even after their corporate backyards are knee-deep in unresponsive toads.
Indian Scenario: - Ambani has taken over 200 plus SMALL and MEDIUM companies post COVID. Have they made meaningful impact on the profitability of the Reliance Industry? Find out.
In fairness, we should acknowledge that some acquisition records have been dazzling. Two major categories stand out.
The first involves companies that, through design or accident, have purchased only businesses that are particularly well adapted to an inflationary environment.
Such favored business must have two characteristics:
Our acquisition decisions will be aimed at maximizing real economic benefits, not at maximizing either managerial domain or reported numbers for accounting purposes.
(He doesn’t want to acquire just to control some companies or to show more sales).
Regardless of the impact upon immediately reportable earnings, we would rather buy 10% of Wonderful Business T at X per share than 100% of T at 2X per share. Most corporate managers prefer just the reverse, and have no shortage of stated rationales for their behaviour.
(He once again makes his goals clear).
Motivating factor for acquisition by major corporations: - ( Reality of TAKEOVER)
However, we suspect three motivations - usually unspoken - to be, singly or in combination, the important ones in most high-premium takeovers:
(1) Leaders, business or otherwise, seldom are deficient in animal spirits and often relish increased activity and challenge. At Berkshire, the corporate pulse never beats faster than when an acquisition is in prospect.
(2) Most organizations, business or otherwise, measure themselves, are measured by others, and compensate their managers far more by the yardstick of size than by any other yardstick.
(Ask a Fortune 500 manager where his corporation stands on that famous list and, invariably, the number responded will be from the list ranked by size of sales; he may well not even know where his corporation places on the list Fortune just as faithfully compiles ranking the same 500 corporations by profitability.)
(ADANI was higher in Fortune list in late 2022 compared to AMBANI. But Ambani was much ahead in profitability!! )
(3) Many managements apparently were overexposed in impressionable childhood years to the story in which the imprisoned handsome prince is released from a toad’s body by a kiss from a beautiful princess. Consequently, they are certain their managerial kiss will do wonders for the profitability of Company T(arget).
Such optimism is essential. Absent that rosy view, why else should the shareholders of Company A(cquisitor) want to own an interest in T at the 2X takeover cost rather than at the X market price they would pay if they made direct purchases on their own?
In other words, investors can always buy toads at the going price for toads. If investors instead bankroll princesses who wish to pay double for the right to kiss the toad, those kisses had better pack some real dynamite. We’ve observed many kisses but very few miracles. Nevertheless, many managerial princesses remain serenely confident about the future potency of their kisses - even after their corporate backyards are knee-deep in unresponsive toads.
Indian Scenario: - Ambani has taken over 200 plus SMALL and MEDIUM companies post COVID. Have they made meaningful impact on the profitability of the Reliance Industry? Find out.
In fairness, we should acknowledge that some acquisition records have been dazzling. Two major categories stand out.
The first involves companies that, through design or accident, have purchased only businesses that are particularly well adapted to an inflationary environment.
Such favored business must have two characteristics:
(1) an ability to increase prices rather easily (even when product demand is flat and capacity is not fully utilized) without fear of significant loss of either market share or unit volume,
(Currently TELECOM Operators in India are in SWEET SPOT where if they decide they can increase the prices and consumer will not object).
and (2) an ability to accommodate large dollar volume increases in business (often produced more by inflation than by real growth) with only minor additional investment of capital.
(Many FMCG companies in India have reported sales which was higher due to increased prices and not due to increase in Volume in recent months).
Managers of ordinary ability, focusing solely on acquisition possibilities meeting these tests, have achieved excellent results in recent decades.
The second category involves the managerial superstars - men who can recognize that rare prince who is disguised as a toad, and who have managerial abilities that enable them to peel away the disguise. We salute such managers.
Your Chairman, unfortunately, does not qualify for Category
2. And, despite a reasonably good understanding of the economic factors compelling concentration in Category 1, our actual acquisition activity in that category has been sporadic and inadequate. Our preaching was better than our performance. (We neglected the Noah principle: predicting rain doesn’t count, building arks does.)
We have tried occasionally to buy toads at bargain prices with results that have been chronicled in past reports. Clearly our kisses fell flat. We have done well with a couple of princes - but they were princes when purchased. At least our kisses didn’t turn them into toads. And, finally, we have occasionally been quite successful in purchasing fractional interests in easily-identifiable princes at toad-like prices.
Follow me on Twitter @hiteshmparikh Or on Whatsapp - +91-9869425399.
Learn a Lesson. Live with Passion & Invest with Reason.
Hitesh Parikh.
(Currently TELECOM Operators in India are in SWEET SPOT where if they decide they can increase the prices and consumer will not object).
and (2) an ability to accommodate large dollar volume increases in business (often produced more by inflation than by real growth) with only minor additional investment of capital.
(Many FMCG companies in India have reported sales which was higher due to increased prices and not due to increase in Volume in recent months).
Managers of ordinary ability, focusing solely on acquisition possibilities meeting these tests, have achieved excellent results in recent decades.
The second category involves the managerial superstars - men who can recognize that rare prince who is disguised as a toad, and who have managerial abilities that enable them to peel away the disguise. We salute such managers.
Your Chairman, unfortunately, does not qualify for Category
2. And, despite a reasonably good understanding of the economic factors compelling concentration in Category 1, our actual acquisition activity in that category has been sporadic and inadequate. Our preaching was better than our performance. (We neglected the Noah principle: predicting rain doesn’t count, building arks does.)
We have tried occasionally to buy toads at bargain prices with results that have been chronicled in past reports. Clearly our kisses fell flat. We have done well with a couple of princes - but they were princes when purchased. At least our kisses didn’t turn them into toads. And, finally, we have occasionally been quite successful in purchasing fractional interests in easily-identifiable princes at toad-like prices.
Follow me on Twitter @hiteshmparikh Or on Whatsapp - +91-9869425399.
Learn a Lesson. Live with Passion & Invest with Reason.
Hitesh Parikh.
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