The seller of Helzberg Diamonds, Barnett Helzberg was very pleased that it found a home within the Berkshire Hathaway family. He was able to step back from the business and devote more time to his family and philanthropic pursuits. The family were diversified now with a large holding in Berkshire which gained income from a broad spread of business sectors; and they could sell the highly liquid Berkshire shares at any time to diversify further.
Most importantly, the future of the company was in good hands. There was a solemn commitment from Buffett and Munger to continue the firm’s business philosophy, to retain the current associates and to maintain the corporate HQ in the Kansas City area.
Jeff Comment, CEO, expected his new boss to give him some instructions. Buffett did indeed ring him up the day after the sale (May 1, 1995), but all he said was “Guess what you get to do today. Start breaking all your banking relationships, because from now on I’m your bank.” (Jeff Comment in an interview with Robert P. Miles in The Warren Buffett CEO (2002) John Wiley).
Thus Buffett required control of capital allocation across the group. But apart from that, Comment was free to manage the business how he thought best “Berkshire hasn’t asked me to do anything that’s really changed the business”.
He told the Kansas City Star paper that Buffett had said that he doesn’t call his presidents but “I like hearing from you guys once in a while.”
Jeff Comment says that Buffett and he are very different people, but they really trust one another, and have a high degree of mutual respect. He thinks that is the case with all of Buffett managers, there is a sort of chemistry. “That chemistry is missing in a lot of businesses today. They’re functional, they’re tactically correct, but boy do you lose the passion, and you lose the love of the business. That doesn’t happen here…Warren is an incredibly cordial, warm, personable person.” (Bob Miles's book)
Why not put Borsheims and Helzberg together?
Most business groups already holding a jewellery retailer then adding another would instinctively look for “synergy”, such as buying economies or rationalising the store estate. They would put them under the same management. But Berkshire is no ordinary group.
First, Buffett had promised that the businesses would be largely autonomous, each with their distinctive cultures and leaderships.
Second the synergistic gains would be pretty small compared with the loss of focus, damage to the esprit de corps and confusion over strategy. On the latter point Buffett wrote in his 1995 letter that “Helzberg's…is an entirely different sort of operation from Borsheim's, our Omaha jewellery business, and the two companies will operate independently of each other.”
He expanded on that thought in at the Meeting in May 1996, “Both [Borsheims and Nebraska Furniture Mart] offer this incredible selection, low prices brought about by huge volume, low operating costs, and all of that. Operating multiple locations…you would lose something, in terms of the amount of selection that could be offered. There’s $50 million-plus at retail of jewellery at Borsheims’ one location. Well, when someone wants to buy a ring, or a pearl necklace, or something of the sort, they can see more offerings at a place like that than they possibly could at somebody who i………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
Buffett and Munger do discounted cash flow (owner earnings) calculations in their head - never on paper or computer
When asked at the Annual Meeting in May 1996 for detail on his discounting method, for example, how many future years does he extend the calculation to, Buffett explained that, yes, the discounted owner earnings is the framework at the heart of investing or buying businesses, but, no, there are no written down calculations at Berkshire with cut-off dates for calculating what is called in “the terminal value”.
He said that though the equation is simple and direct “we’ve never actually sat down and written out a set of numbers to relate that equation. We do it in our heads, in a way, obviously. I mean, that’s what it’s all about. But there is no piece of paper. There never was a piece of paper that shows what our calculation on Helzberg’s or See’s Candy or The Buffalo News was, in that respect.”
Buffett and Munger fear that people get hung up on the illusory appearance of “scientific” quality when using apparently sophisticated numerical analysis. In reality, inputs to the formula are of an imprecise nature.
What you need are good ballpark estimates after taking on board the all-important qualitative factors that create shareholder value (quality of franchise and management).
“We are sitting in the office thinking about that question with each business or each investment. And we have discount rates, in a general way, in mind. But we really like the decision to be obvious enough to us that it doesn’t require making a detailed calculation. It’s the frame
Warren Buffett does things completely differently to most people engaged in M&A. The Helzberg Diamonds purchase illustrates this well.
After the owner of Helzberg Diamonds sent Warren Buffett the financial statements in Spring 1994 a few things struck him. First, sales had grown from $10m in 1974 to $53m in 1984 to $282m in 1994. Clearly the company was on an impressive growth path.
Second, it exhibited remarkable productivity per-store. Turning over an average of around $2m was far superior to competitors operating similar-sized stores. “If the company continues its first-rate performance - and we believe it will - it could grow rather quickly to several times its present size” Buffett told Berkshire shareholders.(1995 letter). The high sales per square foot contributed greatly to the key element Buffett looks for: good returns on invested capital.
Third, the seller, Barnett Helzberg Jr., loved the business and cared deeply about what would happen to his people and customers under a new owner. The character of the seller, including what motivates him, provides clues on whether a good deal can be struck, e.g. he’s not obsessed with accumulating money leading to hiding problems, prettifying accounts or failing to engender good morale.
Fourth, Buffett could see quality managerial leadership was supplied in the form of Jeff Comment. So, even though the patriarch was not going to be around much the managerial team would remain solid. “There was never any question in my mind that, first, Helzberg's was the kind of business that we wanted to own and, second, Jeff was our kind of manager. In fact, we would not have bought the business if Jeff had not been there to run it. Buying a retailer without good management is like buying the Eiffel Tower without an elevator.” (1995 Letter)
Buffett called Helzberg and told him that he would like to talk. He also paid what Barnett thought was the “ultimate compliment” by saying that Helzberg Diamonds was a lot like Berkshire. It wasn’t long before they met in Buffett’s Omaha office to negotiate the sale. As well as Jeff Comment, Helzberg brought along a consulting accountant who had crunched some numbers to come up with a very high price (it was supposedly based on what Buffett had paid for another company). Despite it being obviously absurd, even to Barnett, Buffett was diplomatic in choosing to show no reaction at all.
Morgan Stanley had put together a pile of material on Helzberg Diamonds, as so naturally, Barnett took a copy along to the meeting and offered it to Buffett. He declined to take it. “I’m not interested in books. I’m not interested in working with Morgan Stanley. Why do you want to sell it?” (Barnett Helzberg, Jr. (2003) “What I Learned Before I Sold to Warren Buffett: An Entrepreneurs Guide to Developing a Highly Successful Company” John Wiley & Sons).
For 10 to 15 minutes Barnett explained his need to do other things in life. This made sense to Buffett. After all, he’d witnessed similar motives in many sellers.
Buffett then asked Comment to tell him about the business and why he should buy it. Comment spoke for about an hour and half, answering a dozen questions along the way.
Who needs due diligence?
Buffett said that the deal could be “the fastest in history”. Helzberg was taken aback. How can it be done quickly? What about the time it normally takes for a buyer to carry out due diligence? He said that “most suitors demand to see every scrap of paper you’ve every generated and to interview every top manager.” Buffett’s response was that he could “smell these things. This one sme………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
Warren Buffett bought Helzberg Diamonds in 1995 for - I estimate - around $165m - $183m in Berkshire shares (the precise number of shares has never been revealed). There are lessons for today's investors in understanding what made this company so appealing to Buffett. Today I describe the company's development leading up to the Berkshire Hathaway purchase. Tomorrow's newsletter describes the deal-making process (it took almost a year to reach agreement)
Russian immigrant Morris Helzberg, grandfather of Barnett Jr, opened a small jewelry store in Kansas City in 1915. All five children not only helped-out but were involved in decision making – there was a family tradition of long discussions. Shockingly, within two years Morris had a serious stroke making him unfit to work. Eldest son, Morton, was in dentistry school and another, Gilbert, was soon to fight in the First World War. That left two girls and 14-year-old Barnett.
Barnett Sr - the father of Barnett Jr who sold to Buffett in 1995 - had already shown a great deal of enthusiasm about the business and so the family decided that he was to take over. One problem: he still had to attend school. The solution was that an uncle would run the store during the day, and when Barnett got out of school at 3 o’clock he took over. It was assumed that when Gilbert returned to the USA he would take over.
But Barnett was having a whale of a time. He had a natural talent for retail. A born salesman he was full of exciting plans. In 1920, now all of 17, he opened his own store in a more expensive location in Kansas City while Gilbert ran the original shop. It wasn’t long before Barnett’s grander place was out-selling Gilbert’s, and so Gilbert shut his store and joined Barnett.
His son, Barnett, Jr., was given summer work when 15. He says he was a rather timid child, but soon grew to love building relationships with customers and the thrill of selling. Sadly, Gilbert Helzberg died in a motor accident in 1934, just as the firm was expanding as far as Wichita. By 1940 the chain of five stores was the largest in the Midwest and when Barnett, Jr joined full-time in 1956, after graduating in business from the University of Michigan, the company was set for a period of rapid expansion throughout the Midwest.
The Barnett Junior years
In 1962, when Barnett became President of the firm aged 29, it had 39 shops. Things seemed to be going well in the 1960s, but there was a flaw: the majority of the stores were located in downtown districts whereas people were now flocking to the new suburban shopping malls. Barnett Jr remembers this period with feelings of fear and regret because Helzberg came close to complete business failure following its strategic wrong turn. It was stranded with high downtown costs, dwindling customer flow and cash crises. He decided to close the older stores caus………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
Investors need to be cautious in supporting directors of their companies when pursuing the purchase of other firms. It's well-known that most mergers/acquisitions fail to produce shareholder value. This newsletter looks at the principles Buffett follows to improve the odds of success. He set these down for us shortly after buying Helzberg Diamonds in 1995.
Acquisition by walking around
On a sunny May morning a week or so after Berkshire’s 1994 annual meeting in Omaha, Warren Buffett was about to cross near the corner of 58th Street and Fifth Avenue New York when he was stopped by a woman who just wanted to say how much she had enjoyed the Annual Meeting.
Barnett C Helzberg, Jr, who was in New York to talk to Morgan Stanley about, possibly, selling his business, a 143 jewelry store chain carrying his family name, was 30-40 feet away when the woman in the bright red dress shouted across to Buffett. On hearing the name of the chairman of the company in which he held four shares he stopped and waited for the woman to say her goodbyes.
As Buffett went to cross the street – again - Helzberg saw his opportunity. He thrust out his hand, “Hello, Mr. Buffett. I’m Barnett Helzberg of Helzberg Diamonds in Kansas City” (Barnett Helzberg, Jr. (2003) “What I Learned Before I Sold to Warren Buffett: An Entrepreneurs Guide to Developing a Highly Successful Company” John Wiley & Sons).
Helzberg looked for some recognition on Buffett’s face. But none was forthcoming, despite Helzberg then being one of the largest jewelry chain in the country. But Buffett was polite and shook his hand, said “Hello” and graciously accepted more compliments about the Annual Meeting.
Then, in 30 seconds flat, “right there on the sidewalk, as busy New Yorkers rushed past us and street traffic buzzed around us, I told one of the most astute businessmen in America why he ought to consider buying our family’s 70-year-old jewelry business…I believe that our company matches your criteria for investment.”
As Buffett recalls the encounter his first thought was that he was hearing yet again that phrase about a “good fit” when the business hawker hasn’t really understood the acquisition criteria applied by Buffett and Munger, “it usually turns out they have a lemonade stand - with potential, of course, to quickly grow into the next Microsoft.” (Buffett's 1995 letter to Berkshire shareholders)
Given the probability that this was yet another dead end Buffett cut short the conversation by civilly asking if Helzberg could write to him with the particulars, “that, I thought to myself, will be the end of that.”
Helzberg went home and sent Buffett nothing. He later said he was “afflicted by hang-ups about confidentiality. I’m the kind of guy who asks for someone’s Social Security number before I tell them the time.” Then one night he re-read Berkshire’s Annual Report and paid particular attention to the section where Buffett invites companies that meet his criteria to send him information.
Buffett’s acquisition criteria
Here is the regular “advertisement” included in Berkshire annual reports (this one is from 1995):
“We are eager to hear from principals or their representatives about businesses that meet all of the following criteria:
(1) Large purchases (at least $25 million of before-tax earnings),
(2) Demonstrated consistent earning power (future projections are of no interest to us, nor are "turnaround" situations),
(3) Businesses earning good returns on equity while employing little or no debt,
(4) Management in place (we can't supply it),
(5) Simple businesses (if there's lots of technology, we won't understand it),
(6) An offering price (we don't want to waste our time or that of the seller by talking, even preliminarily, about a transaction when price is unknown).
The larger the company, the greater wi………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
Does Warren Buffett’s recent positioning of Berkshire Hathaway tell us something about his views on the future?
Since Covid-19 struck Warren Buffett has been active in selling a number of long-held shares and in spending billions purchasing stakes in other companies. I’m going to speculate about his motivations.
First, the cash holdings
Berkshire’s cash and cash equivalents rose over the first six months of the year from $125bn to a massive $142.8bn, most of which is in U.S. Treasury Bills earning a tiny interest rate.
By contrast, investments in market-listed equity and fixed maturity securities fell to $226.7 billion from $266.7bn in December. In June $207.5bn was in equities and $19.2bn in fixed income.
Most of this reduction is due to price declines, but some is because of decisions to sell equities. Net sales in the second quarter were $12.8bn.
Apart from the $207.5bn invested in minority stakes in stock market listed companies Berkshire owns 100%, or near 100%, of dozens of companies from See’s Candy to BNSF and National Indemnity. If these were floated on the stock market such a group would command a market capitalisation - I guess, very approximately - of $400bn.
Even allowing for both types of equity holdings, the cash pile is large relative to the amount Berkshire has invested in equities. It is the largest amount of net cash Berkshire has ever had. Indeed, it’s one of the largest cash balances any company has ever had.
So, to my first speculative conclusion
Warren Buffett is worried about the course of the US and the world economies and so holds cash in reserve firstly, as a precaution, “We don’t want to be dependent on the kindness of strangers, or friends even, because there are times when money almost stops”, he said at this year’s AGM.
Buffett does not call market tops and bottoms. He merely continually looks for good investments at reasonable prices. Sometimes there are few to be found (which – not entirely coincidentally - often occurs near market tops), and so cash piles up.
Naturally, an assessment of the economic future feeds into the assessment of what is a reasonable price to pay for a company’s future flows. Thus, the prospect of severe economic disruption affects first a judgement of fair value for equity assets, and then into the accumulation of cash.
Cash also opens up opportunities in those times when others are selling assets on the cheap: “We have $120bn in Treasury bills and some in cash, paying virtually nothing – a terrible investment over time. But they are the one thing that when opportunity arises, maybe the only thing you can look to pay for those opportunities is the Treasury bills.” (Warren Buffett, speaking at this year’s virtual AGM)
Is there anything else to back up that conclusion?
What about what he said after selling all of shares Berkshire held in the four largest airlines earlier this year, raising $6bn?
He noted that the world had changed for the airlines, “there are certain industries – the airline industry among others – that are really hurt by a forced shutdown.” (Berkshire’s AGM)
The airline shares were sold despite Berkshire having to record a loss on their sale, having paid $7 – 8bn.
Paying so much made sense when you expected Berkshire’s share of the earnings of those companies to total $1bn per year, “We felt that we were getting a billion, roughly, of earnings in a year – our share of underlying earnings was about $1bn. We thought that number was more likely to go up than down over a period of time.” (AGM)
He no longer expects a billion of earnings, not for many years at least: “I don’t know whether 2-3 years from now as many people will flying as many passenger miles as they did last year. They may, or they may not. But the future is much less clear to me on how the business will turn out…The airline business has the problem that if the business comes back 70% or 80% it has a problem that the aircraft don’t disappear. So, you’ve got too many planes. (AGM)
It's better to have $6bn in cash available to cope with the possibility of dire economic conditions and for buying opportunities than to have it in assets producing much poorer returns on capital than first envisaged.
What about the sales of US bank shares?
Buffett has been busy spring cleaning of bank stocks corner. At the beginning of the year Berkshire held $8.4bn in JP Morgan Chase. About two-thirds have been sold, and the shares have fallen from $139 to $101, so the value of its holding is now only about $2.3bn
Wells Fargo shares worth $18.6bn on Berkshire’s balance sheet in December (when BH held 8.4% of the bank) are now down to $6bn after selling off 108m shares (out of 346m) and the share price halving from around $54 to $25.
All the Goldman Sachs shares held in ………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
Andy Haldane was the only member of the Bank of England Monetary Policy Committee to vote against expansion of quantitative easing in June. His reasoning was that the glass was half full, in the sense that the economy was on track to recover about half of the lost output.
He had been gathering real time data on economic activity, such as credit card use, footfall and internet search terms, which led him to conclude that people were increasingly Google-searching for restaurants and spending more on credit cards. Also the Purchasing Managers indices were improving. And so we need to wait and see if the economy bounce back significantly before rushing into more money creation.
He gave his thoughts on the economic recovery in a speech at the end of June. The press reported that he spoke about the “V-shaped bounceback”, which gave the impression to many that we’re nearly back to normal “on track for a quick recovery”.
His actual comments are more nuanced that newspaper headlines.
Saying that the economy had grown by 1% in some weeks is not the same as saying we’ve experienced a V-shaped recovery.
Economic output fell by around 25% in March and April. Growth meant that by July only half of the fall in activity had been clawed back. So, we have data on the down part of the V. And we have data on the start of the upward part of the V, but half of the upward part of the V was still missing in July. Now, in September, we are probably a little further along. But it is the final part of the V that will be the most difficult to achieve (perhaps 10% of our economy – think airlines, Rolls-Royce, travel firms, pubs, hotels, and the despondent, depressed, running-out-of-cash-and-hope and the bust in many other business sectors).
In August, Haldane says, unemployment had probably already hit 6% (the numbers are not compiled yet). And he has a fear that unemployment could move to its highest level since the 1980s as the long-term effects of Covid-19 set in.
He expects unemployment to go to 9%, but then fall back quickly, But that assumes only a small risk of workers not being re-hired after furlough. That is considered optimistic by many other economists.
In his 30 June speech Haldane say that “it is early days, but my reading of the evidence is so far, so V.”
But he cautions those who would extrapolate from that by referring to the unknowns:
The two paths from here
Haldane says that he does not know which of the following two feedbacks will be the most potent:
It’s important at this time of enormous economic threat to listen to people who possess, through decades of intellectual effort, an informed long-term perspective on markets. I’ve been reading recent work by James Montier, Andy Haldane and Warren Buffett.
In today’s newsletter I’ll try to summarise James Montier’s views on the American market. James has written insightful articles for decades based on meticulous research. He worked as a Global Strategist at Société Générale before joining the thought-powerhouse and leading investment manager GMO. Apart from his articles, he has written important books such as Behavioural Investing and Value Investing. His knowledge base stretches from academic research on market out-performance through the psychology of investors to stock market history and the usefulness of valuation metrics (I recommend his books and his articles to you, many of which are available free on GMO’s website).
Montier thinks the US equity market has moved into “absurd” territory. It is close to its highest price ever relative to fundamentals such as earnings at exactly the time that it is facing one of the worst economic downturns. It is just not allowing for the possibility of there being a downside – everything is rosy – the market is priced for a perfect business future. The odds of perfection being attained are not good.
My next newsletter considers Andy Haldane’s ideas on where the UK economy has got to. Haldane is the Bank of England’s Chief Economist and was recently in the headlines for saying that the V-shaped recovery was underway. What he actually said was rather more subtle than what the newspaper writers described.
Many scribblers took him to mean that the V was pretty well complete; we’re all going to get back to normal soon. Sadly, for businesses, the unemployed and the soon to be unemployed that just is not where we are. The V is far from complete on the right-hand side. It may not be for a long time yet.
Finally, Warren Buffett has made a lot of large share stake sales in the last six months. For example, all Berkshire’s holdings of Goldman Sachs and JP Morgan have been sold, along with all its airline stocks. Billions have been raised from selling down Wells Fargo, US Bancorp and Bank of NY Mellon. During the same period Berkshire’s cash balance has grown to $143bn (yes, that is billion, not million) and Japanese trading house and Barrick Gold shares have been bought. What is Warren, through his actions, telling us about the future?
James Montier - a Panglossian US equity market
James Montier (in Reasons (NOT) To Be Cheerful, available at GMO’s website) is not focused on predicting the near- or medium-term future of the US equity market. He is more refined than that.
He is using the data we have to point out that current prices are not allowing sufficiently for the potential of bad outcomes “It is as if Mr. Market is taking a tail risk (albeit a good one) and pricing it with certainty.”
What James is saying is that there is a range of alternative futures, as there is at any point in history. We simply do not know which course will be taken.
If the possibilities are potted on a graph with, on the x-axis showing increasingly bad results on the left of the centre, and increasingly good results on the right, and the probability of those outcomes occurring on the y-axis, the “shape” of the distribution could be “bell-shaped”.
That is, the outcomes near the middle have the highest chance of occurring, while the extremes – the tails - have low probabilities. The extremes might contain scenarios such as a depression worse that of the 1930s on the left and, on the right, economic growth of 2%, or 3%, or 4% per year for the next few years.
What James is saying is that the extreme good economic outcomes are the ones Mr Market is placing all his money onto. Investors have bid up share prices so much that they are at record or near record levels relative to rational measures of value.
“Never before have I seen a market so highly valued in the face of overwhelming uncertainty. Yet today the U.S. stock market stands at nosebleed-inducing levels of multiple, whilst the fundamentals seem more uncertain than ever before. It appears as though the U.S. stock market has drunk from Dr. Pangloss’ Kool-Aid – where everything is for the best in the best of all possible worlds.”
James says he doesn’t know what the outcome will be, whether there will be a second Covid-19 wave, or we’ll get the unemployed back to work quickly, etc., but he knows downside risks exist and therefore we should be demanding a margin of safety when we pay for a share - “wriggle room for bad outcomes if you like.” Mr. Market is not allowing for that margin of safety.
What is Mr Market thinking?
A major preoccupation for the generality of US investors/punters is the support to businesses and the economy provided by the Federal Reserve in supplying oceans of liquidity – basically pumping in money.
But Montier points out, much of this involves banks swapping holdings of say long-term Treasury bonds for short term deposits at the central bank and is therefore not directly stimulating the equity markets, even if the thought of the Fed helping out is encouraging investors to buy.
Besides, quantitative easing has also been strong in Europe and elsewhere but equity markets there are not “sporting extreme valuations”.
“So, I think that Fed-based explanations are at best ex post justifications for the performance of the stock market; at worst they are part of a dangerously incorrect narrative driving sentiment (and prices higher)…The U.S. stock market looks increasingly like the hapless Wile E. Coyote, running off the edge of a cliff in pursuit of the pesky Roadrunner but not yet realizing the ground beneath his feet had run out some time ago.”
James quotes Voltaire, “ ‘Doubt is not a pleasant condition, but certainty is absurd.’ The U.S. stock market appears to be absurd.”
Overconfidence and overoptimism
Overconfidence and overoptimism are………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
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