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Buffett, Berkshire, BYD and The Greater Fool Theory in Practice

 BYD, the Chinese automaker whose name stands for “Build Your Dreams,” couldn’t be more aptly named.
 A Chinese rags to riches story, its shares were given the good housekeeping seal of approval several years ago when Warren Buffett bought a 10% stake after his notoriously dour, skeptical (and brilliant) business partner, Charlie Munger, convinced Buffett that the company was not just a car company, it was an engineering marvel with a shot at world domination thanks to breakthrough battery technology.
 Here’s how Munger defended the unusual investment—unusual for Buffett, who prefers low-technology to high-technology, and closer-to-home rather than halfway around the world—at the Berkshire Hathaway annual shareholder meeting two years ago:
 “BYD, while its founder is only 43 years old, it’s not some early stage venture capital company, it’s one of the world leaders of rechargeable lithium batteries…  From a standing start of zero he created the best selling model in China.  This is not some unproven, highly speculative activity—it’s a damn miracle….”
 And Munger, whose distaste for con artists and unproven business models is as well known as his dry wit (read “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett” for some fun examples, didn’t stop with encomium for BYD—he applied it to the entire country:
 “You get a remarkable aggregation of human talent, which when unfettered by the wrong kind of government, they succeed mightily—when they came to this country as coolies, slaves, they would leave and become the most important people in the town, so these are a remarkable people.”
 Of course, Munger was speaking two years before a likewise remarkable number of Chinese scams went public in the U.S., thus paying back, it might be said, some small part of the debt owed by the American railroads to their ancestors. 
 But if Munger’s naïve-sounding enthusiasm was premature, it was earnest, and based in large part on the chance for BYD’s supposedly revolutionary battery technology to help solve the great problem of how to store wind and solar-powered energy so it can be used when and where it is actually needed, as opposed to the Mohave Desert:
 “These lithium batteries are a remarkable technology, we need them.   I know it looks like Warren and I have gone crazy, but I don’t think we have…
 “It may be a small company but its ambitions are large, and I don’t wanna bet against 17,000 Chinese engineers led by Wang Chuanfu I would be amazed if great things don’t happen here.”
 Now, great things did indeed happen at BYD.  In this decade alone, sales grew almost 40-fold, gross profits 20-fold, and pretax income 15-fold.
 And the share price really took off after Berkshire invested a quarter-billion U.S. dollars in the company in 2008.
 Technically, of course, it was MidAmerican Energy Holdings that acquired the stock, buying 9.89% of BYD for $8HK per share.  And in what might now look like a giant red flag for Berkshire shareholders, it was MidAmerican’s CEO at the time, David Sokol, who went to China to look the company over before Buffett approved the investment (Munger recused himself—appropriately—from the decision-making, because his family had owned BYD shares for some time, a fact Sokol later tried to use, lamely, in his own defense after making undisclosed purchases in Lubrizol shortly before Berkshire announced a deal to acquire that company).
 Unfortunately, Sokol may have done Buffett no favors in encouraging the BYD investment, for while BYD shares soared immediately after the announcement, reaching $88.40HK—10 times Berkshire’s cost—they have since returned to earth ($15.40HK last sale) after a series of missteps, including missed sales forecasts in the bread-and-butter car business, an 88.6% profit drop in the most recent half-year results, and a series of missed deadlines for delivery of the company’s revolutionary electric car.
 This last is most worrisome for Munger’s optimism, which he maintained when asked about BYD’s setbacks at the most recent Berkshire shareholder meeting:
 “Any company that tries to move as fast…is going to have its glitches…I’m quite encouraged…”
 But we would not be so sure, particularly after asking an acquaintance from a large and prosperous US-based company, which has been making car batteries for almost 100 years, about BYD’s so-called revolutionary technology.
 The acquaintance shrugged.  “We don’t know much about it.”
 “You guys make batteries.  How come don’t you know?”
 “We don’t work with them.  They make everything themselves.  Everything.  We don’t know what their technology is.”
 “Well, what do you think it is?”
 Another shrug.  “Batteries hold a charge.  It’s how you put them together that makes them better or worse.  We don’t know what they do.”
 “Well, what do you think they do?”
 He speculated that part of the answer lies in the fact that the expected life of a car battery in China is shorter than in the U.S.  “They might only get five years out of it.  We build ours to last 10 years, which means they’ll last 15.  But what they’re doing in lithium, we don’t know.”
 Thus far, the “margin of safety” by which Warren Buffett lives (read “Secrets in Plain Sight” for the meaning behind this phrase), has protected Berkshire Hathaway from an embarrassing loss on its BYD investment.
 But while speculation rages that Berkshire will up its stake in the company, the speculation is dead wrong.
 Warren Buffett is no fool: he can read a balance sheet, and he can read a cash flow statement…and he could have easily bought all the new BYD shares he wanted when the company offered them recently on the Shenzhen stock exchange, supposedly for “research and development.”
 Against all odds—the weak sales, the State Department cables describing BYD’s alleged copycat cars, and the delayed electric car introduction—the BYD offering was 21-times oversubscribed.
 The greater fool theory lives.
  
Jeff Matthews
Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”
(eBooks on Investing, 2011)    Available now at Amazon.com
© 2011 NotMakingThisUp, LLC
                                                             
The content contained in this blog represents only the opinions of Mr. Matthews.   Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.  This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever.  Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored.  The content herein is intended solely for the entertainment of the reader, and the author.
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Buffett Takes Off the Gloves? He’s Getting Worried.


Stop Coddling the Super-Rich

Our leaders have asked for “shared sacrifice.” But when they did the asking, they spared me. I checked with my mega-rich friends to learn what pain they were expecting. They, too, were left untouched.
While the poor and middle class fight for us in Afghanistan, and while most Americans struggle to make ends meet, we mega-rich continue to get our extraordinary tax breaks….
These and other blessings are showered upon us by legislators in Washington who feel compelled to protect us, much as if we were spotted owls or some other endangered species. It’s nice to have friends in high places….

—Warren E. Buffett, New York Times, August 12, 2011 



  Warren Buffett’s politics have always been a surprise to first-time Berkshire observers.   “How can a billionaire like that be such a liberal?” is almost always one of the questions I get after a speech, or before a speech, or during a speech, about Buffett.

 But as anybody who’s followed Berkshire for a few years knows—or who’s read “Secrets in Plain Sight—Business and Investing Secrets of Warren Buffett”— Buffett’s Democrat credentials go as far back as 1968, when he supported anti-war candidate “Clean Gene” McCarthy in the presidential primaries.
 And Buffett’s strident stance on the inequities in the U.S. tax code is nothing new: he’s been talking about the tax advantage accruing to so-called “unearned” income versus wages for years, even testifying before Congress on behalf of “fairness,” at least as he sees it.
 Still, Buffett doesn’t—as readers of “Secrets in Plain Sight” also know—mention that while running what was, for all practical purposes, a hedge fund during the late 1950s, he took advantage of an even greater disparity in the tax code (the top marginal tax rate was 91% back then)—one of those ‘Do as I say, not as I do’ aspects to the Buffett PR machine that drives some investors crazy.
 But Warren Buffett is the most successful investor of his times, possessing not only one of the most rational minds in the business but also the uncanny ability to frame the cloudiest issue in a crisp, clear frame that makes whatever he’s talking about sound, well, pretty rational.
 And while today’s op-ed piece sounds pretty rational, the more interesting aspect is that it unleashes a new aspect to Buffett’s tax “fairness” campaign: he takes off the figurative gloves and talks about what he would do if he ran the joint.
 Among these are “pare down some future promises that even a rich America can’t fulfill,” “leave rates for 99.7 percent of taxpayers unchanged,” “continue the current…reduction in the employee contribution to the payroll tax,” and “raise rates immediately on taxable income in excess of $1 million…”
 Whether Buffett’s prescription is what America needs, let alone whether it will work, we make no judgment on here.
 We’re more interested in why he’s taking off the gloves now.
 And the reason—at least based on a close reading of “Stop Coddling the Super-Rich”—is that Warren Buffett is getting worried:
Twelve members of Congress will soon take on the crucial job of rearranging our country’s finances. They’ve been instructed to devise a plan that reduces the 10-year deficit by at least $1.5 trillion. It’s vital, however, that they achieve far more than that. Americans are rapidly losing faith in the ability of Congress to deal with our country’s fiscal problems. Only action that is immediate, real and very substantial will prevent that doubt from morphing into hopelessness. That feeling can create its own reality.
 The emphasis above—“That feeling can create its own reality”—was added by your editor, but having been written by a man born ten months after the Crash of ’29 who happens to be the head of a company with 260,000 employees making everything from chocolate candy to wind farms, and who is the overseer of insurance businesses holding tens of billions of dollars of exposure to financial markets through stocks, bonds, and the same kind of derivative contacts he once called “ticking time bombs,” the words fairly jump off the page on their own.
 Sounds like Warren Buffett is getting worried.
Jeff Matthews
Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”
(eBooks on Investing, 2011)    Available now at Amazon.com
© 2011 NotMakingThisUp, LLC
                                                             
The content contained in this blog represents only the opinions of Mr. Matthews.   Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.  This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever.  Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored.  The content herein is intended solely for the entertainment of the reader, and the author.
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Standard & Poor’s: Welcome to Our World!

SEC Examines S&P’s Math
Italian Town’s Prosecutors Probe S&P, Moody’s
White House Challenges S&P Decision
—The Wall Street Journal
  
 “The fact is, we didn’t need a rating agency to tell us that we need a balanced, long-term approach to deficit reduction.”
 So said President Obama the other day.
 Unfortunately, on that matter, the President is dead wrong: the fact is, we did need a rating agency to remind us that 40% of what our Federal Government spends is borrowed; that this is unsustainable; and we better do something about it before it’s too late.
 Otherwise, nobody in Washington would have paid attention to that fact until it was too late.
 But our point here is not about our Japan-style budget policies, or the 11th-hour budget deal, or dis-function in DC or even the S&P downgrade itself.
 It is about the fact that Standard & Poor’s is now being attacked—by Congresspersons who wouldn’t know a balance sheet from a tomato; by White House staffers whose paychecks and generous healthcare benefits are paid by the taxpayers S&P is looking after; and even by prosecutors in the Italian village of Trani, which, as Stacy Meichtry and Nathania Zevi of the Wall Street Journal noted, “hasn’t played much of a role in the global economy since the Crusades”—for merely evaluating what it is paid to evaluate and saying in plain English what it has concluded.
 Granted, S&P didn’t cover itself in glory during the downgrade, switching its math at the last minute and rewriting its premise to accommodate the use of a different, less-than-worst-case scenario, and thus opening itself up to political hacks eager to shoot the messenger.
 But the message is right: after all, America has, as PIMCO’s Bill Gross points out, $66 trillion worth of entitlement liabilities—and that’s present value—amounting to half a million dollars per household.
 Still, that fact won’t stop those who benefit from our lousy, unbalanced budget from screaming the loudest at the downgrade, and using every lever at their disposal—Congressional hearings; lawsuits; bought-and-paid-for “60 Minutes” so-called ‘investigative’ stories—to discredit and disable the folks at Standard & Poor’s.
 After all, this is what CEOs do when intellectually honest analysts, short-sellers and just plain folks criticize, publicly, their companies for flaky accounting, serial restructuring charges and worse.
 Which is why so few people bother any more.
 So welcome to our world, Standard & Poor’s, and keep speaking your mind.
 It may be the thing that saves us from ourselves.
Jeff Matthews
Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”
(eBooks on Investing, 2011)    Available now at Amazon.com
© 2011 NotMakingThisUp, LLC
                                                             
The content contained in this blog represents only the opinions of Mr. Matthews.   Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.  This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever.  Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored.  The content herein is intended solely for the entertainment of the reader, and the author.
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The Most Important Call of the Year: “I’ve Got All The Clarity I Need”

 We have, in the past, highlighted in these virtual pages the comments of David Farr, the outspoken and common-sense-laden CEO of Emerson Electric Co.
 Readers not familiar with Emerson should become familiar with it, for in its long history (it was founded in 1890) Emerson has outperformed its more famous relative, General Electric (founded two years later), by a wide margin…and never needing taxpayer dollars to bail itself out from bad decisions like Jack Welch’s bad decision to turn GE from a company that made stuff for Main Street to a company that ‘made the numbers’ for Wall Street, using GE Finance as a perpetual motion machine that lasted only as long as the credit cycle lasted.
 We once talked to an ex-executive at Emerson about the GE comparison.  He said to us: “You know we used to have a finance operation like GE, right?”  We said, “No, what happened to it?” He said, “We shut it down.”  We asked “Why?”  He said, “Because our CEO decided it was too risky.”  That’s the kind of CEO the ‘beat-the-numbers’ folks at GE could have used.
 In any event, Farr runs one of the most value-added earnings calls of the season, offering frank and unvarnished observations about not only Emerson’s far-flung operations, but also about the operating environment in which the company lives.
 And that environment is not getting any prettier, if yesterday’s call is any indication.  Indeed, we think yesterday’s call was the single most important this season, and perhaps this year-to-date.
 Now, for a full flavor of Farr’s comments, readers ought to get a hold of the full earnings transcript—or, better yet, listen to a replay of the call itself.
 But the heart of the call came two-thirds of the way through the Q&A, when he was asked by one of Wall Street’s Finest what triggered Emerson’s recent warning that growth was slowing, and whether it stemmed from the need for greater clarity out of Washington.
 Here’s what Farr said:
 “I just look at the order pace. I think the biggest issue that I’m watching right now is they’re not really — either in the US or Europe really addressing the gut issues. The US have enormous regulations coming at us right now.
 “There’s — the incentive to invest in the United States is negative and from my perspective.
 “People talk about ‘we want clarity’. I’ve got all the clarity I need. They’re spending, they’re regulating us, the tax rates, they’re talking about raising the tax rate.
 “Our tax rate this year will be around — in the US will be around 36%. We’ll pay in US taxes this year over $500 million, actually pay the US government over $500 million, and they say they want to raise it even more. And so I’m looking at that as a — I run a Company, I have a lot of money to invest and I look at that and I say I’m not going to invest it here and I think customers — I think a lot of customers have the same concern.
 “And then when you have a company like Boeing, you’re talking about one of the iconic US companies gets sued by the federal government. If that doesn’t get your attention, nothing will. They get sued for investing $2 billion in South Carolina. Last time I saw South Carolina was a part of the United States of America and you get sued for that. I tell what you, the CEO, you get my attention.”
Let’s hope Farr’s comment get some attention where it matters.
Jeff Matthews
Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”
(eBooks on Investing, 2011)    Available now at Amazon.com
© 2011 NotMakingThisUp, LLC
                                                             
The content contained in this blog represents only the opinions of Mr. Matthews.   Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.  This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever.  Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored.  The content herein is intended solely for the entertainment of the reader, and the author.
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The Least Reassuring Headline You Will Read Today


The least reassuring headline you will read today—and it may not get much attention with all the budget talk going on—is from our friends at Reuters:
 White House Not Worried About Double Dip – White House economic adviser Gene Sperling said on “Fox News Sunday” he was “not worried the U.S. will have a double-dip recession” – Reuters 
 The reason this is not as reassuring a headline as it might appear is that it comes amidst an earnings season that, aside from a few leading lights (mainly in the technology field and those companies doing significant businesses in Asia), has yielded news from the ground which is not nearly so perky as the ‘30,000 foot view’ preferred by lofty economics advisors such as Mr. Sperling.
 Pepsi, for example, had the following to say recently about its U.S. business two weeks ago:
 “Of the three factors impacting North American beverages—inflation, consumer demand and pricing—the consumer demand picture is the most concerning to us at this point.  In fact, the modest pickup in total consumer sending almost all U.S. businesses saw earlier in the year has reversed in the past several months.”
 And it isn’t just North American where things are wobbly.  Newell Rubbermaid warned last week:
 “Unfortunately we are seeing a softer economy in the US and Europe than we would hope for.”
 Indeed, this morning, Armstrong World Industries added its voice to the chorus:
 “We now expect our residential and commercial end markets opportunity to be slightly lower as the domestic economic recovery appears to be delayed.”
 There are many more examples of the sudden bloom of cautious commentary from businesses.  HSBC, no slouch in the world of global banking, this morning announced plans to cut 25,000 jobs—only a few days after the FT leaked that the company was going to “trim 10,000 people.”
 One might say HSBC “beat the number”…but in a double-dip sense.
Jeff Matthews
Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”
(eBooks on Investing, 2011)    Available now at Amazon.com
© 2011 NotMakingThisUp, LLC
                                                             
The content contained in this blog represents only the opinions of Mr. Matthews.   Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.  This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever.  Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored.  The content herein is intended solely for the entertainment of the reader, and the author.
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Memo to Jeff Immelt: When is an Apple Store NOT an Apple Store? When It’s in China…



 We kick off the return to non-Berkshire Hathaway topics here at NotMakingThisUp in the simplest way possible: by referring readers to a different blog.


 That different blog, which was brought to our attention by John Hempton, the ace proprietor of yet another blog, the Bronte Capital blog (which happens to be one of the best in the world), needs no introduction, no commentary, no elucidation from us..but after you are finished reading it, you might want to just think for a bit about what it means:


 http://birdabroad.wordpress.com/2011/07/20/are-you-listening-steve-jobs/


 And if you are Jeff Immelt, who is prepared to put half the vaunted GE jet engine business into a joint venture with the Chinese–the same crowd that thinks nothing of copying Apple Stores down to the shirts and name tags worn by the staffers–you should really think very very hard for a long time about what it means.


 What it means, we think, is you are putting your company’s future at risk.


Jeff Matthews
I Am Not Making This Up

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Munger’s Revenge, Concluded: The Tiger Woods Syndrome, and What Made Berkshire Hathaway as We Know It

 Well, Tiger Woods Syndrome is breaking out all over, even in Omaha, Nebraska.
 By “Tiger Woods Syndrome” we refer to what happens when the Mainstream Media has been sitting on a story it has long known of but couldn’t go with because the subject was too powerful: when the story suddenly, irrevocably blows wide open (like, oh, the guy’s wife tries to bash his head in with a golf club), well, suddenly everyone has a story to tell, and the press is happy to tell it.
And while the David Sokol Affair didn’t involve sex or golf, it did involve enough bad judgment to blow the cover off the notion that Warren Buffett’s perceived successor had everything a Berkshire shareholder could ask for, which is precisely when the knives came out here in Omaha at the Berkshire Hathaway shareholder meeting.
 Friends and financial reporters who’d been told things over the years would say quietly to us, “Don’t quote me, but…” and then tell a Sokol story (more about judgment and personality than about anything you could put down as being wrong) that had either been dismissed as just sour grapes from a Sokol competitor or had been suppressed for the same reason nobody in the Mainstream Media ever bothered to investigate Tiger Woods’ extracurricular activities: the guy was too rich and too powerful.
 And, hey, David Sokol had Warren Buffett’s blessing.
 But with Sokol gone, so is the glow—and a lot of shareholders would like to know exactly how close did Berkshire Hathaway come to putting Warren Buffett’s life’s work in the hands of a guy willing to pick off a few points in a stock ahead of his employer’s acquisition of that company?
 Unfortunately, the real answer to that question—probably a lot closer than Warren Buffett would like to admit—was never actually addressed at the Berkshire meeting, either by Buffett or Charlie Munger.
 Indeed, because of the Sokol Affair, Buffett seemed on his guard and more defensive than usual.  In contrast to last year’s defense of Berkshire’s relationship with Goldman Sachs, when Buffett came out swinging, this year he was more reflective and less direct in getting to the heart of the Sokol-related questions.
 He seemed still stunned at the whole turn of events.
 Charlie Munger, by contrast, was sharp, hard-nosed and positively voluble throughout.  Munger also got the funniest line of the day in the video within the movie that kicked things off.
 (The video—the best in years—was a laugh-out-loud takeoff on the TV show “The Office,” called “Michael’s Replacement,” in which Buffett and Munger take over at Dunder Mifflin from the clueless Michael Scott and his conspiratorial number two, Dwight Schrute.  When a jealous Dwight sizes up Munger, his replacement as Number Two, sneering, “You don’t look so tough,” Munger adjusts Dwight’s tie, leans in and says menacingly, “There are eighteen ways I could kill you.”)
 But it was in the six-hour Q&A following the movie that Munger demonstrated what has made him so valuable to Warren Buffett and to Berkshire Hathaway all these years, participating in an unprecedented number of questions, and with more substance and fewer jokes than usual.
 In fact, at one point Munger abruptly took over one of the Sokol questions from Buffett, saying sharply, “I’ll handle this,” when a shareholder suggested Lubrizol’s board of directors had violated its fiduciary duty by negotiating only with Berkshire Hathaway, and not auctioning the company.
 And whereas Buffett mainly played defense, with long-winded explanations of Sokol-related issues, Munger played offense, summing up matters crisply and, as usual, with no holds barred.


Sisters Under the Skin
 For example, after Buffett explains in long and meandering detail how he came to believe Lubrizol belonged in the Berkshire family, despite its tainted upbringing, Munger simply says,
 “You know ISCAR and Lubrizol are to some extent sisters under the skin…very small markets…fanaticism in service.  If you have any more like that, give Warren a call.”


We Own So Many Wonderful Businesses
 When Buffett wrestles with an explanation for the current valuation of Berkshire’s stock ($125,000 a share at the time of the meeting) compared to one observer’s estimated intrinsic value of $185,000 (based on the faulty premise that Berkshire’s $95,000 per share worth of investments are somehow unrelated to the insurance businesses and therefore a cash-equivalent that should be added to $90,000 per share for the businesses themselves) Munger dismisses the premise that Berkshire’s share price is tied to any break-up calculation, and instead focuses the crowd on the long-term value of Berkshire:
 “It’s terrible trouble you people have…we own so many wonderful businesses we hate to part with them.”


Europe Survived the Black Death…
 As usual, while Buffett takes the bright side of most issues in keeping with his inherent optimism in the future, Munger offers a dour, cynical view based on his broad knowledge of history and human behavior—but usually arrives in the same spot.
 Asked “How can a lousy long-term U.S. economy make you happy?” Buffett gives a long, enthusiastic, cheerleader’s answer, winding up with, “All I can tell you is…the power of capitalism is incredible.”
  Munger, on the other hand, dryly notes:
“Europe survived the Black Death when a third of the people died, but we’re gonna move on.”
  Still, Buffett is crisper and forceful when it comes to his comfort zone: Berkshire and its legacy.  He minces no words when asked about whether, and when, Berkshire will pay a dividend.
 “There will come a time, and who knows how soon because the numbers are getting big…when a dollar only buying 90c of value…but I predict the day Berkshire declares a dividend the stock will go down because that will mean it is no longer a compounding machine…”


It Had Its Head Up Its—
 And Munger does hold back at least once in the six hours of Q&A, when they are asked about Berkshire’s position in Wells Fargo, one of the banking giants whose inherent profitability has been impaired by the Dodd-Frank legislation and the housing implosion. Buffett defends the investment without much input from Munger:
“US banking profitability will be considerably less than early part of this century; one reason is the leverage will be reduced… If you keep out of trouble on the asset side, it’s a good business because credit is very cheap.  I like our positions there.”
  Yet, months later, speaking to investors in Los Angeles, Munger will say that what he admired about Wells Fargo is its management didn’t hesitate to admit “it had its head up its ass” when it came to mortgage lending.
 But Munger bit his tongue here in Omaha.


Not a Terribly Rational Thing
 Still, when he does speak here, it is just as straightforward as that observation in defense of Wells Fargo management.
 When asked about gold as an investment, for example, Buffett launches into almost a professorial discussion of investing.  “There are three categories of investment,” Buffett begins, describing currency, which depends on the behavior of monetary authorities to maintain its value; gold and other commodities that “don’t produce anything and you hope somebody will pay you more for later one,” and then assets “that make things, like a business, a farm”—which is the category Buffett and Munger have generally stuck to, with a few bets on currencies and commodities along the way.
 Munger simply says:
“Buying something that only goes up if the world goes to hell is not a terribly rational thing.”


This Attitude of Trust
 When Buffett is prodded by a shareholder about Berkshire’s lack of formal compliance procedures “like most firms,” he gets defensive, first saying “I don’t think most companies have them” (which is absolutely not true when it comes to financial giants like Berkshire), then dismisses the idea altogether:
“But we could have all the records in the world…they could be trading in their cousin’s name.”
  Munger, on the other hand, defends Berkshire’s culture entirely:
 “If you look at the greatest institutions in the world, they trust their people…it’s so liberating…I think your best compliance cultures are the ones that have this attitude of trust.”


Glitches
 That “attitude of trust” may be Munger’s Achilles heel when it comes to BYD, the Chinese car company of which Munger was a shareholder and fan for their efforts in battery technology well before Berkshire invested in the company.
 BYD’s initials stand for “Build Your Dreams,” but the company has been accused of copying other carmaker’s designs in diplomatic cables uncovered by WikiLeaks, one of which read: “BYD seeks to ‘Build Your Dreams’—based on Someone Else’s Designs.”
 Asked by a shareholder about the company, whose earnings and share price have been under pressure, Buffett demurs, saying, “Charlie’s the BYD expert.”
 Munger begins his answer with the worst line of defense, BYD’s stock price, and then dismisses any issues with bland assurances as uncharacteristic as they are unenlightening:
  “Of course the price is still way higher than the price BRK paid… Any company that tries to move as fast…is going to have its glitches…I’m quite encouraged…”
“Glitches” is the same term Munger employed to describe the Sokol stock trading affair in the immediate aftermath of that black eye, and it may be as understated an adjective when applied to BYD as it was to Sokol’s $10 million investment in Lubrizol in the weeks preceding Berkshire’s bid for the company.
 BYD thus far has failed to produce anything like its past promises, as contained in this 2009 Reuters article:
 BYD says that its new E6 electric car due out before the end of the year will do 250 miles (400km) on a single charge.
 This is a very big number. The Tesla electric sports car does almost as much, but has little room for anything else in the car but the battery.
 The E6 is roomy with space for five passengers and a good-sized boot. The battery tucks under the back seat.
—Roger Harrabin, Reuters
 The E6 was not out “before the end of the year” 2009, nor was it out before the end of the year 2010.  And when the Wall Street Journal inquired about the delay late last year, BYD gave the paper a howler of an excuse:
 Stella Li, BYD’s senior vice president and head of its U.S. operations, said the holdup was caused by BYD’s efforts to make the car roomier, especially its rear-seat area that was cramped thanks to a beefy battery pack that needs to be stored under the seat.
 Ms. Li told the Journal the E6 would be ready for sale in 2012.  (We here at NotMakingThisUp would call that bluff.)


A Star Rises in the East
 But, BYD aside, Munger has few blind spots, and enough blunt assessments about the ways of the world to keep Berkshire shareholders happy…
 On why Berkshire does not trade commodities like oil:
“Oil trading worked best of all for the people who bribed Nigeria.”
 On what caused the financial collapse:
“My answer is that past panics and depressions tended to involve great waves of speculation…. I think you can confidently expect a new mess before your career is over… Part of this mess is due to our academic institutions… Finance really attracts people who should be in snake charming.”
 On the political environment in Washington:
“I remember an era when we had a bipartisan foreign policy, the Marshall plan.  Now it seems we have two parties competing to be more stupid.”
  On CEO compensation:
“I think somebody has to be an exemplar for not grabbing all you can…”
 On which asset class he would add to his ‘circle of competence’ if he were going to live another 50 years:
“It would either be tech or energy.”
 But the best line of the day—one not picked up on by everyone in the arena, so fast and subtle it was—came towards the end, on a question asked by a very sincere investor.
 “If you were to have a baby in the next 5 years,” the shareholder begins, drawing titters from the crowd, “how would you incentivize them to compete against hungrier kids from other parts of the world…”
 Munger, whose age (six years older than Buffett and now approaching 90) has always been the subject of jokes between the two men, sits up in his chair and a huge smile crosses his face at the idea of becoming a father as an octogenarian:  “A star rises in the east,” he says in an awe-struck voice, drawing broad laughter as Buffett begins his answer.

A Fortune Fairly Won and Wisely Used
 Still, it is not wisecracking that makes Charlie Munger so important to Berkshire Hathaway.  It is the genius of his recognition—forged as an attorney working with struggling companies in Los Angeles before hooking up with his fellow Omaha native in the 1960s—that buying good businesses at reasonable prices was better in the long run than buying bad businesses however cheap they appeared to be, which was how Warren Buffett came to take control of Berkshire Hathaway before Munger came along.
 It was Munger’s crucial notion about the long-term value of good businesses versus bad business (“Bad businesses throw tough decision after tough decision at you; good businesses throw cash,” was how he once put it) that led the two men to make their first acquisition together in 1972—See’s Candies, for $25 million.
 And See’s was a very good business.  For one thing, it almost immediately began generating excess cash (well over a billion dollars so far) for Buffett to reinvest elsewhere.  For another, it created the template by which Berkshire would amass a collection of good companies, bought at reasonable prices, that today employee over a quarter-million people and churn out a billion dollars a month in cash.
 Asked about their legacies at the Berkshire meeting, Buffett initially wisecracks that he would like it to be “Old age,” then says he’d like to be known as a teacher.
 Munger, who has always seemed more well-rounded, if less wealthy, than his partner, sums up his answer as succinctly, and appropriately, as you’d expect:
“I have an uncle with a saying: ‘A fortune fairly won and wisely used.’”
Indeed.
The End.
Jeff Matthews
Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”
(eBooks on Investing, 2011)    Available now at Amazon.com
© 2011 NotMakingThisUp, LLC
                                                             
The content contained in this blog represents only the opinions of Mr. Matthews.   Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.  This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever.  Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored.  The content herein is intended solely for the entertainment of the reader, and the author.
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Munger’s Revenge, Part VI: What Bothers People

“What I think bothers people is that there wasn’t some big sense of outrage or something in the [press] release, and, you know, I plead guilty to that.”
—Warren Buffett, Berkshire Hathaway shareholder meeting, April 30, 2011.

 “The facts were complicated, and we didn’t foresee appropriately the natural reaction.  But I would argue that you don’t want to make important decisions in anger.  You want to display as much ruthlessness as your duty requires, and you do not want to add one single iota because you’re angry.”
—Charlie Munger.
 Thus two longtime business partners summed up their disconcertingly un-Berkshire-like handling of the David Sokol Affair in front of 36,000 Berkshire shareholders in Omaha this spring.
 Of the two, Charlie Munger came closer to answering the question than Warren Buffett, who used the old politician’s trick of phrasing the question that he wanted to answer, rather than the one that was asked.
 While Buffett held nothing back about the Sokol Affair throughout the six-hour Q&A session—fielding every Sokol-related question without a pause or a ‘no comment’—the question that was actually asked was not about Buffett’s lack of “outrage” in the press release.  It was about Buffett’s lack of “ruthlessness”—an adjective lifted straight from his Salomon Brothers Congressional testimony that is played for shareholders before the start of every annual meeting: “Lose money for the firm and I will be understanding/Lose one shred of reputation and I will be ruthless.”
 Letting Sokol resign from Berkshire—a money-saving move, to hear Buffett’s subsequent rationalization at the annual meeting—and repeating, in the press release, Sokol’s assertion that the Lubrizol stock purchases “were not a factor in his decision to resign,” is hardly “ruthless.”
 But what really stunned longtime Berkshire investors from that press release—and we’re not talking about the masses who jumped on the Berkshire bandwagon as Buffett’s celebrity profile rose in recent years and were more inclined to wonder what all the fuss was about with Sokol’s stock purchases and Buffett’s handling of the affair: we’re talking decades-long investors whose names a reader would recognize—was the single sentence in which Buffett excused the entire episode with the kind of defense you’d expect to hear from a Wall Street fat cat, not from “The Oracle of Omaha”:
 “Neither Dave nor I feel his Lubrizol purchases were in any way unlawful.”
 (As one Berkshire regular said, “Dennis Kozlowski didn’t feel he did anything wrong either.  Who cares what the guy feels, and since when did Berkshire Hathaway start doing business based on that standard anyway?”)
 No, Berkshire shareholders were not looking for “some big sense of outrage,” as Buffett put it; they were looking for a straightforward acknowledgement that what happened didn’t pass Buffett’s simple smell test for operating a business:
 “If it’s questionable whether some action is close to the line, just assume it is outside and forget it.  There’s plenty of money to be made in the center of the court.”
 And they would have expected a more ruthless exit strategy for an individual Buffett clearly believed violated Berkshire’s principles than the mere acceptance of that individual’s resignation.
 But there’s a second issue raised by the Sokol Affair, and one that has not been addressed by either Buffett or Munger to this day: how do they and the rest of the Berkshire board of directors know that nothing like the Lubrizol purchases ever happened before at Berkshire Hathaway?
 All we’ve been told is that Berkshire’s own law firm, Munger, Tolles & Olson, “worked with the Lubrizol counsel in pulling together what Warren described as Lubrizol’s proxy…” and that was according to Ron Olson, a partner at Munger, Tolles & Olson and a member of Berkshire’s board of directors.
 Leaving aside the obvious question—why a law firm founded by Charlie Munger and which today has a partner who also serves on Berkshire’s board of directors, was in charge of examining the Sokol Affair for the Berkshire board, rather than an outside firm without the obvious and multiple conflicts of interest—David Sokol was involved in plenty of Berkshire deals in the past.  He vetted the BYD investment for Buffett; he came up with the enormously profitable Constellation Energy investment during the financial crisis, and he presumably was involved in the PacifiCorp, Northern Natural Gas and Kern River Transmission acquisitions for MidAmerican.
 So how does Berkshire’s board of directors know that nothing like this occurred previously?  We’re not suggesting anything did occur: but, as a Berkshire shareholder, it seems like a logical question to ask, and if we were on the board, it’s a question to which we’d want the answer.
 And there’s a third issue raised by all this: how close did Berkshire come to naming David Sokol as the eventual replacement for Warren Buffett, and what does it portend for Berkshire shareholders when Buffett is no longer alive?
 One shareholder almost got the answer when he asked, “How can you ensure that there are no more Sokols in the lineup of successional managers that you have?”  But Buffett dismissed the notion that Sokol was indeed the successor-in-waiting, without disclosing what name actually appears in the envelope Buffett keeps in his desk for the day the unthinkable occurs:
 “Yeah, he made an assumption there about Sokol being the next in line, which I’m not sure was warranted….”
 Buffett then added, “That is one of the reasons that I think it’s a good idea if my son, Howard Buffett…be the chairman after I’m not around because you can make a mistake in selecting a CEO.”
 How Howard Buffett will handle that kind of mistake compared to how his father handled David Sokol is not clear.
 What is clear is that, given the high profile David Sokol carried at Berkshire Hathaway, Warren Buffett’s life work may have come uncomfortable close to being run by a guy who saw (and still sees) nothing “close to the line”about doing something (trading stock while  sniffing around potential acquisitions in what the investment bankers surely presumed was his role as a representative of Berkshire Hathaway) that his boss (Warren Buffett) would never, ever, have dreamed a CEO of his would be doing.
 And maybe that’s why attendance at this year’s meeting was down—for the first time in Berkshire history—and why Charlie Munger was unusually talkative at the meeting.
 The fallout from the David Sokol affair may not be over.
To be continued…
Jeff Matthews
Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”
(eBooks on Investing, 2011)    Available now at Amazon.com
© 2011 NotMakingThisUp, LLC
                                                             
The content contained in this blog represents only the opinions of Mr. Matthews.   Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.  This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever.  Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored.  The content herein is intended solely for the entertainment of the reader, and the author.
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Munger’s Revenge, Part V: “It’s a Berkshire Type Company”


Author’s Note: we continue contrasting Warren Buffett’s commentary at the April 30, 2011 annual meeting with David Sokol’s March 31, 2011 CNBC interview, using the Lubrizol proxy as a timeline. 
  This entry starts on the date Sokol first spoke to Buffett about Lubrizol as a potential acquisition candidate—one month after he first met with Citi bankers, discussed Lubrizol and first bought shares in that stock; one week after he finished loading up on nearly $10 million worth of that stock; and around the same time he spoke to Lubrizol CEO James Hambrick about what Hambrick appears to have logically reacted to as a takeover feeler.
 January 14, 2011: Sokol finally talks to Buffett.
 Warren Buffett: “Now bear in mind his first conversation when he said he owned the stock was January 14.  In between January 14 and March 14 [when the deal was announced], Dave gave no indication he’d had any contact with Citigroup of any kind…”
 David Sokol: “Mr. Hambrick called me on the 14th, so I either called Warren just before that call or just after it.  And ah, we had a pleasant conversation.  Mr. Hambrick told me about a health issue he had recently had and talked about my son, who has a similar health issue historically.”
 [After thus diverting the issue to family health matters involving his son, presumably to dredge up sympathy among CNBC viewers, Sokol discussed the conversation with Buffett.]
 “And then I called Warren and said, ‘You know, there’s an opportunity here either for you or I to have dinner with James.  And I told Warren I purchased shares in the company.”
 Warren Buffett: “At that time when Dave called me he said nothing about contact with Citigroup or anything of the sort…and I said, I don’t know anything really about the company.  He said, ‘Well, take a look at it.  It…might fit Berkshire.’  I said ‘How come?’  He said… ‘I’ve owned it and it’s a good company.  It’s a Berkshire type company.”
 And now Buffett acknowledges a mistake: “And, you know, I obviously made a big mistake by not saying, ‘Well, when did you buy it?’  But I think if somebody says ‘I’ve owned the stock’ you know it sounds to me like they didn’t buy it the previous week.”
 Indeed, it probably never crossed Buffett’s mind that an employee of his—any employee—would have taken down millions of dollars worth of a stock he had discussed with investment bankers, however innocently Sokol might have believed that discussion to be, particularly if (as the proxy stated) Sokol had been informed on December 17 that the company’s CEO was going to discuss Berkshire’s “possible interest” with his board of directors.
 Nevertheless, the future of Berkshire Hathaway—a conglomerate now roughly the size and scope of General Electric—ought not to be tied to what might or might not cross Warren Buffett’s mind: the fact that Sokol could keep a lid on his Lubrizol purchases for as long as he did, whether or not he violated any laws, illustrates the problem.
 Buffett, however, does not view more bureaucracy as the answer: “We have 260,000 employees… At Berkshire, there are presently three people that can execute trades and then there are a few other clerical people that would see what was done….
 “If you take Berkshire at 260,000 people, you know, that’s about the number of households in greater metropolitan Omaha.  And as perfect as we like to think we are in Omaha, I will tell you there’s lots of things going on in Omaha right now as we sit here that, you know, do not match the rules….
 “The problem, obviously, with the Sokol thing is it hit very very high up, you know.”
 For his part, David Sokol played down the idea that Lubrizol was even a potential acquisition target for Berkshire Hathaway at that point:
 “And frankly, at that time, Warren was pretty cool to the idea.  He says, ‘Yeah, I know the company.  It’s interesting, but I’m not sure it economically makes sense.’ But he hadn’t looked at it for a while.  ‘But, you know what, why don’t you go ahead and have a look and see if there’s anything there.’ And subsequently [I] had dinner with James… I believe it was the 25th.”
January 19: “Members of Lubrizol’s senior management met with Citi and Evercore to discuss Mr. Hambrick’s upcoming meeting with Mr. Sokol.”
 Certainly the Lubrizol team wasn’t “cool to the idea”: they reacted as any public company would react to a potential takeover bid in the works.
January 25: “Mr. Sokol and Mr. Hambrick met in Cleveland, Ohio.  The two executives discussed their respective backgrounds and business.  Mr. Hambrick provided Mr. Sokol with an overview of Lubrizol’s corporate culture, philosophy and operations.  Mr. Hambrick also discussed Lubrizol’s overall business and past and expected financial performance….
 “Mr. Sokol indicated that he did not believe that there was any more information that Berkshire Hathaway needed at that time, but said that he would get back to Mr. Hambrick if additional meetings would be helpful….
 Buffett: “It struck me as a business I didn’t know anything about initially.  You know, you’re talking about petroleum additives… Are there competitive moats, is there ease of entry, all that sort of thing.  I did not have any understanding of that at all initially…
 “And I talked to Charlie a few days later…and Charlie says, ‘I don’t understand it either.’”
 Sokol, on CNBC: “Well, just before that dinner, he [Buffett] had sent me an email…saying, ‘The real question is…can they sustain this margin growth…that they’ve had the last couple of years?’…
 “That was the primary conversation then that I had with James [Hambrick].  And James offered that if Warren had an interest in continuing the discussion, he’d love to come and meet Warren.  And so, [I] talked to Warren the next day and from that point on I had no more conversations…”
 At this point, CNBC’s Joe Kernen interrupted Sokol: “You knew at that point you had almost 100,000 shares and the wheels were starting to turn for a possible acquisition by Berkshire.  At that point did that seem to you that this doesn’t smell right and maybe I should sell this right now before—”
 “Not at all,” Sokol said.  “Actually I think it would have been wrong for me to do anything.  Once I mentioned to Warren that James had an interest, to me then it was a Berkshire opportunity, whether Berkshire would want to do it or not was up to Berkshire…”
 Unfortunately, Kernen didn’t press the real issue—that Sokol ought to have realized that it was “a Berkshire opportunity” the minute he spoke to Citi’s investment bankers about Lubrizol back on December 13, which the Lubrizol proxy identified as the day Sokol spoke to Citi’s bankers and told them, according to the proxy, that Sokol was interested in speaking with the Lubrizol CEO “about Berkshire and Lubrizol.”
January 27: “Mr. Sokol responded to Mr. Hambrick’s offer to meet with Mr. Buffett by calling Mr. Hambrick, stating that it would be helpful for Mr. Hambrick to meet with Mr. Buffett… Mr. Sokol also said that, if Mr. Buffett wanted Berkshire Hathaway to proceed with an acquisition of Lubrizol, Mr. Buffett would have a view on what Berkshire Hathaway would be willing to pay, but that Mr. Buffett would not make an offer unless Mr. Hambrick wanted him to do so.”
January 27: “Mr. Buffett…called Evercore’s Chairman and indicated that Mr. Sokol’s feedback on his meeting with Mr. Hambrick had been very positive and that Buffett was interested in having Berkshire Hathaway acquire the outstanding shares…if it could be done at a price that made sense to Berkshire Hathaway.   Mr. Buffett also indicated that he was very interested in an opportunity to meet with Mr. Hambrick, and that, subject to the meeting, Berkshire Hathaway would be willing to make an offer at the meeting on February 8, 2011 if Lubrizol was willing to receive such an offer.”
February 8: “Mr. Hambrick met with Mr. Buffett in Omaha, Nebraska… At this meeting, Mr. Buffett responded to a question from Mr. Hamrick about price by saying that Berkshire Hathaway would like to make an offer to buy all of the outstanding shares of Company common stock for $135.00 per share in cash….”
 Buffett: “What Dave passed along to me after having that dinner with James Hambrick, and which I later confirmed in a lunch when James Hambrick came out here…I got a good understanding of industry dynamics and how the business had developed over time…
 “I looked at the question of ease of entry…I decided there’s probably a good size moat on this.  They’ve got lots and lots of patents, but more than that they have a connection with customers…
 “I felt I had an understanding of the economics of the business… I think Lubrizol will be the leading company for a very, very, very long time.  And that’s the conclusion I came to.”
March 8: “Berkshire Hathaway and Lubrizol entered into the confidentiality agreement.  Later that day, Munger Tolles [Berkshire’s law firm, and Charlie Munger’s namesake] provided Jones Day [Lubrizol’s law firm] with initial comments on the draft merger agreement….”
March 14: “Berkshire Hathaway and Lubrizol announced the signing of the merger through a joint press release.”
 Buffett: “On March 14, when the deal was announced in the morning, I got a call from John Freund…John Freund works for Citi in Chicago, and he…has handled the great majority of our business in equities for decades, and I’ve got a direct line to him…  And he called and said ‘congratulations and…that Citi’s team had worked with Dave on this acquisition, and they were proud to be part of it…
 “And this was all news to me…
 “And the next day, I had Marc Hamburg, our CFO, call Dave, and Dave readily gave him the information about when he had bought the stock and how much.”
 So far, so good, until Hamburg asks Sokol about Citi’s involvement:
 “Dave said…he thought he called a fellow there to get their phone number, which turned out to be somewhat of an understatement.”
 How much of an understand Buffett will find when he reads the “Background to the Merger” detail in the draft of the Lubrizol proxy statement…
March 18: Buffett receives Lubrizol proxy draft material, detailing Sokol stock purchases.
Buffett: “At that point…our law firm got involved…in their input to the Lubrizol lawyers as to what we had seen that was different or what we had seen that they didn’t know about that we could add…
 “And I believe he [Sokol] was interviewed at least three times about both the stock purchases, the history of things with…his relationship with Citigroup, and they were assembling this information…
 “And we decided that when we got back [from Asia] we would need to have a prompt meeting of the Berkshire Board about this matter…
 “And we got back on…Saturday the 26th, and on the 28th we were going to bring Charlie [Munger] into it before calling a board meeting…. And then, about five or so in the afternoon a letter was delivered by Dave’s assistant, which really came out of the blue…
 “He said he felt he was retiring on a high point and he gave the reasons why he was retiring… I don’t know whether the questioning the previous week had affected his attitude.  He would say not.  But in any event, we had that resignation…
 “So I drafted up a press release, which has since been the subject of at least mild criticism…”
March 30: “Berkshire Hathaway issued a press release announcing the resignation of Mr. Sokol.  The press release also indicated that Mr. Sokol purchases shares of Lubrizol common stock on December 14, 2010 and on January 5, 6 and 7, 2011. Lubrizol first learned of these share purchases and Mr. Sokol’s resignation on March 30, 2011.”
Buffett: “Now, in there was included the fact that Dave had no indication that—that Lubrizol had any interest in an approach from Berkshire and that, at least according to the final Lubrizol proxy, is not the case…. The Lubrizol proxy now says that Dave did know that Lubrizol had an interest on December 17.
 “But both in the two chances he had to review it [the March 30 press release] and then when he went on CNBC on a Thursday and talked for half an hour, he made no attempt to correct any of the facts in it.
 “Now, on Wednesday when we put out the report, we had to have a board meeting first… We also delivered—we, through our law firm, we phoned the head of enforcement division of the SEC and told them exactly the facts regarding the stock purchases and anything else that they might have cared to know.
 “So I think we acted in that case, very very promptly…
 “So from our standpoint and my standpoint, Dave was gone, minimum severance costs, minimum chances for lawsuits about compensation due to him and we had turned over some very damning evidence, in my view, to both the public and to the SEC.”
All very rational, and Warren Buffett is, if nothing else, entirely rational.  However, there is the matter of “being ruthless,” and here is where Buffett gets defensive.
 To be continued…
  
Jeff Matthews
Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”
(eBooks on Investing, 2011)    Available now at Amazon.com
© 2011 NotMakingThisUp, LLC
                                                             
The content contained in this blog represents only the opinions of Mr. Matthews.   Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.  This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever.  Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored.  The content herein is intended solely for the entertainment of the reader, and the author.
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Munger’s Revenge, Part IV: Serious Benjamins

At the Berkshire Hathaway shareholder meeting, continued…
“Why did you handle this matter in the inadequate way you did?”
 This, the first question of the day, is the most direct criticism ever leveled on Warren Buffett from an actual shareholder, and it is greeted not by boos and catcalls, but by applause.
 Buffett begins his answer by attempting to explain what he knew and when he knew it—which turns out to be surprisingly little.
 To show just how little Buffett knew of what was going on, we’re going to arrange Buffett’s Sokol comments from the meeting along the timeline provided in the Lubrizol proxy statement (in italics), as  events occurred, rather than in the order in which Buffett spoke at the meeting, and contrast them with Sokol’s own version of events from his March 31, 2011 CNBC interview.
Sokol/Lubrizol Timeline
Fall of 2010: Sokol meets with various bankers “from time to time” to discuss “capital-raising and transaction ideas.”  This includes Citigroup bankers, from whom Sokol asks for “more information regarding possible transactions in several industries, including the chemical industry.”  The Citi bankers generate “a list and descriptions of 18 companies, including Lubrizol…”
 According to Sokol, “I get dozens of packages from investment bankers all the time, on ‘Hey, have you thought of some of these companies?’ or this and that.”  Furthermore, Sokol claims he already knew of Lubrizol on his own initiative.  “I got interested in Lubrizol—frankly I can’t tell you where I first heard the name—sometime last fall.  I pulled their 10-K.  Found what they’ve been doing the past couple of years interesting.  I made a decision to buy some shares….”
 Buffett will not hear of Sokol’s interest in Lubrizol until January 2011.
December 13, 2010: Sokol and Citigroup meet “to discuss the list of companies” assembled by Citigroup bankers.  “During the course of the meeting, Mr. Sokol said that the only company on Citi’s list that he found interesting was Lubrizol.  When Mr. Sokol learned from Citi’s representatives that Citi had an investment banking relationship with Lubrizol and its Chairman…James L. Hambrick, he asked one of the Citi representatives to inform Mr. Hambrick that he was interested in speaking with him and discussing Berkshire and Lubrizol, if Mr. Hambrick were available.  Mr. Sokol also advised Citi that Berkshire Hathaway does not engage in hostile transactions, and that Mr. Hambrick should understand that if they met and nothing came of the meeting, their meeting would remain confidential.  Thereafter, Citi made Lubrizol aware of these discussions…”
This is the kind of stuff that M&A activity is made of—serious M&A activity, but Sokol plays it down on CNBC, making his focus on Lubrizol seem personal, not related to business:
 “Now they had sent me a package earlier, with a whole number of chemical companies listed in it, again, all public information.  And they wanted to sit down and see if I wanted to follow up on that.  I mentioned to ‘em when they called, I said, ‘Listen, I’m going to be in New York on the 13th, you know, let’s talk.’ Only a couple of them even seemed to be interesting. And I had mentioned Lubrizol as one of those because it was a company I’d already been looking at, and since it was on their list, I said, ‘well, if we’re going to sit down, let’s talk about it.’”
 Of course, anybody who knows anything about investment bankers knows that they pretty much don’t even go to the bathroom without trying to figure out a way to make money on it: they are out to sell businesses.
 And David Sokol probably knows as much about investment bankers as any businessman on earth.
 Furthermore, it is reasonable to assume that the “package” sent by Citigroup’s bankers went to Sokol’s business address, not his personal address—as would be the case if he had been looking for personal investments.
 But Sokol describes the meeting as a general get-together rather than a discussion about a potential acquisition for Berkshire Hathaway:
 “We had a broad conversation where one of the bankers who was in the meeting said he knew the CEO of Lubrizol, and I said, ‘Gee, if you know him well enough to set up a meeting, that would be great, I’d love to meet him.’”
 Buffett knows nothing of this.
December 14: Sokol buys his first Lubrizol.  According to Sokol, “I put an offer in, actually, to buy 50,000 shares with a limit price.”  He gets 2,300 shares.
 Buffett is still in the dark.
December 17: Citigroup contacts Lubrizol CEO Hambrick and relays “the substance of the conversation between Citi and Mr. Sokol on December 13.”   Hambrick “indicated he would inform the Board of Berkshire Hathaway’s possible interest…”
 “Later on December 17, 2010, Citi informed Mr. Sokol that Mr. Hambrick had indicated that he would discuss Berkshire Hathaway’s possible interest with the [Lubrizol] Board.”
 Buffett knows none of this.
December 21: Sokol sells his 2,300 Lubrizol.  “Tax-planning,” he described it on CNBC.
January 5: Sokol begins buying Lubrizol again, in size.  “I thought it was a good company, a company I’d be happy to be invested in long-term.  The stock came back down, I put an offer in to buy a hundred-thousand shares…”
January 6: Lubrizol’s board has a special meeting during which “Mr. Hambrick outlined Berkshire Hathaway’s possible interest as he understood it from his conversation with Citi.  The Board engaged in an intensive and thorough discussion about Berkshire Hathaway’s possible interest.”
 Lubrizol’s Board retains a law firm and an investment back to help it “review Berkshire Hathaway’s possible interest in acquiring Lubrizol.”
 Sokol buys more Lubrizol.
January 7: Sokol finishes his purchase of Lubrizol, a total of 96,060 shares.  That’s close to being a $10 million investment—some serious Benjamins.
 He still hasn’t spoken to Buffett about Lubrizol.
January 10: Lubrizol holds a special Board meeting for “an extensive and thorough discussion about Berkshire Hathaway’s possible interest.”  The Lubrizol Board instructs CEO Hambrick “to arrange a meeting with Mr. Sokol.”
January 12: Citi calls Sokol to arrange a meeting.
 Sokol tells CNBC, “The next thing that happened is, I think it was January 12th, the banker from Citibank called me and said, ‘Hey, I think Jim Hambrick is going to give you a call to see if you want to…get together for dinner.’”
January 14: “Mr. Sokol and Mr. Hambrick had a telephone conference during which they generally discussed the corporate cultures and philosophies of both Berkshire Hathaway and Lubrizol, and arranged to have an in person meeting on January 25, 2011.”
January 14 or 15: Sokol finally talks to Buffett about Lubrizol.

To be continued…
Jeff Matthews
Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”
(eBooks on Investing, 2011)    Available now at Amazon.com
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