Posted by Doug Rice on Mon, Apr 28, 2008 @ 02:58 PM
Today's FT reports that Mars along with Warren Buffett's Berkshire Hathaway has bought Wrigley, the chewing gum giant for $23,000,000,000.00. Mars has put in the majority of the money - going to all equity, but Buffett and Goldman put in a chunk of dough too - all debt.
This is the quintessential Buffett deal. A company with long-term minded, competent management and a mile-wide moat around it's revenue stream. It's a business he can understand. It's not complicated rocket science, nor a get rich quick scheme that could explode. It's a brand name that has been around for decades and will be around decades from now.
The question is: why he didn't buy the entire company? Buffett is sitting on a mountain of money to invest and, as evidenced by his acceptance of the subordinated role of the his investment (Goldman holds the senior debt), he thinks this is a very safe play. So why not just write the check? I will never have the access to ask him that question, but I wish someone would (hint, hint... CNBC, et. al.)
If you chew gum, you buy out of habit, just like those that drink Coke or buy See's Candy at holidays. Those habits are hard to break and Buffett knows it. The security of that income steam is the moat that he so loves. He avoided Google and many others because, in part, the habit of going to Google to search for information isn't nearly as ingrained to the new age internet users as is the reach for a fresh pack of Double Mint Gum in the check out line at just about any cash register.
What can we learn from this?
When investing for the long term you are buying the future cash flow. The way to determine that is to discount the future cash flow to it net present value. The more certain you are about that future cash flow, the more certain you are about the present value of the company. Buffett is far more certain about chewing gum than internet advertizing through search engines. So he can determine a value with reasonably high certainty and compare that to the price offered. If the price is reasonable, it's a buy, if not it's a pass.
Price is certain, but the value you get for the price isn't. So the more certain you can be in determining the value, the better decisions you'll make. So keep price and value as separate things and compare prior to determining if you will buy or pass. Buffett does, so should you.
Posted by Doug Rice on Thu, Apr 24, 2008 @ 03:05 PM
Today, it was reported that Delta's CEO testified in congress that if the merger with Northwest goes through, less than 1,000 jobs will be cut, from only management positions. Then he went on to say that the merger will yield about a $1,000,000,000.00 (a billion) in savings. But how he is going to save that much money and still employ essentially the same number of people? Unless the managers were earning $1,000,000.00 (a million) each, which even in the bloated executive suites of a major corporation isn't possible, where's the reduction in costs coming from? The numbers don't add up.
If Delta cuts flights that currently running, then they will cut the people currently employed to run them. If they don't reduce the number of flights, planes, etc. how can they cut costs this much?
When asked, apparently the CEO said something about oil being a "game changer" and this will make them stronger "at a time when prices continue to increase." But this makes no sense. Certainly both companies are able to buy their fuel at the same price currently and combined will not be able to get any further discounts. Fuel is typically bought through forward contracts to hedge cost increases for future flights that couldn't be reflected in the air fare. But this already being done. There isn't any cost savings in buying fuel for a combined airline vs. buying fuel for them separately. The market price is the market price. They are both big enough to get the best price available.
So, of course they are going to lay off more than 1000 people and many of them will be from unions of pilots, flight attendants, mechanics, etc. To think otherwise would be to either believe that the cost cuts will be less or to suffer from an inability to do math. The reason for merger from the shareholder perspective is cost cuts, so that number has to be high or the deal isn't worth doing. But the need for congressional approval requires a promise of continued jobs for most all, especially the politically charged area of union jobs.
In an attempt to placate both sides, the CEO has simply told both sides what they want to hear. Either that or he can't do math. Which do you think is more likely?
The only CEO I can remember that was honest about a merger was Larry Ellison of Oracle during the PeopleSoft acquisition. He came right out and said he was canning the majority of their people and taking all their clients. That caused a delay in the merger and almost killed it. Larry has the clout to say such things and a reputation for doing so, but other CEO's don't and, if they didn't know already, they learned that they need to put on a show even when they know full well what they are saying isn't what's really going to happen.
What can we learn from this?
When looking at events such as these, never accept the content, especially when dealing with politicians, without thinking through the numbers. A thousand managers laid off and a billion dollars in savings doesn't add up.
And they CAN do math.
Posted by Doug Rice on Tue, Apr 22, 2008 @ 03:08 PM
The headline on the front page of the FT, "Citi turns to HP for hints on how to handle a crisis" floored me this morning. The first thing I think of when I hear HP and crisis is that new word I had to learn during their last crisis: Pretexting. In fact, there's a Wikipedia page all about the HP spying scandal. What are they thinking asking a firm that's way of dealing with a crisis was to spy on their own people? Well, let's see if we can figure that out.
The article says they are going through something similar in that the shareholders are upset that the business model has changed from when they bought their shares and it hasn't been successful. Therefore they want them to return to the original model and spin off the divisions that are causing the problem. In HP's case, they bought Compaq and got into the low margin, high volume computer business and away from the cash cow of printers and other specialty technical equipment. This made the company larger but, in the eyes of many, not necessarily better. Same with Citi. They added Travelers with it's brokerages, consumer credit services and other far more risky ventures. This was fine as long as things were looking up, but now that the inherent volatility of these businesses has crept into the stock price, shareholders want to spin off the raging waters of risk and retire to the steady flow and calm current that that is the nature of banking. This makes sense for shareholders, but what's in it for management?
There must be something as the first words out of BofA CEO Ken Lewis' mouth when asked about the credit crunch were, "I've had all of the fun I can stand in investment banking at the moment," he said. Then he started cutting it out and going back to the calm waters of just being a bank. Why would Citi not follow suit? Why didn't HP listen to shareholders either?
What can we learn from this?
Both questions have the same answer, although I doubt anyone would say it in public. The crux of the issue falls on a misalignment of incentives. The risk that managers, especially CEO's and others with huge stock options, take isn't aligned with shareholders. To see this clearly just look at the payoffs. If the CEO takes a huge risk and loses, it doesn't cost them anything. In fact, most get to keep their jobs and try again. If not, they get fat severance packages and leave shareholders holding the bag. But if they take a huge risk and win, they get paid huge, while shareholders may not see much, if any, long term gain at all.
The shareholders are the ones taking the risk on the downside and therefore they should be the ones reaping the rewards on the upside. That's aligned incentives. But the incentive for management, and the investment banks pushing the deals, is skewed so heavily in their favor that it overwhelms normally sane people. If management didn't make a dime more because of these expansions, they wouldn't have happened. The entity taking the downside risk must get the upside reward if successful. In both these cases, the downside is held by shareholders, the upside by management. The risks are misaligned.
Ken Lewis knows this and although the upside did look bright enough for him to get in the risky businesses in the first place, he wants to run the bank more than make a quick payday. So he's going back to calmer waters. The new CEO for Citi, Vikram Pandit, who took over after Chuck Prince left in his own little scandal, doesn't have the clout that Mr. Lewis does. He can't tell the people he narrowly beat out for the CEO position that they will just have to learn how to ride it out without huge upside potential. He has only had the job for a few months and he needs to align with them to get their support if he is to be successful.
Alignment of incentives can be used as an invisible hand to guide actions when not being directly supervised. Misalignment of incentives works the same way.
Posted by Doug Rice on Mon, Apr 21, 2008 @ 03:10 PM
Today Forbes.com ran an article asking, "Will Newspapers Tempt Another Billionaire?" with a report from Newsweek that NYC Mayor (and billionaire) Michael Bloomberg might buy the NY Times. The article correctly suggests that the internet is killing the business model of traditional newspapers and ponders why all these bright, wealthy people are interested in a shrinking business. But the article never really answer the question at hand...why?
Let me take a crack at it. POWER, that's why. If you own the NY Times, or as Rupert Murdoch does Fox and the WSJ, you are, by default, very powerful. You only have to see Citizen Kane once to grasp the importance of newspaper ownership. And if you are already a billionaire, so what if you don't make money? It's not about money at that point anyway. It's about what you enjoy. And it's clear that Mayor Bloomberg enjoys power.
Martha Stewart made a mistake because she kept acting poor even though she was very wealthy. No billionaire in their right mind worries about a few thousand shares of stock and certainly doesn't risk jail for a few thousand dollars. She made a HORRIBLE decision, several actually.
Bloomberg thinks like a billionaire. He's got money and as mayor has power. But he is not going to be mayor forever, so it's time to look for another source of power. The NY Times fills that role nicely. Who cares if it's profitable? The Mayor's salary isn't profitable either, but I'll bet the perks are pretty cool.
He's interested because it's one way that he can remain in the spotlight, staying powerful and influential. That's what owning a newspaper does for you, especially the NYT.
(Of course, so does being Governor.)
What can we non-billionaires learn from this?
If you find that you're acting out of habit long after the habit has ceased to be useful, your making a Martha mistake.
If you simply accept the conventional wisdom without question, in this case buying a firm is about making more money, then you will avoid/ignore/miss the Bloomberg opportunity to fill a need.
Turn the autopilot off and put your thinking cap on.
He did, she didn't, you should.