Berkshire Annual Letter 1997 (Part 7)
Whenever Warren Buffett buys into an industry whose leading participants aren’t known to him, he will always ask his new partners, “Are there any more at home like you?”
Here’s something interesting. When he asked that of the Blumkin family upon buying Nebraska Furniture Mart in 1983, he was given three names – R.C. Willey, Star Furniture and one other.
Many years later, Warren Buffett puchased R.C. Willey and put the same question to the CEO, Bill Child. He was given two names which matched the remaining two given by Blumkin.
It is not surprise that industry leaders knew who their strongest competitors were.
Subsequently, Warren Buffett also ended up purchasing Star Furniture.
The reason for the time gap between the various purchases was not because Warren Buffett wasn’t impressed by the companies. The main reason was that the owners were unwilling to sell! When they were, it didn’t take too long for Warren Buffett to conclude the deal.
The Use of Berkshire Stock in Acquisitions
Warren Buffett strongly prefers to use cash rather than Berkshire stocks when making acquisitions. The problem with doing so is that whenever he issues stocks, he is trading away a portion of a wonderful collection of businesses for something new. It is very difficult to find a company that is better than the sum of what they have currently.
If you consider all the Berkshire’s stock-only mergers, you will find that their shareholders are actually slightly worse off than they would have been if the acquisition didn’t take place.
So, most acquisitions will be done on cash terms. In those cases when the selling parties insist on getting stock, Warren Buffett will always include an attraction cash option to tempt as many sellers as possible.
Merging with public companies is not easy for Berkshire. It only makes sense for any company to pay a takeover premium when either
1) Its own shares are overvalued (seldom the case for Berkshire); or
2) There are synergies involved (won’t happen for Berkshire because they buy companies to operate as they would before). Some companies overpay for the synergy. Some others project unrealistic cost and revenue benefits.
Those companies who make use of granting options as one of their renumeration schemes will find their costs rising after being bought by Berkshire. Warren Buffett will always substitute the options grant with an equivalent cash paying component and charge it against earnings.