It’s telling that even Berkshire shareholders are starting to think of Berkshire as a conglomerate.
Maybe it’s Berkshire’s recent shift towards large public company acquisitions. Maybe it’s the Sokol influence, including the increasing redeployment of generated cash back into Berkshire’s more recent, capital-hungry businesses. It would seem a good bet that – hypothetically of course - under Sokol-style leadership, Berkshire would become even more conglomerate-like than it is now. Perhaps much more.
Astute Berkshire-watchers and long-time shareholders never really saw Berkshire in that light. At least not up until maybe recently. We’ll remember that pre-Burlington Northern, Henry Kravis called Berkshire ‘the perfect private equity firm’. We also had always thought of BRK as a publicly traded private equity firm rather than a conglomerate.
Kravis: "He can make any kind of investment he wants," Kravis says of Berkshire CEO Warren Buffett, the object of his admiration. "And he never has to raise money." Kravis thinks Berkshire, with its piles of cash and trove of publicly traded shares with which to make acquisitions, is nothing less than "the perfect private equity model." What Kravis and co-founder George Roberts, 66, covet most is Buffett's ability to pounce on deals of all sizes in any economic environment. "He has certain advantages over us," says Kravis. "I would like to see us create those advantages for ourselves." *
Conglomerates, as we know, frequently rationalize acquisitions as being (hopefully) synergistic in some regard. Even the LTV’s and the Geneen/Araskog ITT’s, with disparate businesses, went after ‘central office’ and other synergies (on a side note, we’ll remember that ITT split up with Rand’s retirement: this huge, disparate enterprise felt that there was nobody at all available who could fill his shoes).
Berkshire, of course, doesn’t wring out that ‘synergistic’ element from its companies, and so its components still have some latent value remaining that would be even more valuable to a synergistic buyer. The businesses aren’t conglomerated, and so the typical ‘conglomerate discount’ doesn’t so much apply.
Instead, Berkshire has had more in common with private equity firms over the years, in both its activities and its performance. For two decades straight it outperformed not only Magellan but pretty much every private equity group for which there was disclosure.
Buffett has had the flexibility in Berkshire to pursue ‘whatever works,’ taking whatever kind of position he wants, in pretty much any asset class. There were no constraints as to investment category, scale, or any predefined risk profile. This is private equity/hedge fund territory, not the mandate of a large publicly traded conglomerate’s CEO.
Ironically, Buffett has routinely lambasted private equity firms. But that of course was for their key differences relative to Berkshire – fee structures and sources of leverage – and not necessarily their investment strategies, which for especially the top 20% have been successful on a Berkshire scale in recent yeras. Until recently, performance discussions involving Berkshire included comparisons to other leading hedge fund, private equity, and mutual fund managers, not the Araskogs of the corporate world. There’s no comparison that's relevant to conglomerates, fortunately -- at least not yet.
So why now the comparisons to conglomerates, and this talk of ‘conglomerate discounts’? Is it Berkshire’s apparently gradual funding from high-ROE towards lower-ROE (and certainly lower-ROCE) business activities? It’s emerging capital-intensiveness? Or is it just an impression we have now, and we’re missing the mark?
When Kass criticized Buffett a year or so back, it was for Buffett’s supposed ‘style drift’. Kass went on about derivatives, alternative investments, and such. Though his call was timely (or lucky) in retrospect, Kass likely had his 'style drift' argument completely backwards. If we were going to make the case that we're seeing style drift in the context of Berkshire, it would be if we were getting away from alternative investments.
This leads to the discussion of management succession. Will Berkshire sans-Buffett still be as opportunistic to ‘alt inv’? While we keep hearing that the stock-picking side is increasingly less material to Berkshire results, the conclusion then seems to be that operating (and insurance/risk management) skills will be more critical. Maybe. But if so, then maybe the ‘conglomerate’ folks are correct in thinking that’s where we’re headed (or that that’s where we are already). That would be a shame.
We’ll be giving up something if we veer off the ‘private equity’ trail we’ve been on. It would be encouraging if there could be some acknowledgement that we’re still headed down that road – that that’s the culture we have in place well into our future. For long-term holders, getting away from private equity thinking (ie, open and opportunistic) and becoming a conglomerate – even an acquisitive one - is a ‘style drift’ that might be of concern.
Which leads to discounts. I’d argue that nobody understands valuation better than Buffett – Berkshire is where it is because he understands valuation inefficiencies. Some of these valuation differences – different perspectives on the same underlying business – are permanent. They’ll always exist, regardless of market perceptions. Others are driven by perceptions. Some examples of each:
• We know that the same business, privately owned, will carry a discount versus its publicly traded twin due to the relatively illiquidity of its position. Buffett takes advantage of this discount better than anyone.
• I’ve noted before that in looking at Berkshire from a ‘conglomerate’ point of view, we should remember that Berkshire’s companies (unlike many traditional conglomerates) each has potential buyers to which it would be more valuable than it is to Berkshire (eg, a strategic buyer). The market probably isn’t oblivious to that.
• We know that an interest that’s controlling will be more valuable than a minority partner’s proportionate share. The discount relative to this is driven in part by minority holders’ confidence level that the controlling interests are aligned with theirs -- including into the future.
• Both private buyers and public markets will discount businesses where there is a perceived ‘key person’ dependency. That’s textbook – typically for small businesses of course - and it can be significant. It can be a significant driver here.
There are others of course, but the point is that there are several issues the market considers in assigning discounts. Some are embedded, some are transitional. I’d argue that to the extent the market discounts Berkshire, it’s not necessarily because it doesn’t understand Berkshire, but because perhaps it does. To the extent that these discounts (or premia, as the case may be) are embedded, fine. But where they are market-subjective, the market may be telling us that something could be improved upon -- that it has concerns that need to be resolved. These aren’t discounts we want.
So is Berkshire going to continue to be primarily a rare publicly traded private equity firm? Or a conglomerate? Right now the market isn’t getting a clear signal. If anything, the company has not been convincingly reassuring in that regard.
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As a follow-up - Kravis was envious of Buffett's ready access to capital to do 'alternative investment' deals - both through its access to low-cost float (vs having to go to the bond markets) or alternatively, through the use of Berkshire company stock, which is a coveted option for some sellers (assuming, for this discussion, value parity for BRK holders). Blackrock, Kravis, and others have tried to at least start to address this by moving toward the equity markets, preferring that to leverage in some cases. They are taking a lesson from Buffett. (I'm sure they'd like to replicate Buffett's access to low-cost float, if they could find a way)
Alternative investments are where the high-return opportunities have been, and will likely be in the future (look at Berkshire's returns on these in recent years, vs for example 'working for a living' sweating out returns in some of Berkshire's cyclical businesses).
Most of us don't have access to the best hedge funds - the top 20% of which, by the way, rival Berkshire at its best. They are either closed to new money, or we wouldn't make the entry level. Research on this has linked likelihood of returns to having access to 'the very best' managers - pick your jockey carefully, as the best usually continue to produce the best results. We have Buffett.
That's the arena we want to be competing in. That's not to disparage good businesses, of course. But we want flexibility to be opportunistic.
Ideally, Buffett's successor will be able to go at least toe-to-toe with the Kravis' in alternative investments.
Maybe it’s Berkshire’s recent shift towards large public company acquisitions. Maybe it’s the Sokol influence, including the increasing redeployment of generated cash back into Berkshire’s more recent, capital-hungry businesses. It would seem a good bet that – hypothetically of course - under Sokol-style leadership, Berkshire would become even more conglomerate-like than it is now. Perhaps much more.
Astute Berkshire-watchers and long-time shareholders never really saw Berkshire in that light. At least not up until maybe recently. We’ll remember that pre-Burlington Northern, Henry Kravis called Berkshire ‘the perfect private equity firm’. We also had always thought of BRK as a publicly traded private equity firm rather than a conglomerate.
Kravis: "He can make any kind of investment he wants," Kravis says of Berkshire CEO Warren Buffett, the object of his admiration. "And he never has to raise money." Kravis thinks Berkshire, with its piles of cash and trove of publicly traded shares with which to make acquisitions, is nothing less than "the perfect private equity model." What Kravis and co-founder George Roberts, 66, covet most is Buffett's ability to pounce on deals of all sizes in any economic environment. "He has certain advantages over us," says Kravis. "I would like to see us create those advantages for ourselves." *
Conglomerates, as we know, frequently rationalize acquisitions as being (hopefully) synergistic in some regard. Even the LTV’s and the Geneen/Araskog ITT’s, with disparate businesses, went after ‘central office’ and other synergies (on a side note, we’ll remember that ITT split up with Rand’s retirement: this huge, disparate enterprise felt that there was nobody at all available who could fill his shoes).
Berkshire, of course, doesn’t wring out that ‘synergistic’ element from its companies, and so its components still have some latent value remaining that would be even more valuable to a synergistic buyer. The businesses aren’t conglomerated, and so the typical ‘conglomerate discount’ doesn’t so much apply.
Instead, Berkshire has had more in common with private equity firms over the years, in both its activities and its performance. For two decades straight it outperformed not only Magellan but pretty much every private equity group for which there was disclosure.
Buffett has had the flexibility in Berkshire to pursue ‘whatever works,’ taking whatever kind of position he wants, in pretty much any asset class. There were no constraints as to investment category, scale, or any predefined risk profile. This is private equity/hedge fund territory, not the mandate of a large publicly traded conglomerate’s CEO.
Ironically, Buffett has routinely lambasted private equity firms. But that of course was for their key differences relative to Berkshire – fee structures and sources of leverage – and not necessarily their investment strategies, which for especially the top 20% have been successful on a Berkshire scale in recent yeras. Until recently, performance discussions involving Berkshire included comparisons to other leading hedge fund, private equity, and mutual fund managers, not the Araskogs of the corporate world. There’s no comparison that's relevant to conglomerates, fortunately -- at least not yet.
So why now the comparisons to conglomerates, and this talk of ‘conglomerate discounts’? Is it Berkshire’s apparently gradual funding from high-ROE towards lower-ROE (and certainly lower-ROCE) business activities? It’s emerging capital-intensiveness? Or is it just an impression we have now, and we’re missing the mark?
When Kass criticized Buffett a year or so back, it was for Buffett’s supposed ‘style drift’. Kass went on about derivatives, alternative investments, and such. Though his call was timely (or lucky) in retrospect, Kass likely had his 'style drift' argument completely backwards. If we were going to make the case that we're seeing style drift in the context of Berkshire, it would be if we were getting away from alternative investments.
This leads to the discussion of management succession. Will Berkshire sans-Buffett still be as opportunistic to ‘alt inv’? While we keep hearing that the stock-picking side is increasingly less material to Berkshire results, the conclusion then seems to be that operating (and insurance/risk management) skills will be more critical. Maybe. But if so, then maybe the ‘conglomerate’ folks are correct in thinking that’s where we’re headed (or that that’s where we are already). That would be a shame.
We’ll be giving up something if we veer off the ‘private equity’ trail we’ve been on. It would be encouraging if there could be some acknowledgement that we’re still headed down that road – that that’s the culture we have in place well into our future. For long-term holders, getting away from private equity thinking (ie, open and opportunistic) and becoming a conglomerate – even an acquisitive one - is a ‘style drift’ that might be of concern.
Which leads to discounts. I’d argue that nobody understands valuation better than Buffett – Berkshire is where it is because he understands valuation inefficiencies. Some of these valuation differences – different perspectives on the same underlying business – are permanent. They’ll always exist, regardless of market perceptions. Others are driven by perceptions. Some examples of each:
• We know that the same business, privately owned, will carry a discount versus its publicly traded twin due to the relatively illiquidity of its position. Buffett takes advantage of this discount better than anyone.
• I’ve noted before that in looking at Berkshire from a ‘conglomerate’ point of view, we should remember that Berkshire’s companies (unlike many traditional conglomerates) each has potential buyers to which it would be more valuable than it is to Berkshire (eg, a strategic buyer). The market probably isn’t oblivious to that.
• We know that an interest that’s controlling will be more valuable than a minority partner’s proportionate share. The discount relative to this is driven in part by minority holders’ confidence level that the controlling interests are aligned with theirs -- including into the future.
• Both private buyers and public markets will discount businesses where there is a perceived ‘key person’ dependency. That’s textbook – typically for small businesses of course - and it can be significant. It can be a significant driver here.
There are others of course, but the point is that there are several issues the market considers in assigning discounts. Some are embedded, some are transitional. I’d argue that to the extent the market discounts Berkshire, it’s not necessarily because it doesn’t understand Berkshire, but because perhaps it does. To the extent that these discounts (or premia, as the case may be) are embedded, fine. But where they are market-subjective, the market may be telling us that something could be improved upon -- that it has concerns that need to be resolved. These aren’t discounts we want.
So is Berkshire going to continue to be primarily a rare publicly traded private equity firm? Or a conglomerate? Right now the market isn’t getting a clear signal. If anything, the company has not been convincingly reassuring in that regard.
-----------------------------------
As a follow-up - Kravis was envious of Buffett's ready access to capital to do 'alternative investment' deals - both through its access to low-cost float (vs having to go to the bond markets) or alternatively, through the use of Berkshire company stock, which is a coveted option for some sellers (assuming, for this discussion, value parity for BRK holders). Blackrock, Kravis, and others have tried to at least start to address this by moving toward the equity markets, preferring that to leverage in some cases. They are taking a lesson from Buffett. (I'm sure they'd like to replicate Buffett's access to low-cost float, if they could find a way)
Alternative investments are where the high-return opportunities have been, and will likely be in the future (look at Berkshire's returns on these in recent years, vs for example 'working for a living' sweating out returns in some of Berkshire's cyclical businesses).
Most of us don't have access to the best hedge funds - the top 20% of which, by the way, rival Berkshire at its best. They are either closed to new money, or we wouldn't make the entry level. Research on this has linked likelihood of returns to having access to 'the very best' managers - pick your jockey carefully, as the best usually continue to produce the best results. We have Buffett.
That's the arena we want to be competing in. That's not to disparage good businesses, of course. But we want flexibility to be opportunistic.
Ideally, Buffett's successor will be able to go at least toe-to-toe with the Kravis' in alternative investments.
