“Warren twisted a lot of capital out of the textile business and invested it wisely. And that’s why we’re all here.” — Charlie Munger
This year marks the 60th anniversary of Warren Buffett’s acquisition of Berkshire Hathaway. Buffett knew the company well by the time he took control. He’d been a shareholder for over three years, buying stock at various prices along the way. An old-school textile manufacturer, Berkshire had fallen on hard times. From a peak of 11 mills and 11,000 employees after the Second World War (when it produced rayon for parachutes), its operations dwindled to just two mills and 2,300 employees by the time Buffett got involved. Management struggled to adapt to changing conditions in the industry and the stock reflected years of accumulated losses.
Buffett started buying at $7.60 a share. In spite of its problems, he calculated that the company had net working capital – before placing any value on plant and equipment – of around $19 a share. Recognising the gap, the company itself had begun repurchasing shares, which Buffett anticipated would continue. In 1965, he drove to Berkshire’s headquarters in New Bedford, Massachusetts, to meet its CEO, Seabury Stanton. Buffett agreed to sell his holding if the company launched a tender offer at $11.50 a share.
When Stanton subsequently launched an offer at $11.375, Buffett felt slighted. “It really burned me up. You know, this guy was trying to chisel an eighth of a point from having, in effect, shaken my hand saying this was the deal,” he told his biographer. Instead of selling, Buffett decided to buy. He made additional purchases on behalf of himself and his partnership at an average total cost of $14.86 a share, and gained the support of other existing shareholders. Soon, with a quarter of his partnership’s capital tied up in the business, he had control.
Initially, Buffett was delighted. “While a Berkshire is hardly going to be as profitable as a Xerox, Fairchild Camera or National Video in a hypertensed market, it is a very comfortable sort of thing to own,” he wrote to his investors. He soon changed his mind. Berkshire was not the low cost producer in its industry and it struggled to be competitive. In 1975, Buffett bought another New England textile company in an effort to eke out efficiencies, but ten years later, he finally threw in the towel and shut the business down. “I would have been better off if I’d never heard of Berkshire Hathaway,” he said.
One good thing to come out of the experience was that it encouraged Buffett to revise his organizational structure. Two years after buying Berkshire, he decided to buy insurance company National Indemnity (NICO), headquartered a few blocks from his office in Omaha. Rather than buy it out of his investment fund, Buffett Partnership Limited (BPL), he bought it out of Berkshire Hathaway. He would later cite this, too, to be a mistake:
If BPL had been the purchaser, my partners and I would have owned 100% of a fine business, destined to form the base for building the company Berkshire has become. Moreover, our growth would not have been impeded for nearly two decades by the unproductive funds imprisoned in the textile operation. Finally, our subsequent acquisitions would have been owned in their entirety by my partners and me rather than being 39%-owned by the legacy shareholders of Berkshire, to whom we had no obligation. Despite these facts staring me in the face, I opted to marry 100% of an excellent business (NICO) to a 61%-owned terrible business (Berkshire Hathaway), a decision that eventually diverted $100 billion or so from BPL partners to a collection of strangers.
Still, Berkshire Hathaway provided Buffett with permanent capital, not subject to the whims of investor redemption. Having withstood $1.6 million of outflows in January 1968 after lowering his fund return targets, permanent capital might have seemed alluring. It also released him from some of his fiduciary duties. In 1969, Buffett wound up his fund and went all-in on Berkshire. “I want to stress that I will not be in a managerial or partnership status with you regarding your future holdings of such securities,” he told shareholders. “I think that there is a very high probability that I will maintain my investment in…B-H for a very long period, but I want no implied moral commitment to do so.”1
The “collection of strangers” who remained Berkshire shareholders did very well (some more than others). The company’s market cap is approximately $1 trillion today and its stock price has compounded at an annual rate of 20% over the past 60 years. Given the success of the model, it’s surprising there haven’t been more copycats. Baby Berkshires have emerged in other markets around the world, but they remain novel: Fairfax in Canada, Investor in Sweden, Exor in Italy (now the Netherlands), Soul Patts in Australia. One reason is that the structure is not as lucrative for its sponsor as traditional partnership structures which throw off higher fees. Another is that it takes a long time to mature: Two thirds of Berkshire’s market cap has been added in the past ten years.
In the US, The Markel Corporation hues closest, its CEO hired specifically to help the founding family replicate Berkshire Hathaway’s business model. More recently, others have joined the fray. “If we could replicate even a portion of what Berkshire has created with their model,” reflected KKR co-CEO Joseph Bae at an investor conference last year. “Yes, there are elements of Berkshire Hathaway,” concurred Apollo CEO Marc Rowan after he announced a deal to take control of insurance company Athene. In these cases, it is the insurance aspect of the model being aped rather than the corporate structure.
Now, Bill Ackman of Pershing Square Capital is looking to replicate the corporate structure. This week, he announced a bid to take control of portfolio company Howard Hughes Holdings Inc. (HHH). “With apologies to Mr. Buffett,” he wrote, “HHH would become a modern-day Berkshire Hathaway that would acquire controlling interests in operating companies.”
Ackman has looked fondly on the Berkshire model for years. He asked questions at the 1994, 1998, 2003 and 2005 shareholder meetings (three of them about the financial services industry). He once even owned the stock in his funds. In 2014, he launched a closed-end fund listed in Amsterdam (and later London) that now accounts for 90% of his total assets under management. But it hasn’t performed well. It currently trades at a 30% discount to net asset value, having traded even wider in the past – an issue we discussed in The Ackman Discount last year. Berkshire, by contrast, trades at a premium (although its assets are not all marked to market). In his 2020 shareholder letter, Ackman compared the structure of his Pershing Square Holdings Ltd to a conglomerate like Berkshire but with tax advantages. He channelled Berkshire yet again when he attempted (unsuccessfully) to launch a new closed-end fund last year.
Will his latest transaction get him any closer? To analyze Bill Ackman’s plans for Pershing Square as well as a bonus on his investments in Fannie Mae and Freddie Mac, read on [total article length: 2,900 words].