Friday, April 6, 2018

Berkshire Hathaway as Idealized Private Equity

We quoted Buffett on P.E. in last month's "How Vulture Capitalists Ate Toys 'R' Us", updated below.

From the Columbia Law School's Blue Sky blog:
How different is private equity from Berkshire Hathaway? The phrase “private equity” has a certain ring to it, suggesting providing shareholder capital to buy and hold businesses.  In fact, most private equity firms use substantial debt to acquire companies, charge considerable fees to restructure them, and finally flip them as rapidly as possible, often to public capital markets.

Berkshire’s approach is essentially the opposite, and sounds more like what the phrase private equity connotes: regularly buying companies using solely its own capital, which includes leverage from insurance float but never debt, and holding subsidiaries permanently while giving managers free autonomy rather than costly advice.

Buffett has been criticizing private equity for decades, sometimes as a means of differentiating what Berkshire offers potential sellers of businesses compared to what private equity delivers.  Consider this 2008 passage (p. 220 of The Essays of Warren Buffett: Lessons for Corporate America):
Some years back our competitors were known as “leveraged-buyout operators.” But LBO became a bad name. So in Orwellian fashion, the buyout firms decided to change their moniker. What they did not change, though, were the essential ingredients of their previous operations, including their cherished fee structures and love of leverage. Their new label became “private equity,” a name that turns the facts upside-down: A purchase of a business by these firms almost invariably results in dramatic reductions in the equity portion of the acquiree’s capital structure compared to that previously existing.
Private equity participants scoff. In interviews for a book I am researching comparing Berkshire with private equity, executives wonder what is really so different between them and Berkshire. Some seem dismayed that Buffett receives adulation while their own industry draws rebuke. For example, George Baker and George David Smith, wrote in The New Financial Capitalists: Kohlberg Kravis Roberts and the Creation of Corporate Value (p. 29):
Warren Buffett earned a measure of popular respect by taking control of undermanaged assets and improving them. . . . The fact that management buyouts achieved much the same kind of result was lost on most people.
In truth, as my research and a related seminar I’m teaching show, private equity is a diverse industry with a wide range of styles, strategies, and results. True, leverage is a common source of acquisition financing, but sometimes no greater than that used by corporate buyers in strategic acquisitions.

Likewise, while private equity firms all tend to charge 2-percent of fund size plus 20-percent of returns over a hurdle rate, they vary in their extent of additional lucrative advisory and management fees. Firms also differ in the use of financial engineering—and related fees—such as arranging for dividend recaps (using debt to fund cash distributions to shareholders) and asset stripping transactions (such as sale-leasebacks to monetize the value of improved real property).

I am working on a project to classify private equity firms along vectors defined by such attributes as scale of leverage, depth of intervention, size of fees, degree of financial engineering, risk of insolvency, length of time horizon, level of outside investor returns, and relative effects on constituencies such as labor. Examined this way, on each dimension, Berkshire is at one extreme and well-known private equity firms reside along a continuum, with a few of the most prominent industry leaders at the other pole, the opposite of Berkshire....

The quote was:
And then there's 2011's "The Porn Shop Operators Strike Again: Harry & David files for bankruptcy";
``You can sell it to Berkshire, and we'll put it in the Metropolitan Museum; it'll have a wing all by itself; it'll be there forever,'' he says at the February meeting.  
``Or you can sell it to some porn shop operator, and he'll take the painting and he'll make the boobs a little bigger and he'll stick it up in the window, and some other guy will come along in a raincoat, and he'll buy it.''
-Warren Buffett 
On why a business may prefer selling to Berkshire Hathaway rather than a private equity firm.

I know Warren is talking down the bidding pressure that PE firms might put on the price he has to pay for privately held businesses but looking at his comments on PE over the years it's more than that:
He actually loathes private equity and its practitioners....
The addendum was a comment by a friend that Warren seems to get along with 3G Capital in their Kraft Heinz investment.
Some related posts:
Kraft Heinz, Warren Buffet and the Packaged Food Business
Buffett Buddy 3-G Capital Has Coca-Cola In Its Sights (KO; BRK; HNZ; BKW)
Investing Lessons From the 21st Century Thus Far: Own the Cash Flow
"Warren Buffett: Baptist and Bootlegger" (BRK.B)
"I can spend money faster than Imelda Marcos when things are right,"
Warren Buffet, quoted by Karen Richardson in this WSJ Heard on the Street column.///