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2002: How does Berkshire do due diligence on acquisitions?
AUDIENCE MEMBER: Good evening from Germany. My name is Norman Reinzhoff (PH). I’m a shareholder for about 10 years. And I want to thank you gentlemen for your long-term performance.
I brought you two of my favorite German chocolates. One for you, Mr. Buffett. One for you, Mr. Munger. And I will give them to you tomorrow at the steak house.
WARREN BUFFETT: How much do they sell for a pound? I’m just curious. (Laughter)
AUDIENCE MEMBER: Well, by the way, this is not the chocolate company you wrote to two years ago.
WARREN BUFFETT: Oh.
AUDIENCE MEMBER: They were sold about a week ago for a very low price.
WARREN BUFFETT: Is that —
AUDIENCE MEMBER: This can still be fixed. (Laughter)
My question is concerning that what you were just describing as smelling.
And, I mean, you told us in former shareholder meetings that if management loves money, do not invest.
If they love what they do, preferably if they come tap dancing to the office every day, and all other things are right, then invest.
That resonated to me very good with the biblical truth that not money itself, but love for money, is the root of all evil.
As a principal that once made once made Prussia the largest of all kingdoms, namely the ethos of doing a job for its own sake.
You tell us in this year’s report that you buy a company after talking to the owners for no more than 90 minutes.
I’m wondering what kind of — is it the wisdom of experience, just like you described it, or do you do more background work before talking to the owners for 90 minutes?
What’s the process like? Do you do background checks or do you talk to competitors?
Do the other people in headquarters do that work for you? How does this whole thing work?
WARREN BUFFETT: Well, it’s a very good question. And all of the things you suggest might well make sense. I mean, talking to competitors, talking to ex-employees, talking to current employees, talking to customers, talking to suppliers, all of those things Phil Fisher laid out in a book over 40 years ago, and we have done a fair amount of that over the years.
But, Charlie would have behaved exactly the same way I did on the company you’re referring to.
I got a call from Craig Ponzio in December, on a Monday. It was about a company that made custom picture frames.
I’d never heard of the company before. I’d never heard of Craig before.
I didn’t talk to him on the phone much more than 15 minutes. He’s a very — he’d be here today but his wife became seriously ill, at least we hope it’s not serious, but at least there was a problem last night — but Craig talked to me, maybe 20 minutes. And, you can tell when — I mean, it’s just all the difference in the world.
And he laid out what the custom frame — how the — custom frame picture business works, and it’s not complicated.
I hadn’t thought about it for 10 seconds in my whole life up till then, you know. I’d had some pictures framed — you know, I get around (laughs)
But it’s not hard — I mean, if you think about it for 30 seconds, you — the economics of the industry will sort of make themselves manifest to you.
There are 18,000 or so framers in the country. It’s a small business. So you’re dealing with thousands of people.
Now, what’s important to those thousands of people that you’re dealing to? They’re doing 250 thousand, or 300, or 400 thousand dollars of business a year, and they have customers who come in periodically — like I come in once every three months, or every six months, and say, here, I’d like a frame, and they may ask me about what kind of frame I want or I may leave it up to them.
It’s a service operation to a very great degree. And Craig built something starting with, in 1980 or so, with 3 million of sales, he built an organization that became enormously responsive to these 18,000 or so framers.
They call on those people five or six times a year. They get 85 percent of the frames to those people the next day when they order them. That’s what counts in that kind of a business.
You know, you’re not supplying the Big Three with auto parts. You’re not — there’s all kinds of things that give it a distinctive economic character.
So Craig told me about that, like I say, in not more than 20 minutes. And he told me the price and he told me the capital that was employed and he gave me some — a few figures.
I knew in talking to him that he had a deal that made sense, you know, and I said, when can you come in? That was on a Monday. He said, I’ll be there Wednesday morning. And he came with Steve McKenzie, who is here today, and who I encourage you to meet, and I think they got there at nine and they left at 10:30, and we’d shaken hands.
I was hoping to see Craig at the — today — or tomorrow — but I won’t because of this illness.
But, I haven’t seen Craig since, you know. I mean, we made — he got this money, he knew he was making a deal, he had a reason why he wanted — he wanted to sell it to somebody that would be sure to close, that would be a good owner, where the people who worked there wouldn’t be worried because he was leaving.
He was leaving with a lot of money, and, you know, people — he wanted to be sure — a lot of people leave with a lot of money and they leave the employees behind and they don’t care what happens. But this guy cared. And I could tell that, and that’s a big plus with me.
So, you know, I have not been to their headquarters yet. I plan to be at their headquarters. Steve, I apologize.
But I understand what the business is about. And you can — most good businesses, you can understand what they’re about in a very few minutes, unless they’re a kind of business that you can never understand what they’re about.
I mean, there are other businesses, if you spent years on them you still wouldn’t understand what the hell is going on.
I don’t know which one of — which American auto company is going to the best 10 years from now. And if I spent all year talking to dealers for Ford and Chrysler and General Motors, and I talked to suppliers, and I talked to people who are driving their cars, I still wouldn’t know anything about what it’s going to look like five or 10 years from now.
But I know that you can’t crack our custom picture frame business. I mean, you cannot figure out a way to call on those 18,000 people that are in that business and figure out a way to divert their business to you when you can’t offer a frame as good as ours and you can’t offer service remotely like ours. So it’s a good business.
And Craig was 100 percent up — I mean, he told me exactly what he wanted to receive for the business. He wanted cash. You know, that fits us.
And there’s nothing complicated about it. I mean, you can drag it out for a long time. But what would be the sense of it? I mean, if you’re going to make a deal, you’re going to make a deal.
CHARLIE MUNGER: Yeah. If you stop to think about it, the ordinary result when a big publicly-held corporation buys another corporation is that, maybe two-thirds of the time, it’s a terrible deal for the buying corporation and yet the people have taken an enormous time doing it.
And we’ve bought all these businesses taking practically no time in doing it, and on average they’ve worked out wonderfully.
Why is that? That’s a good question. The answer is we wait for the no-brainers. We’re not trying to do the difficult things.
WARREN BUFFETT: We’re for those.
CHARLIE MUNGER: Yeah. And we have the patience to wait. And then we’re so peculiar that there actually are a good number of businesses in America where they prefer selling to us than to other people. That’s very helpful.
WARREN BUFFETT: I just saw a review of a major company. Made 10 acquisitions in a recent five-year period.
Every one of those 10 acquisitions was preceded by due diligence and all the baloney they go through, and they probably had an investment banker’s book and everything.
Not one of the 10 in 2001 lived up — or was even close — to the expectations of the presentation that was made at the time of purchase.
In aggregate, the 10 earned one-quarter of what they were projected to earn in 2001. In other words, the projections were for four times the actual earnings.
And these were companies with strategic — this is a company with a strategic, you know, acquisition department with loads of people to go over the due diligence with investment bankers, quote, “helping them,” end quote, all along the way.
And, you know, and 10 out of 10 failed miserably. And, you know, you have to ask yourself, how can you produce that? Because the world didn’t go to hell during that period, either. I mean, that was not a time when we went into a great depression or anything of the sort.
It’s — they were getting — they were buying what was getting sold to them, and it was fulfilling some things that the management — myths — that the management had about itself. And managements have many myths about themselves.
And it isn’t that complicated if you just wait for the fat pitch. And the fat pitch doesn’t have to be somebody else doing something dumb or anything like that, because people don’t do that.
People come to us, come for a good reason. I mean, they usually want a transaction that a) they want one they’re sure to close. They want —if a deal is made — and they want one that will leave the people happy, that are at the business.
When it was announced at Johns Manville, I believe, that Berkshire was the buyer, I understand there was a standing ovation. And I’ve seen it at, you know, whether it’s Jordan’s or Star Furniture.
People are concerned. If you’ve been working at a company for 20 years and you know that the owning family is getting older and has some problems to take care of, believe me, they talk in the hallways about that.
What’s going to happen when, you know, the family sells the place? And people worry about that.
And to have an answer for them, so that they all sleep the night that it’s announced that the business has changed hands, means some —a lot — to some owners. And it doesn’t mean anything to other owners.
I don’t think we’ve ever bought a business from a financial operator. Can you think of any, Charlie?
CHARLIE MUNGER: I can’t think of one.
The — you know, somebody once defined hell, in a legal system, as a place with endless due process and no justice. And we’re getting close.
And similarly, in the corporate world, if you have endless due diligence and no horse sense, you’ve just described a corporate hell, at least for the people who own the business.