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2011: Why did Buffett quickly "warm" to buying Lubrizol?
ANDREW ROSS SORKIN: This question comes from a shareholder named Ralph Coutant (PH) who asks, “In in your press release, your original press release, you noted that Dave ‘brought the idea of purchasing Lubrizol to me on either January 14th or 15th.’
“Initially you said, ‘I was unimpressed.’ You went on to note that on January 24th you sent another note to Dave indicating your, quote, ‘skepticism’ about making an offer for the company.
“However, in a very short period of time after Dave’s discussion with Lubrizol’s CEO, you, quote, ‘quickly warmed’ to the idea.
“Please clarify what caused you to, quote, ‘warm’ to the idea so quickly if this didn’t strike you as being a great business at first glance. What changed? And what was David Sokol’s role in convincing you?”
WARREN BUFFETT: Yeah, the — it wasn’t that it didn’t — it struck me as a business I didn’t know anything about, initially.
You know, you’re talking about petroleum additives. I never would understand the chemistry of it, but I — but that’s not necessarily vital.
What is important is that I understand the economic dynamics of the industry. Is there — are there competitive moats? Is there ease of entry? All of that sort of thing. I did not have any understanding of that at all, initially.
As a matter of fact, I suggested to Dave, I said, “Charlie is a lot smarter about oil than I am. Why don’t you give him a call because I don’t — you know, I just don’t know anything about that business?”
And I talked to Charlie a few days later, and I don’t remember whether I asked him whether Dave had called or anything, but I mentioned it to Charlie, and Charlie says, “I don’t understand it, either.”
So when I talked to Dave later he had not talked — he had not gotten ahold of Charlie. I told him, “Forget it. He’s as bad as I am.”
What Dave passed along to me after having that dinner with James Hambrick, and which I later confirmed in a lunch when James Hambrick came out here on February 8th, but it was the same thing.
I thought I — and I still feel — I thought I got a good understanding of industry dynamics and how the business had developed over time, what the role of oil companies was and would be, in relation to a chemical additive.
The oil companies are the biggest customers. They sell base oil to a Lubrizol, but they buy the — they are the big customers, and they have gotten out of the business to quite a degree, although there’s two of them left in it.
So this industry had consolidated over time. I looked at the question of ease of entry. You know, every time I look at a business — when we bought See’s Candy in 1972, I said to myself, if I had a hundred million dollars and I wanted to go in and take on See’s Candy, could I do it?
And I came to the conclusion, no, so we bought See’s Candy. If the answer had been yes, we wouldn’t have done it.
I asked myself that same question, you know, can I start a soft drink company and take on Coca-Cola if I have a hundred billion dollars, you know?
Richard Branson tried it some years ago in something called Virgin Cola. You know, the brand is supposed to be a promise. I’m not sure that’s the promise you want to get if you buy a soft drink but — laughter) — in any event, I felt after my conversation with Dave, subject to a second conversation with James Hambrick, but covering the same ground, that it’s not impossible at all for people to enter this business.
But in terms of the service that — and the relatively low cost of what Lubrizol brings to the party, and in terms of people trying to break into a market and take them on — and it’s not a huge market, it’s probably only about a $10 billion market overall, I decided that there was a pretty good-sized moat around this.
They’ve got lots and lots of patents, but more than that, they have a connection with customers. They work with customers when new engines come along to develop the right kind of additive.
So I felt that I had an understanding — didn’t understand one thing more about chemistry than when I started — but I felt that I had an understanding of the economics of the business, the same way I felt that when the ISCAR people talked to me — I mean, who would think you can take some tungsten out of the ground in China and put it in the little carbide tools and that you could have some durable competitive advantage? But I decided ISCAR had a durable competitive advantage after looking at it for a while.
That’s the conclusion — I have come to the conclusion that — and Charlie as well — that the Lubrizol position is the dominant — or the number one company, not dominant — but the number one company, in terms of market share, in that business — is sustainable and that it’s a very good business over time.
It helps — you know, they are helping engines run longer, run smoother, you know. You know, when metal is acting on metal, the lubricants are important, and they’re always going to be around. And I think Lubrizol will be the leading company for a very, very long time.
And that’s the conclusion I came to. And I did not have a fix on that, nor did Charlie, prior to Dave relaying on to me what he had learned at that dinner, which incidentally, Lubrizol had been telling the world — I mean they made investor presentations and all that quite extensively over the years.
I simply hadn’t paid any real attention to it. And when it was explained to me, I thought I understood it, and I still think I understand it.
I think Lubrizol will be a very, very good addition to Berkshire. And I saw James Hambrick just yesterday, and despite the turmoil around this, they are very enthused about becoming part of Berkshire, that they regard it as the ideal home.
CHARLIE MUNGER: Yeah, you know, ISCAR and Lubrizol, to some extent, are sisters under the skin.
You’ve got very small markets that aren’t really too attractive to anybody with any sense to enter, and fanaticism in service. So if you have any more like that why, please give Warren a call. (Laughter)
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