Pilot's Founders vs. Berkshire Hathaway
Warren Buffett's reputation as a straight shooter is called into question by the Haslam family in a dispute over the valuation of their remaining 20% interest.
“Imagine the record that he’s achieved with almost no enemies. Can you name another fortune that was built where there wasn’t a significant consensus or a significant view in the world that somehow that person gets vilified. I mean, I think about watching the changing narratives around Jeff Bezos or Bill Gates or Sam Walton and Walmart. … So it’s an amazing thing for Warren to have built this fortune and still have so much of the world viewing him as this sort of kind, gentle presence and patient.”
Berkshire Hathaway has a well-deserved reputation as a friendly acquirer of family owned businesses, particularly those who wish to avoid selling their interest to private equity firms or deal with the complexities of taking their company public. Warren Buffett’s longstanding reputation for integrity is unique in American business. As Chris Davis, a member of Berkshire’s Board of Directors, mentioned in a recent podcast, Warren Buffett has remarkably few enemies for a man of his vast wealth.
I admit to being biased as Berkshire shareholder for nearly twenty-four years and a longtime admirer of Warren Buffett and Charlie Munger. So, I was predisposed to skepticism when I read about the Haslam family filing a lawsuit against Berkshire Hathaway alleging that the family was being treated unfairly in the valuation of their remaining 20% stake in Pilot. However, as a shareholder and analyst, it is important to take an objective look at important matters, particularly when they could have adverse effects on future capital deployment opportunities.
After presenting the basic contours of the agreement between Berkshire and the Haslam family, I will discuss the key facts based on my reading of the lawsuit along with recent statements made by Warren Buffett about the deal.
Background
On October 3, 2017, a joint press release from Berkshire and Pilot was issued to announce Berkshire’s initial investment. On the same day, Warren Buffett and Jimmy Haslam appeared on CNBC to discuss the deal.
The terms of the 2017 agreement were as follows:
The initial transaction called for Berkshire to purchase a 38.6% equity stake in Pilot for $2.758 billion, implying a total value for the company of $7.15 billion.
Until 2023, the Haslam family would own a 50.1% interest and the Maggelet family would own 11.3%.
In 2023, Berkshire agreed to become the majority shareholder by purchasing an additional 41.4% equity stake. This was comprised of the Maggelet family’s 11.3% stake and an additional 30.1% stake owned by the Haslam family.
Following Berkshire becoming the majority shareholder in 2023, the Haslams would continue to own the remaining 20% minority interest and would have a put option to sell their remaining interest to Berkshire starting in January 2024.
This type of multi-stage deal has benefits and potential pitfalls. From the perspective of the Haslam family, they obtained significant liquidity in the initial transaction while retaining majority control. Berkshire, as the minority shareholder, lacked control but benefited from continued management by the founding family.
From Berkshire’s perspective, the final price of the transaction could not be known with certainty in October 2017. A formula would be used to determine the cost of the 41.4% equity stake that Berkshire was obligated to purchase in 2023.
Although Berkshire did not disclose the terms of the transaction for the initial 38.6% stake purchased in 2017, we know from the lawsuit that the agreed price was $2.758 billion and that this figure was arrived at by multiplying Pilot’s earnings before interest and taxes (EBIT) by ten with adjustments for cash and debt.
The same multiple of ten times EBIT was specified for Berkshire’s purchase of the 41.4% interest in 2023. According to Berkshire’s 10-Q for the first quarter of 2023, the purchase price for the 41.4% stake was approximately $8.2 billion which implies a total valuation for Pilot of $19.8 billion.
The terms of the agreement with the Haslams provided the family with a put option to sell their remaining 20% interest, or a part of that interest, to Berkshire for cash starting in 2024. As of June 30, 2023, Berkshire recorded a redeemable non-controlling interest of $3.37 billion to account for the 20% of Pilot owned by the Haslam family.
Warren Buffett made the following comments about the deal structure at Berkshire Hathaway’s 2023 annual meeting:
“… We arranged to buy it in three stages, with the third stage being at the option of the owner of 20%. The first stage we bought at what turned out to be a very attractive price. The second stage turned out to be a very good year for the diesel business, which means that the seller got a very good price.
And I would say that overall, we feel very good about the fact that we own the 80% at the price that we do, but we would’ve been better if we just bought the 80% to start with. And the last 20% the seller has the option, and that’s always an unintelligent way of structuring something.
We’ve had that arrangement with other, well, we had it with the Furniture Mart, we bought 80% of the [Nebraska] Furniture Mart on August 30th, 1983, almost 40 years ago, and it’s worked out perfectly. But when you give the other person the option, they’ve got some advantage.”
Mr. Buffett continued to say that he was happy to own 80% of a business that he likes very much because of Pilot’s large footprint close to interstates, saying that there’s “nothing like it.” He went on to praise Adam Wright, the new CEO that Berkshire named in 2023 after obtaining majority control. However, it is clear that he was not thrilled with the fact that the Haslams had the put option to sell the remaining 20% at a time of their choosing, even calling this an “unintelligent” way to structure a deal.
The Lawsuit
The central point of dispute in the lawsuit filed by the Haslam family is related to the valuation that will be used if they exercise their put option to sell their remaining interest in Pilot to Berkshire in 2024. The terms of the 2017 agreement seem straight forward in that the same 10x multiple of Pilot’s EBIT would be used. However, the question is how EBIT will be calculated now that Berkshire has majority control. To understand the controversy, we must delve into some accounting issues.
As a minority shareholder in Pilot, Berkshire accounted for its investment using the equity method of accounting. Under the equity method, Pilot was not consolidated in Berkshire’s financial statements. On January 31, 2023, Berkshire acquired majority control. This triggered a change in accounting requiring full consolidation. The valuation of assets acquired, liabilities assumed, and the 20% non-controlling interest were accounted for as follows:
As we can see, Berkshire accounted for a significant portion of the purchase price as Goodwill and other intangible assets. This represents the excess of the purchase price over identifiable tangible assets. Goodwill is subject to annual testing for impairment while certain types of intangible assets are subject to periodic amortization which has the effect of reducing EBIT.
Prior to Berkshire taking majority control, Pilot might have had intangible assets on its balance sheet attributable to its merger with Flying J in 2010. However, it is clear that far more intangibles now exist on Pilot’s balance sheet than prior to Berkshire taking control. This results in a higher level of amortization of intangible assets, an expense that would reduce Pilot’s EBIT.
By “pushing down” Berkshire’s basis in Pilot, the Haslams allege that EBIT will be artificially depressed in 2023 compared to what it would have been absent the change in accounting treatment. The family is seeking assurances from Berkshire that push down accounting will not be used to value their 20% stake should they decide to put it to Berkshire in early 2024. Furthermore, since the terms of the put require the Haslams to decide whether to sell their interest during the first sixty days of a year, the family is seeking timely clarification on this matter.
How much is at stake?
The public filing for the lawsuit is heavily redacted, presumably for competitive reasons, but we have some clues. The family alleges that under pushdown accounting, the valuation will effectively result in the use of a 6x multiple of EBIT rather than a 10x multiple. This implies that EBIT under pushdown accounting will be about 40% lower based on higher amortization charges. The lawsuit is very specific about the amount that the family fears losing but all of the figures are redacted.
We know that Pilot’s valuation was about $19.8 billion based on Berkshire’s purchase of its additional 41.4% interest on January 31, 2023 for $8.2 billion. This implies that EBIT, calculated under accounting in place during 2022, was roughly $2 billion.
For the sake of argument, assume that EBIT is $2 billion in 2023. The Haslams would expect to receive about $4 billion for their 20% stake at 10x EBIT. However, they are concerned that they would instead receive $2.4 billion, or around 6x EBIT under pushdown accounting. This is obviously a very large difference even though these numbers are necessarily imprecise since we do not yet know Pilot’s 2023 results.
The lawsuit docket shows that Berkshire filed its reply on October 30. Unfortunately, the entire filing is confidential. We also know that the Haslams filed a motion to expedite the proceedings so they would be in a position to make a decision regarding exercising the put within the first sixty days of 2024. However, based on what is called a “proposed” order for the case schedule, the trial has been set for November 2024. If I am reading this correctly, it implies that the Haslams will likely have to wait until January 2025 to exercise their put if they want to see this lawsuit through a trial. Of course, a settlement prior to trial is always a possibility.
Conclusion
When I read the complaint filed by the Haslam family last week, I refrained from writing an article immediately because I thought that it would be appropriate to wait for Berkshire to respond. However, since the response is sealed, I decided to publish this article with the facts that are known at this time. I am not an attorney but I did delve through the legal documents available to the public. I could be misinterpreting elements of the lawsuit and I am not presenting my interpretation as definitive.
I find it inconceivable that Warren Buffett has done anything underhanded in this matter. Mr. Buffett was probably not pleased to pay a high price for the 41.4% stake in January 2023 and might not be happy with paying a high price for the remaining 20%, but it makes little sense that he would manipulate the terms. After all, this is a man who completed a tender offer for XTRA shares on September 11, 2001 even though he had a legal “out” since the stock market had closed due to the terrorist attacks and it was clear that stocks would be down substantially when markets reopened.
The lawsuit documents a phone call that took place between Mr. Buffett and James Haslam II, Pilot’s founder, on October 13, 2023.Mr. Buffett is reported to have stated:
“I said that Berkshire will comply with the terms of the contract. That’s exactly what will happen,” and that “when and if the Haslam family decides to exit, we will do exactly what the contract says.”
Could there have been some misunderstanding between Mr. Buffett and Mr. Haslam in 2017 regarding the valuation of the put? Of course, that is a possibility. But the use of pushdown accounting is common. Berkshire has recorded goodwill and intangibles for other acquisitions in the past. The lawsuit alleges that this type of accounting change was not permitted by the agreement without the consent of the minority interests. While the complaint does include the original 2017 agreement as an exhibit, it has been redacted so we cannot read the text.
Hopefully this article has shed some light on the situation. Given Mr. Buffett’s reputation, I think he is entitled to the benefit of the doubt in this matter. If this case goes to trial, we may have to wait another year before the dispute is settled.
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Long Berkshire Hathaway.
Alex Crippen reports that Berkshire lost its request to schedule the trial for November 2024. The trial will be held early next year in time for the Haslams to make their decision on selling the 20% stake (within the first sixty days of the year).
Link: https://link.cnbc.com/public/33254223
Very interesting - thank you for doing the grunt work of ploughing through the filings.