The Digest #187
Damage repair, Claude Shannon, Elon Musk's pay, Intellectual obesity, Apple Vision Pro, Ignoring the market, Damodaran data updates, Apple packaging, Samsung, Big Pharma, and more ...
Damage Repair Moves
I recently read an interesting section of Warren Buffett’s 1982 Chairman’s Letter. Mr. Buffett devoted considerable space to a discussion of the proposed merger between Blue Chip Stamps and Berkshire Hathaway that would ultimately occur in 1983. The merger involved issuing shares of Berkshire Hathaway in exchange for shares of Blue Chip that Berkshire did not already own. The share exchange was intended to be fair by using “an identical valuation method applied to both companies.”
The entire letter is worth reading since the question of when to issue stock remains important today. When the acquirer issues shares below intrinsic value in exchange for control of a company at or above intrinsic value, the acquirer’s shareholders suffer harm. They are, in effect, selling part of their company at a bargain price in exchange for a business trading at a richer valuation.
Mr. Buffett presents three ways for shareholders to avoid being harmed when issuing shares to be used in an acquisition. First, the deal can be designed on a “value-for-value” basis which was the goal of the Berkshire/Blue Chip deal. The intent is to do the deal at a valuation fair to both parties. Second, if the acquirer’s stock is trading above intrinsic value, using stock can actually enhance the wealth of the acquiring company’s shareholders since overvalued currency is being used for the deal. Third, a company can use stock in an acquisition and subsequently repurchase an equivalent amount of stock to effectively turn it into a cash transaction.
“The third solution is for the acquirer to go ahead with the acquisition, but then subsequently repurchase a quantity of shares equal to the number issued in the merger. In this manner, what originally was a stock-for-stock merger can be converted, effectively, into a cash-for-stock acquisition. Repurchases of this kind are damage-repair moves. Regular readers will correctly guess that we much prefer repurchases that directly enhance the wealth of owners instead of repurchases that merely repair previous damage. Scoring touchdowns is more exhilarating than recovering one’s fumbles. But, when a fumble has occurred, recovery is important and we heartily recommend damage-repair repurchases that turn a bad stock deal into a fair cash deal.” [Emphasis Added]
In many cases, the sellers of a company might want to transact for stock rather than cash, for example to minimize the immediate tax consequences for shareholders through a tax-free exchange if the deal qualifies.
There have certainly been cases in the history of Berkshire Hathaway when stock has been used for an acquisition at a time when shares appeared to be undervalued. The shares issued as part of the BNSF transaction in 2010 were arguably undervalued. However, at that time, Berkshire did not have a repurchase policy in place. In 2011, a repurchase program was established allowing management to buy back shares at no more than 110% of book value. While this was later changed to 120% of book value, the effect was to establish a “floor” below which the stock almost never traded.
Berkshire’s repurchase policy was amended in 2018 to remove a specific price-to-book value restriction and the company has repurchased $72.9 billion of stock since then. While Berkshire is currently swimming in cash and would most likely prefer to use it for any acquisition, the company can choose to use stock instead and immunize the effect by repurchasing shares. However, funds used for repurchases are now subject to a 1% tax, a situation that did not exist when Mr. Buffett wrote his 1982 letter.
Articles
Elon Musk Is Overpaid by Matt Levine, January 31, 2024. A Delaware judge struck down Elon Musk’s 2018 Tesla pay package this week citing close ties with directors who agreed to the package. As Matt Levine points out in his newsletter, even if the vast majority of Tesla shareholders are satisfied with the arrangement, it only takes one dissident to file a lawsuit and potentially upend the agreement. (Bloomberg)
Sign up for Matt Levine’s newsletter to receive his columns free of charge.
Warren Buffett Q&A Transcript || Detroit Homecoming (2014) by Kingswell, January 29, 2024. “On September 18, 2014, Warren Buffett spoke to a crowd of ultra-successful Detroit natives as part of the beleaguered city’s first-ever ‘Detroit Homecoming’ event. For nearly an hour, he fielded questions from Quicken Loans co-founder (and Cleveland Cavaliers owner) Dan Gilbert — on topics ranging from the Global Financial Crisis to that time that Buffett almost bought a bridge in Detroit.” (Kingswell)
The Intellectual Obesity Crisis by Gurwinder, May 17, 2022. Society is developing “atherosclerosis of the mind”: “We evolved to seek out sugar because it was a scarce source of energy. But when we learned how to produce it on an industrial scale, suddenly our love for sweet things went from an asset to a liability. The same is now true of data. In an age of information overabundance, our curiosity, which once focused us, now distracts us. And it’s caused an epidemic of intellectual obesity that’s clogging up our minds.” (The Prism)
The Vision Pro by John Gruber, January 30, 2024. I linked to this article in my own article about Vision Pro. John Gruber’s review is, by far, the most comprehensive account of the new product that I have read so far. (Daring Fireball)
What I Learned When I Stopped Watching the Stock Market by Jason Zweig, January 26, 2024. “When my last regular column ran last May 26, the S&P 500 was already up 10.3% in 2023—right in line with the long-term average annual return of U.S. stocks. ‘Let’s just call it a year right here,’ I recall muttering to myself. That was the last thing I remember. From that day to this week, I tuned out the daily noise of fluctuations in stocks, bonds, commodities and economic indicators.” (WSJ)
Called to Account by Jonathan Clements, January 27, 2024. “Most folks should go for tax diversification, funding both traditional and Roth accounts during their working years. And while it’s tempting to make big Roth conversions early in retirement, especially if you find yourself in a low tax bracket, don’t overdo it. In your later years, you may face hefty medical expenses, find yourself in a low tax bracket or want to make QCDs—and, at that juncture, you could put your traditional retirement accounts to good use.” (Humble Dollar)
Psychology of Apple Packaging by Trung Phan, January 26, 2024. “Jobs and Apple’s head designer (Jony Ive) long understood the value of packaging. As Ive recounts: “Steve and I spend a lot of time on the packaging. I love the process of unpacking something. You design a ritual of unpacking to make the product feel special. Packaging can be theater.” (SatPost)
Profitability - The End Game for Business? by Aswath Damodaran, January 31, 2024. This is the fifth in a series of data updates for 2024. “In this post, I start by looking at the end game for businesses, and how that choice plays out in investment rules for these businesses, and then examine how much businesses generated in profits in 2023, scaled to both revenues and invested capital.” (Musings on Markets)
Value Investing’s Renaissance Man, January 25, 2024. “I am excited to share this ‘Fireside Chat’ with Jeff Gramm, General Partner of Bandera Partners and author of Dear Chairman: Boardroom Battles and the Rise of Shareholder Activism, that took place at our second annual Ideas & Networking Conference on September 21st, 2023.” (Raging Capital)
Book Review of Dear Chairman, June 18, 2016. (The Rational Walk)
Podcasts
Dear Chairman: Robert Young vs. New York Central, January 30, 2024. 38 minutes. Video. Geoff Gannon and Andrew Kuhn discuss chapter two of Dear Chairman which is about Robert Young and his activist campaign in 1954. (Focused Compounding)
Economists May Be Using Bad Data to Make Big Decisions, January 26, 2024. 18 minutes. This podcast questions whether important government measures of labor market conditions reflect economic reality, especially given changes to labor patterns since the pandemic. It is good to see anyone willing to question government statistics. Perhaps a future episode will examine the many adjustments made to data in the calculation of the consumer price index. (Bloomberg — Big Take DC)
Samsung: Semiconductors over Smartphones, January 31, 2024. 51 minutes. Transcript. “We go inside this vertically integrated technology giant and talk about the history of the business, the manufacturing DNA and what it means to create hardware components, and how those hardware components unlock significant opportunities in the smartphone market for Samsung.” (Business Breakdowns)
Unlocking Innovation in Pharma, January 29, 2024. 1 hour. Transcript. “If you look at how much drug companies are getting for their investment, actually, most of them are pretty near zero or very low return on invested capital. The industry as a whole is not that great of a business. It's very much like a lottery model that is just type of lottery that's attractive to people with biomedical PhDs where most people are not making that much money, but a small number of drugs and companies are making supranormal profits.” (Invest Like the Best)
The Ghost Army of World War 2, January 30, 2024. 41 minutes. “In the summer of 1944, a handpicked group of young GIs landed in France to conduct a secret mission. From Normandy to the Rhine, the 1,100 men of the 23rd Headquarters Special Troops … conjured up phony convoys, phantom divisions, and make-believe headquarters to fool the enemy about the strength and location of American units. Every move they made was top secret and their story was hushed up for decades after the war's end.” (History Unplugged)
The Storm on the Sea of Galilee
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I just see Against the Gods.
The 10-10-10 rule is some subtle high-value aside.