Friday, June 3, 2011

Buffett on Mergers: Berkshire Shareholder Letter Highlights

From Warren Buffett's 1992 Berkshire Hathaway (BRKashareholder letter:

We had a significant investment in a bank whose management was hell-bent on expansion. (Aren't they all?) When our bank wooed a smaller bank, its owner demanded a stock swap on a basis that valued the acquiree's net worth and earning power at over twice that of the acquirer's. Our management - visibly in heat - quickly capitulated. The owner of the acquiree then insisted on one other condition: "You must promise me," he said in effect, "that once our merger is done and I have become a major shareholder, you'll never again make a deal this dumb."

Sometimes (in fact, too often) an acquisition does more to expand management's domain than increase shareholder value.

Management, in order to gain approval, will sometimes make the case for a more-than-fully-priced acquisition using words like strategic or synergistic. Even if the deal works out okay operationally (not exactly a foregone conclusion by the way) the odds are good that existing shareholders will end up poorer when an obviously expensive price is being justified on the basis of the deal being strategic or synergistic.

There are exceptions, of course, but strategic and synergistic is often just code for "this makes my empire bigger at shareholder expense". The fact that shareholders end up a bit poorer, a mere inconvenience.

Keep in mind that, throughout the acquisition process, you can expect management to remain adamant that the deal truly is about enhancing shareholder returns. Yet, when it's all said and done, if you overpay, the transaction is just a complicated way to transfer some of your wealth to the acquiree's shareholders.

Here is a related previous post. In it, Buffett describes some of the ways that management rationalizes issuing stock to purchase another company.

Previous post: Buffett on Favorite Rationalizations

A good business, run by management that sincerely does deals/makes capital allocation decisions with shareholder wealth creation in mind, can be owned for a very long time.

Adam

Long BRKb
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