Viacom's Buyback

In this prior post, I noted that Viacom (VIAB) was in Barron's Favorite Stocks for 2013.

It's also a small holding in the Berkshire Hathaway (BRKa) equity portfolio.
(Likely bought by Ted Weschler.)

I noted that Viacom expects to buyback $ 2.5 billion of stock over the next year in the prior post. This is similar to Viacom's buyback levels over the past two years.

The earnings multiple is certainly not high and seems backed by solid free cash flow. The recent and planned buybacks, at roughly 10% of market value, is fairly aggressive. Debt levels, though growing somewhat in recent years, seem quite manageable. It's in the Berkshire equity portfolio. What's not to like?

Well, I'll let others -- those who know how to value Viacom's business -- decide whether these buybacks will be lucrative for continuing long-term shareholders. In general, I view stock buybacks that are consistently done below a company's intrinsic value to be a very good thing. The key thing is to have at least having a rough idea what the intrinsic value actually is. As I said in the prior post, any investment comes down to knowing when you really have a handle on a company's future prospects and the range of possible outcomes.*

With Viacom, I don't.

I'd have to understand how the emergence of alternative ways for content to be consumed and distributed will impact Viacom's future business economics. This may be less of a long-term threat than it seems, but that's why it's best to invest only in what you feel you truly understand. I just don't know how their pricing power will change over the very long run. Few things are more important than that. They may be able to maintain lots of pricing power but I just don't have a feel for why that's assured (or, at least, very likely).

Basically, it's difficult, at best, for me to assess the strength and sustainability of Viacom's economic moat. Is it persistent? Others may have a great handle on this. Those that do are better candidates to own part of this business.

What other threats is Viacom vulnerable to over the longer run? If I don't have any feel for that (and I certainly don't), I'm not going to risk any capital. So I'm doing what makes sense...avoiding what might be a perfectly good business in light of my own lack of knowledge and insight. Under these circumstances, investing in Viacom would be a dumb thing for me to do.

As is always the case, it's not about what Viacom is earning today or even the next couple of years. It's about what it can produce over the very long haul. Of course, as the price gets lower and the margin of safety increases, it may eventually provide protection against all but the worst possible outcomes.**

From the most recent Berkshire Hathaway Shareholder Letter:

"The first law of capital allocation – whether the money is slated for acquisitions or share repurchases – is that what is smart at one price is dumb at another." 

Buffett wrote that in the context of acquisitions and share repurchases but, of course, logically applies to buying small pieces of a business as well.

So Viacom may turn out to be a great investment (I certainly won't be surprised if the stock does quite well) but I'm no where near interested in owning any shares. It's a reflection of my own limitations. No one gets to invest with the benefit of hindsight. Until that changes, I'll never mind missing it or any opportunity like it.

If the company continues to allocate capital the way they have been, and especially if the business is better than I realize, continuing shareholders will probably not be in bad shape at all. Maybe the company will even avoid chasing expensive growth through acquisitions. All too often, a poor use of capital.

The size of the buyback that, as of now, looks like it can be comfortably funded, and the not very high earnings multiple makes me want to keep an eye on it. Maybe, over some number of years, I'll eventually even understand the business well enough to invest. Better yet, maybe it will even get very cheap to provide an extreme margin of safety. In the real world it's a good bet that neither will happen. I'll either never figure it out or do so too late.

It's the nature of the investing process. An investor can only understand a small fraction of the businesses that exist. The best thing about investing is that you can take a pass on whatever you want to pass on.

Lots of homework, lots of waiting, then acting decisively those rare times a really good understandable investing idea comes across the radar. It's much easier to take decisive action when a justifiably high level of confidence in a company's prospects has been developed. It's easier to act when the discount to per-share intrinsic value is obvious to the investor. It takes patience, discipline, and awareness of limits.

Buy what's not well understand and eventually big mistakes are likely to occur.

In fact, as I've said, the initial success achieved buying what's not well understood might lead to even more substantial permanent loss of capital due to unwarranted overconfidence.

Sometimes, the most important thing in investing is knowing what not to buy; knowing when it's best to "miss" something (and not forget Richard Feynman's quote.)

When the price action eventually goes the wrong way (possibly for an extended time), the investor that lacks conviction is unlikely to be able to hang in there long enough. Also, the investor that lacks conviction likely won't be buying even more shares as the discount to business value becomes even greater.

Of course, this only works if intrinsic business value has been judged well in the first place.

The high level of conviction must be justified.

Adam

No long position in VIAB

* To figure out what the business is conservatively worth per share, and what price represents a sufficient discount to value considering the specific risks.
** Eventually a business gets cheap enough to account for all but earnings falling off a cliff. Basically, it gets to the point where you are purely buying the cash flow the business produces -- even if declining -- extremely cheap. It's buying a dollar of cheap cash and cash flow for 50 cents (or less) on the basis that it will be put to reasonably good -- even if not brilliant -- use. Of course, even if there is a big margin of safety, you still have to watch out for the really dumb capital allocators. So there are subpar businesses that I'll own shares of (and do own shares of) if I feel I understand the flaws (likely downside) well enough and the price represents a huge discount to just the discounted value of the cash.
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