Becoming Berkshire: 1965 - Hostile Takeover
Issue 7 | 1965
Special thanks to those who have recently subscribed!❤️
Welcome to Issue 7 of Becoming Berkshire. Buffett & Munger have given us a roadmap to replicate Berkshire’s success; I intend to follow the crumbs and document what I learn.
The Year is 1965; War begins to escalate in Vietnam as the first US combat troops start to arrive, MLK attempts to march from Selma to Montgomery, Malcolm X is assassinated, and Alexei Leonov leaves his spacecraft in a specialized spacesuit and conducts a twelve-minute spacewalk while Dow Jones returns 14.2%.
Buffett Partnership Limited
Buffett rarely discussed the securities he invested in; however, he seemed keen on introducing Berkshire to his partners.
Our purchases of Berkshire started at a price of $7.60 per share in 1962. This price partially reflected large losses incurred by the prior management in closing some of the mills made obsolete by changing conditions within the textile business (which the old management had been quite slow to recognize). In the postwar period the company had slid downhill a considerable distance, having hit a peak in 1948 when about $29 1/2 million was earned before tax and about 11,000 workers were employed. This reflected output from 11 mills.
At the time we acquired control in spring of 1965, Berkshire was down to two mills and about 2,300 employees. It was a very pleasant surprise to find that the remaining units had excellent management personnel, and we have not had to bring a single man from the outside into the operation. In relation to our beginning acquisition cost of $7.60 per share (the average cost, however, was $14.86 per share, reflecting very heavy purchases in early 1965), the company on December 31, 1965, had net working capital alone (before placing any value on the plants and equipment) of about $19 per share.
Berkshire is a delight to own. There is no question that the state of the textile industry is the dominant factor in determining the earning power of the business, but we are most fortunate to have Ken Chace running the business in a first-class manner, and we also have several of the best sales people in the business heading up this end of their respective divisions. While a Berkshire is hardly going to be as profitable as a Xerox, Fairchild Camera or National Video in a hypertensed market, it is a very comfort able sort of thing to own. As my West Coast philosopher says, “It is well to have a diet consisting of oatmeal as well as cream puffs.”1
Diversification
Another topic in the Buffett partnership letter was diversification.
Buffett again wondered why the overwhelming majority of investment managers underperformed the Dow:
"(1) group decisions - my perhaps jaundiced view is that it is close to impossible for outstanding investment management to come from a group of any size with all parties really participating in decisions; (2) a desire to conform to the policies and (to an extent) the portfolios of other large well-regarded organizations; (3) an institutional framework whereby average is "safe" and the personal rewards for independent action are in no way commensurate with the general risk attached to such action; (4) an adherence to certain diversification practices which are irrational; and finally and importantly, (5) inertia.”
If good performance of the fund is even a minor objective, any portfolio encompassing one hundred stocks (whether the manager is handling one thousand dollars or one billion dollars) is not being operated logically.
Anyone owning such numbers of securities after presumably studying their investment merit (and I don't care how prestigious their labels) is following what I call the Noah School of Investing - two of everything. Such investors should be piloting arks.
We turn to that eminent academician Billy Rose, who says, "You've got a harem of seventy girls; you don't get to know any of them very well.”2
Buffett himself did not subscribe to the notion of diversification;
We diversify substantially less than most investment operations. We might invest up to 40% of our net worth in a single security under conditions coupling an extremely high probability that our facts and reasoning are correct with a very low probability that anything could drastically change the underlying value of the investment."
Nevertheless, our business is that of ascertaining facts and then applying experience and reason to such facts to reach expectations. Imprecise and emotionally influenced as our attempts may be, that is what the business is all about.3
Buffett was more than willing to concentrate his investments after the success he was seeing with American Express. The stock was now trading at $75, far above the floor of $35 it traded at during the Salad Oil Scandal.
Berkshire Hathway
As you recall from Issue 6 - Buffett's Folly, Buffett and Seabury Stanton had agreed that Seabury would tender Buffet’s shares at $11.50; however, Seabury’s tender offer at $11.375 per share sent Buffett on the warpath.
From then on, Buffett initiated a hostile takeover of Berkshire Hathaway.
His first order of action was to purchase any share in the open market that he could get his hands on. Alice Schroeder’s book The Snowball: Warren Buffett and the Business of Life, 2008, details Buffett’s journey in acquiring control of the Company.
Seabury Stanton was set to retire at the end of 1965 and planned to name his son Jack Stanton the next president. Buffett visited New Bedford to understand Jack’s management abilities and get to know Berkshire better. However, Jack was busy and sent Ken Chace, a chemical engineer, to show Buffett around. “Chace spent two days teaching Buffett the textile business while Buffett asked question after question, and Chace explained the mills’ problems. Chace made it clear that he thought the Stantons foolish for pouring money into a business on its way down the drain. Buffett was thoroughly impressed with Ken Chace’s knowledge of the Company.”4
Apart from purchasing Berkshire shares in the open Market, Buffett needed to buy out the Stanton family, who owned large blocks of stock. He first visited Otis Stanton, brother of Seabury Stanton, to convince him to sell his shares. Luckily, Otis was eager for his brother to retire and believed his grandson, Jack Stanton, was unfit to become President. Otis acknowledged that he would sell on the condition that Buffett make an equivalent offer to his brother Seabury. Otis strangely reminds me of Logan Roy’s curmudgeon brother in Succession.
Buffett took it upon himself to tell Jack Stanton that Ken Chace would be given the role of President. Jack's wife was beside herself; she argued that Buffett “surely would not overturn New England’s hereditary mill aristocracy, who had overseen the business for generations, to put a mill rat like Ken Chace in charge.”5 I don’t think Buffett lost any sleep that night.
On May 10, 1965, the board convened at Berkshire’s headquarters in New Bedford. Surprising many, Stanton Seabury declared that he could not continue as president of an organization over which he would not have complete authority and tendered his resignation; Jack Stanton followed suit as both men walked out the boardroom, succumbing to the grim reality that Buffett had taken over the Company. The Board then moved to elect Warren as chairman and confirmed Ken Chace as president of Berkshire Hathaway.
Annual Report
The 1965 Berkshire annual report to shareholders would be the first written by Buffett; however, it lacked the wit and humor one would find in his partnership letters.
Sales totaled $49,300,685, down slightly from $49,982,930 in 1964. Net income was $4,319,206 vs. $175,586 from prior year. However, Buffett instead presented $2,279,206 as the 1965 net earnings figure. He did this for two reasons with the goal of tempering expectations: (1) Net earnings did not include the normal nonrecurring losses incurred on the disposal of assets due to the closing of King Philip Plants A and E, and (2) loss carryovers from prior years allowed Berkshire to forgo paying $2,040,000 in federal income taxes for the year.
As the kids say, Buffett began to cook; he substantially reduced its overhead costs, repurchased 120,231 shares, and sold off a significant portion of the machinery at King Philip Plant E Division. Buffett was just getting started.
Prior Issues:
Issue 6| 1964 - Buffett's Folly
Issue 5| 1963/64 - The American Express Salad Oil Swindle
Issue 4| 1963 - I Want to Hold Your Hand
Issue 1| 1930-1949 - An Oracle is Born
Buffett Partnership, LTD. Shareholder Letter 1965.
Id.
Id.
Schroeder, Alice. The Snowball: Warren Buffett and the Business of Life, 2008.
Id.
I've always been interested in how Buffet switched from a limited partnership to permanent capital. To me this was a game changing move and a key distinction people forget when they want to be like Buffet. Thank you for writing about this.
Concentration all the way if you’ve done your research and diligence 👍