I’m poring over the just-release 2014 annual letter to Berkshire Hathaway shareholders today and, as usual, I’m finding nuggets of wisdom on every single page.
One really interesting bit I wanted to pass on concerns a crucial benefit that their conglomerate structure offers. In countering the idea that Berkshire should break itself up or spin off some businesses to “unlock shareholder value”, Warren Buffett explains a key advantage that his collection of companies offers – beyond the obvious ability to self-fund.
He reminds his shareholders that being able to channel capital across opportunities and be willing to walk away from a dying industry is critical to the corporation’s longevity. He laments the twenty years between 1965 and 1985 that he allowed the legacy New England textile assets to decay before finally pulling the plug. He talks about the conflicts that a more singularly-focused corporation might have when its central line of business goes into secular decline.
One of the heralded virtues of capitalism is that it efficiently allocates funds. The argument is that markets will direct investment to promising businesses and deny it to those destined to wither. That is true: With all its excesses, market-driven allocation of capital is usually far superior to any alternative. Nevertheless, there are often obstacles to the rational movement of capital. As those 1954 Berkshire minutes made clear, capital withdrawals within the textile industry that should have been obvious were delayed for decades because of the vain hopes and self-interest of managements. Indeed, I myself delayed abandoning our obsolete textile mills for far too long. A CEO with capital employed in a declining operation seldom elects to massively redeploy that capital into unrelated activities. A move of that kind would usually require that long-time associates be fired and mistakes be admitted. Moreover, it’s unlikely that CEO would be the manager you would wish to handle the redeployment job even if he or she was inclined to undertake it…
…At Berkshire, we can – without incurring taxes or much in the way of other costs – move huge sums from businesses that have limited opportunities for incremental investment to other sectors with greater promise. Moreover, we are free of historical biases created by lifelong association with a given industry and are not subject to pressures from colleagues having a vested interest in maintaining the status quo. That’s important: If horses had controlled investment decisions, there would have been no auto industry.
Most companies cannot kill their once-golden goose business and reallocate elsewhere. Even the suggestion of something so bold would typically engender a response like “But, this is what we do!” And they’d be right. The reticence to make big changes is only the half of it – there are also the considerations involved with a given CEO’s capabilities outside of a core industry and the high costs that need to be incurred in order to make such a radical shift happen. The hurdles for a company – let alone a public company with outspoken shareholders – being able to pull this off are extremely high. With his conglomerate status and diversified earnings streams to command, Buffett can move decisively toward better opportunities and turn his back on those ventures whose best days are behind them.
Berkshire’s ability (willingness?) to kill and refocus is legendary and extremely rare.
Find some time to read the entire letter. It’s time extremely well spent.