Deal Tips From Buffett and Berkshires Other

Managers
By Lawrence A. Cunningham
November 18, 2014 2:02 pm

LawrenceA.Cunningham,aprofessorofbusinesslawatGeorge
WashingtonUniversityandaformerdeallawyeratCravath,Swaine&
Moore,haswrittennumerousbusinessbooksincluding,mostrecently,
BerkshireBeyondBuffett:TheEnduringValueofValues.Thispostis
excerptedfromthatbook.
Thewaveofmergersthisyearraisesthequestionofwhetherdeal
makersareinthemidstofafamiliarpatternofmanagerialhubris,
overpaymentandbandwagonirrationality.Ifso,evenwellintentioned
managersmaypursuedealsthataddmorepsychicbenefittoexecutivesthan
economicvalueforshareholders.Astheynavigatebetweenhelpingor
hurtingshareholders,managerswoulddowelltoheedlessonsfromagroup
withaproventrackrecord:thedozensofchiefexecutivesofBerkshire
Hathawayssubsidiaries.
Thegroupsupplementstheinvestmentacumenoftheirboss,WarrenE.
Buffett,whoseBerkshirelevelacquisitionsarelegendary.Theyareamong
thesavviestgroupofacquirersinhistory.AtBerkshireHathawayEnergy,
forexample,thechiefexecutive,GregoryE.Abel,hasledmorethan$20
billioninacquisitionsinrecentyears,withresultspromptingMr.Buffettto
pledgetoallocateanother$30billionforenergyacquisitionsintheshort
term.TomManenti,thechiefexecutiveofMiTekIndustries,the

constructionengineeringfirm,hasmade50successfulacquisitionsduring
histenure,buildingwhatMr.BuffettcallsaminiBerkshire.
WhatMr.BuffettandBerkshiresothermanagershaveincommon
whenitcomestoacquisitionsisacertainmanagerialsavvyinallocating
capital.Whetherforinternalgrowthorexternalacquisitions,thistypeof
managerialsavvyisimportantbecausemistakescanprovecostlyto
shareholders,especiallyinthecaseofpayingtoomuch.Theriskof
overpaymentarisesfromacombinationofhubrisandaccesstoexcesscash,
newlyissuedstockorborrowing.Managersmayalsooverestimatewhata
newacquisitionwilldoforacompany,whichthenleadstodestructionof
value.
Curbingmanagerialhubrisandcontrollingthesourceoffundsare
amongthewaystominimizetheriskofoverpayment.Berkshiresculture
offersadvantagesalongbothlines.Acquisitionmarkets,forexample,tendto
runincycles,withburstsofactivityfollowedbylulls.Acommonmistakeis
togetinthewaveandbuyasthecycleshiftsfrombeingabuyersmarketto
asellersmarket.Expertsrefertotheproblemasthefallacyofsocialproof,
thebeliefthatifeveryoneisdoingsomething,itmustbedesirable.Berkshire
anditssubsidiariesadoptanelongatedtimehorizon,measuredindecades
notmonthsoryears,diminishingthetemptationtofollowthecrowd.
Ontheissueoffinancingwhetherbytakingondebtorbyusingstock
orexcesscashBerkshiresstructurelimitsaccesstoallthree,acheck
againstimprovidence.Rivalsoftenfinanceacquisitionswithborrowed
money,frequentlyatcostshigherthangains.Berkshirecultureisthrifty,
whichmakessubsidiariesaversetodebtforanypurpose,including
acquisitions.
Othercompaniesmaypayinstock.Butstockoftenfeelslikeplaymoney
tomanagers,leadingthemtospendmorefreely.Thatpsychologyisakinto
usingforeigncurrencywhentravelingabroadorgamblingchipsatacasino.

AtBerkshire,theproblemisavoidedbecausesubsidiaryacquisitionsare
neverpaidinstock.(Infact,ofatotalofmorethan60acquisitionsatthe
parentlevel,Berkshirehasuseditsstockinonlyseven,whenthesellers
highlyvaluedthatformofcurrency,asinthecasesofDairyQueenand
HelzbergDiamonds.)
AbroaderBerkshirestrategytolessentheriskofoverpaymentin
acquisitionsistoofferintangibleculturalvaluesinadditiontocash.Heres
justonecase.In1995,BerkshireacquiredRCWilley,afamilyowned
furnitureretailer,foraprice12.5percentlessthanarivalbid.Berkshire
paid$175million,bestingoffersexceeding$200million.Theownerschose
Berkshirebecauseofitsculture,includingitsreputationforintegrity,the
operationalautonomyitoffersitsmanagersanditscommitmenttoholding
ontothesubsidiariesitacquires.
Itiscommonincorporateacquisitionstocoaxanagreementonpriceby
thoughtfulunderstandingofeachsidesgoals.Iftwosidescannotagreeon
price,forinstance,asellermayoffertoretainsomecontingentliabilities,or
abuyermayproposetoleaveoutsomeintellectualpropertyassets(like
patents).Giventhatthetwosidesmayhavedifferingvaluationsofthese
elements,thetradingcanleadtoanagreementonprice.Berkshireandits
subsidiarieslikeMiTek,bycontrast,createsituationsinwhichintangibles
likeautonomyandpermanencesubstituteformoney.
AtBerkshire,dealmakersunderstandacquisitionsasinvestments.
BenjaminGraham,Mr.Buffettsintellectualpatriarchandtheauthorof
renownedbooksoninvesting,taughtMr.Buffetttohuntforinvestments
wherethepricewassignificantlylessthanvalue,deliveringamarginof
safety.Priceiswhatyoupayvalueiswhatyouget,usuallymeasuredby
earningsornetassets.InBerkshireacquisitions,youhavetoadjustboth
sidesoftheequationtoreflecttheintangibleculturaltraits.
ThoseintangiblevaluesareBerkshires,anditssubsidiaries,greatest

advantage.Inadditiontoformingadistinctandenduringcorporateculture
forBerkshire,thosevaluesarebehindthestringofsuccessfulacquisitions
rackedupbybothMr.BuffettandthemanagersofBerkshiressubsidiaries.
NooneelseislikelytobuildanotherBerkshireHathaway,buttakingapage
fromitsapproachtoacquisitionscanhelpmanagersavoidthedangerswhile
seizingopportunityintodaysfrothytakeovermarket.

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