Investing in Berkshire Hathaway
Warren Buffett’s partnership owned a majority stake in Berkshire Hathaway (NYSE:BRK.A) by 1967. Considering only its textile operations, this investment was a failure – the company consistently produced net losses; Buffett eventually had to liquidate the company, as he could not find a single buyer. However, Berkshire Hathaway could be seen as a strategic investment, as Buffett used the company’s working capital to make one of his first investments in insurance companies.
Berkshire Hathaway was originally named Berkshire Cotton Manufacturing Company, and incorporated in Massachusetts in 1889. It merged with Valley Falls Company, Coventry Company, Greylock Mills and Fort Dummer Mills in 1929 to form Berkshire Fine Spinning. Berkshire Fine Spinning then commanded significant market share – it contributed to 25% of American fine cotton textile production. Berkshire Fine Spinning then merged with New Bedford textile maker Hathaway Manufacturing Company in 1955 to form Berkshire Hathaway.
One of Warren Buffett’s Earliest Holdings
When Buffett purchased Berkshire Hathaway, it had an accounting net worth of $22 million. He later realized that its intrinsic business value was considerably less, because its textile assets were unable to earn returns that were in proportion to their accounting value. From 1976 to 1985, Berkshire’s aggregate sales of $530 million produced an aggregate loss of $10 million.
At first, Buffett thought that the business could be turned around by good managers. However, this anticipated turn-around never came about, despite occasional improvements in the secular business cycle.
Yet, Buffett remained in the business for several reasons:
First, the textile business was an important employer in many local communities and Buffett did not want to layoff workers unless absolutely necessary.
Second, Berkshire had management that Buffett greatly admired. Ken Chace was an excellent leader in many ways. He clearly identified the problems Berkshire needed to overcome, communicated them to Buffett clearly and was very enthusiastic in trying different remedy approaches.
Third, the unionized labor force was pleasant to deal with. Unlike other unions that may make unreasonable demands regardless of business conditions, Berkshire’s work force was cooperative and understanding in facing common problems.
Fourth, Buffett hypothesized that the business should still be able to average modest cash returns relative to investment. Buffett later realized that this was not true. Berkshire became an alligator that ate a lot of cash, and seemed to have unending losses in sight.
Buffett and his managers tried many things that did not work: they tried reworking product lines, machinery configurations and distribution arrangements; they also tried making acquisitions – Berkshire acquired Waumbec Mills in expectation of important synergies that could benefit both businesses, but nothing substantial materialized.
As Buffett writes in his shareholder letters, there were broad underlying economic forces that made a turnaround extremely difficult. The US textile industry in general was in secular decline. Textile was a commodity business competing in a world market with substantial excess capacity. There was a significant amount of foreign labor competition. Local textile companies found it extremely difficult to compete with foreign textile companies that were able to employ foreign workers paid a fraction of the US minimum wage. Furthermore, the highly competitive nature of the business meant that other competitors quickly copied cost-reducing capital expenditure investments; each investment initially appeared like winners with strong economic benefits, but competitive dynamics soon drove prices down.
In the end, Buffett decided that it was in Berkshire’s best economic interest to admit defeat and sell the business. Huge capital investment would have helped keep the textile business alive, but it was difficult to envision a turn-around scenario where the company would be able to generate significant returns on investment.
Here is the lesson Buffett took away from the entire episode: should you ever find yourself in a chronically-leaking boat, “energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks”.