Berkshire Hathaway Part III

Summary Notes


In this comprehensive three-part series, co-hosts Ben Gilbert and David Rosenthal of the "Acquired" podcast delve into the intricate saga of Berkshire Hathaway and its legendary leader, Warren Buffett. They explore the conglomerate's evolution, from its early days as a struggling textile mill to its transformation into a colossal holding company. The series examines Buffett's investment philosophy, his notable acquisitions like GEICO and Coca-Cola, and his partnerships with influential figures such as Charlie Munger and Bill Gates. The hosts also scrutinize Buffett's later investments, including his foray into technology with Apple, and discuss the company's future under successors like Greg Abel and Ajit Jain. The narrative culminates in a reflection on Buffett's legacy, his impact on philanthropy through the Giving Pledge, and the cultural and financial shifts that challenge the "status quo" investing strategy he championed.

Summary Notes

Beverage Choices and Personal Habits

  • Ben Gilbert opts for water instead of sugary snacks to avoid the manic energy from the previous episode.
  • David Rosenthal chooses Vitamin Water Zero, anticipating the need for electrolytes during their lengthy discussion.

"I'm going with just water as my beverage this time. And no peanut brittle." "I'm going with a vitamin water zero because we are going to need the electrolytes for this marathon."

These quotes highlight the hosts' beverage choices and imply a lengthy and energy-demanding podcast episode ahead, prompting a more health-conscious selection.

Berkshire Hathaway's Ubiquity

  • David Rosenthal observes the pervasive presence of Berkshire Hathaway in daily life, referencing a property for sale during his run.
  • The discussion suggests the difficulty of avoiding Berkshire products or services in everyday activities.

"I was on my run this morning and I was listening to the Adam Mead book that I referenced, and I ran by Berkshire Hathaway properties like House for sale. And I was just like, it's pretty hard to go through your day without using a Berkshire product or service."

This quote underscores the extensive reach of Berkshire Hathaway's portfolio, emphasizing the company's influence in various sectors of the economy.

Excitement for the Episode

  • Ben Gilbert expresses his excitement for the episode, indicating a restless night due to anticipation.
  • The enthusiasm sets the tone for the in-depth discussion to follow on Berkshire Hathaway.

"I'm so excited. I literally woke up in the middle of the night last night and couldn't go back to sleep. I was so excited."

The quote conveys Ben Gilbert's eagerness to delve into the topic of Berkshire Hathaway, suggesting a significant and engaging episode ahead.

Introduction to Acquired Podcast

  • Ben Gilbert and David Rosenthal introduce themselves and their roles in the technology and investment space.
  • They set the stage for the final episode of the Berkshire trilogy, aiming to cover the evolution of Berkshire Hathaway.

"Welcome to season eight, episode seven of acquired, the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert, and I am the co-founder and managing director of Seattle based Pioneer Square Labs and our venture fund, PSL Ventures." "And I'm David Rosenthal, and I am an angel investor based in San Francisco."

These quotes serve as a formal introduction to the podcast and its hosts, providing listeners with context about their professional backgrounds and the focus of the episode.

Berkshire Hathaway's Past Performance

  • The hosts recall Warren Buffett and Charlie Munger's impressive track record with the Buffett partnerships and Berkshire Hathaway's 27% annual returns over 22 years.
  • They tease a shift in the narrative, indicating that such performance will not be the case in the current discussion.

"We told you about Warren's literally perfect record with the Buffett partnerships in the 60s, where he generated a positive return and beat the stock market every single year for twelve years." "When we last left off, Warren and Charlie were, in 1992, finishing up an absolutely monster run of returning over 27% per year for 22 years."

These quotes summarize the historical success of Warren Buffett and Charlie Munger, setting up a contrast with the challenges and changes in the investment philosophy they would face in the years to come.

The Impact of Systemic Changes

  • The episode will explore how Berkshire Hathaway's investment philosophy contends with systemic changes such as the rise of the PC and the Internet.
  • The hosts discuss the difficulties of investing large sums of money and the visibility of potential investments to other investors.

"A story of what happens when a time-tested investment philosophy gets confronted with systemic changes in the world, like the PC and the Internet." "So when you now need to write billion-dollar checks to move the needle. There's only so many places you can go knocking, and all those places are quite visible to other investors, too."

These quotes introduce the theme of adapting to significant technological and economic shifts, which pose challenges to Berkshire Hathaway's traditional investment strategies.

Community Engagement and Sponsorship

  • The podcast encourages listener participation in the Acquired Slack community, highlighting discussions on digital assets and crypto.
  • The episode is sponsored by Pilot, a company offering accounting, tax, and bookkeeping services for startups and growth companies.

"Well, listeners, are you an acquired Slack member? If not, come join us." "Our next sponsor for this episode is one of our favorite companies and longtime acquired partner pilot for startups and growth companies of all kinds."

These quotes emphasize the importance of community engagement and introduce the sponsorship that supports the podcast, demonstrating the hosts' connection to their audience and the startup ecosystem.

Investment Disclaimer

  • The hosts clarify that the show is for informational and entertainment purposes and not investment advice.
  • They disclose their potential investments in the companies discussed on the podcast.

"As always, this show is not investment advice. David and I may have investments in the companies we discuss, and this show is for informational and entertainment purposes only."

The quote serves as a disclaimer to listeners, ensuring transparency and setting appropriate expectations regarding the content of the podcast.

Warren Buffett and Bill Gates' Friendship

  • The hosts recount the initial meeting between Warren Buffett and Bill Gates, arranged by Katharine Graham.
  • Despite initial reluctance, the two bond over discussions about IBM, Microsoft, and the future of media.

"But Mary, his mom, forces Bill to come out. Bill would say later, as I told my mom, I don't know about meeting a guy who just invests in money and picks stocks." "Gates then, he's probably, like, pretty annoyed by this first question, given that he doesn't care about stocks. He's like, look, there's two. You should buy these. Don't do anything else."

These quotes narrate the beginning of a significant friendship between Warren Buffett and Bill Gates, showcasing their initial skepticism and eventual deep engagement with each other's perspectives on business and investment.

Warren Buffett's Investment in Coca-Cola

  • Warren Buffett's investment in Coca-Cola is recounted, starting with his friendship with Don Keough and leading to his purchase of a significant stake in the company.
  • The investment is described as a classic example of Buffett's strategy and the value of brand moats.

"Warren is a little reluctant to go on this, know, this is not sort of his thing, but as he puts it, quote, anything for Kay. So he goes out." "Warren has drawn him away from his work. Amazing. So they become fast friends. Buffett goes back to Omaha after the holiday."

These quotes highlight Warren Buffett's opportunistic investment in Coca-Cola and his ability to recognize the enduring value of a strong brand, which aligns with his long-term investment philosophy.

The Contrast Between Warren Buffett and Bill Gates

  • A panel discussion at the Allen & Company Sun Valley Conference featuring Warren Buffett, Roberto Goizueta, and Bill Gates serves as a pivotal moment contrasting traditional businesses with the emerging technology sector.
  • Bill Gates' remarks about the simplicity of running a business like Coca-Cola compared to the complexities of Microsoft underscore the changing business landscape.

"Bill kind of goes off script here. So Bill would later say that he meant this as a compliment, but he trots out Warren's ham sandwich phrase when talking about Roberto and Don on stage."

This quote captures a critical moment where the differences between Warren Buffett's and Bill Gates' business philosophies are starkly presented, signaling a shift in the economic paradigm towards technology and adaptability.

Exponential Rate of Change and Its Impact on Investment

  • The world experienced rapid changes, especially with the arrival of the Internet.
  • The cycles of innovation compressed, leading to significant shifts in a short time span.
  • This new pace of change contrasted with the slower, less noticeable changes of the past.
  • Warren Buffett's traditional investment approach did not account for this new, fast-paced environment.

"It's not that the world wasn't changing quickly between the mid-fifties and the early nineties. It was that the rate of change hadn't compounded to the point where it was suddenly like, the whole world is changing all at once."

The quote highlights the shift from gradual change to a world where changes are rapid and compounding, affecting the investment landscape.

Berkshire's Growth and Response to the Tech Bubble

  • Berkshire Hathaway's share price and market cap saw substantial growth in the '90s.
  • Warren Buffett remained cautious about the tech bubble, despite the company's success.
  • The rise of Internet trading and day trading created new dynamics in the market.
  • The creation of shadow investment trusts mirrored Berkshire's equity portfolio, against Buffett's preferences.

"So, for Warren, he's just like, okay, back to business as usual. He is, though, concerned about the tech bubble that is forming that he and so many others see."

The quote reflects Buffett's business-as-usual approach and his awareness of the tech bubble's risks.

Berkshire's Stock and the Introduction of Class B Shares

  • Warren Buffett introduced Class B shares to address the demand for Berkshire stock.
  • The Class B shares had diminished voting rights and tracked one-thirtieth the value of Class A shares.
  • The offering aimed to prevent supply-demand dynamics from inflating the B shares' price.
  • Buffett wanted to satisfy retail investors' demand while maintaining control and benefiting Berkshire's cash reserves.

"He decides that he is going to do a stock offering for a new class of shares, what he's going to call the baby B class of shares versus the newly recrissened Berkshire A shares."

This quote explains Buffett's strategy to create a new class of shares, allowing broader investment in Berkshire without altering the company's investor base significantly.

Acquisition of Gen Re and Its Aftermath

  • Berkshire's acquisition of Gen Re, a large reinsurer, was its largest at the time.
  • The all-stock deal was made when Buffett believed Berkshire's stock was overvalued.
  • Gen Re's management was initially left in place, leading to significant losses and an accounting scandal.
  • Ajit Jain's role in Berkshire's insurance businesses was highlighted as a success in contrast to Gen Re's issues.

"In 1998, he makes another shocking announcement. Berkshire is going to buy Gen Re, one of the world's largest reinsurers, for $22 billion."

The quote marks the announcement of the Gen Re acquisition, which later proved to be problematic for Berkshire.

Warren Buffett's Approach to Philanthropy

  • Warren Buffett's decision on philanthropy was influenced by the death of his wife, Susie.
  • He announced the donation of 85% of his Berkshire stock, primarily to the Bill and Melinda Gates Foundation.
  • The giving pledge was created in partnership with the Gateses, encouraging billionaires to commit to philanthropy.
  • Buffett's philanthropic strategy allowed him to focus on his investment work while contributing to society.

"He is going to give away 85% of his Berkshire stock, which was worth $37 billion at the time. And five-sixths of it is going to go to the Bill and Melinda Gates Foundation for them to manage."

This quote details Buffett's massive philanthropic commitment, delegating the management of his donation to the Gates Foundation.

The Financial Crisis and Berkshire's Position

  • The financial crisis saw the collapse of Bear Stearns due to a loss of counterparty confidence.
  • Berkshire Hathaway had significant cash reserves during the crisis, positioning it to potentially assist failing institutions.
  • Warren Buffett's experience with the Solomon scandal informed his perspective on the unfolding financial crisis.

"Berkshire has $37 billion of cash sitting on its books at this point, which today seems kind of quaint compared to Apple and Microsoft and the like. But back then, nobody else had that kind of cash anywhere."

The quote underscores Berkshire's strong cash position during the financial crisis, which was significant compared to other companies at the time.

Valuation of Companies in the Past

  • The most valuable company in the world was likely an oil company valued at $200-$300 billion.
  • Oil companies typically didn't keep a lot of cash on their books due to capital being tied up in operations.
  • Companies were smaller in the past and did not accumulate cash like modern internet companies, with Berkshire Hathaway being an exception.

"I have to assume the most valuable company in the world at that point probably was an oil company when probably was in the neighborhood of two to $300 billion."

This quote indicates that in the past, the most valuable companies were likely in the oil industry and had valuations significantly lower than today's top companies.

Investment Climate and Strategy

  • Berkshire Hathaway had a substantial cash reserve, making it an opportune time to invest.
  • Warren Buffett and Charlie Munger learned from the Solomon debacle to avoid being the primary equity holder during a crisis.
  • Berkshire pursued a strategy of debt and preferred equity investments rather than equity to protect against downside risks.

"So instead of making a lot of equity investments at this time. They decide instead to pursue a different strategy. They're going to make debt and preferred equity, fixed income investments in companies that need capital."

This quote explains Berkshire's strategic shift from equity investments to debt and preferred equity to avoid the risks associated with being the primary equity holder in a crisis.

Berkshire's Investment in Mars and Wrigley

  • Mars acquired Wrigley for $23 billion during a difficult time for bank financing.
  • Berkshire funded the deal by investing $6.5 billion, with $4.4 billion in debt at an 11.45% interest rate and $2 billion as preferred equity at a 5% rate.
  • Wrigley owned various popular gum brands and candies, contributing to a stable investment.
  • Berkshire's investment in Mars and Wrigley resulted in a 14% IRR with low risk.

"So they invest six and a half billion dollars to fund this deal of Mars, not Berkshire buying Wrigley."

This quote describes Berkshire's role in financing Mars' acquisition of Wrigley, emphasizing that Berkshire provided capital but did not purchase Wrigley itself.

Government Intervention and Investment Opportunities

  • Government intervention during the financial crisis made capital available at low interest rates.
  • Berkshire capitalized on this by offering capital at higher interest rates to companies that could not access government funds.
  • This strategy provided Berkshire with high yields and downside protection.

"So you've got this crazy situation where government is making capital available for free, basically, and Berkshire can come into these situations and make capital available in fixed income, guaranteed return with ten to 15% yields."

The quote highlights the disparity between government-provided capital and the high-interest rates Berkshire could charge, illustrating the lucrative opportunity for Berkshire during the crisis.

Berkshire's Investments in Financial Firms

  • During the 2008 crisis, Berkshire invested in several financial firms, including Goldman Sachs and GE Capital.
  • Goldman Sachs received $5 billion for preferred equity with a 10% dividend and warrants for common stock, resulting in a $3 billion profit for Berkshire.
  • GE's deal was similar, but the return was less successful due to GE's stock performance.
  • Berkshire deployed $18 billion during the crisis, ultimately earning about $25 billion in returns.

"So, all told, in 2008, during the crisis, Berkshire would deploy about $18 billion of the $37 billion of cash that it had on hand."

This quote summarizes the extent of Berkshire's capital deployment during the financial crisis, indicating a strategic and successful investment period for the company.

Berkshire's Continued Investment Success

  • Berkshire's investment in Bank of America in 2011 was part of a strategy similar to the 2008 investments.
  • The Bank of America deal involved $5 billion in preferred equity and warrants, and has yielded about $26 billion in profits to date.
  • This investment has been one of the most significant in terms of absolute dollar returns in Warren Buffett's career.

"All in. To date, Berkshire has made about $26 billion in profits on the b of a deal."

The quote reveals the enormous profit generated from Berkshire's investment in Bank of America, underscoring the success of Buffett's investment strategy.

Berkshire Hathaway's Investment Management

  • Warren Buffett announced plans to hire a successor for Berkshire's chief investment officer role.
  • Todd Combs and Ted Weschler were hired to manage portions of Berkshire's investment portfolio.
  • Both Combs and Weschler have outperformed Buffett's own investment returns in recent years.

"I intend to hire a younger man or a woman with the potential to manage a very large portfolio who we hope will succeed me as Berkshire's chief investment officer when the need for someone to do that arises."

This quote from Warren Buffett indicates his intention to find a successor for the investment management role at Berkshire, highlighting the importance of continuity in the company's investment strategy.

Berkshire's Missteps and Successes

  • Buffett made some questionable investments in IBM, precision cast parts, and the airlines, which did not perform well.
  • However, the decision to invest heavily in Apple Inc. in 2016 redeemed these missteps.
  • Berkshire's $36 billion investment in Apple resulted in $89 billion of gains in five years, potentially exceeding the returns from Buffett's entire career.

"One of the fellows in the office who manage money, aka Ted. Yeah, it's never been said whether it was Tod or Ted, but I think it was Ted here, because Tod really focuses on financial stocks, and Ted does everything else."

This quote suggests that it was Ted Weschler who convinced Buffett to invest in Apple, leading to one of the most successful investments in Berkshire's history.

Investment Philosophy and Results

  • Ben Gilbert discusses the importance of results over process in investing, using a baseball analogy from his father.
  • In investing, the outcome (being right) is more valued than the thesis, process, or reasons behind stock selection.
  • Warren Buffett's investment in Apple is highlighted as an example where his traditional investment thesis was not applied, yet the results were highly successful.

"In investing, it's the same way nobody cares what your thesis is. Nobody cares if you're right or wrong. Nobody cares why you bought the stock. At the end of the day, you just want to be in a position to be right."

The quote emphasizes that in investing, the ultimate goal is to make successful investments, regardless of the approach or rationale used to select them.

Warren Buffett's Approach to Apple

  • David Rosenthal highlights Warren Buffett's unconventional approach to investing in Apple, focusing on consumer behavior rather than technical knowledge.
  • Buffett's investment in Apple was driven by his understanding of the company's strong consumer base and brand loyalty rather than its technical aspects.
  • The investment in Apple is seen as one of the greatest in terms of absolute dollar gains in history.

"I didn't go into Apple because it was a tech stock. I don't think that it required me to take apart an iPhone or something and figure out what all the components were or anything. I think it's much more the nature of consumer behavior."

The quote reveals Buffett's investment rationale for Apple, which was based on the nature of consumer behavior rather than the technical complexities of the product.

Berkshire Hathaway's Leadership Transition

  • Berkshire Hathaway appoints Greg and Ajit to vice chairman roles, signaling a transition in the company's leadership.
  • The pandemic's impact on Berkshire's investments, including the sale of airline stocks and missing out on the bull run following economic stimulus measures.
  • Warren Buffett and Charlie Munger's continued skepticism of cryptocurrencies without a deep understanding of them is noted.
  • A slip during the 2021 annual meeting reveals Greg Abel as the likely successor for CEO, indicating future leadership direction.

"Greg will preserve the culture."

This accidental revelation during the annual meeting indicates that Greg Abel is seen as the likely individual to maintain Berkshire Hathaway's corporate culture post-Warren Buffett.

Capital Allocation and Stock Buybacks

  • Berkshire Hathaway's strategy includes significant stock buybacks, reflecting a lack of better investment opportunities in the market.
  • The company prefers to concentrate its positions in its existing portfolio rather than invest in overvalued assets.
  • The intrinsic value of Berkshire's equity holdings and the impact of market multiples on valuation are discussed.
  • The bear case for Berkshire Hathaway post-Buffett focuses on potential changes to the company's investment strategy and the loss of the 'Warren Buffett halo effect.'

"As long as capital markets remain overvalued and private investors, flush with cash, persist in investing at low yields, share repurchases are a magnificent use of capital."

This quote from Christopher Bloomstrom's letter suggests that in an environment of overvalued capital markets, share repurchases are a wise use of capital for Berkshire Hathaway.

Crusoe and Cloud Computing

  • Crusoe is a clean compute cloud provider for AI workloads, partnering with Nvidia and utilizing stranded energy sources.
  • The environmental benefits and cost savings of using stranded energy are highlighted.
  • Crusoe's unique positioning allows it to offer better performance per dollar for AI workloads compared to traditional cloud providers.

"Because Crusoe's cloud is purpose built for AI and run on wasted, stranded or clean energy, they can provide significantly better performance per dollar than traditional cloud providers."

This quote explains the advantage of Crusoe's cloud services, which are designed specifically for AI and powered by underutilized energy sources, leading to cost-effective and environmentally friendly computing.

Berkshire Hathaway's Current and Future Prospects

  • The bull case for Berkshire Hathaway suggests that the company could perform better under new leadership, potentially adopting a less conservative approach.
  • The bear case raises concerns about the company's ability to adapt to changing investment environments and the potential loss of benefits associated with Warren Buffett's reputation.
  • The discussion includes the management of Berkshire's capital, the role of internal growth engines, and the valuation of the company's assets in the context of high asset prices.

"They don't see a better opportunity out there in the market to deploy capital than the businesses they already own."

This statement reflects Berkshire Hathaway's current investment strategy, where the company prefers to reinvest in its existing businesses through stock buybacks rather than seek new investment opportunities in an overvalued market.

Conclusion and Reflections

  • The speakers reflect on the extensive analysis of Warren Buffett's career and Berkshire Hathaway's history.
  • The discussion covers the evolution of investment strategies, the importance of flexibility in corporate structure, and the challenges of maintaining a consistent culture across diverse subsidiaries.
  • The series concludes with personal investment decisions regarding Berkshire Hathaway shares and the broader implications for investors at different stages of their wealth journey.

"Warren has been successful in a lot of environments, and the thing you kind of should cheerlead about Warren Buffett is that he's reasonably consistent."

This quote summarizes the admiration for Warren Buffett's consistent investment success across various market conditions, despite recent criticisms of his approach in the modern investment landscape.

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