MANAGING FOR VALUE CREATION BUSINESS PRINCIPLES OF WARREN
MANAGING FOR VALUE CREATION BUSINESS PRINCIPLES OF WARREN BUFFETT BERKSHIRE HATHAWAY STORY
DRIVERS OF VALUE CREATION SURVEY OF LITERATURE ANNUAL REPORTS INTERVIEWS JOURNAL
Value Octagon Strategy and Business Model Capital Allocation Corporate Governance Financing & Distribution Decisions Mergers, Acquisitions, and Restructuring Corporate Risk Management Performance Management Cost Management
STRATEGIC FINANCIAL MANAGEMENT: MANAGING FOR VALUE CREATION - PRASANNA CHANDRA Mc Graw Hill 2014
Warren Buffett Carl Loomis Tap Dance to Work According to. Bill Gates. . book… two main impressions: 1. How Buffett …. incredibly consistent in applying his vision and investment principles. . 2. His analysis of business and markets remains unparalleled Gates ‘I have never met anyone who thought about business in such a clear way. . Getting into the mind of Buffett is an extremely worthwhile use of time. ”
Market Cap : Top Five Billion Dollars • • • Apple Exxon Mobil Microsoft Google BH 603 401 382 362 340
Berkshire Hathaway: Holding Company: WB. . CM Insurance • GEICO (Cost Adv) …. 2 1970 2013 • BH Reinsurance. . . …. . 1 Float $ 39 m $77. 2 b Regulated Capital – Intensive • BNSF Largest Inter- state Freight Carrier … Cheapest • Mid American Energy …. 11 states … 1 : Consumer (Leader in renewables) Satisfaction Manufacturing, Service, Retailing Lubrizol, H. J. Heinz, Marmon Group, Nebraska FM, Precision Financial & Financial Products ……………………………. 2014 : Net Earnings $ 19. 8 b Market Cap $ 350 b Per share $ 207862 BC. . CAGR 1965 – 2014 21. 6% S&P 9. 6%
CORPORATE OBJECTIVE THE PRIMARY OBJECTIVE OF A BUSINESS ENTERPRISE IS TO CREATE LONG TERM ECONOMIC VALUE IN A LEGAL, ETHICAL, SOCIALLY RESPONSIBLE, AND ENVIRONMENTALLY FRIENDLY MANNER.
Berkshire Hathaway Our long-term economic goal is to maximize Berkshire’s average annual rate of gain in intrinsic business value on a per-share basis.
Berkshire’s decisions are guided by the intrinsic value principle. As Buffett writes: “(Intrinsic value is) an all-important concept that offers the only logical approach to evaluating the relative attractiveness of investments and businesses. Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life. ”
Despite its limitations, Buffett considers per-share book value as a useful measure for tracking performance. As he puts it: “Inadequate though they are in telling the story, we give you Berkshire’s book-value figures because they today serve as a rough, albeit significantly understated, tracking measure for Berkshire’s intrinsic value. In other words, the percentage change in book value in any given year is likely to be reasonably close to that year’s change in intrinsic value. ”
B’s Performance vs. S&P 500 Annual Percentage Change in BVPS of B MVPS of B S&P 500 1965 23. 8 49. 5 10. 0 1966 20. 3 (3. 4) (11. 7) 1975 21. 9 2. 5 37. 2 1985 48. 2 93. 7 31. 6 2014 8. 3 27. 0 13. 7 2015 6. 4 (12. 5) 1. 4 CAGR 19. 2% 20. 8% 9. 7% (65 -15) OVER 798, 981% 1, 598, 284% 11, 355% ALLL (64 -15)
Value Octagon Strategy and Business Model Capital Allocation Corporate Governance Strategic Financing Decisions Mergers, Acquisitions, and Restructuring Corporate Risk Management Organisational Architecture Cost Management
STRATEGY AND BUSINESS MODEL. Invest in simple businesses. . durable. . competitive advantage. . cost leadership. Rely on float. Become the preferred buyer …………………………… Stay Within Your Circle of Competence. Businesses that you understand. Value and good management. Not size…well-defined perimeter
Draw a circle around the businesses you understand then eliminate those that fail to qualify on the basis of value, good management, and limited exposure to hard times”. “The most important thing in terms of your circle of competence is not how large the area of it is, but how well you’ve defined that perimeter “
Strategy and Business Model. Strategy refers to a plan for creating a unique and valuable position whereas business model refers to the logic of the company or as Joan Margretta put it “the story that explains how an enterprise works. ”. For example, Ryanair, which was on the verge of bankruptcy in 1990 s chose to reinvent by pursuing the strategy of cost leadership. The manner in which it created and captured value for its stakeholders was its new business model. . While strategy has been the traditional cornerstone of competitiveness, forces such as globalisation, deregulation, technological changes, and sustainability have underscored the importance of business model as well.
Business Model Ryanair, which was on the verge of bankruptcy in 1990 s chose to reinvent itself by pursuing the strategy of cost leadership. The manner in which it created and captured value for its stakeholders was its new business model. The company decided to offer low fares, cater to only one class of passengers, utilise a standardised fleet of Boeing 737 s, make only short-haul flights, fly out of only secondary airports, charge for all additional services, serve no meals, use a nonunionised workforce, offer highpowered incentives to workforce, and minimise the cost of headquarters, and son. The resultant business model enable Ryanair to lower variable and fixed costs, offer a decent level of service at a low cost, achieve high volumes, and dramatically improve profitability.
Innovative Business Models and Strategies Bharti Airtel. Reverse outsourcing of IT operations and Telecom network infrastructure management. Per minute accounting model based on realisation and cost per minute instead of the ARPU based business model. Microsoft. “Deintegration” of the value chain and establishing of a “de facto standard”. “Cornerstoning” which seeks to leverage on an outstanding initial strategic position into an economically logical opportunity that offers great profit potential.
Dell. Direct business model. Berkshire Hathaway. Double – barrelled approach TCS and Infosys. Global delivery model General Electric. Shift from selling a “product” to offering “a solution” which is an expanded offering that includes the product along with services such as financing, insurance, consulting, and management.
INVESTMENT IN INTANGIBLES • Fed. Ex TRACKING SYSTEM • CISCO’s WEB-BASED SYSTEM OF PRODUCT INSTALLATION & MAINTENANCE • MERCK’S HUNDRED R&D ALLIANCES • WAL MART’S COMPUTERISED SUPPLY CHAIN • COKE’S SECRET FORMULA AND MARKET SAVVY • HLL’s MANPOWER TRAINING SYSTEM • INFOSYS’ KNOWLEDGE MGT SYSTEM
STRATEGY AND BUSINESS MODEL. Invest in simple businesses. . durable. . competitive advantage. . cost leadership. Rely on float. Become the preferred buyer …………………………… Stay Within Your Circle of Competence. Businesses that you understand. Value and good management. Not size…well-defined perimeter
Draw a circle around the businesses you understand then eliminate those that fail to qualify on the basis of value, good management, and limited exposure to hard times”. “The most important thing in terms of your circle of competence is not how large the area of it is, but how well you’ve defined that perimeter “
Value Octagon Strategy and Business Model Capital Allocation Corporate Governance Strategic Financing Decisions Mergers, Acquisitions, and Restructuring Corporate Risk Management Organisational Architecture Cost Management
. CAPITAL ALLOCATION 1. DOUBLE-BARRELED APPROACH 2. DISCIPLNE OF THE CAPITAL MARKET
CAPITAL MISALLOCATION • • Excessive diversification (Herd mentality) Overpayment for acquisitions (Winner’s curse) Hoarding of cash ( Comfort of liquidity) Throwing good money after bad (Sunk cost fallacy) Incorrect measurement of cost of capital Sub-optimal investment in intangible assets Marketing, Human Development): Tangimania Incorrect appreciation of the value of options Investing in mega projects (Overconfidence) (R&D,
This double-barreled approach gives us an important advantage over capital-allocators who stick to a single course. Woody Allen once explained why eclecticism works: The real advantage of being bisexual is that it doubles your chances of a date on Saturday night.
Berkshire does not have a strategic plan which propels it in a particular direction with a certain compulsion. Our practice of making this comparison – acquisitions against passive investments – is a discipline that managers focused simply on expansion seldom use. ”.
Value Octagon Strategy and Business Model Capital Allocation Corporate Governance Strategic Financing Decisions Mergers, Acquisitions, and Restructuring Corporate Risk Management Performance Mangement Cost Management
STRATEGIC FINANCING 1. FINANCE PROACTIVELY, NOT REACTIVELY 2. RELY ON FLOAT AND DEFERRED TAX LIAB. 2014 84 b 2014 BV 60 b MV 130 B 3. RETAIN EARNINGS ONLY. . WHEN YOU CAN CREATE VALUE FOR SHAREHOLDERS 4. REPURCHASE SHARES IN A FAIR AND RATIONAL MANNER
Innovative Financing • In 2002, Berkshire Hathaway issued bonds with a 3 percent coupon rate, but they also had an attached warrant entitling investors to purchase shares of Berkshire Hathaway at a fixed price in the future. However, the warrants were not just given away – investors were required to pay an annual warrant fee equal to 3. 75 percent of the bond’s face value. From a tax point of view, Berkshire Hathaway can claim the 3 percent interest as a tax – deductible expense, while 3. 75 percent warrant fee is not taxable.
In November 2014, Buffett agreed to buy Duracell by swapping about $ 4. 7 b in P & G stock that Berkshire held. The deal is structured to allow Berkshire to exit a longheld investment without incurring capital gains taxes. P & G also stands to limit its tax liability. •
Value Octagon Strategy and Business Model Capital Allocation Corporate Governance Strategic Financing Decisions Mergers, Acquisitions, and Restructuring Corporate Risk Management Performance Management Cost Management
PERFORMANCE MANAGEMENT 1. AUTHORITY & RESPONSIBLILITY DECENTRALISATION&CENTRAL’N 2. PERFORMANCE EVALUATION 3. INCENTIVE S 3. VALUE CREATION MINDSET 4. MOTIVATION (RECOGNITION).
: “There are no show- and-tell presentations in Omaha, no budgets to be approved by headquarters, no dicturns issued about capital expenditures. We simply ask our managers to run their companies as if these are the sole asset of their families and will remain so for the next century. ”. We will never allow Berkshire to become some monolith that is run by committees, budget presentations and multiple layers of management. . Charlie and I will limit ourselves to allocating capital, controlling enterprise risk, choosing managers, and setting their compensation. ”
Berkshires talented and committed people, gives them complete operational autonomy, and lets them run their shows with minimal interference. Warren Buffett supports his managers, pats them on their back, and makes them feel good in his own inimitable style. them feeling this way, and so far we seem to have succeeded: Thinking back over the 1965 -95 period, I can’t recall that a single key manager has left Berkshire Hathaway to join another employer. ”
Berkshire employs many different incentive arrangements, with their terms depending on such el elements as the economic potential or capital I ntensity of a CEO’s business. Whatever the compensation arrangement, though, I try to keep it both simple and fair. When we use incentives – and these can be large – they are always tied to the operating results for which a given CEO has authority. ” Obviously. . has excelled in this task. As he says : “How much time does this aspect of my job take? Virtually none. How many CEOs have voluntarily left us for jobs in our 42 -year history? Precisely none. ” : “
RETENTION AND ATTRACTION Employees leave for a variety of reasons: 1. Limited opportunities for advancement 2. Unhappiness with management 3. Insufficient recognition 4. Inadequate salary and benefits. NON-. MONETARY REASONS 90%
Tribute to Munger : 50 years CONSEQUENTLY, BERKSHIRE HAS BEEN BUILT TO CHARLIE’S BLUEPRINT. MY ROLE HAS BEEN THAT OF GENERAL CONTRACTOR, WITH THE CEO’S OF BERKSHIRE’S SUBSIDIARIES DOING THE REAL WORK AS SUBSIDIARIES. SELF- EVALUATION … 4 D’s 1 F
Value Octagon Strategy and Business Model Capital Allocation Corporate Governance Strategic Financing Decisions Mergers, Acquisitions, and Restructuring Corporate Risk Management Performance Management Cost Management
COST MANAGEMENT COST LADERSHIP Instill Cost Consciousness. Annual rent corporate HQ. . 2010. . $270 k Home office Inv. . $301 k ROLE MODEL
2010 Annual rent World Headquarter $270, 212 Home-office investment $301, 363 Berkshire’s cost consciousness is reflected in the following numbers: The annual rent for its “World Headquarters” in 2010 was $270, 212 and the yearend home-office investment in furniture, art, coke dispenser, lunch room, high-tech equipment – you name it – totaled $301, 363. Justifying this, Buffett says: “As long as Charlie and I treat your money as if it were our own, Berkshire’s managers are likely to be careful with it as well. ”
Value Octagon Strategy and Business Model Capital Allocation Corporate Governance Strategic Financing Decisions Mergers, Acquisitions, and Restructuring Corporate Risk Management Performance Management Cost Management
RISK MANAGEMENT 1. A Gibraltar-like Financial Position 2. Comparative Advantage
Warren Buffett wanted Berkshire to be a financial fortress so that it protects the interests of employees, customers, policyholders, creditors, shareholders, and the community. To build its financial strength, Berkshire has allocated capital rationally and conserved its resources. 2010 annual letter to shareholders: “ Instead, we have retained all our earnings to strengthen our business, a reinforcement now running to about $1 billion per month. Our networth has increased from 48 million to $157 billion during those four decades and our intrinsic value has grown far more. No other American corporation has come to building up its financial strength in this unrelenting way. ”
The financial strength of Berkshire gives its great competitive advantage in writing mega reinsurance policies. Berkshire’s financial strength gives it an edge in exploiting windows of opportunities in the financial markets. For example, in the years 2008 and 2009, Berkshire bought securities of Dow Chemicals, General Electric, Goldman Sachs, Swiss Re, and Wrigley for an aggregate cost of $21. 1 billion.
NATIONAL INDEMNITY’S REINSURANCE 2009 Ajit. . one –of-a- kind giant in the insurance world. Ajit. . billion –dollar limits - and then keeps every dime of the risk instead of laying it off with other insurers. Three years ago. . He took over huge liabilities from Lloyds allowing it to clean up its relationship with 27, 972 participants (“names”) Premium. . $7. 1 billion During 2009, he negotiated a life reinsurance contract that would produce $50 billion of premium for us over the next 50 years or so. Tribute to Ajit Jain.
Adhere to proper discipline in writing insurance • Exposures • Expected t cost • Premium • Walk away
Value Octagon Strategy and Business Model Capital Allocation Corporate Governance Strategic Financing Decisions Mergers, Acquisitions, and Restructuring Corporate Risk Management Performance Management Cost Management
Value Creation Strategic Fit Cultural Fit Financial Fit
MAIN REASONS FOR VALUE DESTRUCTION INFORMATIONAL ASYMMETRY COMPETITIVE BIDDING UNREALISTIC ESTIMATES OF SYNERGY
BERKSHIRE HATHAWAY ACQUISITION CRITERIA WE PREFER 1) LARGE PURCHASES( PAT 0 f $ 75 Million) 2) DEMONSTRATED CONSISTENT EARNING POWER 3) MANAGEMENT IN PLACE 4) SIMPLE BUSINESSES 5) AN OFFERING PRICE WE WILL NOT ENGAGE IN UNFRIENDLY TRANS’NS. WE CAN PROMISE COMPLETE CONFIDENTIALITY AND A VERY FAST ANSWER AS TO POSSIBLE INTEREST-CUSTOMARILY WITHIN FIVE MINUTES
Lubrizol Acquisition On March 14, 2010 (a Monday), Berkshire announced that it will buy Lubrizol for $9 billion in cash. Lubrizol fits much of Buffett’s deal making criteria: It is a large company which earned $732 million in 2010. Its earnings have been relatively consistent. Its products are easy to understand: It makes good for global transportation, industrial, and consumer markets, including fuel additives for gasoline and diesel. It is a global leader in several market applications. The management team has been in place for a while, too it is run by James Hambrick, a talented CEO, who has been with the company from the 1970 s. Buffett said in a statement “Our only instruction to James – just keep doing for us what you have done so successfully for your shareholders. ” Berkshire will pay $135 a share for Lubrizol, a speciality chemical maker in Wickliffe, Ohio, 28% above the closing price on Friday. Lubrizol was advised by Citigroup and Evercore on the deal.
MITTAL STEEL BERKSHIRE HATHAWAY • Underperforming • Management requires an overhaul • Focus on steel • Well performing • Outstanding management in Place • Any business • Benefits from Mittal’s knowhow • Benefits from BHs unique in steel business • Global • Protracted due diligence and negotiations governance structure • Largely U. S. – Centric • Swift and seemingly effortless completion of deal
In 2013, Berkshire and 3 G each purchased half of Heinz common stock for $ 4. 25 billion. With Heinz, Berkshire now owns 8½ companies that, were they stand – alone business, would be in the Fortune 500 only 491½ to go.
Berkshire Hathway Inc. to Acquire Precision Castparts Corp. for $235 Per Share in Cash PCC will remain headquartered in Portland, Ore. as a wholly subsidiary of Berkshire Hathaway OMAHA, Neb. & PORTLAND, Ore. - Aug. 10 -2015 - The boards of directors of Berkshire Hathaway Inc. (NYSE: BRK. B) and Precision Castparts Corp. (“PCC”) (NYSE: PCP) have unanimously approved a definitive agreement for Berkshire Hathaway to acquire, for $ 235 per share in cash, all outstanding PCC shares. The transaction is valued at approximately $ 37. 2 billion, including outstanding PCC net debt. “I’ve admired PCC’s operation for a long time. For good reasons, it is the supplier of choice to the world’s aerospace industry , one of the largest sources of American exports. Berkshire’s Board of Directors is proud that PCC will be joining Berkshire, ” said Warren E. Buffett, Berkshire Hathaway chairman and chief
“We are very pleased to be joining forces with Berkshire Hathaway, ” said Mark Donegan, PCC’s chairman and chief executive officer. “We see a unique alignment between Warren’s management and investment philosophy and how we manage PCC for the long –term. We believe that as part of Berkshire Hathaway, PCC will be exceptionally well- positioned to support our customers’ needs into the future. This transaction offers compelling and immediate value for our shareholders, and allows PCC’s employees to continue to operate in the same manner that has generated many years of exceptional service and performance to our customers. ”
The Seven Sins in Acquisitions Risk transference : Attributing acquiring company risk characteristics to the target firm. Debt subsidies : Subsidising target firm stockholders for the strength of the acquiring firm. Auti- pilot control: The “ 20% control premium” and other myth Elusive synergy : Misidentifying and misvaluing synergy It’s all relative : Transaction multiple, exit multiples Verdict first, trial afterwards : Price first, valuation to follows It’s not my fault : Holding no one responsible for delivering the result
Value Octagon Strategy and Business Model Capital Allocation Corporate Governance Strategic Financing Decisions Mergers, Acquisitions, and Restructuring Corporate Risk Management Performance Management Cost Management
Corporate Governance • • Shareholders as owner – partners Exceptional candour in communication Earnings not managed Long term commitments Board independence No inflated expectations Do not sell any good business … BH owns TRUST
1966 BH AGM BUFFETT: WE WANT TO GROW RICH WITH YOU NOT OFF YOU $18 $36 100%
Buffett has assiduously cultivated a genuine owneroriented culture at Berkshire. As he says: “ Our compensation programs, our annual meetings and even our annual reports are all designed with an eye to reinforcing the Berkshire culture, and making it one that will repel and expel managers of a different bent. This culture grows stronger every year, and it will remain intact long after Charlie and I have left the scene. ”
Warren Buffett and Charlie Munger regard their shareholders as owner-partners and consider themselves as managing partners. Buffett explains this is his Owners’ Manual. “Although our form is corporate, our attitude is partnership. Charlie Munger and I think of our shareholders as owner-partners. He displays exceptional candor in his communication. As he says: “Our guideline is to tell you the business facts that we would want to know if our positions were reversed. We owe no less… We also believe candor benefits us as managers: the CEO who misleads others in public may eventually mislead himself in private. ” Given such a rare commitment to honesty and transparency, Buffett has no reservations in admitting his mistakes. In his 1989 annual report he reported his mistakes under the title The mistakes of first 25 years (a condensed version).
Berkshire focuses on long-term cash flows and scrupulously avoids actions designed to boost short-term performance at the expense of long term value. Warren Buffett explains Berkshire’s position in the 2005 annual report: “If a management makes bad decisions in order to hit short-term earnings targets, and consequently gets behind the ball … no amount of subsequent brilliance will overcome the damage that has been inflicted. ”
Just the way Warren Buffett strives to attract long term investors, Berkshire has a policy to make a long term commitment to businesses and investments. As Warren Buffett says: “We are not pure economic creatures and the policy penalises our results somewhat, but we prefer to operate that way in life. What’s the sense of becoming rich if you’re going to have a pattern of operation where you continually discard associations with people you like, admire, and find interesting in order to earn a slightly bigger figure? We like big figures, but not to the exclusion of everything else”.
An important goal at Berkshire is to have its stock sell at a price that mirrors its intrinsic value. The key to this is rational shareholders. Berkshire strives to achieve high quality ownership by consistently communicating its business and ownership philosophy-without any conflicting signals-and then relying on the process of self-selection. We want those who think of themselves as business owners and invest in companies with the intention of staying a long time. ”
A TEXTBOOK COMPANY SHAREHOLDER WEALTH MAX. PRINCIPLE DISCOUNTED CASH FLOW PRINCIPLE SUSTAINABLE COMPETITIVE ADV. PRINCIPL OPPORTUNITY COST PRINCIPLE WACC MINIMIZATION PRINCIPLE MINIMIZATION OF AGENCY COST PR. COMPARATIVE ADVANTAGE PRINCIPLE VALUE CREATION IN M&A OWNER-MANAGER ALIGNMENT
Google’s Restructuring • • Google. . Internet Search. . Advertising Co. . Huge Cash Flows. . Side bets on projects. . Driverless cars … Biotech Larry Page. . Wants Google. . More like BH ALPHABET. . holding company Oper’g cos. . Google. . etc. . Market Cap $ 29 b. . Thumbs up FT article. . $ 29 b Org. . Chart All has been done is to put various pieces of business… different format… essentially changing nothing. However, Wall street thinks they will know more about Google. . They want more transparency Wild card. . once you disclose business separately. . You manage them better. Long-term, however, these businesses may be spun off and split up and Wall Street loves that kind of stuff
BUFFETT: PSR TRUSTEESHIP IQ + RQ+EQ+SQ M-L-M PRINCIPLE
Mahatma Gandhi • Complete identification with the masses • Simplicity, honesty, transparency • Most powerful communicator • MLM Warren Buffett • Complete alignment with the SHS • Simplicity, honesty transparency • Most powerful communicator • MLM
Strategy & Business Model • Invest … simple… business …. Durable …. competitive advantage … cost leadership • Rely on float Capital Allocation Double – barreled approach Strategic Financing Finance proactively, not reactively Float Performance Management • Hire capable and honest people, empower them, reward them for performance them, and cheerlead them • Balance sheet $ 485 b. 330, 000 employees • 25 persons … Corporate Office
Cost Management Instill Cost Consciousness Risk Management Make Berkshire into a Financial Gibraltar Mergers and Acquisitions Exercise strict discipline Corporate Governance • Eliminate agency costs • Build long-term relationship with all stakeholders
CONSCIOUS CAPITALISM RESPONSIBLE CAPITLALISM COMPASSIONATE CAPITALISM HUMANE CAPITALISM PHILANTHRO-CAPITALISM ‘GIVING PLEDGE’ ANIL AGARWAL 75% 3. 5 B FIRMS OF ENDEARMENT Raj Sisodia
Qualities • • • Integrity Rationality Investment/Business Acumen Candour Humour Zest Fairness Warmth Optimism Work ethics Charity. . Gratitude
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