Money is a lot like sex; if you don’t got it, it is all you think about, and if you got it, you think of other things. –The Hobo Philosopher
Buffett Buys a Business
In honor of the upcoming Berkshire Hathaway Love Fest in Omaha, let’s learn how Buffett analyzes a business. We are taking a short break from our grind through Competition Demystified.
Buffett paid $55 million for 90% of a private business with earnings after tax of $1.5 million. Do you think he lost his senses? Can you name the business and year that he bought this business? What do you think caused Buffett to pay the price that he paid?
Tomorrow or by Wednesday, I will post the analysis of his purchase.
90% of Nebraska Furniture Mart
Bingo! But why did he pay that price? Thoughts anyone?
Nebraska Furniture Mart. It was/is not a franchise (no pricing power, nor the ability to replicate its unit economics), but its management had a relentless focus on being the low cost leader, the size of its 3 stores provided some scale to the overhead and it has a high regional market share. Management knew what is was good at and able to achieve, and did not try to stretch for something great.
Good post, Warren. Let’s see what Buffett says about NFM in his letters.
I’ll take a shot! Here are the following might throw some light!
1. They owned the land & store outright at very low cost(won’t show up in conventional accounting)
2. Invested capital is very low, most of the money invested is inventory, it must have been matched with receivables. Volume is huge, so inventory turn over must be high.
3. It was the only store with that kind of scale in around many hundred miles radius(if not thousands). He must have thought with that kind of specific advantage, they could achieve good ROIC if they increase the sales little bit..Additional investment is lower due to the volume of the business.
4. Obvious inclination towards management ability/integrity.
Hi John,
Welcome back. Hope you had a good trip. Where did you go?
WEB bought it in 1983. Rose Blumkin and her family are exceptional competitors and very good business people. According to the letter, “They buy brilliantly, they operate at expense ratios competitors don’t even dream about, and they then pass on to their customers much of the savings.” Low cost advantage. To top things, they sold more volume of furniture, carpets, and appliances than all other Omaha retailers combined. Large market share, and profitability = competitive advantage indication (Competition Demystified)
WEB says he tries to imagine how to compete against the business he’s thinking of buying, and he wouldn’t want to go up against Mrs. B.
Thanks. My trip to Miami, FL (USA) was OK. NFM use the “costco” model of low cost, pass those on to customers (mostly), gain customer captivity, more EOS and a reflexive cycle that creates barriers to entry within their region.
Note how Buffett hires fanatics on cost control.
I read the book you mentioned, The Davis Dynasty, and he was fanatical about cost control too. In another reading (I can’t recall the source), there was a description of a business owner who had a building that he operated out of and was known as being very frugal. Well, it came time to repainting his building’s exterior, and as usual, he remained frugal. Instead of painting the entire thing, he only had the front of the building painted, because it was the only portion customers saw.
I’m not sure where I stand on being *that* frugal yet, largely because decisions like that will fall under the responsibility of others at any decently large business. Do we micromanage their duties, because maybe they aren’t that frugal in their own life, or do we let them spend more money to paint all 4 sides of the building, even though there isn’t any added value? Who would enjoy being micromanaged?
I think either route can work, so maybe it’s about execution. Buffett never sells a business, whereas White Mountain Insurance will sell the entire company at the right price. They both have really good businesses that have compounded capital at impressive rates, despite doing it in different ways. I’m still learning a lot about business/investing, but I think we’ll often come to many decisions like this, whether we micromanage for frugality, etc., and I’m almost seeing that either model can work if handled properly.
What do others think?
Essentially, that’s a $61M valuation, and so he paid about 41 times earnings.
I would imagine that there must have been a reason he paid that kind of a multiple – either the earnings were temporarily depressed, departed from cash flow for some reason, or he saw the ability to expand into more locations as the future earnings driver. I’m guessing that this wasn’t the multiple he was willing to pay in general, but rather had some kind of vision for the future as to why the earnings would grow significantly.
If i remember correctly, there were tens of millions of dollars of inventory already in the store, which were included in his purchase
Should those be counted? As long as he isn’t liquidating the inventory, the only source of cash return (the source of value) that I like to buy is the excess cash that the business generates.
This is also why I haven’t been as big of a fan of pure balance sheet based “net-nets.” Yeah, a company can be attractive when compared to liquidation value with no operational value, however unless there is a credible threat/reality that the cash will be distributed, it will only keep falling. When I used to bet on those, I was counting on the markets to revert to the liquidation value so that I could exit my position. Ideally, I’m buying securities for which I don’t need a market exit, because the cash distribution will make it worthwhile. I think that may lead into why a lot of great value investors, like Seth Klarman, are so much more active in the debt markets – because debt has a natural catalyst for the realization of value.
Ankit: you are a whirlwind. Once I catch my breadth, I will read through all your comments. I like the diligence and thoughts. Back to you later.
Thanks John – I’m sorry if I come off rude with any of this, because I think my views can be polarizing in general. Looking forward to your thoughts though.
Dear Ankit: For a savage critique/attack/and complaint against Ben Graham’s Net/net philosophy read the chapter: Chapter 6: Benjamin Graham: Mythical Market Hero in the book, Practical Speculation by Victor (The “Blowup Artist”) Niederhoffer.
If you want a full discussion/post let me know.
No worries–no way do your comments appear rude. Disgreements, contradictions and heated debate are welcome provided there is some thought to the discussion.
Net/nets are cigar puffs, ephemeral and time is not on your side. Some money mangers take the activist route to close the gap because when market value (MV) is below Asset value (AV) and Earnings Power Value (EPV) or AV = EPV, then management is often to blame if the situation is chronic.
One thing Greenblatt stresses is to discount the cash, especially if held in the hands of bad management and your minority status. Perhaps this is why Graham played a numbers (insurance) game of widely spreading his bets in net’nets.
A better blog to learn from on net/nets is http://www.greenbackd.com.
Frugal is great when meant as efficiency, but skimping on capex is self-defeating. Note the returns on Heartland Express (Trucking company)–a frugal operator who focuses on the shareholders. Sometimes amazing things can happen in mundane businesses.
The more you read, search and think the better fit you will have with your investment philosophy. There is no one right way only your way.
I will post tonight on NFM and group your comments with others.
Thanks for the intelligent posts.