My Investing Notebook

What Really Happened Between Lehman Brothers and Warren Buffett

2012-05-24T17:49:00.001-07:00

Here is some fascinating information on what really happened between Lehman Brothers and Warren Buffett (from the examiners report):

In late March 2008, McGee suggested that Lehman reach out to Buffett.
McGee had a pre‐existing banking relationship with Sokol of MidAmerican Energy, which is majority‐owned by Buffett’s Berkshire Hathaway. Either McGee or Joseph G. Sauvage, LBI Vice‐Chairman, called Sokol to ask if Buffett would take Fuld’s call.

Jerry A. Grundhofer, who was about to join Lehman’s Board, also asked Buffett if he would take Fuld’s call. Buffett agreed.

Before calling Buffett, Fuld called Sokol on March 27, 2008. That same day, Lehman prepared a draft of a letter, to be sent by Fuld to Lehman employees, outlining a $3.5 billion investment from Buffett in Lehman’s preferred stock at a $54 per share conversion price.

Fuld told the Examiner that he did not know how that letter came to be prepared, and it does not appear that Fuld saw the draft. Fuld also did not recall Buffett indicating a willingness to invest $3.5 billion. Buffett was surprised that Lehman had prepared a draft letter announcing the deal, because he never got close to a deal with Lehman.

And here is where it really gets interesting.

Fuld and Buffett spoke on Friday, March 28, 2008. They discussed Buffett investing at least $2 billion in Lehman. Two items immediately concerned Buffet during his conversation with Fuld. First, Buffett wanted Lehman executives to buy under the same terms as Buffett. Fuld explained to the Examiner that he was reluctant to require a significant buy‐in from Lehman executives, because they already received much of their compensation in stock. However, Buffett took it as a negative that Fuld suggested that Lehman executives were not willing to participate in a significant way. Second, Buffett did not like that Fuld complained about short sellers. Buffett thought that blaming short sellers was indicative of a failure to admit one’s own problems.

Following his conversation with Buffett, Fuld asked Paulson to call Buffett, which Paulson reluctantly did. Buffett told the Examiner that during that call, Paulson signaled that he would like Buffett to invest in Lehman, but Paulson “did not load the dice.”

Buffett spent the rest of Friday, March 28, 2008, reviewing Lehman’s 10‐K and noting problems with some of Lehman’s assets. Buffett’s concerns centered around Lehman’s real estate and high yield investments, lending‐related commitments, derivatives and their related credit‐market risk, Level III assets and Lehman’s securitization activity. On Saturday, March 29, 2008, Buffett learned of a $100 million problem in Japan that Fuld had not mentioned during their discussions, and Buffett was concerned that Fuld had not been forthcoming about the issue. The problems Buffett saw in the 10‐K along with Fuld’s failure to alert Buffett to the issue in Japan cemented Buffett’s decision not to invest in Lehman.

At some point in their conversations, Fuld and Buffett also discovered that there had been a miscommunication about the conversion price. Buffett was interested only in convertible preferred shares.2452 Buffett told Fuld that he was willing to agree to a $40 conversion price per share, while Fuld thought Buffett was offering to buy in at “up‐40,” or 40% above the current market price, which would have been about $56 per share. On Friday, March 28, 2008, Lehman’s stock closed at $37.87

Fuld spoke to Lehman’s executive committee and several Board members about his conversations with Buffett. Lehman recognized that an investment by Buffett would provide a “stamp of approval.” However, Lehman already had better offers for its April capital raise, and Lehman did not think it could give a better deal to Buffett at the same time it gave a less attractive deal to others.

On Monday, March 31, 2008, before Buffett could tell Fuld that he was not interested, Fuld called Buffett to say that Lehman could not accept his terms.

One last-ditch effort with Buffett

McGee contacted Sokol again in late August or early September 2008 and outlined Lehman’s “Gameplan” for survival, specifically SpinCo. During a subsequent telephone call with Sokol, McGee explained the “good bank/bad bank” scenario and stated that Lehman would need an investor. Sokol believed the e‐mail and call were intended to induce Sokol to pass that information on to Buffett, so Sokol briefed Buffett on SpinCo. Buffett thought the idea would not solve Lehman’s problems.

Sometime during the week prior to Lehman’s bankruptcy, McGee again reached out to Sokol with what both Sokol and McGee described to the Examiner as a “Hail Mary” pass. McGee asked, “Do you have any ideas to save us?” Sokol, who was bear hunting in Alaska at the time, told McGee that he did not.

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How Buffett Did the Goldman Deal

2012-05-23T17:10:00.001-07:00

** Details emerging from the insider trading trial against Rajat Gupta **

The second proposal had terms closer to Buffett’s liking, including $5 billion in preferred stock carrying a 10 percent interest rate and the right to buy common shares of stock in a new public offering. Buffett also insisted that top Goldman Sachs executives not sell their own shares.

“Was this discussion confidential?” Brodsky asked.

“Very,” said Trott, who was based out of Chicago and working out of New York at the time. Trott said that winning Buffett’s investment was “like getting the Good Housekeeping seal of approval.”

They hammered out the deal in a 20-minute telephone call on Sept. 23 in which Trott said he wanted Buffett to be the “cornerstone” of the transaction. After they reached a tentative agreement, Buffett told Trott not to telephone until later that afternoon because he had an important appointment.

“He told me he promised his grandkids to take them to Dairy Queen, and he was not to be interrupted,” Trott said. Goldman Sachs executives including Chief Executive Officer Lloyd Blankfein and Chief Financial Officer David Viniar signed off on the deal, and then took it to the full board of directors at 3:15 p.m. that day, Trott said. The board, including Gupta, met by telephone, he said.

“The impact on Goldman Sachs was market-moving,” he said. “The markets were in chaos.” Trott said he spoke to Buffett after the deal was approved, and Buffett asked him to brief Berkshire’s CFO, Mark Hamburg, with the details.

“Warren had alerted him that I’d be calling him about a deal he’d agreed to,” Trott said, laughing and turning to explain to the jury. “Mark Hamburg didn’t know the details until well after the close of the market.”

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David Einhorn's Ira Sohn Presentation - GO-UP

2012-05-22T15:17:00.003-07:00

There are many great companies with great balance sheets that suffer from low valuation multiples in the current environment, when market participants have enormous appetite to pay for yield, but little appetite to pay for earnings. The traditional advice to such companies is to offer a dividend, but dividends often don't work. A stock with a low P/E multiple often just becomes a stock with a low P/E and an attractive dividend.

Rather than enduring low multiples, companies can create value for shareholders by taking advantage of the situation by creating a new type of preferred security and distributing it to shareholders. This new security, which we call Greenlight Opportunistic Use of Preferreds, or GO-UPs, would be perpetual preferred stock distributed directly to shareholders, so that shareholders would own and could separately trade both the GO-UP and the common stock.

Greenlight Opportunistic Use of Preferreds (GO-UP)
PDF of the presentation

William Ackman's Ira Sohn Presentation on JC Penney

2012-05-22T14:57:00.001-07:00

Ackman's Ira Sohn Presentation on JC Penney (embedded)
Ackman_JCP PDF

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Buffett, Munger, And Gates on Fox

2012-05-10T18:35:00.000-07:00

9 videos (embedded below.)

Munger on Occupy Wall Street

2012-05-08T04:02:00.000-07:00

Charlie Munger interview with CNN:

Berkshire's Charlie Munger Speaks

2012-05-04T14:41:00.000-07:00

Vice-chairman of Berkshire Hathaway Corporation Charlie Munger talks to CNBC's Becky Quick about the consistency of Berkshire, Warren Buffett's health, the company's succession plan and his feelings on the future of the company.

Bill Ackman & Hunter Harrison on Canadian Pacific

2012-05-01T15:43:00.000-07:00

Embedded below is a clip from Ackman & Harrison's appearance on CNBC (rss readers click here)

Bill Ackman on Barnes and Noble and Burger King

2012-05-01T15:39:00.001-07:00

Embedded below is a clip from Ackman's interview on CNBC (rss readers click here)

A terrible treadmill to get on

2012-04-29T16:12:00.003-07:00

Warren Buffett:

While I was on the board at Gillette, the company would go to Wal-Mart and offer discount razor blades at quarter-end to boost results. It is a terrible treadmill to get on.

Bill Ackman on Canadian Pacific

2012-04-23T16:15:00.002-07:00

video

How To Own a Market

2012-04-20T15:09:00.000-07:00

For a company to own its market, it must have some combination of brand, scale cost advantages, network effects, or proprietary technology. Of these elements, brand is probably the hardest to pin down. One way to think about brand is as a classic code word for monopoly. But getting more specific than that is hard. Whatever a brand is, it means that people do not see products as interchangeable and are thus willing to pay more. Take Pepsi and Coke, for example. Most people have a fairly strong preference for one or the other. Both companies generate huge cash flows because consumers, it turns out, aren’t very indifferent at all. They buy into one of the two brands. Brand is a tricky concept for investors to understand and identify in advance. But what’s understood is that if you manage to build a brand, you build a monopoly.

Scale cost advantages, network effects, and proprietary technology are more easily understood. Scale advantages come into play where there are high fixed costs and low marginal costs. Amazon has serious scale advantages in the online world. Wal-Mart enjoys them in the retail world. They get more efficient as they get bigger. There are all kinds of different network effects, but the gist of them is that the nature of a product locks people into a particular business. Similarly, there are many different versions of proprietary technology, but the key theme is that it exists where, for some reason or other, no one else can use the technology you develop.

Apple—probably the greatest tech monopoly today—has all these things. It has complex combination of proprietary technology. By building both the hardware and the software, it basically owns the entire value chain. With legions of people working at Foxconn, it has serious scale cost advantages. Countless developers building on Apple platform and millions of repeat customers interacting with the Apple ecosystem provide the network effects that lock people in. And Apple’s brand is not only some combination of all of these, but also something extra that’s hard to define. If another company made an otherwise identical product, it would have to be priced less than the Apple version. Even beyond Apple’s other advantages, the brand allows for greater monetization.

We're inferior

2012-04-16T14:57:00.000-07:00

...Never before in my career have I seen a board and management commission a study at shareholder expense and release it to the general public in an attempt to identify the company's weaknesses in order to prove its inferiority versus its competitors. We have said that CP has a culture of excuses that has interfered with its historic ability to execute. This board-commissioned consultant's report is Exhibit A for the need for culture change at CP.

Bill Ackman's Letter to the board of Canadian Pacific

Leucadia 2011 Letter

2012-04-13T20:05:00.003-07:00

Given the above, we have reduced Leucadia’s leverage by calling $511.3 million of long term debt in 2012 and retiring other debt during the last three years in market transactions. With those steps, we have cut Leucadia’s leverage by over 40%. Borrowing money at 7% without a clear path to make 15%+ is not attractive and we don’t see many opportunities to make at least that return. This cautious approach was evident in the purchase of National Beef; although banks were beating down our door to lend us more money, we paid cash.

A world-wide recovery in the near future is not a foregone conclusion. Europe and the future of the Euro are far from settled. Growth in China is slowing and the risk of a “Chinese Spring” cannot be ruled out. Iran is a big problem. In an environment of slow growth at home and a dysfunctional government, we believe that less financial leverage is better. We expect many other companies and investors share this view. We emphasize that we are not pessimistic, just cautious. We are enthusiastic about the future of our broad array of operating businesses and investments and have our eyes open for additional acquisitions. Never fear, if a good deal comes along we will find a way.

Inside Amazon's Idea Machine: How Bezos Decodes The Customer

2012-04-11T19:35:00.002-07:00

Great profile of Jeff Bezos in Forbes:

More than a century ago another legendary retailer, Chicago’s Marshall Field, championed the fatalist’s slogan: “The customer is always right.” Bezos, perhaps more than anyone, has taken that mantra into the digital era, incrementally cracking one of the business’s great mysteries: figuring what customers want before the cash register rings and then making those insights pay off. In an era when high-flying tech companies outdo each other with worker perks, no-frills Bezos is proving the potency of another model: coddling his 164 million customers, not his 56,000 employees.

Ackman's Presentation on BK — Justice Is Best Served Flame Broiled

2012-04-05T20:15:00.001-07:00

Presentation below (link to the pdf) Justice is Best Served Flame Broiled

Ghosts in the Newsroom

2012-04-05T18:12:00.001-07:00

Buffett’s investing strategy revolves, in part, around what he calls “moated businesses”—that is, businesses whose competitive advantage is so wide that other companies cannot cross it. For him, strong newspapers were the perfect moated businesses. “In newspapers, the basic rule was survival of the fattest,” he told me. “And the trick was to be bigger than the other guy because at that point you had more help-wanted ads, you had more automobiles for sale, you had more people if you lost your dog who might find it if you ran a classified ad. And you got more dominant because to many people—this kills people in the news business—the most important news in the newspaper are the ads.” Buffett made it clear when we spoke that he understood that he was talking about an outdated model of newspapers, one that has not survived the Internet, which has thrown bridges and grappling hooks across the moat and allowed interlopers to surge inside. But it was this old-fashioned dominance that he had loved about the Post.

And, as Buffett sees it, the newspaper’s journalists never understood that fundamental reality. “The Washington Post is a local newspaper,” Buffett said flatly. “I mean, it has national reach, but the grocers that advertise in it, they’re not going to get national customers. The circulation they’re paying for is the circulation that goes to people in the Greater Washington, D.C., area, and that’s way different than The New York Times. One of the things that’s existed over time which I’m sure you’re aware of is that the newsroom, kindled by what happened in Watergate, liked to think of themselves as national. And they are national in an important respect, but they’re not national as a business. And they don’t have a business model that works nationally. What they do have as a business asset is a large and prosperous local market.”

Eddie Lampert on CNBC: Risk 'Coming Back' to Markets

2012-04-04T18:43:00.001-07:00

Steve Jobs on Inventory

2012-04-04T06:00:00.000-07:00

...But it's also incredibly difficult to give information. Take auto dealerships. So much money is spent on inventory - billions and billions of dollars. Inventory is not a good thing. Inventory ties up a ton of cash, it's open to vandalism, it becomes obsolete. It takes a tremendous amount of time to manage. And, usually, the car you want, in the color you want, isn't there anyway, so they've got to horse-trade around. Wouldn't it be nice to get rid of all that inventory? Just have one white car to drive and maybe a laserdisc so you can look at the other colors. Then you order your car and you get it in a week.

Source

Consider Henry the Pheasant

2012-04-03T18:35:00.000-07:00

UCLA neuroscientist Dr. Peter Whybrow, author of the book American Mania, thinks the United States is by and large a victim of its own success because people are simply ill-equipped to handle the abundance of modern times, as opposed to the scarcity our ancestors endured. He says it’s not that Americans are any weaker psychologically than other people. In fact, you’ll find the same emerging behaviors in other cultures where food and money are in rapidly growing supply. Dr. Whybrow says animals—even birds(!)—exhibit the same conduct in the face of abundance.

Consider “Henry the Pheasant.” In England last year, on the grounds of Blenheim Palace, the Churchill family estate, a harsh winter and the efficiency of local hunters took a nasty toll on the pheasant population. As Dr. Whybrow tells this true story, only a single bird survived—and the locals affectionately named him Henry. Having made it through the scarcity of food and safe cover the previous winter, Henry had the entire field (literally) to himself when spring arrived. He made the most of it. Without competition for food in the freshly seeded tract, he ate almost constantly. Before long, Henry was enormous, and he used his gargantuan stature to frighten other birds away and consume even more food. Eventually, he got so obese that the locals noted he could no longer fly. Henry was indeed living the high life … until suddenly one day he disappeared. A fox ate him.

Martin Capital Management 2011 Letter (PDF)

AFA Foods Files Bankruptcy Citing ‘Pink Slime’ Coverage

2012-04-02T18:26:00.000-07:00

When you're this levered can you really blame pink slime?

AFA Foods, a ground-beef processor owned by Yucaipa Cos., sought bankruptcy court protection with a plan to sell some assets after media coverage of “pink slime” cut demand for its products.

The company, based in King of Prussia, Pennsylvania, listed assets of $219 million and debt of $197 million in Chapter 11 papers filed today in U.S. Bankruptcy Court in Wilmington, Delaware.

source

Whitney Tilson's March 2012 Letter

2012-04-02T15:52:00.001-07:00

Whitney Tilson's March 2012 Letter

15 Largest Long Positions
Here are our 15 largest long positions today (in descending order of size):
1. Berkshire Hathaway
2. Iridium (stock & warrants)
3. Howard Hughes Corp.
4. Citigroup
5. Goldman Sachs
6. JC Penney
7. Netflix
8. SanDisk
9. AIG
10. Pep Boys
11. Alexander & Baldwin
12. Dell
13. Resource America
14. MRV Communications
15. Grupo Prisa (B)
monthlyletter-mar12

An Activist Letter To Warren Buffett

2012-04-02T15:39:00.002-07:00

An April Fool Day’s joke

Baker Street Capital Management, LLC
12400 WILSHIRE BLVD, STE 940, LOS ANGELES, CA 90025

April 1, 2012

The Board of Directors
Berkshire Hathaway Inc.
3555 Farnam Street, Suite 1440
Omaha, NE 68131

Dear Members of the Board:

The Chairman’s 2011 Letter to Shareholders notes that the per-share book value of Berkshire Hathaway has compounded annually at a rate of 19.8% since present management took over 47 years ago. While these results are both impressive and encouraging, we are deeply concerned that they have not translated into strong share price performance during the first quarter of 2012. In fact, Berkshire Hathaway stock has underperformed the S&P 500 index by over 5% so far this year. Satisfactory long-term returns offer little consolation to shareholders who have purchased shares in recent months and whose timeframe is shorter than “forever.”

The causes of Berkshire’s lagging stock price are easily identifiable and, in our opinion, within the board’s power to fix. We urge you to consider several important changes that we believe will lead to greater recognition of Berkshire Hathaway in the investment community.

Investor Relations

Berkshire clearly lacks a robust investor relations strategy. A rigorous effort to market the Company to institutional and retail shareholders is sure to have a number of key benefits, such as increased share turnover and better earnings visibility. We call on the Berkshire board to quickly implement the best practices of its peers, including quarterly conference calls, regularly updated financial guidance, frequent marketing road shows with senior management, detailed investor presentations, and a proactive outreach program to help Wall Street analysts fully understand the Berkshire story. The good news is that it is not too late to transform Berkshire from a niche “value investment” to a much more popular market darling stock.

Capital Return and Acquisitions

We also believe that the Berkshire board should immediately reassess the Company’s capital return and acquisition policies. The absence of a regular dividend makes it difficult, if not impossible, for investors to calculate the proper price to pay for Berkshire shares. A monthly cash dividend would finally reward loyal, long-term shareholders and would be much more attractive than the recent share repurchase program, which has only served to further reduce the float and liquidity of Berkshire shares.

Berkshire has historically pursued an opportunistic acquisition strategy. While this whimsical approach may have worked in the past, a more structured process would benefit shareholders in the current environment. We urge the board to immediately retain a reputable investment bank with significant experience in mergers and acquisitions to complement Berkshire’s in-house skill set. An obvious advantage would be to enhance Berkshire’s rudimentary approach to target company valuation and compensate for senior management’s lack of financial modeling experience. All Berkshire directors should take their fiduciary duties seriously and protect shareholders from Mr. Buffett’s track record of losses stemming from questionable acquisitions, including Dexter Shoes in 1993 and a Sinclair gasoline station in 1951.

Compensation

We believe that the board has conveniently chosen to maintain the status quo and ignore these critical issues in order to preserve the directors’ generous board fees, ranging from $3,300 to $7,300annually. Equally disturbing is the fact that this compensation package is not tied to quarterly or annual share price performance. As a result, the board has stood by idly as the stock price has lagged the general market during the past three months. In addition, non-executive directors own, on average, only 3,171Class A shares. Our analysis shows that directors at many of Berkshire’s peers own a much higher number of voting class shares. Given the directors’ excessive board fees and lack of economic ownership in the business, it is not surprising that the Berkshire board has fought for years to maintain a dual-class stock structure, a corporate maneuver used frequently by deeply entrenched and self-interested boards.

Any criticism of Berkshire is incomplete without a discussion of egregious executive compensation practices at the company. As disclosed in the most recent proxy, Warren Buffett received a salary of $100,000 for his services as Chairman and CEO in 2011. By his own admission, Mr. Buffett has delegated management responsibilities to more talented subsidiary company executives. More recently, he has hired investment managers to direct many of Berkshire’s public market investments. In media interviews Mr. Buffett has admitted to spending a significant amount of time pursuing his bridge gambling interests. In the absence of more comprehensive disclosures, shareholders are left to wonder exactly what role Mr. Buffett really plays at Berkshire. We believe that compensation of one hundred thousand dollars represents a significant transfer of wealth from shareholders to Mr. Buffett. We urge the board to retain professional compensation consultants to perform a thorough benchmarking study of executive remuneration at Berkshire.

Succession Planning

The Berkshire board clearly owes shareholders and the media an answer on the question of executive succession. While we seriously question Mr. Buffett’s contribution to Berkshire’s success, we feel strongly that the board should end all doubt and finally disclose its choice of Charles Munger as the successor to the Chief Executive Officer position. Mr. Munger will bring several decades of experience to Berkshire’s management team and his deep expertise in the areas of technology and solar power would be a logical expansion of Berkshire’s limited circle of competence.

Sincerely,

Vadim Perelman
Managing Member

The Auditors Are Part Of The Problem

2012-04-01T08:41:00.000-07:00

There is an interesting article in barrons on forensic accountant Howard Schilit — author of the excellent book: Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports. Schilit says:

Here is how the auditors look at the world: They think of themselves and their legal liability issues first; if it's in the rule book and disclosed, you are covered. Second, they think of their clients. The client asked them to do something, and they want to please the client. A very distant third is they may occasionally ask: How does this look from the perspective of the investor? Investors would be astounded if they realized that this is how the party that is supposed to protect them views the world.

This reminds me of what Charlie Munger said at the University of Michigan.

Of course, the adults who could have fixed it, like the accountants who had ridiculous standards, without which a lot of the bad behavior wouldn't have worked. The accountants utterly failed us. By the way, there's practically no sign of any intelligent reversal of that failure of that profession. I have yet to meet many accountants who are the least bit ashamed for their contribution to our recent troubles, but it was immense. Imagine when Enron comes down to the SEC, and says, "We want to write a little contract with A and a little contract with B. And take all the profits we're going to make from these complicated contracts over the next 20 years into earnings immediately, and put an asset on our balance sheet of $28 million from signing two pieces of paper." And the SEC, led by wonderful accountants who have studied in great places, "Why, of course you should have that kind of accounting." What the hell were they thinking? [laughs] How could anybody have any respectable understanding of human nature without realizing that the kind of people who are going to be tempted by that accounting were not going to be able to resist the temptations? It was disgusting.

When asked — "What happened to the accounting profession and what can be done to try and fix it?" — Munger responded:

Well, partly they sold out. Partly they legitimately fear the liabilities that would come if they had to make more difficult judgments. It's a very, very difficult problem. It could be done by changing laws and rules very easily. And it would cause an enormous upheaval in America, which would be hugely to the plus. 99 percent of the troubles that threaten our civilization come from too‑optimistic accounting, and yet these damn accountants with their desire for mathematical purity want to devote exactly as much attention to accounting that's too pessimistic as they devote to accounting that's too optimistic. Which is crazy! Way more than 99 percent of the problem is from being too optimistic. Therefore, we should have a system where the accounting is way more conservative.

Icahn on Icahn

2012-03-31T16:04:00.001-07:00

...One of the major problems in our country, with many exceptions, are CEOs – and our corporations are run in a dysfunctional manner. It’s amazing when you get in there how badly they’re run. And we can get a lot done as activists. During the last few years the market value of the common stock of companies that we were in, amazingly rose $55 billion and they were only $20 billion when we started buying. This certainly helped all shareholders. Often the boards do the opposite of what they should be doing. A board should make management accountable. They often don’t do that, they’re often buddies. They want to go to the Super Bowl … In the companies that we control, we don’t micromanage. We let the CEO run it, but we keep him accountable at the board level. If the numbers aren’t coming, the board needs to go in and find out why. If there have to be certain changes made, the board needs to do it. It’s hard to do that in a public company. You often can’t get rid of a CEO at a public company, unless I come along with a huge proxy fight.