Bruce Greenwald: Buffett Has Lost His Mind

[txlaw]

Grenville posted this filing on another thread: http://www.sec.gov/Archives/edgar/data/934612/000095015709001025/form425.htm

 

It's an interview between Buffett and the CEO of BNI.  Some key excerpts:

 

Well, [bNI] has to do well if the country does well, and the country is going to do well.  So, you know, I don’t know about next week or next month or even next year, but if you look at the next 50 years, this country is going to grow, it’s going to have more people, it’s going to have more goods moving, and rail is the logical way for many of those goods to travel, and probably a greater percentage all the time, just in terms of, of cost efficiency, in terms of fuel efficiency, in terms of environmentally-friendly.  So there’s no way rail is going to lose share, and I think the pie is going to grow, and I think the rail share of the pie is going to grow.

 

. . .

 

Well, it’s a great business in that you know it’s going to be here forever, to start with.  I mean, the hula-hoop business came and, you know, went, and then, you know, the pet rocks and all that kind of thing.  And even television set manufacturers have, you know, moved over to Japan.  All of that sort of thing.  The rail business is not going to go anyplace.  It’s going to be right here in the United States.  There’s going to be four big railroads that are moving more and more goods.  So it’s, it’s, it’s a good business.  It, it can’t be, it can’t be something like Coca Cola or Google, because it’s, you know, it’s a public service type business, too, and it has, it has a fair amount of regulation that is part of the picture.  But it’ll be a good business over time.  It will make sense for this country to want railroads to continue to invest more and more money, in terms of expanding and becoming more efficient.  So you’re on the side of society, and society will largely be on your side.  Not every day, but most of the time.

 

---------

 

This interview shows Buffett's rationale for why BNI is a great business.  Greenwald is wrong to suggest that it's not a good business and that the purchase is based entirely on energy prices.  He is also wrong to criticize BNI for not raising prices enough.  After all, a railroad is really a utility business.  They can't just raise prices to whatever they want, or they face the risk of being re-regulated to the point where they earn poor returns on capital.  But as a utility, they will be allowed to raise prices enough to earn a reasonable return on capital invested back into the business. 

 

Whether Buffett payed too much is a legitimate question given the opportunities that could potentially be available in the coming years, but since Berkshire likes "hold forever" businesses and is a massive institution that acts on a much longer time scale than most, this acquisition makes a lot of sense. 

 

Actually, Greenwald's analysis of Comcast also seem off the mark.  He seems to totally ignore the fact that Comcast is very much like a toll road that is subject to both regulatory risk and technological/business risk.  See this paragraph from the Advisor Perspectives interview:

 

The one that we like best, even though they break our hearts with their stupidity, is Comcast, which is trading at a 13% earnings return because they are way over-depreciating.  We think they ought to have huge pricing power.  To do that, they’ve got to get along with the Telcos, but they are doing everything in their power to alienate them by going after small businesses, which has always been in the bailiwick of the Telcos.  Hopefully, just like Coke and Pepsi, they will learn to cooperate.

 

What will happen is that you will have a cable wire into your house, and then everything will be wirelessly distributed.  In that world, their costs go to nothing.  If they keep their prices up – and they can probably charge $300/month, because it will cover your cell phone, regular phone, internet access, and on-demand programming – and they collaborate, they can charge a lot and make a ton of money. 

 

Bruce Greenwald must be out of his mind if he thinks that we'll ever get to a world where Comcast can charge $300 per month for a quadruple play.  If they even think about trying that or "collaborating" with the telcos, this Silicon Valley-friendly administration will initiate proceedings to regulate the cable companies on par with the telcos.  And that could also catalyze a political movement to turn the telcos and cable companies into regulated dumb pipe providers.  Any utility has to walk the line and make sure they don't get into territory where the regulator is forced to crack down.

 

Then there is the rumor going around that Apple is making deals with content providers (such as Disney) to offer subscription packages via iTunes.  A deal like that combined with the increasing popularity of sites like Hulu and the increased use of computers connected to one's media screen (think Xbox, PS3, Apple TV, Boxee) threaten to make the cable cash cow much less valuable.  And I don't think the cable companies can expect to recoup the revenue lost from defecting cable subscribers by charging an exorbitant amount for internet service. 

 

Brian Roberts sees this and understands that it's in his and his shareholders' best interests to diversify into content.  He's actually doing the smart thing buying NBC-U.  Reminds me a lot of another company that diversified into content called Capital Cities.

 

And what does Buffett think about what Comcast is doing?  Well, let's see . . . he just placed the COO of Comcast, the son of Tom Murphy, former CEO of Cap Cities, on the board of Berkshire. 

 

Bottom line: Just because Greenwald is a prof at the Heilbrunn Center doesn't mean he knows what he's talking about.

[Ballinvarosig Investors]

Bottom line: Just because Greenwald is a prof at the Heilbrunn Center doesn't mean he knows what he's talking about.

In fairness to Greenwald, he is looking at this deal from a Grahamite perspective and from there, BNI doesn't look particularly cheap. What Greenwald needs to understand is the expectation that Buffett himself has set on Berkshire (return of 10% going forward). Like many have pointed out, at the size Berkshire is now, it's very difficult for him to find a pitch that he can knock out of the park. I think BNI will give him the return he's looking for, but anyone expecting a home run from this deal will be disappointed.

[txlaw]

Bottom line: Just because Greenwald is a prof at the Heilbrunn Center doesn't mean he knows what he's talking about.

In fairness to Greenwald, he is looking at this deal from a Grahamite perspective and from there, BNI doesn't look particularly cheap. What Greenwald needs to understand is the expectation that Buffett himself has set on Berkshire (return of 10% going forward). Like many have pointed out, at the size Berkshire is now, it's very difficult for him to find a pitch that he can knock out of the park. I think BNI will give him the return he's looking for, but anyone expecting a home run from this deal will be disappointed.

 

I think Greenwald is correct that for almost every individual investor, the price paid was probably too much.  But Berkshire is essentially like an endowment fund.  The time scale is waaaay longer than ours.  And we also need to take into account that Berkshire is essentially earning a spread on low cost float and the cash return on their investment.  BNI is a low risk place to put money if there are no other opportunities available.  For example, let's say that at some point in time the entire universe of stocks that Berkshire can invest in is overvalued.  Well, then Berkshire can just pay down BNI debt or reinvest for growth at an adequate return, earning a nice spread between the cost of float and the economic return of taking such action.  BNI is an inflation protected bond that is always available for Buffett to invest in.

 

I'm also not sure that Ben Graham would not have approved of the acquisition if he were alive to see how things have changed.  I can't say that I've read Security Analysis, but my understanding is that Graham had a different opinion of utilities versus other businesses.  But maybe I'm thinking of Martin Whitman rather than Graham.

 

Finally, I bet that a lot of people would not be criticizing the acquisition if the buyer was an LBO firm that was levering up an acquisition entity to purchase the railroad.  They would say, oh look, they are getting a great return on their equity and they will definitely be able to service their debt.  But because this is Buffett and insurance leverage, they are quick to criticize.

 

I'm actually more disturbed by Greenwald's view on Comcast than his view on BNI.  I believe he is just wrong, and he is not taking into account where the puck is going in the media distribution space.  He's certainly not taking a Grahamite approach in his Comcast investment.  I think it will work out in the end, but his rationale for why Comcast might be a good investment is just wrong.

 

I wouldn't give Greenwald my money to invest.

[Guest dealraker]

I'm probably the oldest member of this board and Warren Buffett's timeline is "in line" with mine.  While all the here-and-now trading --- and criticisms of Buffett's actions are the focus-- it is amazing how the far away reality gets here so quickly.  BNI is an excellent business that will likely outperform most.  I have long believed that it is most advantageous to avoid the Gerald Levins of the world (paid $184 billion for AOL and it sold this month for $3.5 billion) than to decide that Buffett was an idiot to pay 18 times depressed earnings for BNI when it was only worth 15 times depressed earnings.  "Idiot" and "terrible decision" type words seem to best represent the writers actions to pen such waste-of-our-time things.

 

I remember clearly bringing up buying Berkshire at my club meeting in the year 2000.  My club decided to go "all tech" because "it will be tech for the next 8 years" according to Harry Dent.  My club has outperformed the market for years and years so they (we) aren't idiots.  Yet the criticisms of Buffett at that time were astronomical, just horrible insults from mature successful businessmen.

 

So were the criticisms of Henry Singleton all during his tenure.

[Guest Bronco]

In my opinion, the criticism is worhtless unless a better alternative is suggested.  It was clear that Buffett was headed down the railroad path.  It is also clear that Berkshire prefers wholly owned businesses.  Again, what were some alternatives?

 

While people aren't looking, I am noticing that Berkshire will be a cash flow machine.  While I am not a buyer of the company right now (doesn't meet my margin of safety) - between the dividends from entities such as coke, preferreds payments from GE and GS, insurance operations, etc... Berkshire will soon again be faced with having too much cash.

 

And I am pretty sure I know how they will spend it.

[Ballinvarosig Investors]

I'm actually more disturbed by Greenwald's view on Comcast than his view on BNI.  I believe he is just wrong, and he is not taking into account where the puck is going in the media distribution space.  He's certainly not taking a Grahamite approach in his Comcast investment.  I think it will work out in the end, but his rationale for why Comcast might be a good investment is just wrong.

Considering he's now working with a multi-billion dollar hedge fund (First Eagle), he has to start taking a position and view on unGraham-like stocks.

[Ballinvarosig Investors]

"Idiot" and "terrible decision" type words seem to best represent the writers actions to pen such waste-of-our-time things.

Who called Buffett an "idiot" and said this was a "terrible decision"?