In the past I have tried to understand rationale and logic of Buffett’s acquisition, both public and privately held companies. While there are abundant books on Buffett, none of them analyse all the privately held entities, most of this information is scattered or not well organised. I collated information on a handful of companies under Berkshire’s flank and posted here
When Buffett makes a bet on IBM, it makes news. However, for individual investors it makes immense sense to understand what Buffett was doing when he had less money. All the companies Berkshire has acquired in the past, which are privately held and not written about are great in their own right and people don’t realise it. Fortunately there is a new book “MOATS : The Competitive Advantages of 70 Buffett and Munger Businesses” by Bud Labitan, author and a value investor, and his associates which nicely stacks up 70 of Buffett’s businesses. It unravels MOATS as conceived and applied by Buffett during his lifetime.
I communicated with Dr. Maulik Suthar of Gujarat, India who contributed in this book and Bud Labitan of Northwest Indiana, US to get some insight into MOATS book writing project. Please find Q&A with Bud Labitan and Dr. Maulik Suthar ending with a few questions from myself:
Maulik: What motivated you to write this book?
Bud Labitan: Maulik, I was in Omaha last May, and I attended Bob Miles Value Investor Conference, the book author’s event, and the 2011 Berkshire Hathaway annual Meeting. At the Value Investor Conference, I met with Bob Miles and Pat Dorsey. Everyone had a great time sharing stories and learning from the guest speakers. And, as you may know Pat Dorsey was formerly Morningstar’s Director of Stock Analysis who wrote about moats of different companies that they would review. As I looked around Mammel Hall and the impressive new building of the University of Nebraska at Omaha – College of Business Administration, it occurred to me that no person had tried to study and document the competitive advantages of Berkshire Hathaway’s businesses.
Maulik: Why did you focus on these 70 Berkshire Hathaway businesses?
Bud Labitan: It occured to me that the general public does not realize how great these businesses are. I took the names of the businesses listed on Berkshire Hathaway’s website… the link to major subsidiaries. Then I added a few of their largest stock investments… The chapters in MOATS are arranged alphabetically. My intent was to study the economic moats, learn more about them, and see which ones are growing and which ones are shrinking. I figured that this would help make me a better manager and a better investor… A part of me wanted to get Warren and Charlie’s attention, and get a job working for Berkshire Hathaway. After Todd Combs and Ted Weschler were hired to help with investments, I figured that my chances might be better on the operations/competition side of the business… As a big fan of the Chicago Bears American football team, I tend to think in terms of Offense, Defense, and Special Teams… and, if you don’t get picked for the Offense or Defense, sometimes you can make a name for yourself like Devin Hester running the ball back on Special Teams.
Maulik: So, MOATS is like one big application and cover letter? How did you start and organize this project, and how did you motivate the researchers to get involved?
Bud Labitan: Sort of… The project may or may not yield dual benefits. Either way, writing and editing MOATS has been a great learning experience. While much of my research was already compiled from notes and previous book projects, I needed to test my ideas about economic moats against someone else… sort of like checks and balances… I started to feel like the size of this project might be too big. So, I needed to simplify the process, stick to 2 main questions, and have research contributors to bounce ideas with. This testing of ideas yielded additional information that is new and valuable. It resulted in a bigger book of 358 pages, but I think it is a better book… The research contributors who contacted me took a chance that they might become part of a book with lasting value. I promised them that their name would appear along side mine on the chapter or chapters that they worked on.
Maulik: …and finding the researchers and editors?
Bud Labitan: I posted an offer on the web, and I wrote to Professors at the University of Nebraska at Omaha’s College of Business Administration. I posed the 2 questions this way: (1.) Name the business’ competitive advantages and (2.) Are the advantages sustainable for the next 10 years? Cost Advantages and/or Differentiation(Brand)Advantages?
Maulik: Did you get many volunteers?
Bud Labitan: At first I would get one or two a week. Then, I got lucky with some of the summer MBA students of Professor Phani Tej Adidam, Ph.D. who is the Chair of their Department of Marketing and Management. Tej Adidam was willing to give some extra credit points for participants. And, as you know, if your grade is somewhere between a B+ and an A-, the extra points help. Professor Adidam’s MBA students of 2011 have contributed valuable ideas to many of these chapters. Also, Richard Konrad, CFA, of Value Architects Asset Management was quite helpful with the financial and insurance businesses.
And, of course you, Dr. Maulik Suthar of Gujarat. You and Scott Thompson, MBA of Minneapolis, Minnesota were also enthusiastic supporters and a big help in discussing topics back and forth. We also have a few enthusiastic international volunteers like Beryl Chavez Li and Stephen Chan, students at the University of Manchester, UK.
Bud Labitan: I learned that some of these Buffett and Munger investments for Berkshire Hathaway have double and triple moats.
Maulik: Before we go into that, could you explain a moat for our readers?
Bud Labitan: Sure, Moats are barriers. They are competitive advantages. One of the oldest moats surrounded the ancient Egyptian settlement of Buhen, on the West bank of the Nile River. And, during the medieval period, the kings of Europe would build wide and deep trenches filled with water around their castles. These moats were built as single or double protective barriers against invading armies. In business, we think of moats as economic barriers to invading
Maulik: and the double and triple moats?
Bud Labitan: Take a look the Coca-Cola Company. One moat is the efficiency reflected in the amount of FCF generated for every sale. Since Coca-Cola has a combination of a special brand advantage, large scale cost of production advantage, and a global network distribution advantage, we could say that it has three moats around its economic castle. Charlie Munger also said that “The muscle power of Wal-Mart and Costco has increased dramatically.” Some of their
housing related businesses have had to make cuts during the recession, but they are now adding to their moats by buying up worthy competitors.
Maulik: Do you think the macro economy is going to grow any time soon?
Bud Labitan: I am not sure. However, I can tell you that these 70 businesses are fundamentally strong, and they will prosper better than many when the general economy resumes reasonable growth.
Maulik: Is there a common theme to their competitive advantages or moats?
Bud Labitan: Generally speaking, they either have a cost advantage or something special. In academia, they use the fancy word differentiation. In my writing of Moats, I wanted this book to be understandable by high school students. So, I tried to eliminate big words and fancy terms. At first, it was funny how some of the student contributors would say that a business was strong because of financial backing from Buffett and Munger and Berkshire. I would say something like “yes, you are partly right. However, these businesses were building up a moat or two before Buffett and Munger invested in them.” This is how I got some of them to focus on cost, special, or a bit of both.
Maulik: Are moats invented or acquired?
Bud Labitan: That is a good question. In these 70 businesses, somewhere in their history, a founder or manager built an advantage into their business model. Then, as they grew, some would acquire competitors and enhance their business model by learning as they grew. The one that comes to mind is Clayton Homes. Clayton Homes right now has diminished sales because of the general macro housing market. However, in the last down cycle before this one, they acquired
competitors and they have innovated better building processes into their product. So, when the economic cycle moves up again, Clayton will be an even stronger competitor.
I think the answer to your question is all of the above. Moats are invented, expanded, contracted, and acquired with bolt-on acquisitions. Moats must be maintained. And, in some industries like the newspaper businesses, moats are contracting because of media substitutes like cable TV and internet websites. In the Washington Post chapter, you will see how WPO is adapting to these changes while growing in educational services.
Maulik: I read that Berkshire Hathaway recently bought 64 million shares of IBM at a cost of $10.7 billion. What is the story on IBM and technology?
Bud Labitan: For me, this investment reflects Buffett and Munger’s continuous learning philosophy and flexible mindset. Charlie Munger has often says “Opportunity comes to the prepared mind.” Warren Buffett has read the IBM annual report every year for 50 years. That is one heck of a preparation period!
In 2011, he got a different slant on it. He said, “I read it through a different lens… just like I did with the railroads… I don’t think there’s any company that’s—that I can think of, big company, that’s done a better job of laying out where they’re going to go and then having gone there.”
Maulik: Was there a moat at IBM or did they just recently invent one in the past few years.
Bud Labitan: Maulik that is another good question. I think there were several factors at work here. First, even with its periods of ups and downs, IBM as a team had built up a well respected brand in IT services around the world. Next, guys like Lour Gerstner and Sam Palmisano led IBM to be less reliant on big hardware, and more towards services. The IBM mix is operations under five segments: Global Technology Services (GTS), Global Business Services (GBS), Software, Systems and Technology, and Global Financing. I think this mix of factors as well as managerial focus on building shareholder intrinsic value per share… the moat became apparent in Warren Buffett’s mind. At some point, these factors came to play in his mind: “Understandable first-class businesses, with enduring competitive advantages, accompanied by able and trustworthy managers, available at a bargain price.”
Maulik: Bud, this reminds me of your other book Decision Framing. Do you think it is intentional or intuitive?
Bud Labitan: Hum… it may not really matter (intentional or intuitive)… if we prepare our minds with continuous learning, like Charlie Munger suggests… and we pin our decisions on the four filters of 1. Understandable first-class businesses, with 2. enduring competitive advantages, accompanied by 3. able and trustworthy managers, and 4. available at a bargain price… I think our goal is to experience such moments of understanding.
Amit Arora : Which businesses (two or three) do you feel strongly about on the long side – out of the seventy written about in the book and reasons for the same ?
Bud Labitan: Personally, of the publicly traded Berkshire Hathaway holdings covered in the Moats book, I like IBM, JNJ, and KFT. Although I am disappointed that Kraft’s management feels that they need to split into 2 companies. After all, Berkshire Hathaway seems to do fine with over 75 companies under one umbrella.
With this I would like to thank Dr Maulik and Bud for their contribution to field of investing and for their time. For more detail visit http://www.frips.com – you can access five chapter sample and also an audio version from selected chapters.