The Warren Buffett You Don't Know – Part 4

Buffett bought Executive Jet in mid-1998 for $725 million. Although this is a pittance compared with what Berkshire paid for General Re, the EJA deal was no less a milestone in its way. EJA, which pioneered the fractional ownership of business jets, is the first true emerging-growth company that Buffett has ever owned. What’s more, the very idea of investing in business aviation would have been considered downright sacrilegious throughout most of Berkshire’s history.

For years, Buffett mocked corporate ownership of jets as a wasteful executive perk. But in 1986, he bought a small used plane for Berkshire, then traded up to a more expensive model a few years later. He named the jet ”The Indefensible” and made sport of its purchase in his 1989 report to shareholders: ”Whether Berkshire will get its money’s worth from the plane is an open question, but I will work at achieving some business triumph that I can (no matter how dubiously) attribute to it.”

The truth is, Buffett had fallen in love with his plane but could not yet admit it. In 1995, he was introduced to Santulli by the head of one of Berkshire’s operating companies and bought a one-quarter share of a Hawker for personal use. His wife, who has become a frequent flier, called the new plane ”The Richly Deserved.” (Not to be outdone, Buffett renamed Berkshire’s jet ”The Indispensable.”) Santulli offered to sell his company to Buffett when Goldman, Sachs & Co. (GS), a founding minority investor, began pressuring him to float a public stock offering.
Executive Jet in no way resembles the sort of business on which Buffett cut his teeth as an apprentice to the late Benjamin Graham, co-author of the value-investing bible, The Intelligent Investor. Graham’s method emphasized creating a ”margin of safety” by investing only in stocks trading at two-thirds of net working capital. He called them ”cigar butts”–companies the stock market had discarded but that still held a puff or two of value to extract.

Buffett was Graham’s most accomplished disciple. But as the pupil established himself, he began to feel constrained by the mentor’s method. For Graham, a business was an abstraction wholly defined by a set of numbers on a page; he had no interest in its products, its management, its personality. But Buffett’s boundless curiosity and enthusiasm were not satisfied by the ghoulish exercise of profiting from the last dying gasps of derelict companies. Buffett’s yearnings and dissatisfactions did not begin to coalesce into an investment philosophy of his own until he met the blunt-spoken Munger in 1959. The two, closely matched in intellect and outlook, quickly became the closest of partners. Munger urged his friend to leave the cigar butts in the gutter and think of value in more expansive terms. Says Buffett: ”Charlie kept pushing me back to the idea that what we really needed to own was the wonderful business.”

Even so, it took Buffett a long time to tailor Graham’s straitjacket conservatism to the more generous dimensions of his own personality. His $11 million purchase of Berkshire Hathaway in 1965 was a costly case in point. Initially, Buffett saw the floundering old-line company as a classic Graham play. But then the textile manufacturer rallied unexpectedly, and Buffett sank more money into it on the belief that this cigar butt had a future after all. It did indeed, but not in textiles.

Buffett did not come fully into his own until he and Munger collaborated on the $25 million acquisition of See’s Candies in 1972. The San Francisco maker of boxed chocolates was the first business of any sort for which Buffett paid more than book value–three times book, in fact.
What, in Buffett’s view, makes a business wonderful? It starts with ”a sustainable competitive advantage.” Underline sustainable. Buffett will not invest in a business unless he feels reasonably certain how much it will earn over the next 20 to 25 years. But for all of Buffett’s cerebration, he does not feel truly comfortable unless a business ties into his own everyday experience. His favorite companies tend to traffic in elementally appealing brand-name products that Buffett not only uses himself but also invests with almost totemic meaning: a bottle of Coca-Cola, a Gillette razor blade, a box of See’s candy, and, yes, even a Gulfstream jet.

Buffett has always been especially partial to companies that can sustain a competitive edge without tying up much capital. Consider Scott Fetzer, which makes a variety of industrial and consumer products, including Kirby vacuum cleaners and Quikut knives. Since 1986, when Berkshire paid $315 million for Scott Fetzer, its earnings have risen by only 5.5% a year on average. Yet Buffett repeatedly has praised it as a model of capital efficiency. In 1998, Scott Fetzer netted $96.5 million after taxes on its $112 million in equity, a return on equity of 86%. This is all the more breathtaking considering that Buffett has been milking it for 13 years, extracting more than $1 billion all told.

Ever since Berkshire’s 1967 acquisition of National Indemnity Co., insurance has held double appeal for Buffett. Not only does he like the economics of the business–or parts of it, anyway–but a well-run underwriter also generates a steady flow of low-cost investment dollars, or ”float,” as a matter of course. The 1996 acquisition of GEICO, now the sixth-largest U.S. auto insurer, doubled Berkshire’s float at one stroke, and the Gen Re buy nearly tripled it, to $21 billion.

In Buffett’s view, the quality of a company’s management is integral to its value as a business. And when acquiring companies, Buffett is as concerned with the motives of the selling CEOs as he is with their abilities. ”What I must understand is why someone will continue to get out of bed in the morning once they have all the money they could want,” Buffett says. ”Do they love the business, or do they love the money?”

No less an authority than John F. Welch, CEO of General Electric Co., considers Buffett a superb judge of managerial talent. Buffett and Welch have gotten to know each other over the years as golf partners and as rivals in auto insurance and other businesses. ”Take 20 people you know quite well but Warren has just met casually,” Welch says. ”If you ask Warren his opinion about them, he’ll have each one nailed. He’s a masterful evaluator of people, and that’s the biggest job there is in running a company.”

In 34 years, Berkshire has never lost an operating chief except to death. In fact, the great majority of its subsidiaries are still run by the same executive who brought them to Berkshire in the first place. The operating head of longest tenure is Charles N. Huggins, who has been president of See’s Candies since Buffett acquired it. Huggins is 74 years old now, but he’s not Berkshire’s oldest manager. That would be 85-year-old Harold Alfond, who founded Dexter Shoe Co. in 1956 and sold to Buffett in 1993 for Berkshire shares now worth $1.5 billion.
Berkshire’s operating ranks contain a second octogenarian billionaire: 82-year-old Albert L. Ueltschi, chairman and CEO of FlightSafety International Inc., a pilot-training concern Berkshire bought for $1.5 billion in 1996. An ex-pilot, Ueltschi founded the company in a LaGuardia Airport hangar in 1951. ”I’m like Warren,” says Ueltschi, who has no plans to retire. ”I like what I do so much that I don’t consider it work.”