On Wall Street

February 15, 2013 8:29 pm

Relish the lessons in Buffett ketchup deal

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Warren Buffett has a strange effect on people. One grizzled veteran of mergers and acquisitions was practically giddy this week to find himself on an email chain with the 82-year-old investor known as the “Sage of Omaha”.

Spend any time with value investors and you will find them quoting him as a reflex, like pilgrims touching the statue of a saint as they pass. “Our favourite holding period is forever”, from the 1988 letter to shareholders in Berkshire Hathaway, for example, or the old saw “be fearful when others are greedy”.

He is the deus ex machina of the stock market, a constant background presence who could decide from his bathtub in 2011 to rescue confidence in Bank of America with bags of cash. Or he can appear, as he did this week with Heinz, with a $28bn deal to extract an iconic US company from public hands all but signed and sealed.

What lesson, though, should mortal investors draw from Mr Buffett’s purchase of the maker of ketchup and baked beans?

It comes as merger and acquisition activity has started to pick up, providing real excitement for investment bankers for the first time since the financial crisis. Speculation that other food companies could be taken out provided a boost to the share prices of companies such as General Mills this week.

Yet looking for more dealmakers to follow in the footsteps of Mr Buffett is the wrong conclusion. His last big purchase was the $34bn he spent on the railroad company Burlington Northern Santa Fe in 2010, and while that was a sign of his long-term confidence in US economic revival, it didn’t set in motion any great round of consolidation for the sector.

This time the economic message is less encouraging in a week where the US stock market has skirted an all-time high. Mr Buffett, with his private equity partner 3G Capital, has bought a solid and dependable business that will withstand all but the worst economic environments.

The billionaire is famously an optimist on the US in the long term, but he has also shown a preference for big, solid and dependable companies with strong brands: Coca-Cola, Gillette and Johnson & Johnson for instance.

For investors nervous about the outlook, consumer staples yielding 3-4 per cent would seem a good idea. Follow the Buffett long-term mantra and let the cash flows from the business slowly compound over time.

Yet, again, simply to follow in Mr Buffett’s footsteps would be to miss a fundamental point. The investor has developed a peerless record over four decades by choosing where to invest capital. He takes cash thrown off from reliable businesses, for instance See’s Candies, and puts it to what he sees as more productive use.

So to pay a 20 per cent premium for Heinz, he will not just want the cash to invest elsewhere; there must be better opportunities to invest the cash within Heinz’s own business, for instance in emerging markets.

It is the difference between invoking the long term, and actually investing for it, as Mr Buffett has done; a choice between profits now and profits in the future, and investors looking at stocks should question where this choice is likely to be on offer.

The giant goods consumer Procter & Gamble, for instance, has a large emerging markets business, but it also has an activist shareholder, Bill Ackman of Pershing Square, lurking in the background. It is under pressure to show results now.

Consider the family-controlled Brown Forman, by contrast. Thomas A Russo, of Gardner Russo & Gardner, says when he first became a shareholder in 1987 the company sold around 5m cases of Jack Daniels in the US, and just 50,000 in the rest of the world. The company took the profits from the mature US and with a Buffett-esque patience used them to invest elsewhere. So today it still sells around 5m cases of bourbon in the US, but 6m cases of “Uncle Jack” abroad, and looks set to reap the benefits of that time spent building.

So the point is not to rush to follow in public what Mr Buffett can do in private; it is to spot that a failure of public markets is what gives him the opportunity to do it in the first place.


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