What a difference 12½ cents makes.
Seabury Stanton was about to strengthen his family’s control of Berkshire Hathaway Inc., the biggest textile manufacturer left in the downward-sliding New England fabric industry.
He agreed to pay $11.50 for each share owned by a young upstart from Omaha, along with stock that other shareholders wished to sell at that price.
But when the letter arrived with the official offer, Warren Buffett was surprised: The price was $11.37½ cents per share, not the agreed-upon $11.50. It was a $14,000 difference out of $1,275,000 — one-eighth of a dollar per share — but the dollar amount wasn’t the issue.
“It really burned me up,” Buffett told biographer Alice Schroeder decades later. “You know, this guy was trying to chisel an eighth of a point from having, in effect, shaken my hand saying this was the deal.”
So Buffett, furious, ignored the letter and started buying as many shares of Berkshire as he could. By April 14, 1965, Buffett owned or controlled enough shares to take over the company, and Stanton knew it.
The critical board of directors meeting came on May 10. Buffett arrived with an attaché case and a large valise. Stanton called the meeting to order, read the agenda and then resigned, as did his son, Jack, the treasurer and chosen successor.
The two men left the meeting.
The board named Buffett chairman of its executive committee, and his handpicked man, Ken Chace, became president, responsible for running the mills. Buffett flew back to Omaha that night. (Chace, who was not wealthy, accepted Buffett’s offer to co-sign a loan for $18,000 so that he could buy 1,000 shares of Berkshire stock at $18 per share, according to biographer Roger Lowenstein. Those shares would be worth about $220 million at the current price.)
Today, shareholders of Berkshire Hathaway are gathering at Omaha’s CenturyLink Center to celebrate the 50 years that Buffett has been in charge of Berkshire. During that time, he has turned Berkshire into the largest conglomerate in the world, a diverse $350 billion collection of businesses and investments.
But Buffett himself rues the actual acquisition of Berkshire, saying it was a huge mistake to be so irritated with Stanton’s 12½-cent discount offer that he decided to actually acquire the company.
Not only that, Buffett said: He followed up a few years later with an even bigger blunder that cost today’s shareholders an estimated $100 billion.
From Buffett’s perspective, the problem with buying Berkshire was that it was a bad company. Owning the company wasn’t his plan when he bought his first Berkshire shares on Dec. 12, 1964, paying $7.50 each for 2,000 shares. At the time, Buffett calculated that the company was worth $19.46 per share, given its cash and the value of its real estate and other holdings.
Buffett was trying to find a few puffs from what he viewed as a leftover cigar.
The “cigar butt” concept came from Buffett’s mentor, Columbia University teacher and investor Benjamin Graham.
In his book, “The Intelligent Investor,” and his classes, Graham explained how to spot a company that was worth more than its stock price. Often such companies were past their prime — like mostly-used cigars — but something about them would yield a tidy profit if their shares were purchased at the right time and price.
In Graham’s terms, that profit was a “free puff,” which could be reinvested in the next deal.
Berkshire was such a stogie because it was a cash-rich company in a declining industry. Textile manufacturers were moving from New England to the South, where labor was cheaper, but Berkshire was resisting the trend in the 1960s.
As demand for his textiles worsened, Seabury Stanton would close plants and use the money to buy back company stock, often at an attractive price.
The buyback offer that Stanton sent to Buffett would have given his partnership a 50 percent profit.
“There it was — my free puff, just waiting for me, after which I could look elsewhere for other discarded butts,” Buffett said.
But he couldn’t overlook Stanton’s original $11.50 offer and instead pursued the takeover, which he later called “childish behavior.”
It’s true that Berkshire, under Buffett, has been a success, winning him accolades for his investment and management skills over the decades. The crowd at today’s 50th anniversary Berkshire meeting is testament to Berkshire’s accomplishments under Buffett.
But he could have done much better, he says, if he hadn’t used a failing textile company as the base for his investments, especially one that remained partly owned by people connected with the old textile mill operation.
What about the bigger mistake that followed, which Buffett says was the most costly in his career?
That happened when Buffett bought National Indemnity Insurance Co. of Omaha for $8.6 million in 1967.
Buffett said he should have purchased the insurance company for his investment partnership, which was 100 percent owned by him and the people who had chosen to entrust their money to him.
Instead, Buffett bought National Indemnity through Berkshire. Why?
“I’ve had 48 years to think about that question, and I’ve yet to come up with a good answer,” he said in this year’s letter to Berkshire shareholders. “I simply made a colossal mistake.”
Here’s why it was a mistake:
If National Indemnity had been 100 percent owned by the partnership, all of the profits from the resulting insurance empire and future acquisitions would have gone to the partnership and its investors.
As part of Berkshire, National Indemnity’s finances were hurt by the failing textile business for 20 years, and the “legacy shareholders” of Berkshire ended up owning 39 percent of the company.
Over the entire 50 years, Buffett said, the decision has diverted about $100 billion to “a collection of strangers” rather than to himself and the investors who chose to support Buffett.
* * *
The Omaha World-Herald Co. is owned by Berkshire Hathaway Inc.
Sources: Buffett’s 2015 letter to shareholders; “The Snowball” by Alice Schroeder; “Buffett: Making of an American Capitalist” by Roger Lowenstein.