Case Study 2: Warren E. Buffett, 1995
This case was prepared by Professor Robert F. Bruner as the basis for classroom discussion rather than to illustrate effective or ineffective handling of an administrative situation.
On August 25, 1995, Warren Buffett, the CEO of Berkshire Hathaway, announced that his firm would acquire the 49.6 percent of GEICO Corporation that it did not already own. The $2.3 billion deal would give GEICO shareholders $70.00 per share, up from the $55.75 per share market price before the announcement. Observers were astonished at the 26 percent premium that Berkshire Hathaway would pay, particularly since Buffett proposed to change nothing about GEICO, and there were no apparent synergies in the combination of the two firms. At the announcement, Berkshire Hathaway’s shares closed up 2.4 percent for the day, for a gain in market value of $718 million.1 That day, the Standard & Poor’s 500 index closed up 0.5 percent.
The acquisition of GEICO renewed public interest in its architect, Warren Buffett. In many ways he was an anomaly. One of the richest individuals in the world (with an estimated net worth of about $7 billion), he was also respected and even beloved. Though he had accumulated perhaps the best investment record in history (a compound annual increase in wealth of 28 percent from 1965 to 1994),2 Berkshire Hathaway paid him only $100,000 per year to serve as its CEO. Buffett and other insiders controlled 47.9 percent of the company, yet Buffett ran the company in the interests of all shareholders. He was the subject of numerous laudatory articles and three biographies,3 yet he remained an intensely private individual. Though acclaimed by many as an intellectual genius, he shunned the company of intellectuals and preferred to affect the manner of a down-home Nebraskan (he lived in Omaha), and a tough-minded investor. In contrast to other investment ‘stars,’ Buffett acknowledged his investment failures quickly and publicly. Though he held an MBA from Columbia University and credited his mentor, Professor Benjamin Graham, with developing the philosophy of value-based investing that guided Buffett to his success, he chided business schools for the irrelevance of their theories of finance and investing.
Numerous writers sought to distill the essence of Buffett’s success. What were the key principles that guided Buffett? Could these be applied broadly in the late 1990s and into the 21st century, or were they unique to Buffett and his time? From an understanding of these principles, analysts hoped to illuminate Berkshire Hathaway’s acquisition of GEICO. Under what assumptions would this acquisition make sense? What were Buffett’s probable motives in the acquisition? Would the acquisition of GEICO prove to be a success? How would it compare to the firm’s other recent investments in Salomon Brothers, USAir, and Champion International?
Berkshire Hathaway, Inc.
The company was incorporated in 1889 as Berkshire Cotton Manufacturing, and eventually grew to become one of New England’s biggest textile producers, accounting for 25 percent of the country’s cotton textile production. In 1955, Berkshire merged with Hathaway Manufacturing and began a secular decline due to inflation, technological change, and intensifying competition from foreign competitors. In 1965 Buffett and some partners acquired control of Berkshire Hathaway, believing that the decline could be reversed. Over the next 20 years it became apparent that large capital investments would be required to remain competitive and that even then the financial returns would be mediocre. In 1985, Berkshire Hathaway exited the textile business. Fortunately, the textile group generated enough cash in the initial years to permit the firm to purchase two insurance companies headquartered in Omaha: National Indemnity Company and National Fire & Marine Insurance Company. Acquisitions of other businesses followed in the 1970s and 1980s.
References: 2 Buffett’s initial cost per share in Berkshire Hathaway in 1965 was about $17.578. On August 25, 1995, the price per share closed at $25,400.
4 Reported in Stocks, Bonds, Bills, and Inflation, 1994 (Chicago: lbbotson Associates), p. 10.
5 Berkshire Hathaway, Inc., annual report, 1994, p. 6.
10 Reported in Stocks, Bonds, Bills, and Inflation, 1994.
11 Berkshire Hathaway, Inc., annual report, 1994, p. 2.
12 Berkshire Hathaway, Inc., annual report, 1992, p. 14.
13 Berkshire Hathaway, Inc., annual report, 1994, p. 7.
15 The yield on the 30-year U.S. Treasury bond on August 25, 1995, was 6.86 percent. The beta of Berkshire Hathaway was 0.95.
16 Quoted in Jim Rasmussen, ‘Buffett Talks Strategy with Students,’ Omaha World-Herald, January 2, 1994, p. 26.
17 Berkshire Hathaway annual report, 1993, and republished in Andrew Kilpatrick, Of Permanent Value: The Story of Warren Buffett (Birmingham: AKPE, 1994), p. 574.
18 Quoted in Forbes, October 19, 1993, and republished in Andrew Kilpatrick, Of Permanent Value: The Story of Warren Buffett, p. 574.
19 Quoted in Michael Lewis, Liar’s Poker (New York: Norton, 1989), p. 35.
20 Originally published in Berkshire Hathaway, Inc., annual report, 1987. This quotation was paraphrased from James Grant, Minding Mr. Market (New York: Times Books, 1993), p. xxi.
21 Peter Lynch, One Up on Wall Street (New York: Penguin Books, 1990), p. 78.
22 Berkshire Hathaway, Inc., annual report, 1986, p. 16.
23 Berkshire Hathaway, Inc., annual report, 1990, p. 15.
24 Berkshire Hathaway, Inc., Letters to Shareholders, 1977–1983, p. 53.
26 Quoted in L.J. Davis, ‘Buffett Takes Stock,’ New York Times, April 1, 1990, p. 16.
27 Quoted in Forbes, October 19, 1993, and republished in Kilpatrick, Of Permanent Value, p. 574.
28 ‘Owner-Related Business Principles’ in Berkshire Hathaway, Inc., annual report, 1994, p. 3.
30 Reported in Stocks, Bonds, Bills, and Inflation, 1994, p. 10.
33 Quoted in Garth Alexander, ‘Buffett Spends $2bn on Return to His Roots,’ Times Newspapers Ltd., August 17, 1995.
Source: Berkshire Hathaway, Inc., annual report, 1994.
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