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  "I spotted it in the newspaper, an estate sale," said Rick Guerin. "It turned out it was a company that made a substance that, when poured into an automobile radiator, would seal up a leak in the car's engine block. The inventor of the product had launched it into the market by, time after time, driving his car into an auto repair shop, calling together the mechanics, and then drilling a disastrous hole in his car's engine block, which he fixed by pouring his product into the car's radiator. This proved quite effective as a sales aid, and the company made a fair amount of money."

  "The company came up for sale because the controlling shareholder [not the original inventor] had died. It was rumored that this owner, a doctor, had died because he over-prescribed addictive drugs to himself. He had borrowed money from his wife's aunts to invest in the company, and the estate owed the aunts $80,000 each. The only asset in the estate was the stock. For some reason the doctor left his estate to his wife, but made his mistress the executor. Needless to say this caused some rancor between the executor and family members. The aunts had not been receiving interest payments and for several years were not able to get any money. Charlie proposed that he and Guerin buy the two $80,000 notes held by the elderly aunts.

  "Under the circumstances, it would be typical to bid less than face value," said Guerin, but Charlie insisted on paying the full $80,000 for each note. "Charlie was not willing to benefit from their distress. He could have taken advantage of them, but did not. I did the leg work. I found the old ladies. Charlie and I became the creditors, then later traded the notes for ownership."

  Next, Munger, who was at best a little awkward when dealing with women, telephoned the mistress/executor and invited her to lunch at the California Club so that they could discuss the matter. Munger was taken aback when the woman showed up at the office. She had flaming red hair, eyes enhanced by bright green contact lenses, and was wearing a snug nurse's uniform that showed off her ample bosom. Charlie was flustered, but there was no way of getting out of accompanying the woman to lunch at his conservative businessmen's club, with its dark paneled walls, leather furniture, and valuable collection of old California art.

  Eventually, Charlie and Rick became fifty-fifty owners of a controlling block of stock in the company, with its management owning the rest. After some time passed, a situation arose where Guerin needed to cash out of the investment. "I still was very poor. We had an informal understanding that one would take the other out if either needed to get out. I went to Charlie and said I need to use that money elsewhere. He said fine, figure out what you want."

  Guerin looked over the accounting statements and thought about it. "I told him it was worth $200,000. Charlie said `No, you're wrong about that.' I said to myself, `Oh darn,' because I needed $200,000. He said, `It's worth $300,000.' And he pulled out a check and wrote it. I would have been delighted with $200,000. I would have been the happiest man on earth. It was an opportunity for him to show me how stupid I was," Guerin said with a chuckle. "Charlie has a saying, `Think about it a little more and you will agree with me because you're smart and I'm right.'"

  The automotive chemicals business was fully acquired in the mid1970s and ultimately became part of Berkshire Hathaway. Berkshire sold it in 1996 to a group of investors that included a former president of the company.

  THOUGH OTIS BOOTH WAS TOO CONCERNED about the risk to participate in Munger's final real estate ventures, he quite willingly put money into the new Wheeler, Munger partnership. "I became the largest participant, and I remained so."

  When he initially went into Wheeler, Munger, Booth had some concerns about what he was doing. "I worried about partnership interests being just pieces of paper. I was taking them on trust. This guy was straight, but there was not a great deal of documentation. But I didn't think it was going to go south. I knew Charlie well enough."

  Charlie's partners say he has a flair for structuring a company in the most effective form and for postponing the tax consequences as long as possible. When it came to Wheeler, Munger, Charlie borrowed a format from Warren that Warren had borrowed from Ben Graham.

  "The structure of the Buffett and Munger partnerships was very important." explained Otis Booth. "At the end of each year profits were distributed, and ownership was reallocated. The reallocation was not a taxable event. Profits were given according to partnership interests at the previous year end. First 6 percent to capital, limited and general partners alike. After that, a huge majority share to capital and a much lower share to general partners. When there were taxes to pay, all partners bore their share according to their interests."

  Buffett explained that Munger followed the fundamentals of value investing, though his portfolio was far less diversified than those established by the managers of traditional value funds, such as Buffett's friend and former co-worker at Graham-Newman, Walter Schloss.

  "Charlie's portfolio was concentrated in very few securities and therefore his record was much more volatile but it was based on the same discount-from-value approach," said Buffett. "He was willing to accept greater peaks and valleys of performance, and he happens to be a fellow whose whole psyche goes toward concentration, with results shown."'

  Some analysts might claim that Charlie was willing to assume more risk than Graham, Buffett, or Schloss would tolerate. "Yes," agreed Otis Booth, "but Charlie feels he has better insight and assessment of risk and he says `Yes, I'll do that.' But Warren also bought stocks that were out of favor, such as American Express. The real risk was less than the perceived risk at the time."

  As he became more and more experienced in business, Munger found small but reliable ways to make risk more tolerable.

  "In no way was there a desire to run foolish risks as many gamblers do," explained Booth. "None of that. And particularly when we were younger and hungrier. He would look for each little edge you could get. The seat on the stock exchange. Ability to get an option on land where the zoning could be changed, whatever."

  Charlie does not consider himself more daring than Buffett where investments are concerned. "Warren is very adventurous when it relates to his lifelong interest. When it has to do with Berkshire, he'll try new things. But when it comes to trying the leg of lamb versus the prime rib, he's not at all interested."

  Molly Munger said during the time he was building his business, her father became acutely aware of the impact of taxes when capital gains were compared to ordinary income. "He made a lot of money in this or that deal and didn't have to pay as much in taxes. He said, `If I'm a lawyer I have to pay more. The capital gains tax is less, and in my case it doesn't seem fair.'"

  DURING THOSE YEARS AT WHEELER, Munger, Charlie and Warren kept up the telephone conversations. Although they didn't always buy the exact same securities in the same quantities, their portfolios overlapped in part. They shared investment in two chains of retail stores owned through a company named Diversified Retailing. Together with Rick Guerin, they bought working control of Blue Chip Stamps. Buffett was the largest shareholder and Munger the next largest in the California retail trading stamp company.

  "We were of a `raiders' generation," observed Guerin. "That of Sol Steinberg, Harold Simmons, and so forth. But we are not like them." The group never made a tender offer without management's consent and never engaged in a proxy fight.

  By the time he quit practicing law in 1965, "1 had more confidence that Wheeler, Munger would work out, and I had much greater wealth," said Munger.

  "I was not particularly surprised when he gave up law," said Munger's sister Carol. "That's what happens ... when someone finds something that is his real love."

  Munger was getting close to his dream of financial independence observed his stepson David Borthwick. "He needed to work for himself. Even with friendly partners in a law firm, you're still in service of clients who call on your time to fit their schedules."

  In his book The Big Test, Nicholas Lemann said that Daniel DeFoe, not Benjamin Franklin, was behind Munger's lust to be his own man. When Charlie's
grandparents read and reread Robinson Crusoe to him, they planted a notion in his head. "He wanted to be rich so he could be completely independent, like Crusoe on his island, and not have to do what anybody else said."3

  IN AN ESSENTIAL WAY, HOWEVER, Charlie Munger remained in the service of clients-those clients being the other investors in Wheeler, Munger. The fact that many of the investors were family members, former colleagues, or friends did not ease the pressure. As fate would have it, during Wheeler, Munger's existence, while the stock market had ups and downs, the overall direction was sideways. By the late 1960s, Buffett was talking about getting out and eventually, at the end of 1969, did liquidate his partnership. Munger and Guerin stayed in longer, especially with a large investment that was made late in 1972, a registered investment company named Fund of Letters.

  Bob Denham had arrived at Munger, Tolles, and part of his early work for Munger was the acquisition of the Fund of Letters. The stock market in the late part of the 1960s-the go-go years-had been torrid. A popular investment at the time was "letter stock." a security sold without SEC registration and therefore not saleable for an extended period of time in ordinary stock market transactions. Under the securities laws, it was necessary to put it rider on the stock saying that the investor was not allowed to sell until an SF3C registration or some other key event had occurred.

  The Fund of Letters was a venture capital fund that its founders had formed in a highly touted initial public offering allowing liberal sales' commissions to stockbrokers. When it was first organized, the fund raised $60 million, but when underwriting fees and other costs were subtracted, only $54 million remained for investment purposes.

  "It was as if," said Charlie "the customers had asked their brokers 'What shall I do with my money?' and the brokers had responded: 'First, give 10 percent of it to me.'"

  Because the Fund was it closed-end registered investment company, no new shares were sold once it was established. The Fund grew only if its money was invested wisely and its asset value increased. As typically is the case with it closed-end fund, the Fund of Letters soon traded well below its net asset value. Moreover, when the market went into a prolonged decline, the Fund tanked with it.

  After Guerin and Munger bought control of the troubled Fund of Letters, they changed almost everything about it. They renamed it the New America Fund, reorganized the board, and redirected the investment style to a value approach. They quickly liquidated assets chosen by former managers. Guerin was the chairman, but Munger's investment philosophy was written all over the New America Fund and, as might be expected, the philosophy ran against the pack. In 1979, Business Week published an article entitled "Shareholder Heaven at New America Fund."

  "New America eschews the common industry practice of paying fat fees to outside investment advisors." wrote Business Week. "Instead, the work is done internally under Guerin's supervision. What's more, the latest fiscal year, director's fees were only $25,000, and remuneration for all officers and directors came only to $54,950.

  New America Fund exhibited "a propensity for publishing and broadcasting investments," continued the article. "In recent years its record has been outstanding: The net asset value per share increased from $9.28 in October 1974, to $29.28 on September 30, 1979. Like most closed-end funds, New America sells at a discount to net asset value. On November 16, shares closed at $18.25, a 25.9 percent discount from net asset value of $24.64."s

  Among New America Fund's holdings were Capital Cities Communications and 100 percent of the Daily Journal Corporation, publisher of a Los Angeles legal newspaper. Regardless of how wonderful New America Fund looked to Business Week in 1979, its purchase by Wheeler, Munger caused many sleepless nights.

  In its first eight years, Wheeler, Munger had a stunning performance, although, said Munger, "We never did get a large amount of money under management. I never did manage a lot of other people's money on a compensated basis."

  When the years 1962 to 1969 are measured together, Wheeler, Munger's average annual return, before the general partners' override, was 37.1 percent per annum which beat performance of the 1)ow Jones Average by a large margin. Then, in the three-year period ending with 1972, Wheeler, Munger's return dropped to only 13.9 percent, barely topping the Dow's 12.2 percent.

  Discouraged by market conditions, Buffett liquidated his partnership at the end of 1969. Within a few years, Munger probably wished he'd followed suit. But Munger did not follow Buffett's example, and 1973 and 1974 were a nightmare. Wheeler, Munger was off 31.9 percent in 1973 (versus a negative 13.1 percent for the Dow Jones Industrial Average) and down 31.5 percent in 1974 (compared to a minus 23.1 percent for the Dow).

  "We got drubbed by the 1973 to 1974 crash, not in terms of true underlying value, but by quoted market value, as our publicly traded securities had to be marked clown to below half of what they were really worth," said Munger. It was it tough stretch-1973 to 1974 was a very unpleasant stretch."

  Others were also finding 1973 to 1974 unpleasant. For example, Berkshire Hathaway, still mostly a textile operation, saw its share price fall from $80 in December 1972 to $40 in December 1974. Gloom and doom permeated the news of Wall Street. Headlines proclaimed "The Death of Equities."

  The main cause of Wheeler, Munger's poor relative performance was its ownership of big blocks of common stock in New America Fund and Blue Chip Stamps. They had purchased New America's predecessor, the Fund of Letters, during a time of stock market exuberance at the end of 1972, paying $9.22 per share, substantially under liquidation value, for their controlling block. And even after the great stock market decline, as Business Week noted in October 1974, Fund shares had an asset value of $9.28, a little higher than Munger and Guerin had paid in 1972. So why Munger's agony? After all, Munger and Guerin had made a big investment at an unpropitious time but had dodged the natural consequences, mostly because of the "margin of safety" of the purchase as required by the principles of Benjamin Graham. Moreover, the Fund possessed a tax loss carryforward that would enable it to make large gains for many future years with no income taxes clue.

  Munger's distress was caused by the limited partnership structure, the fact that some borrowed money had been used in buying Fund stock, increasing declines in partnership net worth, and the fact that by 1974, Fund shares had a market price very much lower, indeed over 50 percent lower, than the asset value per share that could have been paid out in a Fund liquidation. Like it or not, Munger had to report results to his limited partners at the end of 1974 valuing the partnership's large block of Fund stock at only $3.75 per share.

  In addition, Wheeler, Munger was in a similar position with respect to its substantial block of Blue (;hip Stamps. This stock had been purchased at an average price of $7.50 per share, had a market price of $15.37 per share at the end of 1972, yet a market price of only $5.25 per share at the end of 1974. Munger believed that Blue Chip Stamps stock was virtually certain, not too far ahead and regardless of what the stock market (lid, or whether any more trading stamps were sold," to reach a value much higher than $15.37 per share. Yet at the end of 1974, Munger faced a stubborn fact: the market price of Blue Chip Stamps stock was then only $5.25, intrinsic value be damned.

  As Wheeler, Munger's investment numbers went to hell, Charlie realized that sonic partners would suffer hard-to-hear distress. After all, an investment of $ 1,000 on January 1, 1973, would have shrunk to $467 by January 1, 1975, if the partner had never taken any money out during the period. In contrast, a similar $1,000 investment that performed in line with the Dow Jones Industrial Average over the same period would have shrunk much less, leaving $668. Moreover, following precedents in the Graham and Buffett partnerships, all Wheeler, Munger partners drew cash from their partnership accounts at one half a percent per month on start-of-the-year value. Therefore, after regular monthly distributions were deducted, limited partners' accounts in 1973 to 1974 went down in value even more than 53 percent.

  At the end of 1974, after the big stock market cr
unch, the net asset value of the entire Wheeler, Munger partnership was only $7 million. Of this, $4.3 million or 61 percent, was in 505,060 shares of Blue Chip Stamps, selling at $5.25 per share, plus 427,630 shares of New America Fund selling at $3.75 per share. Measured from this nadir, what was the subsequent price history of these two positions?

  New America Fund stock did fine. By the late 1980s, each share that had traded at a $3.75 market value at the low point had turned into about $100 in cash and securities. The Blue Chip Stamps stock did much better, measured from the same low point. Each share of Blue Chip Stamps, then valued at $5.25 became 7.7 percent of one common share of Berkshire Hathaway. With Berkshire common stock selling in March 2000 at about $48,000 per share, this means a former Blue Chip Stamps share was then worth 7.7 percent of $48,000 or about $3,700 per share. Each dollar of 1974 market value thus became about $700 in year 2000 market value. This represents an increase of about 28.5 percent per annum, compounded, for 26 years, with no income taxes due for any shareholder who held on to the stock. Furthermore, because Blue Chip was held within a corporate structure, there was no fee from Munger and Buffett for management services.

  "Over the course of Wheeler, Munger's first 13 years of life, ending with 1974, an investment mimicking performance of the Dow Jones Industrial Average, after counting all dividends received, would have produced a nominal return just above zero," explained Munger. After the ravages of taxes, inflation, and withdrawals of funds for use, the real return would have been embarrassingly negative. Wheeler, Munger, during its entire lifetime, did much better. Limited partners who stayed the course after 1973 to 1974 fared exceptionally well and 95 percent of the partners did stay the course. For instance, Otis Booth stood pat after 1973 to 1974, and stood pat again with securities distributed in Wheeler, Munger's liquidation at the end of 1975."