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Buffett Critiques Breakup Ideas Even as Spinoffs Surge

Posted by Joe Cornell, CFA on Mon, Mar 02, 2015 @ 08:03 AM
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By Tara Lachapelle | March 2, 2015

Warren Buffett’s criticism of spinoffs is creating a rare instance where investors may clash with the Oracle of Omaha.

The world’s second-richest man devoted a chunk of his annual letter to Berkshire Hathaway Inc.’s shareholders to defending the company’s conglomerate structure. He denounced the deal cycle in which a fee-hungry “banking fraternity” urges acquisitions, only to later encourage their undoing for the sake of “unlocking shareholder value.”

Spinoffs “make no sense for us,” Buffett wrote in the letter, which was published on Saturday. Berkshire, as a collection of businesses and investments, has reaped steady profit and returns for investors, the letter said.

His remarks follow a record number of the transactions in the past 12 months, according to data compiled by Bloomberg. The rationale behind spinoffs is that a unit tucked under a diverse company’s umbrella may be worth more if it were a separate publicly traded entity. So far, it’s working: A Bloomberg index that tracks spinoff stocks produced almost double the gain of the Standard & Poor’s 500 over the past five years. From Pfizer Inc.’s former animal-heath business Zoetis Inc. to drugmaker AbbVie Inc.’s split from Abbott Laboratories, investors have been cheering the moves -- and calling for more.

“Proof is in the pudding” because spinoff stocks have “smoked the S&P 500,” said Joe Cornell, an analyst for Spin- Off Advisors LLC in Chicago. “I expect Warren Buffett, with all due respect, is talking his book a bit and may wish to dismiss any dialog about him breaking up the company.”

Berkshire Returns

Buffett, 84, has used acquisitions to build Berkshire into a $363 billion behemoth with businesses spanning from the insurer Geico to railroad BNSF and underwear maker Fruit of the Loom. Its stable of companies also includes See’s Candies and a utility unit formerly known as MidAmerican Energy.

In the past 50 years, Berkshire shares have appreciated 1.8 million percent. And earnings at businesses other than insurance and investments have grown about 20 percent a year since 1970, his letter said.

Given the growing number of activist investors urging big, diverse companies to narrow their focus, Buffett may be concerned that there will be calls someday to break up his empire when he’s no longer running it.

“Buffett is the best capital allocator of all time and his decentralized conglomerate structure has created tremendous shareholder value,” said Todd Lowenstein, who helps manage $16 billion at HighMark Capital Management in Los Angeles. “A cynic might think he planted this controversy as a pre-emptive strike to preserve his legacy.”

Better Together

Buffett says it would make no sense to break up Berkshire because its businesses are worth more as part of the conglomerate than as separate entities. They can enjoy certain tax benefits, for instance, while saving on regulatory and administrative costs. He also said that corporate breakups are often driven by bankers seeking to generate fees.

While investors may agree with him on the first point, many have been showing support for other companies that are pursuing splits. A more narrowly focused business is easier for shareholders to value, said Walter Todd, chief investment officer at Greenwood, South Carolina-based Greenwood Capital, which oversees about $1 billion.

“I can understand his dislike for what is perceived as financial engineering perhaps, but allowing investors to determine values for more pure-play companies versus conglomerate-type companies makes some sense,” Todd said.

Cash Advantage

Unlike most conglomerates though, Todd said that at Berkshire “there is no illusion of some type of combined synergies between these businesses.” He simply buys companies he finds attractive and lets managers keep doing what drew him to them in the first place. And the cash they generate is often sent to Berkshire headquarters for Buffett to reinvest.

The diverse nature of Berkshire’s businesses also allow Buffett the “ongoing ability to build value” in a way that firms that are focused on just one industry can’t, said Tom Russo, who oversees about $10 billion including Berkshire shares at Gardner Russo & Gardner.

“The ability to take See’s cash flows and invest in MidAmerican means that we’ve never really run out of places to deploy capital in Berkshire,” Russo said in a phone interview.

Since 1992, Berkshire has struck about $170 billion of acquisitions, according to data compiled by Bloomberg. But it continues to accumulate cash at a faster rate than Buffett can invest it.

Breakup Risk

The rise in shareholder activism from investors such as Carl Icahn could be both good and bad for Buffett. On the one hand, he says it should create more takeover candidates so that Berkshire’s $60 billion in cash can “constructively decrease.”

But a future Berkshire under different leadership could itself become an activist target.

“The biggest risk in Buffett’s mind in terms of the sustainability” of Berkshire is breaking the company up, said David Rolfe, who manages about $11 billion including Berkshire shares at Wedgewood Partners Inc. If the next CEO ever “sends out a letter to the board saying, ‘I had an interesting conversation with Carl Icahn,’ that’s his last day as CEO.”


Spin-Off Research is published by Spin-Off Advisors, LLC. Spin-Off Research is a subscription-based service for Professional and Institutional Investors.  Blog entries are delayed.  Spin-Off Research subscriber-base receive the spinoff report at time of press via Email Bulletins.  To learn more about becoming a subscriber, please contact us. Spin-Off Advisors, LLC provides coverage on all US and major Global spinoffs, carve-outs and split-offs; Spin-Off Research published since March 1997.

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