Birth of Berkshire Hathaway： In the dawn of 20th century New Bedford, CT was a bustling Textiles town. It had around seventy cotton spinning mills. Hathaway Manufacturing Corporation was one of them. It was founded in 1888 by Horoto Hathaway. New England's success in Textile industry was short lived. It could not compete with the cheap labor of South. At its peak, New England Textile industry employed 30,000 people. But by 1940 the number had dwindled to below 10,000.
As the textile industry declined, its investors ran for safety and consequently diversified into other sectors. But Hathaway corp. was one bright star that still had the courage to face the headwinds. It was headed by an industry visionary named Seabury Stanton. Stanton was the chip of the old block. He had learnt the ropes of the industry from his father Young Seabury. Other than his Harvard credentials, he possessed strong military experience that had molded him to be a disciplined leader who was not afraid of venturing unchartered waters. His vision was to make Berkshire a state of the art Textile company. Stanton was bold to pour huge amounts of capital in modernizing its mills. The company also pioneered the research of synthetics and reaped its benefit during World-War-II. But as the war ended, the cost competence of Southern states forced the Textile companies of Northern states to mover their operations to southern states.
Hathaway's only chance of survival was to look for a partner who could complement its strengths. Its best bet was Berkshire Fine spinning associates inc. Oliver Chace founded the company in 1806. His descendants continued the family business and by 1950 Malcolm Chace was heading the company. Even though the business had survived for one and a half century, but it faced intense pressure from the southern mills. It did not have a large capital outlay and conserved most of its cash. Berkshire was high tech with large capital outlay, Hathaway operated with minimal capital outlay and conserved most of its cash. They thus complimented each other. In order to maximize each other's strengths they decided to merge in 1955, thus paving the way for creation of Berkshire Hathaway inc. Malcolm Chace became the Chairman of the company and Stanton became its President. Stanton empowered the new company with his vision of modern technology. But he was short on financial insight. He did not have a clear plan of when the huge investments would pay-off. The decreasing price of Textiles made his job still tough. In 1962 the company incurred a loss of $2.2million.
Seabury was trying to project his son Jack as the next leader of the company, but he was not looking eye to eye with his brother Otis who controlled the commercial department of the company. Seabury also had some differences of opinion with Malcolm Chace. All this was taking a big toll on the company. Wall street had axed its stock from around $14 ? in 1955 to 8 ? in 1963.
How Buffett got interested in Berkshire Hathaway? When Buffett was working for Graham Newman, Berkshire's stock made it to the firm's watch list. But eventually the firm passed it. Buffett kept following the stock and in 1962 bought it thru its partnership when the stock was $8/share. Other than the company's capital of $16.5 / share, it had able managers like Seabury and with its impeccable R&D had an edge over its competitors. Buffett was keen in knowing more about the company's top management. He first met Jack (Seabury's son) who was helpful in giving Buffett a detailed financial history of the company. But he didn't have time to give Buffett a tour of the company. He instead passed on this privilege to Ken Chace a senior executive of the company. Ken spent two days giving Buffett the first-hand knowledge of the company's operations. Buffett was deeply impressed with Ken's detailed insight of the business and his dedication towards the company.
In the meantime Seabury was sensing the unrest that was building around him. The only way he could overcome that was by having absolute control over the company. He started approaching major shareholders of the company to buy back the stock. Buffett was also approached. The deal was called off at last moment because their offers were separated by 3/8th of point. Buffett and Seabury's differences continued. This prompted Buffett to engineer a change in management and appoint his own man at the top. In order for a management shakeup Buffett needed to pick up more blocks of shares. He first approached Malcolm Chace. But Chace's family sentiments were very much attached with Berkshire, so he refused to sell his shares. Buffett then through his broker Stanley Rubin met Otis at Wamsutta club over lunch. Through his charismatic appeal, Buffett won over Otis. This was enough for Buffett to influence the board of directors.
On May-10, 1965 the board met. Seabury and his son Jack made a final attempt to win over the board of directors, but at the end had to bite the dust and resign. As per Buffett's recommendation Ken Chace was made the president and Buffett became the Chairman of Executive committee. Malcolm Chace continued as Chairman of the board. Berkshire's stock closed at $18 that day.
Buffett's initial days at Berkshire Hathaway: Berkshire Hathaway went through tough times from 1955 to 1965. It had accumulated a net loss of $10.1 million during that period. But it was seeing the light at the end of the tunnel. It had pioneered the use of synthetics and its demand was rising. Now it was up to the partnership of Buffett and Ken Chace to unlock this intrinsic value. Buffett had great respect for Chace's technical abilities and had given him full control over the operations of the business. But he had made it clear right from day-1 that the keys to the coffer would always be in Omaha.
What were Buffett's first management decisions when he took over as Berkshire's Chairman? He believed that stock options rewarded the executives when the company grew, but the recipients did not share the downward risk. This accounted for Heads I win, Tails I don't lose? But Buffett knew that it was only Ken Chace who could pull the company from Doldrums. In order for getting Chace's full support he had to keep Chace's fortune aligned with that of the company. Thus Buffett arranged for a loan of $18,000 to Chace so that he could buy 1,000 shares of Berkshire. But Chace had some reservations towards use of credit. Buffett talked him into this deal. Thus Buffett had his cake and ate it too. He was able to impinge his principle of guardian of Shareholder's interest by having a "NO STOCK OPTION PRINCIPLE" and at the same time kept Chace's fortunes in line with the company's fortune.
Buffett also laid down his golden principle of measuring the company's progress through "Return on capital". He laughed at the remarks of managers who boasted about their company's record earnings without giving the context of the kind of capital involved while generating that profit. Even a simple bank fixed deposit produces an ever growing interest every year if the principal and accumulated interest are compounded annually. This Golden principle kept the management on edge and forced them to keep a tight control over inventory and any additional capital expenditure. The third major reform brought about by Buffett was to completely eliminate dividends to shareholders. It was just once in 1967 since Buffett became its chairman that Berkshire declared a dividend of 10cents/share. Till this day Buffett regrets that decision. His philosophy is that Shareholder's best interest is by retaining the dividends and growing it, rather than paying it off and forcing the shareholder to pay tax on it.
How Berkshire got into insurance? Textiles made a decent comeback in late sixties. Plus the company was keeping a tight lid on its expenses and capital expenditures. This resulted in generation of abundant free cash for Buffett to play with. Buffett was also sensing the need to diversify as Textiles' future was not that bright. In 1967 he eyed National Indemnity co. Its major shareholder was Jack Ringwalt. Jack had met Buffett before when the latter had approached him for a $50,000 investment in his partnership. Jack had viewed Buffett as still very green and did not invest with him.
Ringwalt was a pure street smart guy. He had started his business by providing insurance to Taxicabs. He had developed a niche in markets that were usually ignored by major carriers. His mantra was that there was no risk as bad or good. It all just depended on the price one is getting for it. Buffett had a close associate named Charles Heider. Charles knew how much to offer Jack to part with his company. He also knew when to approach Jack for this.
Charles arranged the meeting between Buffett and Jack at Kiewit Plaza. National Indemnity that time was selling for $33/ share. Jack demanded a steep premium of $17/ share, plus a whole lot other promises that included his employees job safety. Surprisingly Buffett agreed to all of Jack's demands and thus Berkshire bought National Indemnity for $8.6 million
Wall Street was puzzled as to why a Textile company would go out of the way to buy an Insurance co. But Buffett had his work cut out. Ever since he had first analyzed GEICO in 1951, Buffett had steadily built his expertise in insurance sector and knew it like the back of his hand. He viewed insurance business as a provider of FREE cash for him to invest, provided the business didn't make an Underwriting loss. He called this FREE cash as the FLOAT and has always possessed that as of the key growth factors for Berkshire Hathaway.
© 1996- The Buffett