Finance

Will Buffett’s Successor Have His Appeal?

Also never-ending ICOs, investor meetings and FitBit subsidies.

The Buffett party.

Many kinds of investing success are mean-reverting. You buy some stuff, it goes up, you sell it at a profit, you feel like a genius, and now you have to do it all over again. It is not so easy to do it over again. 

Other kinds of investing success, though, are self-reinforcing. You short a company, you say it’s a fraud, it turns out to be a fraud, you make a lot of money, and now you go short another company and say it’s a fraud. “This guy knows frauds,” people say, and the minute you announce your short the stock craters and you make money. You can’t live off this forever—you need to keep making correct calls for it to keep working—but it helps.

Warren Buffett has had a fair amount of self-reinforcing investing success, of several kinds. One simple dumb one is that he has a reputation for buying stocks that will go up, so when he announces that he’s bought a stock, other people tend to buy it and it tends to go up. This is not particularly important to him, since he normally holds the stock until long past everyone forgot their initial excitement that Warren Buffett was buying it, but it does have some mark-to-market effect.

Another one is that he sometimes invests in regulated industries where “oh well if Warren Buffett is doing it it must be fine” is the sort of thought that a regulator might have. A bank or insurance company or mobile-home lender might have a certain regulatory advantage if it has the halo of being owned by Warren Buffett, who seems nice.

But a third and most important one is that sometimes companies come to Warren Buffett and ask him for money and offer him very favorable terms. He has lots of opportunities to buy companies, or stakes in companies, for less than the sticker price. When he gives companies money, he is giving them something other than money too, and so they are willing to give him more economic benefits for less money.

Sometimes the thing that he is giving them—other than money—is just the Warren Buffett seal of approval: When banks raised money from Buffett during the financial crisis, the idea was that his purchases sent a signal to the rest of the market that the banks were sound and trustworthy. This signal was incredibly valuable to the banks at the time, and they couldn't have gotten it anywhere else, and they paid Buffett an arm and a leg for it.

Other times the thing that he is giving them is just a place in the happy Berkshire Hathaway Inc. family of companies. When Buffett buys a whole company, particularly a private one, the public-signaling mechanism doesn’t matter. But private companies do seem to like selling out to Berkshire Hathaway for reasons that seem to be largely cultural. Buffett makes decisions quickly without a lot of bankers and process. Once he’s bought you, he leaves you alone: There’s not a lot of headquarters function at Berkshire, and private-company owner-managers who need money can sell out to Berkshire to get long-term capital while still running their businesses fairly independently. And you cannot entirely discount the fact that a lot of businesspeople think that Warren Buffett is a rock star and are willing to sell their businesses for a discount just to be able to hang out with Warren Buffett now and then.

Anyway Berkshire Hathaway Inc. had its annual meeting this weekend and there was some talk about where this ability comes from:

Buffett downplayed any unique skill he has to drum up deals, using his inability to find recent ones as evidence. Berkshire often makes large investments in times of panic, when its stable capital, and not the Buffett name, is the allure, he argued.

“The reputation belongs to Berkshire now,” Buffett said at the meeting in Omaha, Nebraska. “We are the first call and will continue to be the first call.”

Charlie Munger, Buffett’s 94-year-old vice chairman, said already most acquisitions are coming from the chiefs of the company’s operating subsidiaries, not he and Buffett.

If that's true it’s interesting to try to figure out why. After all, lots of investment managers have lots of money. In fact, it is widely believed that having a lot of money makes it harder for an investment manager to succeed: Only giant successes will move the needle for a giant fund, so you’re stuck looking only at giant opportunities, and there are fewer giant opportunities—and even fewer overlooked gems among giant opportunities—than there are small ones. (Buffett has this problem himself with his huge cash hoard these days.) And yet Buffett’s big pile of stable money seems like a positive.

Will it stay that way? Well, a lot of this stuff does seem to be Buffett-specific. If you’ve heard of only one investor, it’s probably not Todd Combs. If Buffett’s successors announce a stake in a company, they are unlikely to trigger hordes of copycats. Similarly if a bank in crisis needs a few billion dollars, Berkshire will always be on the speed-dial because it has a lot of billions of dollars, but “Warren Buffett Invests $10 Billion in Beleaguered Bank” just sounds better than “Insurance-Railroad-Candy Conglomerate Invests $10 Billion in Beleaguered Bank,” and in the last crisis the banks really were paying for the soothing powers of the name. 

But a lot of it really isn’t Buffett-specific, or not exactly. It’s cultural: You go to Berkshire for a deal because you know they can act fast, that they have a long investment horizon, and that they tend to trust company managers and leave them alone. Those are all appealing attributes, and easy to describe. On the one hand, you’d think that would make them easy to perpetuate even after Buffett leaves. On the other hand, you’d think that would make them easy for others to copy. If it’s as easy as “quickly give companies money and then leave them alone” then anyone—well, anyone with money—could do it.

Part of why it's not that simple is that you have to (quickly!) pick which companies to give money to, and Buffett is good at that, but I believe him that others could do that too. A bigger part of why it’s not that simple is that it is hard to build a culture that invests that much trust in a single decisionmaker. Behind the veil of ignorance, you might not want to set up a company that lets the chief executive officer decide on a $5 billion investment in his bathtub, without committees and due diligence and board approval and an exit plan. If you knew the CEO was Warren Buffett, though, you might be fine with him doing deals in the tub. The question is whether that culture—of moving fast and trusting executives and locking up capital long-term—can survive if the next CEO doesn’t have the charisma, or the track record, of Buffett himself.

Elsewhere at the Berkshire meeting:

Warren Buffett has warned about the “nightmare” tied to new accounting-rule changes. Now it’s beginning.

The rules, which require Berkshire to report unrealized gains or losses in equity investments in net income, helped fuel a $1.14 billion loss at Buffett’s Berkshire Hathaway Inc. in the first quarter, the Omaha, Nebraska-based company said Saturday in a statement. That marked the company’s first net loss since 2009. ...

Buffett has said operating results are a better barometer of company performance, in part because Berkshire’s more than $170 billion stock portfolio can fluctuate from quarter to quarter. 

Look: There is a sense in which if you run a giant investment fund and you buy stocks and those stocks go down, then you have lost money. I mean there is also a sense in which you haven’t, but it is the less conventional sense. I am not going to argue for the objective reality of GAAP net income accounting, and I see Buffett’s point that combining a bunch of operating businesses with a hedge fund leads to weird accounting results, but on the other hand (1) he’s the one who combined them!, and (2) it does feel a little like special pleading for Buffett, a long-time critic of companies that use non-GAAP accounting metrics, to complain that it’s unfair for GAAP to make him report a loss just because the stocks he bought went down.

Elsewhere I feel like Elon Musk needs a hobby, or more responsibility at work, or something:

Musk is "starting a candy company & it’s going to be amazing," he said in a Twitter post Saturday. He was pushing back after Buffett and his business partner Charlie Munger said the Tesla Inc. founder was wrong to believe "moats are lame," as Musk said in a conference call earlier this week. A moat is a business’s competitive advantage that keeps rivals at bay.

Buffett said there are still businesses with moats, including the See’s Candies unit that Berkshire owns, and that Musk wouldn’t want to take on his company in that area.

"I am super super serious," Musk said of his candy idea. He also tweeted a movie clip from the animated "Trolls," with characters dancing to Justin Timberlake’s song "Can’t Stop The Feeling!" 

Doesn’t he have a Tesla backlog to sort out and rockets to shoot into space and tunnels to dig under the earth? 

Elsewhere in Tesla, by the way: “Tesla Is Becoming a Punchline on Other Companies' Earnings Calls.” And its own! And “Tesla probably needs to raise capital this year,” writes Alexandra Scaggs.

The crypto.

I mean this had to happen eventually:

Ripple Labs Inc., the fintech startup that controls the world’s third-largest cryptocurrency, was hit by a lawsuit alleging that it led a scheme to raise hundreds of millions of dollars through unregistered sales of its XRP tokens.

The San Francisco-based company created billions of coins “out of thin air” and then profited by selling them to the public in “what is essentially a never-ending initial coin offering,” the class-action complaint filed Thursday in the Superior Court of California said. Ripple violated state and federal laws by offering unregistered securities to retail investors, the filing said.

“Whether or not XRP is a security is for the SEC to decide,” said a Ripple spokesman, and “we continue to believe XRP should not be classified as a security.” 

So funny story: It’s not really for the SEC to decide. I mean, the Securities and Exchange Commission may decide at some point whether or not XRP is a security—it has made some ominous noises!—and its decision will undoubtedly carry some weight with the courts. But the SEC’s decision is neither exclusive nor final. If, for instance, the SEC does decide that XRP is a security, and Ripple disagrees, then the SEC will probably sue Ripple, and it will be for the court to decide. And even without the SEC, if XRP buyers file a lawsuit—like this one—claiming that XRP is a security, then it will also be for the court to decide. (Is it a security? I don’t know; that is not the point here.)

The SEC is generally in the business of enforcing the securities laws, but it is not exclusively in that business. And a very standard other way of enforcing the securities laws is for aggrieved securities buyers to sue. In particular, aggrieved buyers of securities that were not registered as securities (or exempt from registration) can sue and, if they convince a court that the securities should have been registered but weren’t, get their money back. For many cryptocurrency projects, for a long time, this was not an immediate worry, because everything kept going up, so who would sue? But if you are a company that raised a ton of money by selling a cryptocurrency as its price went up, then as the price becomes more volatile you should be increasingly worried about lawsuits like this. “Ripple has sold more than $185 million in XRP since September 2016,” so this lawsuit really was inevitable.

Elsewhere in ICOs, I enjoyed the white paper for Cosmecoin, which is supposed to improve trust in the cosmetic-surgery business by putting it on the blockchain:

By issuing COSX, iConsult will strive to create a much-needed trust based community around the cosmetic surgery business which uses a trusted token for the medical beauty and advanced beauty sectors and, in doing so, will reward medical professionals carrying out high quality procedures with positive feedback for their work and associated loyalty benefits.

It is less ambitious than it ought to be really; the real cryptoblather version of this would be to advocate for doing away with medical licensing entirely and replacing it with a blockchain-based system of decentralized reputation. Honestly if you are doing an ICO you should hire me to be a consultant; I will take your moderately ridiculous white paper and tune it up so it is utterly bonkers. (I will not, however, give you advice on securities law; for that you’ll need a lawyer.)

Investor meetings.

We talk from time to time around here about the facts that (1) investors sometimes meet with company management, (2) the investors sometimes trade after those meetings, (3) those trades seem to be informed, that is, they seem to outperform trades by investors who don’t meet with management, (4) U.S. securities regulations forbid companies from disclosing “material nonpublic information” in these meetings, and (5) there are effectively never any enforcement actions against companies or investors based on these meetings.

I do not really know how you fit all of those facts together. I just think it is one of the more interesting puzzles in securities law. Why are investors meeting with companies (and trading afterwards, and making money on the trades), if they’re not learning anything material? Why don’t regulators mind these meetings, if the investors are learning material information? What does “material” mean anyway? (There is a term of art in securities regulation, “mosaic theory,” which means “I do not want to think about this puzzle.”) Is this bad? (Because some people don’t get the information that others get?) Or good? (Because the investors are owners of companies and should be allowed to talk to their hired managers, and because getting good information should be the reward for doing the work and asking good questions?) Etc.

Anyway here’s a post from Robert Bowen, Shantanu Dutta, Songlian Tang and Pengcheng Zhu about similar meetings in China, where there is more data:

While private meetings between investors and corporate management are common in the U.S., these meetings are a black box to public investors, as there are generally no requirements to disclose anything about their timing or content.  The Shenzhen Stock Exchange (SZSE) in China is the only stock market that requires disclosure of the existence, participants, and content of these private meetings.  The SZSE provides a unique setting to look inside the black box to examine the attributes and consequences of private in-house meetings.

As you’d expect, they find that “the stock market reacts strongly around private meeting dates (despite those dates being undisclosed publicly) suggesting that these meetings are informative to investors.” One of their suggestions is “that the U.S. and other Western economies adopt disclosure rules similar to those required by the SZSE”: If we knew more about private investor meetings at U.S. companies, then … well, then we'd know more about private investor meetings at U.S. companies. “Simple disclosure requirements would shine a bright light directly on the practice of private meetings – and perhaps change behavior,” they write, but I do not think we even know enough to think that behavior needs changing. At this point it would just be nice to know a bit more about the puzzle.

Fidelity?

I don’t know what’s going on here but I find it weirdly depressing:

Fidelity Investments has fired or allowed more than 200 employees to resign over alleged misuse of workplace-benefits programs, according to people familiar with the matter. … 

In one benefits program, Fidelity reimbursed staff for as much as 20% of the cost of computers and related equipment. In the second, the firm helped employees buy physical-fitness-related products such as FitBits.

In some instances, employees purchased equipment and immediately canceled their orders but still collected the company’s reimbursement. In some of the cases, the company identified employees who had received reimbursements for as much as $2,000 for equipment they didn’t keep, one of the people said.

The article quotes one guy who says that he canceled a laptop order for legitimate reasons but forgot to cancel the reimbursement. But even assuming that most of these 200 people were really doing this to defraud Fidelity out of … 20 percent of the cost of a laptop? … it is just … not what you think of when you think of fraud at a financial-services firm. I guess the thinking has to be, look, if someone is going to steal a FitBit subsidy from his employer, we can't trust him not to steal from client accounts, but it is all just perplexing and sad. Also, if you’re really good at fleecing clients, you probably wouldn’t even bother scamming the FitBit subsidy.

Things happen.

Shake-Up Considered on How Banks Lend to the Poor. Quarles: Liquidity Regulation and the Size of the Fed's Balance Sheet. Long lending boom will be a test of ‘shadow’ finance. Glencore Scraps Planned Sale of $9 Billion Stake in Russian Oil Company. Nestle Pays $7.2 Billion to Sell Starbucks Coffee. The Problem With Prosecuting ‘Spoofing.’ VW CEO Given Rare U.S. Safe-Passage Deal. Lauren Bonner, the Face of #MeToo on Wall Street, Is Still Reporting to Work Every Day. Jimbob Ghostkeeper Is Your 2018 Name of the Year

If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Thanks! 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

    To contact the author of this story:
    Matt Levine at mlevine51@bloomberg.net

    To contact the editor responsible for this story:
    James Greiff at jgreiff@bloomberg.net

    Before it's here, it's on the Bloomberg Terminal.
    LEARN MORE
    Comments