The activism of Warren Buffett

Most investors are familiar with some of Warren Buffett's greatest investments - like Coca-Cola and American Express - but far fewer have studied the Oracle of Omaha's early career successes.

The early Buffett years, from the late 50's to the early 70's, were fundamental in his investing career, providing the building blocks for his reputation as one of the world's greatest investors.

Indeed, before Berkshire Hathaway became the conglomerate we know today, Buffett ran several partnerships, which invested using three different strategies.  Firstly, Buffett has his "generals", which were usually undervalued securities where he had nothing to say about corporate policies. Generals made up the bulk of Buffett’s portfolio. Then there were the "work-outs", which were undervalued securities where corporate action was required for the market imbalance to correct itself. And finally the "control" situations where Buffett aimed to influence policies of the company in order to unlock value.

Buffett’s work-out and control situations are without a doubt, a style of activist investing. These situations were not rare occurrences. In fact, many of Buffett’s earliest investments were activist situations.

Dempster Mill - successful restructuring

One of the first investments Buffett mentions in his early partnership correspondence is Dempster Mill Mfg. This was in fact a “general” that became a “work-out” and then transformed into a “control” situation.

Dempster stock was first acquired for Buffett’s partnerships during 1956, at a time when the company’s stock was trading at $18. Book value stood at $72 per share, with $50 per share of current assets. Dempster had been a highly profitable company but when Buffett began buying, it was only breaking even. According to Buffett:

“...[The lack of profitability] reflected a poor management situation, along with a fairly tough industry situation… Certainly, if even moderate earning power can be restored, a higher valuation will be justified, and even if it cannot, Dempster should work out at a higher figure…”

Between 1956 and 1961, Buffett sat on Dempster’s board of directors. Using this position, he was able to get to know Dempster inside out and quickly realised where the company was going wrong.And after this period of observation, Buffett made his move. With his partnerships holding 70% of Dempster’s outstanding stock, during 1961 Buffett replaced Dempster’s management team, cut costs and sold assets.

After a successful restructuring, which only lasted a year, during 1963 Buffett sold Dempster for around $80 per share. A total gain of 186% based on an acquisition cost of $28 per share.

Sanborn Map - unlocking value

During 1958 and 1959 Buffett made a huge bet. Thirty-five percent of partnership net assets were channelled into one investment; Sanborn Map Co. Sanborn was never a “general” situation. Buffett bought in with the intention of unlocking value from the business within a year.

Sanborn produced detailed maps of all cities of the United States, a business in which the company had a monopoly for around 75 years. Unfortunately, during the early fifties, its maps fell out favour and profits fell by 80% between the late 1930s and 1959.

However, Sanborn had been busy building an investment portfolio since the late ‘30s. Buffett worked out that during 1958, Sanborn's portfolio of securities was worth around $65 per share, although at the time Sanborn’s stock was trading at only $45 per share. As Buffett puts it:

"… [the] map business was evaluated at a minus $20 with the buyer of the stock unwilling to pay more than 70 cents on the dollar for the investment portfolio with the map business thrown in for nothing…"

Through various means, Buffett took control of around 50% of Sanborn’s outstanding stock and began to push for change. His plan was to separate Sanborn’s investment portfolio and re-energize the map business - there were still customers who were willing to pay for Sanborn’s services (the company still exists today). Eventually this plan was pushed through.

While there’s no exact per-share selling price for the Sanborn trade, it’s reasonable to assume that Buffett netted at least $65 per share from sale of the investment portfolio. A gain for Buffett and his partners of 44% within a year.  

Berkshire Hathaway - taking control

Berkshire Hathaway was originally one of Buffett's deep value "work-out" situations, which due to Buffett’s ego, accidently became a “control” situation. I doubt he could have realized what the tiny textile company would become.

Buffett started buying Berkshire during 1962 at a price of $7.60 per share, a depressed price that reflected a lengthy restructuring. As usual, Buffett kept buying, working up an average cost of $14.86 per share during 1965. Berkshire had working capital of $19 per share.

Eventually, after running out of patience with management, Buffett took control of Berkshire himself. As it turns out, this became Buffett’s $200bn mistake.

Hallmarks of a corporate raider

These early Buffett investments actually have many parallels with the activities of the famous corporate raider, Carl Icahn, who is considered one of the most dreaded finance personalities in America.  

One of Icahn’s many takeover battles involved Uniroyal, the third largest tire manufacturer in the U.S. and a deep-value style investment. At the time Icahn’s stake become public, Uniroyal was trading at $13.75 per share, despite a book value of around $20 per share. Further, the company was in the middle of a turnaround and earnings of $2.50 to $2.60 per share for 1984 were expected, up from 1983’s EPS of $1.56. So, not only was Uniroyal trading at a P/B of 0.7 but the company was also trading at a forward P/E of around of 5.3.

Eventually, during 1985 Uniroyal succumbed to a leveraged buyout at $22 per share by Clayton & Dubilier Inc, netting Icahn a hefty profit. Uniroyal was later acquired by Michelin.

Today, many investors consider Buffett to be a long-term buy and hold investor, not a corporate raider and activist. However, many of his early investments did involve activism, and without them he would not have been able to gain the reputation he has today. 

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