Warren Buffett once observed that, “When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.” So what happens when an investor with a holy reputation tackles an unholy task?
One answer was given this week by Kraft Heinz, in which Mr Buffett's Berkshire Hathaway is a leading investor. It withdrew a $143 billion (€136 billion) attempt to take over Unilever amid hostility to its relentless approach to cutting costs and jobs. Mr Buffett, who sits on Kraft Heinz's board, clearly wanted his reputation for saintliness to remain intact.
Desire to be liked
Paul Polman, Unilever's Dutch chief executive, runs it as an exemplar of sustainability and stakeholder capitalism rather than the pure shareholder variety, and the abortive bid pitched two of Mr Buffett's instincts against each other. One is to invest in processed food and drink companies such as Coca-Cola and Kraft Heinz with reliable global brands; the other is to be liked.
The latter does not bother Jorge Paulo Lemann, the Brazilian billionaire whose 3G Capital private equity firm is cutting through the food and drink industry. As growth has slowed nearly to a halt thanks to price deflation and competition from makers of healthier fare, 3G has reacted by rolling up consumer groups and slashing budgets.
It troubles Mr Buffett and so it should, for it strikes at the heart of how he built his company, and his unique investment record. “At Berkshire, we only go where we are welcome,” he promised in his 2015 letter to shareholders in a defensive passage about how he works with 3G despite their conflicting methods. If nothing else, it displayed the tension in his own mind.
It was once easier to be nice. Although Berkshire Hathaway has made much of its money in insurance, Mr Buffett was happiest investing in consumer brands, particularly in the US, with a “moat” to protect them: they were less vulnerable to competition because people always needed to eat, drink and buy household products, and instinctively turned to familiar names.
A quarter of a century ago, his biggest non-financial investments – the “sainted seven” – were brands that included See’s Candies and Nebraska Furniture Mart. The sweet spot emerged in the 1980s as US companies started to go global. In his 1989 shareholder letter, he noted that overseas sales of Coca-Cola, in which he had just raised his stake, were “virtually exploding”.
Ingest vs invest
Mr Buffett embodies his belief in food brands. He drinks several cans of Coke a day, often accompanied by potato sticks made by Utz, a Pennsylvania company he has discussed buying, and picks up breakfast from McDonald’s on his drive to work. He ingests as he invests.
He used to enjoy another advantage: owning strong brands in growing markets meant that he could leave the executives who ran them alone, rather than ripping up their way of operating. “Our role is simply to create an environment in which these CEOs . . . can maximise both their managerial effectiveness and the pleasure they derive from their jobs,” he wrote last year.
But the food and drink business has developed in ways that make such cosiness impossible to sustain. Companies such as Unilever and Nestlé are larger and more global – collections of billion-dollar brands rather than owners of one or two. They are run by a global cadre: the top two executives at Kraft Heinz hail from Brazil.
The industry has also stopped growing. The international acceleration has given way to falling sales at some companies and lacklustre expansion at others. Nestlé last week announced a “time out” from an annual organic sales growth target of 5-6 per cent. Even before Kraft Heinz’s bid, Mr Polman had adopted 3G’s cost-cutting mantra at Unilever.
Hence Mr Buffett’s hesitation. His investments alongside 3G Capital first in Heinz and then Kraft have been highly profitable but sit uncomfortably with his preference for maximising happiness. Kraft Heinz has shed 13,000 jobs since the companies merged two years ago – as Mr Buffett says, 3G specialises in “eliminating many unnecessary costs . . . very promptly”.
Naked aggression
The Unilever bid has confronted him with a choice. He either has to behave with naked aggression in the industry he knows best or find other outlets for Berkshire’s capital. I doubt whether he could change personality at the age of 86 even if he wanted to, so he must amend his investment strategy.
He is doing so. Berkshire holds 9 per cent of Coca-Cola but it has shed investments in Procter & Gamble and Walmart, and the "sainted seven" consumer companies have been overtaken in importance by a "powerhouse five" of industrial holdings. They include BNSF, the US railroad group that he acquired in 2009, and Lubrizol, which produces speciality chemicals.
Neither makes tasty snacks but both meet his aim of investing in “large businesses that satisfy basic needs and desires”. They are also growing profitably without the need to slash costs and jobs. The food and drink industry used to be like that but it is no longer sweet enough for Mr Buffett.– (Copyright The Financial Times Limited 2017)
