Fidelity Investments is not responsible for the accuracy or completeness of the statements or data contained in this book. As usual, Dan Kelly has been both a sounding board and a psychiatrist during the writing and production of this book.
Acknowledgments
First of all, I would like to thank Warren Buffett for having had such a rich and varied career to create the material then used for this book. Michelle Donley, Karen Ludke, and Omid Malekan have all helped me at various stages of editing this book, and all three have not been shy in telling me which chapters and passages could be much better.
Does Warren Buffett Trade?
Arbitrage spreads have narrowed. The “workout” trades that Buffett mastered in his hedge fund days are no longer as easy to accomplish as
When Buffett started, only a handful of hedge funds existed that attempted to use these techniques. Now there are more than 7,000 hedge funds trying to squeeze the blood out of every arbitrage situation.
People don’t give us money. Warren Buffett has enormous deal flow
The reality is that it is easier to research any of the above is also an advantage. A commonly quoted aphorism is "buy when there's blood in the street." Buffett and Graham both recount the story of Mr.
Graham-Dodd and a Dose
Heavy insider purchases since June - the president, two directors, two senior company officers. A more famous example in the Buffett mythos is that of the Dempster Mill Manufacturing Company.
Equities
Second, Buffett realized that this scandal had nothing to do with American Express' core businesses—the traveler's checks and credit card businesses. The cost of funding doesn't get any better than this (at least until the 2003 SQUARZ bonds that Buffett himself issued - the first negative interest bonds in history).
Current Holdings
Buffett bought shares in the first quarter of 2001 and kept adding to his position until early 2003, around the time the stock bottomed. Then, in the mid-1980s, the installation of CEO Roberto Goizueta got the company back on track. But he hasn't added to his post in a while; my guess is that he won't anytime soon.
Steady revenue growth in the 1990s wasn't enough to combat the market contraction that hit in mid-1998, and Buffett started buying. During the growth phase, the company acquired more than 110 other companies engaged in the same business. In the early 1990s, Buffett began collecting banks when the banking industry was going through one of its worst periods ever.
Suffice it to say, Buffett was a buyer when the market brutally punished bank stocks and especially California banks in the aftermath of the Savings and Loan Crisis.
Merger Arbitrage Like
Interest rate risk. If a deal is going to take a year to close and the spread between the target company and its acquisition price is four
Don't short as much as you should, which increases the risk of the deal but puts a bullish bias on the outcome. It gets complicated because as much as you try to put yourself in the buyer's shoes, it's hard. If there is an advantage to be gained, it will come from taking an independent view of the trade from a valuation and earnings standpoint and taking a look at.
The higher the quality of the companies, the bigger the bet we are willing to take. We hate to be in a position where we're panicking with the rest of the street. That's the kind of deal that leaves you completely unbalanced by some form of fraudulent activity on the part of the target company's insiders.
The abuses and dollars involved were small relative to the overall size of the deal.
Relative Value Arbitrage
At this point, only four percent of the company was available to the trading public. 3Com (Nasdaq: COMS) still owned 95 percent of the company and was preparing to issue 1.5 shares of PALM for every share of COMS. The first is fundamental risk, the risk that the stocks of the two securities never converge.
On the fourth day, the value of the stump increased from −$80 million to −$28 million. Assuming Creative intended to distribute the shares to shareholders within six months of the IPO, the return to the arbitrageur would be about 45 percent. However, within a few weeks, the value of the stump would drop from −$28 million to less than −$700 million.
The losses incurred by an arbitrageur would have been close to 100 percent, provided the arbitrageur met all margin calls, as described in Exhibit 6.4.
PIPEs and High Yield
When there is a secondary share, the company's current shareholders know that they are about to be diluted and therefore each share is worth less. If the company is a legitimate investment, the buyer of the PIPE stock has just received a tremendous bargain compared to the common stock holder. If the shares rise, the debtor can take advantage by converting to common stock at a much lower share price and reaping the benefits.
This provided a significant margin of safety and offset the fact that the company's economic situation may not have suited Buffett's good wishes. That's why it came as an incredible shock when he played his queen pawn as the opening move in the middle of the game. Energy companies were all quarantined by the banks in a vicious epidemic of 'Enronitis'. In other words: all energy comes together.
Buffett does not look at the concept of safety margin only in the fundamentals of the underlying equity, but in the structure of the transaction itself.
Junk
However, Buffett goes on to say in the same annual letter: “Despite these risks, we periodically find some—very few—junk securities that are interesting to us. In the case of WPPSS, the "business" contractually earns $22.7 million after tax (via interest paid on bonds) and these earnings are currently available to us in cash. He noted that these bonds were not long-term, and the risk of distant future inflation makes him reluctant to ever buy a long-term bond.
In both cases, the sale of the bonds was not directly related to faltering economics in the business. RJR Nabisco was the target in the famous takeover engineered by leveraged buyout shop KKR and made famous in the book and subsequent movie, "Barbarians at the Gates." To pay for the takeover, KKR had to issue junk bonds backed by RJR's cash flow. As seen in Chapter 7, Buffett's interest in high yield extended to not only buying discounted bonds on the open market, but buying them directly from the company in the form of convertible preferreds.
In the tech and energy sell-offs of 2001 and 2002, Buffett repeatedly dipped into the high-yield market.
Warren Buffett’s Personal Holdings
The choices in his personal portfolio are more reminiscent of the types of trades he would make in his hedge fund. For all these transactions it is impossible to know the full details of the transaction; Buffett never talks about it and is only required to give up his ownership if he owns more than five percent of the company. REITs involved in shopping center development were particularly affected due to the belief that shopping would soon be dead except through e-commerce.
In April of 1999, Buffett bought five percent of the company, eventually increasing his stake to more than 13 percent by 2000 and then reducing his stake to below five percent by mid-2001. Buffett bought more than five percent of the liquidating company in December 2001, reaping the benefits of his last six months of liquidating properties for more than they were initially valued at. In most of the situations, Buffett bought purely for the liquidation value and the subsequent arbitrage.
The Buffett Foundation's holdings are worth noting here, although its portfolio is not quite the same as his personal portfolio, which Buffett appears to actively manage.
Closed-End Fund Arbitrage
The high dividend that one gets at a discount
A third catalyst would be if Buffett (or Munger, in the case of the Fund of Letters described below) planned to take control of the fund to either "a" (since he would be the manager) or "b, ” or both. In the first instance, Buffett and Munger began buying up shares of the “Fund of Letters.” The Fund of Letters got its start in the go-go 1960s, just as Buffett was ending his partnership due to a lack of opportunities in the stock market Carr started the closed-end fund Source Capital in 1968 to take advantage of the public's demand for this type of speculation.
They eventually owned 20 percent of the fund and Munger took a seat on the board of directors. At that point, Munger and Guerin bought up the shares and became activists, eventually taking control of the fund. They immediately changed the name of the fund to “The New America Fund” and changed the style to value investing.
Many critics of Berkshire Hathaway view Berkshire as a closed-end fund that should trade at a discount to net asset value.
Interviews with Two Buffett-Style
Hedge Fund Managers
Wouldn't you say the market is pricing these single-digit cash flow companies because there's some expectation that they're going to stop growing, or growth will be negative? I call it "the running of the bulls," and I think it's the funniest thing I've ever seen, that grown men and women are willing to do it. JA: So with these companies -- including Berkshire Hathaway -- that don't have a constituency, it's not necessarily the case that there's going to be a future constituency.
In our net net working capital strategy, you are buying a mediocre at best asset at a going-out-of-business price. We usually like it when they're a little larger in size, so there's quite a bit of float in there. So if they are unable to redistribute the cash, now that cash is earning one percent.
They are not very good to see in a wallet that is a hundred and fifty billion.
