The following is a writeup I did for Wal-Mart on Sum Zero, included in its entirety below. Also at the end of the post are some charts that show how Wal-Mart has evolved over time. There is no doubt that Sam Walton and Wal-Mart are one of the, if not the greatest success story over the past 50 years. So it’s a great case study to take a look at. (I believe Warren Buffett once said that his greatest error of omission was not investing in Wal-Mart, a business he could understand very well, in its early days–which is clearly seen in the charts below.)

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Wal-Mart is often listed as a cheap large-cap, but is owned by surprisingly few value investors. One reason is that it’s big and well scrutinized and hence its price is more “efficient.”  This is partly true, and you won’t get stellar returns investing in Wal-Mart. But it is a cheap, well-managed company that returns cash to shareholders and should fare well under a number of different macro scenarios.

Competitive Advantages

The U.S. stores division of Wal-Mart (about 3/4 of pre-tax profit) has significant competitive advantages. To consumers, Wal-Mart’s brand represents one thing: low prices. Customers in the vicinity of a Wal-Mart remain loyal because they can be certain that they will have the lowest prices. And as long as Wal-Mart doesn’t slack off in the service and facility departments, there will be no good reason for customers to switch.

Wal-Mart can have the lowest prices because of their (1) efficient operations and (2) economies of scale. Operationally, expenses are lower because of their non-unionized workforce and other shrewd cost management (shrinkage, inbound logistics, etc.). This penny-pinching mentality has been ingrained in the company since it was founded by Sam Walton. The biggest cost advantages are from Wal-Mart’s economies of scale. The most obvious consequence is purchasing power—Wal-Mart can buy products at lower prices because they can purchase in such enormous quantities. But the biggest and most un-replicable scale advantage is geographic concentration. Wal-Mart has a “hub and spoke” system of a distribution centers with 100-150 stores around them, all within about a day’s drive. Because of this concentration, costs can be distributed over a larger base of potential customers: distribution, advertising, regional management, etc. Wal-Mart also has some of the most technologically advanced merchandise and logistics systems in the world. This is something that smaller or more spread-out retailers can’t match.

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The following is a section from my 2007 letter to partners. It examines the buyout of the Tribune Company, an arbitrage situation we took part in last year. Tomorrow I will post another section that discusses risk arbitrage. (Please note that I have removed some of the non-public information that was included the actual letter). Enjoy!

On April 2, 2007 Tribune Co. announced that Sam Zell prevailed in his bid for the struggling newspaper company. The final $34 per share offer was chosen over another eleventh-hour bid from Los Angeles billionaires Eli Broad and Ron Burkle. Sam “The Grave Dancer” Zell—contrarian real estate magnate—had just completed the sale of Equity Office Properties, his real estate holding company. With the cash he received from the sale (the largest leveraged buyout in history), Zell jumped back into business with his offer for Tribune. The company owns coveted newspapers such as the Chicago Tribune and the Los Angeles Times. Other assets include a string of TV stations and the Chicago Cubs baseball team.

Under the terms of the agreement, each share of Tribune would eventually be exchanged for $34 in cash. The deal would be subject to shareholder approval and regulatory clearance from the FCC. Sounds simple, right? The end result of the transaction was easy to understand, but the mechanics of the deal were anything but. It was especially unique because the shares would initially be owned not by Zell, but by an Employee Stock Ownership Plan (ESOP) where Tribune employees would share in the company’s upside.

Immediately after the announcement, the ESOP would purchase $250 million of newly issued stock for $28 a share. Zell’s initial investment consisted of a $200 million promissory note and $50 million in new stock. In May, Tribune would borrow $4.2 billion to finance the purchase of about half of the company from public shareholders.

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By the time Buffett finished buying in 2003, Berkshire’s total cost for the 2.3 billion shares was $488 million. This gives the investment an average cost per share of about $21 for the ADSS (for the rest of the post, all figures will be in US$ and refer to the PTR shares traded on the NYSE). On October 18, Buffett sat down with Liz Clayman for an interview on the Fox Business Network where she asked him about his investment in PetroChina. In addition to confirming they had sold the entire stake, Buffett mentioned that at the time of purchase he read through the annual report and pegged PetroChina’s intrinsic value at around $100 billion.

PetroChina was established in 1999 as the publicly traded arm of China National Petroleum Corporation (CNPC), the largest producer of oil in China. PetroChina is vertically integrated where it explores, refines, and sells oil and natural gas. Because of the company’s duopoly in China with Sinopec, PetroChina is the most profitable company in Asia¹.

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1. Wikipedia: PetroChina [ ^ ]

See’s Candies, Warren Buffett and the perfect investment.

By Max Olson

PDF Version of “Quality Without Compromise”

William Ramsey, an executive at Blue Chip Stamps, stood in the office of Robert Flaherty as they both awaited a call. Moments earlier, Flaherty attempted to persuade Warren Buffett, majority owner of Blue Chip, to con­sider purchasing See’s Candy Shops Inc., a popular West Coast candy maker. Buffett turned them down—up until then, he was used to buying boring businesses on the cheap: banks, textile mills and insurance companies. Ramsey however, thought See’s was a great buy, and desperately tried to get Buffett back on the phone. Their sec­retary finally got hold of Buffett at his home in Omaha. He had reviewed the numbers, and liked what he saw.

After consulting with Charlie Munger, Buffett’s friend and business partner, they were willing to make an offer. This would be Buffett’s biggest investment to date, and he wasn’t one to overpay for anything—the deal al­most fell through during negotiations, but the sellers finally accepted their proposal. The final price was $35 per share. With one million shares out­standing and $10 million in cash on the books, the net purchase price was $25 million. Blue Chip Stamps now owned 67.3 percent of See’s Candy Shops, with the remainder purchased from about 2,200 public holders in the months after. But one thing remained unfinished: who would run the com­pany? Buffett made it clear upfront that they wouldn’t be calling the shots at See’s. Suggested by the previous owner, Buffett, Munger and a friend named Rick Guerin met with Charlie Huggins—executive vice president and twenty-year veteran of See’s. After three hours of discussion, Buffett knew that Huggins was the man for the job.

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By Max Olson

PDF Version of “Warren Buffett & The Washington Post”

There is no question that Warren Buffett is one of the greatest investors of all time. To study his investment methods, there are the Berkshire Hathaway annual letters, biographies, and dozens of other books written on the subject of value investing. But, Buffett’s specific investments are rarely examined within the context of the time he made the purchase—and without the benefit of hindsight. To more fully understand Buffett’s past successes, “reverse engineering” his purchases is essential. One investment in particular interested me, both because I like the business and because it is one of the only investments Buffett made where he disclosed an estimate of intrinsic value. That business is The Washington Post Company.

Background

Buffett began acquiring shares of the Washington Post in early 1973, and by the end of the year held over 10 percent of the non-controlling “B” shares. After multiple meetings with Katherine Graham (the company’s Chairman and CEO), he joined the Post’s board in the fall of 1974.

According to Buffett’s 1984 speech The Superinvestors of Graham-and-Doddsville, in 1973, Mr. Market was offering to sell the Post for $80 million. Buffett also mentioned that you could have “…sold the (Post’s) assets to any one of ten buyers for not less than $400 million, probably appreciably more.” How did Buffett come to this value? What assumptions did he make when looking at the future of the company? Note: All numbers and details in this article are from the 1971 and 1972 annual reports and “Buffett: The Making of an American Capitalist” by Roger Lowenstein.

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