Reading my news feed, the headlines were hitting me one after another:
Losses of over $3bn are not to be taken lightly, but when one takes a deeper look things don’t look that bad. Starting with Tesco, it was indeed a mistake. I never understood the rational behind this investment of his but mistakes do happen. Berkshire’s portfolio of stocks was worth $117.5bn on December 31st 2013. The loss on the ‘huge mistake’ Tesco is only 0.8% of the total value of the portfolio and loss developed over time. While nobody likes to lose money, 0.8% doesn’t sound as bad losing $1bn, right?
Were the other two mistakes?
Coca-Cola’s third quarter earnings disappoint. After being in the headlines for it’s excessive compensation plan the least that Coke’s management could have done was to perform well and at least earn some legitimacy to the initial version of the compensation plan they put on the table. But they didn’t. Now the company takes actions to reduce costs and to re-franchise some of the bottling operations in North America, after bringing these operations in-house not too long ago. I wonder if it was the same consulting firm that advised Coke to take the bottling operations in-house who now advices a re-franchising strategy.
While Buffett did lose money over the sloppy performance of the management team it pales in comparison to the gain he made. His cost base for the Coca-Cola shares that Berkshire holds is only $1.3bn, these shares are now worth $16.2bn. Not a bad deal after all. Lately there have been some rumours that the Brazilian PE firm that bought Burger King and is known for its success with Anheuser-Busch and it’s recent deal with Buffett to take Heinz private–3G Partners–may buy Coca-Cola and put an end to the mismanagement and beat the company back into shape. Buffett said he will do more deals with 3G and as crazy as it may sound, the target may already be on Coke’s back.
While Coke had it’s ups and downs through the years, Buffett’s recent investment, International Business Machines, earnings disappointment had more than it’s fair share of media coverage.
The shares of IBM plunged in the last few days in the face of continued decline in revenue and profitability. While I hold no position in IBM, I follow the situation there out of curiosity. The naysayers claim that IBM has missed the tectonic shift to the cloud and competitors are already well entrenched in market niches that could have been dominated by IBM. For instance, Amazon recently slashed the price for it’s cloud service by 40%! Jeff Matthews even criticized IBM for the frequent usage of non-GAAP metrics in their reports and conference calls.
Is Buffett wrong about IBM? Will it be a ‘huge mistake’ Tesco? Fortunately, a group of extremely smart and successful investors who run the Sequoia Fund hold IBM’s shares and they were asked about in in May’s investor day (I highly recommend you to read it in full as it contains a ton of business insights that you won’t get anywhere else). Here are the main things:
Can you share your thoughts on IBM? It seems like there are doubts on the Street regarding the company’s long term prospects. Sequoia seems to have a relatively small position. I am just wondering at this point what your view is and what your view of its valuation is.
I will start with the valuation question first because that is a very important factor. The valuation is not demanding. It is ten times earnings, eleven times free cash flow. At that valuation, when the company is buying back 5% of its stock consistently a year, you do not need the business to do extremely well for it to work out for you as an investment.
In the long term, we keep track of the prospects for the company. We monitor those very closely. We think that management is making the right moves for the long term. The issue with IBM is that it has been so successful in the past. It completely dominated mainframes. It still does, but that is not a business that is growing very quickly, if at all. So IBM has this enormous anchor behind it. But at the same time, we see the company seizing on new opportunities like the move to the cloud. IBM has made a lot of progress on that front. The cloud enables IBM to deliver technology infrastructure as a service and so it can compete with Amazon for the small and medium-sized business IT market as well as for the smaller departments within large companies.
Even in what you might consider IBM’s stodgier chips business the company announced a promising new initiative whereby Google, for example, actually says it is going to build its third generation data center, possibly, around one of IBM’s chips. A year ago, two years ago, you would have never thought that a company like Google at the vanguard of what you would consider Internet technology and technology in general would go to IBM for one of its chips. So it shows that IBM is on top of things technologically. Management is thinking properly long term about how to improve the prospects for the business. But you do have to remember that it is a large company and it has a significant base of business that is not going to grow very quickly over time. In the meantime, the valuation is undemanding and management is doing the right things with capital by buying back a lot of stock.
So the smart people at Sequoia are inline with Buffett on the IBM investment. And now you have to decide if you want to side with Jim Cramer or with Buffett and the Sequoia Fund.