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POSTED: Sun, 01/31/2010 - 11:53
Analysis of See's Candies
If I understand correctly, we're looking to analyse great businesses in this forum. I believe Warren Buffett has called See's Candies a great business many times so it seems a good place to start. Below is my analysis of See's plus some unanswered questions. Please add, amend, correct etc! Quantitative -----------**1972** Purchase Price - $25m (16% off the asking price of $30m) Sales - $30m on 16 million 1bs of candy = to $1.88 / lb of candy Pre-tax Profits - $4.5m (56% on invested capital) Post-tax Profits - $2.25m? (estimate) growing 12% a year Invested Capital - $8m **2006** Sales - $383m on 33 million 1bs of candy = to $11.61 / lb of candy Pre-tax Profits - $82m Post-tax Profits - £60m? (estimate) Invested Capital - $40m **2006 at 1972 prices** Sales - $80m on 33 million 1bs of candy = to $2.42 / lb of candy Pre-tax Profits - $17m Post-tax Profits - £8.4m? (estimate) So Berkshire invested $32m since 1972 (approx $1m / year) whilst pre-tax earnings over the period total $1.35bn. Total investment $57m. ROI = >2300% over 34 years. Please see a public google spreadsheet posted as a web page for the above here: http://spreadsheets.google.com/pub?key=t248xiVFFLXMMjEj3fwS91Q&output=html Qualitative ----------The product tasted great - used the highest quality ingredients The personality of the product -> nostalgia, share of mind, reputation for innovation, history (the inspiration for Charlie & the Chocolate Factory?) Reasonable price (too reasonable) - untapped pricing power. WEB believed another $0.15 was possible. This would increase profits by $2.4m. Total control of distribution Exceptional service Market leader Minimal funds needed to operate - cash eliminated accounts receivable & production & distribution cycles are short minimizing inventories Virtually all of the post-tax profits are free cash Tough to grow volume All these factors lead to an extremely wide moat. The loyalty of the customers can be seen by the 2 years they spent defending See's when it was purchased by Blue Chip Stamps.
(Editor: See’s had a brand in its established region (Calif) but struggled to grow outside that region.)
Unanswered questions: - why was so little capital investment needed? isn't chocolate making equipment expensive? or is it more labour
intensive? - I'm confused regarding 'invested capital'. Is this book value? ie net asset value? Does anyone have any idea what See's balance sheet looks like? (I imagine there are few liabilities) - where can See's go now? can it continue to raise prices above the rate of inflation?
POSTED: Tue, 09/13/2011 - 00:11 — Redliner
Would like to access the 19 replies to Nick's analysis of See's candies. Can't seem to figure out how to do so. Any advice?
POSTED: Wed, 11/03/2010 - 15:46 — nickwebb
Ships that pass in the night
Hello all! Sorry for the long period of quiet on this thread. If empty vessels make the most noise we must all be very full! I did intend to finish with a consolidation of everyone's input on See's and publish that analysis on a 'Backwards BRK' wiki. But I don't think that's necessary now given seekingwisdom's excellent analysis. The next company I'd like to look at is Coke. Has anyone seen any analysis that they think is of value? In the mean time, I'd like to share a side project I've been working on. It's a compilation and categorisation of all the question & answer sessions I could find with Mr. Buffett. See what you think at buffettfaq.com. Nick
POSTED: Sat, 02/27/2010 - 20:33 — tim83030
Alice, You've mentioned several times that the case method would be the best one to learn more about how WEB evaluates a great business -- Can you present a case? Say like, something recent like IDQ, McLane, XTRA, or something you would prefer? Cheers!
POSTED: Fri, 02/26/2010 - 19:33 — aliceschroeder
"Warren practicing his craft"
P.S. I appreciate that you're seeking meaningful information that will add to your own store of knowledge. What is best to help you folks understand more about the thought process is to eventually work through some specific cases with the caveat that each is unique rather than writing narrative descriptions that try to generalize what Warren does. It's not as generalizable as you might think despite any offhand statements from either one of them that might be interpreted that way. Warren-watching has morphed into a sort of Kremlinology (literally Buffettology, but to say that would sound pejorative to Dave and Mary's book, which is not my intent) anyway Buffettology in which every little crumb of information is examined to see whether it means something more. It's better to think about it the other way around (invert). When Warren and Charlie make a statement like the seven/eight hours it may merely mean one of them is trying to summarily counter a wrong impression using a quick declarative. Here, I think that rather than being literal, Charlie is simply countering the impression that Warren riffles the pages of an annual report for ten minutes and is done. The work of security analysis is always painstaking if done right. But Warren can screen faster than he can analyze and much of what he does is screen. I would argue he does both (screen and analyze) very fast compared to the rest of us. When he does analyze, it's largely the same process as anyone would go through. What is interesting are the specific about any one company. Perhaps this is a better explanation. Ok?
POSTED: Fri, 02/26/2010 - 18:22 — aliceschroeder
"Warren practicing his craft"
Hi Lorax, Okay. Here goes. Sometimes, Warren spends five minutes thinking about a company and sometimes he spends many hours - seven, eight, twenty, or more. It depends on all the obvious reasons. The more time he spends the more likely he is to take notes of things he is interested.He may (or may not) take notes about footnotes, balance sheet #s, cash flows, projections, income statement, ratios, capex, hundreds of other items. His notes, when taken, are brief -- keywords not sentences. He writes notes in the margin of annual reports or on the cover of SEC filings or on a separate sheet of paper or on the back of an envelope or on a burger joint takeout menu or in the margin of a letter from somebody else about some other topic. Sometimes he files the notes and sometimes he throws them away after he's thought about them. The files are chronological to the extent they are organized at all. He works in his office and at home and while traveling. He works in between phone calls. He spends more time on this kind of work when SEC filings and annual reports come out, as you would expect. He is content to update himself on information no more than quarterly except by reading the newspaper/Internet for major breaking news. Except for this and the absence of a computer and an earnings model, the way he works is very similar to the way every good analyst I've ever known works. He simply reads all the available material he can find, and takes notes in an ad hoc manner. I think what's truly different about him goes on inside his head and doesn't have a whole lot to do with his work method. This may not add materially to The Snowball, but hope it helps. Please understand, sometimes the way individual company files are organized has a bearing on the thought process in that specific situation. The point is that you
can't generalize from it. Make sense? I am not holding back on you here. You just can't bridge meaningfully from the specific to the general when it comes to these files. If you could, I would of course have put it in The Snowball.
POSTED: Mon, 02/22/2010 - 01:32 — The Lorax
Alice, Thanks for commenting on Warren's files. It's both a treat and a help to get a more tangible depiction of what you discovered when you waded into his office. What fun you must have had, and what a challenge. I hope you'll find more opportunity, as you blog, of telling us not only what you've learned, but also about the discovery process, and perhaps even about your writing process. It all lends so much valuable perspective. Thanks again for the comments, and indeed, for spending time blogging to us at all. I hugely appreciate it, as I'm sure everyone here does.
POSTED: Sat, 02/20/2010 - 20:08 — aliceschroeder
add: shelves a cash register and trade dress, the store decor? the margins on candy are so much higher than your local greengrocer's and yet the capex should not be dramatically different except for training the employees. the store decor is probably very cheap despite its neat uniform appearance.
POSTED: Sat, 02/20/2010 - 19:35 — aliceschroeder
thank you for this (all of you) there are a lot of wonderful thoughts here. i will respond to a few of them... "I must point out that it drives me crazy listening to the investment community regurgitate “Buffett Like” terms like intrinsic value and cash flow. Intrinsic value is a loosely, and often misused term in the investment community. Intrinsic value is not a precise figure, rather it is an estimate. Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life." This is the most important thing that anyone has said. People talk about "intrinsic value" as though such a thing were calculable as a point estimate. Yet Warren recently discussed the value of Berkshire stock as a simple multiple of book value. I keep repeating that his way of thinking about valuation is simpler than many people believe. Where he spends his time is figuring out What Is a Good Business. This is the hard part. How much are the cash flows, and how sustainable are they. 98% of the investor's time should be spent on the "Is It a Good Business?" question. okay, with that said, a couple of things. > See's suffered from inflation in the 1970s. The price of cocoa shot up and it was not able to pass along the cost to customers because of price controls. This was a temporary factor but when thinking about pricing power don't forget this story. "See's has pricing power" is not a glib phrase to throw around. When inflation is serious, nobody has pricing power.
> During WWII, See's shut down the stores rather than use inferior chocolate or dilute its concentration. When a company forgoes sales and closes its doors to maintain its authenticity, customers remember it for a long time. This event was pivotal for See's. > Franchising is a terrible business model. Managing franchisees is no fun. Look at all the trouble Berkshire has had with IDQ. Again, 'what is a good business?' Opening a See's store requires nothing more than signing a lease, printing some signs, and hiring a few people and training them - training the employees may be the largest component of "capex" as it were and they are doing this all the time anyway. Other thoughts on capex of opening a new store?
POSTED: Sat, 02/20/2010 - 19:22 — aliceschroeder
the files are an incredible mosaic of the man's mind. with that said, warren is extremely consistent in the way he thinks and does business and always has been. therefore, the files break down into a few basic categories. > most of the companies he follows out of interest - reads annual report and sometimes other sec filings. not much in these files. maybe a marginal note or two. this represents the majority of the files. > berkshire subsidiaries. varies enormously because it is a compendium of company history, business transactions, investment analysis and in recent years less material rather than more. it is important in reading these files not to assume that they perfectly reflect what was in warren's mind. to some extent they are simply the material he happened to keep and inherently a bit random, but yes, it is fascinating. > companies that he's considered buying, or has studied very closely, or where he owned the stock but it's not a berkshire sub. there are a few of these and they're interesting. the material is what you would expect - a somewhat random collection that very much depends on the investment. sorry i cannot be more specific but it depends entirely on which one you're talking about. > the files were not compiled in the manner that a security analyst would use. warren keeps a lot of information in his head. companies used to disclose far less information than they do today. as a private investor he did not have the responsibility to document his work that most securities analysts would feel. on the other hand, he might toss in things that interested him that a securities analyst would find of marginal relevance. > biographers often treat any new material as if it were the rosetta stone or the dead sea scrolls. a new cache of letters, and it becomes the basis for an entirely new interpretation of someone's life. this may be justified or not depending on the contents. with the files, a sense of perspective is in order. the man has lived a long life and hundreds of thousands of pages of documents (if not millions) have passed through his hands. his files a) are not complete and b) were casually assembled. > as a biographer i considered his files essential because contemporaneous documents are simply more credible than oral histories.
POSTED: Mon, 02/15/2010 - 14:17 — The Lorax
Nick, I have The Snowball on my Kindle, so I can't point you to a page number, but I have copied and pasted below a couple of the passages on Rickershauser. "No sooner had Buffett achieved the glory of joining the Post board than his and Munger’s need for legal services was about to grow with stunning rapidity. Rickershauser, who already knew what it was like to work with Buffett, had once explained to a colleague that “The sun is nice and warm, but you don’t want to get too close to it.”25 He would spend the next couple of years testing what could be called Rickershauser’s Law of Thermodynamics."
"Those who tested Rickershauser’s Law of Thermodynamics found that the sun was indeed nice and warm, but Buffett was so focused and his mind worked at such speed that extended conversations with him left them sunburned. “My mind was so tired,” said one friend. “I had to recuperate from seeing him,” said another. “It was like being pounded on the head all day long,” said a onetime employee." I think Alice communicates Warren's intellectual intensity extremely well with these passages, and others, but I yearn for more concrete examples of what Warren is like "in the raw" when he does his work. Three cases-in-point: When Buffett bought Justin, if I'm not mistaken, he called the company to ask if the method of depreciation used in the financial statements had been changed from one period to the next (apparently the footnotes didn't make this clear). As I recall, the answer was "no," but the company was stunned that he was attentive to such a small detail. In the second case, recently one of the major newspapers reported that when Buffett reviewed the 10-K of one of the investment banks during the financial crisis (Lehman, I think), he made notations on the front page of the 10-K of all the footnotes he didn't understand, which apparently is his habit. Indeed, the paper even posted a pdf of the actual 10-K with Warren's handwritten notes on the cover. Third, I recall that at one of the BRK annual meetings, in response to a question, Buffett talked about how he reads masses of annual reports, press releases, 10-Ks, 10-Qs, etc., when he wants to bring himself up to speed on any given company. I remember Charlie then chiming in to reassure the questioner that even Warren needs quite a bit of time to plow through such details; he doesn't just fly through it. I think Buffett added that he might spend 7 or 8 hours to just cursorily brief himself on a company. From my perspective, these are marvelous concrete examples of how Warren works, of his attention to detail, and of the fact that even a man operating at his level still needs to invest a considerable amount of time and effort to "make the grade." I can't imagine that he ever shirks the necessary work. Alice has talked about how when Warren comes to work he cocoons himself in his office and reads trade publications, company reports, etc., etc. But it would be fabulous if she could embellish these observations with additional details that, like the double-stitches on a fine garment, add texture so that we can visualize, to some degree, this man's habits, and methods, and focus. This is why I'm asking her about the contents and organization of his files, for example. I'm hoping Alice will paint us a less abstract and more particularized picture so that we can "see" Warren practicing his craft.
POSTED: Mon, 02/15/2010 - 10:33 — nickwebb
Wow! Very educational. Thanks
Wow! Very educational. Thanks everybody. Seekingwisdom - what bonds are you referring to? I'm assuming long-term government bonds? - would you mind explaining why "businesses following the LIFO inventory method usually do not require additional working capital if unit volume does not change"? Not sure I understand. Wouldn't there be less spoilage using the FIFO method? (given the limited shelf-life of a few weeks) - would you expand on: "Trademarks, intangibles, ect., are factored in on the return on equity calculation as economic goodwill. That is another subject (that we can explore) and applies after the purchase of See’s has been made." Why would you look at this after the purchase has been made? Why not before? - looks like Fanny May chocolates are $23/lb versus See's at around $15/lb (up $3 per lb since 2006). I know which I'd choose!
Sahil - what is persistent capital intensity? A google search only turns up this post - a googlewhack of sorts! - Regarding how WB got the deal - I understand it was initially found by Robert Flaherty, an investment advisor for Blue Chip. Robert contacted William Ramsey, Blue Chip Exec, who contacted WB. Robert Flaherty is still on the board of Wesco and is former president of Flaherty & Crumrine (http://www.flaherty-crumrine.com/). The Lorax - Could you remind us what Rickerhauser's Law of Thermodynamics was? I've had a quick search of The Snowball and couldn't find it. An entertaining 5 minute video at the See's factory: http://www.youtube.com/watch?v=jrj-GgZNoXI Interesting insight into the difficulties of expanding overseas in this history of See's: http://www.answers.com/topic/see-s-candies-inc "By the early 1990s, See's instead was moving ahead with plans to sell its candies abroad. See's had had stores in Hong Kong since the 1960s, but international distribution was tricky for the company, since the chocolates had to be kept refrigerated and then needed to be sold within a few weeks. See's moved its products to Hong Kong by air. It had its own refrigerated storage unit at the San Francisco airport, and the flight was met in Hong Kong by a refrigerated truck." Further questions: - how are employees well trained and relations kept up with vastly varying demand of candy? (ie. most demand on valentines day and last few weeks leading up to Xmas) - what should See's strategy be now? - How can the cost per store opening be close to zero? - what explains See's lack of success outside of California? Is it the distance from the See's factory? - How does See's compare to it's competitors? Godiva, Russell Stover, Fannie May, Fannie Farmer On a final note, when I came over to the US last year for the Wesco meeting I went to the See's store in Pasadena. It was going to be closed down because of it's lack of parking. Apparently, ability to park makes a very significant difference to sales at most See's stores. Nick
POSTED: Sat, 02/13/2010 - 17:36 — The Lorax
Alice, About that big file cabinet of stuff on See's, etc., did you just copy scads of Warren's files and take them home in the course of your research? When you say these materials are "complex and sophisticated" are you talking about materials generated by Warren himself, like his analysis of coca futures and such, or internal reports generated by the subsidiary, or both, or something else? I ask because knowing what a person is reading or writing down, and saving, can be very revealing in itself. For example, if you came into my living room and saw my book shelves, you could gain some insight into me by seeing the titles, or even just by seeing the number of titles. If you came upon my diary, and skimmed the pages, you could learn something just by knowing where my attention was focused. I love biographies. It has left a mark knowing that Truman spent many hours reading history when he was still just a poor Missouri farmer, preparing himself for something (who could have then guessed what), and that Lincoln spent much time with Shakespeare, learning the best cadences of the English language. Bernard Baruch always went for
long walks after he made an investing mistake, to settle himself down and reevaluate his decisions (thoughtfully managing himself, I suppose Drucker would say). And as I recall, Jim Rogers, the investor, has talked about creating long, detailed spreadsheets, by hand, to inculcate into himself the particulars of a company's or a commodity's financial history. We all know there is no "secret sauce" to Warren's investing, just as there was no secret sauce to Lincoln's writing of the Gettysburg Address. But knowing where Lincoln focused his attention in preparation for his accomplishments is a useful character study, as I suspect that similar studies of his political forebears was useful to Lincoln himself. In this vein, what does a Warren Buffett company file look like? How big is it? What's inside? Does Warren thoughtfully organize his files, or are they thrown together haphazardly? Are there spreadsheets, a la Jim Rogers, or does Warren keep all the numbers in his head? Does he write memos to himself to record or organize his thoughts? How do Warren's files reflect his extraordinary personality, or do they? In The Snowball, you talked about Warren's passion for detail, his treasure hunt-like search for obscure facts, and his affinity for the like-minded Herb Wolf. You write of Rickershauser's Law of Thermodynamics. Do Warren's files reflect these traits? Are they a mass of intensely accumulated facts and figures? Let me put it one final way. You are a securities analyst. No doubt, you have compiled many company files in your time. How would the company files in Warren's office compare to those of a typical sell-side or buy-side securities analyst? Thanks, Alice. I love your commentaries.
POSTED: Sat, 02/13/2010 - 11:05 — nickwebb
Deliberating, Cogitating, Digesting
Seekingwisdom / Sahil - what an excellent and thoughtful analysis. I've still thinking about what you've both written. I'll reply back later when I've properly digested your posts. One question springs to mind right away though. Taking Seekingwisdom's point that each company cannot be analysed using the same matrix, what do you think is the best way of learning the unique methods of analysis for different types of company? I'm assuming you break it down by industry? ------One addition of interest - Charlie Munger was asked this question on See's at the 2001 Wesco meeting: Why not franchise See's candy stores? "It takes almost no capital to open a new See's candy store. We're drowning in capital of our own that has almost no cost. It would be crazy to franchise stores like some capital-starved pancake house. We like owning our own stores as a matter of quality control." How can the cost to open a new See's store be close to nothing? [I've compiled all the Wesco meeting notes I could find on the web for myself: http://tinyurl.com/wesconotes I hope the original note-takers, all attributed in the notes, forgive me for publishing it here] Nick
The Buffett Enigma
Hmm, Alice's words should not be forgotten for their prescience. Certainly, evolution should not be ruled out as a majority part of the cause behind shattered belief systems. Besides railroads, something of an anathema to be studied by Buffett in his early Graham Days, bailing out a competitor to his Wells Fargo stake, has to be high on the totem pole of oxymorons requiring contemplation at this time. I don't expect we will be hearing him brag about $15.00 per second ticks ($9.00 per second is the velocity of BAC's interest rate) for this round of financing. A nice wink and a nod from his friends at The Central Reserve Bank will probably be sufficient. :-( Had I not heard Charlie Munger's mouth disparage them with my own ears not much more than one month ago, I might have been gullible enough to take this news at face value. Then again, somebody has to continuously act as JP MORGAN once did during The Panic of 1907, except for the modern era JP Morgan themselves at dimes on dollar today, right?
Wed, 08/17/2011 - 22:33 — The Lorax
I think Buffett (as distinguished from Munger!) cult-members do you a disservice by calling you on the carpet for expressing contrarian views. My own view of Buffett is a pragmatic one: If Warren's approach to business, image, etc., serves to advance Berkshire for shareholders' benefit, I'm a happy shareholder. If Warren, for example, sees fit to put Burlington in the same segment as MidAmerican, it works for me, although I know it irks the CPA in you. But in the context of Berkshire, I think it's fine. Charlie once said that an unfunded pension plan would trouble him at most companies, but not at Cravath. I feel the same way about Berkshire in most respects, and I suspect the backlash you're getting when you challenge the so-called core beliefs of the cult stems from the fact that most of the cult-members feel a similar level of innate comfort about how Warren runs the show and does his job. It's not that everyone thinks he's infallible or a saint, but that through whatever means, he's looking after their interests effectively - and far more effectilvely than would be the case at most conventionally managed enterprises. Nonetheless, I think that criticism of you for illuminating Warren's ways and means, based on your incomparable perspective, is greatly misplaced. As shareholders, or as Charlie might put it, "learning machines," we can only profit from the special dimension you bring to the table. In blunter language, I wish your critics would shut-up and let you talk. We're only going to learn from you, and we should all be appreciative for every one of your tweets; I am. I assume that the core-beliefs of the cult shortly to be overturned relate to Berkshire's transition to a post-Buffett era. Would you expand on which core beliefs you think will be going out the window, and how, as a result, you think Berkshire will function differently after Warren is gone? Also, what's the status of the new Buffett book? Is it months or years in our future? Will Alice Schroeder fans get a preview of coming attractions? Thanks, Alice
Mon, 08/08/2011 - 16:09 — Anonymous
If the company is already up
If the company is already up for sale, I wouldn't say it's an unfriendly offer. He's just giving the Transatlantic board another option if they want it. That said, the offer is certainly unfriendly to Allied World. RESPONSE: Thanks for asking, this is an opportunity to clarify an important point. Transatlantic actually is not for sale nor was it ever for sale. The Allied World deal was structured as a strategic combination which legally does not constitute putting the company up for sale. The distinction is not meaningless; it means that Transatlantic expressly arranged the transaction so that it would not have to consider unsolicited bids. The deal terms also prevent the Transatlantic board from accepting a higher offer without holding a vote on the Allied agreement if Allied choses to hold a vote. There is probably some cute colloquial term for this provision (like "grenade" or "land mine" ) and if someone knows it I would like to hear it. The practical effect is that a would-be buyer must take the market risk of waiting a couple of months until after a vote is taken on the Allied deal before it can reach any agreement with TRH. In addition, the vitriol back and forth with Validus has made it clear that TRH is extremely committed to the Allied deal. We don't have to look far to find a reason. The Allied deal would keep TRH largely intact and its board members would retain their board seats. Because the Allied deal was structured to deter unsolicited offers and make them difficult to complete, I would say that any other bid, including Berkshire's, is "unfriendly." (If Buffett were not involved, most people would call a spade a spade, and refer to it as hostile.)
POSTED: Wed, 02/10/2010 - 16:58 — seekingwisdom
I must apologize for my typo when I referred to Fannie May as Fannie Mae. Big mistake on my part, as you know, one is easier to swallow than the other. First, it does not matter whether Warren purchased 1% or 100% of the business in order to evaluate the business. All of the numbers presented are proportional to his "share" of the business. Second, all businesses are not evaluated under a single matrix. Therefore, the evaluation of a company like See's falls under the category of "Unique". Unique, because it possesses something that relatively few business in 1972 (and now) have. That is the ability to consistently earn 25% after tax on net tangible assets, with conservative accounting and no financial leverage. Let's break this down. The first step is to establish the taxable "Owners Earnings" of the company. Owner Earnings is represented by: reported earnings plus depreciation, depletion, amortization, and certain other non-cash charges less the average annual amount of capitalized expenditures for plant and equipment, ect. that the business requires to fully maintain its long-term competitive position and its unit volume. (If the business requires additional working capital to maintain its competitive position and unit volume, the increment also should be included. However, businesses following the LIFO inventory method usually do not require additional working capital if unit volume does not change.) In See’s case it was $4 million. Is $4 million pre-tax a good return in 1972? Well, that depends. What could you earn if you invested the same amount in bonds at that time? In 1972, you could earn 9% on bonds. So, considering the opportunity to own a truly unique businesses or a safe steam of bond income, what would you be willing to pay? $4 million divided by 9% equals $44 million. If you invested $44 million in bonds at that time you would receive the
same $4 million stream of income. Which would you rather have a steady stream of $4 million coming in each year or a variable "Equity Bond" producing $4 million in the first year? Hmmmm. Well, let's dig a little deeper and try to figure out what we are really getting. Inflation is the next issue to tackle. As long as you anticipate, as Charlie and Warren did in 1972, a world of continuous inflation, then you better understand the effects it will have on both the steady steam of bond income and the steady effect it will have on the business that you are buying. See's at the time had $8 million in "honest-to-God" assets, or net tangible asset. This consists of (net) receivables, inventories, and property plant and equipment. It is important to point out, not all companies are alike from a net tangible asset perspective! This is one of the reasons that there is not a "black box" to evaluating businesses. For this part of the evaluation, we use after-tax earnings to evaluate efficiency. After-tax earnings are what are left over at the end of the year for management to deploy. Well, not quite. Businesses require the replacement of "tangible assets". Let’s break them down individually. First we must address receivables. Receivable will increase proportionally with sales. Notice I said sales and not unit volume increases. This is important to point out, especially in See’s because See’s has not had a staggering amount of unit growth over the years (nor is it necessary) because they had pricing power. An important point to make here is that the value of See’s box of chocolate is in what the consumer believes is the value of the product and not the production cost. This allows Warren to increase the price per pound of chocolate above the rate of inflation without jeopardizing unit volume. This is also why you do not need unit volume increases in a business that possess these “Unique” qualities. Next, we must address inventories. Inventories are most certainly not created equal, but in the case of See’s, one can reasonably assume that inventories are not going to build up and “lose value”. The turnover in the candy business is high. That brings us to the last and usually the largest inflation exposed asset of all, fixed assets or property plant and equipment. Once again, I must point out that all fixed assets are not created equal. This is where the term “ain’t broke, don’t fix it” comes in handy. See’s makes a product that is “frozen in time”. They produce a product that it timeless and requires very little maintenance. Because they have not changed the design of the product, retooling to keep up the latest and greatest “candy fad” is not an issue that See’s must address. This is one of the most important “factors” of any businesses intrinsic value calculations. I must point out that it drives me crazy listening to the investment community regurgitate “Buffett Like” terms like intrinsic value and cash flow. Intrinsic value is a loosely, and often misused term in the investment community. Intrinsic value is not a precise figure, rather it is an estimate. Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life. So, if you follow See’s history, aggregate net tangible asset expenditures have totaled only a fraction of the total sales. Therefore, See’s true “Cash Flow” has been extraordinary. What Warren and Charlie saw in See’s in 1972 was a company who’s product was underpriced in the market and therefore, had bottled up pricing power (even if unit volume did not increase) that would outpace inflation. Since (net) tangible asset requirements were so “Uniquely” low, this deviation created an increasing intrinsic value over time. This leads to the next important factor that weighs in on the decision of capital deployment, “Margin of Safety.” Ben Graham so eloquently states in chapter 20 of “The Intelligent Investor”, “In the ordinary common stock, bought for investment under normal conditions, the margin of safety lies in an expected earning power considerably above the going rate for bonds”. Well, let’s test this concept and see what type of margin of safety was allowed for when this purchase was made. In 1972, See’s earned pre-tax $4 million and they paid a total “Enterprise Value” of $25 Million. Therefore, the earnings power in 1972 was 16%. Given the bond rate at the time of 9% and the earnings power of 16%, they would average an annual margin of 7% annually accruing in their favor. Since See’s required so little capital going forward, over a ten-year period of time, the excess of stock earning power aggregated to over 50% of the price paid. This figure is sufficient to provide a very real margin of safety – which, under favorable conditions, will prevent or minimize a loss. Trademarks, intangibles, ect., are factored in on the return on equity calculation as economic goodwill. That is another subject (that we can explore) and applies after the purchase of See’s has been made. Lastly, expanding a business’s moat is the primary goal of management. In a truly “Unique” business, the “secret is in the sauce”, so to speak, and it requires no additional capital. What is required is the ongoing maintenance of consumers “share of mind”.
POSTED: Wed, 02/10/2010 - 15:53 — sahilgujral
More on Nick's Qualitative Factors
Nick, You are posting really excellent material! Some more thoughts: -See's had been open (indeed expanded) during the great depression. It is analogous to what Buffett may be thinking about the "resilience" of confectioneries in Cadbury behind the scenes despite the public presentation. His interest in this idea may go back as far as the Rockwood cocoa situation. People are often startled that WB has these buying opportunities from private owners so early on. One simple point we can make is that during an absolute economic crisis like the 20s simply being willing to look at who was not only still in business but thriving during this point -- and then looking at accounting data to see the actual trends -- is surely an instructive way to "screen" for investments. That he went from being aware of the opportunity to actually being in a place where he knew the right people to buy it is a testament to his "never criticize" approach, "networking" abilities, trust building abilities especially with people in love with their businesses, and general "entrepreneurial" traits. --Regarding the persistent capital intensity questions, it will be helpful to understand more precisely the nature of the contract and supply relationship with Guittard. Given the presumed 21% "return on capital" (we are unsure what kind but this company does not seem to have been heavily indebted so its perhaps a less important issue) and what you write about Ed Peck's abilities (and what is known about the Sees themselves), it is plausible that they identified and drove a very interesting, branding, less "manufacturing" oriented part of the value add chain at a time in America (before the 1970s) when VERY FEW people in business were yet totally thinking that way. To the extent that the "commoditized" parts of the businesses were "outsourced" onto Guittard, it is plausible that Buffett both recognized, benefitted from, and in conversations with management that later also led to the famous "price raise", drove that trend. --More than simply getting the family to sell to him, this business deal is iconic for the way Buffett quickly used it to generate not simply "synergies" but actually "synergistic dependency" that most company M&A/PE firms just BS about. The most important of these might be allying See's operating with hugely efficient distribution operators and logistics chains of other BRK acquisitions again during a period when it could have otherwise had very different economics to break out of CA distribution and expand market penetration. Note that NE furniture mart is one of See's largest distributors today. This admits at least the possibility of that very rare situation in retail where you can grow volume without "diluting" the original brand's pricing power (margin) as say happened with Lacoste brands when they went to discount stores to try and save the company. --Further, as people writing on Alice's blog have pointed out in respect to BNI, this business and its development ultimatley gave Buffett profound quarter by quarter insight into how rich the US consumer was feeling and what she was spending. Though inelastic to an extent, an "upmarket luxury" like chocolate is at least plausibly a leading indicator for people's " consumer happiness" and "willingness to go out and spend." That See's has stores state by state in so many key markets each of which probably report individually sliced data to BRK is no doubt a great asset as an investor trying to read what is really going on in America. --A final thought is that this may be one of the rare "manufacturing" businesses that actually has negative working capital or something very close. That is part of the benefit of owning the stores and controlling your channel. My memory is that most See's stores are pretty small and have high foot traffic so it makes sense. Ben Graham's oft-cited quip is you don't need to weigh a man to know that he is fat. With the statistics you gave we are talking about a 21% economic return business, valued about 11x earnings, growing at 15% a year that qualitatively showed itself to be not simply recession but depression proof given a wide variety of "normal" states of the world. "exact calculation of intrinsic value" is interesting but probably less important than the actual contracts this business had, its execution, and how WB actually got the deal.
POSTED: Mon, 02/08/2010 - 12:01 — nickwebb
Thanks Alice & Seekingwisdom
Thanks Alice & Seekingwisdom (Peter?). This is very educational and interesting. On a few points I'm not sure I understand correctly: > I thought BRK, through Blue Chip, bought all of See's? What happened to the other 33% of the business? (if BRK bought 67% of business for $35m). $25m of the $35m investment wasn't cash? > Would you mind explaining why the capex looks reasonable to double sales? > Why do price increases tend to lag cost increases? Is it because increases in costs are not predictable and anticipating them is tough? > If the market can bear greater price increases (after the period of price controls) why didn't See's go for them? > Do you know what the thinking was behind Japan? It seems an unusual move Like seekingwisdom, I'd love to see See's balance sheets. :) Further qualitative factors on the See's purchase that have come to mind since my first post: - everything about the company demonstrated it wasn't about to let the quality of the product slip. It had great quality control - testing - their quality assurance lab is an industry leader - it was famous for not compromising the quality even during rationing in WW2 - the potential to modernise processes without touching anything else (the packaging hasn't changed in 70 years!) - long trusting relationship with chocolate supplier Guittard was in place (from the 1950s!) - unlikely to cause trouble - a bit of luck and a bit of skill in choosing Chuck Higgins to lead See's - and with Ed Peck, the Sam Walton of Sees - investigated competitors, kept managers talking about what sold and what didn't, he'd take them out to fancy restaurants and hire the best candy makers away from the competition all across the US. - Having 'old-time' equipment that continues to be used to this day is part of the selling point - trademarks (as Alice mentioned) - very distinctive stores and uniforms A couple more discussion questions - what is your estimate of intrinsic value given what Buffett / Munger knew in 1972? Trying to avoid the bias of hindsight, what's the maximum you would have paid? - what other businesses are there like See's? A brewery would seem to have similar attributes although I'm not aware of one that doesn't have a huge amount of competition and full control over the distribution. p.s. just noticed a pound sign crept into my first post a couple of times. They should all be in dollars. I'm betraying my nationality! Nick
POSTED: Sun, 02/07/2010 - 15:21 — aliceschroeder
:-) I would rather buy products from See's than Fannie Mae especially in recent years :-)
In a business like See's invested capital should include trademarks. See's has had to spend some money along the way to defend their trademarks e.g. against Russell Stover, these are part of their "real" net assets = invested capital even if they do not depreciate. The file on See's is pretty voluminous. It probably contains the material you want but needs to be sorted out and vetted. Am still working out what is the best way to handle this material.
POSTED: Sun, 02/07/2010 - 00:36 — seekingwisdom
Net tangible assets
Warren refers to the $8 million as net tangible assets. He further states that the net tangible assets include: (net) receivables, inventories and (net) property plant and equiptment. This represents all of the required capital to operate the business. Therefore, the $2 million net income on See's net tangible assets of $8 million was 25%. Not many businesses are capable of earning 25% return on net tangible assets. As long as a business owns a "share of mind" then prices may be increased year after year. See's has been able to increase prices since 1972 because the candy was underpriced in the market at the time Blue Chip purchased them. As long as you do not abuse your pricing power, you can pass along price increases greater that inflation. Compare the prices of See's candy per pound in 2009 to Fannie Mae's 2009 prices. I believe that there is still room to increase prices. The enterprise value of $25 million paid and the recognition of untapped pricing power gave them years of future price increases without "requiring" them to increase prices to what the market would bear. You do not need volume increases in order to compound your profits if the net tangible assets required to maintain normal business operations is not growing as much as the sales. See's candies have not changed since 1972, so the equiptment required to make the same candy in the same box, ect. is minimal. Alice, I would be interested in looking at the balance sheet the year prior to the Blue Chip purchase. Do you have a copy of that?
POSTED: Sat, 02/06/2010 - 12:12 — aliceschroeder
Hi Nick, Let me weigh in a bit more. So as to your question on capex, See's chose essentially not to expand except for a brief foray into Japan that did not work out well. The capex looks reasonable to me to double sales. On the purchase price, the $25M was net of $10M cash; BRK bought 67% of See's for $35M. Invested capital I believe is the See family's original investment i.e., retained earnings at the date of purchase (excluding goodwill - the difference between that and the $25M). I have a big file cabinet of stuff on See's that probably includes a balance sheet. The materials in these files are complex, sophisticated, and could easily be misused (aha! on page 270 I found the "secret sauce" to how Warren Buffett REALLY invests! when there is no such thing). This is the sort of material I'm trying to figure out how to handle. In an investing book, you would only get 1/1000th of it. In a business school type case study, you would only get 1/500th of it. Yet if more is ever to be made useful to mankind it has to be filtered and vetted. Where can See's go now? In the 1970s it could not raise prices above the rate of inflation because of price controls and because prices tended to lag cost increases. The latter will probably be true in any future inflation scenario. BUT
See's could increase prices on a lagging basis and eventually they caught up. More important it did not require a lot of capex. Where you get killed on inflation is if you are having to make continual capex with customer pricing that can't reflect your costs. The epitome of a bad business in the 1970s was Berkshire the textile mill, where worn-out equipment needed to be replaced and yet these costs could not be possibly passed through to customers. This is one reason why Warren and Charlie harp constantly on the mistake of thinking only in terms of EBITDA and ignoring depreciation as a real cost.
POSTED: Thu, 02/04/2010 - 13:22 — aliceschroeder
Nick, this is great. It would be helpful if some people would review/comment on it. Anyone
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