Berkshire Hathaway (BRK.A)(BRK.B) was originally a textile business that Warren Buffett bought because it was trading below working capital, with the intention of selling it later. (Interested readers can read about it being described as the worst investment that Buffett has ever made in his investing career.) And from the time that he bought the controlling stake in Berkshire Hathaway, he had to stick to the bad textile business.
Back In 1967, cash was generated by the textile operation and luckily Buffett used those funds to make the entry into the insurance field by purchasing National Indemnity Company. Some of the money, as he discussed, came from earnings and some from reduced investment in textile inventories, receivables and fixed assets. He thought it was a very wise move because the textile business never earns a good amount of money, not even in the cyclical upturns. And from that time on, Buffett had diversified away from the textile business, so the effect of the poor performance on the overall business results became less and less.
He had still kept the textile business for 21 years for four main reasons: First is that textile businesses were important employers in their communities. Second, the management had been straightforward in reporting problems and energetic in attacking them. The third reason is that the labor has been cooperative and understanding in facing our common problems. Last but not least, it is because the business should average modest cash return relative to investment. All the reasons above I personally think show a very human side of Warren Buffett. The only economic reason is the business would earn "modest cash returns relative to investment." The human side of keeping jobs for the communities led him to support the textile business even though there were more attractive alternative uses of capital.
However, in 1985, he admitted that he was wrong about the fourth reason. He would prefer to sell the business rather than liquidate it, even if that would result in lower proceeds for Berkshire. But he couldn’t find an interested party to sell it to. The poor performance from the time of the 1960s – 70s and onward was because of the competition from foreign countries whose workers were paid very little compared to U.S. wages.
With Berkshire, compared to the American industry as a whole, average wages were lower, and it had been the case in the textile business. Berkshire’s union was sensitive to the company’s condition and they didn’t ask for rising wages. In contrast, they helped the company as hard as Berkshire did to keep the competitive cost. Buffett had joked that Berkshire would have been better off financially if the union behaved unreasonably some years ago. Then the close down might have happened sooner, avoiding huge future losses.
In addition, there were several proposals of employing capital expenditures for new machines and facilities, and it gave the promise of benefits which were greater than comparable expenditure in Berkshire’s highly profitable businesses such as candy and newspaper. But he said the promise of the textile business was illusory.
“Many of our competitors, both domestic and foreign, were stepping up to the same kind of expenditures and, once enough companies did so, their reduced costs became the baseline for reduced prices industry wide. Viewed individually, each company’s capital investment decision appeared cost-effective and rational; viewed collectively, the decisions neutralized each other and were irrational. After each round of investment, all the players had more money in the game and returns remained anemic.”
Then Buffett gave the example of a big player in the textile business and its operating performance over time. The company was named Burlington Industries. In 1964, sales were $1.2 billion, and it had strengths in both distribution and production, and the stock sold at $60 at the end of 1964. It made the decision to stick with the textile business due to the favorable results over decades. In 1985, at the time of this writing, it had sales of $2.8 billion.
For 21 years from 1964-1985, Burlington Industries made total capex of $3 billion, around more than $200 a share on that $60 stock. The large capex seemed to be dedicated to cost improvement and expansion. Nevertheless, the result was not very promising; Burlington lost sales volume in real dollars and had lower return on sales and equity. The stock on adjusted basis was a little over $60, nearly the same price in 1964. During those 21 years, the CPI had tripled. That means each share had only one-third the purchasing power it did back in 1964, a loss of two-thirds of the value.
The business experience from the textile business has taught Buffett that “Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.”
Back In 1967, cash was generated by the textile operation and luckily Buffett used those funds to make the entry into the insurance field by purchasing National Indemnity Company. Some of the money, as he discussed, came from earnings and some from reduced investment in textile inventories, receivables and fixed assets. He thought it was a very wise move because the textile business never earns a good amount of money, not even in the cyclical upturns. And from that time on, Buffett had diversified away from the textile business, so the effect of the poor performance on the overall business results became less and less.
He had still kept the textile business for 21 years for four main reasons: First is that textile businesses were important employers in their communities. Second, the management had been straightforward in reporting problems and energetic in attacking them. The third reason is that the labor has been cooperative and understanding in facing our common problems. Last but not least, it is because the business should average modest cash return relative to investment. All the reasons above I personally think show a very human side of Warren Buffett. The only economic reason is the business would earn "modest cash returns relative to investment." The human side of keeping jobs for the communities led him to support the textile business even though there were more attractive alternative uses of capital.
However, in 1985, he admitted that he was wrong about the fourth reason. He would prefer to sell the business rather than liquidate it, even if that would result in lower proceeds for Berkshire. But he couldn’t find an interested party to sell it to. The poor performance from the time of the 1960s – 70s and onward was because of the competition from foreign countries whose workers were paid very little compared to U.S. wages.
With Berkshire, compared to the American industry as a whole, average wages were lower, and it had been the case in the textile business. Berkshire’s union was sensitive to the company’s condition and they didn’t ask for rising wages. In contrast, they helped the company as hard as Berkshire did to keep the competitive cost. Buffett had joked that Berkshire would have been better off financially if the union behaved unreasonably some years ago. Then the close down might have happened sooner, avoiding huge future losses.
In addition, there were several proposals of employing capital expenditures for new machines and facilities, and it gave the promise of benefits which were greater than comparable expenditure in Berkshire’s highly profitable businesses such as candy and newspaper. But he said the promise of the textile business was illusory.
“Many of our competitors, both domestic and foreign, were stepping up to the same kind of expenditures and, once enough companies did so, their reduced costs became the baseline for reduced prices industry wide. Viewed individually, each company’s capital investment decision appeared cost-effective and rational; viewed collectively, the decisions neutralized each other and were irrational. After each round of investment, all the players had more money in the game and returns remained anemic.”
Then Buffett gave the example of a big player in the textile business and its operating performance over time. The company was named Burlington Industries. In 1964, sales were $1.2 billion, and it had strengths in both distribution and production, and the stock sold at $60 at the end of 1964. It made the decision to stick with the textile business due to the favorable results over decades. In 1985, at the time of this writing, it had sales of $2.8 billion.
For 21 years from 1964-1985, Burlington Industries made total capex of $3 billion, around more than $200 a share on that $60 stock. The large capex seemed to be dedicated to cost improvement and expansion. Nevertheless, the result was not very promising; Burlington lost sales volume in real dollars and had lower return on sales and equity. The stock on adjusted basis was a little over $60, nearly the same price in 1964. During those 21 years, the CPI had tripled. That means each share had only one-third the purchasing power it did back in 1964, a loss of two-thirds of the value.
The business experience from the textile business has taught Buffett that “Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.”
