If there is one business in the Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) stable that has attracted more criticism than any other, it is Clayton Homes. Over the past couple of decades since the business was acquired in 2003, it has attracted criticism for poor build quality and predatory lending practices. It has been accused of taking advantage of low-income consumers, who have no choice but to acquire their homes on finance at relatively high interest rates compared to 30-year mortgages.
I am not here to comment on these accusations and criticisms. I think every business has its weaknesses, and consumers should hold companies to account. Customer service does matter, and the fact that Clayton continues to grow suggests to me that some of the accusations leveled at the business may not be widespread nor terminal. From a purely business standpoint, even if they are true, the company is still making money.
Moving these issues aside, what I am interested in is why Warren Buffett (Trades, Portfolio) decided to acquire the business for his conglomerate in the first place.
Building an edge
Clayton is not a typical Buffett-style investment. The building industry can be highly cyclical, and profit margins are relatively unpredictable. Homebuilders also tend to lack moats. Anyone with enough money can decide to build properties, and anyone with enough influence can stop the building of properties.
What's more, homebuilding is a politically charged industry. Not that homebuilders are necessarily involved in politics, per say, but the state of housing in a country can profoundly affect political opinions. Housing quality and affordability is in constant conflict with landlords' push to buy up more homes so that they can further increase prices and reap a profit. For a lot of people, buying a house is the biggest financial decision they will ever make. If a homebuilding company is found to be taking advantage of these consumers with illicit businsess or construction practices, the political and regulatory ramifications can be significant.
Talking about the deal in 2003 at the Berkshire annual meeting, Buffett said that he'd decided to make an offer for the company after reading its founder's autobiography:
"And then I called Kevin Clayton, Jim Clayton's son, and Kevin is the CEO of the company. And I told him how I'd enjoyed his dad's book. And I said we still had a little money left in Omaha — (laughter) — and, if they ever decided to do anything, you know, we would be interested. And I suggested at what price we might be interested in. A phone call or two later, a couple of phone calls, we made a deal."
In typical Buffett style, he'd not been to see the business or its operations. However, he did know something about the industry, and he knew how having a deep-pocketed backer like Berkshire could be an advantage.
The competitive edge
Buffett noted that a lot of manufactured homes companies had got into trouble when the housing market slowed and they couldn't offload their customer receivables. That caused financial stress across the industry and with consumers, he noted. With a financial backer like Berkshire, Clayton did not have to worry about these issues, he argued.
Even though the company was in a class of its own, it still struggled when the rest of the industry struggled. It could not live up to its full potential because it was tied to other industry operators and the sector's cyclical nature. With Berkshire's vast capital resources behind the enterprise, it would be able to better navigate future challenges, the billionaire argued.
This is a great example of how Berkshire has developed its own competitive advantage. By developing a robust financial platform, the corporation does not have to rely on third-party financing. Neither do its subsidiaries. This means they can concentrate on developing their competitive advantages without having to worry about the influence of others.
This is a competitive advantage few other businesses exhibit, and it is one Berkshire has built through decades of conservative investing and balance sheet management. Clayton is a deal that might not have worked for many other firms, but Berkshire has been able to shape the company into its own image.
