In 2014, while he was taking part in an interview on CNBC, Warren Buffett (Trades, Portfolio) announced that Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) would be acquiring Van Tuyl Group, the nation’s largest privately held car dealership chain.
The acquisition illustrates why the conglomerate has become such a great business over the past six decades, and it also shows why it will likely continue to be so successful for many decades to come.
Van Tuyl was founded in the mid-1950s by the Van Tuyl family. It grew through acquisitions and, at the time of the Berkshire buyout, was the fifth largest auto dealer in the U.S., with 78 independently operated locations in 10 states and $9 billion in revenue.
Despite its size, the company was still relatively small in the grander scheme of things. The car dealership market is highly fragmented, with many small single-operator locations.
This is not a business that lends itself to rapid growth. Dealers need to know their locations and their suppliers. Just because a car sells for $10,000 on one side of the country does not mean it will sell for $10,000 on the other side of the country.
What's more, this business requires a lot of up-front capital. No customer is going to walk into an automotive dealership if there is nothing in the window. Dealers have to acquire huge inventory in order to give customers the most choices, but this can cost millions of dollars.
This is a huge barrier to entry for the industry. Banks are likely to be reluctant to lend this sort of money, especially as the used car market can be so volatile. Individuals might be willing to put up the money themselves, but this is not going to be a quick process.
These are the reasons why the combination of Berkshire and Van Tuyl, which is now named Berkshire Hathaway Automotive, made so much sense in the first place. With its huge capital resources and fortress-like balance sheet, Berkshire can provide the capital the group needs to expand organically and through acquisitions.
Indeed, Buffett said soon after the agreement was announced, "We will hear, I predict, from hundreds of dealerships in the next year."
Interestingly, according to the corporation's second quarter SEC results filing, it has not grown as fast as initially expected. Berkshire Hathaway Automotive owned just 80 dealerships at the end of June, an increase of two since 2014.
Still, I think this deal is a great case study of something I have discussed several times in the past, Berkshire's advantage of size. The conglomerate is so big and liquid that it can take on business risks that other corporations can not. The most famous example is the insurance market, where the group is able to underwrite multi-billion-dollar risks that competitors are unwilling or unable to take on. It has taken on some risks that no other insurer in the world would be able to quote for and earned huge profits as a result because it can charge whatever it wants.
By having such a large and liquid balance sheet and a presence in so many different sectors, the company has a competitive advantage in terms of size and knowledge. For example, Berkshire Hathaway Automotive could provide information on automotive pricing for GEICO to help the insurance group accurately price its insurance policies. Meanwhile, railroad BNSF gives Buffett and the other executives at the group an unrivaled view into the state of the U.S. economy.
These competitive advantages are not going to go away any time soon. They may disappear if the group decides to break itself apart after Buffett is no longer at the help, although that is going to be many years in the making.
I do not think investors should underestimate the power of size and scale in the Berkshire story, even if the conglomerate structure has fallen out of favor with investors who are looking for simple high-growth stories.
