Fellow GuruFocus contributor “Snowballbuilder” recently pointed me to a June 2017 speech by Mohnish Pabrai (Trades, Portfolio) at UC Irvine. I greatly enjoyed the talk and conclulded it would probably be worthwhile to share my notes.
The presentation reviewed some of the key investments Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) made in the 1960s and 1970s, starting with Blue Chip Stamps, as well as the substantial returns realized out of these investments over the ensuing five decades.
Our story begins with S&H Green Stamps, which Pabrai describes as “a kickback mechanism to get loyalty into particular merchants.” Customers received stamps for shopping and could redeem them for a variety of items (like appliances). S&H operated under the model where only a single merchant in a given category (like a drugstore) in a geographic region would be able to issue their stamps.
The stores that did not make it into this exclusive club decided to strike out on their own. In California, nine grocers banded together to start a new competitor: Blue Chip Stamps. Unlike S&H, any merchant could offer Blue Chip Stamps. Naturally, the merchants that issued Blue Chip Stamps wanted in on the profit stream. After a legal tussle, the founders of Blue Chip were forced to offer these merchants an ownership stake in the company (based on their stamp volume in the past year). This led to Blue Chip shares becoming publicly traded.
Rick Guerin, an early partner of Buffett and Munger's, realized Blue Chip shares were quite attractive (at this time, the market cap was approximately $40 million). It is worth noting Blue Chip Stamps was already in decline by the late 1960s. From 1970 to 1980, revenues would decline by more than 85%.
But the company also had roughly $90 million in float in 1970 – or what Pabrai calls “OPM” (other people’s money). The three men realized a certain percentage of the stamps given to customers would never be redeemed: many were lost, stuffed in the back of a kitchen drawer and forgotten about or thrown away. The “permanent float” from these unredeemed obligations was akin to free money. Despite the significant drop-off in revenues mentioned above, float only declined by around 30% (cumulatively) from 1970 to 1980. Pabrai estimates the “permanent float” at Blue Chip was somewhere around $60 million.
But the float was of limited value in the wrong hands. Buffett, Guerin and Munger thought it was being mismanaged. One way to effect change was to effectively take control of the company: between 1967 and 1970, they invested $24 million in Blue Chip – good for 60% ownership (at Munger’s firm, Wheeler, Munger & Co., this amounted to 61% of its assets). Eventually, the three investors joined the board of directors; they took control of the investment committee as well.
Now they had roughly $60 million to work with. In 1972, they took $25 million and bought 99% of See’s Candies. In 1973, they took another $25 million and bought 80% of Wesco Financial. Finally, in 1977, they took another $35.5 million and bought the Buffalo Evening News (with roughly 70% of the purchase price funded with the retained earnings from See’s Candies).
These investments worked out quite well. See’s generated nearly $30 million in after-tax profits from 1975 to 1980. At the Buffalo News, there were problems in the early years. But after their direct competitor went out of business, the Buffalo News earned $19 million (pre-tax) in 1982.
As Pabrai notes, they effectively bought these businesses with their $24 million investment. In 1983, the businesses were merged into Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial). After 50 years, the initial investment in Blue Chip was worth $60 billion in Berkshire shares - all from a starting investment in a business where revenues declined by nearly 85% over 10 years.
It was not always a smooth ride: from 1972 to 1974, Blue Chip’s market fell by two-thirds. For Wheeler, Munger & Co., this caused the fund to fall by roughly 50%. When Munger talks about reacting to significant price declines with equanimity, he is talking from personal experience.
In closing, here is what Pabrai views as the key takeaway from these investments:
“From the late 60s to the late 80s, for the most part with these different investments, they made five decisions. There were five meaningful decisions. So approximately a decision every four or five years… Few bets, big bets and very infrequent bets.”
Disclosure: Long BRK.B