When Warren Buffett (Trades, Portfolio) found a company that he liked, because it possessed valuable assets and had a quality business, and when the price revealed a considerable discount and he had the liquidity to buy a meaningful position, he was ready to go all in. These were his punch-card investments: "Controls."
“'Controls' - These are rarities, but when they occur, they are likely to be of significant size. Unless we start off with the purchase of a sizable block or stock, controls develop from the general category. They result from situations where a cheap security does nothing price-wise for such an extended period of time that we are able to buy a significant percentage of the company's stock. At that point we are probably in a position to assume some degree of, or perhaps complete, control of the company's activities; whether we become active or remain relatively passive at this point depends upon our assessment of the company’s future and the management's capabilities."
This description, from the Jan. 18, 1964 Partnership letter, is very much aligned with Berkshire Hathaway’s (BRK.A, Financial) (BRK.B, Financial) strategy for businesses takeovers: within circle of competence, with good prospects and excellent management.
With the control strategy, Buffett managed to speed up value realization on the investment he was making in very large positions.
At the time, the market capitalization of the target companies would have to be low, so that positions could grow to a controlling stake.
Small-cap activism today
Micro and small-cap stocks, as an ignored category as they are, tend to be a more inefficient market segment. This hapenned in the Ts but also happens today. There are fewer analysts and investors researching small stocks, fewer dollars able to be invested, less Wall Street research coverage and illiquidity causes more micro- and small-cap stocks to be more mispriced versus larger-cap stocks.
If we look into the universe of companies that were the target of activists in 2017, we can see the majority of companies are in the nano, micro and small segment. Although large and mid-cap companies represent a considerable percentage of deals in the U.S. and Europe, the smaller segments continue to present plenty of opportunities for activists investors. And empirical studies confirm that small-cap activism or small-cap private equity provide better returns to investors than larger-cap endeavors.
Examples
Two of the most well-known activist investments from the Buffett Partnership era were Sanborn Maps and Dempster Mill.
Sanborn Maps, which made maps for the fire insurance industry (close to a monopoly business at the time), held a large portfolio of investments worth more than the share price. Buffett took over the company in a proxy fight, swapping Sanborn shares for the investment portfolio.
Dempster Mill, which made windmills, sold at a fraction of book value. Buffett took over the company via a proxy fight. This was not a high-quality business, but had valuable, tradeable assets, like its inventory. Buffett had to nominate a CEO for the company (a rarity) who concentrated on realizing the inventory’s market value. He made almost three times his investment.
Conclusion
Controls, when combined with the Generals and the Workouts, managed to produce different kinds of ideas, with different time horizons and different correlations with the markets. A wonderfull portfolio structure that should be used more often.
For more information, please read the Partnership letters!
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