This weekend, Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) will release its annual report for 2018 and, more importantly, Warren Buffett (Trades, Portfolio) will publish his annual letter to investors in Berkshire Hathaway.
Buffett's annual letter has become the most important event in the value investor's annual calendar. Investors look to the Oracle of Omaha's letter for his insights on the current market environment, as well as his views on the outlook for Berkshire Hathaway and any insights he may offer into the conglomerate's investment portfolio and potential deals he may be eyeing up.
It is this last appointment that investors will be most interested in hearing about this year. In his last annual letter to investors, Buffett made clear that he did not do any deals throughout 2017 because many of the opportunities considered were just too expensive.
Specifically, he wrote in his 2017 letter to investors:
"In our search for new stand-alone businesses, the key qualities we seek are durable competitive strengths; able and high-grade management; good returns on the net tangible assets required to operate the business; opportunities for internal growth at attractive returns; and, finally, a sensible purchase price.
That last requirement proved a barrier to virtually all deals we reviewed in 2017, as prices for decent, but far from spectacular, businesses hit an all-time high. Indeed, price seemed almost irrelevant to an army of optimistic purchasers."
The Oracle of Omaha went on to say that the availability of extraordinary cheap debt in 2017 fueled purchase activity by other companies, pushing deal prices to levels where Berkshire Hathaway could not compete. Buffett went on to conclude:
"Despite our recent drought of acquisitions, Charlie and I believe that from time to time Berkshire will have opportunities to make very large purchases. In the meantime, we will stick with our simple guideline: The less the prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own."
Considering that market valuations have fallen slightly over the past six months, it will be interesting to read Buffett's views on potential deals today.
A unique approach
When it comes to acquisitions, Berkshire Hathaway is unlike any other large business. When other companies consider large acquisitions, the board of directors usually considers carefully any opportunity before making an offer.
However, at Berkshire Hathaway, outside of Buffett, the other directors generally have little input in large deals.
According to Susan Decker, the former Yahoo chief financial officer who became a Berkshire director in 2007 (she's also on the board at Charlie Munger (Trades, Portfolio)'s favorite business Costco), the board is "not involved in the valuation decision for acquisitions." She made these comments as part of a panel discussion on Berkshire Hathaway at Stanford University's Rock Center for Corporate Governance.
Decker went on to say, "Warren will often discuss large deals with the board in advance, but usually at the conceptual level, rather than asking for approval of valuation and structuring ... It's the opposite with other boards I'm on, in which approval is required by the board for the funds used for large acquisitions and for structuring considerations of the deal."
When she approached Buffett to recommend that the board have more say in deals, mainly smaller deals, he replied: "You need to devise that for the next CEO."
On this topic, Buffett might provide his investors with some additional information on succession planning in his 2018 annual letter.
So far, Berkshire has not publicly published its succession plans, but it is clear that when Buffett eventually moves on, the company's process of doing deals will have to change.
Without the Oracle of Omaha overseeing things, it is likely the board will have more say over acquisitions. Only time will tell if this is going to be a good or a bad development.
Disclosure: The author owns shares in Berkshire Hathaway.
