Today, CNBC had Warren Buffett of Berkshire Hathaway (NYSE:BRK-A / BRK-B) on for a few hours, answering questions on everything from Coca-Cola to Greece’s financial crisis. There were some interesting exchanges and you can pore over the entire transcript at CNBC, but I would like to highlight a bit of it.
On Coca-Cola
I’ve blogged in the past on Coca-Cola’s (NYSE:KO) decision to purchase its bottling unit Coca-Cola Enterprises (NYSE:CCE). To me the strategic rationale was that Coke wanted to get control over distribution so that they could more agilely deploy new products to the market place. Buffett seems to agree here, and does note that the bottling business is in general worse than the concentrate business. I thought it was interesting that Indra Nooyi was brought onto the call, she provided some good insight on why Pepsi did their deal:
QUICK: Well, we do want to ask you about another one of your companies, Warren. Coca-Cola came out and surprised a lot of people with this news that it’s going to be buying the North American bottling operations. This is different than what they’d been talking about in the past.
BUFFETT: Right.
QUICK: And it follows what Pepsi did about a year ago; in fact, follows very closely what they’d been doing. What do you think about this deal?
BUFFETT: Well, I think on balance I like it. I mean, Muhtar Kent has done a fabulous job with Coke, and there’s a lot of execution problems in doing anything like that. Pepsi will have them and we’ll have them at Coke. But with Muhtar, I feel confident in the fact that it will get carried off right now. The bottling business is very different than what they call the concentrate business, which is making the Cola-Cola concentrate, gets turned into syrup, gets turned into Cola-Cola. The bottling business is very capital intensive and has low margins. The concentrate business is not capital intensive and has very wide margins. Literally, Coca-Cola with 5 billion of capital could make 8 or 9 billion pre-tax just from the concentrate business. But the bottling business is an entirely different business. So long-term, I like being in the concentrate business much more than the bottling business. But the bottling business, Coca-Cola has what they call a fountain division that sells direct. They have the bottlers. Any time they get a new product there’s a question of how it comes under this contract that originally goes back to 1899. It needed rationalization and this move is a big, big step toward rationalizing it, make it so it’s more–it’s more friendly to the big box retailers of Walmart or some–Costco or somebody like that. And it–but it will–there will be some real execution time involved in it and over time, you would hope that Coca-Cola would have less money involved in the bottling business, because it’s a less attractive business.
QUICK: Obviously, you’re a long-term shareholder, but when you say that there are very likely to be come execution steps, some difficulties along the way, maybe some stumbles, how much patience do you have as an investor? You talking about year or two?
BUFFETT: I–well, no, I just say that–whenever you’re doing anything this big you better–you have to have a lot of confidence in the management and I have confidence in Muhtar to carry this off…
KERNEN: All right. I kind of understand a lot of that, how, you know, you don’t want the two companies competing. But there was a rationale at one point to do it that way, and Mr. Buffett had pointed out the different–you know, it’s a low margin bottling business vs. a high margin syrup business. What exactly changed? Why–you are going to deploy more capital–or you have deployed more to own the bottlers. Why not leave them owned by someone else with a lower margin business? What’s changed? You say something’s changed to make it make more sense.
NOOYI: Yeah, that’s a great question, Joe. So 10, 20 years ago, the market–the beverage market in North America was essentially carbonated soft drinks, and there were a few megabrands that controlled the business, and the market was growing 6, 7 percent in terms of volume. Fast-forward to today. Carbonated soft drinks are now less than 50 percent of the total market, and that’s a very highly profitable part of the whole market. And the overall liquid refreshment beverage business is growing in volume about minus 2 percent and in value about 1 percent positive. So this is not a huge growth business. It’s a big market, it’s about $100 billion category. But it’s not growing in leaps and bounds like it used to a couple of decades ago. When you have one or two publicly listed companies positioned as growth companies trying to fight over a profit pool, that’s not a very good situation, especially if the profit pool is not growing enough to feed the appetites of two or three publicly listed companies. So the only way to compete and stay ahead of competition in this environment is to bring the profit pools back together and figure out how to operate more efficiently.
KERNEN: Warren, you were going to talk about the Coke strategy abroad, right, with their–I guess they’re not buying in those assets, right?
BUFFETT: Well, the–no. The franchise operation works extremely well around the–around the world. And, I mean, you take somebody like Coca-Cola FEMSA in Mexico, I mean, the per capitas there are incredible. I think they’re up close to 500 or thereabouts. And so the franchise system in just country after country, 200 countries around the world, has developed the market in a way that’s been very good for the bottlers and very good for Coca-Cola. And actually, in many countries the bottling operation has been considerably more profitable than it has been in the United States, partly because of the growth aspect that Indra mentioned. So it’s not a system that needs fixing at all around the world. There can be an occasional spot where the bottler isn’t doing the job and the Coca-Cola company will buy it and then–and put it back on its feet and then resell it to somebody in that country. But having local bottlers really works pretty darn well around the globe.
QUINTANILLA: Warren, some people…
QUICK: Warren, there–right.
QUINTANILLA: Some people have been saying that you–people historically bought Coke as an international growth play. Now all the sudden North America’s an awfully bigger piece of the pie. Does it dilute some of the reasons that people got into the stock in the first place?
BUFFETT: No. In terms of where the money is being made, you know, Coke makes, I don’t know exact percentage, but 80 percent of its money around the globe, and it’s growing and just in country after country. Coke has been gaining share really quarter after quarter around the world. And add–none of that volume’s going away, or none of that growth is going away because they’re integrating the bottling system in the United States. It does–it means a concentration more of assets in the United States, but it does not take away from the profit growth that is occurring around the–around the world. I think Coke earned like 9 billion pretax last year, and I think well over 7 billion of that was from outside of North America. And that 7 billion is going to have the same kind of growth rate, which has been substantial, whether or not–you know, wherever the bottling system in the United States is owned.
On Currencies
This is a pretty interesting question because in the past, Berkshire has done some currency trading, particularly with the Brazilian Real.
QUICK: You said, though, that a bet either for or against a currency is a bet for or against that government. If you were worried, and let’s say you’re worry level and let’s just measure a couple of things against each other, euro vs. the dollar, which worries you more?
BUFFETT: That’s a tough–that’s a tough call. I mean, both the euro, European Union countries and the United States are running very large deficits. I mean, they–both of those currencies in terms of purchasing power will decline in value over time in my judgment.
QUICK: British pound vs. the dollar. Is that the same story?
BUFFETT: Same way. I–there are all–they are all following policies that will cause their currencies to lose value. Which one will lose more value than the other, it’s so hard to tell.
QUICK: Yen vs. the dollar? Same story?
BUFFETT: The yen is–Japan is the great mystery of all time. I mean, in terms of the policies they follow, what happens, you know, low interest rates, huge deficits and all of that sort of thing. That one is a mystery I don’t even try to think about solving.
Private Equity:
Private equity gets a lot of criticism for acquiring companies and then piling them up with debt to juice their returns. Usually, the companies that can survive that kind of treatment end up performing quite well when IPOed, but many fail in the process. I am expecting that if we see a big bankruptcy wave, these companies will do pretty well. A lot are great businesses that are just overburdened with debt. I would imagine distressed debt guys like Baupost, Third Avenue, and others will make a killing on these plays. After all, Buffett himself said that he would love to buy TXU at bargain prices if it went into bankruptcy.
KERNEN: One of the reasons I brought up that TXU situation was because in the piece it said there’s a lot of really great companies that–in the private equity universe that have really lousy balance sheets based on the bubble that was around in 2007. So there’s going to be some problems. But is that somewhere where you can look to try to help work out some of the situations? There must be some real gems in there that just, for whatever reason, I look at the fees that the PE firms take, and I look at the dividends that they pay out, and it used to work, but now they actually got to manage some of these things. I mean, couldn’t you find some nuggets in there?
BUFFETT: It’s possible, Joe, but on balance, if you notice, the private equity firms are very reluctant, it seems to me, to come forth with anything that involves big losses. I mean, they–what they usually try and do is get bond holders to make concessions or something. But I’ve not seen them wanting to sell the businesses at large losses. Now, you know, if they go into bankruptcy, then you buy them for the bankruptcy process. I mean, if the old TXU gets to 2,014 and they can’t meet the maturities that they have at that time or they haven’t done it earlier, you know, we may buy–we might think about buying the whole place, you know. But we’ll–we might buy it cheaper after a bond default than we would buy it from a private equity place.
KERNEN: Well, you know how to run utilities, and you might get the chance with, I forget how much is coming due.
BUFFETT: We might get the chance.
KERNEN: Yeah, 20 billion or something.
BUFFETT: Yeah, we might get the chance.
Health Insurance:
Unfortunately, I don’t see his ideas here happening. Although it is interesting to hear about how much Buffett and Munger admire Gawande, whose works are popular among value investors.
KERNEN: But you’re saying start over and do it on a bar–bipartisan basis is what you just said.
BUFFETT: I would–I would call in the smartest people in the health care field. I mean, you know, people like the fellow out of Kaiser Permanente or Mayos or this fellow the…
KERNEN: Mayo, Cleveland Clinic, Safeway…
BUFFETT: Or Gawande, the doctor–yeah, yeah. Cosgrove at…
KERNEN: Whole Foods.
BUFFETT: …Cleveland Clinic and…
KERNEN: There’s a bunch of smart–there’s a bunch of people that have some great private market–or free market ideas. And to do it…
BUFFETT: I’d lock them–I’d lock them in a room, Joe, and I’d tell them, you know, come out when you figure out how–some way to get this going in the other direction toward 13 or 14 percent. And it can be done. It can be done…
QUICK: Right. Warren, very quickly, so a viewer wrote in, Greg Robinson from Portland, Oregon, on this subject, said, “Wouldn’t a better fix for health care be a system similar to auto insurance? Could you give a specific–a simple scenario of how Geico would insure a large portion–population of people, perhaps having them pay a portion of the bill themselves so they will police the doctors? I’m a big believer in catastrophic care, but paying for your own maintenance.” Does that sound like a feasible idea?
BUFFETT: Yeah, it probably does. But the truth is, I would get people that know a lot more about it than I do. And, I mean, it–if you get the fellow that’s written on health care recently in the New Yorker, Gawande. I mean, he had–he had an article last summer that was absolutely magnificent (THE COST CONUNDRUM – Atul Gawande). My partner Charlie Munger sat down and wrote out a check for $20,000 to him and he’s never met him, never had any correspondence with it, he just mailed it to the New Yorker and he said, `This article is so useful socially.’ He says, `Just give this as a gift to the–to Dr. Gawande.’ It compared medical costs in McAllen, Texas, to El Paso, and it just showed how, with no better results, that in McAllen they were, you know, they were spending close to twice as much per person. And you have these enormous variances around the country. And, you know, if you had some really smart people running it that knew a lot about medicine, they’re going to–they could do a lot about it.
Using Stock as Currency:
I think this is a case where over simplification causes people to get the wrong idea. I believe that while Buffett was pretty opposed to issuing stock for deals, he can act rationally and do it when the terms make sense. In Kraft’s case, making sure you are not using stock that is greatly undervalued to purchase something that is less than a bargain– especially when you have to sell off key pieces of your business at ultra low prices, like the pizza business.
KERNEN: Welcome back to SQUAWK BOX. Still to come in the next hour, PepsiCo CEO Indra Nooyi, that’s coming up at 8:10. Let’s get back to Omaha, that’s where we find our very own Becky Quick with Warren Buffett. Beck, I was thinking about Matt Rose and Burlington and using stock and Warren with Kraft and Cadbury and I love to get him talking about that, to try to figure out why stock was a good idea for Burlington, that it wasn’t a good idea for Kraft and I love it when you say you don’t like that deal, even though you love management. Go into that again. What was the difference between Kraft using stock and you using stock, other than maybe valuation on the company being acquired?
BUFFETT: Yeah, well, we hate using stock. No question about it, Joe. And because we already owned some Burlington beforehand, it turned it we had to use about 30 percent stock and as I put in the annual report, even though the Burlington holders were getting $100 a share, we felt it cost us more than that because we thought our stock at the time we made the deal was somewhat underpriced. We’d have done all cash if I’d felt comfortable in terms of our balance sheet, using all cash. But I never want to put us in a position where we’ve–we’re stretched in the least. So to make the deal, I had to do it. And I came to the conclusion that using 30 percent stock, which was about 6 percent of all the shares we had outstanding, still left us with a deal that made sense. But if it had to have been all stock or 50 percent stock, we couldn’t have done it and if I’d had enough cash around to do it, so I could’ve done it all cash, I would’ve liked it better.
KERNEN: How about Kraft? You warming up to that finally? Or are you still–you still don’t like it. You don’t get to vote, I guess, do you?
BUFFETT: No, we didn’t get to vote. And it wasn’t just–it wasn’t just the stock that was being used, although that was a terrible currency to use, just as our own stock is a terrible currency to use. But it wasn’t just the stock, it was the price being paid and it was the fact that the pizza business was sold in a very tax inefficient manner to partly fund the purchase. And it just–in the end, I felt poor after the deal was made. But I, you know, I wish Irene the best on executing well on it and I hope it works out. We’ll be a lot better off financially if it does, but I wouldn’t have done it.
QUICK: Warren, that question that Joe raised is one that we got from a lot of viewers, too. In fact, Todd in Parker, Colorado, wrote in and said, “In your annual report, you say that you’ll consider issuing stock when we receive as much in intrinsic business value as we give up. When exchanging Berkshire shares for Burlington Northern, did Berkshire shareholders receive less, equal or more in intrinsic value?”
BUFFETT: Well, we felt, Charlie and I, felt that we received as much or a tiny bit more in intrinsic value as we gave up. But we factored into that some other things I mentioned in the annual report. Namely, that putting $22 billion of cash to work made good sense for us in this business and that the opportunities over the next 40 or 50 years to keep putting more and more cash at reasonable returns in, just like we do in our utility business, also was an attractive opportunity. We’re going to generate lots of cash over the years and we don’t always have great places to put that. This offers one vehicle where we can put it at decent rates of return. Not great rates of return, but decent rates of return.
Animal Spirits and Acquisitions:
QUINTANILLA: Warren, you go–we know this is–you’re passionate about this from the letter, you go into a long hypothetical about company A buying company B whose stock is undervalued. You say that CEOs long on confidence and short on smarts, wants to buy company B for the prestige and maybe the compensation. Is that a–is that a veiled slight at Rosenfeld?
BUFFETT: No, it’s 50 years of being in board rooms and just seeing what happens. And you know, Keynes talked about–probably the best–the best chapters written on investing were chapters eight and 20 in “The Intelligent Investor” for individual investing. The best chapter ever written in sort of describing how the world works in markets is chapter 12 of “The General Theory” written by Keynes and in it he talks about animal spirits and what causes people to do the deals and all of that. It’s a marvelous chapter. And I’m not sure that he had Kraft in mind, but he had a lot of the companies that I’ve experienced over the years in mind. It’s a very normal thing. I mean, you know, everything looks–everything looks rosy, you know, when you first are looking at a deal. You don’t see the downsides. You don’t see the execution problems, you don’t see the people who are going to leave. You don’t see–you don’t see all kinds of things. And I’m guilty of that, too, incidentally. I’ve made some dumb deals in my life and I’ll make some more dumb deals and animal spirits will enter into those dumb deals. I guarantee you that. I just try to keep them under control and if I don’t, I count on Charlie to keep me under control.
Debt Problems in the US
QUICK: All right. Let’s get to some more questions that came in from shareholders. There’s one guy’s–number 184 for the control room. This came from Scott Deller in New York. He says, “How much debt would sink the United States? If the answer’s unknown, isn’t it risky to race at top speed toward that line?” There were a lot of questions like this that came in.
BUFFETT: Yeah. Well, we are doing things that are causing the debt to rise at a very rapid rate, I mean, when you’re running, you know, a fiscal deficit like we are. As long as you issue debt in your own currency, debt doesn’t sink you. Now it–what it does is it destroys the value of money over time. So you can make–you can make it so that the person who lent you money, 10 years from now or 20 years from now gets back dollars that aren’t worth very much. But you can–as long as you’ve got a printing press, you can–you can issue any amount of debt in your own currency. It’s when the world says to you, `We don’t want debt in your currency any more, issue it in something that’s more solid,’ and that’s what they do–they’ve done to various developing countries. That’s what they used to do to South American countries and so on. And then the music stops. The IMF comes in and whatever they take. We have this great reputation for 200 years, and people will accept dollars for a long time. But if the printing presses would run at a sufficient rate, people after a while would say, `Wait a second. We’re going to get stuck.’ You know, it’s interesting, when we talk about what’s happened in the last year or two how the taxpayers paid for this or the taxpayers paid for that, taxpayer hasn’t paid for any of it. We haven’t raised taxes on anybody. What we’ve done is the lenders have paid for it. So it’s…
QUICK: Well don’t those–don’t those costs eventually get passed onto the consumer too, though?
BUFFETT: Not–the costs really get passed on–generally speaking, they get passed onto the saver. They just–inflation steals from savers, and inflation is the logical consequences of printing too much money.
QUICK: And seniors who are living on fixed incomes.
BUFFETT: Anybody that’s living on any kind of fixed income. I mean, you know…
QUICK: And small businesses that are maybe hoping to get a loan from a bank that can’t give it at this point.
BUFFETT: …anybody that has their money–anybody that has their money in a money market fund or anything like that, you know, if we issue enough–if we keep printing enough–if we keep a large enough fiscal deficits we will eventually print a lot of money and money will be worthless. And incidentally, if the United States runs up trillions and trillions and trillions of debt to the rest of the world, you know, I will guarantee you that the politicians of 10 or 20 years ago will not want to pay that back in hard money. It just doesn’t–it doesn’t make any sense.
The Financial Crisis in Greece
Buffett’s advocates swift action in dealing with the problem in Greece. I think that this is pretty appropriate. What we saw in the financial crisis here was that companies which did not deal with their problems fast enough wound up dead. When you are in a situation where you depend on borrowed money, you don’t have the luxury to sit and twiddle your thumbs. You’ve got to act before your credit lines dry up.
QUICK: When you look at the situation in Greece right now and what’s happening with the trouble they’ve gotten into, do you believe that contagion spreads to not only other EU nations, but potentially other states here in the United States? Is that a huge worry for you?
BUFFETT: There’s a huge incentive for the EU to handle something like Greece and, of course, that’s what you’re seeing now. I mean, it isn’t–it isn’t because the rest of–the other 15 countries in the EU have suddenly developed this great affinity for Greeks. They just–they know the consequences of, you know, if A is going to lead to B and you can’t stand B, solve A. And that is essentially the situation. That’s what we went through a year and a half ago, you know, after–when we stepped in and guaranteed money market funds and commercial paper and all of those things. We saw a run on the country developing, and, believe me, it was developing. And no one has to lend money to country A or country B or country C. And if they lose money with country A they’re going to get more worried about country B and country C just like the same experience we had with financial institutions in the fall of 2008. The time to stop runs is early on.
QUICK: But do you think that this is something that could happen here in the United States, if you look at California or New York, if you start looking at some of the states that have very large financial problems?
BUFFETT: Yeah, and they can’t print money.
QUICK: They can’t.
BUFFETT: No, no. What they can do is one of three things. They can cut expenses, they can raise income, or they can go to Washington eventually.
QUICK: And you think Washington would cover all of those problems?
BUFFETT: It would be very tough if you’re in Congress and they say, `Well, you bailed out General Motors, and you did this and that. And are you going to say, “People in the largest state in the union or whatever it is, that we’re not going to take care of you? I mean, the political problem would be huge. But there’s no question that states and municipalities the fiscal–the financial situation for them has deteriorated dramatically. We did not write any municipal insurance to speak of in 2009. The risk got higher and the premiums got lower and that just–it made it a dumb sort of thing to do in our view.
QUICK: Tying this back to Europe and if Europe and Germany do step in and provide for Greece, as it looks like they very–may very well do at this point…
BUFFETT: Almost have to, yeah.
QUICK: …does that make you think that all these hedge funds that are betting against the Euro are on the wrong side of this fence?
BUFFETT: Well, I don’t know what happens to the euro exactly, but I mean, there are–I’m sure there are hedge funds that are betting against the euro that are hoping that for one reason the Germans gets mad at the Greeks, or whatever it may be, you know, they are–let’s say there are two banks in town. You own a bank and I own a bank. Now, if I want to put you out of business what do I do? I go out and hire 50 bums on the street and get them to stand in line in front of your bank. You know, that’s all I have to do. You know, and those 50 will become 100. And after a while, I can let the 50 bums and go, and it will create its own dynamic. You do not want that to happen with countries. So you better stop it, you know, right off the bat. And everybody realizes that. The only question is whether it gets it gets bogged down in something or other.