After the Gillette turnaround, Buffett paid what Kilts considered the ultimate compliment by withdrawing entirely; he resigned from the board. “If you’ve got the right person running the business,” he said at the time, “you don’t need me.”
WHEN WARREN STANDS BACK
Few companies need Buffett more than Moody’s (MCO), the troubled credit-rating agency. Moody’s and its peers have been blamed as enablers of the financial crisis because they inflated the credit ratings of dubious mortgage-backed securities. In March 2009, Berkshire owned more than 20 percent of Moody’s. Why, several former ratings analysts ask, didn’t the investor light a fire under the board to tighten the company’s standards, or speak out? Surely he was as obliged to denounce flawed ratings that endangered the global financial system as he was to offer an opinion of how much Kraft paid for Cadbury.
A former Moody’s employee with intimate knowledge of the executive suite there describes Buffett as “not a very engaged investor.” (Like most Moody’s sources, he asked not to be identified in light of ongoing investigations into the company.) Another insider confirms that senior management of Moody’s, including CEO Raymond W. McDaniel Jr., “doesn’t have regular conversations with” Buffett nor does it “seek advice from him on corporate governance or business strategy.” Moody’s declined to comment.
Moody’s and Buffett had reason to keep their distance; it’s a conflict of interest for the agency to rate a major investor such as Berkshire. Analysts who review a company are supposed to be free of thoughts of what a downgrade might mean to their personal net worth. Moody’s discloses the Berkshire conflict in a Securities & Exchange Commission filing.
Even so, one former Moody’s analyst describes e-mailing Buffett in 2007 to warn that rating securitized products was a ticking time bomb, and to ask whether he wanted more information. His e-mailed response, says this analyst, said he was a passive investor with a hands-off approach to Moody’s. Buffett didn’t respond to requests for comment about the e-mail.
It is impossible to quantify the cost of Buffett’s disengagement from the rating agency under these unusual circumstances. Moody’s stock has since declined more than 50 percent and investors in asset-backed securities have lost billions. The agency downgraded Berkshire’s top AAA rating by one notch in April 2009; Buffett began to sell in July 2009 and has since disposed of about one-third of Berkshire’s holdings.
FORCING AN OUSTER
If Moody’s is an illustration of what it means to have Buffett’s money but not his engagement, Coca-Cola (KO) is a portrait of the investor exploring virtually every kind of relationship with management. For years, Buffett admired Coca-Cola’s revered CEO, Roberto Goizueta, and never meddled; Goizueta did not want advice. When the beverage giant began to falter after Goizueta’s unexpected death from cancer in 1997, Buffett helped force the early departure in 1998 of Goizueta’s successor, M. Douglas Ivester. That year, Coca-Cola stock was at a peak and Berkshire’s stake was worth $17billion. For the next few years, the company meandered further off course, and as it did, Buffett became increasingly involved in trying to set things right. In 2000, Ivester’s successor, Douglas N. Daft, proposed buying Quaker Oats for its Gatorade brand. Buffett quashed the idea at a special board meeting, using a trademark one-liner: “We would have given up 2 billion cases a year of Coca-Cola to get something like 400 million cases a year of Gatorade.” PepsiCo (PEP) subsequently bought Quaker Oats in a deal that is widely regarded as successful, and the wisdom of Coca-Cola in passing up the opportunity has been debated far and wide. What is not debated is Buffett’s influence.
Buffett became deeply disturbed by Coca-Cola’s chaotic culture and poor earnings, but few people knew how upset he was because he said little in public. Daft retired in February 2003, citing health reasons. Buffett became directly involved in the CEO search. He tried to charm Kilts into taking the job. When Kilts said no, he tried to recruit former General Electric (GE) CEO Jack Welch. Eventually, Buffett signed off on bringing former Coca-Cola executive E. Neville Isdell out of retirement to stabilize the company. When Isdell retired, he was succeeded by Muhtar Kent, who has offset declines in domestic sales with growth in emerging markets. As Coke’s fortunes improved, Buffett’s relationship with its CEOs grew more cordial. He withdrew from his activist role, resigning from the board in 2006. Berkshire still owns 200 million shares and 8.6 percent of Coca-Cola, a stake now worth $11billion.
BETTING ON A “CHOO-CHOO”
In April 2008, Buffett took a hamburger- and jellybean-fueled trip on a vintage railcar from Kansas City, Mo., to Chicago with Matthew K. Rose, CEO of Burlington Northern Santa Fe (BNI). They used the 430-mile journey to talk over Rose’s plans to move the railroad’s recent turnaround into high gear. Rose showed his guest Burlington’s Chicago intermodal freight yard, which handles containers that move among ships, trains, and trucks without being unloaded. Buffett eventually increased Berkshire’s ownership of Burlington to 22 percent.
In 2009, Rose agreed to sell the rest of the railroad to Berkshire for $26billion, giving Buffett what he calls his “choo-choo.” Buffett described this as an “all-in wager on the economic future of the U.S.” He’s betting that rail traffic will grow, and imports from Asia will continue to dominate as the economy mends. Burlington is the nation’s biggest coal hauler—coal transport represents more than a fifth of its revenues—so he’s assuming the world will keep using coal even if the U.S. switches to cleaner energy sources. Lastly, Burlington could be a big winner if railroad rights-of-way become power corridors to conduct energy from wind farms.
Buffett always likes a sweetener, and Burlington gives him one in the form of information. He learns about wallboard demand from USG and consumer-credit trends from American Express, but Rose has called the railroad a kaleidoscope of the economy. Rail traffic patterns are a window on commodity, wholesale, consumer, and international trade flows. Buffett is adding this kaleidoscope to what his other CEOs tell him about the “reset of the consumer” to a lower level of spending. They feed him data from Berkshire’s portfolio of companies—sales of building materials, jewelry, furniture, real estate, credit, fractional jets, vacuum cleaners, fabricated steel, newspaper ad lineage, and other products and services. He may now command as much information about the state of the U.S. economy as anyone, including the Federal Reserve—and probably gets his faster.
This should go a long way toward maintaining Rose’s relationship with his new boss. What else can he expect now that he works for Buffett? He can call whenever he wants and get the best advice in corporate America, and Buffett will put on events to boost his employees’ morale. In return, Rose, who declined comment, needs to make money for Buffett. If he does, he will be celebrated at Berkshire’s annual meeting in Omaha—where Buffett sells all of his products to the 35,000 investors who come for the show—and cheered in Berkshire’s shareholder letter, Buffett’s annual report card on his managers, in which he praises loudly or faintly, or punishes with silence.
There is only one way for a company that’s wholly owned by Berkshire to make money for Buffett—by earning it. Berkshire can’t offer high-priced deals like USG’s and Goldman’s to its own businesses when something goes wrong because the proceeds would come straight out of its vault. So Rose’s No. 1 job is to keep Burlington out of trouble.
Buffett is betting that Rose can do it. He bought Burlington partly out of confidence in the executive. If all goes right, their dealings will be long, friendly, and mutually profitable. As former Gillette CEO Kilts says, “We had a warm, close, personal relationship, but at the end of the day, I knew it was business.”
Alice Schroeder was a noted insurance industry analyst and writer who was a managing director at Morgan Stanley.