Thoughts on David Sokol controversy
Posted on 04. Apr, 2011 by TheFreeInvestor in General, Stock Analysis
Unless you have been hiding under a rock, you would have noticed the widely reported issue of alleged unethical trading and resignation of David Sokol from Berkshire Hathaway (BRK.A, BRK.B). If you haven’t been following the story then you can read it here on NY Times and watch his interview with CNBC. I am not a lawyer and can’t comment of the legal merits of the allegations of front running. But, it is amazing how oblivious Sokol is about the public perception and potential ethically murky situation. Andrew Ross Sorkin of NY Times has a great analysis of the perception angel.
I own Berkshire (BRK.B) shares. Though it is not a significant portion of my portfolio to move the needle, I have been giving some thought to what will happen to Berkshire after departure of Buffett.
Change in operating model?
One of the questions I have been re-thinking recently is whether Berkshire can continue with its current operating model unaltered in the post-Buffett era. In the current model, Buffett buys companies and leaves the management intact. In fact, he buys only companies only if likes the management. After acquiring the company, the operating business the stays same as before but the “capital allocation” decision is shifted to Buffett and Munger at the headoffice.
This model works fine as long as the Oracle, Buffett, is at the helm. Over the decades, he has proven himself to be one of the best asset allocators or investor that we know. So, the CEOs of the acquired companies are probably happy to delegate the investment / asset allocation decision to Buffett. This model worked particularly well in the past decades when Buffett was acquiring smaller companies. Those CEOs, with presumably smaller egos, were more likely to be happy to delegate the asset allocation and investment decision to the most successful investor in the world. Apart from the asset allocation decision, Buffett gives a completely free reign to the existing management to run the company the way they want to run.
However, as Berkshire has grown into a behemoth, most of the future acquisitions are likely to be large companies as we saw with Burlington Northern deal and recent Lubrizol deal. Large companies have CEOs with large egos. Though they might be ok to defer asset allocation decision to Buffett for now, I doubt they will want to outsource how they invest their company’s excess cash to the next person who takes over from Buffett — unless the operating model changes towards a more centralized structure with Berkshire CEO at the top (think GE).
Insider trading allegations aside, I think, Sokol resignation provides a preview of the issues to expect when Buffett steps down. With the recuitment of Todd Combs as an investment manager, it is clear that Buffett’s role will be split into mutiples roles – CEO and investment managers. So, if professional investment managers are running the portfolio of investments then what value the CEO will provide unless there is a drastic change in the operating structure of the firm towards a more centralized structure?
Final Thoughts
Even with the premise that the operating model is going to change or may be some businesses will be broken apart, the sum of the parts may be still higher than the current market value. But, as a long term investment, it is time to stop relying on Buffett’s acumen as an investor and start looking at Berkshire as the sum of the values of its underlying businesses.
[Note: Photo by PhOtOnQuAnTiQuE]
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