B000U5KFIC EBOK (33 page)

Nevertheless, some of the businesses acquired by Wesco did not perform well. Such was the case with New American Electric, a company discovered by Glen Mitchel, a Caltech electrical engineer and a friend whom
Munger believed had good business abilities.

Charlie suggested Mitchel buy the business, and agreed to go into it
with him. Charlie was short of cash at the time, so he and Rick Guerin invested in the electrical supply company through the New America Fund.
For years New America Electric, which sold electrical equipment to
Southern California home builders and mobile home parks developers,
was a cash cow.

It was still a cash cow when New America Fund liquidated. At that
time Munger gave Mitchel three choices: (1) distribution of New America
Electric shares to New America Fund shareholders, which would turn
New America Electric into a small publicly traded company, dominated
by Mitchel; (2) sell New America Electric in its entirety in any way
Mitchel wished; or (3) have Wesco buy 80 percent of New America Electric at a price approved by Buffett, 70 percent coming from New America
Fund and 10 percent coming from Mitchel, leaving him with 20 percent.
Mitchel selected the third alternative. However, business conditions soon
changed and Mitchel's choice appeared far from optimal for Mitchel, bad
for Wesco, and good for New America Fund shareholders like Munger. The next year California went into one of its periodic real estate nose
dives and the company lost about 30 percent of its value.

"It was the worst recession in Southern California since the Depression. New America Electric got clobbered," said Munger. "Wesco sold it at
a moderate loss. It wasn't as if I knew it was going to result in a loss to
Wesco. If so, I would have never done it. It was very embarrassing."

BESIDES THE FREDDIE MAC STUCK and some preferred shares, all that remains from Wesco's Mutual Savings days is a small real estate subsidiary,
MS Property Company, that holds tag ends of assets and liabilities with a
net book value of about $13 million. MS Property manages office buildings in downtown Pasadena and a small shopping center in Upland, California. It was under Wesco's property segment that Munger developed
"Mungerville," or Montecito Sea Meadow in Santa Barbara.

As it has evolved today, Wesco can be divided into an investment segment, the securities in its insurance subsidiaries, and its business portion.
In one year, 47 percent of Wesco's net income came from realized gains
on securities it held.

At the end of 1999, Wesco's consolidated balance sheet contained
$2.8 billion of marketable securities, stated at market value. The largest
holding was Freddie Mac, with a value of $1.9 billion. This holding is the
28.8 million shares of Freddie Mac purchased in 1988 for $71.7 million.
The second and third largest holdings were shares of The Coca-Cola Company and The Gillette Company, with a combined value of $800 million.
Like Berkshire, Wesco has held preferred stock positions in Travelers, U.S.
Airways, and small equity positions in American Express and Wells Fargo.

Wesco's business segments fall into two major categories-insurance
and industrial. The company has four major subsidiaries: Wesco-Financial
Insurance Company (Wes-FIC, the Omaha-based supercat re-insurer), the
Kansas Bankers Surety Company, Precision Steel, and Cort Business Services Corp.

At the end of 1999, the Wes-FIC subsidiary held $2.5 billion in investment assets. Munger called it "a very strong insurance company with very
low costs ...... Nevertheless, Munger often has warned shareholders that
"supercat reinsurance is not for the faint of heart. A huge variation in annual results, with some very unpleasant future years for Wes-FIC is inevitable."',

As part of its on-going search for appropriate acquisitions, Kansas
Bankers Surety Company was purchased in 1996 for $80 million in cash.
Founded in 1909, the Topeka, Kansas, company insures about 1,200 banks, including 70 percent of the banks in Nebraska. Originally the
KBSC served mainly as a deposit guarantee company.

Though it seems completely out of character for Wesco, since 1979 it
has owned Precision Steel, a steel products supplier with locations in
Franklin Park, Illinois, and Charlotte, North Carolina.

Wesco acquired Cort Business Services, owner of Cort Furniture
Rental, in February 2000, for $467 million cash.

In 1999, Wesco had a 5-year-revenue growth rate of 11.8 percent, and
an earnings per share growth rate of 27.64 percent. Total return for 1999
was 19.6 percent; the total return for the previous three years was 58.7
percent; and the 5-year total return was 27.5 percent. Berkshire Hathaway itself doesn't pay dividends, but Wesco Financial, like most of the
companies partially owned by Berkshire, does pay them.

"Wesco's dividend policy is that which the minority shareholders
prefer," explained Munger, referring to Betty Peters. "At least the ones
we know who invited us in. So, we are just deferring to the wishes of the
very much minority shareholders. Now you can say, `that's eccentric,' and
you're right.""

Buffett explained further, "At Berkshire, incidentally, we have about
three or four 80 percent-plus owned subsidiaries where the balance is
owned by a few people, as opposed to Wesco, where the minority interest
is owned by a great many people. In each case, we tell the owners of
the 20 percent or less interest that they set the dividend policy. It's up to
them. We have no tax consequences to us in terms of dividend policy,
they have the tax consequences. They have a lot of other considerations
within families and all of that, and they set the dividend policy."'"

Since Berkshire owns such a large percentage of the shares and the
founding family owns a fairly substantial block, Wesco is thinly tradedaveraging 1,300 shares per day on the American Exchange. There are
about 5,000 shareholders.

Though Munger does not approve of the practice, many investors
pore over Wesco's Form 10-Q filing for insight into Buffett's investing
style at Berkshire Hathaway. To investors trying to mimic Buffett this
seems to be logical, since Berkshire owns many of the same stocks that
Wesco holds.'

Analysts sometimes call Wesco a miniature, or "tourist class" version of Berkshire Hathaway, much the same, but cheaper, since Wesco's
price tends to fluctuate between $220 and $350 per share, compared to
$40,000 to $90,000 per share for Berkshire A. Blue Chip bought its first
Wesco stock at about $6 per share and paid around $17 for stock it
bought later.

Munger does not like the comparison of Wesco to Berkshire and
warned: "Wesco is not an equally-good-but-smaller version of Berkshire
Hathaway, better because its small size makes growth easier. Instead,
each dollar of book value at Wesco continues to provide much less intrinsic value than a similar dollar of book value at Berkshire Hathaway. Moreover, the quality disparity in book value's intrinsic merits has, in recent
years, been widening in favor of Berkshire Hathaway."

Though it was never their intention to do so said Munger, "what we
have created at Berkshire and Wesco is, to some extent, a cult. And you
can say it's a nice cult and you like the people who join-and we do feel
that way. But to some extent, we have followers who are unusually interested in what we do and feel comfortable about investing with us. I think
it's had effects on the stock prices of Wesco and Berkshire."22

Just to keep everyone's thinking straight, Munger departs from the
philosophy of Berkshire Hathaway and in the annual report he calculates
Wesco's intrinsic value for shareholders. At the end of 1998, Munger said
Wesco's intrinsic value was $342 per share. At that time, Wesco was selling for $354, about 4 percent above intrinsic value.23

Munger has no compunction about telling shareholders when the
stock is overpriced. Back in 1993, he said, "An orangutan could figure out
that the stock is selling miles above the value of the company if it were liquidated. I keep telling people this, but they keep buying the stock."24

In June 1999, Munger told shareholders that their equity was worth
$294 per share, a decline from the year earlier. The change was based on
the fluctuating price of the publicly-traded equities that Wesco owns,
which in turn affects Wesco's unrealized gains from these holdings. At
the close of 1999, Wesco was trading near its 52-week low of $253, disappointing for investors who during the year saw the stock price soar as
high as $353. Part of Wesco's decline could be attributed to its Freddie
Mac holdings. After two consecutive years of stock price increases of
greater than 50 percent, Freddie Mac's share price was driven back down
by higher interest rates. The stock fell 30 percent over a 14-month period
between December 1999 and February 2000.

The price dip didn't disturb Munger's equanimity. "I'm 76 years of
age," he said. "I've been through a number of down periods. If you live a
long time, you're going to be out of investment fashion some of the time."

Munger said it is appropriate to calculate Wesco's intrinsic value for
shareholders, and not to do it for Berkshire shareholders, because the
companies are quite different.

"Wesco is so liquid and its operating businesses so moderate in size
that it's rather easy to make a computation as to its asset value. You can figure out what would happen if you just closed the place and mailed
checks back to all the shareholders."

Partly because of the reflected glory of Berkshire, partly because
Wesco has many of the same investment holdings that Berkshire does, and
partly because of Munger's unusual personality, Wesco attracts its own
cult following.

Munger protests at the silliness of it all, but he is willing to sit for
hours answering questions posed to him by shareholders and the media.
The audience seems to enjoy the discourse, staying until Munger is out of
time and must leave for the board meeting that is scheduled directly after
the annual meeting.

At the 1999 meeting, when the share price was fluctuating wildly,
Charlie explained to Wesco shareholders that some corporate problems
seem large at the moment, but in time, they will seem trivial. That is why
long-term investing pays off. "Wesco once moved its account from Security Pacific to Bank of America where we had the account get out of
balance and nobody at the bank could get it back in balance. We closed
our account and let it run out and made some accounting adjustments. In
five years, nobody will remember...."

If you're going to learn to drive a car, it doesn't do any good
just to know how to use the accelerator. There are four or five
things you have to know before you understand the system
correctly. I do think some things are way more important
than others, and in the game we're in, understanding the advantages of scale, scale of experience, efficiency in the plant,
scale of experience in leasing, other advantages of scale.
[Take] Adam Smith's pin factory, I think that's a very important basic concept, but it's just one.'

Charlie Munger

HARLIE MUNGER WAS CALLED UPON to testify in court when a small Los
Angeles legal publication sued the Daily Journal Corporation for unfair trade practices. To demonstrate Munger's experience in evaluating
the worth of a business, attorney Ron Olson first established that Munger
was vice chairman of Berkshire Hathaway, chairman of Wesco Financial,
and former chairman of Blue Chip Stamps. His testimony provided a
thumbnail sketch of how Berkshire grew into a twenty-first century
company.