In his book Principles, Ray Dalio discusses patterns and pattern recognition. He says you can get so adept at pattern recognition that when you take the broad view of an economy or business, you can tell what is going to happen before it happens because you’ve studied history and have seen this play out before. It actually isn’t new or “different this time.” It’s been done before. As Dalio says, “It’s another one of those…” We’ve seen this rhythm play out.
Warren Buffett says that Mr. Market is a manic depressive who has a terrible memory of things that have happened to him. While Mr. Market’s mood swings are all over the map, he doesn’t remember the good or the bad things that have happened to him. Worse, he tends to make up a lot of his experiences in his head. As a result, when these things, good or bad, happen to him, it causes his mood swings to go even wider, exacerbating his manic depression and emotional highs. Because he has no emotional will or mental tools to deal with his manic depression and wild mood swings, poor Mr. Market occasionally acts irrationally. OK, maybe more than occasionally. It is nice to think this is efficient for market participants. But it seems that Mr. Market would disagree, even if were having an emotionally stable day.
Buffett would likely agree with Mr. Dalio’s calculus that it’s another one of those. This isn’t a new, wild mood swing. It isn’t different this time. We saw a similar pattern back decades ago; therefore, this one may play out similarly.
Buffett and Munger always say if you had to distill their investment thesis down into a statement, it would be we sell (or do nothing) when people are greedy and we buy when people are fearful, which, of course, is the exact opposite of what most people do. This strategy requires patience, clear thinking, and discipline. Even those who try it cannot replicate it, for they do not possess the emotional equipment to pull it off. It is one thing to say you do this; it is completely another to actually do it and stick to it.
Never forget emotional contagion.
What do you do when everyone around you is freaking out and tells you that the sky is falling? What is your emotional state like then? Most peoples’ mirror neurons flare up and they act the same way as Chicken Little. Which is to say, they capitulate and sell. It takes guts and gumption to say, “No. I’m hanging in there despite the blood in the streets. In fact, I may buy more.” It really takes guts and gumption when your actions are on public display. How do you react when everyone around you tells you the sky is falling?
Emotional states are contagious.
Enthusiastic highs are contagious. Dreaded emotional lows and misery are also contagious. Like Mr. Market, it seems we are quick to forget this when we choose who we hang out with the most. The emotional tone of an organization, for-profit or not-for-profit, starts at the top and trickles down. This is a common, wildly unfortunate, leadership error in lack of oversight and properly thinking things through. If you don’t want your people to act like banshees, than you yourself should not act like a banshee. If you don’t want your people to yell at each other all day, then you yourself ought not yell at your lieutenants all day. If you don’t want your people to cheat, then you yourself should never cheat. It is a straightforward formula: embody the values you wish to see in others. Always keep in mind that people look up to you whether you want them to or not. By default, we’re wired to admire our leadership.
Buffett’s actions upon buying companies is typically the opposite of what most acquiring companies do. Mergers & Acquisitions (M&A) Buffett style is not your usual Wall Street M&A. What do most companies do after acquiring another company? They announce the deal. They select a team to lead the integration. This team does their best to get to know the company they just bought. They make their evaluations. They begin to size-up where they’re going to cut, and they begin cutting, usually up to or beyond 50%. They essentially take what they feel is the wheat and discard the chaff.
“We do not provide management.”
Now, look at what Buffett does when he acquires a company. He thanks the founders and leadership team for doing such a wonderful job thus far and he ensures they stay on with the firm. He doesn’t want them going anywhere. As he states, “We do not provide management.” He also does not pillage the existing company. He leaves it alone. He also doesn’t have to provide the founders with wild buy-out packages or crazy salaries and bonuses. “They’re already rich,” he says. Buffett also involves Wall Street or investment bankers as little as possible in the transaction. “We don’t need the help,” he says. Buffett gives the acquired company access to Berkshire’s credit lines and AAA credit rating, and invests the acquired company’s future profits into his firm. And off they go together. Two years later, the acquired company looks very similar to what it did pre-acquisition. The same cannot be said of what most acquired companies look like in your typical Merger & Acquisition. Most acquired companies are fractions of what they once were.
Traditional Mergers & Acquisitions are hard. They require everyone to be on their ‘A’ game. What’s most difficult about them is when you do a deal, you’re attempting to merge two cultures, and cultures often clash into an Us vs. Them fight. It becomes those people, and we know what that means. (As Marshall Goldsmith says, “Nothing good or positive ever follows the phrases, “Those people…” or “You people…”)
The software M&A boneyard is littered with shells of acquired companies and their cultures left for dead by the behemoths who acquired them.
Think about all the deals Microsoft has done. While they’re trying to change it, historically, Microsoft has had a very top-down, Soviet-style, Putin-like driven culture, led by Gates and Ballmer. My way or the Highway. And by the way, if it is the highway, you better watch out or we’ll run over you when you’re not looking. You have to know what you’re getting into when you work at Microsoft. It’s not easy there. When they go and buy a startup and desire to integrate its technology into their software repertoire, they pillage and take and trample the startup until there’s little left of it. They try to integrate what they can and then they’re done with it. It becomes a shell of its former self. The founders are long gone. The acquiring company is not interested in what the startup’s culture was. You’re a part of Microsoft now, the King. The software M&A boneyard is littered with shells of acquired companies and their cultures left for dead by the behemoths who acquired them.
It is interesting to note that founders do not stick around for too long post acquisition. They can see the writing on the wall. It is a new culture, a new route, a new way of doing things that they are likely not interested in. There’s that, and there is the sense of serial entrepreneurship: they’re ready to go start something else new. Some founders just cannot help themselves. There are other problems to be solved. To their credit, most wouldn’t want to stick around Microsoft for long, either.
IN contrast, while Buffett does not acquire, nor target startups, the people he acquires stick around. They love working for him because he leaves them alone. He doesn’t tamper with a good thing. He sees success, he desires for it to continue, and he is humble enough to know to leave the management team alone. Think about it: does Buffett know a lot about tool making? Does Buffett know a lot about manufacturing electric cars in China? Even if he does, he wouldn’t presume onto others’ decisions about those companies. Warren knows humility.
Berkshire Hathaway is the embodiment of M&A that works. Buffett and Munger acquire and then leave alone. It’s a rather simple formula for success. Why mess with a great thing? These folks have figured it out. Let’s buy ’em, leave ’em alone, and then share in their success.