I was reading Andrew Kilpatrick's "Of Permanent Value" yesterday and came across the following fascinating story about Warren Buffett and Dempster Mill, which was one of his early investments when he ran the Buffett Partnership. The story involves activism, turnaround, pricing power and cigar butts investing. I thought readers might get a kick out of it. The following is quoted directly from Volume I of "Of Permanent Value."
The intrinsic value of BRK.A
"Harry Bottle is known as Buffett's 'doctor of sick businesses.' Dempster Mill Manufacturing is one of the businesses Doc Bottle has treated. In his mid-80s, he is alive and well in Ventura, California.
In 1956, the Buffett Partnership began acquiring Dempster Mill Manufacturing Co., a producer of windmills and farm equipment in Beatrice, Nebraska, about 100 miles south of Omaha. The investment was recorded as a "general" because the stock was selling at $18 a share but had a book value of about $72.
One Berkshire shareholder thinks the playbook for Dempster read like this: Buy the company at a quarter of book value, liquidate a substantial portion of the book value to generate funds for investment, borrow money on the unleveraged company for future investment, then spin off the core business.
Buffett continued buying Dempster stock in small quantities for five years. By mid -1961, his partnership owned more than 70% of the company. About $1 million was in Dempster, which when sold in 1963, and netted the partnership about $2.3 million.
When Dempster didn't succeed, Buffett called Harry Bottle to rescue. Buffett and Bottle began a cost-cutting era, laying off about 100 employees in the town of 12,000 people. Eventually the business sold to First Beatrice Corportion. Beatrice city fathers, interested in revenues and jobs, helped obtain financing.
Buffett wrote about the investment in his letter of Jan 18, 1963. (link to the letter)
In an October 2003 interview, Bottle recalled his introduction to Buffett. Bottle says it was Charles Munger who wanted the two to meet. Bottle was an officer at Dempster at the time, and Munger was on the board of TEC in Pasadena. Bottle traveled to Los Angeles to meet with Buffett who immediately asked him to run Dempster.
Bottle said about Buffett: "He's a very intelligent fellow and has a sense of humor. Not all intelligent people have a sense of humor. And he's accommodating."
Bottle took the job and within days began implementing a strict turnaround of the faltering business. The following is Bottle's account of the Dempster days:
Between 1959 and early 1962, I worked as a consultant for a very successful turnaround specialist here in Los Angeles, and in so doing gained considerable expertise in assisting companies in distress.
Charlie introduced me to Warren in early April 1962 and after some discussing regarding his need for an operating manager for a farm machining company he owned in Nebraska, we very quickly came to a mutual employment agreement and I departed for Beatrice two days later.
Now you must realize Dempster Mill was a fine old company with an excellent potential or I'm sure Warren wouldn't have been interested.
This has a stimulating effect on all of us especially me for I knew if we exerted the effort we could turn it around and make it produce up to Warren's measure of performance - and that's pretty high.
I hasten to say there were others involved in this venture - Warren and Charlie of course, Bill Scott and Verne McKenzie who at the time was our outside auditor.
The all came up with ideas and made my task easier.
One idea came from Warren and Charlie. Upon investigating our sales pricing structure we were evaluating replacement and repair parts equal to the total of the sum of the completed item.
So lacking of any cost data to determine correct pricing, they suggested that we simply categorize all parts into three categories.
1. An item 100% proprietary, not available except from us. Increase up to 500%.
2. An item semi proprietary - Increase 200-300%.
3. Nonproprietary - Increase 0 to 100%.
We turned this inventory with an estimated inventory value of three hundred thousand into a resale value exceeding $2 million. Incidentally, we had few, if any, objections to our pricing strategy and continued to sell these parts at higher sales prices with little, if any, sales resistance.
This, of course, led us into other pricing updates and to support continued upward sales price adjustments. A cost data system was installed and maintained.
Our initial efforts at reorganization, including of course among other things, a substantial reduction in employees, which didn't exactly endear us to the Unions or some of the local business people.
Warren, after all, stepped in and rescued an ailing business, made it well, sold it to local principles for continuance of operation and support for the area (a win-win situation).
Buffett said the following about Bottle: "Hiring Harry may have been the most important management decision I ever made. Dempster was in big trouble under two previous managers, and the banks were treating us as a potential bankrupt. If Dempster had gone down, my life and fortunes would have been a lot different from that time forward."
This article first appeared on GuruFocus.
The intrinsic value of BRK.A