A Case Study of a Buffett Business Principle

As both a “student” and “teacher” of Warren Buffett’s business principles the past three years, I am continually amazed at their timelessness. I remember once reading that he said they’re not principles if they’re not timeless.

Twenty-four years ago, he wrote:

“ When a management with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact.”
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Warren Buffett, 1985 Letter to Berkshire Hathaway Shareholders

Now, let’s fast forward to a recent article in the New York Times regarding Chrysler. Included below are selected excerpts from the article:

"FOR Steve Feinberg, the onetime owner of Chrysler, the past year has been a crawl toward defeat. He lost billions of dollars. He lost prestige. He lost his privacy. And he ended up a ward and supplicant of the federal government…..

Mr. Feinberg took over Chrysler almost exactly two years ago, promising to revive the company. Chrysler filed for bankruptcy protection at the end of April. So how he and his private equity firm, Cerberus Capital Management, chose to describe their journey with Chrysler is a delicate matter.

If he says he should have shelled out more money to help Chrysler, he could face the ire of investors who have already suffered heavy losses on his gambit. If he says he should have simply dumped Chrysler’s auto arm, while clinging to its more promising finance unit, he could be accused of caring more about his wallet than he did about Chrysler’s workers and the automaker’s role in the economy.

When Cerberus began poking around Detroit, some at the firm said that the American automobile industry was going to be the biggest turnaround story in history. In sessions with potential investors in the last few years, the Cerberus team came across as passionate, skilled and incredibly confident that they should succeed where others had failed.

Cerberus and its co-investors ultimately invested $7.4 billion in Chrysler, a sum now worth an estimated $1.4 billion. Ideally, Cerberus hoped to wed Chrysler’s finance arm to another finance company it controlled, GMAC. To that end, the risks in Chrysler’s auto business were something that the Cerberus team thought it could manage and that wouldn’t stand in the way of making billions of dollars for investors.

……GMAC and Chrysler became so weak that they needed $22.6 billion in government aid in the last year to stay afloat. For Chrysler and its workers, investors, business partners and customers, was all of that worth it?
According to Maryann Keller, a longtime auto analyst and consultant, the company that Mr. Feinberg took over was already suffering from myriad problems: a bad cost structure, a limited product line and no pipeline of more diverse offerings. In short, she says, Cerberus had simply bought a “basket case.”

Cerberus now values its Chrysler stake at 19 cents on the dollar. It is humbling and embarrassing figure for Mr. Feinberg. But its better than zero cents on the dollar, which is what his stake might have been worth had the government not bailed him out."
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Louise Story, For Private Equity, a Very Public Disaster, New York Times, August 9, 2009

The Fallout

"Investors in hedge funds run by Cerberus Capital Management LP, whose audacious multi-billion dollar bet in the U.S.auto industry went bust, are bolting for the door, clinching one of the highest-profile falls from grace of a superstar in the investment world.

Clients are withdrawing more than $5.5 billion, or nearly 71% of the hedge fund assets, in response to big investment losses and their own need for cash, according to people familiar with the matter."
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Peter Lattman and Jenny Strasburg, Clients Flee Cerberus, Fallen Fund Titan, New York Times, August 29, 2009