MOHNISH PABRAI 00:00
So some of you might have seen the talk on YouTube where we focus on Coke last year. And so this year we’ll try to go further back from the – because the Coke investment at Berkshire Hathaway came from some of the lessons they learned from See’s Candies. The purchase of See’s Candies in 1972, but we go further back from there into the mid to late 60s and then kind of take it from there.
And there are a number of rich lessons in some of the journey that some of these folks took over the years and I think that there’s a lot of that could be applied to the likes of yourselves as you embark on your careers and such, whether or not you become full-time investors, I think it’s always good to understand a few things about investing in allocating capital.
So, I’ll go back, you know, into the, you know, 40s 50s 60s, there was a company called S&H Green Stamps and most of you probably were not born when the S&H Green Stamps were thriving. Maybe even not even your parents were users of them because of quite a ways back but the S&H Green Stamps were really the precursor to what today we think of as airline miles.
So it was a kickback mechanism to get loyalty into particular merchants. So for example, if you went to a grocery store and you spend $50, they would give you one of those stamps for every 10 cents that you spent and then you stick these stamps in these books and then you could redeem them at various stamp centres for a variety of things, you know, toasters or you know, tennis rackets or whatever, so the wide range of things you could buy.
And so, you know, with humans kickbacks work and they worked in the 50s and 60s and 70s and they work today. I mean, you know a lot of the way I decide which credit cards I used and so on so forth is been determined by the miles and the deals that we get, probably similar to most of you.
And – but Green Stamps had a policy that in a particular geographic area, let’s say for example, Irvine, if one particular drug store offered Green Stamps, they wouldn’t allow competing drug stores to offer it. So they kind of created some exclusivity and it also tended to direct business towards the drugstore that carried and offered these stamps.
So the have-not drugstores if you will or the have-not grocery stores were not happy about this. And so what they did in response to – because they understood that the loyalty programs actually boost in sales. In California, 9 different grocers got together and created something called Blue Chip Stamps. And so Blue Chip Stamps basically said we’re going to, you know, allow anyone who wants to offer these stamps or for any merchant, we’re not going to have these exclusive type deals.
And so these 9 grocers basically owned Blue Chip Stamps and they were a lot of small merchants who felt like they were kind of shut out of the profit streams that came out of the ownership of Blue Chip. So they felt like, you know, we want to own the mothership, we don’t want to just be kind of giving you money every time we get a bunch of stamps to give to our customers. So they sued Blue Chip for basically saying this is kind of antitrust and it’s kind of collusion in all these things.
And in the early 60s that kind of lawsuit wound its way through the court system and by 1966, the court agreed with the plaintiffs that they were right and that Blue Chip should be more equitably held by all the merchants who offered it. So what they forced the company to do was offer ownership stake – shares of Blue Chip Stamps – to all the merchants who were kind of purveyors of these stamps if you will and they gave it to them in the proportion of their volume in the last year.
So there was a market created for Blue Chip Stamps and as a result of that market being created, Blue Chip Stamps started trading on the OTC exchange, you know, so you could actually gonna buy and sell shares of Blue Chip.
And there’s a gentleman, Rick Guerin who was an early partner of Charlie Munger and Warren Buffett. He kind of in LA reading the newspapers notice that all this stuff was happening with Blue Chip and he looked at the stock price and you know, Rick is a very good value investor, and he thought that the price that the stock was being offered at was quite compelling. And so he brought it to the attention of Warren Buffett and Charlie Munger, and they looked at it as well.
But one of the nuances about Blue Chip is that every time the merchants gave these stamps to various, you know, buyers of groceries or drugs whatever else, a certain percentage never got redeem. You know, they kind of go to the back of the drawer or people just forget about them and so on so forth.
And so the Blue Chip business was very much like the insurance business. In the sense that with insurance you collect premium dollars today and then the claims come in sometime in the future, and sometimes you can be paying claims even 20-30 years after you’ve taken the premium in.
But in the case of Blue Chip, it was kind of like traveller's checks where people gave you the money today and sometimes those traveller’s checks may not be cash for a year or two years or three years or never, you know, because they just – they get lost, people never claim them and so on so forth.
So Blue Chip had float, just like insurance companies have float, but one of the things about float that BlueChip float was, there was a portion of the float that what I would call permanent float.
So if you look at the kind of chart behind me, you see how the revenues of Blue Chip is going down because it peaked towards the late 1960s and then after that it kind of started losing its appeal, but you can see the float is multiples of the revenue and the reason for that is that a certain percentage of the float is permanent in the sense that, I don’t have the exact number but I would guess something like 5% of the Blue Chip Stamps that were issued, never ever came back for redemption.
And in fact, my friend Alex is sitting there with a whole bunch of these Blue Chip Stamps that never came back from redemption and as a gift for you guys coming today, he’s going to give you some stamps. So you know, keep one packet for yourself and then pass it on to your neighbour if you will. And so there is about approximately 50 or 60 million dollars of these stamps which are now gradually making their way through Etsy and eBay, which never got redeemed.
Okay, and so in 1967 when Rick Guerin looked at this company, the company had about 50 million in equity which was that, you know, the book value of the company, the stock was trading at 40 million and they have another approximately about 100 million of OPM (Other People’s Money) that they were holding which was the float of Blue Chip.
And out of that 100 million, my estimate is something like 50 million of that was never going to be redeemed. So that was kind of like found money. So basically you were able to buy a company with a dollar of assets for 40 cents, it was available really cheap. And so when Rick Guerin brought it to the attention of Warren Buffett and Charlie Munger and they looked at it, they said, “Yeah, this is great.”
But they also noticed that the way the Blue Chip float and equities where invested was useless, you know, people these grocers who were on the board really didn’t have a clue about investing. And so they knew that they had to basically in effect take control of the company and then get control of the investing.
So what they did is from 1967 to 1970 about three year period, a number of different entities like the Buffett Partnership, Warren Buffett personally, Berkshire Hathaway, Wheeler Munger Partners, Rick Guerin and then an entity called Diversified Retailing, all these companies, all the identities together invested about $24 million dollars and they got 60% ownership of Blue Chip and they got control of the company.
And first Charlie Munger went on the board, then Rick Guerin went on the board and then Warren Buffett, so there were three of them, all three of them on the board. And then they took control of the investment committee and sold everything that these guys owned and started to kind of redo everything.