Although Warren Buffett gets all the hype, investors should also pay attention to Charlie Munger, Buffett’s right-hand man at Berkshire Hathaway. Munger and Buffett have known each other since 1959, and Munger became vice-chair at Berkshire in 1984.
Munger’s influence on Buffett is more important than most of us realize. It was Munger who convinced Buffett to abandon his “cigar butt” principles (buying ultra-cheap stocks with the hope of getting one last puff of the proverbial cigar) in favour of something a little more permanent and scalable. You know how Buffett always looks for a competitive advantage? That’s at least partially due to Charlie Munger.
Because Munger doesn’t get nearly the attention Buffett draws, he isn’t quite so careful about his words. Recently, during a shareholders meeting for the Daily Journal Corporation, a newspaper where he serves as Chairman, Munger had this to say about Valeant Pharmaceuticals Intl Inc. (TSX:VRX)(NYSE:VRX): “Valeant is like ITT and Harold Geneen come back to life, only the guy is worse this time.”
What exactly does Munger mean by this?
A little history lesson
Who exactly was Harold Geneen? And what did he do at ITT that’s so infamous?
Geneen took over ITT Corp in 1959 when it was still mostly a telegraph and telephone company. After being blocked by the FCC in an attempt to buy the ABC television network in 1963, Geneen decided to diversify away from the company’s traditional business and completed more than 300 acquisitions during the decade in areas such as hotels, insurance, for-profit education, and the company that made Wonder Bread.
Geneen used cheap debt to finance these acquisitions, which later proved to be the company’s downfall. After Geneen’s retirement as CEO in 1977, subsequent CEOs spent much of the next two decades paying off the debt by selling most of Geneen’s acquisitions.
Is Valeant really comparable?
On the surface, Valeant looks like it could be pretty comparable to ITT. Since merging with Biovail in 2010, Valeant has made more than 30 different acquisitions, most of which were paid for with debt or by issuing shares.
Since the end of 2010, Valeant’s debt has skyrocketed from US$3.6 billion to US$15.3 billion. Shares outstanding have also gone up considerably from 196 million to 335 million. It’s obvious that Munger is onto something.
But on the other hand, I’m not sure Valeant is anywhere close to being as bad as ITT was. For one thing, all of the company’s acquisitions are at least in the same sector. ITT was buying up hotels and car dealerships, while Valeant is buying up pharmaceutical companies. Valeant’s efforts scale up a whole lot better than ITT’s ever did.
There’s also a bit of hypocrisy coming from Munger on this issue. Munger is actively involved in a company that does pretty much the same thing as ITT did back in the 1960s. Sure, Berkshire doesn’t use much debt or engage in hostile takeovers, but Berkshire and ITT have more in common than Munger is willing to admit. Both attempted to dominate the business world using a roll-up acquisition strategy; Buffett and Munger were just a little more patient with their plan.
But just because Munger exaggerates how bad Valeant’s acquisition spree has been doesn’t mean the stock is necessarily a buy at these levels. The company had earnings of just $2.67 per share in 2014, putting the stock at a P/E ratio of nearly 100 times. Yes, earnings are expected to grow substantially in 2015, but the outlook is simple. For the stock to continue performing, the company must continue to make acquisitions.
After making more than 30 acquisitions in just a few years, it’s hard to keep finding deals that will not only be big enough to make a difference, but will also prove to be good long-term buys. There’s so much pressure on management to keep buying that a serious misstep could be coming. If that happens, this hyped stock could head down in a hurry.
Although I don’t buy Munger’s alarmist concerns about Valeant, I agree with him on one thing. The stock just isn’t attractive at current levels.
