Part 2 of the 1960 partnership letter, written by
Warren Buffett
, describes the partnership's investment in Sanborn Map.
Before we take a look at the 1960 letter, I want to jump back to
the 1958 and 1959 letters. In these letters, Buffett alludes to a
large investment, and in the 1960 partnership letter we find out
that this large investment is Sanborn Map.
Here's what the 1958 letter says about the Sanborn Map
investment:
:
Late in the year we were successful in finding a special
situation where we could become the largest holder at an
attractive price, so we sold our block of Commonwealth obtaining
$80 per share although the quoted market was about 20% lower at
the time.
...This new situation is somewhat larger than Commonwealth and
represents about 25% of the assets of the various partnerships.
While the degree of undervaluation is no greater than in many
other securities we own (or even less than some) we are the
largest stockholder and this has substantial advantages many
times in determining the length of time required to correct the
undervaluation. In this particular holding we are virtually
assured of a performance better than that of the Dow-Jones for
the period we hold it.
And here's what the 1959 letter says about Sanborn Map:
:
Last year, I mentioned a new commitment which involved about 25%
of assets of the various partnerships. Presently this investment
is about 35% of assets. This is an unusually large percentage,
but has been made for strong reasons. In effect, this company is
partially an investment trust owing some thirty or forty other
securities of high quality. Our investment was made and is
carried at a substantial discount from asset value based on
market value of their securities and a conservative appraisal of
the operating business.
We are the company's largest stockholder by a considerable
margin, and the two other large holders agree with our ideas. The
probability is extremely high that the performance of this
investment will be superior to that of the general market until
its disposition, and I am hopeful that this will take place this
year.
With that background, let's look at
Buffett
's full treatment of the Sanborn Map investment in the 1960
letter.
:
Sanborn Map:
Last year mention was made of an investment which accounted for a
very high and unusual proportion (35%) of our net assets along
with the comment that I had some hope this investment would be
concluded in 1960. This hope materialized. The history of an
investment of this magnitude may be of interest to you.
Sanborn Map Co. is engaged in the publication and continuous
revision of extremely detailed maps of all cities of the United
States. For example, the volumes mapping Omaha would weigh
perhaps fifty pounds and provide minute details on each
structure. The map would be revised by the paste-over method
showing new construction, changed occupancy, new fire protection
facilities, changed structural materials, etc. These revisions
would be done approximately annually and a new map would be
published every twenty or thirty years when further pasteovers
became impractical. The cost of keeping the map revised to an
Omaha customer would run around $100 per year.
This detailed information showing diameter of water mains
underlying streets, location of fire hydrants, composition of
roof, etc., was primarily of use to fire insurance companies.
Their underwriting departments, located in a central office,
could evaluate business by agents nationally. The theory was that
a picture was worth a thousand words and such evaluation would
decide whether the risk was properly rated, the degree of
conflagration exposure in an area, advisable reinsurance
procedure, etc. The bulk of Sanborn's business was done with
about thirty insurance companies although maps were also sold to
customers outside the insurance industry such as public
utilities, mortgage companies, and taxing authorities.
For seventy-five years the business operated in a more or less
monopolistic manner, with profits realized in every year
accompanied by almost complete immunity to recession and lack of
need for any sales effort. In the earlier years of the business,
the insurance industry became fearful that Sanborn's profits
would become too great and placed a number of prominent insurance
men on Sanborn's board of directors to act in a watch-dog
capacity.
In the early 1950's a competitive method of under-writing known
as "carding" made inroads on Sanborn's business and after-tax
profits of the map business fell from an average annual level of
over $500,000 in the late 1930's to under $100,000 in 1958 and
1959. Considering the upward bias in the economy during this
period, this amounted to an almost complete elimination of what
had been sizable, stable earning power.
However, during the early 1930's Sanborn had begun to accumulate
an investment portfolio. There were no capital requirements to
the business so that any retained earnings could be devoted to
this project. Over a period of time, about $2.5 million was
invested, roughly half in bonds and half in stocks. Thus, in the
last decade particularly, the investment portfolio blossomed
while the operating map business wilted.
Let me give you some idea of the extreme divergence of these two
factors. In 1938 when the Dow-Jones Industrial Average was in the
100-120 range, Sanborn sold at $110 per share. In 1958 with the
Average in the 550 area, Sanborn sold at $45 per share. Yet
during that same period the value of the Sanborn investment
portfolio increased from about $20 per share to $65 per share.
This means, in effect, that the buyer of Sanborn stock in 1938
was placing a positive valuation of $90 per share on the map
business ($110 less the $20 value of the investments unrelated to
the map business) in a year of depressed business and stock
market conditions. In the tremendously more vigorous climate of
1958 the same map business was evaluated at a minus $20 with the
buyer of the stock unwilling to pay more than 70 cents on the
dollar for the investment portfolio with the map business thrown
in for nothing.
How could this come about? Sanborn in 1958 as well as 1938
possessed a wealth of information of substantial value to the
insurance industry. To reproduce the detailed information they
had gathered over the years would have cost tens of millions of
dollars. Despite "carding" over $500 million of fire premiums
were underwritten by "mapping" companies. However, the means of
selling and packaging Sanborn's product, information had remained
unchanged throughout the year and finally this inertia was
reflected in the earnings.
The very fact that the investment portfolio had done so well
served to minimize in the eyes of most directors the need for
rejuvenation of the map business. Sanborn had a sales volume of
about $2 million per year and owned about $7 million worth of
marketable securities. The income from the investment portfolio
was substantial, the business had no possible financial worries,
the insurance companies were satisfied with the price paid for
maps, and the stockholders still received dividends. However,
these dividends were cut five times in eight years although I
could never find any record of suggestions pertaining to cutting
salaries or director's and committee fees.
Prior to my entry on the Board, of the fourteen directors, nine
were prominent men from the insurance industry who combined held
46 shares of stock out of 105,000 shares outstanding. Despite
their top positions with very large companies which would suggest
the financial wherewithal to make at least a modest commitment,
the largest holding in this group was ten shares. In several
cases, the insurance companies these men ran owned small blocks
of stock but these were token investments in relation to the
portfolios in which they were held. For the past decade the
insurance companies had been only sellers in any transactions
involving Sanborn stock.
The tenth director was the company attorney, who held ten shares.
The eleventh was a banker with ten shares who recognized the
problems of the company, actively pointed them out, and later
added to his holdings. The next two directors were the top
officers of Sanborn who owned about 300 shares combined. The
officers were capable, aware of the problems of the business, but
kept in a subservient role by the Board of Directors. The final
member of our cast was a son of a deceased president of Sanborn.
The widow owned about 15,000 shares of stock.
In late 1958, the son, unhappy with the trend of the business,
demanded the top position in the company, was turned down, and
submitted his resignation, which was accepted. Shortly thereafter
we made a bid to his mother for her block of stock, which was
accepted. At the time there were two other large holdings, one of
about 10,000 shares (dispersed among customers of a brokerage
firm) and one of about 8,000. These people were quite unhappy
with the situation and desired a separation of the investment
portfolio from the map business, as did we.
Subsequently our holdings (including associates) were increased
through open market purchases to about 24,000 shares and the
total represented by the three groups increased to 46,000 shares.
We hoped to separate the two businesses, realize the fair value
of the investment portfolio and work to re-establish the earning
power of the map business. There appeared to be a real
opportunity to multiply map profits through utilization of
Sanborn's wealth of raw material in conjunction with electronic
means of converting this data to the most usable form for the
customer.
There was considerable opposition on the Board to change of any
type, particularly when initiated by an outsider, although
management was in complete accord with our plan and a similar
plan had been recommended by Booz, Allen & Hamilton
(Management Experts). To avoid a proxy fight (which very probably
would not have been forthcoming and which we would have been
certain of winning) and to avoid time delay with a large portion
of Sanborn's money tied up in blue-chip stocks which I didn't
care for at current prices, a plan was evolved taking out all
stockholders at fair value who wanted out. The SEC ruled
favorably on the fairness of the plan. About 72% of the Sanborn
stock, involving 50% of the 1,600 stockholders, was exchanged for
portfolio securities at fair value. The map business was left
with over $1 � million in government and municipal
bonds as a reserve fund, and a potential corporate capital gains
tax of over $1 million was eliminated. The remaining stockholders
were left with a slightly improved asset value, substantially
higher earnings per share, and an increased dividend rate.
Necessarily, the above little melodrama is a very abbreviated
description of this investment operation. However, it does point
up the necessity for secrecy regarding our portfolio operations
as well as the futility of measuring our results over a short
span of time such as a year. Such control situations may occur
very infrequently. Our bread-and-butter business is buying
undervalued securities and selling when the undervaluation is
corrected along with investment in special situations where the
profit is dependent on corporate rather than market action. To
the extent that partnership funds continue to grow, it is
possible that more opportunities will be available in "control
situations."
Here is my attempt to briefly summarize the Sanborn Map
investment:
- Sanborn Map is a story about a once-vibrant map business.
Sanborn's detailed maps were mainly of use to fire insurance
underwriting departments. In the early years of this map
business (because it "operated in a more or less monopolistic
manner"), the insurance industry put a number of insurance men
on Sanborn's board of directors to "act in a watch-dog
capacity." In the 1930s, Sanborn began accumulating an
investment portfolio with its retained earnings; over time,
this portfolio grew to be substantial in size. In the 1950s,
however, "a competitive method of underwriting known as
'carding' made inroads on Sanborn's business and after-tax
profits of the map business fell." It was in late 1958 that
Buffett
began purchasing shares in Sanborn Map for the partnership. At
this point in time, the market price of the stock only valued
Sanborn's investment portfolio at around 70 cents on the dollar
-- with the still-profitable map business thrown in for free.
Buffett stated that the partnership "hoped to separate the two
businesses [investment portfolio and map business], realize the
fair value of the investment portfolio and work to re-establish
the earning power of the map business." However, there was
"considerable opposition on to the Board to any type of
change." In the end, to avoid a proxy fight and time delay, a
plan was developed to allow shareholders to exchange their
stock for "portfolio securities at fair value." The partnership
opted for this exchange and exited the investment.
Here are some general thoughts about the Sanborn Map
story/investment:
- Sanborn Map shows us that a business that operates "in a
more of less monopolistic manner" can lose its competitive
positioning if it is not vigilant. "Carding" made inroads on
Sanborn's business, and Sanborn did not update the way that it
sold and packaged information. This led to a decline in after
tax profits. According to Buffett, this decline in profit (over
the time period mentioned in the letter) "amounted to an almost
complete elimination of what had been sizable, stable earning
power." This is a cautionary tale for all operating businesses
that think that competition can't touch them.
- To maximize the value of a business, it's important to
focus on the individual components of that business and not
just overall results. The income from Sanborn's investment
portfolio masked the lackluster performance of the map
business. Buffett states: "The very fact that the investment
portfolio had done so well served to minimize in the eyes of
most directors the need for rejuvenation of the map business."
However, to get full value out of Sanborn Map, the map business
needed to be addressed separately from the investment
portfolio.
- In 1958, Sanborn's map business was probably not worth the
reproduction cost of its detailed map assets (assuming no
change in how the business was being operated). Buffett states:
"Sanborn in 1958 as well as 1938 possessed a wealth of
information of substantial value to the insurance industry. To
reproduce the detailed information they had gathered over the
years would have cost tens of millions of dollars." So, the
reproduction cost of the detailed map assets was "tens of
millions of dollars." Additionally, Buffett states:
"...after-tax profits of the map business fell from an average
annual level of over $500,000 in the late 1930's to under
$100,000 in 1958 and 1959." So the question is: Does under
$100,000 in after-tax profits in 1958 support a value of "tens
of millions of dollars"? I think the answer is no. If we are
conservative and assume that after tax profits equal $100,000
and reproduction cost equals $10 million, we end up with a
return of 1% per year. So, if you were to assume that intrinsic
value was equal to reproduction cost, you would essentially be
saying that a return of 1% per year was an appropriate return
for this map business. However, in 1958, the 10-year U.S
treasury bond rate was a little above 3% (over 3 times higher
than Sanborn's return). Thus, I think it's fair to say that
Sanborn's map earnings in 1958 probably did not justify an
intrinsic value equal to the reproduction cost of its detailed
map assets.
- Conflicts of interest contributed to a decline in Sanborn's
map business. From Buffett's letter, it sounds as though the
insurance men on the board of directors acted in accordance
with their own self interests and those of the insurance
industry (and not in the interests of Sanborn's
shareholders).
:
What were the interests of the insurance men on the board?
Buffett states, "In the earlier years of the business, the
insurance industry became fearful that Sanborn's profits would
become too great and placed a number of prominent insurance men
on Sanborn's board of directors to act in a watch-dog capacity."
So, they were probably on the board to keep Sanborn's profits to
a minimum (which is exactly what every shareholder wants to
hear).
Let's take a look at the composition of the board, and the amount
of stock owned by the board members.
Prior to Buffett's entry on the board of directors, there were 14
directors. Nine of these directors were "prominent men from the
insurance industry who combined held 46 shares of stock out of
105,000 shares outstanding." For those of you doing the math in
your head, these nine directors from the insurance industry, as a
group, owned 0.044% (46/105,000) of the outstanding stock of
Sanborn - yet they made up 64% (9/14) of the board. Buffett also
notes about these nine directors: "Despite their top positions
with very large companies which would suggest the financial
wherewithal to make at least a modest commitment, the largest
holding in this group was ten shares. In several cases, the
insurance companies these men ran owned small blocks of stock but
these were token investments in relation to the portfolios in
which they were held. For the past decade the insurance companies
had been only sellers in any transactions involving Sanborn
stock." So, these nine directors from the insurance industry (and
their insurance companies) were not heavily invested in Sanborn
Map, yet they effectively controlled the board.
Of the remaining five directors, four recognized the problems
with the map business: a banker (who owned 10 shares, actively
pointed out the company's problems, and later added to his
holdings), two top officers of Sanborn (who owned about 300
shares combined, but were kept in a subservient role by the
board), and the son of a deceased president of Sanborn (whose
widowed mother owned about 15,000 shares of stock). The last
director was the company attorney (who owned 10 shares).
Buffett's letter implies that the insurance men on the board,
with an almost two-thirds majority, did not act in the best
interests of the shareholders. Instead, they protected their own
interests and those of the insurance industry. Let's take a look
at some of the actions of this board (controlled by insurance
men):
- Sanborn's board of directors resisted making changes of any
kind to the map business, even though four directors (a banker,
two top officers of Sanborn, and a son of a deceased president
of Sanborn) were in favor of trying to improve the map
business.
- In 1958, Sanborn's board accepted the resignation of the
son of the deceased president (after the board turned him down
for the top position in the company - a position he sought
because he was "unhappy with the trend of the business"). While
it is uncertain as to whether or not the son was qualified for
the top post at Sanborn, it does give the appearance that the
controlled board was not willing to give the top company
position to someone who wanted to change/improve the map
business. And remember, the son probably represented his
widowed mother -- and she owned a little over 14% of the
common's stock.
- Buffett states: "The very fact that the investment
portfolio had done so well served to minimize in the eyes of
most directors the need for rejuvenation of the map business."
The insurance men on the board must have been more than okay
with the status quo, because "the insurance companies were
satisfied with the price paid for maps." And while the
stockholders still received dividends, "these dividends were
cut five times in eight years although . . . [Buffett] could
never find any record of suggestions pertaining to cutting
salaries or director's and committee fees."
- Buffett notes that "there was considerable opposition on
the Board to change of any type, particularly when initiated by
an 'outsider,' although management was in complete accord with
our plan and a similar plan had been recommended by Booz, Allen
& Hamilton, Management Experts." So, the majority of the
controlled board was opposed to change of any type (even if it
was an attempt to reinvigorate the map business). In pursuing
the status quo, the controlled board opposed the
suggestions/recommendations of large shareholders, management
and a professional business consulting firm.
- Shortly after the son of the deceased president was turned
down for the top role at Sanborn (and resigned), the Buffett
partnership "made a bid to his mother for her block of stock,
which was accepted." It's pretty clear that Buffett purchased
this large block of stock from a motivated seller. The son of
the widow (who owned these 15,000 shares) had just resigned
from his seat on the board and no longer had any say regarding
the management of Sanborn. This widow might have decided that
the situation was hopeless or that it wasn't worth the trouble.
Whatever her reasons, it appears that she wanted out - even if
she had to sell at the depressed price prevailing at the time.
- The Buffett partnership's goal with the Sanborn investment
was "to separate the two businesses [investment portfolio and
map business], realize the fair value of the investment
portfolio and work to re-establish the earning power of the map
business. There appeared to be a real opportunity to multiply
map profits through utilization of Sanborn's wealth of raw
material in conjunction with electronic means of converting
this data to the most usable form for the customer." Buffett
realized that the way to maximize value with the Sanborn
investment was to realize the value of the investment portfolio
and work to re-establish the earnings of the map business. I
think we can infer from this passage that it was worth the
effort to try and re-establish the earnings power of the map
business. The last sentence in this passage is interesting:
Buffett recommends how Sanborn may be able to "multiply map
profits," and it's by putting the map data in the "most usable
form for the customer." Buffett is saying that Sanborn needs to
focus on giving the customer what he/she wants.
- Buffett states: "To avoid a proxy fight (which very
probably would not have been forthcoming and which we would
have been certain of winning) and to avoid time delay with a
large portion of Sanborn's money tied up in blue-chip stocks
which I didn't care for at current prices, a plan was evolved
taking out all stockholders at fair value who wanted out." I
find this passage interesting because Buffett could have won a
proxy fight and had the pleasure of seeing many of the
insurance men leave the Sanborn board, but that's not what he
did. Buffett wanted to "avoid time delay with a large portion
of Sanborn's money tied up in blue-chip stocks which ... [he]
didn't care for at current prices." So, a plan was created to
take out "all stockholders at fair value who wanted out."
Buffett was afraid that the value of the investment portfolio
would decline (it must have contained some overvalued
securities), and so he did the practical thing. He struck a
deal/compromise to avoid time delay. This deal also helped him
to realize a profit on his Sanborn stock sooner than he would
have otherwise. Obviously, Buffett didn't get maximum value for
his Sanborn stock (i.e. he left a little meat on the bone), but
he was able to exit with a nice profit. At the time, this might
have been the best choice available to him (given time value of
money considerations, current security prices, etc.).
- Finally, I think it's noteworthy that the remaining
shareholders (i.e., those that didn't exchange their stock for
portfolio securities) were also better off than before the
exchange deal. Buffett states: "The map business was left with
over $1 � million in government and municipal bonds
as a reserve fund, and a potential corporate capital gains tax
of over $1 million was eliminated. The remaining stockholders
were left with a slightly improved asset value, substantially
higher earnings per share, and an increased dividend
rate."
Well, that's all I have for now. Thanks for reading my general
thoughts on Sanborn Map. Next time, we'll take a closer look at
some of the numbers behind the Sanborn investment.
Links to other articles in the Buffett Partnership Series:
Previous article:
Buffett Partnership Letter Series - 1960 (Part
1)
Introduction:
Buffett Partnership Letter Series
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