Why Buffett Would Never Buy Google

Yesterday on TickerHound.com, a member asked, “Would Buffett really buy Google?”

The question was based on a Fool.com article (click here to read it) that quoted this year’s Berkshire Annual Shareholder Letter where Buffett writes, “It's far better to have an ever-increasing stream of earnings with virtually no major capital requirements. Ask Microsoft or Google.”

I could see why this led some to wonder – and the Fool.com even wrote an article about it – if Buffett could potentially invest in Google. This made me laugh if for no other reason than Buffett mentions Microsoft in the same sentence…a company he knows intimately (considering Bill Gates sits on Berkshire’s board) but has yet to ever invest in.

But let’s leave that part out of the equation for a moment, let’s just look at the “Google angle” and try to answer the question: Would Buffett really buy Google?

For consistency’s sake, I’m going to analyze this in the exact same way the Fool.com article did:

Is The Business Simple and Understandable?

Definitely!

Google is an ad broker – plain and simple.

We can talk about their technology all we want – and believe me, that’s what makes their ability to broker ad dollars so effective – but at the end of the day, the way the company makes 99% of its money is by putting publishers and advertisers together.

That’s a pretty plain vanilla business to me (regardless of all the sophisticated search technology they have on the backend).

Do They Have Favorable Long Term Economics?

I’m going to skip this for a moment and come back to it at the end. You’ll see why below.

Is Management Candid and Competent?

I’d have to give the affirmative answer on this one as well.

The founders, Larry Page and Sergey Brin, both have the better part of their net worth’s tied up in Google stock. That means management’s interests and the share holders’ interests are certainly aligned – something Buffett always looks for in a company he’s buying.

And in terms of candor and competence – their execution speaks for itself and if you’ve read Google’s annual reports and even their S-1 filing, you’d know that they’re candid and up-front about how they manage their business.

So this item gets checked off the list as well.

Is The Price Right?

Here’s where we run into problems…

Buffett’s brilliance isn’t based on the fact that he knows how to value an asset…I know a lot of folks who can value an asset.

My father knew exactly what we should pay for our home when I was a kid.

I could tell you right off the bat how much I’d pay for new car.

In fact, Finance 101 teaches people basic asset valuation models – more specifically, Discounted Cash Flow analysis.

The ability to value an asset isn’t difficult…you just plug some numbers into the equation and you get your value.

The difficult part is making sure the NUMBERS themselves are the right numbers.

So now you’re probably asking, “How do we know if the numbers we’re using are correct?”

Well, you’ll never be able to tell if the numbers are EXACTLY correct – you’ll have to use your best judgment (and even then you’re probably going to be off, and that’s why in Ben Graham’s infinite wisdom he taught Buffett – and thousands of other value investors – to apply a “margin of safety” approach to business valuation…but that’s another story).

But here’s the caveat (and this goes back to the “Does the business have favorable long term economics?” question)…according to the Fool.com article, because the internet has favorable long term economic characteristics, and Google is by far and away the leader of the internet pack at the moment, they assume that Google will therefore have favorable long term economic characteristics as well.

But that just isn’t so…the tech sector is predicated upon the process of creative destruction. Companies must find new and innovative ways of doing things or they’re destined to become obsolete. I mean, how many times have we seen this happen in the last 10 years?

To argue that Google will ALWAYS maintain a competitive advantage in a space that changes by the hour is foolish (no pun intended).

That’s why Buffett only invests in mature companies that compete in mature industries. It makes the tough part of business valuation (using the right numbers) much, much easier.

So to answer the original question as simply as possible, would Buffett ever buy Google?

In my opinion...Not anytime soon!

Click here to leave your answer to this question.

Is Hershey the Value Play of the Year?

A great question appeared on TickerHound the other day that really caught my eye. One of our members asked:

“Is Hershey going to be the biggest value play of the year?

This has to be something Buffett would be licking his chops over - and not just because the chocolate is good - Hershey looks like Coke did back in the 80's. Getting hit by competition and internal problems but still has this ridiculous amount of brand equity and consumer reach.

My only question is, when do we buy?”

Click here to read some of the answers or submit one of your own.

Being that I’m a chocolate fanatic and an avid Buffett follower, the question immediately had my attention – I was even tempted to post a quick answer to it, but I decided to dig a little deeper and do my homework on this one.

Full disclosure: I do NOT own any shares in Hershey or any other company I discuss in this article.

So the story behind Hershey’s recent decline is this:

Back in January of 2007, Hershey’s CEO at the time, Richard Lenny, met with his counterpart from Cadbury, Todd Stitzer. Stitzer was proposing a merger between the two consumer food & beverage giants that would create a global candy making powerhouse.

Cadbury was willing to give up its beverage business (a huge point of contention between the two companies in the previous merger discussions they’ve had) as well as incorporate in Delaware, maintain a US stock listing and keep the headquarters in Hershey, PA.

Somehow, after that meeting, Mr. Lenny got into a major dispute over the merger with Hershey’s largest shareholder – The Hershey Trust Co.

The Hershey Trust was formed by the company’s founder, Milton Hershey, as a school for orphans which he eventually transferred all of his assets to, including his stake in Hershey’s chocolate. The trust currently owns almost 30% of Hershey’s stock, controls 79% of the voting shares and can remove 5/6 of the company’s board if it saw fit to do so…in fact, that’s exactly what they did do, as well as force Mr. Lenny out along with a number of other top ranking executives.

They say it had to do with Mr. Lenny’s withholding information about the proposed merger and Hershey’s growing financial problems. This is all disputed by a number of parties on both sides of the fence, so I won’t go into it here.

Now, the stock is down 31% in the last 12 months – the stock hasn’t been this low since 2000 – 2001.

For me, when a brand name like Hershey’s is getting beaten up in the market, it smells like an opportunity to make some money. So here are the pro’s and con’s for Hershey as I see it.

Positives:

• Largest candy maker in the US
• One of the strongest consumer brands in the country
• Aggressively moving into global markets
• In the process of integrating a massive overhaul of its supply chain in order to improve efficiency and reduce costs
• Stock has been hit hard and is at historically low prices

Negatives:

• 80% of its sales come from the US
• Brand reach doesn’t extend outside of the country
• International probe from US, Canadian and European regulators into whether Hershey (and several other candy makers) engaged in a concerted price fixing scheme
• Revenue and profits fell short in 2007
• Recent management and board shakeups have left the company in untested hands
• Still going to see roughly $200 million in operating charges next year in relation to its supply chain overhaul

Potential Outcomes

So the negatives seem to be outweighing the positives…for the moment, at least. The chart is in a solid downward trend and while it might’ve found support where it is now, I can’t see it moving dramatically to the upside anytime soon, especially with all the other uncertainties surrounding the company.

The new management and board have me concerned as well. Reason being, the folks who control Hershey’s Trust are all local Hershey, PA elites – not veterans from the candy business. It doesn’t give me that “warm and fuzzy feeling” knowing that the largest shareholder is making such dramatic changes based on one bad year and for feeling like they’ve been kept out of the loop.

So to answer the original question – the time to buy is not right now. I’d wait until this stock builds a base and starts trending upward. However, if you’re already a Hershey shareholder, I wouldn’t be too alarmed at the moment. We’re still talking about the largest candy maker in the US with one of the oldest and most powerful consumer brands in the country.

If the company doesn’t recover on its own, here are some other potential outcomes that will help shareholders see some serious upside in the stock:

• Merger with Cadbury: The Hershey Trust isn’t opposed to a merger with Cadbury – in fact, as they were planning to shakeup the company they held additional talks with Cadbury in New York late last year. While the two companies didn’t come to an agreement, I don’t see why the conversation couldn’t be picked up again, especially if Hershey’s stock continues to languish.

• Merger with Wrigley’s: A few years back Mr. Lenny architected a merger with Wrigley’s – the gum maker – again, Hershey’s Trust nixed the merger at the last minute. But again, if the stock continues to languish we could see some of these conversations pick up again.

At the end of the day I think it’s fairly clear to all parties that Hershey needs to diversify its business away from the US market. They need a partner overseas, especially in Europe, and Cadbury would be a fantastic fit in my opinion.

So while I wouldn’t be a big buyer just yet, my guns will be locked and loaded because at some point in the not-so-distant future, Hershey’s stock will become a part of my portfolio.

Click here to read some of the answers or submit one of your own.