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May 12, 1999

Interview with Legg Mason Focus Trust Manager
Robert G. Hagstrom

Part 3 Continued

YC: People see Berkshire and Buffett interchangeably -- Buffett as Berkshire, Berkshire as Buffett. Do you think Berkshire can continue to be successful after Buffett is gone.

Hagstrom: Absolutely. I'll tell you two things that will happen. The day that Buffett does get hit by the proverbial bus, the stock price is going to go down big, and Bill Miller and I will be the biggest buyers of Berkshire Hathaway on that day. The one thing you recognize very quickly about Berkshire is its decentralized structure and that there are operating managers at every single level, including Ajit Jain in super-cat, Tony Nicely at GEICO, and Rich Santulli at Executive Jet -- all these guys are very good at managing businesses.

Warren does two things exceptionally well: He allocates capital and he sets executive compensation. My guess is that they've probably institutionalized the executive compensation. That part's probably figured out. The question is, who can allocate capital as well as Warren? Well, nobody can. But Lou Simpson is there and there are other people that can allocate capital at least above average. My sense is that Berkshire will surprise people on its upside after Warren's gone, because he's figured out how to make it keep going without him. But the market will massively misprice that stock and we'll be buying every damned share we can get our hands on, because that will probably be the one last fire sale on Berkshire Hathaway.

DW: That's a funny thing, the assumption that in running his business, Warren Buffett is an uber genius, but when it comes to planning his succession, all of a sudden he's a dummy. That's a poor assumption, I think.

Hagstrom: A very poor assumption. He's very passionate about the Buffett Foundation and he really wants to leave money and devote that to two principal causes. My sense is that he hasn't thought this all the way through just to see his net worth plummet by three-quarters just because he didn't figure out how to make this thing work. My guess is that the market misprices it, but it'll be just fine.

DW: If I could jump on NASCAR for a second, I just wanted to say that The NASCAR Way was my favorite book, because I knew nothing about NASCAR before reading it. It was the most eye-opening to something I didn't know. International Speedway <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ISCA)") else Response.Write("(Nasdaq: ISCA)") end if %> and Action Performance <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ACTN)") else Response.Write("(Nasdaq: ACTN)") end if %> are top ten five positions?

Hagstrom: It's gotten down now. They're both about 5% positions. The reason is pricing on them. International Speedway is up probably 50% for us and the stock's now almost heading to 50 times earnings and it's a little ahead of itself. We want to own this stock, but we haven't [added to it]. As funds have come in, it's started to drop back down [in its weighting]. We love the business� we think International Speedway is great and we want to own it ten years from now. I think the France family is wonderful. I understand the returns on the business very well. I think NASCAR has still got a lot more to grow. At this price, the probabilities of beating the market over the next two years are probably not as high.

DW: It has probably already earned its 1999.

Hagstrom: Right. I don't want to let loose of the stock and have to re-buy it again.

DW: Now, something happened earlier this year that justifies some of that move up from around $40.

Hagstrom: The TV rights deal. That number doesn't hit until 2002. I think the market's already heavily discounting that. France down at Talladega said that he thought the $300-$400 million number for TV rights was probably right. So if you take the $400 million high-end number, and discount it back, that may be in the price right now.

DW: Do you think there's a positive feedback loop there, where you've now got this national package and that sucks in more people?

Hagstrom: I think things that make that more lucrative is if Fox gets in the game and wants to get in heavily, then that number will go higher. It depends upon how aggressive NBC gets. You figure CBS and ABC are going to be there, because they had 80-90% of the package and NBC just had a little bit. If Fox gets into this game in a big way -- because they run out of stuff after football and need something to carry them in the spring -- if the advertising revenues that the salesmen can start charging for each 30-second spot start to go up much faster, that number can change.

The thing where it ran into a little bit of a problem, and it's just probably catching up, is that the salesmen at ESPN and CBS have a Rolodex of people who they want to sell ads to, and they kept calling the same people at GM, Budweiser, and the like. When they tried to call somebody else that wasn't a typical NASCAR advertiser, there was some resistance to advertising on the sport, even though the demographics were there and the ratings were there. So what David Hall at TNN and CBS was saying was, "Our salesmen are having trouble bringing in more revenue, even though we've got the ratings and demographics; it's still the typical beer, auto, oil Rolodex that drives the advertising dollars for these things and we've got to figure out how to get Avon and that."

DW: And now 3Com is advertising. The one big insight I got from The NASCAR Way -- and I thought the book had many good insights -- that made it worth many more times its cover price, is your discussion of the loyalty factor and how much more loyal NASCAR fans are to the sponsors. If you're selling ads and marketing, you know what that means.

Hagstrom: Sponsorship-based marketing is huge and it's one thing I learned by doing the research. From what I get from the advertisers in the consumer products area that spend on TV, newspapers, and magazines is that they're very frustrated. They don't know what the return is and they're not sure they're getting their money's worth. The one thing about sponsorship-based marketing is that they know they're getting their money's worth and it's a high return investment. They can see the translation very quickly into product sales, whether they do a regional test or other ways. They want to allocate more money to sponsorship-based marketing because it's effective.

The only thing I see disruptive to that is how well the Internet works for advertising. That's the ultimate -- getting the message to you at your PC, where it gets one-on-one with the consumer, which is the most effective an advertising message can get. It comes to me, specifically on the product and the kind of message that will stimulate me to make that purchase. But my sense is that will probably be a number of years.

Bill Miller says in ten years we're all going to have a DNA card that has our genetic make-up. Well, in ten years we're probably going to have a genetic advertising make-up, and the advertisers are going to know that. That's what makes the Internet exciting. It could be a competition for sponsorship. That's what makes newspapers, magazines, and TV scary, because this one-size-fits-all advertising model just isn't going to work. You go to Procter & Gamble and talk to those people, and they're dying for the Internet to win. Why? Look how much money they're spending and they don't know what they're getting for it. They've got one message out there on the TV or one message in the newspaper. Obviously, not everybody is effected by that message. Some are and some aren't. They don't know that. Sponsorship-based marketing is huge.

DW: Back to Berkshire, why doesn't every general equity fund own a big slug of Berkshire?

Hagstrom: It used to be that there wasn't a research report on it, so the analysts couldn't figure out if they should buy it or sell it. But now Alice Schroeder at PaineWebber has the detailed report, so that can't be the answer. The misperception is also there that you're just buying a mutual fund, and that's obviously wrong. There are some institutional reasons why people can't buy stocks without dividends, so that holds back a number of people. It's not in the S&P 500, so that holds back some people. There's a lot of money that tracks the S&P 500.

If they solve the S&P issue and we get a couple more analysts following Berkshire Hathaway and more information gets out about what Berkshire is, as opposed to what it isn't, it seems to me that stuff breaks down. And clearly an $80,000 share price doesn't help. It doesn't matter, but it intimidates those that want to put it in the portfolio. It's never been an institutional holding. I think the reason why the stock is still working out sideways is there's still a rotational shift out of GenRe. You talk to the specialist [at the NYSE], he still says there's some old GenRe guys still coming out of the stock.

DW: The last comment I had for you is that I want to put a vote in for your next book. I think it should be The Charlie Munger Way.

Hagstrom: Well, apparently Janet Lowe is doing a biography.

YC: With his help?

Hagstrom: Well, she apparently beat him down. He basically gave in and said, "You're going to do it anyway, I guess I'd better pipe in there." She's a good writer. I think the next book is, and this is very much off the record�

* * *

That's where we turned off the tape recorders. The next book is, as you can see, a secret.

Just a note on the last question -- I believe it's impossible to figure out Warren Buffett and Berkshire Hathaway of today without knowing something about Charlie Munger. It would probably go too far to call Munger a Renaissance Man, but he's pretty much the modern equivalent. That's one of the reasons why Hagstrom's book goes into psychology and behavioral finance, probabilities analysis, and discussions of topics like complex adaptive systems or economic profit. Because the team of Warren Buffett and Charlie Munger have done so well in looking at the world from a multi-disciplined viewpoint, it would be pointless to analyze what they do from a fixed, doctrinaire standpoint. At some points, common modes in their approach and Hagstrom's approach are going to meet, and that's where you're going to hit on some elemental truths in what goes on with Berkshire Hathaway. You can see this to be the case where Hagstrom compares super-catastrophe insurance underwriting to focus investing, a conclusion with which Charlie Munger smilingly agreed.

There is no single answer to figuring out what makes Berkshire Hathaway, Warren Buffett, and Charlie Munger tick. There are objective facts that have to be identified and processed, but like a problem in geometry, there's more than one way to do a proof. The thinking process of Charlie Munger is imbued with the influences of many different disciplines and the conclusions he comes to are arrived at through using models from all these different disciplines. Those who want to understand Warren Buffett by clinging to a couple known and obvious influences in his life, such as Ben Graham, are going to miss the boat. Ben Graham was an enormously complex individual who was an accomplished scholar in a number of areas of life. It's probably no surprise that Buffett's Vice-Chairman and 40-year friend, Charlie Munger, exhibits these same characteristics. Rather than deviating from the known patois of Berkshire Hathaway discourse, I believe Robert Hagstrom actually introduces the reader to a style of thinking that is elemental to Berkshire. As Charlie Munger said at the annual meeting this year, The Warren Buffett Portfolio makes a real contribution. I agree wholeheartedly.

-- Dale Wettlaufer

I have nothing to add.

-- Yi-Hsin Chang (in Mungerian fashion)

Learn More About Buffett in Our Recent Special Feature

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