Credit: Shutterstock photoPart 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:
- 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).
- 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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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
