One of Warren Buffett’s early investments profoundly influenced his approach to turnaround situations
Every investor goes through a process of discovery and growth while gaining experience, scoring early victories, and suffering inevitable setbacks. Reading about the triumphs and follies of others only goes so far. The searing feeling of working hard for money that you lose in a bad investment can only be appreciated through direct experience. It is equally valuable to understand that even successful investments of certain types can impose emotional costs that outweigh the profits.
Warren Buffett began to accumulate shares of Dempster Mill Manufacturing Company in 1956.1 Dempster was in the business of manufacturing and selling windmills and various types of farm equipment and was headquartered in Beatrice, Nebraska, a small town 100 miles from Omaha. The company was a classic “cigar butt” and was selling for $18 per share at a time when book value was $72 per share.2
The Buffett Partnership slowly accumulated shares of Dempster until Mr. Buffett controlled more than 70 percent of the outstanding shares by the middle of 1961. The stake accounted for a fifth of the partnership’s total assets. Although Dempster was a cheap business from a price to book value basis, the company was struggling to generate an acceptable return on invested capital.
After Mr. Buffett assumed the Chairman role at Dempster, he was faced with the decision of either liquidating the company or trying to fix the business to make it viable as a going concern. Faced with uncooperative management that appeared unwilling to change course, Mr. Buffett recruited Harry Bottle, an experienced operating manager recommended by Charlie Munger, to implement changes that dramatically reduced the capital requirements of the business. As a result, the company turned around and was significantly overcapitalized by mid-1963.
The goal of the reorganization was to allow Mr. Buffett to redeploy assets from an underperforming manufacturing business with a poor return on capital toward more productive uses. In 1963, Dempster’s operating business was sold, and excess cash and securities not required to run the business were distributed to shareholders. Ultimately, the Buffett Partnership nearly tripled its investment and netted a $2.3 million profit.3
While the final result turned out to be highly profitable for the partnership, by all accounts the process of achieving this result was very unpleasant for Mr. Buffett for a number of reasons.
First, the outcome depended on fixing a business that had been underperforming for years. It was only after hiring Mr. Bottle that a turnaround took place. This was hardly an inevitable outcome. Mr. Buffett only learned about Harry Bottle by speaking to Charlie Munger. If a skilled operating manager had not been found, the turnaround might not have taken place.
Second, the process involved layoffs and led to heavy criticism of Mr. Buffett in Beatrice since Dempster was a large employer.4 Although these layoffs and other cost cutting measures almost certainly prevented an eventual liquidation and a loss of all of Dempster’s jobs, the reputational damage of taking the steps to fix an ailing business could not have been pleasant, especially given the proximity of Beatrice to Mr. Buffett’s home town of Omaha.
One of the unpleasant tasks associated with fixing a business involves making changes at the top, and by all accounts this was a bruising experience for Mr. Buffett when he had to fire Dempster’s CEO. The process apparently did not go smoothly because Mr. Buffett later received a letter from the wife of the fired CEO accusing him of being “abrupt and unethical” and destroying her husband’s self-confidence. Mr. Buffett’s long standing aversion to firing employees probably dates back to his experience at Dempster.5
At the end of the restructuring process, Dempster survived, many jobs were saved, and the partnership had funds to redeploy elsewhere.6 But the process was unpleasant, to say the least. The investment was profitable for the partnership but at a high emotional cost for the manager.
Warren Buffett has obviously been in positions where he had to make changes at the top many times in the nearly six decades since his searing experience at Dempster Mill. Berkshire Hathaway’s textile operations underperformed for two decades before they were shut down in the mid-1980s. Managers at other subsidiaries had to be let go, and some situations were no doubt unpleasant. But Mr. Buffett’s stated goal has long been to acquire businesses that do not require turnarounds and have sound management in place. It seems likely that his aversion to taking on an activist role dates back to the criticism he faced in Beatrice, Nebraska in the early 1960s.
Does this mean that no one should take on an activist role? I don’t think that is the conclusion we should draw from this story. Some investors are comfortable taking a hands-on role in fixing a business even if it requires unpleasantness. There is nothing inherently wrong with doing this type of work assuming it is done in an ethical manner. In fact, capitalism would not work very well without this type of activity.
The lesson we should take away from Warren Buffett’s experience with Dempster Mill is that every investor’s temperament is different and there are many ways to win the game. It is counterproductive to participate in activities that make you miserable.
- This article has been partially adapted from a section of In Search of the Buffett Premium, a report on Berkshire Hathaway that I wrote in 2011.
- For a history of Mr. Buffett’s involvement with Dempster, I recommend Andrew Kilpatrick’s Of Permanent Value: The Story of Warren Buffett, Chapter 23.
- Buffett: The Making of an American Capitalist by Roger Lowenstein, Page 76-77.
- Lowenstein, Page 76.
- The Snowball: Warren Buffett and the Business of Life by Alice Schroeder, Chapter 25.
- As of 2011, Dempster was still in business in Beatrice, Nebraska and had operations in energy, recycling, water management, and agriculture. The company changed hands several times since 1963. It closed in late 2011 but manufacturing resumed in 2014. However, the company’s website is now inactive. The National Park Service’s Homestead National Historical Park has published an article describing Dempster’s long history.