Warren Buffett: His Net-Net Investment Does Amazing!
UNION STREET RAILWAY
Union Street Railway is a good example of a terrible business that paid off handsomely for Buffett. The business prospered during the war years as rubber, steel, and other commodities were diverted from consumer goods to military equipment. As a result, consumers bought fewer vehicles so Union Street's ridership was strong. The company experienced a significant drop-off in revenue passengers, from 27 million in 1946 to just 14 million by post-war 1953. Profits eroded and the firm started losing money.
The stock dropped in sympathy with the firm's poor post-war showing, from a high of $50 in 1949 to $25 two years later. When Buffett found it, its price had recovered to $30 per share, but he still felt value dwarfed the market price: "I started buying the stock because they had eight hundred thousand dollars in treasury bonds, a couple of hundred thousand in cash, and outstanding bus tickets of ninety-six thousand dollars. Call it a million dollars, about sixty bucks a share."
Buffett was buying in at less than 50% of net-net working capital, but he had other reasons to be optimistic. Aside from working capital, the firm owned a significant amount of fixed assets: 116 buses, an amusement park, plus special reserves, other land and buildings, and car barns where it stored old streetcars.
It was clear that the firm had a massive amount of value on offer for a very cheap price, so Buffett began buying heavily. But he wasn't alone. Management were keen to exploit the situation and began buying back shares, running an advertisement in the local paper to attract sellers. This amounted to buying undervalued assets for remaining shareholders, a tactic that would disproportionately increase the value of their shares and attract investor interest. Buffett, keen to buy as much of the stock as he could, matched management by running his own ad. Eventually he obtained a list of the firm's largest holders and contacted them directly.
Not yet satisfied with management's actions, Buffett decided to pay company head Mark Duff a visit to see if he could get his hands on some of the firm's cash:
"I got up at about four a.m. and drove up to New Bedford. Mark Duff was very nice, polite. Just as I was about ready to leave, he said, 'By the way, we've been thinking of having a return of capital distribution to shareholders. ' That meant they were going to give back the extra money. And I said, 'Oh, that's nice.' And then he said, Yes, and there's a provision you may not be aware of in the Massachusetts statutes on public utilities that you have to do it in multiples of the par value of the stock The stock had $25 par value, so that meant it would be paying out at least $25 per share. And I said, Well. That's a good start. Then he said, Bear in mind, we're thinking of using two units. ' That meant they were going to declare a fifty-dollar dividend on a stock that was selling at thirty-five or forty dollars at that time."
That special dividend provided Buffett with an enormous short-term profit. Having bought in at $30 per share, his $50 dividend amounted to a 167% yield. Even better, he still hung on to the stock which represented a significant amount of value in fixed assets. Alice Shroeder notes that Buffett's $20,000 in profit was several times the average American's yearly salary.
Was Buffett instrumental in management's decision to redistribute capital? Nobody can know for sure, but the experience encouraged him to become more active in the firms he bought.
Source: Benjamin Graham's Net-Net Stock Strategy/ Harriman House