Opinion

Felix Salmon

Charlie Munger’s BYD conflicts

By Felix Salmon
April 5, 2011

In April 2009, Marc Gunther wrote a glowing cover story for Fortune profiling hot Chinese automaker BYD, the recipient of hundreds of millions of dollars of Berkshire Hathaway’s money. The headline was “Warren Buffett takes charge” (charge, electric cars, geddit?), and two things were abundantly clear. The first is that Berkshire’s stake had catapulted BYD into the international spotlight and given the company invaluable credibility. And the second is that Charlie Munger was BYD’s biggest cheerleader, both before and after the stake was bought.

Buffett’s friend and longtime partner in Berkshire Hathaway, Charlie Munger, suggested early last year that they invest in BYD…

Buffett, who is 78, was intrigued by Munger’s description of the entrepreneur behind BYD, a man named Wang Chuan-Fu, whom he had met through a mutual friend. “This guy,” Munger tells Fortune, “is a combination of Thomas Edison and Jack Welch – something like Edison in solving technical problems, and something like Welch in getting done what he needs to do. I have never seen anything like it.”

Coming from Munger, that meant a lot. Munger, the 85-year-old vice chairman of Berkshire Hathaway, is a curmudgeon who frowns on most investment ideas. “When I call Charlie with an idea,” Buffett tells me, “and he says, ‘That is really a dumb idea,’ that means we should put 100% of our net worth into it. If he says, ‘That is the dumbest thing I’ve ever heard,’ then you should put 50% of your net worth into it. Only if he says, ‘I’m going to have you committed,’ does it mean he really doesn’t like the idea.” …

In acquiring a stake in BYD, Buffett broke a couple of his own rules. “I don’t know a thing about cellphones or batteries,” he admits. “And I don’t know how cars work.” But, he adds, “Charlie Munger and Dave Sokol are smart guys, and they do understand it.”

Nowhere in the article was there any indication that Munger owned a large stake in BYD before bringing it to Buffett.* And all over the article is the idea that Buffett bought his stake in BYD precisely because Munger was such a strong proponent of the company and its CEO.

But now, in the wake of l’affaire Sokol, Munger’s changing his story:

Munger, 87, said his family invested with money manager Li Lu in BYD through a partnership that has a stake of about 3 percent and that he urged Sokol, then the leader of Berkshire’s energy business, to scout the business.

“I had Dave look at it, because I knew I couldn’t talk Warren into buying into the damn thing by myself,” Munger said…

Munger said his family holds a “little more” than half of the fund with the BYD investment, and that he didn’t participate in Berkshire’s discussions on its deal.

“I recused myself,” Munger said. “But there’s no question about it, that I caused Dave’s original interest.”

What seems clear here is that Munger wanted to “talk Warren into buying into the damn thing”; that he got Sokol to visit BYD with that very end in mind; that Buffett would never have bought his stake in BYD without Munger’s active participation; and that in the wake of Berkshire’s investment, Munger’s stake skyrocketed in value.

Munger’s recusal, on the other hand, seems pretty weak tea. As BYD’s chief cheerleader and Warren Buffett’s right-hand man, it’s pretty much impossible to see how he could effectively recuse himself from discussions: his input had already been made and clearly understood by the time that any formal investment decision took place.

Which brings me back to the question of why Munger feels the need to trade for his personal account in the first place. Why create an unnecessary opportunity for what seems in hindsight to have been a huge conflict of interest? And why was Munger’s personal stake in BYD never disclosed until Sokol blurted it out on CNBC Thursday? It certainly looks as though he felt that he had something to hide.

*Update: Fortune’s Gunther, in the comments, says that there was a sidebar in the print issue of the magazine which never made it online. And that sidebar said this:

Warren Buffet may be BYD’s most famous investor, but Li Lu, whose company LL Investment Partners owns 2% of BYD, has quite a story of his own. Born in China in 1966, Li Lu was raised by foster parents after his were forced into labor camps during the Cultural Revolution. As a 10-year-old, he barely survived an earthquake that killed 250,000 in the city of Tangshan. Then things got really interesting: Li Lu became a leader of the pro-democracy movement that organized protests in Tiananmen Square in 1989, appeared on China’s Twenty-One Most-Wanted List, and escaped to New York, where he was embraced by the human-rights community and earned three degrees from Columbia. After stints at Allen & Co. and DLJ, he met Charlie Munger through friends and started his own investment fund; Munger, the Berkshire vice chairman, is his largest investor. Li Lu, who is not allowed to travel freely in China, politely declined to be interviewed by Fortune. When asked about Li Lu’s story, BYD CEO Wang Chuan-Fu says: “That’s past history. Today, Mr. Li and I share the belief that the best way to help China move forward is to make BYD a world-class company.”

A close reading here would seem to show that Munger did have a stake in BYD, via LL Investment Partners — although it’s far from clear, and certainly there’s no indication when Munger invested. But this is even more subtle than Sokol’s passing mention to Buffett that he owned shares in Lubrizol.

Update 2: The WSJ’s Susan Pulliam had more detail in July 2010, saying that Munger invested some $50 million with Li Lu in early 2004, who rapidly invested a lot of that money in BYD. She continues:

In 2008, Mr. Munger persuaded Mr. Sokol to investigate BYD for Berkshire as well. Mr. Sokol went to China and when he returned, he and Mr. Munger convinced Mr. Buffett to load up on BYD.

There’s no mention of Munger recusing himself from that decision in any meaningful way; the WSJ now says that Berkshire policies bar “trading in shares of companies in which Berkshire might invest”, without publishing the memo, giving the exact language, or saying whether Munger is covered by it.

Comments
9 comments so far | RSS Comments RSS

Felix, you raise some good questions here but I need to correct what I believe is a mistake in your post when you write “Nowhere in the article was there any indication that Munger owned a large stake in BYD before bringing it to Buffett.”

In the print edition of FORTUNE, there was a sidebar about Li Lu, the money manager who invested Munger’s money in BYD. I’ll copy it here but I think it’s clear that the Li Lu/Munger investment in BYD predated Berkshire’s:

Warren Buffet may be BYD’s most famous investor, but Li Lu, whose company LL Investment Partners owns 2% of BYD, has quite a story of his own. Born in China in 1966, Li Lu was raised by foster parents after his were forced into labor camps during the Cultural Revolution. As a 10-year-old, he barely survived an earthquake that killed 250,000 in the city of Tangshan. Then things got really interesting: Li Lu became a leader of the pro-democracy movement that organized protests in Tiananmen Square in 1989, appeared on China’s Twenty-One Most-Wanted List, and escaped to New York, where he was embraced by the human-rights community and earned three degrees from Columbia. After stints at Allen & Co. and DLJ, he met Charlie Munger through friends and started his own investment fund; Munger, the Berkshire vice chairman, is his largest investor. Li Lu, who is not allowed to travel freely in China, politely declined to be interviewed by Fortune. When asked about Li Lu’s story, BYD CEO Wang Chuan-Fu says: “That’s past history. Today, Mr. Li and I share the belief that the best way to help China move forward is to make BYD a world-class company.”

Posted by MarcGunther | Report as abusive
 

If he has to disgorge the stake, that could make BH’s shares more valuable –or they could even buy his shares. Either way, he wins, no?

Posted by klhoughton | Report as abusive
 

“Which brings me back to the question of why Munger feels the need to trade for his personal account in the first place.”

If he can’t have the company buy everything he believes in, there’s nothing wrong with him making personal bets. He obviously liked the company a lot; unless he sold his stake after BH’s investment drove the price up, or didn’t tell Buffet about the size of his investment, then he didn’t do anything wrong. What would be bad is if he bought his shares after BH started looking at it.

Posted by KenG_CA | Report as abusive
 

I’m not sure I really understand the conflict. Assuming WB knew that he was a beneficial owner of some BYD stock. I don’t think there is a regulatory precedent that stops someone who works for a holding company for owning individual equity names. It isn’t the same fiduciary responsibility as say a mutual fund or hedge fund manager having cross ownership of individual names that their fund also trades. Even in that latter case there are compliance structures/procedures that would allow the PM to hold those individual positions.

WB could have looked at BYD and been roundly uninterested and made those views public. This isn’t like insider trading where CM was front-running a known or high probability event. The price that WB would be willing to pay for BYD shares could never have been known a priori and that figure isn’t arbitrary or detached from whatever subsequent analysis non-interested parties provided WB.

I would find it very hard to believe that CM didn’t disclose his ownership to WB. That would be sufficient would it not? That’s all we ask of more overtly “idea pushing” money managers: disclosure. If I talk with my buddy who is an analyst at say Pershing (or any activist fund) about the company that I love as an activist position (and I tell him I own some of it) and then he looks at it and loves it and so does Bill and they pull the trigger on it. Have I done anything wrong? Does it matter if I know the analyst has a high opinion of me?

Posted by BRM3 | Report as abusive
 

Once again a clear example of sloppy journalism. Go back and read the print edition of the article and you will clearly see Munger’s stake is disclosed. Funny how everyone is all over Berkshire Hathaway these days. The recent events at Berkshire have zero impact on the intrinsic value of the business. Now is the time to buy.

Posted by ShortingReuters | Report as abusive
 

Dealbook also has an interesting post on this subject:

http://dealbook.nytimes.com/2011/04/05/t he-private-equity-parallels-with-buffett  /

Posted by dedalus | Report as abusive
 

Buffett and Munger have to RESIGN !

As soon as Sokol told Buffett that he purchased shares in Lubrizol, Buffett should have seen the RED LIGHTS flashing.

As for Munger, he explicitely recommended that Buffett bought shares in BYD.

Sorry, we loved them both, but they made big mistakes, and they have to go ! Not even an apology from Buffett yet ! What is he waiting for ??

Posted by JPhil | Report as abusive
 

According to today’s WSJ, Buffett had a published policy in place that “bars certain Berkshire officials from trading in public companies that may be involved in a significant tranaction with Berkshire.” Munger’s investment seems to be a violation of that policy.

Posted by Curmudgeon | Report as abusive
 

A pretty significant difference in the facts relating Munger’s investment in BYD is that he had invested in BYD “for years” before mentioning it as a potential acquisition for Berkshire and then recused himself from Berkshire’s consideration. At the time Munger invested in BYD, it likely wasn’t large enough to be a feasible investment for Berkshire Hathaway.

http://www.bloomberg.com/news/2011-04-05  /munger-says-he-told-buffett-of-byd-sta ke-stayed-out-of-berkshire-s-talks.html

Posted by bklawyer | Report as abusive
 

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