Felix Salmon

Reading Warren Buffett’s latest shareholder letter, I was struck by the number of times he talked about bolt-on acquisitions — situations where one of his subsidiary companies makes an acquisition of its own. They’re mentioned six times in this letter, and then at the end he mentions a “tuck-in” acquisition, which is essentially the same thing.

I wondered if he’d ever been so keen to talk about such things in the past, so I called up the last ten years’ worth of shareholders’ letters. He’s never used both terms in the same letter before, and he’s never used the term “bolt-on” more than once.

This could of course simply be random variation, but I think that something important is going on here. The big question, with Berkshire Hathaway, is how it’s going to invest its billions of dollars, especially now that companies like Swiss Re, Goldman Sachs and General Electric are exercising their options to return billions of dollars of emergency funding from Berkshire.

In the past, Buffett has talked about spending enormous sums buying very large companies: last year, for instance, he said that Berkshire will need “major acquisitions” (his emphasis), adding that “our elephant gun has been reloaded, and my trigger finger is itchy.”

This year, there’s no talk of elephants. Instead, various bolt-ons are scattered throughout the letter, Princeton Insurance being the only one mentioned by name. The rest are relatively small and anonymous. But I see a message here: just because you don’t see Berkshire bagging elephants, that doesn’t mean it isn’t growing by acquisition. It probably is, but just at the level of subsidiary companies, buying other companies you probably haven’t heard of and which probably aren’t big enough to warrant Berkshire’s shareholders being told the details.

Essentially, Buffett is saying “trust us: we’re growing, even if you can’t really see it.” But what you can see is the change in his language. The only real difference between a bolt-on and a tuck-in is that a bolt-on sounds bigger and more important. And so after using the term “tuck-in” seven times between 2006 and 2008, he’s now largely abandoned it. And the bolt-ons are coming thick and fast.

John Hempton singles out one 2002 acquisition which Buffett made and which has been extremely successful — but the fact is that the company in question was bought for $139 million and is now worth maybe $1 billion, after throwing off $180 million in cash. That is indeed impressive, but it doesn’t move the needle for a company with a market capitalization of $200 billion. You need a lot of such acquisitions to do that, and they don’t scale: they’re hard to find, and don’t come along every month.

At the beginning of every annual letter, Buffett compares the performance of Berkshire Hathaway’s book value to the performance of the S&P 500. Here’s two ten-year periods: on the left is 1973-1982, and on the right is 2002-2011.

What you’re seeing here is something that Buffett makes no secret of: it’s much easier to grow very fast when you’re relatively small than it is when you’re huge. Check out that run of growth beginning in 1975, in the first column: it’s simply astonishing. And even the relatively modest performance in 1973 and 1974 looks fantastic when you compare it to what the rest of the market was doing.

Buffett’s kept his ability to stay conservative and outperform in down markets. His two best years of the past ten, if you look at the “relative results” column, were — by far — 2002 and 2008, when the broad stock market fell a lot, but Berkshire’s book value did much better. And that’s largely an apples-to-oranges test in any case: after all, the book value of the S&P 500 didn’t fall nearly as much as its market value either.

If you look at Buffett’s own favored metric, the per-share book value of Berkshire, he’s had some good years of late, but nothing which even comes close to the numbers he was posting in the 70s.

That’s to be expected: big, mature companies don’t grow as fast as the best small companies. But when you’re a public company, shareholders’ desire for growth never goes away. Especially when, as at Berkshire, the stock doesn’t pay any dividends. As a result, every year Buffett does two things in his letter to shareholders. Firstly, he tries to downplay expectations as to how fast Berkshire is going to be able to grow going forwards. And secondly, he tries as best he can to explain where the future growth they want is going to come from. He’s consistent on the first part. But on the second he moves around a bit more. And this year, the message is that he’s going to encourage his subsidiary companies to make lots of acquisitions.

Why is Google buying Zagat, a company which has failed miserably online, rather than, say, Yelp or Tripadvisor? I suspect a lot of the reason has to do with its pseudoscientific ratings, on a 30-point scale: Google loves being able to quantify stuff. But those ratings are silly: they’re not at all comparable between markets (try a sushi joint in Long Island and then compare it to one in New York City with an identical food rating), and they suffer from enormous inflation.

On top of that, the one concrete datapoint that Zagat does provide — the cost estimate — is simply dreadful. Steve Cuozzo exposed this five years ago, and nothing has improved since then — you will basically never get out of a restaurant for the ridiculously low price that Zagat purports to think that a meal costs.

Zagat is mainly useful as a source of phone numbers and opening hours — information Google Places already has. Yes, it has a trusted reputation — but Google has that, too. And it has a massive global print-publishing business; I can’t for the life of me imagine why that’s something that Google wants to get into.

Most puzzlingly of all, Google’s Marissa Mayer refers twice in her short official announcement to Zagat’s “insight” — it’s “impressive” at first mention, and “tremendous” at second. Does anybody have a clue what she’s talking about? Zagat doesn’t do insight — that’s simply not the business it’s in.

So color me very confused at this weird entry into what looks very much like Old Media — something which was very useful before the mobile internet came along, but which has already been comprehensively disrupted by Google itself. Google is the future of information; Zagat is the messy and conflicted past.

Ethical questions about the Zagat guide abound — about the way that restaurants game their ratings, the things that diners will do for a free guide, and the way that Tim and Nina Zagat themselves are extremely chummy with the restaurateurs they’re judging in a supposedly objective manner. I hope Mayer and Google know what they’re doing, here. But it makes no sense to me.

The acquisition of Skype by Microsoft comes just in time for the Capitalyze conference in San Francisco, which I’m sure will be talking about this:

The biggest winner of this deal could actually be Facebook. The Palo Alto-based social networking giant had little or no chance of buying Skype. Had it been public, it would have been a different story. With Microsoft, it gets the best of both worlds — it gets access to Skype assets (Microsoft is an investor in Facebook) and it gets to keep Skype away from Google.

If Om’s right about this, then Facebook is just plain lucky that deep-pocketed Microsoft came along to keep Skype out of Google’s hands. If Facebook were public, on the other hand, then it could have just snapped Skype up itself.

I’ve already said that Facebook will go public — but for boring technical reasons, rather than for big strategic reasons like this. And so the question arises: is Om right? Does being public give companies the ability to make large strategic acquisitions, which are impossible so long as they’re private?

This particular case, like so many other cases where Facebook is involved, is exceptional. Skype’s owners, including Silver Lake Partners and Andreessen Horowitz, might well have been quite well disposed towards a deal where they sold Skype to Facebook and got a large yet illiquid chunk of Facebook in exchange. But I’m not sure if that’s even possible, the way that those funds are set up in Silicon Valley: while Silver Lake and Andreessen Horowitz are indeed investing in the likes of Facebook, they’re investing their new funds in those companies, rather than the old funds which invested in companies like Skype and are now reaching maturity.

In any event Om’s point is a good one: if a private company wants to make a big acquisition, that’s a lot easier if your stock is public than if it’s private.

Staying private, then is something which companies might like to do for much longer than they did in the past. But if you’re extremely ambitious and want to grow through the acquisition of large companies, then you pretty much need to be public. Look at Glencore: it desperately wants to buy Xstrata, and the only way it can see of doing that is by going public first.

I’m not entirely clear on why this should be. After all, private-equity companies make enormous acquisitions all the time, and they’re not public. (At least the funds making the acquisitions aren’t public.) It makes for an interesting intellectual exercise to wonder whether Facebook could borrow $7 billion or so to buy Skype, if it were so inclined. But of course it isn’t so inclined: that kind of leveraged buyout makes no sense in Silicon Valley, and Skype would be crushed under such a debt burden. The only remotely sensible way to borrow the money would be if it were a bridge to an IPO, and then at that point you might as well just IPO first.

But the lesson of Skype is that you never know when a big strategic opportunity might arise. And when it does, there will be some part of you wishing that you were public, if only for the option value it confers.

In the immortal words of David St Hubbins, it’s such a fine line between stupid and clever, and Nasdaq’s Robert Greifeld is walking that very line with his $11.3 billion bid, with ICE, for NYSE Euronext.

Why is the bid stupid? For one thing, it will be very hard to get past antitrust regulators. Even in a world where it looks as though AT&T is going to be allowed to buy T-Mobile USA, regulators are likely to look askance at a single exchange controlling substantially the entire market in US stock listings. And if Greifeld is denied his merger, the setback will be enormous. On top of that, as Antony Currie notes, the bid dilutes the Nasdaq’s current shareholders, and involves taking on a lot more debt to boot.

Aaron Elstein adds a few more reasons to the mix today. For one thing, there’s the touchy subject of the NYSE trading floor, which has stubbornly survived a series of CEOs philosophically inclined to abolish it. Greifeld seems to be doomed to be the latest name on that list: an electronic-trading enthusiast who’s lumbered with an enormous building on the corner of Wall and Broad for the sake of a huge trading floor he neither wants nor needs.

Greifeld’s also, of course, getting the commoditized, low-margin part of the NYSE Euronext business: the stock exchanges. The really profitable bit, the derivatives exchanges, is going to ICE. Here’s Elstein:

The stock exchange business, simply put, is lousy stuff these days. Profits have been squeezed for years, due to technological and competitive pressures, and the reason NYSE wanted to merge with Deutsche Börse in the first place was to turbo-boost its options-trading business.

And politically it’s far from clear that a Nasdaq takeover of NYSE is significantly better than a German takeover. Deutsche Börse promises $400 million in synergies, largely in Europe, while Nasdaq sees $610 million — and for “synergies”, here, read “layoffs”: Elstein thinks that a good 25% of the combined US employees of Nasdaq and NYSE could end up losing their jobs.

But in the final analysis, Greifeld had no choice here. Even a bad merger with the NYSE is better than being left out in the cold, a small, low-margin, marginalized exchange in a world of giants. His best-case outcome now is to become a large, low-margin utility — and that’s not a bad business to be in. Because the only thing dumber than overpaying for an acquisition is losing your relevance and market power altogether.

The WSJ has a great article today about that most fickle and capricious of creatures, the Goldman Sachs investment banker. He’ll sidle smoothly up to you, buy you a drink at the bar, even get in to bed with you — but it’s not you he wants, he’s really only in it for the money. And if your rich uncle raises his eyebrow in a suggestive enough manner, your paramour is suited up and out the door faster than you can say “secrets of the boudoir.”

A few months ago, the spurned lover was J Crew. Goldman was dating J Crew if not quite going steady: “from time to time over the past several years,” the proxy statement says slightly wistfully, Goldman had “prepared various illustrative financial analyses for the Company.” Ah, those were the days. But sadly they came to an end: a commitment to J Crew would never last long, seeing as how the company was about to be sold. An engagement with the mighty Texas Pacific Group, by contrast, was likely to be a much more lucrative union over the long term. Especially when TPG didn’t just want Goldman’s confidential advice, but also wanted to delve deep into its debt-finance facilities.

But that was just a warm-up for Goldman’s latest show of caddishness. Last summer wireless networking company Clearwire tied the knot with Goldman in a formal ceremony which involved paying a substantial dowry. Yet mere months later, having gotten to know the most private and confidential secrets of Clearwire’s special board committee, Goldman formally transferred its affections to Clearwire’s more buxom step-sister, Sprint Nextel. Oh, the betrayal!

Clearwire’s directors, report Anupreeta Das and Gina Chon, are “upset” — and you can see why! Clearwire was what’s known as a “sell-side client” — one where investment-banking fees are pretty much guaranteed. No matter who ends up buying the company, its financial advisers end up getting paid. Buy-side mandates, by contrast, are much less certain affairs: if you lose the bidding, your client won’t pay you much. Or even anything at all, in many cases.

And like good-for-nothing scoundrels, Goldman’s has decided to go very quiet when called on its behavior. It declined to comment to the WSJ, but did let it be known that “Goldman lawyers reviewed the relationships” before signing off on the treachery.

As if that’s likely to make the Clearwire directors feel any better. And of course they can’t even get their own back. Goldman’s cunning that way: he’ll get you to confide all your deepest and most private secrets. But he’ll never reveal any of his own.

NYSE CEO Duncan Niederauer doesn’t speak German, despite the fact that he was a Grand Marshal in the 2008 German-American Steuben Parade of New York. So we at Reuters (with many thanks a certain very senior editor who shall remain nameless) thought we’d help him out with a few phrases which might come in handy:

English: Dick Grasso? Before my time, sorry.
German: Dick Grasso? Sorry, der war vor meiner Zeit.

English: Daimler-Chrysler? I don’t see any comparisons there.
German: Daimler Chrysler? Also den Vergleich kann ich wirklich nicht verstehen.

English: The New York Stock Exchange is the cradle of American capitalism. It is a national treasure.
German: Die New Yorker Börse ist die Wiege des amerikanischen Kapitalismus — ein nationales Heiligtum.

English: Just because we’re German doesn’t mean we’re intent on world domination.
German: Nur weil wir deutsch sind, heisst das noch lange nicht, dass wir die Welt dominieren wollen!

English: I, for one, welcome my new overlords.
German: Also ich, fuer meinen Teil, heisse meine neuen Chefs herzlich willkommen!

Further phrases are left as an exercise for the reader. A few to get you started: “This is a merger of equals, not a takeover”, “Chuck Schumer? He’s just a passing acquaintance”, “Flying commercial hurts productivity and is a major security risk”, “Greed, for lack of a better word, is good”, “Co-located algorithmic high-frequency traders are important liquidity providers and are fundamental to the efficient allocation of capital on modern electronic exchanges”.

The $315 million that AOL is paying for the Huffington Post is roughly 3X the valuation seen at its last capital raise two years ago, is 10X its 2010 revenues and is roughly 5X estimated forward 2011 revenues. Those are all big numbers, but not insanely so, for what is clearly a big strategic move on the part of AOL. After all, AOL has a market cap of $2.3 billion: right now it still dwarfs HuffPo. That might not be true in a few years’ time, if HuffPo continues growing at its current rate and AOL continues to lose subscribers and revenues.

My feeling, then, is that this deal is a good one for both sides. AOL gets something it desperately needs: a voice and a clear editorial vision. It’s smart, and bold, to put Arianna in charge of all AOL’s editorial content, since she is one of the precious few people who has managed to create a mass-market general-interest online publication which isn’t bland and which has an instantly identifiable personality. That’s a rare skill and one which AOL desperately needs to apply to its broad yet inchoate suite of websites.

As for HuffPo, it gets lots of money, great tech content from Engadget and TechCrunch, hugely valuable video-production abilities, a local infrastructure in Patch, lots of money, a public stock-market listing with which to make fill-in acquisitions and incentivize employees with options, a massive leg up in terms of reaching the older and more conservative Web 1.0 audience and did I mention the lots of money? Last year at SXSW I was talking about how ambitious New York entrepreneurs in the dot-com space have often done very well for themselves in the tech space, but have signally failed to engineer massive exits in the content space. With this sale, Jonah Peretti changes all that; his minority stake in HuffPo is probably worth more than the amount of money Jason Calacanis got when he sold Weblogs Inc to AOL.

And then, of course, there’s Arianna, who is now officially the Empress of the Internet with both power and her own self-made dynastic wealth. She’s already started raiding big names from mainstream media, like Howard Fineman and Tim O’Brien; expect that trend to accelerate now that she’s on a much firmer financial footing.

Most interestingly of all, however, is the way that AOL is creating a new entity, the Huffington Post Media Group, to run all of its content business. Given that AOL CEO Tim Armstrong has repeatedly talked about how he wants to be a content company, one has to wonder what that means for the rest of AOL — a group of businesses which still throw off the vast majority of the company’s revenues but are strategically non-core. The question now has to be asked: is AOL really the right parent for the unique and very valuable HPMG? My guess is that as AOL continues to divest itself of non-core assets, HPMG will make it increasingly attractive as a takeover target itself. HuffPo was definitively sold off today. But it might wind up getting sold again in the none too distant future.

January 14: Cash-rich Canada banks shy away from acquisitions

September 15: Canada banks eye growth as capital shackles drop

December 17: Canada’s BMO buying U.S. M&I bank for $4.1 billion

December 21: TD Bank to buy Chrysler Financial for $6.3 billion

“The history of the Internet is, in part, a series of opportunities missed,” says Jim Surowiecki in this week’s New Yorker. Blockbuster could have bought Netflix for $50 million dollars; Excite turned down the chance to buy Google for less than $1 million.

But how valuable were those opportunities, really? If Blockbuster had spent $50 million on Netflix, then it would just have run out of money that much more quickly. There’s no chance that Blockbuster’s management would have let Netflix grow, unencumbered, in the way that it did independently. Similarly, Google would have been stifled as part of Excite: it would have been nothing more than one of many search algorithms competing on the internet.

Buying internet companies is very, very hard: even if they are set to be very successful on their own, that’s no reason to believe that they will have similar success in-house. Google bought Foursquare back in 2005, when it was called Dodgeball, but then closed it down; only when its founders left Google and recreated the company as Foursquare on their own were they able to succeed.

And so I’m suspicious that Surowiecki’s employer, Conde Nast, is going to do well with its new $500 million warchest. Conde is rich, and can buy companies, but at that point the problems start: it’s always much easier to spend money on acquisitions than it is on internal growth, with the result that those acquisitions can end up starved of money. Conde is a particular case in point: it bought Reddit and neglected it so badly that the site ended up having to run a pledge drive to raise needed funds.

Big established companies with their own revenue streams simply don’t have the skillset needed to be the next Y Combinator or Softbank, and they probably shouldn’t try. If Conde is smart, it’ll restrict itself to taking minority stakes in companies where it can be strategically helpful. Otherwise, it’s liable to end up looking like News Corp with MySpace.

Vinicius Vacanti has a very smart analysis of the economics of Groupon, which also helps explain why companies like OpenTable are trading at such stratospheric valuations. The real value of Groupon lies in its email list. But Groupon’s list is a list of bargain-hunters. Companies with large lists of people who have already demonstrated their ability and willingness to pay full price—companies like OpenTable—can present an even more attractive proposition to would-be advertisers.

This doesn’t mean that Google’s overpaying for Groupon at $6 billion. No one else has cracked the local-advertising-online conundrum nearly as well as Groupon has, and, as Evelyn Rusli points out, the multiples involved are significantly lower than Google has paid for other acquisitions. Besides, shareholders want Google to put its enormous cash pile to good use and try to get a decent return on it, rather than letting it just sit there gathering dust or returning it to shareholders who wouldn’t know what to do with it either.

There’s also something a little snobbish about the criticism of the deal:

Despite Groupon having some social media trappings, and being profitable, it feels oddly old-fashioned.

Groupon amasses groups of users to take part in mass one-off discounting programmes by retailers – hence the name. In the US, where coupon-clipping is still popular, despite the power of Wal-Mart’s “every day low prices”, it grown very rapidly…

Buying an electronic coupon company? Is this the way to revolutionise the world?

No, it’s not a way to revolutionize the world: Google’s good at growing those in-house. Instead, it’s just a natural way for Google to expand its ad revenues: it started with simple text ads, moved into display with the acquisition of DoubleClick, got into mobile with AdMob, and is now doing coupons.

Sure, there’s defensive strategy involved here: Google doesn’t want Groupon ending up in the hands of Facebook or Yahoo. But Jon Fortt, when he says that Google would be better off buying Gannett, does a good job of presenting Google’s dilemma. Local advertising dollars have historically flowed into local media companies, and Google has no desire whatsoever to be in the business of producing local media. It wants to be a pure advertising play, with no editorial content of its own. And it also wants to be online: its attempt at selling print ads was a disaster.

Groupon gives Google access to a whole new market segment it otherwise would have great difficulty reaching. Maybe the acquisition will turn out to be overpriced. But Google can afford to make a $6 billion mistake. So the risk is worth taking.

If you want to hone your financial-media reading skills — if you want to be an active, critical reader of the financial press — then here’s an exercise for you: find an important study of some kind which has been reported in many different places. Read the study, and then read the different stories reporting on it. Then, ask yourself about the degree to which the reports accurately sum up the contents of the study. The result is what I like to call a report report report, and it’s a great way of keeping readers alert.

There’s a great example right now: the Canadian conference board’s report on the effects of a takeover of Potash Corp. It’s been widely covered, and a look at that coverage is if anything even more illuminating than the report itself.

The first thing that jumps out at you is that no one actually bothers to link to the report. (Very honorable exception: The Canadian Press.) The NYT does provide a link where it talks about “the Conference Board of Canada”, but hilariously the link leads to a page of NYT stories about the Conference Board of the US. It’s not that the link is exactly hard to find: it’s splashed across the top of the board’s home page. But for some reason the place where readers can find the report on the internet is not considered important information by anybody covering it.

But how’s the journalism itself? I think the Canadians have acquitted themselves best on this front. The Canadian Press report, out of Regina, does I think the best job of summarizing the study, as well as being the only place with a link to the study itself. Here’s how it begins:

A successful takeover of Saskatoon-based PotashCorp could slash the province’s revenues by at least $2 billion over the next decade while having little or no net effect on employment, according to a report commissioned by the province.

Rob Gillies of the AP in Toronto also produces a good straight-down-the-line summary:

BHP Billiton’s potential hostile takeover of Potash Corp. would have few negative effects on the province of Saskatchewan but could reduce the government’s revenues by at least $2 billion over the next 10 years, a Saskatchewan government-commissioned report released Monday said.

But the minute that you start looking at the foreign press, things start getting messy. The WSJ throws three reporters at the story, and manages to produce a lede which is simply wrong:

BHP Billiton Ltd.’s bid for Potash Corp. of Saskatchewan Inc. could be beneficial to the province, especially in the long term, while a potential offer for the fertilizer giant from a state-owned Chinese company would pose a bigger threat to the local economy, according to a report commissioned by the provincial government.

Well, the “bigger threat” bit is right — but the thing about bigger threats is that they tend to be compared to smaller threats. While the WSJ makes it sound like the BHP bid isn’t a threat at all, and in fact “could be beneficial to the province, especially in the long term”.

I have no idea where the WSJ finds that conclusion in the report: I certainly can’t find it. The word “beneficial” appears nowhere in the report, which explicitly comes with an end point of 2020, ten years away. Over the course of those ten years, the report finds that a takeover by BHP would reduce tax revenues by $2 billion; beyond those ten years, it can’t really say. It’s possible that BHP investment in something called the Jansen Lake project will pay off for the government in terms of new economic activity — but that won’t happen until 2026 at the earliest. That’s very long term. And there’s nothing at all in the report, that I can see, that stresses any long-term benefits of a BHP takeover over a non-takeover option. All of these bars point downwards:

I don’t know about you, but my reading of this chart says that tax revenues will decline over the short, medium, and long term if BHP buys Potash Corp. (That’s the blue bars.) And they could decline even further if BHP becomes desperate for revenue and starts running Potash at full production. (That’s the red bars.) BHP promises it wouldn’t do that, but as the Globe and Mail points out, promises from big foreign miners are often broken.

Yet somehow the WSJ concludes, in the words of its picture caption, that “a report found that BHP’s bid for the company could be beneficial for Saskatchewan”. Very odd. Yes, there are silver linings — a BHP takeover would prevent an even worse Chinese takeover, for instance, and being open to foreign takeover bids “would ensure that Saskatchewan’s turn in the spotlight encourages the sustained investment in the province that is vital to Saskatchewan’s long-term economic prosperity”. But there’s little if anything which says that the takeover itself would help the province.

I think that the problem here is that the financial press is looking at this as a deal story, and from that perspective the report makes a deal slightly more likely than it was before the report was released. Ergo, the report must be positive!

The Reuters story makes this connection very explicit, saying that the report favors a BHP deal over a Chinese deal, and highlighting the effect of the report’s release on the Potash share price. Meanwhile, Marketwatch comes up with the dreadful headline “BHP’s bid for Potash has ‘few negatives’: study”. That headline clearly implies that it’s quoting the report on the “few negatives” front, but that phrase never appears in the report, and I have no idea where it came from.

It’s instructive to compare these finance-based stories with the much more downbeat NYT story, which leads with the potential revenue losses for Saskatchewan, and which I think does a better job of conveying the report’s substance.

Of course, very few people have the time or inclination to read the original study, let alone all the stories reporting on it. But once you start reading these things critically, red flags start appearing. The WSJ lede about the study’s upbeat conclusions, for instance, conspicuously fails to be backed up by any quotes from the report or even any paraphrase of what the long-term benefits of a takeover might be. That’s a giveaway, really. Journalists hate leaving opinions unsupported, and when you see an opinion unsupported like that, it’s often a sign that it’s unsupportable.

Which raises the question of what it’s doing in the paper at all. But that’s a bigger story, which has something to do, I think, with the constant pressure on journalists to “add value” in the form of analysis and conclusions. Sometimes, you won’t be surprised to hear, they’re not very good at that.

The UK’s FSA has conducted an investigation into the way that big M&A transactions can get leaked before they are formally announced. Its conclusion might shock you, so make sure you’re sitting down for this:

Our enquiries revealed that media reports containing leaks were often closely preceded by telephone conversations between insiders occupying senior roles on a corporate transaction, and the journalists who published those media reports. Due to their position as insiders, these senior individuals held detailed knowledge of the transaction. The calls between the insiders and journalists lasted up to 20 minutes in length and in some cases took place with journalists the afternoon or evening before the leak was first published.

The FSA is unhappy about this: “leaks ahead of announcements pose a threat to market integrity”, they write. But never fear, they’ve worked out how firms should deal with this problem:

Regulated firms should have a robust and detailed media policy…

Internal policies should require all initial media enquiries received by a regulated firm’s staff to be immediately directed to the firm’s media relations team…

Internal policies should also require that once an initial media enquiry has been passed to a regulated firm’s media relations team, the media relations personnel should review the enquiry to decide if it potentially relates to inside information…

If the enquiry potentially relates to inside information, [and] if it is necessary to involve non-media relations personnel, the media relations team must only grant authorisation to other staff members to communicate with the media… where the conversation between the other staff member and the journalist is held on a recorded telephone line.

There, that should do the trick. I’m sure that from here on in, there will be no more M&A leaks in UK newspapers. I only wonder why the SEC hasn’t figured this out yet.

(HT: PTL)

Citigroup famously paid $800 million for a young and doomed hedge fund, Old Lane, just so that it could hire its founder, Vikram Pandit. No one thinks that decision was a good one, in hindsight. But JP Morgan is setting its sights rather higher, looking to buy Gávea Investimentos, along with (one presumes) its founder, Arminio Fraga.

The price would certainly be higher than $800 million, but then again Arminio (as he’s universally known) is a much juicier catch than Vikram. After cutting his teeth successfully running large amounts of money for George Soros, he more or less singlehandedly gave much-needed credibility to the Brazilian central bank in the wake of the Russia crisis and through Argentina’s default. Facing a monster liquidity crisis and spreads of more than 2,000bp over Treasuries, Fraga navigated the markets and the multinationals masterfully, setting the stage for the improbable yet lucrative embrace of Lula’s left-wing government by the international markets.

Now that Arminio has become dynastically wealthy through setting up Gávea, he might just see one last act left in his life, taking over the House of Morgan and solving Jamie Dimon’s succession dilemma. But he’s only one year younger than Dimon, who shows no signs of wanting to leave, and in any case it’s hard to imagine Arminio moving back to chilly New York from his beloved Rio.

That said, I can’t imagine that JP Morgan would be happy simply leaving Arminio where he is; at the very least they’d be likely to give him some sort of oversight at Highbridge. That would quintuple Arminio’s assets under management at a stroke. My guess is that a JP Morgan board seat is probably on the table as well. Whatever makes Arminio happy: there’s really no point in JP Morgan buying Gávea if he just turns around and leaves shortly after the acquisition. His investors are loyal, and their money would be sure to follow him out the door.

One thing I can’t quite understand, though: why is JP Morgan putting what is presumably quite a lot of effort into trying to acquire Gávea now, given that they’re not going to close until after the financial regulatory reform bill has been signed and there’s a lot more clarity on what they’re allowed to do on the buy side? Why not wait and see how powerful the Volcker rule ends up being, before getting deep into negotiations? Is there urgency here to buy Gávea? And if so, what is it?

John Gapper and Nadav Manham have both picked up on Warren Buffett’s explanation of how he thinks about M&A, especially when a company is paying with stock:

Kraft, in my judgment, well just in the past two weeks there’s been two things that caused me to feel poorer. They sold a very fine pizza business and they said they got $3.7 billion for it. But, because it had practically no tax basis, they really got about $2.5 billion. They sold a business for $2.5 billion that Nestle is willing to pay $3.7 billion. Now can Nestle run it that much better than Kraft? I doubt it. But that business that was sold for $2.5 billion earned $280 million pre-tax last year. But they sold that at less, right around nine times pre-tax earnings in terms of their own figure.

Now they mentioned paying 13 times EBITDA for Cadbury, but they’re paying more than that. For one thing, EBITDA is not the same as earnings. Depreciation is a very real expense. But on top of that, they’ve got a billion-three they’re going to spend of various rearrangements of Cadbury. They’ve got $390 million of deal expenses. They are using their own stock, 260 million shares or something like that, that their own directors say is significantly undervalued. And when they calculate that 13, they’re calculating Kraft at market price, not at what their own directors think the stock is worth. So, the actual multiple, if you look at the value of the Kraft stock, is more like 16 or 17 and they sold earnings at nine times. So, it’s hard to get rich doing that.

There’s a lot of very smart analysis packed into this extemporizing (Buffett was talking on TV). Kraft is selling a business for $2.5 billion, after taxes, which throws off $280 million a year. Yet it’s buying Cadbury at a much higher multiple than that, and it’s paying in undervalued stock.

In general, you see many more stock-based acquisitions when companies are overvalued than when they’re undervalued. (Think of AOL buying Time Warner, or for that matter just about any acquisition by WorldCom.) It’s even possible to use stock-based acquisitions as an indication that a company thinks its shares are trading at too high a level. But sometimes, as Buffett notes, companies will use their stock even when it’s undervalued. And that can be very bad for existing shareholders.

All of which raises the question: what are we to make of the fact that Bufffett himself is using Berkshire Hathaway stock to buy Burlington Northern? Does it mean he thinks that his stock is overvalued? Or, if he thinks BRK is undervalued, does that mean he’s making a similar mistake to that which he deplores at Kraft? Either way, there seems to be an implicit “sell” signal here. Or is there something I’m missing?

So, that happened. Guess I was wrong about this. But if you’re never wrong, you’re never interesting, nicht wahr?