Friday, January 23, 2009

Alice Schroeder: Mid-Continent Tab Card Co.

During her presentation, Schroeder provided a fascinating case study of a private investment Buffett made in 1959 in a company called Mid-Continent Tab Card Company. At the risk of sounding technical, tab cards were something used in computers back in the day. At any rate, with over 50% profit margins, selling tab cards was IBM’s most profitable business in the 1950s. As a result of a settlement with the Justice Department, IBM was forced to divest of its tab card business. A couple of Buffett’s friends, Wayne Eaves and John Cleary, had started a tab card company themselves in the mid-to-late 1950s. It was an extremely profitable business. Tab cards were made on what was called a carel press. They were turning their capital over 7x per year while earning 40% net profit margins. In 1959 they were looking to grow this profitable business which required buying more carel presses.

So, in 1959 Eaves and Cleary approached Buffett to see if he had any interest in investing in the company. This is where Schroeder’s presentation gets interesting as she describes the process Buffett went through in deciding if he wanted to invest in the business and the return criteria he desired for putting up the money. I suspect the first thing that most analysts would do when presented with such an investment opportunity is to ask for management’s financial projections and then create a discounted cash flow model. According to Schroeder, Buffett did none of this. In fact, given complete access to all of Buffett’s files, she never once saw anything remotely resembling a financial model. Instead, he analyzed on a quarter-by-quarter and plant-by-plant basis, the historical profit and loss statements for both Mid-Continent and all relevant competitors. From there he acted like a horse handicapper figuring out which one or two factors would make the horse succeed or fail. In the case of Mid-Continent it was sales growth and cost advantages. When presented to Buffett in 1959, the company had $1 million in sales, was growing at 70%+ per year and earning 36% profit margins. According to Schroeder, the ultimate decision to invest came down to the question, can I get a 15% return on $2 million of sales. The answer in his mind was yes, so Buffett invested $60,000 of his non-partnership money representing 20% of his net worth. This investment gave him 16% of the company’s stock plus some subordinated notes.

As one would expect the Mid-Continent investment turned out quite well for Buffett. Over time he put another $1 million in the company, which would later be renamed Data Documents. The company was sold in 1979 to Dictograph. Buffett held the investment for 18 years earning a 33% compounded annual return…sign me up!

What was interesting to me from this case study was that he did not seem to bother himself with projecting revenue and profits out five years, did not grind over whether to use a 10% or 12% discount rate, nor worry about which terminal multiple to use. There certainly was no investment banker’s “book.” Instead, he approached the investment wanting a 15% “equity coupon.” From there, he had to decide for himself whether it was a cinch to get such a return while relying solely on analyzing historical profit and loss statements.