How Charlie Munger Turned Wesco Financial Into a Mini Berkshire Hathaway
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In June 2011, Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) acquired the 20% of Wesco Financial that it did not already own, bringing the financial group's life as an independent business to an end. To understand how Berkshire came to own 80% of the business in the first place, we need to take a look back to its distant past.
Berkshire and Wesco
Warren Buffett (Trades, Portfolio) first started buying shares in Blue Chip Stamps, a trading stamp company, for his investment partnerships in the 1960s. He wasn't the only investor buying the stock, however. Charlie Munger (Trades, Portfolio) had also been acquiring shares in the business, and so had Munger's friend, Rick Guerin.
When Buffett's partnerships were dissolved in 1969, investment assets were distributed to partners. This meant Buffett himself became a substantial investor in a handful of individual companies. In 1971, Buffett and his wife owned 13% of the Blue Chip business, and Berkshire, another company Buffett had been buying, owned 17% (the Buffetts owned 36% of Berkshire at the time). Munger's investment partnership owned another 8%, and Guerin owned 5% of Blue Chip. Effectively, these three investors owned the majority of the company's outstanding shares.
Blue Chip had an investment portfolio, where it invested the money it earned from consumers who had purchased its stamps to earn a return. When they took over the business, Munger and Buffett used this cash to buy a handful of other businesses, including See's Candy and Wesco Financial, among others.
Blue Chip had started buying shares in Wesco in 1974. The group was the parent company of a small Pasadena-based savings and loan institution named Mutual Savings.
Savings and loan
The savings and loan institution almost instantly became a headache for the group. By the group, I mean the collection of companies Munger and Buffett had acquired by the middle of the 1970s.
By the early 80s, the government had begun to deregulate the so-called thrift industry, leading to changes Munger, in particular, was unhappy with. As chairman of the business, he began to diversify and moved into other sectors, which he believed would strengthen and grow the group.
By the middle of the 1980s, Wesco was starting to transform into a mini Berkshire. In 1987, the group paid $100 million to join Berkshire in its $700 million fundraising for Solomon Brothers. The deal left Wesco with 100,000 newly issued shares of Series A Cumulative Convertible Preferred Stock of Salomon Inc.
Following this deal, in 1989, Munger decided to dramatically increase Wesco's investment in the Federal National Mortgage Association, commonly called Fannie Mae (FNMA).
According to Janet Lowe's book, "Damn Right! Behind the Scenes with Berkshire Hathaway Billionaire Charlie Munger (Trades, Portfolio)," Wesco used Mutal Savings to buy 28.8 million shares in Freddie Mac for $72 million. At that time, only thrifts could buy Freddie Mac stock, and Munger took the maximum allowed by law.
Munger's decision to diversify into other businesses and financial assets ultimately helped Mutal and Wesco avoid the coming financial storm and the collapse of the savings and loan industry, which became one of the biggest financial disasters in the history of the United States.
In 1992, Mutal gave up its thrift business and liquidated associated assets, leaving Wesco as a pure financial holding company.
Using cash to leverage returns
What's interesting about Munger and Berkshire's association with Wesco is that it is another example of how Buffett and Munger used the capital of other companies throughout their career to accelerate Berkshire's growth.
Munger used the capital of Wesco's subsidiary, Mutal, to build a large investment portfolio, which helped the company diversify away from the struggling savings and loans sector and helped turn it into a financial powerhouse.
By 1999, Wesco's investment portfolio was worth $2.8 billion. The largest holding in this portfolio was Freddie Mac, with a value of $1.9 billion.
This article first appeared on GuruFocus.
