Wednesday, December 3, 2008

The Warren Buffett Way: Chp 7 Part 3: Equity Marketable Securities

In 1990, General Dynamics (GD) was the second largest U.S. defence contractor in the United States. The company focused on building nuclear submarines and armored vehicles. In 1990, the Berlin Wall was brought down signalling the end of America's cold war. Soon after the event, General Dynamics CEO, William Anders, realized that the defense industry had significantly changed and decided to reorganize GD's business.

Anders started selling off GD's business units and assets that did not display franchise like characteristics. Ander's only wanted GD to be in businesses that were market leaders and that could achieve a balance between research and development and production capacity. With significant cash on hand generated from the rationalization of GD's assets, Anders declared the company would buy back 30% of its shares as way of a Dutch auction. Warren Buffett took an interest in GD after Anders' announcement of the company's intent to buy back its shares.

By July 1992, Berkshire had acquired 4.3 million shares of GD. Buffet explains that "seeing an arbitrage opportunity, I began buying the stock for Berkshire, expecting to tender our holdings for a small profit." Buffett explains that after studying the company more intently, he became very interested in holding onto the shares due to the rational strategy that Anders was executing and the sense of urgency that Anders displayed in executing his tasks. Buffett also liked the fact that Anders was shareholder friendly.

Berkshire invested in GD's common stock at $72 per share and within two years, received $52.60 of dividends for each share held and witnessed the share price rise to $103 per share. Anders' actions of divesting the company's underperforming assets and returning the excess cash to shareholders resulted in a tremendous increase in shareholder value.

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