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Andrew Ross Sorkin: A Warning From Buffett About Banks

"Money-shufflers don't come cheap."

That was Warren E. Buffett's latest salvo against Wall Street from his annual letter to shareholders published over the weekend.

Mr. Buffett has long ridiculed the financial industry, but this year's letter, laced with references to bankers, lawyers and consultants as "a lot of mouths with expensive tastes," seemed to amp up the pugnacity and was clearly noted by the industry, which pored over the letter.

Mr. Buffett used his annual letter not only to describe the performance of Berkshire Hathaway but also to warn — or educate — his faithful followers about "the Street's denizens" and how they "are always ready to suspend disbelief when dubious maneuvers are used to manufacture rising per-share earnings, particularly if these acrobatics produce mergers that generate huge fees for investment bankers."

At one point in the letter, Mr. Buffett argues: "Investment bankers, being paid as they are for action, constantly urge acquirers to pay 20 percent to 50 percent premiums over market price for publicly held businesses. The bankers tell the buyer that the premium is justified for 'control value' and for the wonderful things that are going to happen once the acquirer's C.E.O. takes charge."

He goes on to say that "a few years later, bankers — bearing straight faces — again appear and just as earnestly urge spinning off the earlier acquisition in order to 'unlock shareholder value.' Spinoffs, of course, strip the owning company of its purported 'control value' without any compensating payment."

No doubt, Mr. Buffett speaks the truth. There are countless examples of the build-it-up-and-tear-it-down phenomenon, most recently illustrated by Hewlett-Packard, which grew through mergers and now plans a series of spinoffs.

And Mr. Buffett's views have clearly endeared him to the public, making him one of the few billionaires beloved by the masses. He often talks about raising taxes on the wealthy and the need to close the inequality gap.

But as Mr. Buffett often points out the foibles of the finance industry, he also extols the personal virtues of some of the biggest names in investment banking. Berkshire owns a stake in Goldman Sachs, and Mr. Buffett has talked publicly about owning shares of JPMorgan Chase in his own account.

Of Lloyd Blankfein, Goldman's chief executive, Mr. Buffett once said, "If Lloyd had a twin brother, I would vote for him." Of Jamie Dimon, chief executive of JPMorgan, Mr. Buffett told The Wall Street Journal, "If I owned JPMorgan Chase, he would be running it and he would be making more money than the directors are paying him." He added, "If Jamie decides he wants to make more money, all he has to do is call me, and I'd hire him at Berkshire."

So how to explain Mr. Buffett's stance on the industry?

An investment banker and blogger who has long offered incisive and witty insights about the industry under the name Epicurian Dealmaker offered this take over the weekend: "He despises investment bankers and employs his considerable folksy charm to scare potential business sellers away from using us for the plain and simple reason that we make his job harder and more expensive. For sellers of comp anies, investment banks level the playing field."

And Mr. Blankfein, reached by email, quipped: "Warren's comments about bankers must be based on conjecture or hearsay. As far as I know, he doesn't take advice from bankers or pay them." (He did add that "occasionally he invests in them.")

The part about not paying bankers is only half true. While Mr. Buffett typically doesn't use investment banks as advisers, he has done so in certain circumstances, including Goldman, and he has often paid fees to banks, especially as the buyer of companies that ultimately has to pay his targets' advisers.

Byron Trott, a former Goldman banker, was famously Mr. Buffett's favorite, "a rare investment banker who puts himself in his client's shoes." Mr. Trott often brought Mr. Buffett deals, though sometimes on behalf of a family-controlled seller. Mr. Buffett has also paid huge lending fees to firms like JPMorgan and Wells Fargo, for example, which together lent him $8 billion to purchase the Burlington Northern Santa Fe Corporation.

Jeffrey Matthews, a longtime Buffett watcher and author of "Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett," has a very simple explanation of Mr. Buffett's views on bankers. "The short answer is, he means it," he told me. "I see no non sequitur regarding his investment banker critiques: He's pals with Obama, but he critiques politicians as a class too. The few good ones (Dimon, Blankfein, Byron Trott) just make the rest look worse, I suppose."

Mr. Buffett's derision in this year's annual letter wasn't just reserved for investment bankers — he also had some tough love for private equity.

" 'Equity' is a dirty word for many private equity buyers; what they love is debt," he wrote. "And, because debt is currently so inexpensive, these buyers can frequently pay top dollar. Later, the business will be resold, often to another leveraged buyer. In effect, the business becomes a piece of merchandise."

While many private equity firms have long sought "permanent capital" to look a little more like Berkshire, Mr. Buffett has worked to differentiate his approach from theirs. He once described the difference between himself and private equity: "You can sell it to Berkshire, and we'll put it in the Metropolitan Museum; it'll have a wing all by itself; it'll be there forever. Or you can sell it to some porn shop operator," he said, adding: "He'll stick it up in the window, and some other guy will come along in a raincoat, and he'll buy it."

Mr. Buffett, who shuns t he auction of assets and has said he much prefers when companies come directly to him, may have been trying to lay the groundwork for the next deal.

"Old Warren knows his audience, and his audience in this section is family-owned businesses or professional managers of corporate subsidiaries who aspire to get off the big company hamster wheel," Epicurian Dealmaker wrote.

When I reached Mr. Buffett at his office in Omaha, he said his critique of bankers and private equity wasn't personal. "I work with them — some of them I like," he said. "They are personal friends."

He explained that he was trying to educate his shareholders.

"There's nothing wrong with looking at the biases of a given field," he said. "If you talk to a life insurance salesman, he's going to try to sell you a life insurance policy."

Of course, as he pointed out: "I've got a bias — in favor of selling to Berkshire."

By Andrew Ross Sorkin

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Posted: March 2, 2015 Monday 09:11 PM