The purchase of See’s Candies by Berkshire Hathaway was one of the first deals in which Warren Buffett learned how to pay up for a great business. Prior to that, most of Buffett’s deals involved buying not so great business for a wonderful price sometimes referred to as “Cigar Butt Investing.” See’s Candies also taught Buffett the power of a brand as a moat.
Historical Background
See’s Candies is a manufacturer and distributor of candy, especially chocolates. It was founded by Charles See, his wife Florence, and his mother Mary See in Pasadena, California in 1921. The company differentiated itself by focusing on small-batch production and using only the highest quality ingredients.
After Mary See’s death in 1939, her son Charles took over the business and later Charles’ son Laurence expanded the business to more than 160 stores. Laurence See died in 1969, and his brother Harry was not willing to carry on running the business. It was said that brother Harry See wanted to enjoy “wine and girls” instead. As a result, Chuck Huggins, who was then serving as the company’s Vice President, was asked to find a buyer for the business.
In 1972, Robert Flaherty, an investor at Blue Chip Stamps (later merged into Berkshire), was tipped off that See’s was on the market. At this point, Blue Chip was already part of Warren Buffett’s portfolio through his holding company, Berkshire Hathaway. Warren Buffett and Charlie Munger met with Harry See and Chuck Huggins in Los Angeles. Buffett and Munger wanted Huggins to maintain the high ethics the See’s family had instilled in the business culture, keep enhancing the reputation of the brand and offer higher standards of service. They wanted Huggins to continue to manage the business should the deal close.
Buffett and Munger were hesitant to buy See’s Candies since Harry See wanted $30 million for the business while the net tangible assets were only $8 million and after-tax profits were only about $2 million. This deal was way too expensive for what Buffett was accustomed to. Buffett was not accustomed paying more than three times net tangible asset for the business.
High Return on Tangible Asset
However, Charlie Munger and Ira Marshall (Munger’s partner in his investment fund Wheeler and Munger) pointed out to Buffett that See’s was a special company and that it had after tax returns of 25% percent on tangible assets of $8 million. A high return on capital is an indication of a great business. Further, the Blue-Chip Stamp team (Blue Chip Stamps was later merged into Berkshire) believed that See’s had pricing power. Although it was pricing its candies at par with its closest competitor Russell Stover at the time, they believed that they could raise prices yearly. Buffett offered $25 million to buy See’s Candies and was willing to walk away from the deal if the seller demanded a dollar more. Fortunately, Harry See agreed to sell the business for $25 million in 1972.
After the acquisition, Huggins was made President and CEO where he continued to build the franchise and widened the moat by never compromising on the quality of the products. See’s is a prime example of the effect of Brand on people’s mind which provided a basis for price increases and exceptional returns on capital employed.
One peculiar thing about See’s Candies is that the brand did not travel. The brand was well recognized in the western states such as California, but Berkshire attempted to open stores in other states which was not successful. Customers were unfamiliar with the brand and unwilling to pay the high prices.
Pricing Power
Since its acquisition, Buffett has been raising prices of See’s Candies annually. If you buy See’s candies during the holidays, you will notice the higher prices year after year. A comparison of See’s Sales and Profit in 1972 as compared to 1982 will show the effect of its pricing power. During that 10-year period, the number of pounds of candies sold only increased 45% from 17 million lbs. to 24 million lbs. The number of stores only rose 21% from 167 stores to 202 stores. However, the Sales increased by 295% from $31 million in 1972 to $124 million in 1982 due primarily to price increases. What is even more astounding is Profit after taxes increased a whopping 452% during that 10-year period from $2.3 million in 1972 to $12.7 million in 1982 due to a combination of price increases and operating efficiencies in advertising and distribution.
By 1991, See’s increased its pre-tax profits tenfold to $42.4 million while only tripling its tangible assets. By 1999, See’s has achieved operating profit margin of 24%. However, Berkshire is not able to reinvest See’s profits back into the business. The Business does not require a lot of capital to operate. In fact, Munger said that it takes almost no capital to open a See’s store. Cumulatively since its purchase in 1972, See’s total pre-tax earnings exceeded $2 billion which Berkshire was able to reinvest in other businesses all from the original $25 million investment. Even if they had paid the $30 million that Harry was demanding, it would still have turned out to be a great investment. The purchase of See’s Canies was pivotal in the evolution of Buffett’s investing style from investing in cheap but not so good businesses to investing in great businesses at a reasonable price. This also paved the way for future investments in name brands such as Coca-Cola, The Washington Post, Apple, Dairy Queen, and Benjamin Moore.
Kenneth U. Reyes is founder and Managing Partner of Reyes Capital Management, LLC which manages a long-term value oriented private investment fund. He is also founder of the Law Offices of Kenneth U. Reyes, APC, a five-lawyer boutique law firm in Los Angeles specializing in Family Law. He can be reached at (213) 500-4836 or at [email protected]. Reyes Capital Management LLC, 3699 Wilshire Blvd., Suite 747, Los Angeles, CA 90010.
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