See's Candies for sale

One day, Buffett got a call from Bill Ramsey, Blue Chip's president, saying that a local Los Angeles company, See's Candies, was for sale.

"See's has a name that nobody can get near in California," Munger told Buffett. "We can get it at a reasonable price. It's impossible to compete with that brand without spending all kinds of money." Ed Anderson thought it was expensive, but Munger was overflowing with enthusiasm. He and Buffett went through the plant, and Munger said, "What a fantastic business. And the manager, Chuck Huggins - boy, is he smart, and we can keep him on!"

See's had a tentative deal on the table already and wanted $30 million for assets worth $5 million. The difference was See's brand, reputation, and trademarks - and most of all, its customer goodwill.

Buffett and Charlie Munger decided that See's was like a bond - worth paying $25 million for. If the company had paid out its earnings as "interest," the interest would average about 9%. That was not enough - owning a business was riskier than owning a bond, and the "interest rate" was not guaranteed. But the earnings were growing, on average 12% a year. So See's was like a bond whose interest payments grew. Furthermore:

"We thought it had uncapped pricing power. See's was selling candy for about the price of Russell Stover at the time, and the big question in my mind was, if you got another 15c a pound, that was 2.5 million dollars on top of 4 million dollars of earnings. So you really were buying something that perhaps would earn 6.5 or 7 million dollars at the time, if just priced a little more aggressively."

At the price offered, $25 million, the $4 million it was earnings pretax would give Buffett and Munger payback of 9% after-tax on their investment from the first day they bought it - not factoring in future growth. Adding in the $2 to $3 million of price increases they thought See's could institute, the return on their capital would rise to 14%: a decent level of profitability on an investment, although it wasn't a sure thing. The key was whether the earnings would continue to grow. Buffett and Munger came close to walking. The pickings had been so easy until now, and they had such an ingrained habit of underbidding, that it was like swallowing live guppies for them to pay the asking price.

"You guys are crazy." Munger's employee Ira Marshall said, "There are some things you should pay up for - human quality, business quality, and so forth. You're underestimating quality."

"Warren and I listened to the criticism," says Munger. "We changed our mind. In the end, they came to the exact dollar limit of what we were willing to pay."



Price paid: $25 million
Earnings: $4 million pre-tax
Initial return: 9% after tax
Earnings growth rate: 12% per year

If earnings increased to: $6 - $7 million
Return on their capital: 14%


Ref: Page 345 The Snowball, Warren Buffett and the Business of Life, by Alice Schroeder