Textile Industry Economics

·     In 1964, Berkshire Hathaway had an accounting net worth of US$22mn, but its intrinsic value was less because the assets were unable to earn returns that commensurate with their accounting value.

·      At the time of purchase, most Northern textile operations, which were unionized, were closing and Southern textile plants were largely non-union.  Buffett thought that it would give Berkshire Hathaway an important competitive advantage.

·      Berkshire further diversified into other business, using the cash generated by the textile operations to fund entry into insurance and other businesses.

·      Buffett intended to continue to support the textile operation despite more attractive alternative use for capital. After 1985, however, the textile operations consumed major amount of cash.

·      The domestic textile industry operates in a commodity business, competing in a world market in which substantial excess capacity exists. Most of the trouble of the industry was attributed to competition from foreign countries whose workers are paid a small fraction of the US minimum wage.

·      Berkshire had the option of making large capital expenditure that would have allowed the textile operation to reduce its variable costs. But many of the competitors, both domestic and foreign, were stepping up to the same kind of expenditures and their reduced cost became the baseline for reduced price industry-wide. Viewed individually each company’s capital investment decision appeared cost effective and rational; viewed collectively the decisions neutralized each other and were irrational.

·      It is instructive to look at Burlington Industries, the largest US textile company, to understand how a commodity business plays out. In 1964, Burlington had sales of US$1.2bn, by 1985 it had sales of US$2.8bn, but during the 1964-85 periods, the company made capital expenditure of about US$3bn. Nevertheless, Burlington has lost sales volume in real dollars and has lower return on sales and equity now than 20 years ago because CPI tripled in the same period and the invested capital has increased.

·      Another important investment lesson on book value and replacement cost can be learnt from the disposal of Berkshire equipments. While the equipment originally cost US$13mn, had a book value of US$866k, had a replacement cost of US$30-50mn and was in working condition, gross proceeds from the sale of the equipment came to US$163k. Allowing for pre- and post- sale costs, the net was less than zero.

·      In contrast, the economic goodwill attributed to the two newspaper routes in Buffalo or a single See’s candy store considerably exceed the proceeds that was received from the sale of tangible assets, which were able to employ over 1,000 people not too long ago, under different economic conditions.