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Even great businesses take the wrong path from time to time, and in the early 1990s the senior managers at GEICO stumbled. Yet again, they saw visions of things being better on the other side. Thus they expanded away from their core competitive advantage in auto insurance with a low cost distribution model, into aviation insurance, home insurance and finance. This resulted in a loss of focus and poor returns.
Without Jack Byrne there to constantly pull the senior executives away from the siren song of business outside of where they had an economic franchise they had drifted. Byrne resigned in 1986 attracted by the prospect of running an insurance company, Fireman’s Fund, spun out of American Express.
Another hit was received from Hurricane Andrew in 1992, causing significant pay-outs – an underwriting loss was made for the year. GEICO’s share reached a peak at over $300, for a market capitalisation of around $4.5m. It then fell to not much over $200. (This is measured by each old share before the 1992 share split. After the five for one split the shares were actually trading at slight over $40).
| YEAR | Market price of one share, $ | Total market value of BH’s GEICO holding, $m | ||
| 1976 | 3.13 | 24 | ||
| 1977 | 8.13 | 44 | ||
| 1978 | 7.00 | 37 | ||
| 1979 | 11.88 | 68 | ||
| 1980 | 14.63 | 105 | ||
| 1981 | 27.75 | 200 | ||
| 1982 | 43.00 | 310 | ||
| 1983 | 58.13 | 398 | ||
| 1984 | 58.00 | 397 | ||
| 1985 | 87.00 | 596 | ||
| 1986 | 98.50 | 675 | ||
| 1987 | 110.50 | 757 | ||
| 1988 | 124.00 | 849 | ||
| 1989 | 152.50 | 1,045 | ||
| 1990 | 162.12 | 1,111 | ||
| 1991 | 198.98 | 1,363 | ||
| 1992 | 325.00 | 2,226 | ||
| 1993 | 256.87 | 1,760 | ||
| 1994 | 245.00 | 1,678 | ||
| 1995 | 349.34 | 2,393 | ||
| 1996 | BH bought the other 49% for £2.3bn |
Source: Chairman’s Letters to Berkshire Hathaway shareholders, Ignoring GEICO’s 1992 five for one share split.
Buffett became concerned with the firm’s direction, i.e., away from its circle of competence, and even considered selling Berkshire’s stake.
After the resignation of the CEO in May 1993, Tony Nicely took over as co-CEO in charge of the operational side of the business, with Lou Simpson co-CEO responsible for investments. Under Nicely the business distractions were dropped and the rock bottom low-costs auto insurance through direct selling received additional investment. “In business, I look for economic castles protected by unbreachable “moats.” Thanks to Tony and his management team, GEICO’s moat widened.” (Buffett’s letter to BH shareholders, 1995)
Buying the other half
Now that GEICO was re-focused on its no-agent model of selling auto insurance Buffett wanted Berkshire to own the whole company.
He and Charlie Munger started negotiating a price with Chairman Sam Butler, Lou Simpson and Tony Nicely in 1994. The tough but friendly talks dragged on into 1995. Butler, Simpson and Nicely took their fiduciary responsibilities to GEICO’s minority shareholders very seriously and, commendably, negotiated robustly, demanding a high but fair price for the remaining 49%.
Buffett swallowed hard and accepted that BH would pay $2.3bn for the second half of a business for which he had paid only $45.7m for the first half (the price was $70 per share, or $350 per original share if we ignore the five for one share split).
Tony Nicely warmly welcomed Berkshire Hathaway’s full ownership. Shortly after agreeing the deal he told the Washington Post, “I really believe we probably are in a better position now for faster growth than perhaps we’ve ever been”. With Buffett pushing for a long-term focus he felt he could pursue growth without hesitating to spend aggressively in the short run to build the business Nicely said, “In the insurance business, you tend to lose money in the first year on [new] business. You have higher losses and higher expenses….We won’t have shareholders who are concerned with year-to-year [results]. We have a long-term investor who says, ‘You folks there grow it to the best of your physical ability and I’ll worry about the finances,’ ” (“Premium Partners” By Albert B. Crenshaw September 18, 1995, Washington Post)
Under new management
Nicely was very keen to expand the advertising budget, and Buffett encouraged him, thinking that the more people who knew about the low cost of GEICO’s insurance the better – more underwriting profit and more float to invest.
But this is only a good thing so long as GEICO maintained downward pressure on the cost base. Nicely was just the man for this job because he had been through the school of hard-knocks when the company barely survived, and he really understood that GEICOs competitive advantage lies with excellent operational efficiency.
Expenditure on marketing more than tripled to $100m in by 1997. But they didn’t stop there; within another two years it was $242m, and by 2009 $800m.
Buffett expressed his enthusiasm for more advertising in his 1998 Letter to Berkshire shareholders “there is no limit to what Berkshire is willing to invest in GEICO’s new-business activity, as long as we can concurrently build the infrastructure the company needs to properly serve its policyholders. Because of the first-year costs, companies that are concerned about quarterly or annual earnings would shy from similar investments, no matter how intelligent these might be in terms of building long-term value. Our calculus is different: We simply measure whether we are creating more than a dollar of value per dollar spent — and if that calculation is favorable, the more dollars we spend the happier I am.”
And in his letter the following year: “Tony’s foot is
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