2010: How would Buffett grade Kraft's capital allocation?

ANDREW ROSS SORKIN: I received a number of questions regarding Kraft, and this one comes from a shareholder who says they prefer to remain anonymous. The question is, “Given your stake in Kraft and your public criticism earlier this year about the Kraft-Cadbury deal, how would you grade the Kraft board of directors’ capital allocation and the management compensation abilities? What did you think of Kraft CEO Irene Rosenfeld’s $26.3 million compensation package for services, including her leadership in completing the Cadbury acquisition and selling Kraft’s North American frozen pizza business?”

WARREN BUFFETT: Well, I didn’t like either the Cadbury decision or the pizza decision. But we’ve made our share of dumb deals at Berkshire, you know. So I’ve gotten more tolerant of other people, and incidentally the fact I think it’s a dumb deal doesn’t for certain make it a dumb deal, but I think the odds are it was a dumb deal.

In fact, I think the odds are that both deals were dumb. The pizza deal was particularly dumb, but — in my view. But just think of all the dumb things we’ve done, right? Starting with that department store in Baltimore.

CHARLIE MUNGER: Oh yeah, right. A few Irish banks, you know.

WARREN BUFFETT: Right, (inaudible).

CHARLIE MUNGER: We never seem to go —

WARREN BUFFETT: I wish you hadn’t brought this up.

CHARLIE MUNGER: — we never get over it. (Laughs)

WARREN BUFFETT: We expect to do some dumb things, it’s just we get mad when other people do dumb things with our money. (Laughs)

You know, the pizza business — somewhere I probably have some figures on that — but when they sold the pizza business for $3.7 billion they announced it as selling it for $3.7 billion. They didn’t sell it for $3.7 billion, that’s what the other guy paid. What they got was about $2.5 billion. And that was a terribly tax-inefficient deal when they’d already shown their ability to understand that you could do a tax-efficient deal when they sold the Post cereals business earlier.

And when they referenced — well, they didn’t reference at all what pizza was earning beforehand, but I think that Nestle said it was earning something like 280 million pre-tax, but that was referring to the previous year. When they talked about the Cadbury earnings they were buying, they were talking about next year. And when they talked about the pizza earnings they were selling, they talked about last year.

Pizza in 2009, believe it or not, earned three hundred and, I think, 40 million pre-tax. So they got 2 1/2 billion for 340 million of pizza earnings that were growing as fast or faster than the Cadbury earnings and where the sales were going as fast or faster. It really didn’t make sense in my view.

Now, you know, Irene is a perfectly capable manager and she may know a lot of things about that business I don’t know. Like I say, we’ve made plenty of mistakes ourselves. But if it’d been me, I would have voted to keep pizza and not buy Cadbury. And I expressed myself, and I don’t do that too often, but we owned a lot of Kraft.

And Kraft, still, is selling for considerably less than the value of its constituent parts, particularly if you value them the way they valued Cadbury. (Laughter) But if they don’t sell them all like they sold pizza, you know, the present price is below the value of Kool-Aid and A.1. Sauce and — and Jell-O and Oscar Meyer wieners and a few things.

Those are very good businesses. I just hated to see them give up a significant portion of those businesses to buy Cadbury at what I felt was a very fancy price.

Charlie?

And in terms of her compensation, you know, we’ve got a compensation system at Berkshire that I regard as quite rational. And there’s a lot of companies in the United States that have different compensation systems. (Laughter)

CHARLIE MUNGER: Yeah, I think generally, at the top of American businesses, people think they know too much about strategy. And they tend to hate the tough competitive conditions in the business they’re in, and to yearn for some business where it’s less difficult.

You remember when Xerox bought Crum & Forster, an American insurance company, one of the dumbest acquisitions in all time? The reason Xerox did that is they didn’t have any tough Japanese competing in the insurance business. They were really tired of facing the tough competition they had in the business they were in.

I think it’s quite typical to dream, if you’re in business, that something that’s a little different, no matter how much you pay for it, will make your troubles less.

WARREN BUFFETT: And you will have an absolute army of lawyers, investment advisors, public relations people, all of whom will have a strong economic interest in having you push ahead on deal, after deal, after deal, regardless of how the shareholders come out. It’s just — it’s the way it works. OK.

CHARLIE MUNGER: That’s why Berkshire is a better deal. (Laughter) We are very stupid in many ways, but we have avoided a slight subset of stupidities. (Laughter) And they’re important.