Salomon Inc

Salomon Inc (formerly Salomon Brothers) was one of Wall Street's most powerful investment banks. Berkshire Hathaway became a major stakeholder in 1987 through a $700 million investment.

🤝 The 1987 Investment

In the 1987 Letter, Buffett describes a deal for $700 million of 9% convertible preferred stock.

• The Terms: The preferred stock was convertible into Salomon common stock at $38 per share after three years. If not converted, it would be redeemed ratably over five years starting in 1995.
• The Rationale: Buffett admitted that investment banking economics were less predictable than other Berkshire commitments. However, the deal was driven by trust in CEO John Gutfreund.

📉 The 1991 Crisis

In 1991, a massive bond-bidding scandal engulfed Salomon Inc. To prevent the firm from collapsing and to salvage Berkshire's investment, Buffett stepped in as Interim Chairman. He famously stated, "When I was elected Interim Chairman of Salomon Inc, it was a different story: I put my mouth where our money was." While he stepped away from day-to-day operations at Berkshire, the exceptional operating managers across Berkshire's subsidiaries meant the company did not skip a beat.

📈 Management Post-Crisis

During the 1994 Meeting, Buffett and Munger discussed the ongoing difficulties of managing Salomon. They discussed executive Deryck Maughan, who took on significant leadership responsibilities post-crisis, noting that his compensation targets (30% on allocated equity and 10% above competitors) were "hellishly hard to hit," equating them to hitting 150 home runs in a baseball season due to the inherently severe economics and systemic risk of investment banking.

🔄 1997 Conversion Decision

In the 1997 Meeting, Buffett addressed the status of the convertible preferred stock.

• Stock over Cash: While Berkshire had taken cash for 20% of the issue in 1995, it elected to take common stock in 1996 and 1997.
• Confidence in Management: The decision to convert was cited as a "vote of confidence" specifically in the leadership of Deryck Maughan, though Buffett remained cautious about the industry's aggregate economic returns.
• Conversion Math: The conversion was scheduled for October 31, 1997, at which point Berkshire would move from a preferred creditor to a common shareholder in the firm.

🎭 Relation to Gutfreund & GEICO

Buffett first met Gutfreund in 1976 when the latter played a key role in rescuing GEICO from near-bankruptcy.

• In 1987, Berkshire acted as a "White Knight," helping Salomon fend off a hostile takeover attempt by Ronald Perelman.

🧠 Economic Characteristics

Buffett noted that the investment was structured as a convertible preferred to protect Berkshire against the inherent unpredictability and volatility of the investment banking industry.

• At yearend 1987, Berkshire valued the investment at 98% of par ($14 million less than cost) due to market conditions, but remained confident in the long-term conversion value.

🔗 Connections

• Source: 1987 Letter
• Entity: John Gutfreund
• Entity: Deryck Maughan
• Entity: GEICO
• Concept: Convertible Preferred Stock
• Source: 1987 Letter, 1991 Letter, 1994 Meeting