We don’t have any intention to be the “ultimate source for all things Buffett”, as a lot of people already do a great job at this and we thank them for uncovering these pearls. But this video is special. The parts on “moats” add up to some of his most detailed comments yet on the subject.

We don’t think it’s any exaggeration to say that Buffett has transcended the investment realm and that this is interesting for people in all walks of life. We’re certainly making backup copies.

Her former experience makes it all the more shocking that she could come up with such generalizations as “there is only so much alpha – that excess return above a baseline average – to be had in an efficient market”. Efficient market??? One would think that she would use her time with Warren Buffett a little better.

Take this sentence: “The harder that money managers, traders and analysts must work to get information that gives them an edge, the more likely some are to cross a legal line.” Her point is that one must have an edge to get alpha, and since some people obviously will cross the legal line to get this edge, therefore the incentive is there for everyone to behave in legally unclear territory (her own words are stronger than this).

Wow. The logical implications of this line of thinking in other aspects of life are just too obvious to explore, so let’s stick to our own bread-earner.

Sometimes “edge” is as simple as having a long-term horizon while others panic with short-term fluctuations. Sometimes “edge” is receiving the same information everyone else is receiving and processing it in a more sensible context, depending on one’s general latticework of frameworks, mental models and past experiences – all of which is taken to the next level when one has a team of bright people with diverse backgrounds just itching to get their hands on a problem of this sort. Sometimes edge is checking an information against suppliers, customers, competitors and industry consultants’ opinions. Some people are even finding edge in the “wisdom of crowds”, e.g. sites where investors share their best ideas for the sake of gaining access to other investors’ ideas.

That’s called diligence, also referred to as “hard work”.

Incentives for criminal behavior have always existed, and incentives to deter it – threat of punishment, corporate culture, moral standards – have always been around, too. It is no “privilege” of Wall Street, as much as it is no privilege of authors, engineers, politicians… OK, we may be wrong about that last one.

I wish we could end this right here, but Ms. Schroeder doesn’t stop there. She says banks are so crooked as to need a break-up between its many different areas. Since everyone is chasing the same “alpha” inside a bank, “The aggregate number of people trying to carve fees out of investor returns simply overwhelms the potential gains for stockholders.” And then she completes the thinking: “Breaking up the banks into their constituent parts and forcing them to return to privately funded partnerships might reduce the apparatus that provides all parties with the incentives to cheat.”

Even if that wasn’t a generalization, who’s forcing anyone to invest in bank stocks? It’s precisely because such conflicts sometimes exist that we have always been very careful when approaching investment banks as investment opportunities. From what we’ve seen, the model doesn’t seem like it is built for shareholders, so we have a general aversion to these stocks. That doesn’t mean we advocate government intervention to change it! We just vote with our feet and stay out. If we are to tamper with investment banks’ model, why not tamper with insurance companies? Asset managers?

As if it wasn’t enough, she adds the coup de grâce: “(…) I sense a breath of change in the air. Kids who left college to import crafts made by women war refugees in Sudan are beginning to be envied by junior bankers who toil 80 hours a week creating spreadsheets. That’s a trend to be encouraged. Aspiring young bankers and hedge-fund managers, be assured of this: The more of you who choose to import crafts from Sudan, the easier the rest of you will find it to make a living legally on Wall Street.”

Should we point out that these things are cyclical and there used to be a time when everyone wanted to be an internet start-up slave? Then VC, then oil, then private equity, then… then…

Well, the overall message here is to remain very skeptical of what you read, no matter who it comes from. It’s amazing that Ms. Schroeder used her position as a “former player” to perpetuate such old stereotypes and “make-sense” generalizations. In the end, it can all be forgiven if she was just trying to sell more magazines…

BONUS: if you’ve read this far, here are books we think are also very useful on Mr. Buffett:

1) The Essays of Warren Buffett: Lessons for Corporate America, edited by Laurence Cunningham. It’s a selection of “best moments” from Mr. Buffett’s own annual report letters – organized by topic, which makes it the best overall AND reference source on Buffett’s thinking.

2) The Warren Buffett Way, by Richard Hagstrom. An analysis of Buffett’s classic investments – hits and misses – by one the portfolio managers at Legg Mason. A more direct, investment-oriented book, a perfect complement to the classic above.

Now back to what got us interested in Western Union (“WU”):

Western Union, a spin off from FDC in Dec’ 06 at $20 (having reached $30 at the high and $10 at its lows), is trading at 18$, or 13x fwd earnings, has a relatively low tangible assets base (it doesn’t need to lease, own or operate offices/points of sale: they use OPA (other people’s assets) that are already ‘there’, like a post-office, a general retail or groceries store, a bank, a pharmacy – and its (WU’s) software solution seems to be easy to plug-in and get going), seems to enjoy capillarity + network effects (now with 400,000 agents connecting millions of people/businesses) and a very old, strong, familiar brand (trust is paramount).

The main point is to understand quickly the barriers to entry/ risk of substitutes in the core business, since in theory it would be “so simple” to banks, cards or processors to compete with them, and yet, at least in the core, they don’t. These potential competitors act as channels (Itaú, for instance, is a channel for Moneygram – deal signed recently).

The second point of attention would be ‘existence and use of float’ in the model. WU was making almost 50% ROIC before the spin-off. It is now using its excess cash to buy back shares and deleverage the company, as debt was inherited when it paid the traditional “special divididend” to the parent company at the IPO.

As usual, people are paying more attention to the Mexican-US corridor market ($26 billion), but emerging markets, like India ($55billion) and China ($40 billion) are already larger transfer pools. It should go without saying that cross-border “mobile-enabled” cash transfers (such as payments via cell phones or credit card money transfers) are a few years away due to regulation issues. Also, banks like Citibank, BofA, Wells Fargo and US Bancorp tried to go on their own and achieved negligible results (3% of the market altogether, and some like US Bancorp decided to act as distribution). Citibank tried something with Banamex more centely, and it should be interesting to see how it’s working. Wal-Mart has also started to play the game. In India, Internet remittances seem to have a relevant share (it’s totally different in Mexico) and might force some margin compression, and VISA is always trying something “new”. In 2006, WU’s internet transfer in the US was still pretty small, at $100MM, just 2% of its total revenues. Regulatory risk (especially in Europe) also demands a special check.

It all boils downs to the famous “why wouldn’t their hefty margins collapse?” question. That’s the case to kill.

Useful links:

Can the global flow of remittances survive the crisis? – Foreign Affairs, Oct. 16th 2009

Western Union empire moves migrant cash home – Old (Nov. 2007), big but very interesting NYTimes article on Western Union. Free registration required. Don’t miss the cool interactive chart! Also read a related article published 4 days before this one.

One of Western Union’s videos on Youtube. Yes, they have a channel… Check out the Global Migration Forum videos.