Berkshire Hathaway & The Gates Foundation: A Small World, After All

From Associated Press, released this afternoon:

Microsoft exec to Jeff Raikes to Run Gates Foundation

SEATTLE (AP) — The Bill & Melinda Gates Foundation said Monday that Microsoft Corp. executive Jeff Raikes will take over in September as chief executive of the world's largest charitable foundation...

...Raikes, 49, who announced in January he was retiring from Microsoft in September, said he thought before Stonesifer's announcement that he would like to play a role in the foundation's future but was unsure what he would like to do.

He went through the same screening process as the more than 150 other candidates. As a finalist, he was interviewed by top executives of the foundation and needed the blessing of the foundation's third-biggest donor, Warren Buffett, head of Omaha, Neb.-based Berkshire Hathaway Inc.

Melinda Gates said she and her husband each interviewed "quite a few" candidates, but they kept coming back to the same idea.

"We really wanted to find someone to build the organization as it was," she said. "We saw in Jeff the right leadership qualities."

Raikes, who grew up in Nebraska, said he met Buffett years ago when the Gateses and Buffett came to his farm and accompanied him to a Nebraska Cornhuskers football game.

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"Years ago" ...was likely in the mid-'90s, per the note below:

Warren, I apologize in advance for this being a long note. I do hope you find it interesting, and be certain I don't expect a long reply (or any reply at all for that matter). Perhaps sometime we'll get a few minutes where I can get your reaction to the thoughts on business below...

...In some respects I see the business characteristics of Coca Cola or See's Candy as being very similar to Microsoft. I think you would love the simplicity of the operating system business. E.g. in FY96 there were 50 million PC's sold in the world, and about 80% of them were licensed for a Microsoft operating system. Although I would never write down the analogy of a "toll bridge," people outside our company might describe this business in that way. Those 40 million licenses averaged about $45 per, for a total of about $1.8B in revenue...

...We also have "pricing discretion" - I think I heard this term used in conjunction with our pricing decisions on See's Candy. We will be transitioning the world to a new version of our operating system, Windows NT. Today, we get more than $100 per system for NT, but only on a small percentage of the PC's. But NY will be on closer to 70% of the PC's sold in FY2000. We can achieve average license revenue of $80. So 90M licenses at $80 per license totals about $7.2B, up from just under $2B in 3 or 4 years. And since there are effectively no COGs and a WW sales force of only 100-150 people this is a 90%+ margin business. There is an R&D charge to the business, but I'm sure the profits are probably as good as the syrup business!

There is actually upside in the number of PC's sold. Similar to your analysis of Coca Cola, the penetration of PC's in International markets leaves a lot of room for growth...

...I remember one of our very first conversations in 1991. You asked me my view on what happened to IBM...

The response from Mr Buffett:

Your analysis on Microsoft, why I should invest in it, and why I don’t could not be more on the money. In effect the company has a royalty on a communication stream that can do nothing but grow. It's as if you were getting paid for every gallon of water starting in a small stream but with added amounts received as tributaries turned the stream into an Amazon. The toughest question is how hard to push prices and I wrote a note to Bill on that after our December meeting last year. Bell should have anticipated Bill and let someone else put in the phone infrastructure while he collected by the minute and distance (and even importance of the call if he could have figured a wait to monitor it) in perpetuity.

Coke is now getting a royalty on swallows; probably 7.2 billion a day if the average gulp is one ounce. I feel 100% sure (perhaps mistakenly) that I know the odds of this continuing- again 100% as long a cola doesn’t cause cancer. Bill has an even better royalty - one which I would never bet against but I don’t feel I am capable of assessing probabilities about, except to the extent that with a gun to my head an forced to make a guess, I would go with it rather than against. But to calibrate whether my certainty is 80% or 55%, say, for a 20-year run would be a folly. if I had to make such decisions, I would do my best but I prefer to structure investing as a no-called-strikes game and just wait for the fat one.

I watched Ted Williams on cable the other day and he referred to a book called the science of hitting which I then ran down. It has a drawing of the batters box in it that he had referred to on the show with lots of little squares in it, all parts of the strike zone. In his favorite spot, the box showed a .400 reflecting what he felt he would hit if he only swung at pitches in that area. Low and outside, but still in the strike zone, he got down to .260. Of course, if he had two strikes on him, he was going to swing at that .260 pith but otherwise he waited for one in the "happy zone" as he put it. I think the same approach makes sense in investing. Your happy zone, because of the business experience you have had, what you see every day, your natural talents, etc. is going to be different than mine. I am sure, moreover that you can hit balls better in my happy zone than I can in yours just because they are faster pitches in general.

The Full Raikes/Buffett Letter