As owner of one share of Daily Journal Corporation [ticker: DJCO] common stock, I thought I had better pop into the annual meeting since, at $180.70, it represents such a large portion of my net worth. By way of background, you should know that Charles T. Munger is Vice-Chairman of Berkshire Hathaway [ticker: BRK-A] where Warren Buffett is his sidekick, and that the Daily Journal is a legal publisher in California and Arizona that has entered the legal software business. The notes that follow are my own and, while detailed, they are not a transcript. I present them for your delectation. If it sounds smart, it’s Munger; if it’s wrong, it’s me.
Chairman Charles T. Munger began with some opening remarks:
I’m Charlie Munger, Chairman of the Board of the Daily Journal Corporation (DJCO), and I welcome all of you, including the groupies….Our [new] independent accounting firm is here. We prefer you to our old one. You remind me of my own personal circumstances. They once asked me what one person accounted for most of my personal felicity in life, and I said, “That’s easy – that would be my wife’s first husband.” You have an ideal position of the same sort.
I’m going to talk briefly on accounting and then I’m not going to talk any more on the subject.
To be as late in publishing an audit as the Daily Journal is absolutely unheard of. It’s unbelievable. Had the mafia been running the company with the worst excesses in the world you wouldn’t expect an audit to be this late. It set a new record in the history of the world. We obviously had an audit from hell, and the question is, what caused it? Our auditor would say it was our sloppiness in internal controls. God knows, we’ve had a few imperfections, but in my judgment they were trivial and of no practical consequence to anybody with any sense. The auditors would say that our difficulties were really serious. They were confused by the difficulties of our business, which God knows are confusing and difficult, but that’s external reality. They were like the doctor who wants to fix a nose bleed by feeling around in the groin, and charge for it by the hour.
It wasn’t malevolent. They’re a big bureaucracy and they did us enormous damage, the way an elephant would do damage if it went through a barnyard and stomped the chickens. It just comes with modern life, but [DJCO Board Member] Peter Kaufman always says that no occasion, no matter how terrible, is totally un-useful. It can always serve as a useful bad example. That’s the way I feel about this audit.
We are a service operation ourselves. We’re a bureaucracy, and we have plenty of power in this complicated software business of disappointing some customer who trusts us. We’re using our audit as an example of the kind of thing we never want to do to anybody else ourselves: just unwittingly do something stupid that does a lot of damage.
Now of course our main competitor in this software struggle just loves our being in the headlines for not getting audits out on time. Just think of how a commissioned sales force reacts to that. The auditor was feeding our main competitor lots of red meat and billing us for it. It was not the happiest occasion in the history of auditing.
I don’t think it hurt us at all in the financial community. Any ordinary company would have been crucified, but we have a reservoir of trust and reputation, so I think it was a non-event to people like you. I do think it hurt us with the customers. Whether our auditors hurt us five million dollars (counting opportunity costs) or some larger sum I cannot tell you, but it was a significant unpleasantness, and it was – in my judgment – totally unnecessary. But there is no feeling on our part that our auditor was any worse than any other member of the Big Four. I think when we have big bureaucracies and new responsibilities under the law you get some odd occasions. Our business situation being a venture capital-type situation would have confused practically anybody who was restricted to auditing experience. It was sort of a natural human craziness and it’s not unexpected.
The right way to react to it I think is clear. Turning the other cheek didn’t start with Jesus at all. The real guy who figured that out was Aristotle. He just thought it was crazy to spend your time trying to get even based on some injury. You just suck up your gut. We paid all the invoices with the extra payments so they could hurt us more. We’re not going to do any more. Our new auditor at least is local and we’re a bigger client to it than we were to the old one. Part of our trouble was that our business situation was complicated and I’m sure we didn’t draw the top talent to our tiny little business.
I also think that when something bad happens it’s always partly your own fault. With 20/20 hindsight both Gerry [Salzman, DJCO CEO] and I have a fault, and I have it way worse than Gerry, and that is we get along beautifully with people we trust and admire – it really causes something more like love, which I like in business and in life – but the people we don’t admire, neither of us is very good at disguising it. I think that this went from bad to worse, and I don’t know how to fix people as old as Gerry, and of course I’m old, so we just have to soldier on as best we can.
Hopefully, the new auditors will be more admirable. It’s hard to imagine that they could be worse. They have one of the easiest jobs in the whole world in satisfying a client. We’re treating it like Aristotle. It may have cost the company quite a bit of money, counting its competitive effects. They did not do it on purpose. They did it utterly unwittingly, without the faintest idea that maybe if they delayed our audit report month after month after month it would hurt us in the market with a big competitor with a bunch of commissioned salesmen around spreading the happy news that the Daily Journal’s internal controls were non-existent and they were no good and so on. That’s all I’m going to say about auditing.
Daily Journal: the Business
As we have said over and over again, we have a declining business. The business of running a newspaper with information content delivered by printing presses, even when it’s a legal newspaper, is declining. The golden revenues were from publishing foreclosures notices. We made a lot of money for a while. It was sort of like being an undertaker during the Black Death. For two or three years it was a wonderful business and the population of Europe declined by 40 percent. That’s what we went through.
We kept the money. I would say that we handled our situation very well, and we still have a 90% share of the public notices in foreclosures, but there practically aren’t any right now. The banks, the lenders, have all tightened their standards and the real estate prices are back up, so of course the foreclosures are pretty close to zero. We have a declining business in its very nature.
If you take the whole history of businesses that make a fair amount of money and have a little surplus but their basic business goes to hell based on technological developments, the results are lousy. The normal result is Kodak (ticker: KODK). Imagine having a business like Kodak and having it go all the way to bankruptcy. That’s the normal occurrence: technological obsolescence.
There are few exceptions in the history of the world. One of them is Thompson Reuters (ticker: TRI). They were a newspaper company with a few television stations added and they basically milked them as long as they could, sold them for high prices, and went into a different business – online information – and they successfully made the transition. That is really rare.
The other rare example, of course, is Berkshire Hathaway. Berkshire started with three failing companies: a textile business in New England that was totally doomed because textiles are congealed electricity and the power rates were way higher in New England than they were down in TVA country in Georgia. A totally doomed, certain-to-fail business. We had one of four department stores in Baltimore [Hochschild Kohn], absolutely certain to go broke, and of course it did in due course, and a trading stamp company [Blue Chip Stamps] absolutely certain to do nothing which it eventually did. Out of those three failing businesses came Berkshire Hathaway. That’s the most successful failing business transaction in the history of the world. We didn’t have one failing business – we had three. Out of that little nothing, the excess capital that we took out and put somewhere else did better than anybody’s ever done. As a matter of fact, we recently passed General Electric [ticker: GE] in terms of market capitalization, and GE was founded by Thomas Edison himself in 1892, and one of the most powerful companies in the world.
It was a considerable stunt. But the normal result is more like Kodak. Xerox [ticker: XRX] is an interesting case. They went to the brink of extinction and then came back, but they are a pale shadow of their former greatness. They actually invented most of the stuff other people made so much money out of, and they still failed. Bill Gates is a big student of this subject, and he says that the standard result is failure. Imagine General Motors [ticker: GM] who went bankrupt. Can you imagine how they towered over the economy when I was young? It was the biggest, more valuable, most admired company, and it took the shareholders to zero.
What Daily Journal is left with is a declining business. It may last quite a while, but at really modest profits. The future is our software business and we really like that. We think all these courts should be automated, and it should be a configurable system and it should be in the cloud and these public agencies should be serviced lovingly and honorably and loyally, and that’s exactly what we plan doing. New Dawn Technologies, which so worried our auditors, I asked them a question today before we came in here: of your existing clients, how many are threatening to leave? They have about four hundred clients and they named one. As far as I’m concerned, I like the way that’s worked out, as a venture capital type of investment. I like the people and I like the ethos and I like what we’re trying to do. It’s a great big market.
Most big software companies hate dealing with the government. IBM [ticker: IBM] got very good at it, but everybody else just hates it. You have a business like Microsoft [ticker: MSFT] and you don’t need a bunch of RFPs [Request For Proposals] – it’s just agony. We actually kinda like the agony. The people really need better products. Who knows, we may actually pull it off, but the objective evidence would be that we’re trying to do something that very few people have ever succeeded at: take a successful business, clobbered by a change in competition, and have it out of the ashes raise something that’s pretty damn good. That’s what we’re trying to do.
I think the odds are better than even that we pull it off creditably. I don’t think it will be a super-bonanza, but our standards of creditable are pretty satisfactory. As to the surplus money, thank God we have it. Most of the newspaper businesses – about half of them went broke or nearly broke and they borrowed so much to buy other newspapers because that’s all they know how to do, with the aid of so many friendly investment bankers and consultants, that they basically took their own shareholders to zero after having long years of monopoly. That has not been the result here. We have all this extra money on the balance sheet and we’re using it to create a software business.
I think you all would have liked the board meeting we had before we came in here. The people strike me as honorable, intelligent and cheerful about the difficulties of this very difficult business, which are a whole lot of bureaucracies, governmental in nature, with a whole lot of different consultants influencing the customer. It’s not a bit easy, with very difficult questions of what you do and why you should do it, whether the new system is going to work, and if so, why? I actually kind of like it even though I don’t understand it. I have the feeling that we’re not going to get a lot of new entrants into this business. Our main competitor is in a formidable place, but if I were buying the product, I’d buy ours and not theirs, and that’s my test of proper competition.
With those remarks, I’ll take questions….
