The Lex Newsletter: Charlie Munger nailed why US capitalism flourishes

Dear reader,

Charlie Munger, Warren Buffett’s veteran sidekick, died this week. The vice-chair of investment group Berkshire Hathaway had a penchant for zingy aphorisms. The one I always remember is: “Capitalism without failure is like religion without hell.”

Munger was smartly articulating a principle that is well understood in the US and which underpins its commercial strength. Capitalism is a test bed where businesses either flourish or fail. You cannot have one without the other.

This concept is celebrated by the picture above. It shows fictional corporate drone Norville Barnes from the movie The Hudsucker Proxy. His invention of the hula hoop rescues a failing conglomerate — whose president has just taken an indefinite leave of absence by leaping through a skyscraper window.

Some Europeans do not get the success/failure-yin/yang thang. I went to a dinner for UK business pundits just after Carillion, the UK building contractor, collapsed in 2018. The host asked me what I made of it. There was a sharp intake of breath around the table when I replied: “It’s good to see that British capitalism works sometimes.”

A journalist from a certain state-supported broadcaster was particularly annoyed with me for suggesting that a company with a flawed business model should be allowed to fail.

I’m a dyed-in-the-wool Brit and wouldn’t live anywhere else. But my personal investments are heavily and profitably skewed to US index funds* in recognition of America’s capacity for innovation and reinvention.

The US economy is expanding and stock prices are up on the year. The depth and expertise of New York’s capital markets are luring foreign businesses in search of financing.

Chinese fast-fashion group Shein is the latest to file for a listing. Lex likes aspects of its business model — direct dispatch of goods to customers, for example — though we are dubious about its labour practices.

Well-financed US corporations have used the same capital markets to play the yield curve. They borrowed cheaply during the pandemic when rates were low and held cash on deposit as they rose.

Pricier money is straining the finances of highly indebted corporations, meanwhile. For a decade, they insisted everything would be fine as long as ebitda comfortably covered interest payments. Now the denominator has risen, eroding coverage. It turns out leverage matters after all.

Bankruptcies are rising. The impact will mostly be felt by smaller businesses. Lex remains broadly bullish on the US, where rebounding earnings mean multiples look affordable.

Munger, for his part, reckoned investors should not get hung up on valuations. A good business was worth buying, in his view, even if it did not look cheap by the standards of pioneering value investor Benjamin Graham.

It is hard to work out how Elon Musk now fits into US narratives of entrepreneurial derring-do. The success of electric-vehicle maker Tesla has amply illustrated the ability of the US to foster maverick brilliance. But Musk’s acquisition of X, as Twitter is now known, has been a catalogue of unforced errors.

This week, during a televised rant, Musk told advertisers who had pulled their campaigns from the website to “go fuck yourself”. This is alarming enough in itself. Corporations are right to withhold promotions they fear might appear beside racist content.

Musk’s demeanour during the interview should prompt deeper concerns among those close to him.

Lex reckons the equity of X is worthless given the company’s current travails. Musk has the resources to buy back billions in debt stuck with underwriters led by Morgan Stanley. They might take 50 cents on the dollar to be shot of it. I doubt Musk has sufficient interest in good relations with banks to bother, however.

The travails of Robinhood are more susceptible to conventional analysis. The revenue of the US trading app has shrivelled. The fad for meme stock trading has proved as ephemeral as Barnes’s hula hoop. It now depends on the interest income from deposits. These will fall in line with interest rates.

Robinhood launched a UK service this week. We doubt it will prosper.

The big COP out

When individuals or nations take collective responsibility, it usually means no one is responsible. Feeble progress in combating climate change illustrates the problem. So do not expect too much from current COP 28 talks.

One consequence of previous failings of nerve will be a clamour for “abatement” — reducing emissions from fossil fuels rather than doing without them entirely.

Carbon capture and storage is a key initiative. So far, it has largely been financed by oil majors from their balance sheets. Scaling up will give project finance investors the chance to get involved.

Trapping CO₂ on its way out of industrial chimneys costs about $100 per tonne. Hoovering it out of the air costs about 10 times that but should get cheaper as investment rises.

Aviation is a big polluter. Electric and hydrogen aircraft are unlikely to ever work for long-haul travel. “Green” fuel at present lacks sufficient feedstock.

This will create problems for Rolls-Royce longer term. But at the moment, the UK jet engine group is at cruising altitude. This week, it promised to add £2bn to operating profits by 2027, quadrupling a figure of £650mn in 2022. The target appears achievable. The shares have soared but are still worth owning.

It is easier for earthbound airports to reduce their own carbon footprints. France may therefore subject airports such as Paris Charles de Gaulle to a tougher taxation system with the aim of spurring green investment. That possibility triggered a drop in the shares of ADP, France’s main airport company, this week.

Heathrow is already subject to the tax system that Parisian airports may wind up with. Infrastructure investor Ferrovial sold its 25 per cent stake in the facility for £2.4bn this week. This looked like a reasonable deal on both sides.

The transaction valued Heathrow at a 30 per cent premium to its regulated asset base. Investors including Saudi Arabia’s Public Investment Fund and buyout group Ardian should still be able to bank returns in high single digits if they decide to sell in a few years.

FT readers love to hate Heathrow. Having experienced the chaotic horror of Newark, New Jersey, more than once, I can just about cope with it.

Flying gives us the opportunity to observe the proliferation of solar panels that may save the planet even as we contribute to the problem they seek to address.

Lex is bullish on solar energy, thanks to the falling price of photovoltaic cells. This should help energy companies such as Iberdrola. But given our dire record on wind power stocks — which we tipped ahead of a price slump — you might want to get a second opinion.

Thanks go to Lex readers for some smart comments on last weekend’s article concerning the 500bn plastic bottles we wasteful humans discard every year.

Your key suggestion “use less” works for me. If you live in a temperate country, you do not need to carry water on every trip as if you were setting off to cross a desert.

What I enjoyed this week

I caught up with Dan Buettner’s engaging Netflix documentary series Live to 100: Secrets of the Blue Zones.

It appears you can hang around bugging your children for longer if you eat homegrown vegetables and live in a stress-free peasant community. I suspect for a lot of us, that advice sounds like “don’t start from here”.

Munger almost made it into triple figures, however. So there is hope even if you don’t live in Costa Rica or Okinawa and don’t subsist on plantain or sweet potatoes.

Enjoy your weekend, however many miles you have on the clock.

Jonathan Guthrie
Head of Lex

*You might legitimately ask why the head of a column that opines on individual stocks holds only timid passive investments. The reason is that the FT’s rule book rightly precludes staff writers from stock picking if they are in a position to influence individual prices, however marginally

Correction: I got the figure for Julius Baer’s write-off wrong in the email version of this newsletter last week. It was SFr70mn, not SFr170mn. Apologies.