[DRAFT] Wrong on the Timing Means Wrong on the Thing
The year was 1956, and the telegraph monopoly Western Union was in a hole. It had an unfunded pension liability worth twice its market cap. Our enterprising lawyer, still licking his wounds from a previous investment, spotted the opportunity and leapt at it. Market cap of $118M, earnings of $19M, cash pension costs of $10M, and reserves of $2.4M. Of course, the stock must go down, Charlie Munger thought. It tripled in three years.
Growing 15% a year, the pension would become a $200-250M obligation Western Union had no clear path to filling. Earnings were steadily growing, but couldn't catch the retirement liabilities. Any appearance of earnings was a mirage. Instead of capitalizing the liability or estimating its future impact, the burden was pay-as-you-go.
The market was paying $17 a share for a stock worth less than $5.
Source: FCC, Statistics of Communications Common Carriers, 1956 (full report)
He didn't short often. By his own count, he made exactly three short sales in his life, and all of them were more than 30 years ago. Two were stocks: one made him a lot of money, one lost him a lot of money (this one!), and they canceled out. The third was a currency bet he characterized as "a very irritating way to make a million dollars." Margin calls kept coming. He kept wiring over treasury notes to cover them. He was profitable at the end of it and never wanted to do it again.
Watch: Charlie Munger on his three short sales
Within five years Bell's long-distance rates started falling while Western Union's kept rising, and the last real argument for the telegram went with it. The company was no longer the value option, it was the dying one. The telegraph peak was two decades ago, and the phone was gobbling up market share daily. Western Union knew it needed a new story.
The Desk-Fax machine had launched in Fort Worth back in 1950. Telex, the direct-dial teleprinter, was still two years from commercial launch. The uniformed messenger, once the face of the company, was already being phased out as the machines took over.
1956 was the thesis year. The stock ran 17½ to 22½ and closed the year near 19. Whoever put the short on was right the day they put it on.
1957 was the one year it worked. A real recession pulled the stock down to a range of 14⅝ to 20⅝, and for twelve months, being short Western Union looked like being right about Western Union.
Then in 1958, the thesis broke. Telex finally launched, and the stock didn't care that the pension cost was still compounding underneath it. It ran from 15 to 34¾, more than doubling off the 1957 low. In 1959 it doubled again, to a range of 29¾ to 53¾.
Source: Bank and Quotation Record, NYSE tables, Jan. 1960 issue (full-year 1959) (archive.org)
Two years of growth outrunning two years of worsening fundamentals, and the whole time, the pension cash cost was climbing from $10M toward $19M, and the debt load tripled from $43M to $149M. In 1962, the pension expense alone was $19M against operating income of only $7M, and Western Union still paid out a $10.5M dividend against $6.7M of net income that year, because a monopoly in decline can keep writing checks long after it's stopped earning the right to.
1960 was the top. The stock hit 57, a 3x against the original 1956 short, before falling 33% off that high in the same year. That's the year the market paid $57 for negative owner earnings, and it's the worst point of pain a short seller could have marked on the position.
They were functionally insolvent and making just enough cash to avoid a cratering stock price, buying themselves another story to outrun their obligations.
"Everything we've ever thought about shorting worked out eventually. But it's very painful" - Warren Buffett, 2001 shareholders meeting
The reckoning was still decades away. In the 1960s, a second narrative, data networks, saved the company again. They raised preferred stock and issued debt to fund it. From 1970 to 1974 they bought TWX, the teletypewriter exchange network, from AT&T, launched Mailgram, and built out Westar, the first U.S. domestic communications satellite fleet. More debt, funding a peak in revenue near $335M, but the earnings still couldn't sustain the company underneath it. All it needed was one more straw.
In 1974, ERISA ended pay-as-you-go pension funding for good. By 1980, new FASB disclosure rules forced the real liability into the footnotes, and the hole Charlie had already found in 1956 became visible to everyone else at once. Telex was being eaten by MCI, fax machines, and data lines, declining at 20% a year.
Even then, the market gave Western Union a final reprieve. High interest rates in the late 1970s and early 1980s meant a lower present value on a pension obligation payable decades out, so the gap shrank on paper without a dollar of it actually being paid down. Then the 1980s bull market let the pension trust's own assets compound faster than anyone had planned for, closing more of the gap without requiring new cash from operations. Twice, the world did Western Union's job for it.
It wasn't enough. $117M in losses hit across 1983 and 1984 combined. The dividend was suspended. Banks pulled their credit. It took twenty-eight years, but the thesis Charlie had run in 1956 was finally paying off.
Western Union Flashes Warning, Washington Post, Dec. 19, 1984
In 1987, Drexel arranged a $450M financing package it called "highly confident" behind Bennett LeBow, a New York investor who put in $25M for 53% control. LeBow used the money to buy ITT World Communications for $170M and pay off Western Union's $273M of bank debt for $175M plus stock, merging the two into a leading international telex service. Western Union sold its satellites to Hughes and its telex and email business to AT&T, selling off its own organs to service the debt, and it still wasn't enough. On November 15, 1991, an involuntary Chapter 11 hit the company. Western Union, once the sterling monopoly, renamed itself New Valley Corp to shield the brand from the filing, then auctioned off the money-transfer business, and the name attached to it, for $1.19B in 1994 to pay back creditors and fund the pension. The old common shareholders were left holding a worthless certificate.
Source: New York Times, May 8, 1987
The money-transfer business came out of the estate intact. It passed through First Financial, then First Data, and in 2006 First Data spun it off under the old name. A year later, the shares turned up in Berkshire's portfolio. Fifty years after the thesis, the shop that knew never to short Western Union ended up owning its remnants anyway.