Warren Buffett: Buying Berkshire Hathaway (NYSE: BRK) Was $200 Billion Blunder

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Warren Buffett says Berkshire Hathaway is the “dumbest” stock he ever bought.

He calls his 1964 decision to buy the textile company a $200 billion dollar blunder, sparked by a spiteful urge to retaliate against the CEO who tried to “chisel” Buffett out of an eighth of a point on a tender deal.

Buffett tells the story in response to a question from CNBC’s Becky Quick for a Squawk Box series on the biggest self-admitted mistakes by some of the world’s most successful investors.

Buffett tells Becky that his holding company (presumably with a different name) would be “worth twice as much as it is now” – another $200 billion – if he had bought a good insurance company instead of dumping so much money into the dying textile business.

Here’s his story:

BUFFETT: The- the dumbest stock I ever bought- was- drum roll here- Berkshire Hathaway. And- that may require a bit of explanation. It was early in- 1962, and I was running a small partnership, about seven million. They call it a hedge fund now.

And here was this cheap stock, cheap by working capital standards or so. But it was a stock in a- in a textile company that had been going downhill for years. So it was a huge company originally, and they kept closing one mill after another. And every time they would close a mill, they would- take the proceeds and they would buy in their stock. And I figured they were gonna close, they only had a few mills left, but that they would close another one. I’d buy the stock. I’d tender it to them and make a small profit.

So I started buying the stock. And in 1964, we had quite a bit of stock. And I went back and visited the management, Mr. (Seabury) Stanton. And he looked at me and he said, ‘Mr. Buffett. We’ve just sold some mills. We got some excess money. We’re gonna have a tender offer. And at what price will you tender your stock?’

And I said, ’11.50.’ And he said, ‘Do you promise me that you’ll tender it 11.50?’ And I said, ‘Mr. Stanton, you have my word that if you do it here in the near future, that I will sell my stock to- at 11.50.’ I went back to Omaha. And a few weeks later, I opened the mail-

BECKY: Oh, you have this?

BUFFETT: And here it is: a tender offer from Berkshire Hathaway- that’s from 1964. And if you look carefully, you’ll see the price is-

BECKY: 11 and-

BUFFETT: -11 and three-eighths. He chiseled me for an eighth. And if that letter had come through with 11 and a half, I would have tendered my stock. But this made me mad. So I went out and started buying the stock, and I bought control of the company, and fired Mr. Stanton. (LAUGHTER)

Now, that sounds like a great little morality table- tale at this point. But the truth is I had now committed a major amount of money to a terrible business. And Berkshire Hathaway became the base for everything pretty much that I’ve done since. So in 1967, when a good insurance company came along, I bought it for Berkshire Hathaway. I really should- should have bought it for a new entity.

Because Berkshire Hathaway was carrying this anchor, all these textile assets. So initially, it was all textile assets that weren’t any good. And then, gradually, we built more things on to it. But always, we were carrying this anchor. And for 20 years, I fought the textile business before I gave up. As instead of putting that money into the textile business originally, we just started out with the insurance company, Berkshire would be worth twice as much as it is now. So-

BECKY: Twice as much?

BUFFETT: Yeah. This is $200 billion. You can- you can figure that- comes about. Because the genius here thought he could run a textile business. (LAUGHTER)

BECKY: Why $200 billion?

BUFFETT: Well, because if you look at taking that same money that I put into the textile business and just putting it into the insurance business, and starting from there, we would have had a company that- because all of this money was a drag. I mean, we had to- a net worth of $20 million. And Berkshire Hathaway was earning nothing, year after year after year after year. And- so there you have it, the story of- a $200 billion- incidentally, if you come back in ten years, I may have one that’s even worse. (LAUGHTER)

For Google, Android Means Keeping More Revenue

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Friday, Google (GOOG) announced their Q3 earnings. And they were good. Really good. But that doesn’t mean that questions still don’t linger about the company going forward. Namely, how are they going to make money off of something besides text-based search advertising?

Google’s position is that they already are. They shared three key numbers to show how well three other areas of their business are doing: YouTube, display ads, and mobile. And mobile came up again later during the Q&A session on the call. Google CEO Eric Schmidt was on the call and took the question about how Android will make money for the company.

Schmidt called Android “probably the largest single platform play in the market today.” And going forward, he thinks that’s only going to increase as more and more people buy smartphones. At the same time, “in the open source approach, that means we give the software away, which is always paradoxical. People say, well how do you make money from that?,” Schmidt was quick to jump to.

“The evidence we have is that people who use Android search twice as much as everything else,” Schmidt continued. “So, clearly, there is more revenue associated with those searches.”

One of the specific numbers shared by Google SVP of Product Management, Jonathan Rosenberg, was that the annualized run rate on mobile for Google is now one billion dollars. But it’s important to note that this is across all platforms and devices. That just means that a lot of people are searching on their phones and seeing ads.

That’s exactly what Google wants, but Android is a bit different since they’re pouring so many resources into it. “If they are using Android systems, revenue that we share in the search are shared with operators but not with anybody else. So, again it’s more lucrative,” Schmidt noted.

Schmidt also said that on that basis alone, Android is already “hugely profitable.” And he continued on to say that Android is likely to be financially successful even without any of the other mobile ideas that are possible. “We can layer on value-added services,” he said.

That’s interesting. It suggests that Google is definitely thinking about ways they can layer premium services on top of the platform in order to make money. At the very least, they haven’t ruled it out. What kinds of services? Who knows. One obvious one would be turn-by-turn navigation, but they’re already giving that away for free.

But Schmidt was quick to jump back to, “Our primary purpose right now is building this open platform.” He also stated that the goal with their app store is to make money for developers, not themselves.

Written by MG Siegler of TechCrunch

Apartment Stocks Benefiting From the Housing Crisis

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Several months ago, I was lucky enough to sell my home relatively quickly (at full asking price, no less). Unfortunately, when the time came to hand the keys to the new owner, we still hadn’t found a replacement.

Luckily, I knew a local commercial property manager who specializes in apartments. I assumed he would have no trouble reserving a nice unit for us on short notice. No such luck. Even with a large portfolio stretching from Baton Rouge to Texas, his company didn’t have a single vacancy — nice or otherwise.

That’s how my family and I ended up in a Days Inn for a few weeks with all our belongings crammed in a storage shed. Let’s just say I’m glad those days are over. But ever the investor, I did manage to take something away from the ordeal: a newfound appreciation for the residential REIT sector.

Clearly, I wasn’t the only apartment hunter to be turned away by no-vacancy signs. Millions of homeowners that got in over their head have been forced to downsize. Some have moved into less lavish homes, but many others have reached the conclusion that apartment living just makes more sense.

First, apartment rents are generally affordable and don’t require a sizeable down-payment. Renting also eliminates the hassle and expense of home maintenance — no unexpected repair bill for that leaky faucet. Nor do you have to worry about losing equity should home values keep moving south. Finally, many renters like the flexibility to quickly relocate without being anchored to a mortgage.

Whatever the reason, apartment complexes around the country seem to be filling up fast. But I don’t rely on anecdotal evidence. So I did some homework and found that my suspicions were correct — the days of giving away free gym memberships and other concessions to lure tenants were over.

So on June 16, I recommended iShares FTSE NAREIT Residential (NYSE: REZ). The fund invests predominately in companies that own multi-family housing and self-storage units.

In the months since, the industry has continued to heat up. In fact, there are currently 84,382 more apartment occupancies now than there were three months ago. That’s a record absorption for the industry. Meanwhile, vacancies have fallen from 7.8% to 7.2%, one of the sharpest quarterly improvements on record.

But it gets better. Apartment construction activity slowed dramatically during the recession, so there hasn’t been much new capacity to soak up. That lack of availability, coupled with the increased demand, is pushing rental rates higher.

According to Axiometrics, average rent prices reversed a two-year downturn and climbed +3.2% during the first half of the year. That trend has been even more pronounced in major metro areas (some of which have seen their available inventory drop by one-third). An average apartment in New York City now goes for $2,756 per month, for example.

Major apartment owners are already moving to cash in. Equity Residential (NYSE: EQR), for example, has been feasting off distressed property sales and recently bought two luxury Manhattan residential towers for pennies on the dollar. Others are breaking ground on new developments — while single-family housing starts edged up +4% in August, construction of new apartment buildings jumped +32%.

The combination of robust demand and firmer pricing power has juiced earnings and given investors reason to cheer. For new money, I’d recommend Avalonbay Communities (NYSE: AVB) — arguably the industry’s premier player.

It’s no secret that real estate values are pretty much determined by three things: location, location and location. And while Avalonbay has a diverse portfolio of 164 properties (46,000 units) spread throughout 10 states, most are in densely-populated areas. Two dozen of those complexes are in the Washington D.C. area, with even more in Boston and San Francisco.

Needless to say, upscale mid- and high-rise apartments in these regions (where space is at a premium) command higher prices. They also have higher barriers to entry and face less competitive threats from the “shadow inventory” of foreclosed homes.

Those competitive advantages are a big reason why Avalonbay’s shares have delivered a gain of +201% in the past decade. The stock isn’t cheap, trading at 25 times forward earnings. But it does offer a tempting yield of 3.4% and could easily climb into the $120s with favorable macro trends and an ambitious development pipeline.

I consider it a strong portfolio contender, and will have my eye on third quarter results due out later this month.

Article by Nathan Slaughter,
StreetAuthority

Asian stocks up on solid US corporate results

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Asian stock markets advanced Thursday, lifted by better-than-expected earnings results from U.S. corporate bellwethers and growing expectations for action by the U.S. Federal Reserve to spur growth.

The dollar hit another 15-year low against the yen in Tokyo and continued to weaken against the euro. Oil prices rose to near $84 a barrel in Asia as a report showed U.S. crude supplies dropped unexpectedly last week, suggesting demand may be improving.

With the U.S. dollar being pummeled — it twice hit bottom this week against the yen — traders seeking higher returns in equities sent Asian markets higher. That was despite a new sign of weakness in the global economic recovery: Singapore said Thursday its volatile manufacturing sector had faltered, causing a precipitous fall in growth.

Singapore’s economic growth slowed in the third quarter from a record pace, the Trade and Industry Ministry said. Gross domestic product rose 10.3 percent in the July-to-September period from a year ago, compared with a rise of 19.6 percent in the second quarter.

“Singapore is the most exposed to global growth. It’s a bellwether for the global economy,” said Song Seng Wun, an economist at CIMB Research.

Japan’s benchmark Nikkei 225 stock index jumped 163.02 points, or 1.7 percent, to 9,568.73. South Korea’s Kospi added 0.5 percent to 1,886.54. Australia’s S&P/ASX 200 was up 1.6 percent at 4,692.9.

Elsewhere, Hong Kong’s Hang Seng index rose 1 percent to 23,704.70. The Shanghai Composite Index gained 0.4 percent to 2,873.837. Markets in New Zealand, Malaysia, Singapore and Taiwan all rose in early trading.

Sentiment was upbeat across Asia as investors took heart from strong earnings results from Intel Corp. and JPMorgan Chase & Co. The solid results lifted Wall Street on Wednesday as the Dow Jones Industrial Average climbed 75.68 points, or 0.7 percent, to 11,096.08, a five-month closing high.

JPMorgan Chase said Wednesday its third-quarter profit jumped 23 percent and that it earned $4.42 billion, or $1.01 per share, beating analysts’ forecast of 90 cents per share. Intel announced a 59 percent jump in net income after the closing bell on Tuesday.

Global stocks have rallied in recent weeks as investors bet the Federal Reserve will enact a bond-buying program in early November. Buying bonds would drive interest rates and yields even lower, which makes stocks a more attractive investment.

In currencies, the dollar fell to 81.19 yen from 81.79 yen in New York late Wednesday — the lowest level since 1995. The euro rose to $1.4071 from $1.3955.

Benchmark oil for November delivery was up 75 cents to $83.76 a barrel in electronic trading on the New York Mercantile Exchange. The contract gained $1.34 to settle at $83.01 on Wednesday.

Report by Pamela Sampson

AOL, private-equity firms may bid for Yahoo (NASDAQ: YHOO)

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AOL Inc. and a handful of private equity firms are discussing a possible buyout offer for Yahoo Inc., The Wall Street Journal reported Wednesday, sending Yahoo shares climbing sharply in after-hours trade.

AOL (NYSE:AOL)  is in talks with firms including Silver Lake Partners and Blackstone Group LP (NYSE:BX)  , about a possibile offer, the report said citing unnamed sources.

According to the report, AOL and its potential private-equity partners are considering a deal in which Yahoo would sell off its roughly 40% stake in Chinese Internet giant Alibaba Group (PINK:ALBCF)   (THE:HK:1688)  , in addition to other, unspecified assets, thus making it a much more manageable potential acquisition. See full WSJ.com report on possible AOL bid for Yahoo.

Much of Yahoo’s market value is tied to its stakes in various Asian assets. The company’s stake in Alibaba grants it access to the world’s largest Internet market, for example. Certain other Alibaba assets are likely to grow much further in value once they’re spun out onto the public markets.

Shares of Yahoo, which closed over 5% higher during Wednesday’s session, shot up a further 13% in after-hours trading, following the Wall Street Journal report. Shares of AOL were down 0.5% in late trade.

In addition, AOL is mulling a reverse merger with Yahoo (NASDAQ:YHOO)  , with the resulting entity possibly becoming a private company, according to the report.

The talks are “very preliminary” and do not include Yahoo, it said.

Both AOL and Yahoo spokespersons declined to comment.

Written by John Letzing

Microsoft’s (NASDAQ: MSFT) Bing Gets a Social Lift From Facebook

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Facebook and Microsoft announced a partnership on Wednesday that will give the results on Microsoft’s Bing search engine a social twist — and could help both companies compete against a common adversary, Google.

The new feature allows people who use Facebook to see Bing search results that incorporate information from their friends, like restaurant recommendations.

When a user searches for something like a movie, place or product on Bing, information about how many of their friends “liked” that item on Facebook and related links they have shared will appear alongside the results. The Facebook data will help determine how prominently these will appear, said Yusuf Mehdi, a senior vice president for online business at Microsoft.

“It isn’t just about the common connections between data and the offline world, it’s about the connections between people,” Mr. Mehdi said.

Mark Zuckerberg, a founder and chief executive of Facebook, said the move was a deepening of the company’s current partnership with Microsoft.

In 2007, Microsoft paid $240 million for a 1.6 percent stake in Facebook. Since then, the two companies have worked together to introduce advertisements on Facebook and incorporate Bing Maps into Facebook’s location application, called Places.

Facebook and Microsoft appear to be forming a united front against Google, a rival to both in several ways.

Despite heavy investment by Microsoft, Bing still greatly lags Google in terms of market share. Google has made several attempts to strengthen its social networking offerings and compete with Facebook.

At stake, analysts say, is the ability to know more about users, and to charge more for ads that are more effectively aimed at those users.

“Making search more social is ultimately going to drive more targeted advertising, which you can charge a premium for,” said Mukul Krishna, a digital media analyst at Frost & Sullivan. “Search hinges on that business model.”

Report by Jenna Wortham

Wal-Mart (NYSE: WMT) Sending Good but Mixed Messages

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I think the new head of Wal-Mart (WMT) US Bill Simon is missing a big opportunity to go after apparel, which represents about 12% of annual sales and can be used as an offset to higher sales of low margin consumables. If the core customer to Wal-Mart earns $70K a year or more, as was implied today at the meeting, then certainly this customer would not mind spending for something that is non-basic. Keep in mind, prices on fashion pieces would still be below peers in most cases. If Sears (SHLD) can partner up with Forever 21, why can’t Wal-Mart?

Of course, execution on the rollout of small square footage stores will be of key importance. At the meeting, management just tossed all of these initiatives out there, but can Wal-Mart learn local customer preferences? Wal-Mart will need local people on the ground, in the same manner maybe as the “My Macy’s” initiative. They need the systems to know when to reorder local product and the trust in the managers. We won’t really know if Wal-Mart can pull the urban push off until one of these stores of the future actually open to a sizable footprint.

Things to like:

  • Sam’s Club doing better on sales and with member traffic.
  • Wal-Mart US. comps are awakening as items removed from the assortment in 2009 are added back. However, the 4Q positive comp nod by CEO Mike Duke is more a function of an easy year earlier comparison.
  • Small store rollout, aggressive, international.
  • No big bump in capex for calendar 2011, just reallocation of funds.

Things not to like:

  • I can see a sizable increase in capex for calendar 2012 in view of the initiatives articulated today.
  • Initiatives will take time to play out in sales and earnings.
  • Company is now going back to fix actions that did too much, such as shrinking apparel pad and action alley. This costs money and time.
  • Tempered the talk on inflation, I think this is a problem for 2011.
  • Marketing message still unclear.

Article courtesy of Brian Sozzi, Wall Street Strategies

Roubini Expects 35-40% Chance of a Double Dip Recession in U.S.

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New York University Professor Nouriel Roubini said he expects a 35 percent to 40 percent chance of the U.S. entering a double dip recession, highlighting the risks faced by the world’s largest economy.

Roubini also said in a conference today in Seoul that U.S. economic growth could decelerate to as low as 1 percent by year-end. “The growth rate is so low it’s going to feel like a recession even if technically this is not a recession,” he said.

Federal Reserve policy makers last month said U.S. growth is likely to be “modest in the near term” and added that they are prepared to ease monetary policy further if needed. The recovery of advanced economies including the U.S. is likely to be anemic and “U-shaped,” Roubini said.

A U.S. jobless rate hovering near 10 percent is shaking consumer confidence and limiting spending, the biggest part of the economy. The American economy expanded at a 1.7 percent annual rate in the second quarter, according to the Commerce Department.

Roubini said that deflation is the biggest risk for advanced economies. Japan’s producer prices in September fell for the first time since July as the yen’s gain makes imports cheaper, according to Bank of Japan data released today.

He said Japan’s central bank isn’t reacting aggressively to economic developments. The Bank of Japan on Oct. 5 created a 5 trillion yen ($61 billion) fund to buy bonds and other assets, and pledged to keep its benchmark interest rate at “virtually zero” until the end of deflation is in sight.

In contrast with the slow pace of recovery among advanced economies, emerging economies are likely to undergo rapid and sharp rebounds, Roubini said.

Report by By Jun Yang, Bloomberg News

Why Florida’s Foreclosure Machine Is Slowing Down

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At the George E. Edgecomb Courthouse in Tampa, Judge Sandra Taylor presides over one of the special courts set up to help work through Florida’s backlog of foreclosure cases. Sitting at a desk in a fifth-floor conference room, with a court assistant and a cart stacked with manila envelopes at her side, Taylor uses a speakerphone to talk to attorneys for the banks and mortgage servicers who call in rather than appear in person. Most borrowers don’t show up to contest the loss of their homes.

One day in early October, Taylor had 51 cases on her docket. It took her about 30 seconds to approve some of the actions and set a sale date after lenders’ attorneys summarized the case and the amount owed. “I wish there was more we can do,” Taylor told one homeowner who did appear. She said there was “no legal reason” why she shouldn’t approve the foreclosure on the home.

Another homeowner, Ingrid Young, 44, told Taylor she couldn’t afford the $1,900 monthly payment for her Tampa house because she earns only $1,800 a month. “I am in default, and I do realize that,” she said. Taylor approved the foreclosure after persuading attorneys for CitiMortgage, a unit of Citigroup (C), to set the sale date in January, after the holidays. “It’s a very sad business,” the judge said during a break.

Florida has the third-highest foreclosure rate in the U.S. after Nevada and Arizona, according to RealtyTrac, the Irvine (Calif.)-based data firm. One in every 34 housing units—double the U.S. average—was in the foreclosure process or bank-owned as of Sept. 1. Florida’s legislature appropriated $9.6 million this year to hire semi-retired judges and case managers to preside over foreclosure hearings such as those in Tampa, which have come to be known as “rocket dockets.”

Growing Backlog

The goal is to clear 62 percent of the backlog by next July, according to Craig Waters, a spokesman for the Florida Supreme Court. J. Thomas McGrady, chief judge of Florida’s Sixth Judicial Circuit, once thought that was achievable. Now that JPMorgan Chase (JPM), Ally Financial, and other banks have put the brakes on foreclosures or evictions to look for any paperwork irregularities, McGrady is “very doubtful” his courts can do that. The Sixth Circuit, which covers the area around Clearwater and St. Petersburg, faces a backlog of 33,000 foreclosures, he says.

“All of a sudden all of these issues pop up with the lenders,” McGrady says. “It’s going to slow down the whole process. We’re still getting 1,000 cases a month.” At the Clearwater court, lenders as of Oct. 12 had canceled more than half of 84 hearings to approve foreclosures that were scheduled for the following day, according to Ron Stuart, a court spokesman. Half of 110 hearings set to take place the day after that had been canceled as well.

Among the alleged defects the banks are examining are lender affidavits signed by people, often described as “robo signers,” who repeatedly failed to verify the accuracy of the information in the documents. A lawsuit filed last week by Ohio’s attorney general accuses Ally and its GMAC Mortgage unit of committing fraud by submitting hundreds of false affidavits in foreclosure cases. Ally said in a statement that it “believes there was nothing fraudulent or deceitful about its foreclosure practices.”

A coalition of all 50 state attorneys general, led by Iowa’s Tom Miller, announced a joint investigation into foreclosures on Oct. 13. Florida Attorney General Bill McCollum has asked five lenders and mortgage servicers to meet with him to discuss ways to “redeem the integrity” of the foreclosure process. “Every homeowner that’s in foreclosure now should be questioning” the documents, says Matthew Weidner, an attorney in St. Petersburg who defends homeowners in foreclosure cases. “This entire system is now a great big question mark.” Oliver Chang, a housing strategist at Morgan Stanley (MS), says that as many as 9 million U.S. mortgages in the foreclosure pipeline or already through the process may face legal challenges. 

Law Firms Investigated

The lenders aren’t the only ones coming under increased scrutiny. McCollum is investigating four law firms, including Shapiro & Fishman and the Law Offices of David Stern, that handle foreclosure cases on behalf of lenders. Among the banks represented by the firms the attorney general has targeted are CitiMortgage, Bank of America (BAC), and Deutsche Bank (DB). McCollum accuses the firms of “unfair and deceptive actions” and says thousands of foreclosures that had been approved by judges may have been the result of their allegedly improper actions. Gerald Richman, an attorney for Shapiro & Fishman, says the firm is ready to cooperate with the attorney general’s office if it narrows the scope of a subpoena seeking information, which Richman calls “invasive.” Representatives of the other firms didn’t return phone calls seeking comment. Citigroup says it has stopped steering foreclosure work to the Law Offices of David J. Stern.

Meanwhile, the foreclosure process grinds on. Weidner criticizes judges for continuing to hold rocket docket sessions amid the controversy over flawed documents. “Inside these courtrooms, judges—the bad ones—are just granting summary judgments like nothing’s happening, like it’s business as usual,” he says. “They’re abdicating their responsibilities to be real judges.”

Several Florida judges say their job is not to advocate for homeowners or investigate the accuracy of documents—courts depend on homeowners or their attorneys to raise objections. “We’re processing thousands of cases where no one is really contesting them,” says W. Douglas Baird, a judge in Clearwater. “It’s not a situation where the courts have the ability to go through every document that’s filed and challenge and question those documents.”

McGrady, the chief judge in Florida’s Sixth Circuit, says his courts have seen “numerous situations of some very sloppy practice” by lenders. “I’m disappointed that perhaps they’ve taken advantage of a system that was set up to allow them to obtain their foreclosures in a reasonably fair and expeditious process,” he says, “and they may have abused that.”

The bottom line: As more questions arise about the legitimacy of foreclosure proceedings, Florida is having a hard time clearing its case backlog.

Written by David McLaughlin

An Expensive Face-Lift On Burger King’s (NYSE: BKC) Menu

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When Joyce Jacaruso Castillo grabbed a quick coffee at a McDonald’s (MCD) in Manhattan last month, she was wowed by the low lighting, cushioned stools, and piped-in bossa nova music at one of the chain’s newly remodeled units. The 69-year-old New Yorker doesn’t feel the same vibe at rival Burger King (BKC), however. “McDonald’s is more uplifting,” she says. “Burger King is so blah.”

Leveling that playing field could be expensive for the new private equity owners of Burger King Holdings, who agreed in September to buy the chain for $3.3 billion. Burger King Chief Executive Officer John W. Chidsey said last month that 85 percent of the chain’s 7,200-plus locations in the U.S. need to be remodeled. Modernizing stores with the company’s new “20/20″ redesign will cost about $500,000 each, he said in June, with some going as high as $1.1 million. That could push the cost past $3 billion. “The image is 20 years old,” says Charles M. Fallon, president of Burger King’s North American business. “We’re working hard on making the economics work.”

Persuading franchisees to go along may not be easy. Slowing sales at the No. 2 burger chain have made many store owners reluctant to spend on renovations, says Steve Lewis, who owns 36 outlets near Philadelphia. So acquirer 3G Capital Management may need to chip in funds to spur remodeling, says Jordan Krolick, president of consultant Tound & Drowth. “It’s the hidden cost in any restaurant acquisition, and should be planned for as an addition to the initial investment,” says Krolick, who previously ran acquisitions at McDonald’s.

Susan Robison, a Burger King spokeswoman, says outlets without drive-throughs will be cheaper to remodel and franchisees can remodel using the old look, which costs less. Steven Lipin, an outside spokesman for 3G Capital, says “it’s premature to talk about whether 3G’s going to provide funding or what the cost will be” for upgrades.

McDonald’s, which owns much of the real estate underlying its franchises, fuels renovations by matching 40 percent of funds put up by its franchisees, on average. At Burger King, franchisees, who own about 90 percent of outlets, are responsible for renovation costs and must remodel their stores every 10 years to Burger King’s specifications.

Burger King unveiled its 20/20 redesign two years ago. So far, more than 30 U.S. restaurants have been outfitted with chrome-trimmed booths, brick walls, LCD menu screens, red and black paint, and “flame” chandeliers. Some franchisees say they won’t pay for the extensive remodels. Lewis says four of his restaurants have come up for contract renewals in the past two years and he has opted for less expensive updates such as adding carpeting and terminals with Internet access. “I’m doing whatever the minimum is,” he says.

Remodeling stores lifts sales 12 percent, according to Burger King. Shoukat Dhanani, who operates 61 Burger Kings in the Houston area, built the first 20/20 restaurant in the U.S. in May 2009. Sales are 40 percent higher than at his other locations, he says. Some customers couldn’t believe the sleek store was a Burger King, he says. “Customers were like, ‘Wow, this is nice!’” he says. “‘Are we in the right place?’”

The bottom line: Burger King’s new owners could face a hefty bill to help update its restaurants, which trail competitors in performance and appearance.

Written by Burt Helm