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The First Ten Years | |
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Today marks the tenth year since I started my own investment company. Prior to starting my company I worked for the Swire Group in Hong Kong -- a major conglomerate which owns, amongst other things, Cathay Pacific Airways -- and for Dow Chemical (HK) Ltd. I graduated from the University of Melbourne, Australia, in 1983 with a Bachelor of Science degree in Microbiology and Pathology. Originally, I wanted to follow in my father's footsteps and be a doctor. However, business just seemed more interesting and I decided to return home to get my feet wet.
I was itching to do my own thing in 1986 and never really wanted to work for anyone. As such I took the leap in 1987 and formed a private investment company with seed capital from my family. The goal of the investment company was, and still is, to invest our money in sound businesses with good long-term growth potential, whether in part via listed common stocks or in their entirety.
Goodman Medical Supplies Ltd. (Goodman) At the time, the two owners wanted to emigrate and retire to Canada due to the uncertain political situation in Hong Kong. In July 1987 I purchased the company for $1.34 million, all of which came from the seed capital provided by my family. I was pretty much a hands-off owner with Goodman, preferring to let the business continue being run the way it had been run in the past. I did get involved in the financial side, ensuring that working capital was managed efficiently and installing new financial control systems. About six months later, I brought in a great manager, H.Y. Lo, to run the company. H.Y. used to be the Regional Marketing Manager at Dow Chemical. I met him when I was working for Dow. I was lucky to be able to get H.Y. -- aside from being a magnificent hands on manager, he is a man of utmost integrity. I pretty much just sat back and let H.Y. run the show. In the process he created a lot of wealth for us. Less than two years after I bought Goodman, I recouped close to 80% of my original purchase price through dividends. In April 1990, I sold 100% of Goodman to a Singapore-based listed company, United Engineers Limited, for $4.26 million. Inclusive of dividends received during my ownership period, the Goodman investment achieved a compound annual return of 61%. For a 28 year old with a couple of million dollars in my pocket, I was (naively) feeling pretty pleased with myself. Little did I know that I had just made a huge mistake in selling the company. Looking back now, the first lesson I learned from my experience with Goodman is that a good business should not be sold unless the buyer is willing to pay an irrationally high price. In fact, one should hang onto a good business tenaciously. This principle applies to outright ownership of a private business and to part ownership via marketable common stocks in publicly listed companies. A non-capital-intensive business that generates cash steadily, and has solid prospects, is not easy to find in one's lifetime. I was lucky enough to find Goodman at an early stage in my career and, more importantly, I was able to buy into it at a very cheap price. The unfortunate thing was I didn't have the intellectual discipline that I have today. The prospect of realizing a quick return was too tempting for me to refuse at the time. To put things in perspective, I have estimated that by 1994 Goodman's net after-tax profit was close to $1.8 million a year. I am talking about no-strings-attached profits that can be taken out as cash, with the business requiring minimal working capital to maintain. If I had simply kept Goodman instead, I would have collected more than $9 million in dividends from 1987 up to now. In addition, I would continue to have a steady cash-generating business, similar to a perpetual annuity of $1.8 million (assuming no growth in the business). A perpetual annuity of $1.8 million under today's interest rate environment can easily be worth $18 million. I left far too much money on the table. Goodman could have been my foundation for a substantial fortune. I have come to understand that cash flow is crucial in building a great fortune. A lot of great fortunes were built, whether by design or by accident, by getting into businesses with strong free cash flow and reinvesting this free cash flow wisely to generate more cash flow. If you do this consistently and steadily, eventually you will become a billionaire. The master of this game is Warren Buffett. Warren buys businesses that generate a lot of cash and in turn uses the cash generated to buy more such businesses. Some of the businesses he buys outright in their entirety and therefore controls their cash flow. Others are parts of similar businesses represented by listed common stocks. Even though he does not have access to the cash flow of the stocks he owns, the growing free cash flow shows up as capital gains in the stocks' market prices. At the risk of oversimplifying what is actually a very sophisticated approach, the end result of this is a net worth of over $22 billion and making him the second richest man in America (I venture to say that in the not too distant future, Warren will be the richest man in America assuming his health continues to be good).
Travel and Trade Publishing (Asia) Limited (TTP) In 1989, TTP was making approximately $192,000 annually which means I paid close to ten times earnings. This was considered a fairly rich price at the time, due to the uncertain political situation in Hong Kong, and also because small private businesses generally changed hands at 5-7 times earnings. I was willing to ante up because I liked the economics of the publishing business. An established magazine title or newspaper is a strong franchise with low ongoing capital requirements and high free cash flow. By 1992, Sawasdee magazine was netting close to $1.55 million per year. So what seemed like a very high P/E multiple actually turned out to be a ridiculously low multiple. With what I considered to be two home runs in a row, my confidence was in cloud nine by this time. The major drawback with TTP was that it was essentially a one-product company. All of the profits of the company were generated by Sawasdee magazine, which was published under a renewable three year contract with Thai Airways. Every three years when it came time for renewal and competitive bidding, we sweated bullets. So the logical conclusion was to diversify in order to make the company less reliant on Sawasdee. I totally immersed myself in the operations of TTP and went on an expansion binge. We launched four Pan-Asian trade magazines within a very short period of time (Asian Advertising and Marketing, Asian Meetings and Incentives, Asian Printing, Asian Property, and related directories and yearbooks). As anyone in the publishing business knows, a new publication takes at least 3-5 years to become profitable assuming it can make it. So launching four new magazines in a row was definitely against all odds, as well as a heavy drain on capital. The second major lesson I learned is youth and early success without a proper framework of intellectual disciplines can be a deadly combination. After sustaining heavy losses for some time, I closed down all the trade publications, except for Asian Advertising and Marketing, which was sold at a loss, in September 1992. I also wrote off two other ventures which I got into under the guise of diversification. All in all, the total damage amounted to $3.5 - $4 million. After the restructuring in 1992, I just stuck to Sawasdee and hoarded the cash it generated. We eventually lost the Sawasdee publishing contract to a division of Time Warner in September 1996 after a 13 year stint with Thai Airways. Sad, but no good thing lasts forever. This experience left me very suspicious and skeptical of diversification. If I hadn't diversified but had simply stayed with Sawasdee, I would have returned around $7 million in cash dividends to my shareholders (i.e. my folks and myself) from 1989 up to the time I lost the Sawasdee contract. So not diversifying, being a one product company, and losing the Sawasdee contract in the end is definitely far more beneficial than diversifying in order to create durable earnings. When I invest in companies now, I get very nervous when management talks about diversification and aggressive acquisitions. I much rather they stay focused and stick to their knitting. If they cannot grow their existing business, then it is much better to return the excess cash to shareholders via increased dividends and stock buy-backs. This is easier said than done since most successful entrepreneurs and CEOs got there by being aggressive and active. They almost all have a "can do" spirit and relish the action in expansion and deal making (I know exactly how they feel). To do nothing with surplus cash and return it to shareholders goes against their nature. CEOs that have the discipline to keep their egos in check and ask themselves honestly whether they can really deploy excess cash effectively are a rarity (on this count I am definitely not a rarity). As a result you see endless restructuring and divestitures in corporations all the time. The usual rationale in such instances is the business is no longer strategic or there is a need to refocus, all of which means I screwed up and therefore I need to get rid of the excess baggage now.
One World Records, Inc. (One World) One World was a turnaround situation. The company was close to bankruptcy in 1991 due to over rapid expansion and shortage of capital. Initially I invested $1 million into it in the form of a convertible note fully secured by the company's receivables and inventory. I tried to remote control the company from Hong Kong after the cash infusion, seconding my CFO from Hong Kong to One World to straighten out their finances. After about 6-8 months, it became evident that the problem was much deeper than just shortage of capital. I left Hong Kong in 1992 and started living full time in Boonton for the next three years. What followed was the most intense and challenging period in my career thus far. After a few expected clashes with management, I took over the day-to-day operations of One World. The company was bleeding close to $100,000 every month at the time and I managed to reduce the losses to around $60,000 per month. In retrospect, learning on the job while simultaneously trying to perform major surgery on a dying patient was not a good idea at all. My life during this period seemed like a blur consisting of endless work days starting at 5 in the morning and frequently ending after midnight. I was learning how to cut a record deal, about music publishing, and also about the rough-and-tumble world of indie music distribution. There is a joke in the music distribution business that the goal is to sell the records faster than the retailers can return them. I hit the road with my sales manager and visited all the major record retail chains in the US to drum up business. I think we covered closed to 10 cities throughout the US in 13 days. I am grateful to my music attorney Bill Leibowitz who educated me on the music business and made crucial introductions for me. The business of One World touched on retailing, marketing and promotions, production (both physical production of CDs and recording of the acts I signed), and deal making. Consequently I consider the hands on operating experience I gained invaluable. I wouldn't trade it for anything in the world. In the process I also became enamored with the US. By 1994, it became clear to me that this turnaround was never going to turn. After sinking close to $2.5 million of our money into One World, I decided to close down the entire operation in August 1994. It is one thing for the CEO of a Fortune 500 company to lay off thousands of people. He can probably press a button and get his subordinates to do the job for him. When you are a small company and you, yourself, have to lay off the people you work with day to day, it is a different story. I tried to recoup some of our investment by liquidating the inventory and receivables (we had a first charge on these assets via our convertible notes). The proceeds from these assets were a pittance compared to their balance sheet values. However, the liabilities were solid. A number of our suppliers lost money from One World and were never repaid in full. Legally, I did nothing wrong since our position was that of a senior secured creditor. Morally, however, it was an inexcusable blemish.
Fantasy
No Longer A Virgin As a result, all is not lost. I believe such hands-on investing and operating experience have better equipped me in business analysis and valuation. Without such hands on experience, I'll be like a virgin trying to write a book about sex. Some things are never the same until you've experienced them. |
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