This company has moved beyond selling physical products and lifestyles into the business of selling an identity.
I am youthful and vibrant, I am passionate about the great outdoors and I will fight to preserve the environment which I so much love.
Nowhere within this 100 page magazine was there ever a mention that Patagonia sells outdoor gears but if you identify with the persona just described above then Patagonia is your go to brand.
The company has positioned its brand at the self actualization level of the Maslow’s hierarchy of needs.
This book documents the series of events leading up to the successful leverage buyout (LBO) of RJR Nabisco.
Mechanism of an LBO exercise
- Figure out the cheapest possible price to acquire the asset and its future cashflows while keeping transaction costs low
- The acquisition team access the business to decipher potential cashflow, areas for cost savings and parts that could be sold off
- The acquisition team raises private money to do the acquisition
- During this period of time bandwidth of law firms and banks are fully engaged
- Competing offers should be expected once a public announcement of an LBO buyout is made
- Law firms and investment banks will charge fees even if the hiring party does not win the bid
Methods for financing an LBO exercise
- issue of junk bonds
- raising from private investors
- issue of shares to directors to drive down level of cash required for the purchase
- payment through cash
- utilization of legal loop holes to reduce taxation on the LBO transaction
Motivations for an LBO exercise
- The management team:
- a option to exercise when the market is persistently undervaluing the shares of the business
- free up value to reward themselves and their share holders
- the CEO being the typical Type A personality got bored and restless from running his day to day business
- The investment banks:
- when the market is down but they still need to figure out ways to make money through business transactions
- some needed an opportunity to enhance their prestige so as to attract future opportunities. Securing a prominent position in the transaction has that effect
Lessons from the LBO exercise
- The inability to sit in a room and doing nothing is the source of most trouble.
- The CEO ended off worst off than he did before the LBO event
- Having inside support matters
- Having support of the management team provides knowledge of where cost savings could be had in the operations
- Just when you think shit will not happen, it usually does.
- The management team was expecting an uneventful transaction. Unfortunately, the operation quickly escalated out of control when competing bids surfaced.
- When money is cheap, Wall street gets creative
- the Federal reserve provides cheap money which cannot be put to real economic use, LBO is just another method Wall Street utilizes to make a profit from this cheap money
- When egos start getting involved, its no longer about making a profit
- the successful acquirer ended up defaulting on a lot of the junk bonds issue
- what started as an initial USD76/share bid quickly escalated to USD106/share
- When an opportunity as large as this becomes available, the services of lawyer firms and bank credit becomes scarce and it is hard to gain access to such facilities as a new comer to the table
- Companies actively manage Wall Street expectation
- RJR Nabisco actively engaged in wasteful activities to project a steadily advancing year over year profitability and thus share price. It could have operated efficiently and have the share price reflect the actual value on day one
- The core business will falter overtime when the operators get distracted by other activities and are no longer engaged and connoisseur of their own products
- early employees of Reynolds cigarettes are themselves enthusiast smokers. They released a new product only when it passes their own taste test
- later management were focused on milking the cash cow and started changing the culture as such
- Negotiation dynamics
- the senior financiers will generally play the diplomat (good cop)
- the junior and middle level financiers will be in charge of hashing out the details (bad cop)
Chain of events and decision making
The decision making processes from June 2019 after the federal reserve signal likelihood of cutting interest rate leading up to the 2019 August downward mean reversion of the SnP.
19th June 2019, Federal Reserve signals for first time likely decrease of interest rates
Federal Chairman expresses concerns about potential cross winds caused by US trade policies and its impact on their dual mandate.
10th July 2019, news paper reports SnP reaches all time high
SnP on the cusp of crossing 3000 threshold for the first time to an all time high. Market is euphoric. Trade issue between US/China yet resolved but discussions are underway.
Short positions SQQQ and SRTY were utilized as hedges against downward macro environment reversion risk when the SnP extended beyond 3000 to reach an all time high
1st August 2019, US announcement of 10% tariffs on US300 billion imports from China starting September 2019
on 1st August, 24 hours after actual interest rates cut, Trump signaled 10% tariffs on USD300 billion Chinese import. SnP dropped.
Exited SQQQ and SRTY for 10% capital gain after reaching 30SMA and 50SMA range. Net combined loss to portfolio was 0.5%. Left remaining long positions open.
4th August 2019, Chinese response
On 4th Aug 2019, China’s exchange rate dropped for the first time below 7RMB/1USD.
5th Aug 2019 trading day
On 5th Aug 2019, China announced they will halt all imports of agricultural goods from US.
Portfolio continued declining an additional 2% on the trading day of 5th August 2019.
Closed all long positions with the exception of REITs
- Value shares
- Growth shares
6th Aug 2019 trading day
On the evening of 6th Aug 2019, China announced decision to control fluctuation of RMB exchange rates to USD
Bought into TQQQ and URTY at below 30SMA and 50SMA
7th Aug 2019 trading day
TQQQ and URTY automatically exited at the mid point between the two following highs and lows:
- highest point before Trump’s tariff announcement came into effect
- lowest point after China’s halt on US agricultural imports and RMB/USD breaking 7 came into effect
Once a project’s mission statement is defined, it becomes easy to determine when to stop further iterations.
Below are the listed of statements I periodically revisit when pursuing GetData.IO’s mission to help people make good decisions by making data gathering simple and affordable.
Hypothesis 1: People no longer need make good decisions.
Hypothesis 2: People no longer need data to make good decisions.
Hypothesis 3: People no longer find it hard to get data.
Hypothesis 4: We have exhausted all known approaches to lower the cost of data gathering to an affordable range.
Hypothesis 5: We have exhausted all viable approaches to reach people who need to make good decisions.
Hypothesis 1 and 2 are existential questions, while hypothesis 3 focuses on substitute availability. These are out of our control. The only thing we could do is monitor for changes.
Hypothesis 4 and 5 focuses on economic feasibility. These we will fully focus our efforts on. Once we eliminate all none viable options, whatever remains will be the limitations we must accept and live with.
It is useful to note the lack of any mention on funding. The underlying assumption is that every successful iteration necessarily unlocks resources from the environment which is then fed back to further the compounding process. The discipline is to minimize wastage.
Relying on external funding is like utilizing margins during day trading. While earnings get amplified, failures tend to be really spectacular. One additional drawback is that they tend to mask critical flaws in the short run leading to the commonly observed greater fool phenomena in the financial markets.
The decision maker and the executor operates with different cognitive models.
The decision maker
The decision maker operates within an environment of incomplete information. He takes in conflicting signals from the environment to figure out the underlying Markov Chain that holds his environment altogether.
A successful decision marker minimizes the price paid for knowledge of each section of the Markov Chain.
Each success unlocks more resources that could be redeployed to this activity.
Inner fortitude is the primary trait required to navigate the high failure rate inherent to the nature of this activity.
Perpetuate accumulation of mental models from different domains reduces taken to form judgement while increasing overall batting average.
The executor operates within an environment that has been made predictable by the activities of the decision maker.
He is predisposed towards systems, structures and processes. A successful executor measures and optimizes with the goal of increasing yield from a well defined process while minimizing costs.
Disciplined consistency is the primary trait required to ensure continued excellence in this repetitive activity.
A strong decision maker profile with a weak executor profile will feel repressed/bored when forced to operate as an executor in a structured environment.
An strong executor profile with a weak decision maker profile will feel overwhelmed when required to operate within an unstructured environment.
- Ability to see things as is when others are in mass hysteria
- Ability to do nothing most of the time
- Practice of constantly accumulating more mental models
- Focus on process not outcome
- Minimizing cognitive behavioral biases