“The ironic thing about professional investing is that when opportunities are their greatest, everyone is either too scared to invest or has no capital. When opportunities are their worst, that’s when capital is flowing freely and risk-taking is ubiquitous.”
Julian Klymochko’s pithy tweet produced a wry grin on my face. It was a good summary of the dilemma many of us have faced over the last couple of months.
It also serves as an early warning for the investment opportunities that will undoubtedly present themselves over coming months.
Brent Beshore runs a venture capital firm that invests “boring” traditional family-owned small to medium sized businesses often located well away from “glamorous” locations like Hollywood, Silicon Valley, and Wall Street.
Viewing the world through the lens of his portfolio companies has provided some fascinating alternative insights to those talking heads and rent-a-quote merchants who obsess over the daily movements of the S&P500.
“Ad costs are plummeting as dropping demand is met with increasing inventory (more online minutes). Conversions are also decreasing, but situation-dependent.
It’s cheaper to get peoples’ attention, but, on average, harder to get them to buy stuff.”
“This is why the “it’s just the service industry” narrative around unemployment is wrong. Service industry is a harbinger, not an isolated situation.
The length of sales cycle matters. You can see a lack of diners immediately. Other industries take time for reality to be seen/felt.”
“If you want to understand Main Street employment, look at housing.”
That sales lifecycle comment is very astute.
It takes time to advertise. Identify a lead. Work the prospect. Convert the sale. Ship the good or perform the service. Invoice the customer. Collect payment.
For a simple hospitality business, that process is brief. Entice the punter through the door. Render service. Receive payment immediately.
Yet even that simple hospitality case has a run-up involved.
You can’t sell meals without having first sourced the ingredients. Hired the staff to cook and serve them. Leased the equipment. Paid the rent and utilities.
Each activity requires time. Effort. Forward planning. A credit worthy counterparty willing and able to conduct business.
Now consider what happens when the economy pauses for three months.
Those relationships age. Become dated. The network gets stale.
Some suppliers will survive the storm, and reopen on the other side. Others will have failed.
However, not all those surviving suppliers will immediately be able to resume normal levels of operation. They too will have empty sales funnels, forward work pipelines, and order books.
Like the hospitality firm, they will be conserving cash reserves. Juggling creditors. Figuring out which of their staff they can afford to return to active duty, and how many will need to be let go once the government’s furlough subsidy ends.
Now consider how many layers a typical supply chain contains. Each participant will be concurrently going through similar challenges.
Those with strong cash reserves will be well placed to steal a march on their competitors and gain market share. Mergers and acquisitions will be commonplace, as those without the means to service their obligations or restart their economic engines sell up to those possessing larger war chests.
The timing and duration of this emerging from hibernation will vary by firm and sector.
Sales in many industries have a much longer run-up than that simple hospitality case. For those firms, the business they are currently executing was brought in months ago. The longer the sales cycle, the later the impact of the pandemic induced economic deep freeze will be experienced.
Opportunity favours the brave
There is a once in a generation opportunity looming. Cashed-up investors will soon be able to scoop up bargain-priced businesses who are fundamentally sound but are experiencing a temporary externally induced cashflow problem.
Warren Buffett executed a play like this during the Global Financial Crisis, when he bailed out Goldman Sachs with a cheeky USD$5 billion cash infusion on very favourable terms.
A couple of private equity firms executed a similar rescue of Airbnb earlier this week. They are charging Airbnb an eye-watering 10% annual interest rate for the privilege of receiving a USD$1 billion cash transfusion.
According to their most recent quarterly filings, Berkshire Hathaway is sitting on USD$128 billion cash. Google USD$120 billion. Apple USD$108 billion. Amazon USD$55 billion. That is a lot of cash waiting for attractively priced opportunities.
Most of us won’t have a spare billion hidden in our sock drawer, slowly having its purchasing power inflated away, while waiting for a rare opportunity to swim against the tide and make a killing.
However, with a little imagination, most of us do have access to some cash. Liquid investments. The ability to borrow at record low interest rates. We have access to more funding options than we may initially consider.
A note of caution here: just because we can do something doesn’t mean that we should!
History echoes: a case study
I remember having a conversation with my father during the early stages of the Great Recession. Opportunities were emerging in the US housing market for those with cash. Overextended homeowners were defaulting on their mortgages in droves.
Foreclosure sales were completing for cents on the dollar.
At the time my cash reserves were largely committed or tied up in my business. I forlornly watched from the sidelines as many folks, my father included, cashed in on the emerging arbitrage play.
In his case, the logistics of buying individual homes in a foreign country proved to have too great a hassle factor. Instead, he poured money into an investment fund who scooped up undervalued housing assets on an industrial scale.
As the housing market recovered he realised a 400% return on his investment. He sold down some of his holdings, extracting his original investment. Unfortunately at that point, he got greedy. Fell in love with a winner, whose best performance was behind it. Let his profits ride.
Over the subsequent decade, the fund was became over-leveraged and asset-stripped as short-termist bonus seeking management profited at the expense of their shareholders. Accounting scandals erupted. Class action lawsuits formed.
Then the pandemic arrived. The economy stopped. Tenants lost their jobs en masse. Rents have stopped being paid. Lenders judged the fund to be a bad credit risk, closing off financing facilities. Property values have started to fall.
Like many property funds, it finds itself teetering on the brink.
Asset rich, but suddenly cashflow poor.
Closed to redemptions.
Unlikely to survive. Hoping for a shotgun wedding or a white knight. Preparing for a fire sale.
But here is the thing: the individual properties that the fund owns are fundamentally sound.
Located in places where there are typically decent employment prospects. Regional cities. Transport hubs. University towns. Places requiring people, who each need somewhere to live.
Greed and bad management practices cruelled the investment vehicle. Yet somebody with cash will swoop in, scoop up the underlying assets for a song, and feel pretty good about themselves as they ride the property cycle out of the bust and up into the next boom.
Morgan Housel recently quoted a small company CEO: “anyone who thinks you can just flip a switch and restart a business after it’s been shutdown for two months has never operated a business”.
This reflects my personal experience. Staff furloughed. Clients hibernating or on life support. Amputating divisions and cancelling projects to conserve precious cash.
Acutely aware that things will get worse before they get better. Hoping, but far from certain, that they will be amongst the ranks of the survivors.
The post-pandemic economy will be brutal for many, as creditors default and businesses fail.
As some furloughed workers return, while many become unemployed former workers.
As conserving cash reserves becomes a survival skill.
Amidst all the dystopian imagery and Eeyore-esque predictions lie some amazing opportunities for those willing to seek them out and possessing the reserves to act upon them.
Sound businesses experiencing temporary cashflow problems. Who may be willing to offer favourable terms to forward-thinking lenders, or accept silent partners who may profit handsomely from their ability to help businesses ride out the storm.
These opportunities won’t show up in the cover story of Shares or Fortune magazine. You won’t find them being marketed by Vanguard or Fidelity. Completely overlooked by the charlatans who endlessly spruik affiliate marketing schemes and online courses promising to teach you to be rich.
Instead, they are out in the real world. The businesses you walk past or interact with on a daily basis.
Many of them will be worthless pebbles.
People buying themselves jobs, high on effort and low on profit margin.
Occasionally there will be a gem amongst them. Possessing good fundamentals. Strong margins. Excellent future prospects.
The branded fleet of on-call plumber vans with strong name recognition.
That rapidly expanding specialist consultancy who is dominating a profitable niche.
The venture capital averse startup who is well on the way to demonstrably solving one of the big FinTech problems.
There is a once in a generation window of opportunity out there for the taking. To buy, or buy into these businesses. Helping them bridge a temporary cash flow gap caused by these most interesting of times.
But only for those willing to do the work. Financially able to act upon it. Willing to create value.
Everyone else can stay on their couch binge watching box sets today. Then in years to come, enviously recount “buy when others are fearful” stories like Buffett’s Goldman play from the last time that the sky was falling.
- Alphabet Inc (2019), ‘Quarterly Balance Sheet’, Wall Street Journal
- Amazon.com Inc (2019), ‘Quarterly Balance Sheet’, Wall Street Journal
- Apple Inc (2019), ‘Quarterly Balance Sheet’, Wall Street Journal
- Berkshire Hathaway Inc (2019), ‘Quarterly Balance Sheet’, Wall Street Journal
- Beshore, B. (2020), Twitter
- Beshore, B. (2020), Twitter
- Beshore, B. (2020), Twitter
- Brumley, J (2019), ‘Here’s How Much Warren Buffett Has Made on Goldman Sachs’, Motley Fool
- Housel, M. (2020), Twitter
- Jolly, J. (2018), ‘The global financial crisis 10 years on: A timeline of the global events that shaped the crash from the credit crunch to the recession and beyond’, CityAM
- Klymochko, J. (2020), Twitter
- Parker, J. L. (2020), ‘Airbnb’s New Billion-Dollar Deal Signals Confidence In Recovery’, Forbes