Kobrick has some interesting history at State street research capital fund generating great performance, however, most importantly he documented his first-hand professional investment experience through 1980–2000s, these are exceptional observations on the ground floor of many multi-baggers that are worthy of understanding. Whether or not Kobrick compounded capital as well as others of his time these are must-read lessons and decisions that were made at the coal face with all the real-time uncertainties.
This blog has been written from my reading of The Big Money – Peter Kobrick. Buy the hardcover. it is one for the bookshelf!
McDonald's - You need a system to scale
It's important to understand the system a business has in place to implement its strategy. For example at the time of the IPO McDonald (MCD) on the surface was just another Fast Food chain however if you had gone to the stores and met with management you would have gained invaluable insight from how focused management was on their system. MCD knew that pre-slicing hamburger buns saved time to toast (17seconds), how many rows and columns of burgers fit on a grill, a higher temperature was needed for quarter pounders and that each batch takes 15minutes. This precise understanding of the process allowed the company to lower the price of hamburgers from 30c to 15c while maintaining profit margins which drew in more diners.
Kobrick says in his first visit to company headquarters in Oakbrook Illinois he was shown the “Amber Room”. The Amber Room was a circular room lit by amber light with a circular waterbed in the middle the walls of the room formed a conical shape sweeping up to a point in the ceiling. The Company host explained to Kobrick that “scientists have proven that the amber light and relaxing atmosphere stimulated the brainwaves most responsible for creativity, and creativity and innovation are at the core of our culture”.
When you compare McDonald's, which was corporatized in 1961 when Ray Kroc bought out the McDonalds brothers there were a number of fast-food restaurant chains around but very few became great long term investments for outside shareholders. MCD had a systemized operating model, Real Estate plan and financing to become a mega-chain. Ray Kroc the founder of MCD credited the system to the success of the business, by 1979 MCD had a 35% market share of the burger industry vs Burger King at 11% and Wendy’s at 8%.
The Home Depot – Audacious goals
Over the years the best investments were the growth stocks that started their run when they were rather small, The Home Depot (HD) was one of these. In 1981 when HD listed it had 4 stores and annual sales of $22M, it now has over 2,200 stores producing almost $150B of sales, see below the first annual report as a listed company.
HD was focused on attracting a more sophisticated DIY customer with its new format for home improvement. There were a lot of doubters of the company at the time because of its very small size, grand ambitions, and aggressive expansion plans. Adding to the market's concerns about HD was the business model that required experienced salespeople and higher staff costs to offer advice to customers. At the time of the IPO the 4 existing stores had only been operating for 2 years which also made investors nervous about the big promises. 8 years after the IPO the store footprint grew from 4 stores to 100 stores and in 1990 it was the largest home improvement retailer in the USA. At the time of the IPO, the stock traded around its listing price for several months while people who expected a large jump sold out. As the revenue and earnings grew the stock took off and was a 10x from the IPO in less than 2 years. The founder's first letter to shareholders is also attached at the bottom of this blog if you’re interested in reading it.
Nike – Phil Knight, founder & long term focus
Nike went public in 1980 when it was doing $270M of sales, the backdrop to this IPO was interesting because there was a view in the market that Nike was scratching the itch of the running boom that was occurring at the time, it was estimated that 25M Americans took up some aspect of running between 1970 and 1980 and there were many small fitness companies emerging. The sales growth at the time of the IPO had been 100% every year for the past 4 years (see below), Phil Knight’s founder letter also attached at the bottom of this blog.
What mattered that drove the adoption of the Nike brand was the ability to convince the best and most prominent athletes to wear their shoes in competition – in 1983 Joan Benoit set a Marathon world record wearing Nike shoes. The insight that Kobrick had at the time was that Nike was gaining market share rapidly and was spending considerably more on marketing and advertising, however, during this time Reebok started to respond and became more aggressive on price which resulted in Nike's net earnings falling from $40M in 1984 to $10M in 1985. In 1985 Phil Knight returned as president to the business and assisted with the turnaround. The insights during 1985 were:
1) Phil Knight was exceptional, and he responded to changing conditions
2) Nike was taking market share
3) Kobrick owned some Nike runners, ran 5ks a day, and loved them
4) Retailers and running gurus loved the product
Yet another example of the customers 'love' of a product leading to the success of the company.
Observations from the Microsoft IPO – Bill Gates 25 year old wizard
When Microsoft was completing its IPO in 1986 Wall Street held Bill Gates in very high regard calling him the “technology wizard” and always had great excitement when he was present at Management presentations. Kobrick recalls that it was explained at the time that Gates quit College at Harvard University to pursue his burning desire to start a business in the brand-new computer industry "before it was too late". Gates said being first or at least early was critical. He had a view that customers would want software to carry out powerful functions on their computers but they would want uniformity and continuity so that users would not learn something only to have to undertake an entirely new learning process in the future. The Microsoft IPO pitch centred around three assumptions:
1) Customers would have a critical need for standards and therefore would stay with a provider through all the product cycles if it performed.
2) The early leaders would set these standards. And these standards had to dominate the market early.
3) Technology had to be the best or close to and the customers had to believe it.
Kobrick recalls the fascinating story of Gates’ urgency to get scale which was epitomised in his determination to win IBM, he made a deal to develop an operating system for their hardware. Microsoft was not ready in time for IBM so Gates quickly completed a $75k acquisition of a company called 86-DOS which was then renamed MS-DOS, which was then licensed to IBM for a fraction of the price of the alternative bidder (Digital Research). The genius in this deal was not in the pricing to IBM it was the fact that the deal was non-exclusive. The non-exclusivity allowed Microsoft to retain ownership of DOS, develop it in conjunction with IBM and then sell it to other hardware providers. IBM were so focused on Hardware they never thought to consider the software business. Gates was only 25 years old at the time – imagine backing a 25yr old CEO making decisions like this.
MSFT completed its IPO at $21.00 per share, at the time of the IPO it had ~25M shares outstanding, making the market cap ~$525M or around 22x P/E. Gates retained 49% of the company post the IPO and paid himself a salary of $130k per annum!. Based on today's market cap of ~$2T, MSFT has been a 3,800 bagger, look at the revenue growth prior to IPO in 1986:
If you would like a copy of the IPO S-1 from 1986 please email me and I can forward it to you, a great read for some software history. Shaun.firstname.lastname@example.org
Compaq and Dell – Same business but a different business model
One day in 1982 two ex-Texas Instruments managers and a VC manager got together and came up with the idea to start a PC company to go after IBM, the three men started this company and called it Compaq Computer Corporation, in their first year they generated $111M of sales the highest first-year sales in the history of American Business!, a year later they went public. Compaq went on to become the youngest company to be included in the Fortune 500 and then became the youngest company to reach $1B of sales. Moving forward 5 years after the Compaq IPO the PC industry growth had been enormous, industry sales of Intel-based PCs leapt over 10x from 700T units to 7M by 1988. Compaq had secured a 5% market share during this time. In the run-up to 2000 Compaq sales grew to over $42B:
In mid-1988 along came Michael Dell and took Dell computer public (another college dropout who didn’t want to miss the opportunity). Michael was 23 years old at the time of the IPO with a tiny amount of experience and wanted to take on IBM and Compaq. This was an audacious goal and took some believing especially considering that at the peak of PC industry growth there were about 1,000 companies around the globe making PCs! this was like the combustion engine manufacturers of the 1920s. When Kobrick looked at the prospectus it was clear that Dell was doing something right because they were gaining market share, growing sales and expanding profit margins.
The heart of the Dell business plan was different than the rest of the industry, selling direct to customers and not using intermediaries – primarily through telemarketing. Dell saw themselves as much a marketing company as a hardware company, sales staff trained for six weeks before taking their seats at the phonebanks, they were incentivized to upsell memory or built-in modems and troubleshoot problems. This direct to consumer model allowed Dell to cut prices but most importantly it allowed them to get close to the customer and collect data on their preferences, this knowledge of the customer was all the difference. Because Dell was selling direct to the consumer, they didn’t need to support a pipeline of dealer inventory and they were also able to cut out the retailer and advertise these discounts directly.
A particularly useful insight of Kobrick into the quality of Michael Dell came from a meeting he had with him a few years after the IPO. Prior to the IPO Andy Grove from Intel had put a supply stop on Dell because of a shortage of chips and at that time Dell was one of the hundreds of emerging PC companies, Michael said he flew to San Jose California; walked into Intel Headquarters and said he was Michael Dell of Dell Computer and wanted to meet with Mr Grove, Andy said he was too busy so Michael waited the whole day, then came back the next day and sat in the foyer, the same happened for a few days and Michael said he would camp in the lobby until he got 10 minutes, They eventually did meet and ended up speaking for over an hour, the plea for parts was honoured and the two have had a great relationship since. Only a founder would have this focus and determination for the company!
Dell completed its IPO in 1988 at a market cap of $85M by 2000 the market cap had swelled to $100B a market cap it has not reached since. This expansion in valuation was fuelled by exceptional fundamentals, revenue grew from $159M in 1988 to over $25B by 2000, however, the ultimate creation of economic value was the inventory turn which shot up from only 3.2x in 1988 to over 60x by 2000:
National Semiconductor vs Intel - The power of focus
NSM was founded in 1959 its earliest integrated circuits were targeted at the space program, scientific applications, and consumer markets. In the 1970’s it then started aggressively targeting markets including calculators, watches, grocery checkout machines. It then expanded to speech synthesis chips and mainframe computer chips constructing three factories in the 1980s. The company continued to develop a huge number of products for numerous end users, the company then acquired Fairfield Semiconductor in 1987 and introduced new graphics chips. During this time Intel focused their R&D efforts and capacity on personal computers which resulted in the lions share of product design contracts eventually becoming the most important market but also led to significant IP being co-developed with hardware manufacturers.
Intel was founded in 1968 by Gordon Moore (The now-famous Moores Law) and Robert Noyce, while led by Andy Grove. In 1974 Intel released a new PC chip, the Intel 8080 which received glowing reviews. The lead extended and in 1982 when they released the 286 chip which cemented their supremacy in microprocessors. PC’s became Intel’s primary business and during the 1990s Intel invested heavily in this market to control the direction of the industry.
During the 1980’s Intel’s revenue surpassed National Semiconductor. The most impressive results of Intel during the ’80s was the disciplined investment in R&D, even during the 1987 crash they increased R&D spend:
Andy Grove’s leadership of Intel was widely heralded as exceptional. From 1980 to today Intel has been a 160 bagger, however, in 1980 focusing on this new market for “Personal Computers” would have seemed far from obvious and highly risky.
Staples – Tom Stemberg
A great example of exceptional management was Tom Stemberg from Staples. Stemberg took Staples public in 1989 and raised capital from several private equity groups in conjunction with own severance pay he received from his prior employer. Interestingly Office Depot went public one year earlier and was founded by three very able and experienced founders. Staples and Office Depot opened stores rapidly, collectively over the next decade opening nearly 2,000 office warehouse stores between them. The competition further intensified but despite this Stemberg managed to grow EBIT from $37M in 1993 to $1.2B at the time of his retirement in 2006.
Great management makes great business models, remember that! Great business models do not exist without great management. It is management that creates great assumptions, execution, and the rest. Over time these models need adjusting for competitive conditions. Make sure you identify the traits of great managers to recognize another Bill Gates, Jeff Bezos, Ray Kroc, Bernie Marcus or Steve Jobs if they emerge. Kobrick outlines his experience in observing Gates, Dell, Marcus and others:
a) The top person had a vision and could translate that into a strategy to make the company a long-term winner not just a good story for a year or two.
b) The top person was very competitive, not a risk-taker but showed a plan to dominate the industry and become number one.
c) Each person had already done something right, had a good business model and showed how they would excel in the industry and become highly profitable.
d) Each company was positioned in an industry that was taking off and looked to be a huge industry well into the future – not shrinking.
Xerox – The training ground
Xerox listed in 1959 and was making the first automatic office copying machine to use regular paper. Kobrick worked with a mentor while analyzing this company that leads him on the path to becoming one of the best stock pickers in his time. The lessons learned while studying Xerox were:
- The efficiency improvement was vast, to make paper copies at that time you were required to use carbon paper in between two sheets of paper in a typewriter.
- The technology was expensive at the time so extensive customer interviews were required to estimate a rough earnings model – simple models are always the best.
- Xerox came about before personal computers and even word processors, It was very early!
- There were many doubters of the technology that claimed it would be unaffordable for broad market adoption and the technology was slow and noisy, these doubters shook countless investors out of the stock.
- The main difference with being able to hold onto a multi-bagger is building a thorough knowledge of the company this knowledge keeps you in the stock while the market fluctuates, it allows you to have conviction.
Xerox turned out to be more of a great product than a great company and failed to develop a technology culture to develop and innovate new products. The key lesson Kobrick discusses with his mistake of continuing to hold Xerox was that the company became complacent and when its patents expired it experienced intense competition.
Market Bubbles and Mania
Kubrick's observations of bubbles and mania are very interesting, he considers a mania leads to bubbles. “A mania is simply something that is more emotional than tangible or rational, so it can be thought of as irrationality”. The irrationality is not easy to see at the start because since there would be no bubble if it was easily visible. Normally bubbles emerge when knowledge is incomplete or wrong and has the story of unlimited potential. It happened with electricity to households, the advent of canals, railroads, and radio in the 1920s. With all bubbles, there is an element of mystery, in the internet bubble of 2000 many investment professionals thought there was unlimited demand for many communications and internet stocks. Kobrick observed three interrelated bubbles in 2000 which is what made it so extreme:
1) Stock Market bubble: Internet, telecommunications and various technology stocks were overhyped – “The Internet Changes Everything”.
2) Capital Spending by corporations in the ‘Great telecommunications build out’. The same hype that caused the stocks to soar was driving the capital spending and vice versa.
3) The US economy reached peak growth rates of the decade of 5.28% during this year.
Crashes are always the way that manias end, in the UK the famous railway mania led to the Britain financial crisis of 1847. Like most manias, the fundamentals of economic improvement was very sound and genuinely creating economic expansion.
I hope you enjoyed the read.
Shaun Trewin CA