MidasMoments
Rob Slee's Comments on the Nation
Welcome to MidasMoments – the written voice of MidasNation. Each week, we'll comment on issues that are important to private business value creation.
May 13, 2013 – from Rob Slee
The One-Off M&A Market
This year is shaping-up as a terrible year for middle market M&A. Author after author has been bemoaning this fact, all seemingly at a loss to explain the dearth in acquisitions. Yet it’s all too easy to explain.
Let’s start by considering the Ten Year Transfer cycle. I discovered this cycle a lifetime ago and have made a fortune by living what it represents. Behold the chart that I created 20 years ago.
As the chart shows, the United States middle market transfer market runs in 10-year cycles. It is no coincidence the cycle mirrors general economic activity. Transfer cycles begin each decade with two to three years of relative deal recession. This period is characterized by a flagging economy that causes banks and other capital providers to lessen lending and investment activities. Most private business owners will not be able sell-out for an acceptable price during these years. Most large companies tend to focus on core businesses and curtail aggressive acquisition plans. For acquirers with cash, this is a buyer’s market.
From a seller’s perspective, the prime time to sell a business occurs during the middle years of the cycle. Capital is available for buyers to finance deals during these years. During this period, the MBA crowd has again convinced Wall Street to fund roll-ups and other consolidations. Big companies are back in the game, growing income statements and balance sheets through strategic acquisitions.
The smartest sellers typically wait until near the end of the seller’s market before making a move. In this way they get the benefits of increasing profitability plus the highest transfer pricing. Economic storm clouds start forming after eight years or so of the cycle. Because of the economic uncertainty during this period, deals are harder to initiate and close, therefore waiting too long is risky.
Why a One-Off Market Now?
The 3rd and 4th years of every decade offer great opportunities to cherry-pick distressed and zombie deals. But during these years it’s not a great time to sell mundane or average performers. And right now, 80-90% of middle market companies are mundane or average. How can this be? Because 80-90% of middle market companies have not been covering their costs of capital for much of the last decade, and this has created large value gaps in the market. The M&A market is now feeling the effects of those gaps.
Let’s look behind the M&A curtain for a minute. For the past 15 years the primary drivers of the M&A market have been private equity groups (PEGs). In that period, about 5,000 PEGs have acquired about 30,000 middle market companies. Since PEGs almost exclusively acquire good/great companies, their buying represents the top 10% of the 300,000 companies in the middle market. Now PEGs have nothing to buy, as they already own most of the “A” companies. What a high class problem: a couple of trillion dollars with nothing to buy.
In the meantime, the US has not been creating new middle market companies fast enough. I think this is mainly due to several factors. The technology crash of 2000-2002 killed the crop of middle market seedlings, while in the process shuttering hundreds of Angel groups. At this time China was taking off, and thousands of American investors decided to place bets there instead of doubling-down in the US.
So what’s going to happen to middle market M&A the rest of this decade? It will be more of the same. Dealmakers who know how to create their own deals (ala MidasNation) will be plenty busy. Owners who still hold “A” businesses will feel like the prettiest girls in school in the weeks leading-up to prom. The rest of the market will continue to struggle with one-off deal hell math: at most, there’s only 1 good deal per PEG and per dealmaker per year.
Now you know why I’m cherry-picking investment banking deals, but spending most of my time buying and growing zombie businesses.
- Rob
May 6, 2013 – from Rob Slee
Come Sail Away With Me
My Name is Rob, and I’m a niche-aholic. I’m also a cruise-aholic. Put these two things together and you’ll find me speaking about niches aboard Royal Caribbean’s Oasis of the Seas, from October 12-19. And you’re all invited.
First, a few words about the ship. The Oasis is the world’s largest cruise ship. I sailed aboard her a couple years ago and am still shaking my head in wonder. The entertainment alone makes the cruise worthwhile. Shows range from outdoor platform diving to indoor Broadway, with all manners of entertainment in between.
And if you think you can stay with me in ping pong, you’re sadly mistaken.
This particular cruise is a 7-nighter out of Ft. Lauderdale. It will stop 3 times: at Royal Caribbean’s private island of Labadee (I usually jet ski there); in Jamaica; and in Cozumel, Mexico. In October, I expect 80 degree weather which is about twice as warm as the beer.
Royal Caribbean does a nice job with food. You won’t go hungry. I gain a pound a day on cruises. This would be doubly worse if not for the on-shore running around.
Importantly, the itinerary leaves 3 days at sea. For the cruise uninitiated, these days represent free time. I’ll be yapping during these days…on topics ranging from competing in a global economy to identifying and exploiting niches. If you’ve never heard me speak, you’re really missing out. I haven’t heard anyone better. Of course I’m jaded. I admit that I rarely hang around at conferences long enough to hear others yap.
The real action will be found during the afternoons of sea days. I want to do a 2 hour group brainstorm each day on several topics close to my heart. These are:
- Converting a family of parts from traditional manufacturing to 3-D printing. What would be the best candidates (for example, obsolete or hard-to-find auto parts)? How best to setup an internet portal to market the parts? Could we position 3-D printers around the world to be close to markets?
- Buying zombie businesses. I’m on the inside of this game and will share how it works from that vantage point. I could use some help in several key areas and would use the time to describe the play.
- Becoming a Value Architect in your business. There are a number of traits that can be learned and I’ll share these. I would like to hear what is holding you back from achieving Midas metrics, such as $3 million in revenues and $750k in profits. Btw, I just invested in a business that is getting more than $10 million in EBITDA per employee.
Speaking of buying zombies, I’m giving away a cabin (2 person with balcony) on the October 12 sailing to the first person who introduces me into a zombie deal, or other opportunity, in which I get to a letter of intent…starting now and going to August 1. I don’t have to close the deal…just get to an LOI before August 1. You have to pay your way to Ft. Lauderdale. Hey – I’m not made of money.
There are two ways for you to learn more about the upcoming cruise. First, here is the link to the travel agent’s cruise website:
http://itravelconsultants.com/seminar-at-sea4/getting-healthy-wealthy-a-wise-on-the-open-seas.html
Or second, just email me and I’ll introduce you to the travel agent.
Hope to see you on the Oasis in October.
- Rob
April 29, 2013 – from Rob Slee
Where Art Thou, Green Shoots?
The "green shoots" of economic revival are already evident, Bernanke told "60 Minutes" back in 2009. To leave nothing to chance, he then proceeded to apply more stimulus fertilizer to those shoots than had ever been done before. Alas, four years later we’re still waiting for the green shoots to show themselves, especially as it relates to growing businesses in the private sector.
Historically, small businesses have been the primary engine of new job creation in the United States. If the economy was getting healthy, we would expect to see the number of jobs at new businesses rise. Instead, we are witnessing just the opposite. We are constantly told by the Wall Street media that the economy is "recovering", but the number of "startup jobs" at new businesses has fallen for five years in a row.
According to an analysis of U.S. Department of Labor data performed by economist Tim Kane, there were almost 12 startup jobs per 1000 Americans back in the year 2006. By 2011, that figure had fallen to less than 8 startup jobs per 1000 Americans. According to Kane, the number of jobs in the United States at businesses that are less than one year old has fallen from 4.1 million in 1994 to 2.5 million in 2010. Overall, the number of "new entrepreneurs and business owners" has fallen by more than 50 percent as a percentage of the population since 1977.
The United States was once known as "the land of opportunity", but now that is fundamentally changing. At this point we truly do have a "crisis of entrepreneurship" in this country, and that is a huge reason why America is in decline. We are witnessing the slow death of the small business in America, and as I’ve written numerous times in the past five years, that is incredibly bad news for all of us.
Economic theory states that the shoots should have bloomed: historic low interest rates; historic amounts of liquidity provided by the government (stimulus); and improving personal and corporate balance sheets. What happened?
Of course, interest rates don’t matter if you can’t access the money. For four years the Pepperdine capital surveys have consistently shown that small firms have little/no access to low cost capital.
I believe the bigger reasons for the decline of entrepreneurship in America can be found in the lack of an ecosystem to support such growth. Let’s review the cast of characters who are in position to make a positive difference.
Business owners – the vast majority of owners are lifestylers. They themselves have no strong desire to create the kind of businesses that can compete in a global economy. As I wrote in Midas Marketing, the Aggregation Age is destroying lifestyle businesses at a rapid rate. Creating growth on Main Street starts with the owners.
Professionals – few lawyers, CPAs or financial planners aggressively help owners increase the market value of their businesses. If anything, most professionals try to inhibit owners from making strong moves, because if anything goes wrong, they may lose a client.
Academics – I’ll combine business valuators with the academics, because both groups are completely clueless as to what it takes for a private company to compete in a global economy. With their theoretical teachings, business academics are doing far more harm than good to the American private economy.
Consultants – I truly believe that many management consultants know what owners need to do to compete in a global economy. But since most (80%+) owners will not change their behavior in this area, consultants have to offer mainly tactical solutions, and these do not remake the business sufficiently to create substantial value.
Institutional Equity – it took me years to figure out the real motives of most private equity groups: it’s all about the management fees (ordinary income along the way). Sure, a couple portfolio companies will hit pay dirt, so capital gains are important for those. If even our institutional equity players are not generating risk adjusted returns for investors, and they are not, we’re in serious trouble.
America’s Wealthy – Prior to ten years ago, a large percentage of our successful entrepreneurs invested 10-20% of their wealth back into American small businesses. They accomplished this through angel networks and direct investment in early stage companies, mainly located in the communities in which they lived. After the tech crash of 2000, it seems our entrepreneurially wealthy decided the Asian market was a better bet, and many took their money and intellectual capital to China. That move helps explain why China has had so many green shoots in the past decade.
Government – the federal government is killing the private capital markets. Even as the politicians gratuitously say how important small business is to America, they are busy pouring sand into our gas tanks. I believe that no one with any power in D.C. has the least understanding of what small business is facing in terms of the lack of a value creating ecosystem.
So when will green shoots blossom again in America? That’s easy: it will happen as soon as we get the characters above fully engaged in the business of value creation.
- Rob
April 22, 2013 – from Rob Slee
My 20 Minutes with Jimmy
I vividly remember the most unusual moment of my life. Of course, it happened while I was a graduate student at the University of Chicago. And the memory has never really left me.
It started with me sitting in George Stigler’s History of Economic Thought class. Stigler teaching this course was somewhat akin to God teaching a class on the Bible. Stigler was one of the giants of economics in the last century. He was John F. Kennedy’s chief economic advisor, picked up a Nobel along the way, and most importantly, was the only person on earth who Milton Friedman acknowledged might be smarter than himself. High praise indeed.
In any event, Stigler was exposing Marx that day in a way that made the listener think he and Marx had discussed the lecture just before class. At the end of class, Stigler did something totally unexpected: in a voice just loud enough for others to hear, he asked me to lunch. Stigler never fraternized with students, and this invitation was met with general guffaws. I choked out an “Of course,” and we left without another word.
Then another unexpected thing happened: we walked south. Back then it was openly accepted that if you went south and crossed the Midway, your life was forfeited. Remember, South Chicago was the baddest part of town…possibly the baddest area in all of America. It’s always amazing that so many of our greatest universities are located in ghettos.
We walked 10 minutes past the line of demarcation, so I accepted that we were dead men. Once again, not a word. Stigler was a lot of things, but small talker was not one of them. Finally, he stopped in front of a nondescript door and entered like he had been there before. From what I could tell, this place served food and drink, although I hesitate to call it a restaurant.
Stigler spotted someone sitting in the back and walked right to that table. This Twilight Zone moment had just gotten stranger, as the person sitting there was a complete bum. I’m talking ratty clothing with a smell to match. He was so dirty that I couldn’t even determine his nationality. Yet there we were.
Stigler stood in front of the table (never sat) and said “Jimmy, I have a problem.” For his part, Jimmy never looked at us; in fact, he never acknowledged our presence.
Then it got weird.
Stigler launched into a song comprised totally of mathematical lyrics. I think he was reciting - from memory - integrals and covariants from stochastic calculus, although who would know. He never drew a breath for 20 minutes. He just kept singing endless alphanumerics as if it were a normal thing.
For his part, Jimmy was captivated by the salt shaker on the table. He fiddled with it for the first half of Stigler’s song, then apparently saw something on the floor that became more important. Jimmy was crawling on the floor for the second chorus. At no point did it appear he was even listening.
For my part, I had never felt farther from the family farm in Ohio.
All of a sudden, from the floor, Jimmy interrupted Stigler and starting singing in the same language. This went on for a minute or two. I can only imagine what the patrons were thinking. After Jimmy finished, Stigler didn’t say a word for at least 5 minutes. He just stood there, working his 200 IQ brain. Finally, he said: “Thank you Jimmy.” Then Stigler paid the going rate for accessing probably the world’s biggest brain. He bought Jimmy 3 brats and a beer. Old Milwaukee, if I’m remembering right.
Stigler and I walked wordlessly back to campus. After 10 minutes I couldn’t take it anymore, so I asked: “Mr. Stigler, what was that all about?”
Immediately he registered disappointment that I was speaking English, and not the preferred tongue of math. After a few minutes of uncomfortable silence, he explained: “Mr. Slee, there may come a time in your intellectual pursuits that you encounter a truly intractable problem; one that cannot be solved through a traditional thought process.”
And that was that.
I’ve re-lived that 20 minutes so often that it is now ingrained in my consciousness. It taught me an otherwise unlearnable lesson; namely, an intelligence exists that supersedes subjects such as physics, math or economics. A few people on earth possess beautiful minds that float above academic silos. These poor souls live in a frictionless intellectual space.
For the first - and last - time of my life, I witnessed true genius that day. It taught me that linear thinking would not solve the most difficult problems. I think George Stigler understood the importance of the gift he was giving to me.
My 20 minutes with Jimmy changed the trajectory of my life. It showed me that answers could come from unlikely sources, and that I shouldn’t be afraid to seek different paths. It put me into a higher, albeit curvilinear and often unstable, orbit. One that I remain in to this day.
- Rob
April 15, 2013 – from Rob Slee
Let's Talk About Jobs
Several years ago I wrote that the U.S. would not generate a sufficient number of high-paying jobs this decade. It was an easy call to make. Most such jobs are created by private companies, and most private companies are destroying market value in a big way. They just can’t afford to create high paying jobs. Let’s see how my prognostication is working out.
First, let’s get real about where we currently stand on jobs. As with most of our economic issues, the government is trying to paper the problem over. But even all the money the government has created is not working as they'd hoped when it comes to job creation. Unemployment remains high, at seven or eight percent officially, but more than twice as high if you look at the shadow stats. It would be even higher if you counted the so-called discouraged workers who are no longer looking for jobs. And it's even higher if you break it down and look at segments of the population like young, black males. Their unemployment rate is over 40%.
True un(der)employment is probably around 20%. Congratulations, say us, at least we have Europe beat. Comparing ourselves to Europe on any economic metric reminds me of my kids coming home during grade school proclaiming that everyone did poorly on a test, so a “C” was a really good grade. I wasn’t buying then, and I’m not buying now. I prefer to use a higher standard.
The truth is that America's most common jobs come with lousy pay. Workers in seven of the 10 largest occupations typically earn less than $30,000 a year, according to new data published Friday by the Bureau of Labor Statistics. That's a far cry from the nation's average annual pay of $45,790. Food prep workers are the third most-common job in the U.S., but have the lowest pay, at a mere $18,720 a year for 2012. Cashiers and waiters are also popular professions, but the average pay at these jobs tallies up to less than $21,000 annually. There are 4.3 million retail sales workers out there, making them the most common job, but the position pays only $25,310 for the year. Among the 10 most popular professions, only the nation's 2.6 million registered nurses earn a good living, bringing home nearly $68,000 a year on average. Another two of the most common jobs -- secretaries and customer service representatives -- have an average annual wage of about $33,000.
Now let’s consider what kinds of jobs we are creating. Middle-class Americans have been losing ground, as median household income dropped by more than $4,000 since 2000. Part of this decline stems from a disappearance of middle-class jobs and an explosion of lower-paying ones. Some 58% of the jobs created during the recovery have been low-wage positions, according to a 2012 report by the National Employment Law Project. These low-wage jobs had a median hourly wage of $13.83 or less, with limited/no fringe benefits. I don’t even consider these full-time jobs.
Aside from private companies not being in position to hire, we also face the “problem” of dramatically increasing productivity. Solving this productivity riddle leads us to the biggest reason for the good jobs deficiency. We might call this the Midas Dilemma. Historically companies needed to generate $200,000-$300,000 in sales per employee to break-even. By using Midas models and strategies, many companies now generate more than $2-3 million in sales per employee. Another way of looking at these numbers is to consider that avant-garde companies need only 10-20% of the employees than what was required in the past. Uh-oh.
As more companies move to Midas models, and they will, highly-skilled people (the top 2% or so) will make tons of money, but the bottom 75% of the populace will be stuck. In reverse.
Does this mean that the U.S. is destined to have the majority of its population living outside of the global economy, at least in terms of increasing living standards?
Yes.
Have I met a single person who has a viable solution to this jobs dilemma?
No.
Maybe we’ll figure it out next decade.
- Rob
Comment directly to Rob: r.slee@midasnation.com
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