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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.
 
 
June 17, 2013 –  from Rob Slee
Our Torn Social Contract

Over the past few years, I have written a number of MidasMoments on various travails facing the United States. Let’s see if you’ve been paying attention. Choose the greatest threat to continued U.S. sovereignty:  a)  Old white men (OWM) are making a mess of things, but refuse to clean-up after themselves;  b)  a $200 trillion federal, state and individual funded and unfunded debt burden;  c)  the fact that most of us want to live like millionaires, but only 5% are creating substantial value;  d)  the Fed has flooded the market with so much liquidity that it’s impossible to tell fact from fiction;  e)  un(der)employment is above 15%.
 
OK – it’s a trick question. While all of the listed maladies are serious and are mainly being ignored, I think the most important dilemma facing America is not even mentioned above. What might this be?  Our social contract is torn.
 
America’s social contract was created from the patriotic fervor of our founding fathers. This country started and grew strong by relying on a few unifying themes. Aside from several interruptions, such as that major tiff over state’s rights, Americans have prospered from a shared vision. Until recently.
 
For such an important concept, it is hard to find a definition of social contract. Here is mine: social contract is what the people, government and business expect from, and owe to, each other. There’s a triadic logic at work here, such that all three stakeholders must agree and signoff in order to make the contract binding.
 
Let’s review the tenets of America’s existing (albeit torn) social contract. What does the government owe to the people and to business? The government is the guarantor of our collective future. It owes citizens a good education, such that they can add value to society. It is the safety net for the people, for both emergencies and for retirement. It owes business reasonable regulation and a level playing field. It owes business the resources it needs to compete. Government is the tool that creates the opportunity for people and businesses to succeed. Although unspoken, the people expect government to create a condition where each generation surpasses the prior in economic terms and in education.
 
What do the people owe the government and business? People owe the government an undying loyalty. They owe the government their trust. They owe the subjugation of their individual rights, if that is what is required to benefit the many. People owe business a work effort that creates value. This means that people will generate more economic impact than they receive from business.
 
What does business owe the people and government? Business owes people the chance to work for fair compensation, including benefits. It owes people job security if they create value. People expect to earn enough to buy a home and a car, and to eventually earn their retirement. Business owes government honesty, in that it will follow the government’s rules and regulations. Several ideals helped glue our social contract together as well, such as: our collective faith in God and religion; our reliance on the family unit; our sense of belonging to a community; and our belief that hard work and faith can conquer any evil.
 
During the last fifty years or so, many elements of our social contract began to tear. Certainly the turmoil of the 1960s caused some shredding. Many people lost faith in the government, business and each other. Fighting inflation in the 1970s kept us busy for most of that decade – so not much to report on the social contract front during that period. The “Me” decade of the 1980s certainly added fuel to the lost-sense-of-community fire. And the “greed is good” 1990s had the effect of running a chainsaw through the contract. The 2000s finished with a bang – meaning that it blew-up what was left of the contract.
 
What happens to a society that no longer has a shared vision, or in-tact social contract? First, an every-man-for-himself mentality sets in. Government, people and business become thoroughly self-serving. Second, enemies abound. Without anything to bind the populace, all of the deadly sins are on full display. These society-breaking activities should seem familiar. America is becoming a hate-filled place (just spend an hour listening to Fox or MSNBC), with too many doing their own thing, without any regard for the other stakeholders. It’s to the point that driver’s can’t be bothered to engage their turn signals. In a sense, the American Dream is devolving into the American Nightmare of Red State-Blue State politics, blame and Wall St. corruption.
 
I believe many Americans are searching for a shared set of beliefs to unite us as citizens again. These beliefs must allow personal freedoms and diversity to co-exist. To get us started, we could use a dose of what John F. Kennedy was prescribing some fifty years ago when he challenged Americans to think and act communally.
 
So what must be done to solve our most important national problem? It’s clear to me that politicians and perhaps even our political system can not reconceptualize America to where it needs to be. We need to take back our country from the lobbyists, special interests and clueless politicians. Ross Perot – where art thou? 
 
One way or another, it’s beyond time to create a new social contract.
 
- Rob
 
 
June 10, 2013 –  from Rob Slee
Where Have You Gone Joe DiMaggio?

I’ll never get used to living in an America in which denial has replaced baseball as our national pastime. I expect this kind of thing in totalitarian China, where facts are created to suit the party. Our government does the same thing, but we package it in a legitimized democratic wrapper. The NSA spying on us? No biggie – it makes us safer. The IRS using its unlimited power to harass the opposing party? Whatever – it will blow over. And on and on.
 
I especially enjoy how the government will change the way it reports numbers to support its “everything is much better than you think” message. Here are a few examples.
 
We Have Low Inflation
 
We all know that inflation is low in the US, only 2-3% or so. How do we know this? The government has told us. But inflation is found everywhere in our economy, except in the government's statistics. Corn, the most important food crop in America, is up 75% since 2008. Gasoline is up from $2.25 a gallon to more than $3 a gallon – an increase of more than 30%. The nationwide minimum wage is up by 40%. Rents are up by 25% nationwide and up 40% in most urban markets.

And my favorite example, the base price of a Ford F-150, the best-selling passenger vehicle in America, has gone from $18,225 to $23,670 – a 30% increase. That's a domestically sourced and manufactured product… something whose price is completely dominated by the value of the U.S. dollar.
 
Meanwhile, the government says there is no inflation… and that continuing to print $85 billion a month to buy government and mortgage debt is merely "interest-rate policy by other means." Talk about denial.
 
We Create Enough Real Jobs
 
We’ve all seen the headlines:  America created 175,000 jobs last month! Wow – we are so much smarter than the rest of the world.
 
The truth is that America's most common jobs come with lousy pay. Workers in seven of the ten 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.
 
Finally, let’s consider how many “real” jobs we normally create during a recovery. From the end of the 1981-82 recession through the end of 1985 —  the first 37 months of the Reagan recovery — the US created 9.8 million net new jobs. And if you adjust for the larger U.S. population today, the comparable figure is more than 12 million jobs. That’s about 324,000 jobs per month.  It would be a good start.
 
Most Americans Will Be Able to Retire
 
Excluding the value of a primary home and any defined benefit plans, 57% of households say they have less than $25,000 in savings and investments, while 28% say they have less than $1,000. Furthermore, the Center for Retirement Research at Boston College has warned that 53% of American households have not saved enough to maintain their living standards in retirement.
 
There are dozens of other areas where we have institutionalized denial. So why does all of this denial matter? Because, by continuing this nonsense, government policy will not lay a glove on the real problems. Worse yet, there are days when I think most Americans have bought into the denial.
 
Where have you gone Joe DiMaggio?
 
- Rob
 
 
June 3, 2013 –  from Rob Slee
I Remember When

I remember …

…when growing up to be president of the US was the highest aspiration for an American kid
 
…when getting a trophy required success and not just participation

…when going to college was both affordable and a good bet

…when working for darn near no money just to learn and build skills was typical

…the day color TV was introduced
 
...when Steve Jobs was universally viewed as a failed dreamer

…where I was on the days that John F. Kennedy and Harry Truman died

…when Japan, the main economic threat to the US and China, was broke

…when I realized in 1986 that Detroit was a microcosm of America

…when I figured out middle market finance theory

…when I realized Private Capital Markets was at least 5 years ahead of the market, only to learn later that it was 10 years ahead

…when I truly understood how Edwards Deming must have felt when he aimed his theories at Americans, only to be heard and understood by Asians
 
…when I realized that America was in harvest-wealth mode, while China was in build-wealth mode
 
…when I realized (about a year ago) that trying to convince people that it was in their best interest to achieve financial independence was a total waste of time – for both parties.
 
- Rob
 
 
May 27, 2013 –  from Rob Slee
Creating A More Valuable View

I’m constantly amazed by how few owners even attempt to create more valuable businesses.  This makes no sense to me, as owners have tremendous risk of ownership, but don’t demand a corresponding return.  I bet they don’t exhibit this behavior in any of their other investments.  For example, can you imagine an owner buying a bond that legally contracts the issuer to pay 5% interest, yet the issuer only sends 2% from time to time?  The owner would scream bloody mercy and no doubt line-up with all of the other owners to sue the issuer.  Yet these same owners short change themselves each and every year in their own businesses.
 
In any event, it is not a mystery what owners need to do to create more valuable businesses.  All they need to do is generate returns that are recurring, while minimizing the risk of achieving those returns.  In Midas, we call this creating a more valuable view of the business.  The following describes the characteristics of a valuable view.
 
Creating a More Valuable View
 
            1.         Focus on the business model
            2.         Develop a recurring revenue/income stream
            3.         Institutionalize the business (mgmt, systems, etc.)
            4.         Create transparency on all fronts
            5.         Rationalize the process chain/aggregate niches
 
End Result:     A higher acquisition multiple
 
The business model is the way a company plans, organizes, and controls to meet its goals.  Good business models help a company create extreme value.  Business model transparency is vital because key managers and other stakeholders are able to see clearly the critical success factors affecting the business.  Therefore, the more transparent the business model a company has, the simpler it is to delegate to managers who can then create value.
 
The market of investors pays handsomely for companies that generate recurring revenues and profits.  A company doesn’t have to have 100% recurring sales/profits to receive a valuable view; rather, at least 30-40% will do.  Niche-centric businesses typically yield high levels of recurring sales/profits, and therefore are more valuable than traditional businesses.
 
Companies that rationalize their process chain tend to be viewed as more valuable.  This means that everything a company does to provide its goods or services should be outsourced if it isn’t adding value.  Intellectual capital is always owned by the company; the rest of the process chain need only be controlled.  Of course, the company should be highly focused on building high margin niches.
 
Companies that perform at the top of their industry are usually viewed as less risky than their under-performing counterparts.  This explains why some companies fetch much higher acquisition multiples than their similarly-sized competitors.  In other words, investors believe these winners generate more return for the level of risk than might be indicted by their diminutive size.   
 
It’s possible to graphically depict the achievement of a valuable view.  The following chart shows segmentation of the U.S. capital markets.
 
 
Each segment yields an expected acquisition multiple.  This represents how the marketplace views and values companies associated with that segment.  For example, the typical small business is viewed (valued) at 2-3 times adjusted earnings; whereas, the market usually values lower middle market companies at 4-8 times earnings.  What if a small business can be viewed as a lower middle market business?  Or a lower middle market business can be viewed as a middle market company?  It happens – occasionally a $20 million in sales company sells for a 10 acquisition multiple.  This is what happens when the owner creates a more valuable view.  In other words, the owner creates an arbitraged return by creating a risk/return imbalance in his/her favor. 
 
So why are less than 10% of owners aggressively creating more valuable views of their businesses?  I have no idea.
 
- Rob
 
 
May 20, 2013 –  from Rob Slee
Honor Loan Program

As you know by now, I believe America’s future sovereignty can best be assured by educating and investing in our private capital markets.  Multinational corporations get most of the press, while private companies create most of the jobs and pay most of the taxes. 
 
So when someone recently pointed me to the Honor Loan program (www.honorloan.org), I was drawn to its mission of helping students compete in the global economy.  The following is taken from the Honor Loan website. 
 
The engine of the American economy has always been entrepreneurship.  From the spark of individual creativity have emerged the global businesses, ingenious inventions, and pioneering solutions that characterize the world economy today.  Today’s students in American high schools and universities are the leaders to the next chapter of history.  In an extremely competitive environment, it is imperative to equip them with the guidance necessary to become the next great creators of jobs, opportunities, and innovations.  In the service of this vision, the Time Entrepreneurship Foundation aims to promote and support entrepreneurship at the secondary and tertiary levels of education.  The Foundation achieves this goal by providing institutional Honor GrantTM funding to high schools and universities, which in turn administer Honor LoanTM funding to individual students. 
 
The Honor LoanTM program allows students at educational institutions receiving Honor GrantTM awards to obtain the resources necessary to pursue their entrepreneurial passions.  These educational loans are disbursed on an interest-free basis, and carry no legal requirement for monetary repayment.  Instead, students promise on the honor system to pay back the original funds if their entrepreneurial venture succeeds, or else simply volunteer their time to help fundraise those funds back if they lack the financial means. 
 
In addition, students must complete an academic curriculum of entrepreneurship study prior to their eligibility for the loan.  This entire process instills in students the educational values of responsibility and accountability.  In addition, Honor GrantTM institutions will distribute Honor LoanTM awards based upon each recipient’s specific needs and stage of development.  For instance, the Honor LoanTM program can underwrite the cost of creating a legal business entity, securing services such as consultancies and marketing, creating prototypes of physical products, building websites and online networks, purchasing basic office and research supplies, and filing for trademark and patent protection, among other purposes.
 
The Foundation’s activities fill a major gap in today’s educational system.  Most high schools and universities do not offer dedicated programs on entrepreneurship, and those that do typically provide support only through annual competition-based models that disproportionately favor a tiny fraction of the participants.  By contrast, the Honor LoanTM program offers non-competitive, year-round funding to students committed to entrepreneurship.  Its emphasis on the honor system removes the fear of failure, because students need not repay the principal through monetary means.  Indeed, by the mere act of pursuing an entrepreneurial idea, students will gain the education, experience, and lessons necessary to succeed later on—assets they would not otherwise obtain through other models of support.
 
All donations to the Foundation, which operates as a non-profit entity, go directly to the Honor GrantTM portfolio, which in turn will disburse to qualifying educational institutions.  At minimum, at least 90% of all incoming donations will be allocated to this primary financial mechanism.
 
The Foundation's email address is:  info@honorloan.org.  Or you can email me and I will connect you with someone at the Foundation.
 
Just so you know, I will not benefit financially in any way should you decide to participate.  Let’s make something happen here. 
 
- Rob
 
 
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
 
 
 
Comment directly to Rob: r.slee@midasnation.com