The Rebel Allocator

by Jacob Taylor

  “My grandfather always used to tell me to buy sweaters in the summer,” I recalled. “Is this along the same lines?”

  “It’s similar,” he said. “But in this case the seasons run longer than most can tolerate. Especially if they have investors who require immediate returns. It can really cloud a decision-maker’s thinking when there’s a shot clock.”

  “I can see how it’d be difficult to have patience in the typical corporate environment. At Big Rock, they’re always looking to turn things around as fast as possible and then sell before the wheels fall off.”

  “That’s one way to do business. It doesn’t fit with my personality. Here’s the lesson I want you to take away from the humble pine cone. Patience may be the least-exploited advantage in the game. While we’re talking about strategy and patience, I have another story for you.”

  “I love your stories,” I said. I wasn’t buttering him up; I actually did love his stories.

  “Do you remember much of the 1980s?” he asked.

  “A little bit. Like Back to the Future or Miami Vice?”

  “I meant more in the business world,” he said.

  “Not really. I have seen the movie Wall Street.”

  “Close enough,” he said with a shrug. “That movie gives you a sense of the feeling of greed that permeated the culture. Around that time, it became very easy to borrow money, even if you were a little dodgy on how you would pay it back. The idea was you could always borrow more and reset the clock when the debt was due. No problem, as long as the money was flowing.”

  “I think I remember reading about that,” I said.

  “The money companies borrowed came when they issued what were called ‘junk bonds.’ Now they’re called ‘high yield bonds,’ so they must be quite a bit better than back then,” Mr. X said sarcastically. Nice euphemism, Wall Street. “We were coming out of the 1970s which were a very turbulent time in the U.S. Inflation, Vietnam, long gas lines.”

  “Disco!” I cut in.

  “Yes, even disco,” he said. “As the 1980s got rolling, a fresh sense of optimism was in the air. And naturally, access to cheap money made people’s eyes bigger than their checkbooks. They were overconfident about the kind of businesses they could build. In my industry, there were several restaurant chains who borrowed a lot of money and built new stores. Lots of stores. They saw a bright future ahead.”

  “I assume from your tone that you weren’t building like they were. What did you see?”

  “You’re right, we weren’t building anything. Our competitors had bid up the price of land, raw materials, and construction labor to the point where new buildings were very expensive and it was hard to see how we’d make our money back. I’ve noticed that when there’s a lot of easy money sloshing around, the returns on capital start to suffer. Instead of borrowing, we ended up accumulating a lot of cash through operations and just sitting on it. The press at the time said we were behind the times, indecisive, old and stodgy. That we were going to be left in the dust by all of these movers and shakers. And I was a much younger man back then!”

  “I bet that was hard to listen to,” I said.

  “I wouldn’t be much of a rebel if I let it bother me, would I?” he said. “Besides, what was the alternative? Do something that didn’t make sense, just to be like everyone else? That would be patently foolish.”

  “You’ve earned your ‘rebel’ moniker,” I teased. “So what happened?”

  “Unfortunately for the aggressive ones, economies are cyclical, much like nature. Trees don’t grow to the sky in nature or business. There are feedback mechanisms which create cycles, limits, and reversions to the mean. And just like nature, these cycles take years to play out. It’s very difficult to watch from the sidelines for years--to wait patiently while your pine cones just sit on the forest floor.”

  “With the price of everything going up, did it seem like everyone was making easy money but you? I vaguely remember stories from the dot com mania that everyone was getting stupid rich overnight.”

  “Yes, it had many of the same hallmarks. As I said, these companies borrowed a lot of money to build new stores. They got ahead of themselves with how much restaurant space consumers really wanted. It’s simple economics: any time you have too much supply, prices start dropping. All the projections on how they were going to pay back that debt went sour because they couldn’t get the prices they needed due to overcapacity. Boom is followed by bust, surely as night follows day. Many of these companies went into bankruptcy or were taken over by competitors at very cheap prices. Who wants money-losing assets after all?” His tone had a hint that he was leaving me a clue. His pregnant silence confirmed my suspicion.

  “Wait, weren’t they making money?” I said. “Just not as much as people originally thought they would when they borrowed to build?”

  “That’s right!” he said. “That’s an important takeaway of this story. There’s really no such thing as a bad asset. Just paying the wrong price for that asset.”

  “After being proved right, I bet it felt good to tell everyone, ‘I told you so!’” I said.

  “No, you should know me well enough to know that’s not my style,” he gently scolded. “We quietly went on a buying spree. We used our pile of cash to purchase dozens of great buildings out of bankruptcy for twenty-five cents on the dollar. Reminder me later to tell you a story about Conrad Hilton.”

  “OK.”

  “We also acquired an entire private burger chain and absorbed them into Cootie. We even bought the stock of a tough competitor we felt was unduly cheap in the stock market. It was a very productive time, all set up by our patience during the boom period. Both the private acquisition and stock purchase are longer stories for a different time.”

  “Didn’t you have the same problem of weak pricing that fouled up everyone else?”

  “We did,” he said. “For a while. But eventually the economy grew to where we had the right number of restaurants. I say right with tongue-in-cheek. There’s no right number, at least not one that any human could calculate. Just like there’s no right number of trees in the forest. Humans wouldn’t be able to figure out what that is either. The number and type of restaurants people want is an ever-changing calculus based on the desires and needs of our tastes. And that’s just for restaurants! It’s sheer lunacy to think you could plan an entire economy. No wonder the Soviet Union collapsed." I had yet to read anything about economic miscalculation being the cause of the collapse of communism. I had always been told it was because they didn’t fully commit to true socialism. "Sorry… where was I before I went off on a tangent?”

  “I was asking about soft pricing,” I said, getting us back on track.

  “Ah, yes,” he said. “Anyway, as demand caught up with supply, prices firmed up, even overshooting when there became a shortage. Always in cycles. Remember back to when we talked about the importance of same-store-sales to profitability?”

  “Yes,” I said. “Operational leverage.”

  “Good boy. As we had more people coming through the same four walls to buy burgers, we earned an increasingly higher margin on each burger. As traffic increased, we enjoyed that tailwind at our sails.”

  “So would it be fair to say that you zigged when everyone else was zagging?” I asked.

  “Sort of. We weren’t being contrary for no reason though. Their zagging just made no sense to me. There’s an ebb and flow that’s woven into the very fabric of capitalism. People who forget cyclicality are bound to be hurt by the bust, whereas we were able to benefit. Every bubble forces you to make a choice: do you want to look like a fool during the build up as you’re missing out? Or would you rather look like a fool after it bursts? There’s no getting around looking foolish. But you do get to decide the time frame. I call it ‘The Bubble Ultimatum.’”

  “I think I now understand the quote you sent about over-capacity and under-capacity causing price swings and cycles. ‘Nothing fails like success.’ And you might add,
‘Nothing succeeds like failure,’ right?” He just nodded. Not even a high-five for my cleverness?

  “Now, I have a quiz for you,” he said.

  “Uh oh...”

  “You’ll be fine. We’re now standing in an empty lot. To sell hamburgers, we need to have a building here eventually. We have to put a roof over our head to provide the restaurant experience people are accustomed to. Here’s the quiz question: how many different options does Cootie have to create a roof over our customer’s heads?” This must be a trick question.

  “I can only think of one option. Hiring a construction crew to erect a building for you. Is that what you mean? What else is there?”

  “Where’s the creative thinking these days?” he muttered. “I can think of at least eight ways.”

  “Eight?!” I said. How is that even possible?

  “At least. Let’s start with the most obvious. We could buy a fresh plot of land like this one and build on it immediately. That’s one option, as you mentioned. We could buy land by itself and wait to eventually put a building on it. That would be a second option. We could technically buy a building and store it somewhere before we have the land, like a manufactured home. We haven’t tried that one yet, by the way. That makes three options to start. What else?” he said.

  “I see how this works,” I said. “You’re being tricky. Let’s see… you could buy an existing building and convert it to a Cootie Burger.”

  “Good,” he said. “Have you ever heard of Conrad Hilton?”

  “I’ve heard of Paris Hilton... ‘That’s hot.’” He didn’t get my joke.

  “I think she’s his great-granddaughter. Conrad created Hilton Hotels. He was a builder who was almost wiped out by the Great Depression. He saw how cheap hotels could get in times of panic compared to what they cost him to build and he came to a realization. From that moment forward, he’d only buy distressed properties and would never build anything himself again. For the rest of his life he’d only wait for property to go on sale. Anyway, that’s four,” he said encouragingly. “Keep going.”

  “You could buy a competitor’s chain and convert all of its restaurants into Cootie Burgers?” I said.

  “Very good, although I basically gave you that one with the Hilton story. That’s five.”

  “I’m not sure what the other three are,” I finally said.

  “You’re going to think this is cheating, but see if you can follow. We could calculate how much a publicly-traded competitor is selling for on a per-restaurant basis and buy partial ownership by investing in their stock. You’d have less control than if you built a Cootie Burger yourself, but it’s still a way to become the owner of a roof for a restaurant operation.”

  “That is sneaky,” I said. “But I can see how if you were able to get a good deal on a competitor by buying their stock, it might make more sense than building your own new store to compete with them. Especially if you’re worried about creating overcapacity and harming the industry’s pricing.”

  “Exactly right. Mr. Buffett would be proud of that observation.” The old man got me with that one. I tingled with pride. “So that makes six ways, leaving us with at least two more.”

  My silence indicated I was stumped.

  “OK,” he said patiently. “This one applies if you’re a publicly traded company and can be a little hard to conceptualize at first. You can buy back your own stock, which in a way is purchasing some of your own roofs back from your business partners. That’d be seven.”

  “Sorry, I didn’t follow that one.”

  “That’s alright. We’ll discuss stock buybacks more at a later time. They’re a very important topic and I don’t want to give them short shrift. Here’s a hint for the last one: deciding not to decide is still a decision.”

  Exasperated, I laughed, “Mr. X, your hints are never helpful.”

  “Just think about it for a minute,” he said.

  “Are you counting not doing anything and just keeping cash in your bank account an option?”

  “Indeed, I am. Remember our patient pinecone sitting on the forest floor? Often the smartest thing to do is nothing. Wait for a better slate of opportunities to be presented on your menu.”

  “Jeez, eight ways just to put a roof over your head,” I said. “Even a simple business like running a restaurant sure seems complicated. Capital allocation is hard.”

  “Perhaps, but it’s not so bad once you have the menu laid out in front of you. All you have to do is evaluate each idea and decide on the most logical choice. This is the secret to good capital allocation. Have a lot of options and pick the best one. You want to cast the net wide when you’re measuring all of your choices against each other. It’s the missed opportunities right in front of your face that really hurt.”

  “The ones that got away...” I said. I should have been a philosopher.

  “You have no idea how true that is,” he replied in a haunting tone.

  “I think I understand the other quote now and why Mr. Buffett doesn’t stress about not having a long term plan,” I said.

  “Oh yeah, why is that?” Mr. X replied.

  “At every juncture, he’s looking at his various investment options and trying to pick the smartest one. Even if the answer is to wait for a better menu. How can you make too many plans if you don’t know what opportunities the future holds? You’re limiting yourself by pre-deciding today what the best option is ten years from now.”

  “That’s the smartest thing I’ve heard you say,” he said.

  “Must be picking up some good habits from hanging around the right people.”

  “Must be.”

  “Mr. X, do you think of yourself as happy?” I asked.

  “That’s quite the segue,” he said. “To tell you the truth, I haven’t spent a lot of time thinking about my own happiness. I’ve always felt my best when I’ve focused on being useful to others. And the most useful version of myself has always been in the business world.”

  “Do you think those feelings of wanting to be useful come from your upbringing?”

  “Probably,” he said. “You couldn’t worry about concepts like being happy when you’re living on the edge. Even after my life had become materially more comfortable, I always felt the urge to keep striving. Like maybe the other shoe would drop if I relaxed too much.”

  “Sounds exhausting,” I said.

  “It is. But when it’s all you’ve ever known, it feels normal.”

  “There’s something that’s been bothering me for a while,” I said.

  “What is it, Nick?” he said.

  “Why did you pick me?” I asked. “It just doesn’t make any sense. You could have gotten anyone you wanted to write about you.”

  “You’re right,” he said. “I’ve been approached by many to write a biography and I’ve turned them all down. Part of it is that my own mortality stares me in the face every day. I can see life draining out. It feels like now or never.”

  “But why me?” Mr. X stared me in the eyes as if he were contemplating an important decision.

  “You didn’t know it at the time, but your first visit to Wichita with your classmates was a job interview,” he said. “I have research done on every member of an audience I’m going to speak to. It helps me choose where to steer the conversation to make the biggest impact.”

  “Are you serious?” I said.

  “If I’m going to do something, I’m going to do it to the best of my damned abilities,” he said. “There’s no excuse for poor preparation.” Wow, what did my dossier look like?

  “You caught my eye for a few reasons,” he continued. “First, you had a background in both business and journalism. Having a pure biography written isn’t of much interest to me. Who cares about a poor farm boy from Kansas? I want this book to be something others can learn from to make them better businesspeople.”

  “Little did you know how dumb I was about business,” I said.

  “It took a little hand-holding at the beginnin
g, but you’ve blossomed into an apt pupil, Nick.”

  “Thanks, Mr. X,” I said.

  “Your working at Big Rock was also a factor,” he said. “I knew you’d be seeing a version of capitalism that is pretty far from what I espouse. My hope was that you’d be able to appreciate the differences. Maybe you’d be able to wrestle the term away from Big Rock’s version that I think gives capitalism a bad name.”

  “I’d have to be pretty blind not to see the difference between you and Big Rock.”

  “It also didn’t take a Sherlock Holmes to find your columns in the school paper and figure out that you were strongly anti-capitalist.” I didn’t know what to say to that before he continued, “I wanted someone who would be critical of my views. If I was able to make a believer out of you, then I knew the project could help anyone.”

  “I have to be honest; you’ve challenged many of my core beliefs,” I said.

  “I suspected that might happen,” he said. “It was also important to me that you were young. I’ve noticed a disturbing trend toward socialism in today’s youth. I’m less concerned with my generation appreciating capitalism--they’ll be gone soon enough. It’s the next generation of decision-makers I want to influence. I’m an old man; there was no chance I’d be able to connect with your generation. But I thought you might be an ideal translator to reach them.”

  “I’ve always felt like an outcast with people my age, but I see your point,” I said.

  “An outcast... or a rebel?” he said with a pointed tone.

  “I’m working my way up to rebel.”

  “The last piece of the puzzle fell into place on your first visit to Wichita. I wanted to get a first hand sense what you were made of. You weren’t afraid to think for yourself and stand up to me about taking notes, and you asked a great question under pressure. I was testing you.” My head was spinning with realizations.