Buyers and Builders
00:32:54 · Mikk
And his father came to visit him in New York. As we discussed the economy, my father confessed to me how troubled he was by the French state of the markets. I feel as if I don't understand the markets anymore, said Marco Hellman. The things that I have always believed in most implicitly fundamental valuation metrics such as price earning ratios, price to book value, free cash flow, none of them mean anything anymore. And Warren said, you are absolutely right. You just don't understand at all what is going on. It's a whole new world out there. It wasn't long after his visit that the stock market crashed, and along with it, my proud portfolio of high technology IPOs. In a phone conversation soon afterwards, my father reminded me how much he had enjoyed our conversation in New York. Clearly, one of us didn't understand what was happening and it wasn't me, he said. Periodically, the markets go through a phase where the old economics seem completely outmoded. In the last decade alone, we have seen this happen twice. During the dot com boom, profits themselves seemed a quiet way to call value, rather true value was all about eyeballs and cost per click or so the thinking went. More recently, we experienced the leverage frenzy that came crashing down in mid two thousand and seven. These events led to the ultimately collapse of my own Wall Street Alma matter. In the end, there is a little new under the sun. Companies that have lasting franchises, which meet the need or provide a mission critical service that are run by high caliber managers whose interests are aligned with shareholders that produce strong free cash flow and don't require significant capital investment to grow, those are the ones that will always last. And my firm seeks to invest in companies that possess these traits. And this part actually, this this became the foundation of Hellman Friedman's investment philosophy. Look for lasting franchises, strong management teams, strong free cash flow, and businesses that don't require enormous amounts of capital to keep growing. They learned over time that they preferred businesses that, again, didn't need huge amounts of physical assets or constant capital investment to grow. He says, tough time and experience. We have focused on companies with fewer physical assets and lower capital costs. Hellman keeps coming back to people.
00:35:41 · Mikk
Even if every number looks right, somebody still has to run the company. I also believe it is impossible to overstate the people quadrant in the investment decision. And rather than buying companies and immediately replacing management, H and F preferred to back a management team they already believed in and then give those people meaningful ownership. We change management teams if we have to, but we prefer to invest behind and support an existing management team that we believe can execute the joint vision and will be motivated by their own significant equity stake in our deal. What I find interesting is that they didn't even need majority control. They were comfortable owning minority positions if they had the right business and the right people. And this leads to probably Hellman's most memorable investing rule. Every potential investment should be considered guilty until proven innocent. And what he means by this is don't start the assumption that you want to do the deal. Make the business prove that it deserves your money. Hellman had been an investment banker, so he knew firsthand how dangerous the opposite mindset could be. A smart financial person can find a way to construct an elaborate capital structure that will justify almost any investment. You can make the spreadsheet work, you can change the leverage, you can structure the security differently, but none of that turns a bad underlying business into a great one. And their discipline didn't end once they owned the company. Tully and Warren would periodically go back and re underwrite the investment from scratch, reassesses the original thesis, the expected performance, and whether they should continue holding it. They learned that lesson painfully with mobile media. And at one point, mobile media was worth roughly three times what H and F had originally invested. Then the paging industry came under severe pricing pressure. The company collapsed and eventually filed for bankruptcy before H and F could get out. An investment that had been three x on paper ultimately become a loss. Hellman says, we learned several key lessons from the mobile media experience. Among them were the vital experience of investing in high quality defensible businesses and being proactive in determining when to exit an investment.
00:38:23 · Mikk
He also said, the errors have hurt, but without them, we would not have learned the vitally important lessons by which we have built a track record of success. Same thing, I was listening to the podcast with Fred Wilson, the legendary venture capitalist and cofounder of Union Square Ventures, and arguably one of the the best VC investors we have ever seen. And what he said, super interesting. He said that one of the biggest risks is actually not investing. You can invest in company and lose your money, but in a business, missing one exceptional company can be far from costly. That's why Wilson believes investors need to play offense and accept that getting some investments wrong is simply part of the game. Why it's interesting and why I'm bringing this out is we can see two of the massive private equity firms today, Hellman Friedman and Clayton, Dubilier Rice. They both had deals which went to zero in in private equity, which is... This was surprising for me, and that's... That made this book so much better, I would say, because in in mobile media case, like, on one one moment, they had this three x on a paper, which again ultimately become a loss. So it seems the Fred Wilson advice and lesson from from his career is that sometimes it's the biggest mistake by not investing. Warren Hellman himself came from a family with a remarkable history in finance. His great grandfather, Isaias Hellman, founded Farmers and Merchant Bank in 1871 and later bought Wells Fargo in a distressed sale in nineteen o five, helping turn it into a major bank financing the growth of California and the West. The part I love a lot on what Warren says, he... What he inherited from him, the desire to own businesses outright rather than just work for them. And his great grandfather had an even simpler way to putting it. I don't run businesses. I own them. That mindset seemed to run through Warren's entire career. Think like an owner, not an employee. Hellman's time at Lehman became a lesson in what kind what kind of firm he didn't want to build. He and Pete Peterson, and Pete Peterson eventually became a cofounder of Blackstone together with Steve Schwarzman. Him and B. Peterson too controlled during a difficult period and worked relentlessly to turn it around, at one point cutting workforce from 1,300 people to five fifty people.
00:41:08 · Mikk
But when Lehman decided it could no longer invest as a principal in buyouts, Hellman realized that that was the time to leave because that's exactly what he wanted to do. And overall, the experience stayed with him when he later built Hellman Friedman. He describes this that I decided how the old quar that Lehman would have behaved, and then I do the opposite. No hoarding power, internal politics, lack of accountability or intellectual laziness. After Lehman, Warren did was he spent eight years working and building investment firms in Boston. And this is a great moment to stop, to just show how patient he was, always just kept learning and didn't just jump and start building his own firm immediately. And while working in Boston, he finally met Tully Friedman, who they would become the cofounders, founding Hellman Friedman. And Tully's background, he had gone to Stanford and Harvard Law School before joining Salomon Brothers. And where they met was they both were restructuring the deal Crown Zellerbach. What I also like is that they didn't immediately go out and raise a fund. They wanted to prove the partnership really work. What they say is we wanted to take some time working with each other. Their thinking was let's see how we exist together as a firm for a few years before we raise a fund backed by institutional investors. Then came the deal that really put them on the map. It was the Levi Strauss deal. Levi's originally came to them for advice on its capital structure, but the more Hellman and Friedman studied the company, the more they kept looking at each other and simply saying this company should not be public. They saw one of the world's great brands, huge market share, strong free cash flow. They say a veritable cash machine. And importantly, the company had no debt. They structured 1,600,000,000 management led buyout. To take control of the company, we needed to borrow approximately 1,200,000,000 and roll approximately 400,000,000 of family stock into the deal. And after the deal, the Levi's family owned about 93 and Hellman Friedman owned 7%, which Hellman Friedman received as its advisory fee. And remember, they still hadn't raised their first institutional fund. At the time, the Levi's deal was the largest leveraged buyout of publicly held US firm to that point. The real idea wasn't just leverage.
00:43:54 · Mikk
They already had the person they wanted running the company, Bob Haas. Hellman says one of the formulas for success is to have the right chief executive in place and give him or her the right backing or to replace the CEO if need to be. With Haas, they backed him. Taking Levi's private gave him the freedom to restructure and invest for the long term without constantly worrying about Wall Street's quarterly expectations. By the mid nineteen nineties, Levi's had paid off over two thirds of the debt we used to help the company go private. The company also was head of schedule with debt repayments, a condition that made possible a major recapitalization. Following the recap, we had approximately 3,500,000,000 in debt And despite the tough conditions that begin in the early 2000s, we paired that town to about 1,500,000,000 by the time I came off the board in 2008. He was served on a board for twenty three years. The company proved to be quite cyclical and it seemed Haas had to reinvent it every few years. However, even in its tough periods, Levi's cash flow and basic business remained very strong. Now another example they had, not too great one actually, was with a company called American President Lines. They invested 50,000,000 because the security looked incredibly attractive. But then they realized the obvious problem. It simply wasn't a great business. High capital costs, mediocre industry and little ability for H and F to influence it. That changed their mindset from investment bankers to owners. An investment banker will look at the prospective deal and say, we have an opportunity to do something. Let's figure out how to do it. As principal, Hellman says, you have to think completely differently, where he keeps repeating every potential investment should be considered guilty until proven innocent. One of Hellman's big lesson was to avoid double leverage, putting lots of financial debt on a business that already needs huge amounts of physical capital just to operate. That pushed H and F toward asset light businesses like software, financial services and advertising. Now two great outcomes they had. One was Western Wireless, which returned 10x their money and VoiceStream, which was 8x, something we covered before mobile media, the Beijing investment.
00:46:35 · Mikk
This went bankrupt and at one point Hellman asked whether they should put another 5,000,000 into mobile media and Matt Berger replied over my dead body, we will invest another 5,000,000. I wouldn't put 25 more cents into this investment. Eventually they realized the problem wasn't something they could fix and their competitor PageNet had collapsed too and the entire paging industry was dying. Hellman says nothing we could have done, changing the capital structure, consolidating the industry, changing the management team, back office improvements would have made a difference. We were in dying industry and our investment was not going to bring it back. That's one lesson. A great PE firm can improve a business, but it can save a dying industry. What I liked about the end of Warren Hellman's story is that his investing philosophy seems to mirror the way he lives his life, as I said earlier. Outside of business, he loved Blue Cross music so much that he personally funded the Hardly Strictly Bluegrass festival, a free San Francisco festival that attracts as many as 700,000 people. And another thing is running. Hellman ran every single day starting at 03:45 in the morning and even completed the Western States one hundred mile ultra marathon twice. And his wife had sang nothing exceeds like excess. Nothing exceeds like excess. Hellman's interruption was simple. We achieve our greatest success only when we push ourselves to an excessive degree. This is interesting because I was listening one interview with him as well. There is not much you can find, but there's one where he described why he decided to go after this ultra marathons and 100 mile marathons was because he wasn't very fast when it comes to sprints, but he knew that he can outwork the other guy by just lasting longer, and that's why he chose those marathons. Another thing he added, we need to be confident, but not overconfident. We need to be aggressive, but not foolhardy. On the final page here on this book again, there are those lessons from Warren Hellman. I would say this as well, like reducing decades of investing into into five simple rules. The first is probably the one that defines the his old process, guilty until proven innocent. Don't start by convincing yourself why an investment will work. Start skeptical and make the business prove itself.