Buyers and Builders
00:19:08 · Mikk
So these aren't retired CEOs sitting around giving advice once a quarter. The idea is if something goes wrong, the person sitting next to us needs to be capable of actually running the company. And it goes back to the principle they built the firm around, put financial capability and operating capability inside the same investment firm. Not advisers on the outside, operators on your side of the table who can actually take over when needed. There is another deal described. It's the company called Lexmark. And CDR was looking at buying IBM's typewriter and printer business and turning them into a completely independent company. Martin Dubilier had actually run a business products company and held the original patent on the daisy wheel printer. This was an area where they had real operating knowledge. Their view was basically this, we can do this. This will be a great business and strategy. Very simple. Use the cash flow from the major businesses to build the laser printer business. They knew they couldn't just take this business out of IBM and continue operating like IBM. IBM had this incredibly strong corporate culture, white shirts, dark suits, regimented training, but it wasn't particularly entrepreneurial. They started changing their incentives. They lowered the emphasis on fixed compensation and increased performance based compensation. But the most important thing they did was ownership. Most importantly, we gave every employee of the new company a direct or indirect ownership interest in it. And the crazy part, when the new company went public, the value of the employees investment interest was greater than at $1,000,000,000. IBM's product development cycle was around thirty months. HP, Heblett Packard was doing it in eighteen months. They decided Lexmark needed to get to fifteen months, and they basically did it. They introduced pay for performance into the development lab and cut the product development cycle in half. The deal closed in March 1991. By the end of that same year, they had already paid down 300,000,000 of debt, which is way ahead of schedule. They streamlined manufacturing, speed up product development, and got the sales force moving. Then in 1995, they took Lexmark public. By the time they were financed, the CDR had returned more than four times the original investment to its LPs.
00:21:53 · Mikk
What they did, they took a piece of IBM, gave it its own culture, changed the incentives, came to employees ownership, and made the company move a lot faster. Previous thirty month, they were able to now do the development cycle in fifteen months. That's the true like operating side of Private Equity. You're not just buying the business, you're changing the environment in which the people inside the business operate. The next two stories are are super interesting, and these are the stories, I think, show both sides of private equity very well. First is Kinko's, and Kinko is the American copy and print shop, the chain of of those shops, which was founded in 1970. And CDR ported in 1960... 1996, but it wasn't really one company. It was 127 businesses spread across The US with different opening hours, different services, even different ways of dealing with customers. George Thumpka, one of CDR's operating partners, eventually run the company on an interim basis. And he used his used this incredibly simple idea called called quality lying, where you take one metric, for example, revenue per employee, rank every store, divide them into four groups, and then study the best performance. What are they doing differently? Then you're gonna just take those practices and push them through the rest of the company. He also throw the units in each quartile to perform at the level of the quartile above them. It was common sense and it worked extremely well. So they eventually sold Kinko to FedEx, but then he gives the very opposite example of a story which didn't go well, and it's the company US Office Products. And this was a roll up of more than 100 distribution businesses. They hadn't done enough due diligence. When the business began to slide, we could not stop the decline, and the business was eventually restructured and our investment was lost. His reflection on that, the whole period is probably the most important part. Looking back on this period, I believe we suffered because we thought we were better than we really were. We thought we could do anything, pride caught before the fall. He also adds, but I also believe that it is a measure of our institutional resilience and the strength of the firm's underlying investment model. Even with significant underperformance of the investments made in 1998 and year 2000, our overall performance continued to be strong.
00:24:42 · Mikk
Now their take was that don't blame the bad investments, only look at at at themselves, look at yourself. Because after these failures, CDR realizes they had gone too far up the risk curve. And around this time, Jack Welch joined the firm after spending decades at GE. The idea was that they didn't bring Welch in to run individual portfolio companies. They wanted him to look across the entire portfolio and helping the firm think about strategy. And they then create two things, an operating review and then investment screening committee. The operating review is they put portfolio company management teams in a room with seven operating partners who had all previously been CEOs of a major international businesses. So if you really imagine a CEO and having seven former CEOs sitting across from you going through your business. And the second part is the screening committee, basically quality control before they do a deal. And I think the lesson for them is is pretty simple here. After making those huge mistakes with those investments, they applied the same philosophy to themselves that they applied to their portfolio companies. Joseph saying, in many respects, we as a firm did what we ask our companies to do, respond to changing circumstances decisively and effectively by making positive strategic changes. That's a good operating principle for any business. When when something stops working, don't just explain the failure, Change the system that allowed it to happen, and they did that in a big way. And here on the page 46, this page page is basically Joe Rice reducing decades of private equity experience down to down to five lessons. The first one is probably the most important. Labor hard at the front end of an investment. And in other words, do the hard work before you own the company. Understand the structure, understand the operations, not just the financials, and don't loan the business with so much debt that one bad year kills you. He specifically says to build the balance sheet with plenty of liquidity cushion for tough times. Then he... Another piece of advice or a lesson, go beyond the numbers. I think this connects to everything else in the chapters we covered before.
00:27:18 · Mikk
A spreadsheet can tell you what happened in the business, but it can't necessarily tell you whether the management team is good enough, what operational problems are hiding underneath or what opportunities haven't been exploited yet. Third lesson, be prepared to turn on a dime. Lexmark is his example. They had mature technologies producing cash, and instead of just harvesting that cash, they used it to fund the emerging laser printer business. The old business essentially financed the thing that eventually transformed the company. There's another one which I really like. Look in the mirror. Don't only demand change from your portfolio companies. Be willing to change your own firm. Change the people. Change the processes. Admit when something isn't working. That goes back to CDR's own failures earlier in the chapter where they didn't just blame the investments. They changed how they operated. And the last one is much more personal. It's be passionate about your vocation. And here, I want to read you the page 35 where what he learned earlier on his career, and I read it this to you. I learned years ago the importance of natural talent as prerequisite for success. After graduating from Williams College, I enlisted in the Marine Corps, then went to Harvard Law School and ended up practicing law at Sullivan & Cromwell. At this great law firm, I had the good fortune to work for a born lawyer, John Rabin. He had a very prospective legal mind. John could see all the issues, turn them on their side and view them in a way no one had thought of before. Clients respected him tremendously. He was a great lawyer and everyone knew it. I recognized that my chances for becoming a lawyer on a par with John fell somewhere between slim and none. That motivated me to look for a field in which I too would have that natural ability. One of Sullivan & Cromwell's clients was an institutional research firm called Laird and Company. Its corporate finance practice was the deal business, bootstrap deals, we called them. Laird would find companies they wanted to acquire, then go out and raise the financing necessary to do the deal, which is called bootstrapping and bootstrapping themselves into position to make the purchase. As I grew to understand that business, it appealed to me. When a position opened at Laird, I left the law practice and went to work doing deals.
00:30:05 · Mikk
And very quickly, I found I was a better deal guy than I was a lawyer. Over time, I learned the craft of deal making. I'm not a great financial analyst, but fortunately, we have plenty of partners who complement my weaknesses. So if you listen all this, it's it's very obvious. But he got this lesson where be passionate about your vocation. And Rice is saying great lawyers, managers, and dealmakers might actually be born rather than made. His point isn't that you don't need to work at your craft. It's that you should pay attention to what you're naturally good at. And he ends with follow your heart and your natural talent to achieve success. Do not remain in a profession that seems a poor fit. And I think that's a pretty good way to end this chapter. Do the work before the deal. Don't let the numbers become the whole story. Be willing to change quickly. Apply the same scrutiny to yourself that you apply to your investments, and then spend your career doing something that actually fits who you are. Now the next master of Private Equity, Warren Hellman, and he's the cofounder of Hellman Friedman. He founded the firm in 1984, which is forty two years ago with Friedman. And this book was written in 2007. So years in private equity, '25. And at that time, they had 25,000,000,000 in assets under management. And on March 2025, they had 107,000,000,000. And their headquarters is at the Salesforce Tower in in San Francisco. What makes him an super interesting individual was how hardcore he was with with... Obviously, his work, but things outside of his work as well. He was waking up every single morning, like, three forty five, ran, like, 16 miles. And I will I will get all all into this why he was doing this. And he was a massive fan of playing Pancho, and he created this festival. And the lesson and the quote shared on this book, all potential investments should be considered guilty until proven innocent. Warren Hellman came from one of California's great banking families. One of his most important investment lesson... Investing lessons came from a very simple conversation with his father. And in 1959, Hellman had just started his career at Lehman Brothers, and Wall Street was in the middle of an IPO boom. And the atmosphere was familiar. Markets were running. Optimism was everywhere. And it felt as though the old rules of investing were become obsolete.
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.