An old truism is that the best thing you can do in life is to fail early…
It’s not a question of whether or not you’ll meet failure. With enough time, and enough endeavors, something is bound not to go to plan. The important point is to do it early and learn from it so you can grow.
In that sense, I guess you could say I’ve been lucky over the years.
Last week, I told you how I lost a million dollars trying to run eight Papa John’s (PZZA) stores. But that wasn’t the worst hit I’ve ever taken, believe it or not.
The worst happened around 2004.
It was in the middle of a nasty breakup I had with a business partner of over 20 years. He was developing a large hotel and conference center in my hometown – one I knew wasn’t going to turn out well. So I was trying my best to distance myself from him altogether.
That wasn’t easy considering all of our joint property, however. Throughout our partnership, we jointly developed nearly $100 million of commercial real estate projects…
Including Blackstock Center, shown below.
It consisted of around 100,000 square feet of retail space and three outparcels. And of all the projects I developed, it was my favorite.
I was the one who oversaw construction and had it all leased it up even before it was completed. And, even today, it remains 100% occupied, standing as a testament to the value of quality, well-placed real estate.
Unfortunately, it’s just not 100% occupied under me anymore.
That’s because my business partner had placed additional mortgages on the property without my knowledge. I was aware of the senior mortgage, of course. But our partnership agreement prohibited additional loans without the consent of both parties.
So I was shocked when I found out. And I was even more shocked when I learned there were a whopping five mortgages all told… in addition to an assignment to a third party.
Plus, my business partner had apparently funneled even more money into his private coffers by not paying the original mortgage for a full year. That meant we were on the line for a whopping $3 million together.
And I ended up paying for every single bit of it.
Management Matters
I won’t go into all the ugly details, but suffice it to say I ended up in my attorney’s office soon enough. If I’d been hoping for even a glimmer of good news, I was sorely disappointed.
“Brad,” he told me, “this should be a textbook law school example of how to navigate a bad partnership. This property is tangled up like a plate of spaghetti.”
According to him, I had three options:
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Civil recourse
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Criminal recourse
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Do nothing
I decided to pursue option No. 1, reaching out to a bankruptcy attorney to slow down the string of foreclosures related to Blackstock Center. However, as I found out the hard way, bankruptcy simply delays the process.
I had to eventually give up the property altogether. And since it’s in my neighborhood – and making its new owners reliable monthly paychecks with a fully paid-off senior loan and a $10 million valuation – it serves as a constant cautionary reminder of how not to form business connections.
That’s why I consider management such a critical factor in Wide Moat Research’s research process. We spend countless hours reviewing (and, if possible, meeting with) management teams to understand whether they’re honest and knowledgeable.
Even if we decide to move forward, communication with management remains a critical part of our research process. We’ll, of course, review earnings press releases and listen to conference calls ourselves. But we’ll also plan one-on-one meetings to ask them directly about what we’ve learned.
Forgive the title, but I read a book by Harry Frankfurt called On Bullshit after my business partner debacle happened. This always stood out to me:
When an honest man speaks, he says only what he believes to be true; and for the liar, it is correspondingly indispensable that he considers his statements to be false. For the bullshitter, however, all of these bets are off: He is neither on the side of the true nor on the side of the false. His eye is not on the facts at all… except in so far as they be pertinent to his interest in getting away with what he says.
We want to avoid that kind of person (and flat-out liars) at all costs – because the cost otherwise is exceptionally high indeed.
Our Favorite Holding Period Is Forever
That’s not the only lesson I learned from my dealings with that old business partner of mine though. As a result of getting so badly burned, Wide Moat Research takes our analysis even deeper still.
There are plenty of ways to corroborate the information publicly traded companies publish – just as long as you’ve got the time and commitment to do so.
A large majority of the time we spend analyzing stocks is in the capital markets arena. After all, much of a business’ success or failure is directly related to its cost of capital.
As such, we sift through plenty of income statements to determine whether or not the company is generating consistent profit margins.
For instance, good management teams can build “wide moats” by utilizing key advantages such as low cost of capital, scale, or other barriers to entry. And insider ownership is also critical, showing how much confidence executives really have in what they’re doing.
These people are usually the first to know when operations are improving and earnings are headed up. And they have additional insights into technology, marketing, and industry conditions.
So, we definitely keep an eye on what they’re doing in this regard, as well as what they’re saying. To quote Warren Buffett, “When we own portions of outstanding businesses with outstanding management, our favorite holding period is forever.”
It’s that kind of practice that has helped Buffett make so much money and keep it, too. We’ve adopted a similar mantra for Wide Moat Research.
Buffett also said, “It’s better to hang out with people better than you. Pick out associates whose behavior is better than yours, and you’ll drift in that direction.”
I paid the price – over $5 million when everything was said and done – for associating with a bad business partner. That was an expensive lesson to learn. But I took it to heart. And it has informed my analysis ever since.
Regards,
Brad Thomas
Editor, Wide Moat Daily
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