Bad businesses, great management

[petec]

One of the few Buffett pearls of wisdom that I question is his comment about how when a business with a bad reputation meets management with a good one, it's the reputation of the business that survives.

 

I'm sceptical because as a rule I think management is absolutely key in business success. In my experience very few businesses are so good that they can do well under bad management, yet very average businesses can do well under good management. Ironically Buffett's two main businesses, insurance and investing, are excellent examples of this, and his emphasis on the people who run his businesses suggests to me that even he doesn't really believe the quote.

 

Clearly if a business is in secular decline the best management in the world won't save it. But as a rule I tend to think smart management make all the difference in the world.

 

Thoughts? Examples?

 

 

[John Hjorth]

That's a great topic, Pete, because I think it's NEW!,

 

As investors [at least, the long term of us], we certainly need both a good company and a good management to create good investment outcomes. So to me personally, it's somehow a twisted, outdated phrase.

 

Personally, - and somewhat related to the topic - I also question the existence in real life today of "the company, that could be run by any idiot, because, eventually, it will". [i hope I'm not clogging up the topic here.]

[petec]

I also question the existence in real life today of "the company, that could be run by any idiot, because, eventually, it will". [i hope I'm not clogging up the topic here.]

 

No, I don't think so - they're tightly related.

 

I think that to a significant degree good management makes a good business. At the risk of making this a quotefest, I'm not saying you can polish a turd - but you can put glitter on it.

[bizaro86]

There are a number of examples of long term compounders based on good management in what I would consider poor businesses. Alimentation couche tarde would be one - great success in the convenience store/gas station business.

[John Hjorth]

I also question the existence in real life today of "the company, that could be run by any idiot, because, eventually, it will". [i hope I'm not clogging up the topic here.]

 

No, I don't think so - they're tightly related.

 

Pete, I hope I've understood your "No" here as to you, I'm not clogging up the topic.

 

To me, it's like a two dimensional proposition [here : simplified]:

 

Company : Good - mediocre - bad,

Management : Good - mediocre - bad.

 

That simplified perception gives you 9 applicable investor modus operandi [please feel free to refine, if needed]. ... They are all some sort of opportunity of dumpster diving for a value investor, based on variant perceptions to market, market sentiment, company sentiment etc.

 

-No matter what you do, the price you pay matters.

[LC]

Just stick to the top left (or bottom right depending on how you arrange it) corner and you'll be OK :)

 

For bad biz - good mgmt examples, wasn't it the designer from Apple who went to JCPenny (or Macy's - I forget which) for like a week?

 

Eddie and Sears come to mind.

 

 

[bizaro86]

Just stick to the top left (or bottom right depending on how you arrange it) corner and you'll be OK :)

 

For bad biz - good mgmt examples, wasn't it the designer from Apple who went to JCPenny (or Macy's - I forget which) for like a week?

 

Eddie and Sears come to mind.

 

I think there is a distinction to be made here around competitive advantages somehow. Most people (including WEB) would say that retail is a pretty bad business in general. But there are some companies that have been long term compounders in that industry (WMT, COST). I think their managements have been able to generate competitive advantages from the beginning of the firm.

 

By comparison, someone new coming into Sears or JC Penney is trying to fix something that is probably irreparably broken. A below average position in a below average industry isn't something good management is likely to be able to fix.

 

I really think there is an epiphany somewhere in this thread that I can't quite put my finger on- thanks for starting it!

[Cigarbutt]

1-Recently looked at Mattel. The toy industry used to have great economics but now participants like Mattel will likely continue their secular declines even if they keep hiring outstanding CEOs.

 

2-In 2009, was involved with The Brick (Cdn furniture retailer). Basically a mid- to low-end retailer in a terribly competitive landscape. Operational weaknesses built up during good times and became apparent in a tougher environment (tide moving away revealing...). Management responded by applying remedies that worsened previous operational difficulties and shortcomings. Because of financial distress, management changes were made (Bill Gregson, who now leads the restaurant unit related to FFH was made CEO and the founder Bill Comrie was asked to come back and contribute (bridge financing and expertise as a "consultant") and operational changes were made. During that time, I built a significant stake and visited several stores and relevant competitors to confirm the reported financial numbers in relation to operational changes (increased advertising, hiring of sales personnel and especially improved operational management of inventory). The turnaround happened because, in part, of financial support by key providers but the operational changes (and the level of competence required) made the difference and were instrumental in the transformation to a sustainable model (in both good and bad times).

-----

Side note #1: Fairfax and others then provided a sort of quantitative ease to the liquidity crunch that the firm faced (self-inflicted injury) but like Bagehot (illustrious British guiding light of another era it seems) described, if you want to prevent stupid money from zombification, the liquidity infusion has to be, sufficient, short-lived, expensive and associated with adequate collateral (or margin of safety). The cost of capital provided was high (but I did not mind then 'cause I was on the right side of the transaction) but was clearly linked to the needed operational changes necessary to reach a sustainable level of operations and solvency.

Side note #2: petec, in a FFH related and interesting thread, your inputs were appreciated but the case above described IMO is an example showing that FFH will eventually get its investment mojo back but, for that to happen, we may need an environment which is different from the last few years because I think that it is better for them to wait for the right environment instead of awkwardly trying to adapt to this era.

-----

https://www.theglobeandmail.com/report-on-business/the-brick-putting-its-house-in-order/article4282184/

 

3-More recently, an example that may be relevant to you petec, is the involvement with Aimia's preferred shares. Loyalty businesses continue to show a promising future in some instances but loyalty programs with an airline anchor partner should be part of the airline itself IMO. So, my take was that, in itself, Aimia had become a "bad" business. The main part of the thesis was for an effective and fair transfer of the Aeroplan brand from Aimia to Air Canada. During the process, I did not hold until the full realization of the potential of the transaction because I could never build a sufficient level of confidence with Aimia's management team (even the new generation related to Mittleman). In that specific case where evaluation of management's level of competence was critical, there was an element of expectations that management would end up doing the "right" thing which is tricky because they may end up doing the right "thing" for themselves and that may not correlate well with minority stakeholders.

 

In conclusion, management can make a difference, even in "bad" businesses, especially in selected cases but management evaluation (competence, energy and honesty) is qualitatively hard.

[SHDL]

Interesting topic. 

 

My own experience is consistent with what bizaro86 said.  I’ve had a few big winners in the past that operate in industries that are normally considered “bad” (e.g., retail, restaurants, …) and were not cigar butts.  In each case, I had some sense as to why companies in those industries tend to struggle, and then invested in those that seemed like exceptions in terms of their business models.  And invariably, it was pretty obvious (at least to me) that the founders/management were keenly aware of the common difficulties in the industry and that they had carefully designed their business models so as to avoid them. 

 

Not sure if that confirms or refutes the famous Buffett quote, but as an investment strategy this has worked pretty well for me.

[John Hjorth]

bizaro,

 

Thanks for the examples, but please try to keep this "general" [faithful to the general line of thinking of Pete].

 

Examples [why not start based on what some CoBF members would consider "homebias"] :

 

[VWS.CPH] - Vestas Wind Systems A/S : Near death experiences two times, if you include its predessescors. New and current management steered the ship off the cliff. Forward looking: A steal? I [still] don't know. [Great management now, not sure of the business prospects going forward, - before : documented awfull management, in a "?" business. [What will it get you, if you buy it now?]

 

[DANSKE.CPH] - In rear hindsight, a great business [a minor part of it being absolutely rotten], earlier run by bad & by principles, incompetent management. Now new management. [What will it get you, if you buy it now?]

[bizaro86]

bizaro,

 

Thanks for the examples, but please try to keep this "general" [faithful to the general line of thinking of Pete].

 

Examples [why not start based on what some CoBF members would consider "homebias"] :

 

[VWS.CPH] - Vestas Wind Systems A/S : Near death experiences two times, if you include its predessescors. New and current management steered the ship off the cliff. Forward looking: A steal? I [still] don't know. [Great management now, not sure of the business prospects going forward, - before : documented awfull management, in a "?" business. [What will it get you, if you buy it now?]

 

[DANSKE.CPH] - In rear hindsight, a great business [a minor part of it being absolutely rotten], earlier run by bad & by principles, incompetent management. Now new management. [What will it get you, if you buy it now?]

 

Just to check - your position is that I'm not permitted to share examples but you are welcome to? It seems to me that the last word of his original post "Examples?" Rather directly invited examples, and it's not like I wrote a case study...

 

Anyway, I think good management can overcome a poor industry but maybe not a poor business (or secular decline as mentioned above). I think there is probably something to be said for having competitive advantages at the beginning of a firm. I can't think of too many companies that went from a non-differentiated offering in a poor business to eventually become a compounder. The only one that comes to mind is when Intel pivoted from memory to CPU chips only, and became differentiated in a notoriously poor industry (semis). They had scale advantages in a large niche, which I think was the difference, and good management intentionally pursued that.

 

 

 

[LC]

Fiat Chrysler needed to go thru BK to rationalize their business. They’re doing Ok now.

[BG2008]

Fiat Chrysler needed to go thru BK to rationalize their business. They’re doing Ok now.

 

You only get a Sergio every once in a while

[SHDL]

Speaking of examples, Apple might be another one. They effectively transformed a nearly bankrupt  computer hardware manufacturer into whatever it is now.

[BG2008]

One of the few Buffett pearls of wisdom that I question is his comment about how when a business with a bad reputation meets management with a good one, it's the reputation of the business that survives.

 

I'm sceptical because as a rule I think management is absolutely key in business success. In my experience very few businesses are so good that they can do well under bad management, yet very average businesses can do well under good management. Ironically Buffett's two main businesses, insurance and investing, are excellent examples of this, and his emphasis on the people who run his businesses suggests to me that even he doesn't really believe the quote.

 

Clearly if a business is in secular decline the best management in the world won't save it. But as a rule I tend to think smart management make all the difference in the world.

 

Thoughts? Examples?

 

Challenge accepted, Rock Pits and NYC Class B/C apartment units from 1990s and onward.  Sometimes the gentrification trends are so strong that a caveman can do it.  I know lots of people who got rich off buying NYC real estate.  Most don't have a story of scoring a crazy deal.  They just bought and collected rent. 

[vinod1]

One of the few Buffett pearls of wisdom that I question is his comment about how when a business with a bad reputation meets management with a good one, it's the reputation of the business that survives.

 

I'm sceptical because as a rule I think management is absolutely key in business success. In my experience very few businesses are so good that they can do well under bad management, yet very average businesses can do well under good management. Ironically Buffett's two main businesses, insurance and investing, are excellent examples of this, and his emphasis on the people who run his businesses suggests to me that even he doesn't really believe the quote.

 

Clearly if a business is in secular decline the best management in the world won't save it. But as a rule I tend to think smart management make all the difference in the world.

 

Thoughts? Examples?

 

I think you are misinterpreting Buffett. I believe Buffett is pretty close to your line of thought.

 

His point is in a terrible business, even great management would not be able to do much. Here is a quote you are probably familiar with:

 

Time is the friend of the wonderful business, the enemy of the mediocre. You might think this principle is obvious, but I had to learn it the hard way… It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price. Charlie understood this early; I was a slow learner. But now, when buying companies or common stocks, we look for first-class businesses accompanied by first class managements. That leads right into a related lesson: Good jockeys will do well on good horses but not on broken down nags.

 

So the idea is to avoid really bad businesses. Since as soon as one problem is fixed another problem turns up.

 

Generally the idea is to avoid both really bad businesses and really bad management.

 

Take Stericycle as an example. It has a wonderful moat, but poor management is lighting up IV for the past few years.

 

Vinod

 

[Guest longinvestor]

In this discussion, is good management the same as a good (named)manager or a good practice? Can this be separated from the good business?

 

I realize that the runway behind is very pertinent. KO for example. At some point the great business breaks away from the great (named)manager and then the moat endures. I believe that the benign  “idiot” Buffett calls out is one who doesn’t rip out the enduring principles, perhaps just causes superficial harm.

 

How about Walmart/Walton? Apple/Jobs? Berkshire/Buffett?

 

Time will tell but businesses like KO are very very rare.

 

 

 

 

 

 

 

[Jurgis]

People on CoBF may want a definite answer, but IRL the answer is "it depends".

 

Like vinod1 said, Buffett talks not about definite outcome but about tendencies and trends.

 

As a lot of posters have shown, it is possible to get good (to great) results in so so business. If you don't look for (very) long term, it's even possible to have great results in very crappy business. Businesses (as well as managements) also change. Business may be great then become crappy and maybe even become great again. So can a company and management.

 

If you look for tendencies and trends, there are businesses and business areas that tend to have more moat, higher margins, etc. than others. So naturally Buffett gets attracted to these areas and may talk about them as wonderful businesses. But he is simplifying and exaggerating that you might be fine with a wonderful business run by an idiot or that bad business will always trump good management.

 

So it might be fine to invest in COST or WMT. But while doing so, it's probably worthwhile to remember what happened to Tesco.  8)

[Gilp]

What is bad business? Unprofitable? Operating in high-competitive field? No advantage vs. competitors?

Too much debt?

 

I think you should separate the factor related directly to business itself, and issues related to actual management.

 

If those factor are intrinsic to the business, management will not be able to change much.

 

If those factors do depend on management, then better management will do much better job.

 

In general, I would avoid bad businesses, there is a reason why they are bad. Even if they trade at what might seems a cheap price. Your value for money is still low, it is basically gambling on market perception of the business, you get some crap for cheap, and hope that someone will be willing to pay more.

 

 

 

[AdjustedEarnings]

It's possible to be successful in many different ways. This is about 'likelihood', particularly 'forecast-able likelihood'.  Let me start with examples. There are tons on both sides:

 

1. Good management, tough business that didn't work out... may I start with the obvious.. the original Berkshire Hathaway. I think WEB had said the opportunity cost of not having started with NIC has been about 100% of BRK's market value (i.e. they could be double the size now as that early capital invested in BRK didn't compound for a long time). So not all 'failures' of tough businesses look like Sears, you can do badly in opportunity cost as well. Anyway, then we've got General Re (for the first 5 years after purchase), Platform Specialty, Spectrum Brands, Axalta, Nordstrom, Crown Crafts, etc. etc.

 

2. Good management, tough business that did work out... the obvious one here being Amazon. Others include Mainfreight, Walmart, Costco, Old Dominion, many small regional banks, Meritage Group, Tropicana Casinos, etc.

 

3. Average management, great business that did not work out.. it's tough to think of examples here of a truly extraordinary business that just failed due to management. Over-leverage/BK is not a consideration (so not Charter, etc.), I'm speaking of permanent operational deterioration and beaten by competition (not technological change, which is beyond management control).

 

4. Average management, great business that did work out... there are many here and I'm sure you are all aware of the names so I won't repeat them. The problem also is when things go very well, it's really hard to tell whether the management is average or better. Example, Moodys and S&P Global have both done well. The have had so much wind at their back, it's almost impossible to say if either management team is truly extraordinary.

 

Interesting examples are also where management goes from a good business to a bad one and to see whether the SAME person could again perform as well. I wish the track record on this gave only one answer, but it doesn't. Someone said Ron Johnson and that's a great recent example of what he did at Apple could not save JCP. On the other hand Frank Bisignano did 'save' First Data and has kind of changed the trajectory of the businesses. One ongoing example will be Ed Breen's experiment at Dow-Dupont. The founders/leaders of Arch Capital all came from Berkshire and have been able to repeat their success in a tough industry. I wish there was just one answer, but I doubt there's such a thing.

 

BUT! What we do care about is not so much the likelihood, but rather the predictable likelihood, on basis of which you can invest. So while it is POSSIBLE to have a great result from a great management in a mediocre or worse business, could you see this and bet on it ahead of time or is it only recognizable in hindsight? It appears much easier to bet on a strong business continuing to be strong rather than a weak business becoming stronger. But both are within the realm of possibility and it's possible to bet on both if you know enough about the business and the people involved (John Byrne?).

 

I think Buffett's quote is right AND has placed his chips accordingly. The MAJOR businesses of Berkshire are more on the side of 'good' rather than 'average'. (It's not right to say "insurance", as there are many kinds. GEICO is about as straightforward as they come and execution is key, underwriting is mostly competitive and automated. Ajit does not write each auto policy... General Re, etc. are a little different.) BNSF and the utilities are clearly less reliant on management. Even major investments, Coca Cola, AmEx, Wells, etc. have gone through management changes and have done fine (over his period of ownership). He has not sold because of those changes.

 

This is getting long, so I'll stop and let others respond to it before I write more.

[SharperDingaan]

'Bad' businesses are often pretty good businesses ... that are just badly executed.

Example: 'Retail' is a terrible business? When did 'selling' suddenly become not very profitable?

 

Next to the top-4 in most companies, who makes the most money in the company - the top salesperson!

And that is pretty much true in every nation, and every industry.

 

Why? Simply because the selling 'agent' carries no inventory, has no obsolence cost, can 'vote' with their feet, and does not have to put up infrastructure, the 'principal' does. And that principal is very happy to pay substantially more for any rainmaking (alpha from new clients) that 'agent' may bring. Hence the 'agent' who is very good at selling (their 'craft'), will enjoy a very comfortable life. 'Seling' is clearly a profitable activity.

 

Maybe the real problem of 'retail' is that a great many 'retail' organizations really shouldn't be selling for themselves, but rather for someone else. Managements 'playing' at being 'principal', when they should really be doing what they do best - 'selling' through the traditional pyramidal incentive structure.

 

The investors choice is just whether it's worth the wait.

 

SD