David Rosenthal: uncertainty

Transcript context

…It's a good question. Sometimes it's really based on how special a company is, but it's also based on how the market views the company. Because if I think that the market's misunderstanding the company, then there's an opportunity for alpha. Again, we talked about people, so that has to be a critical equation. You got to look at the financials. You got to look at the balance sheet. If it has too much debt, if some unforeseen event could put the company over the edge, I tend to be shy a bit, but I'm not totally afraid of debt because sometimes you have the best opportunities in public markets with companies that have a pretty good amount of debt. They could go through bankruptcy, but you have to use your judgment and say, okay, they have a good amount of debt. Everybody thinks it's going to go BK, but I think this company is not going to go bankrupt for the following reasons. If you have a thesis that everybody thinks it's going to go bankrupt and you don't think it will, then you have an opportunity to make an interesting bet that has asymmetric upside. The classic example of this I always think of now is Buffett's Coca-Cola investment where there's the new coke disaster. The market thought, oh, my gosh, get me out of Coca-Cola before they go bankrupt. They've killed the golden goose. I don't know if this is how Buffett looked at it but you could go back, look at that in time, and be like, okay, let's say Coca-Cola Classic is done. They still have Diet Coke, which is the biggest soda in the world, so there's a huge margin of safety there that people were not appreciating. Yeah, absolutely. One of my favorite examples was during the 2008 crisis. There's a little company called Select Comfort. Now, it's called the Sleep Number. I remember that The Motley Fool was touting the stock as this great stock and it was growing crazy. Then, it completely cratered in the crisis. A lot of people were saying, well, they're going to go bankrupt. Or maybe not bankrupt, but they were saying things like, well, no one's going to buy a $3000 or $4000 mattress in the middle of a crisis. People say these kinds of things which are just ludicrous. Like, seriously, nobody is going to buy this? Is it that revenue is going to go from $600 million to $0 overnight? Let's see what happens. You could look at the financial statements. You could listen to the quarterly earnings. Yeah, of course, they're going to struggle and revenues are going to go down, but they sold quite a lot of mattresses actually during the crisis. Nobody goes to the shopping malls and traffic is a lot lighter, but lo and behold, they sold $650 million worth of mattresses right in the middle of the crisis. The world just doesn't end. When bad things happen, very few things just go to zero overnight. You just have to look at it. The management team made a bunch of mistakes right in the middle of that SAP implementation, switch over into ERP, which is always really painful. It's a fairly small company trying to do SAP. They probably overreached. I knew Intel was doing SAP implementation back a number of years ago and oh my God, that was such a nightmare implementation. They spent hundreds of millions of dollars. It was like one of those black holes. You could imagine a little company like Select Comfort trying to do it. They kind of wasted a few tens of millions of dollars, they got in over their heads, and things were getting a little bit tight around them. They had all these lease obligations and they did have some debt. This is where we had to apply the judgment of, well, they have debt, but what are the chances that the lenders are going to come in and seize control? I have to think about that. Now, you could imagine, this is a little fun detour in public investing, but look at the Altos portfolio during the 2008, 2009 crisis. We had some companies struggling, of course, and there were no prospects of raising more equity, so we had to rely on some debt and the bankers were getting awfully nervous. I remember literally sitting across the conference room table with one of the bankers. They were giving us a really hard time about one of our companies. We stopped making payments and we wanted to renegotiate a few things. You got to give us a little more time. Of course, the bankers hold all the cards. They could seize control. And literally, I think I pulled out the keys. It's a mythical key out of my pocket, like, here it is, take the keys. Good luck. Just take over. If you don't want to work with us, just take the keys. It's yours.…

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