By The Acquirer’s Multiple. Originally published at ValueWalk.
One of my favorite investors is Sam Zell.
According to Forbes, Zell is one of America’s most prolific real estate investors, Sam Zell is the son of a Polish grain merchant. His parents and sister escaped Poland by train hours before Hitler’s army bombed the tracks that ran through their town. The family reached the U.S. by way of Japan in 1941. Sam was born four months later. In October 2015, Zell agreed to sell 23,000 apartments — about 20% of his Equity Residential’s portfolio — to Barry Sternlicht’s Starwood Capital for $5.4 billion. His private equity firm Equity International, which invests in emerging markets, closed its first Asian fund in September 2016 with $205 million committed. It plans to invest in Japanese warehouses.
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One of my favorite Zell interviews is one he did with the Graham and Doddsville Newsletter in the Winter of 2012 in which he spoke about his investing strategy and how he finds great investment opportunities when others see distress.
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Here’s an excerpt from that interview:
G&D: How do you think about valuation, whether it‘s a real estate or a non-real estate asset, and could you perhaps give us an example of your approach?
SZ: I start by not paying much attention to the market. I think the Street reflects the value of the last share traded, but the true value of the asset may be more or less than what‘s indicated publicly. In the same manner, I don‘t make investments predicated on the assumption that there‘s a greater fool out there who‘s going to buy it from me for more than I paid for it. I look for situations that logically make sense to me.
As an example, in 1985 I took over Itel Corporation. At the time, Itel had been the largest bankruptcy in the history of the United States. Coming out of Chapter 11, the company still owned a subsidiary that leased 17,000 railcars. Business had been so terrible that utilization of the railcars was 32%. While others might have considered this a really horrible situation, I looked at it and said: ?These railcars are almost new because they haven‘t been used. By virtue of this fact, I bought them at dramatically less than their replacement cost. I then looked at the broader rail business and determined how many railcars there were, who had built them, when they had been built and what the general story of the business was.
It turned out that in 1979, the US government had changed the tax laws and created a special one year 100% tax deduction for heavy equipment. Furthermore, in 1979, the United States had built 120,000 boxcars. But between 1979 and 1985, the United States had built a total of only 20 boxcars.
In the meantime, demand for boxcars was as flat as a dead man‘s EKG. Therefore, nobody wanted to touch the business because there was no growth. During this same period, 65% of the boxcars in the country were scrapped. I reminded myself that everything is about supply and demand. I knew that when the supply and demand curves for boxcars met, I could make a fortune. So I went out and bought all of the used railcars in America.
By the time I was done, we owned 92,000 railcars and became the largest lessor of railcars in the United States. We did extraordinarily well because we had bought these railcars at significant discounts to replacement cost and yet rented them at market rates. Now, you tell me I‘m a genius but the truth of the matter is that the information I‘ve laid out was available to everybody. All anyone had to do put the pieces together. For some reason, that‘s what I do well. I see things differently.
G&D: Could you give us another example where you saw something that was obvious to you but not to others?
SZ: Another division of Itel was in the container leasing business. At the time, the container leasing industry was comprised of the seven sisters, which were seven container leasing companies that represented 95% of the world‘s container leasing business. The one I acquired through Itel was number four. This business had $100 million of revenue, $50 million of expenses, and $50 million of cash flow. Then I looked at the number three business in the industry, which had roughly $100 million of revenue and $50 million of cash flow. I considered what would happen if I put these two container leasing businesses together. All of a sudden, I would need only one shipyard in Hong Kong and only one shipyard at the other ports throughout the world, and I would need only one computer system.
I don‘t really believe in synergies, such as cross-selling and all the other elements they teach in business schools. The only thing that‘s relevant to me is redundancy. Everything else is if-come-maybe. So, I acquired the number three business in the industry, put the two companies together and the revenue was still $200 million but the expenses were now $85 million instead of $100 million. We picked up a 15% expense difference, which was all profit, and we became the low-cost producer. We then acquired the leasing company that was number seven in market share and became number one in the container leasing industry. By virtue of this, we had the lowest costs in the business and a real competitive advantage.
So that‘s the way I look at things. It isn‘t like there are six rules of investing or something like that – certainly there haven‘t been in my life. One of my criticisms of business schools is that the definition of an MBA graduate is someone who knows how to do the numbers; they just don‘t know what the numbers mean. This is the product of business schools emphasis on formulas. In other words, business schools teach how the pieces should be put together. But for me, there is no formula. Similarly, I‘m pretty agnostic about industries. We‘ve been in the container leasing business, the railcar leasing business, the insurance business, the real estate business, the agricultural chemicals business, the oil and gas business, and I could go on and on.
G&D: Do you have another example of a unique investment opportunity that presented itself due to a shift in an economic cycle?
SZ: As was true for my philosophy of being the first national real estate investor in second-tier cities, I‘ve always been willing to shift my ideas and criteria, but I‘ve also always believed in what I‘m trying to implement. In the early ‘70s, buying apartments became too expensive so I started financing builders to build apartments. By 1972, everyone believed the world was going to grow to the sky; there were cranes on every block. But I knew that supply and demand were out of balance, and I stopped backing developers. Then, seemingly overnight, market sentiment shifted, and in 1973, everyone seemed to believe there was no future. Asset prices plummeted, and I realized that this didn‘t make sense either. So, I began aggressively acquiring property, financed very cheaply, to take advantage of what I thought was a
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