The Value of Financial Slack
During crises, assets shift from weak to strong hands, from the weakly capitalized to the strongly capitalized. This morning I see at least two examples:
- Citadel, SAC Capital Get Pick of Casualties as Carnage Worsens
- Buffett Becomes Vulture as HomeServices Gets Deals Black Can’t
Hedge funds are an inherently weak structure for managing assets, because the liabilities often don’t match the assets. Lockups are short, and in some cases, very short to non-existent. All it takes is a significant series of bad picks, and investors will bail, and the lack of liquidity exacerbates asset management thereafter. Beyond that, the best talent is often lost after a few bad years with no bonuses, and the high water mark is distant. Hedge funds in better shape are there to pick up business at a discount, and the best talent.
Buffett gets to pick up residential real estate sales firms when they are out of favor, and need liquidity. He gets them at favorable terms; his managers will rationalize them, and they will likely be the #1 real estate brokerage when the dust settles and the next bull market in residential real estate starts in about 2 years from now. Little tuck in purchases at 20-25% of past levels can be quite a deal, and Buffett has the capability of doing the deals because he was prudent during the boom phase, and let others do deals at imprudent levels while we watched, sat on cash, and tended his insurance and other enterprises.
Sitting on financial slack is tough during the bull phase. Not only do you look dumb when other seem to be making easy money, but you can become a target for acquisition yourself. Surviving in such a position requires good management of the operating businesses, such that your stock is expensive enough, that potential acquirers can’t make the M&A math work.
But, if you have excess purchasing power in the bear phase, how delightful it can be. Whether buying distressed assets or whole companies, the intelligent acquirer can add new markets, technologies, or cheap capital assets to make the existing business more productive.
