This is a companion discussion topic for the original entry at https://commoncog.com/c/cases/marvel-stories-origin
Below, please find my synthesis on Capital Expertise. Feedback welcomed!
Capital expertise can look like having the ability to access the right pool of capital for various objectives: to start, stabilize, grow, or transform a business. We saw this in the Dell case a few times (stabilize, grow, and transform) and in the Marvel case with David Maisel (start).
The access mentioned above is based on reputation and whose access can range in from local to global networks. Lee Walker had a local reputation in central Texas that gave Dell access to capital. Similarly, in the case of Circuit City, Sam Wurtzel and Abe Hecht had a local network of bank and business contacts in Richmond, Virginia. The Marvel case had a related, but different instance of this: David Maisel used his relationship with a Dreamworks executive to get proper economic terms for Marvel’s distribution deal with Paramount. This dynamic seems to come up in varied ways. (Note: Link to Good To Great To Gone when complete).
Accessing the LBO pool of capital is an instance of capital expertise that can be used for good (benefits often oversold) and bad. For a business that needs to invest and innovate to survive in a rapidly changing market, the LBO structure becomes a straight jacket that chokes off a businesses ability to be dynamic resilient and is a bad instance of capital expertise. The debt service costs combined with a preoccupation to return dividends to equity owners leads to short-term cost cutting decisions, fragilizes the business and rarely allows the business to survive. In contrast, this structure did work for Dell, but I think it was due to several structural factors: the FCF generation of PC business, the embedded assets of VM Ware that gave Dell / Silverlake latitude, and Michael Dell’s significant equity position, attention, and credibility / reputation. What other successful LBOs have occurred? Why were they successful?
Closely related to the above, a capital structure with high leverage is a deterrent to being opportunistic and taking advantage of the industry capital cycle. The most sustainable path to expansion and profitable growth is a conservative capital structure based on low leverage and growth from funded from free cash flow / retained earnings. The Koch cases exemplify this idea. With a conservative capital structure, it makes allocating capital to M&A more productive, especially if its done opportunistically. An exception I can think of to this idea is that of Transdigm who is both active in M&A and maintains high levels of absolute leverage. Perhaps they can maintain this because of their scale and cash cemented playbook they have (I really don’t know yet!).
Capital can be used to respond to drastic changes in demand and supply. We saw this in the Dell case as it used private capital to adjust to changes in Demand – the move from desktops to laptops and services – and supply, its changing competitive landscape.
Capital expertise can look like growing a business without the need to raise outside capital or raising little capital. These firms are usually effective at reinvestment and are relying on FCF and retained earnings to fund its growth. We saw this in the early days of Dell and in the Koch case. Koch has what I would call a reinvestment moat.
A variant of not needing to raise capital (above) can look like capital efficiency, either due to structural factors a business enjoys or capital constraints. Those who recognize and exploit it are demonstrating capital expertise. We saw this in the early days of Dell in its moves to reduce and keep its cash conversion cycle down and in the Marvel case with Ironman’s first budget. Finally, we saw this dynamic in Cedric’s POS case, both realizing you had an indirect funding source and exploiting it. This idea is hugely rich and comes up in many ways.
Capital expertise can look like unique or savvy deal structures and instruments to capitalize on the situation at hand. We saw this in the Dell Case with the EMC merger using a tracking stock for VM Ware to reduce purchase price and accessing IG debt markets and in the Sampo case through its “If” joint venture in P&C insurance. We also saw this in the Dell case through its deal with Honeywell Bull to provide service support for its PCs.
Capital expertise is the demonstrated ability to raise capital, spend it well, and use capital in service of supply or demand.