Thanks, Kyle

For showing me how not to play the business cycle

He made me feel like I didn’t exist.

Kyle walked straight over to our table with a big smile. He locked eyes with my boss. He didn’t even glance at me, or Tony, the other salesman. The conversation didn’t last long. And I’ll never forget it.

I had no idea who this little guy was. Or why he was so confident.

There are two types of confidence. One makes you want to join the team. The other repels you. Kyle had the latter.

It was early-2003. I’d just landed my first real job. Real to me meant a shot at making adult money. I was young, hungry, and totally focused on success.

The guy who hired me had my full attention. He also had Kyle’s attention. More importantly, he had the attention of the two men who paid over $100 million for 11 bankrupt mattress factories and called him to fix them…fast.

Fixing meant unwinding the mess left by the former owners. That meant stabilizing operations, and boosting sales.

Sales are the oxygen of every company. You can bolt the body back together after an accident. Without oxygen, you’re dead.  

And people like Kyle don’t understand sales. There’s no spreadsheet for boosting sales. There’s no effective class taught on the subject. It’s 20% learned skill, and 80% spontaneity. You either have it, or you don’t.

This drives some people crazy. They feel the salespeople make too much money. They run them off, and sales tumble. Nobody can figure out how to automate the process.

My boss at the time had it figured out. He knew generating sales was a lot like making good music. After he hired skilled bandmembers, he had to help them play in harmony to produce a hit. And that’s exactly what we did.

The Fleece Vest

Kyle was the kind of guy who wears a fleece vest. It was my first winter in West Palm Beach, but I got the sense he’d wear it all the time.

The fleece vest makes a statement. Only a certain type of person wears one.

There’s no thermal benefit. It provides very little warmth for the trunk of the body…and leaves upper limbs exposed. It’s a mystery why finance people like them so much.

Eyes locked, smile chiseled, Kyle disregarded the existence of the lieutenants and went right for the general, “I can’t believe you’re here…come over and meet my friends from New York.”

I also couldn’t believe we were there. We’d been on the road all day meeting with angry customers. Pulling a factory out of bankruptcy is no easy task. It was probably 9:00 PM when we loosened our ties and sat down in the Irish pub for dinner. Guinness & wings is the only fix for what we’d been through. Sales, especially fixing broken relationships, is an emotionally draining experience.

Kyle didn’t know anything about that. He was in town for golf…with important people from New York. And he wanted my boss to meet them. But the boss showed his true colors… he cocked his head and told Kyle, “Nah man, I’m hanging over here with my two best sales guys…”

Nobody denies Kyle… except for my new boss, and the federal bankruptcy court.

Everything I Know About Business

It might surprise you to learn many professional investors have never worked for a real company. By real I mean a company producing and selling a physical product to customers. Selling financial services doesn’t count.

I grew up working in a furniture store. It makes up most of my childhood memories.

From dinner table conversations to car rides, it’s all we talked about. I knew every facet of the business before I was old enough to legally drive one of the delivery trucks.

The upside of that meant higher education in finance years later was a breeze. The big public companies work just like the small companies, only with more spreadsheets.

The downside of that early education meant my first real job was not in finance.

The furniture industry wasn’t the right long term fit for me, but I couldn’t say no to the opportunity. I tried to say no… but he wouldn’t let up.

~20 years ago

The boss who didn’t have time for Kyle found me, hired me, and trained me. He later pushed me into finance…he chose to lose me from his team so I’d be happier in the long run. I’m forever grateful for it… I still know him today.

Kyle Killed the Mattress Business

As soon as Kyle walked away, the boss told us, “That’s the guy who bankrupted the factory…” and he said it with a grin.

Right then, I felt like I was on the right team. Sure, Kyle had vast wealth…and connections. I didn’t have either at the time. What I had was a job on a team I thought could win a championship. And we did.

A few years before all this, in the mid-1990s, Kyle and his partners got the idea to buy up family-owned mattress factories. It’s a scattered business. The time from purchase order to delivery is often only 72 hours. The factory needs to service a tight geographic area.

Most families owned their factory for generations. They’d buy a license to produce one of the name brands, and wholesale the product to retail stores within a trading area.

Kyle bought up one factory, then another, and another. When he got to 6 or 7 of them, business slowed. He’d borrowed big and bet the 1990s would be a go-go period, giving him a tailwind. Then he’d flip the collection of factories to a larger buyer booking a big profit on the sale. Turns out, the disparate factories don’t run well without hands-on attention.

Typical of many private equity owners, the New York fleece vest crew tightened the screws on costs. The best salesmen left, long term employees left, and eventually, customers left.

Meanwhile, the company had big debts to service. Kyle is a rich guy, but nobody puts their own money in these deals…private equity is all about small down payments and huge loans.

Watch Out for The Business Cycle

After the early 2000 meltdown in technology stocks, people froze up. Sales stalled.

Kyle and his partners needed growth. Since they had no idea how to generate it running the business, they decided to buy growth in the way of more factories. In total, they now had 11 factories, spread across the country.

Shortly after, September 11 rocked the nation. Business slowed more. It was the final straw for an already sluggish economy. Kyle’s indebted collection of factories missed an ~$8 million debt payment. His company entered bankruptcy proceedings.

Watch out for the business cycle…

A Different Approach

The lenders who funded Kyle’s foray into the mattress business had a problem. They needed someone to take over the factories. It was the only shot they had at recovering the value of their loans.

The best option was two guys who had a totally different approach to the business.

Over the past decade, this pair along with their loyal team, bought up 9 factories in a very different way. They looked for the worst performing facilities, with the most disjointed sales teams, and fatigued owners. While this might sound crazy on the surface, they only bought factories at bargain prices.

Next, they’d ship a fresh management team from the last factory turnaround to clean house. This team earned the right to a promotion. They came in like a revolutionary government who seized power. Within months, they had the facility running at full steam.

Slow, steady, and disciplined, this new ownership group was smaller than Kyle’s. What it lacked in size, it made up with stability. The bankruptcy court realized it was the only viable option for saving the 11 facilities gobbled up by the fleece vest crew.

Too thin to immediately staff all 11 facilities, the two men behind the new ownership group recruited my new boss to fix the biggest factory. It seemed critical to the success of the overall purchase…which was risky in the middle of a recession.

They’d known my new boss for years. The new owners were personal, deliberate, and serious about success. They hired him, then he hired me.

Road Warriors

The first full year after the deal closed, we had things stable. The next year, we had profits. By 2005, we had a bonanza.

We lived on the road. We showed up at stores on Saturday mornings, big sales holidays, and anytime we thought our competitors wouldn’t. We earned back the trust of our customers by outhustling the competition.

It didn’t hurt the economy turned around. Greenspan lowered interest rates to rock bottom. People bought houses like crazy. Those houses had lots of bedrooms…and those bedrooms needed new mattresses.

By 2005, the two owners sold a minority stake in the firm to private equity giant Ares. The next year, they sold the rest for ~$800 million. That’s roughly 4-times what they paid for the business buying with discipline, staffing with all-stars, and paying attention to details.

Buying the Recession…Selling the Boom

They bought the worst factories at the lows of a business cycle. They turned them around, and sold at the highs.

It was good news for them, and bad news for me. Ares sent in an army of Kyles to slash costs, run off the top performers, and slowly ruin the business. Just like the 1990s, they paid top dollar just before a huge economic slowdown. Serta is the lore creditor drama again today.

That’s the way the business cycle works. On the lows, only the conservative, focused buyer has the courage to step in. On the highs, the fleece vest crew assumes they can’t lose, they’re smarter than the stodgy old sellers, and the cure for any rough patch is more debt.

And we’re on the highs now.

Too Much Money Chasing Deals

We see this play out every day right now as we wait for the Fed to cut rates. Nobody talks about the business cycle. Rate cuts can’t fix overpaying for a business you don’t understand. When sales dry up, there’s nowhere to turn.

From my view, it’s a terrible time to take big risks.

“Deferral mindset”

The business cycle always looks obvious later…successful investors see it in advance.

For instance, Home Depot Inc (HD) surged during the 2020-2021 speculative boom. Bored, and armed with excess cash, customers emptied store shelves. From early 2020 through the end of 2021 HD shares almost doubled.

It’s a good company. And it’s the best place to survey homeowner sentiment. Right now, that’s cautious.

Try ordering a major appliance, or materials for a home renovation. What was a multi-month wait, now takes mere weeks. The excess demand is gone… and as the company reports, customers are in a “deferral mindset.”

Slow Home Sales

That matches what I notice in home sales. Maybe you see the same in your area.

$5-7 million homes on the water seem stuck. I notice on Zillow they say 200, 300, 400 days on the market. Most show price drops of 5% or 10%. Look up the price history and you’ll often see it’s not the first price cut.

But the $1.5 million homes are more interesting. That’s the part of the market where builders offer spec product. I’m seeing $1.5 million sit on the market for months when it used to be days, or hours. When they sell, I’m seeing ~$1.35 million as a sale price. That means the builder needs to get the house off its books even if it generates a loss. It’s not a good sign…

Builders made a lot of money during the most recent boom…and they’re giving it back now.

It’s across the board. Friends tell me home services are also slow. PE firms bought up service companies hoping to combine them, slash costs, and sell to another buyer. It’s not working as well as planned.

The obsessive Fed watch captivating the market is the wrong thing to focus on. Lowering borrowing costs won’t save broken businesses. Broken, because the owners only bought them hoping to flip to a larger PE firm at a profit. They had no interest in running the company. Over time, customers migrate too.

The unwind won’t be pretty…and it hasn’t even started yet. While PE firms, passive investors, and the Kyle’s of the world freeze in place and wait for the Fed, we should stand aside.

Portfolio Update

What the Fed does won’t matter. The forthcoming rate cut might be the most anticlimactic event of the year.

Notice the volume of headlines discussing rates, Fed policy, and timing of rate cuts everyone seems to know are imminent. It’s the equivalent of moving the goal posts. People go for it every time. Instead of doing any homework, they stay hopeful each time the posts move. That’s not what we’ll do here.

We can’t…we don’t have the option. We don’t have access to bailouts, handouts, or special lifelines. We’re on our own. And that’s a better place to be. It forces us to stay objective.

With that in mind, notice what’s happening in the portfolio.

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