How to Lose $100,000,000 and Other Valuable Advice

“ADVICE #2: 1 have foundfrom sad experience that purchasing large tracts of raw land is not the perfect inflation hedge. It isn't even a good investment, for two simple reasons. First, the payment of real estate taxes and the loss of cash flow income on the investment amount to more per annum than the land will increase in value. Second, and even more important, there is a greater spread between the bid and asked prices on land than on any other commodity. When you insist on buying landfrom someone who really doesn't want to sell, you are probably paying a price that the land may be worth on a forced sale ten or twentyyears hence. Unlessyou can afford to be very, very patientfor the next twenty years, stay away from undeveloped land purchases.”

“Busy men never have time to do all of the things that need doing. Many have a tendency to get beguiled by the peripheral aspects of running a business. In Indian Head we have always said that the main priorities of executive attention are these, and in this order: Number i: Avoid catastrophe!!! Number 2: Keep the show on the road. Meet or beat the current plan. Number 3: Plan for future profit improvement. Don't go off chasing rainbows with grandiose growth schemes until you are sure that you have been minding the store, don't start vast proj- ects WITH HALF VAST IDEAS.'”

“Jim Robison had always stated that the basic objective of the company was to increase the intrinsic value of the common stock. His theory was that the market value would ultimately reflect true intrinsic value. He was wrong. In the 1970s, market prices of most companies whose shares are publicly traded do not reflect true in- trinsic values. The many tender offers for shares of public com- panies at prices well above their quoted market prices is clear proof that this is true.”

“ADVICE: Ifyou are a business executive in a growth company forget about cattle, oil wells, and other tax-saving investments. Put your capital in your own company and leave it there. Ifyou andyour associates do a goodjob you'll be far better off in the long run than ifyou had diverted time and money to a venture in which you would be an absentee owner.”

“managed REITs made some fantastic mistakes by forcing capital out to unqualified borrowers at unprofitable spreads. Result—one of the worst financial debacles in the history of this country oc- curred in the last ten years because of these excesses. The banks thought that by having huge advisory fees and using OPM (other people's money) they could earn more for the stock- holders of the banks than they could earn if the banks made the loans directly to the developers. Because of this huge surplus of capital, the risks taken by REITs were unwarranted and the com- petition to put funds out was so great that the spread between the cost of money and the return received produced no profit to the lenders. In addition, most of the leverage was created through open lines of credit to the REITs at floating rates. On the other hand, the REITS were making largely long-term fixed rate commitments to their customers with this short-term money. When prime rates went to 12 percent in 1974, the roof fell in. Practically every REIT in the country was in serious trouble and many of them will never recover. Since practically all of the leading banks in the country lent money to the REITs, aggregating even today many billions of dol- lars, the situation finally reached the stage where the banks could not foreclose their mortgages. They have had to be satisfied with work-out situations at low-interest rates requiring many years in the future to resolve. I'm glad to say that one of the very few REITs that has come through this situation intact is Realty Income Trust, which has never missed an interest payment to its banks or to its debenture holders and is currently paying dividends at the rate of Si.40 per share. It is, I believe, the only REIT in the country that is currently paying such a high return through dividends on its total equity capital—approximately 9 percent. The two young managers of Realty Income Trust, Ron Kutrieb and Rob Freeman, have done an outstanding job in an industry that has been nothing but disaster for practically every other REIT ever formed.”

“ADVICE: When you invest in a situation that really gets into difficulty, it is far better to take the first loss instead of struggling as we have in Bevis for fifteen years to try to recoup our original investment. As a result of our attempt to make a success out of this one bad investment, Narragansett invested an ad- ditional $2,340,000 and Narragansett stockholders, through subscribing for rights at $10 per share, put up another $1,000,000 of equity capital. The stockholders, creditors, and Narragansett lost close to $10,000,000 in Bevis. We should have written off that $1,100,000 loan when the company went into receivership. The grief we are going through is unbelievable!”

“ADVICE: If it becomes tempting to have dealings between companies in which you are interested in both sides, avoid it ifyou possibly can. If it is a matter ofgreat importance to all concerned, be sure to have ratification of any transaction—preferably prior to the completion of the transaction—by the stockholders of both companies. Otherwise, you may be subjected to this kind of minority stockholder suit.”

“non-textile acquisition. Our basic concept of unrelated diversifica- tion at that time was to accomplish these objectives: 1. Eliminate the effect of business cycles on the parent company by having many divisions in unrelated fields. 2. Eliminate any Justice Department monopoly problems by avoiding acquisitions in related businesses. 3. Eliminate single industry's temptation to overexpand at the wrong time. Finance the growth of only those divisions which show the greatest return on capital at risk. Rather than overex- pand any division, use surplus funds to buy another business. 4. Confine acquisitions to leading companies in relatively small in- dustries. Never buy a small company in a $5 to $10 billion indus- try. One of my particular "No-No's"—never buy a company that manufactures a product with an electric wire attached—no radios, televisions, washing machines, driers, electric stoves, or refrigerators. 5. Having made a complete analysis of all major manufacturing companies' return on net worth and found that only about twenty-five in 1952 earned over 20 percent on common stock”

“ADVICE: When new production is brought into any market, it is bound to cause severe price competition. No competitor is going to stand idly by and let his share ofmarket evaporate. All ourforecasts ofsales, profits, and prices had been made on the assumption that the $10 market price would continue even after our large production became available. Any businessman who overlooks the effect of competitors 3 price reductions when enormous new capacity is added to the market, will have a rude awakening. It is impossible to start a new op- eration like Mass lite and throw many tons of capacity on the market without creating an uncontrollable price situation. The Masslite investment was a disaster.”

“paid off, he said to me, "Roy, don't ever buy another company on an incentive basis and put a top dollar limit on the price." I said, "Why not, Tim?" He said, "I never took any chances in building up a bigger business for you. I just played it safe, to be sure to get my three million dollars. As a result, that division is not nearly as big and as important as it could have been. I had no incentive to work hard after we had our three million dollars in the bag. If Textron's contingent payout had been open-ended for ten years, Dalmo Victor would have been a far more profitable division."”

“'Success covers a multitude of blunders. —George Bernand Shaw”

“ADVICE: Never buy shares in a company for which you are working if it is earning over 100 percent return on equity. In our free enterprise system that high rate of return will not last. Capital will pour into that industry from other sources, and ultimately the rate of return even in the best of companies will decline to 15 to 20 percent. You will almost certainly take a loss on the investment that you made when the rate of return was too high.”

“ADVICE: Before you build a facility for the entertainment of people in a small community be sure, through some type of survey, that they can afford such a luxury.”

“Being unable to resist an optimistic note, the report ended: "The Management feels confident that the Corporation is in a splendid position to take full advantage of any opportunities that may be presented, and if business volume continues throughout the year at current rate, satisfactory results should be obtained." It took me many, many years before I learned to stop making predictions in”

“annual reports. Things never happen the way you would expect them to, especially in the textile business.”

“ADVICE: The Defense Department should discontinue its policy ofpermit- ting civilian employees to receive royalties on civilian usage ofgovernment ar- ticles patented by them. An impossible conflict of interests is bound to occur. Product improvement will be delayed. Even ifA and Z had actually been the real inventors of the forty-six patents in their names, and I have no proof that they were not, it certainly was not in the public interest for them, or any other civilian employee who had the power of approval of competing products, to be receiving royalties of any kind. For example, what is the civilian employee who has a patent on a bulky flying suit on which he is collecting nongovernment usage royalties going to do when a manufacturer of a far less bulky electrically heatedflying suit (which will at least fit in the cockpit of a smallfighter plane) submits his product to the patent owner for approval? Stall! What do you think?”

“"For many years in the past the directors of the company had made awards in current earnings to a large number of key people as additional compensation. The directors have recently adopted an incentive compensation plan, based upon engineering studies, which will be directly related to the return which management makes on capital used in operations."”

“This was the first time that we put into effect a new type of in- centive compensation based on return on assets rather than a year- end handout or bonus based on a percentage of profit. (This whole”

“ADVICE: Don't make a large investment to make a single specialty product, which may become obsolete. One of the reasons that Textron failed in its ef- forts to develop a completely integrated textile operation from raw material through to the finished garment was that, with our big plant investment, we were always committed to make fabrics that our garment operations no longer required. In other words, our competitors in the garment business had more flexibility and, of course, far less capital tied up in productive equipment. They were able to switch the design of garments to the fabrics most popular with the consumer, while we were stuck with production that was no longer in demand.”

“equity, I set that rate of return in 1953 as Textron's goal for the future.”

“There is one basic policy to which there will never be an exception made by anyone, anywhere, in any activity owned and operated by In- dian Head. That policy is as follows: Play it straight, whether in contact with the public, stockholders, cus- tomers, suppliers, employees, or any other individuals or groups. The only right way to deal with people is forthrightly and honestly. If any mistakes are made—admit them and correct them. Our com- mitments will be honored and Indian Head has the right to expect the same performance from those people with whom it does business. This is fundamental. We will not welsh, weasel, chisel, or cheat. We will not be party to any untruths, half truths, or unfair distortions. Life is too short. It is perfectly possible to make a decent living without any compro- mise with integrity.”

“ADVICE: When you make the owners of a small business you purchase wealthy, try to have some meaningful incentive so that they will continue to work hard for you in building up the business.”

“ADVICE: Ifyou have an opportunity to purchase a company as outstanding as Josten, don't let a mere $500,000 stand in the way. If a business such as Josten's with its tremendous future potential is worth $12,500,000 it cer- tainly is worth $ 1j,000,000. Refusing to meet the firm offering price in this case was one of the worst mistakes I ever made at Textron.”

“Josten would have been an ideal acquisition for Textron since it fitted our basic concept of being a leader in a relatively small in- dustry. Today Josten is the undisputed leader in the school ring business, and their performance is so superb that their shares are selling at a price/earnings multiple of 12, whereas Textron stock has recently been selling at only 6 times. In retrospect, of the many situations that Textron missed by being too conservative in the price we were willing to pay, the outstanding examples have got to be Tupperware and Josten.”

“ADVICE: Check your product liability policies to be certain your coverage is adequate to meet the awards currently being made in your industry.”

“ADVICE: Ifyou've raised capital with a public offering, be certain that you review frequently your statement of business purposes to avoid the careless mistake we made in the Bevis case. After the derivative action was brought, we even went to the expense of calling a special meeting of the Narragansett stockholders to give us retroactive approval of the transaction. Even though we got overwhelming approval, the court refused to dismiss the case. If we had not obtained the assistance of Abe Pomerantz in dealing with Mr. Garwin, this action could have been far more expensive. If we had not settled the case, the directors and officers could have been found guilty of hav- ing violated one of the i(Stated Business Purposes" in the original registration statement, and would have been required to pay the company $2 million. The Bevis investment was a dilly! In derivative suits it is usually advisable to make a reasonable court-ap- proved settlement that permits the corporate defendants to have the company reimburse them for all legal expenses. Otherwise you run the risk of having to pay not only the judgment but also all your legal expenses out ofyour own pocket.”

“ADVICE: Ifyou are an investment banker, have no fear of the financial re- sponsibility for signing a contract involving your best efforts to file a registra- tion statement to sell securities. If market conditions become adverse, you are off the hook. However, all other businesses should be extremely wary of be- coming involved in a "best efforts" commitment for the sale of securities as a result of our sad experience.”

“ADVICE: Don't invest in a project in which you are personally influenced by association without sitting down andfiguring out how much you are going to have to gross to make a fair return on your money.”

“ADVICE: Just because you have been extremely successful in an industry in one part of the country, don't assume it will be equally easy to succeed in some other area. Check very carefully the price structure and all other elements of the business before you commit an investment in another area in a business in which you have been successful elsewhere.”

“ADVICE: Don't let a super salesman con you into making an investment. This company was formed and named at the height ofpopularity of the musi- cal WdL\Y.Just the fact that someone would name his company after the prin- cipal musical hit of that show should have been warning enough.”

“ADVICE: Be careful about taking on the development of highly scientific ventures ifyou do not have thefinancial staying power to carry them through to their full potential.”

“ADVICE: When you are dealing with a company like Emerson, with a fan- tastic track record and, which is, in my opinion, the most efficient, highly di-”

“versified company in the United States, don't be worried about taking their shares on an acquisition even though the multiple is high. Where there might have been a serious drop in the value of their shares in igy^, even if they had failed to increase their earnings every quarter as they did, the management of that company is so superior that in the long run, taking their shares would have been far preferable to selling out at a low price the way we did. At the present time, Emerson has now completed twenty-one years with a perfect record of having increased their earnings per share every quarter over the prior quarter during that entire period.”

“ADVICE: Where we made our original mistake in financing this small com- pany whose product was excellent was in not anticipating trouble and poten- tial lawsuits from the landlords. It was obvious that the high cost of installing fire control systems could not be passed on to the tenants under their long-term leases and that the $400 million cost therefore had to come out of the landlords' pockets. It is vital, therefore, not to get into a similar situation involving regulations requiring building owners to absorb huge capital expenditures. Landlords are heavy contributors to the politicians in all cities, and they have too much polit- ical clout to accept any such huge cost as the fire department's regulations im- posed upon them in New York City.”

“It is interesting to look back and see how Narragansett became so heavily involved in many situations by repeatedly putting up more and more money without realizing that we would ultimately reach our maximum before the venture was successful.”

“ADVICE: Don't throw in the sponge too soon on some investments. Ifyou have a competent businessman like Bill Considine who is willing to tackle the job of rehabilitating a loser, give him a chance—he may perform a miracle the way Bill has at Photo Systems.”

“As a result of this new opportunity to make leveraged deals we now started a trend, which many other REITs later followed, of buying land under office buildings and other real estate properties and net leasing the land back to the owner with the ground lease being subordinated to the first mortgage. We always put in a pro- vision that the first mortgage could never be refinanced for an amount greater than the original nor the maturity date extended, with the result that our ground leases would ultimately be superior to any new financing. One of the most successful of this type of operation was at the Center Plaza development in Boston, directly opposite all the new government buildings. This was in the Redevelopment Agency area where old buildings had been torn down and developers were being given options to acquire land and build new structures on these sites. The Leventhal brothers in Boston had received such options but did not have sufficient capital to pay cash for the land as the options expired. Our REIT, Realty Income Trust, agreed to put up the cash on three separate occasions as they developed the property and to subordinate the ground lease to their first mort- gage lenders on the buildings. Our net lease required a 10 percent return to us on the land investment plus an override based on their gross rents in excess of a specific amount in each of the three loca- tions. This was typical of the sort of deal that we were making in our REIT before the deluge of financing that occurred in this field in 1969 to 1971. When money got tight and the banks were having difficulty in providing mortgage financing for real estate developments at that time, they became aware of the advantages of setting up REITs that they managed through advisory companies raising capital from the general public through the sale of common stock and subordinated debentures. The law was so drawn that the advisor was permitted a fee of 1V2 percent not only on all of the investments made by the REITs but also on all the commitments outstanding for which the money had not yet been put out. The result of this outrageous fee structure was that everybody and his brother set up REITs all over the country. Through the sale of securities to the public plus huge borrowings from banks with high leverage up to 4 to 1 permitted, some $20 billion of new capital was injected into the real estate market within a three-year period. The greed of the advisors was so great and the capital available for investment so enormous that absolutely everyone who”

“ADVICE: For hundreds ofyears almost every generation has been tempted by greed to overspeculate in some promising new venture. When too much capital enters any new field prices rise too fast and disaster ensues. For example: South Sea Bubble Holland Tulip Boom”

“Ponzi Scheme Florida Land Boom, ig20s Stock Market, ig20s Sugar Speculation, 19J4.”

“ADVICE: Ifyou don't enjoy being sued, my advice is: Don't get involved in publicly owned companies the way I have—stay private. I'll guarantee that if you are active in business for sixty years as I have been and are an officer or director of a public company, sooner or later you'll be involved in some kind of class action or derivative suit. Just relax and enjoy it—it's all part of the free enterprise system!”