The Family Office Takes Over Wall Street

In recent years, wealthy families have directly hired advisors, attorneys, tax specialists, and even business operators to purchase publicly traded businesses outright rather than, say, purchase 25,000 shares of Exxon Mobil and achieve their investment goals through passive investments in the largest, most profitable businesses in the world.

Perhaps the most recent high-profile example involved the acquisition of Panera Bread, which was bought out by JAB Holdings—the Reimann family heirs to the Benckiser fortune are in the process of adding Panera to their asset collection which features Peet’s Coffee, Caribou Coffee, and a majority interest in Keurig Green Mountain. Alongside Starbucks, they are Big Coffee. Now, the Reimann family is paying over $7 billion to buy Panera, and in the process, remove the chain from the scope of investments that are available to the public.

This development is the result of a confluence of factors.

The predominant advantage is the lack of oversight requires of family offices. After all, the reason why the public securities markets are so heavily regulated are because it is essential to protect minority interests. Management and large stockholders have little incentive to care about an investor with 100 shares in the same corporation, so fiduciary duties, wash rules, and other disclosure requirements exist to protect that little guy. This imposes costs, time, and sometimes even avoidance of the best course of action if the regulatory rule errs on the side of over-inclusivity.

Also, there is the matter of control, which takes on additional relevance when credit is cheap and cash is in abundance. Sticking with my Exxon alternative, you are the mercy of the Board of Directors when it comes to matters such as dividend distributions. Recently, the Exxon Board raised the quarterly dividend from $0.75 to $0.77.

If you are a family entity, you can arrange affairs to wield more discretion. You can convince your Board to hold off on dividends altogether to build up the balance sheet or make acquisitions. You can raise the dividend by 20%. You can cut it by 40%. Whatever you think are the needs at the time, you can fulfill without needing to take into account the opinions of other owners.

The family office is able to take advantage of lack of regulatory oversight, control advantages, and the ability to invest heavily in long-term innovation. The downside is that they are acquiring publicly traded businesses that are no longer available to smaller investors.

And even the executives find themselves preferring to work for family businesses or other private entities that exist beyond the harsh glare of the quarterly earnings report spotlight. If you were the CEO of Perrigo, which is publicly traded, you have to deal with the fact that the price of the stock fell from $157 per share in 2013 to $69 in May 2017. But if you were running the business for a private entity, you would be focusing instead on the fact that you were delivering almost $700 million in annual profits to your owners in 2017 compared to the $440 million you delivered to them in 2013.

It is a tremendous advantage to only focus on the question “How can I improve this business?” without having to simultaneously answer the question “How will other people perceive the transition in the meantime?”

The most interesting question is trying to figure out how this trend relates to the experience of the individual investor in the public markets that is purchasing 10 to 1,000 shares of a given business at a time.

First, I think the private investing class should be overjoyed by the sheer amount of publicly traded businesses that are currently available for them to purchase an ownership stake in. We don’t have a “right” to own stock in ExxonMobil, Coca-Cola, or McDonald’s. It was a financing decision made to raise capital at one point in time, which means that the floodgates for ownership are still available to investors today. There could be an alternative universe where the Rockefellers, Candlers, and Krocs owned those businesses outright.

I think people should be motivated to save even more capital because there are so many great businesses still left in the public markets. This is a historical anomaly in the history of Western Civilization, and it is often taken for granted because it has existed for over 200 years in the United States. If you recognize that something is a blessing, and not a guarantee, that gratitude may be more likely to transform into action.

More narrowly, it can make sense to develop expertise in analyzing the biggest small-caps and smallest mid-cap stocks, which I define as businesses with current market values between $500 and $3 billion. These are companies that are ripe for being taken private. Between 2014 and 2017, over $1.1 trillion was involved in taking over businesses across the world. Approximately $400 of that involved publicly traded companies being taken private.

Companies with a $1 billion valuation often have an established business. WD-40, the oil lubricant, has been a profitable product with reliable demand for decades and decades. If you bought that stock when the price was attractive, you would own a business that is growing at about 8% each year. That is nice, but it also has the advantage of coming with a lottery ticket attached because it could someday be taken over. And when that happens, you get a 30% to 60% immediate premium. For these investors, the focus should be on that $1.1 trillion in merger activity because it doesn’t matter whether you get taken over by an entity that is publicly traded or private. Experiencing this two to three times with meaningful investments during the first half of your working career can dramatically the investment results that you are able to produce over the course of your lifetime.

My own speculation is that family offices will continue to acquire stable cash cows that have been generating profits since at least the 1950s. For those investors that want reliable cash flows from steady businesses, I expect that they will see a modest reduction in opportunities. The offset will be the rise of IPOs from tech-oriented businesses that have quick growth at the moment you’re analyzing them but don’t have the business model to give you the confidence that the business will still be around and profitable in the 2050s.

The upside of the proliferation of family offices is that they tend to be more reliable employers than publicly traded entities. I would rather work for a brewery that grew profits at 6% in the private sphere when the owner was projecting 8% than a publicly traded alcohol firm that grew by 6% when the market was expecting 8%. I also think this bodes well for long-term investment, as firms like Panera will be able to “tech-ify” its business model and create a new competitive advantage even if it hampers profit growth in the short term.

The downside is that some jewel assets will become inaccessible to average investors. Clorox is an excellent business with 13% annual returns for its investors since the 1950s. It is valued around $17 billion. It is not inconceivable that this business will be taken private someday. That is a detriment to the typical American investor. Family offices may benefit employees and consumers due to innovation, but it does a disservice to small-scale investors by removing opportunities from their grasp. This can be mitigated by developing a portion of your portfolio to investment in steady publicly traded businesses that are in the sweet spot size for takeovers.

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