William Wrigley, Jr., the founder of the eponymous gum company that bears his name, is one of the greatest students of efficiency and pragmatism that the business world has ever produced. Wrigley was a young man with the equivalent of $1,000 in his pocket who moved to Chicago to become a soap salesman, and the William Wrigley Soap Company also provided baking powder with the purchase as a gratuity.
Finding that the customers preferred the baking powder to the soap, Wrigley changed his business to the William Wrigley Baking Powder Company and repeated a new iteration of his formula, this time giving two packs of gum as a gratuity to the baking powder purchases. You can guess what happened next. The gum outsold the baking soda! At that point, presumably sick of changing the name, Wrigley began to sell of his gum under the “Wm. Wrigley Jr. Company” umbrella.
As Wrigley’s gum company began to prosper, Wrigley started investing heavily in the residential real estate market in Santa Catalina, California. Some of these properties were owned by the gum company.
I recently began studying the terms of Mars’ $23 billion acquisition of the Wm. Wrigley Jr. Company back in 2008 that was financed in part by Warren Buffett’s Berkshire Hathaway–with a $4 billion loan coupled with a $2.1 billion equity investment in a 10% stake in the company that Mars had the right to buyout in 2015 (which it did).
When I first encountered Alice Schroeder’s biography of Buffett titled “The Snowball”, she made a remark that has stuck with me:
“Warren Buffett does not negotiate. He is very straightforward with the price he is willing to pay to acquire a company, but he will not go back and forth in an attempt to ‘split the difference’. His deals are take it or leave it deals, and the terms are set up so that almost no matter what happens, he cannot lose. He is able to get them done because he always offers a reasonably fair price.”
I did some digging on the terms of the financing component for the Mars-Wrigley acquisition, and I was struck by the ways in which Buffett “couldn’t lose.” If you saw the news item of the $4 billion loan, you might have just thought that Berkshire would get repaid so long as there wasn’t a sharp decline in the rate at which American’s bought chewing gum–i.e. That the debt was financed as an unsecured debt backed by Wrigley’s general earnings power.
Upon investigation, the terms of the deal for Berkshire were incredible. He had a secured interest in all the assets that Wrigley gum owned outright–certain machines, rights to accounts receivables, and other inventory rights–and had a junior lien right against the some of the real estate that Wrigley owned, including some stray properties that remained on the corporation balance sheet from William Wrigley’s fascination with Santa Cantalina.
If, somehow, the gum chewing business became insolvent, Buffett had all of these property rights with some liquidation value. Losing money on the investment would not only involve Wrigley itself failing, but it also involve a failure to recoup money that could be received through the sale of the machines, accounts receivable and inventories, and even the real estate (Berkshire Hathaway was second only to the mortgage lender).
I would describe Buffett’s deal as follows: “Buffett’s investment in Wrigley had a 0.001% chance of failing, but if it failed, he had a 80% chance of recouping at least 35% of his investment value.”
That second clause is the part that most investors neglect. They just focus on how brilliant Buffett is in the original instance, not realizing that he is also providing a backup for himself in the event the first low probability event took place.
Of course, not many reading this are in the position to dictate the terms of private-money institutional and corporate lending. But almost 40% of this readership is part of a millionaire household that have a relationship with an investment advisor that can connect them to unique investment opportunities.
One of the best perks of having access to private wealth management is that you can also get access to secured corporate bonds that are not usually available to the typical retail investor.
For instance, all of Domino’s Pizza’s debt is part of an overall package of cross-collateralization. If you buy a 6.3% bond from Domino’s, you will be part of a creditor group that has access to the pizza ovens, store equipment, and second-liens on the real property owned by Domino’s. If you buy a 5.8% bond from Pizza Hut, you get no promise of the collateral as backup–you are just borrowing against the general earnings power of Pizza Hut. If you conclude that both businesses are of equal quality, or that Domino’s is of higher earnings quality, you would actually be taking on less risk to earn a higher interest rate by purchasing Domino’s debt rather than that of Pizza Hut.
At the present time, I cannot recommend any secured bond funds that are publicly available to retail investors as a whole. My only guidance is that, if you have access to purchasing individual corporate bonds, you should perform a screen that filters for (1) bonds yielding over 6% with (2) that are secured by hard assets, and ideally, some real estate owned by the company in which (3) the company itself has been profitable for each of the past ten years. It can be a nice way to turn a $30,000 pile of capital into a $500 quarterly interest check for a decade or so that ends up with the return of your principal on the maturity date. It may not not be the secret to quickly creating wealth, but it is a secret to augmenting wealth.
Originally posted 2018-09-19 01:20:03.