A letter a day!

A letter a day!

Letter#10 Dec’2008

The theme of this letter is focused on crisis management (2008 witnessed financial crisis)

Key learnings:

1.At the time of crisis or otherwise, always think about the price to value ratio.

The nomad partnership has always focused on price to value ratios (market prices in Comparision to business value). Since inception, the price to value ratio of the partnership has been significantly lowered, implying healthy deferred returns to come.

“Whether business values rise faster than share prices, or share prices fall faster than business values, either way the effect is the same: a growing differential between the price of a business in the stock market and its real value. It does indeed “feel different” when performance has been as poor as it was in 2008, but the rational mind will anchor on the notion that today the birds in the bush are very large indeed. It may not feel like it but, in many respects, these are the best of times for an investor, and we shall lay out why in this letter.”

2.How to efficiently use the safety net? (i.e. deployment of additional cash at the time of crisis)

1)Output maximization looks efficient at least in the short term, but that is not the same as being long term optimal. The flaw to putting money to work immediately, for instance, is to presume that all relevant opportunity sets are available immediately.

2)What passes for industry standard best practice today may look short term efficient but, in any lasting sense of the word, and from the perspective of the long-term business owner, it does not really get the job done.

“All this is a far cry from the early years of Rolls-Royce Limited, the manufacturer of motor cars, where Frederick “Henry” Royce made the engineers personally sign the parts they were responsible for making. That way, if any component proved faulty, he knew who was responsible and he made them correct the fault in their own, unpaid time – I paid you to make a working part, not a faulty part, he would argue. And that is how he ended up making the best motorcars in the world. That level of personal accountability has been largely lost inside organizations today and has instead been replaced with “efficiency” to the point of Taleb’s “busy incompetence” and “real world isolation.”

(“When someone says he is busy, he means that he is incompetent”, Nassim Taleb again, “having a stupidly busy schedule isn’t a sign of being important. It means that you have become insulated from the world”.)

3)Nomad partnership also had some slack (i.e additional cash in the system). But they never preferred immediate deployment of the same.

“We do try and run Nomad with some slack in the system. In the June 2007 letter to partners we suggested that one of the benefits of a long holding period was that it allowed time for gentle contemplation, to “retreat and simmer” a little, and we quoted the gardener Charles Jencks: “understanding requires a certain slowing of time. Why else enter a garden?” Notice, “slowing”, it is important. Slack is provided in our company structure: Zak is perfectly capable of running Nomad on his own (someone tell him I do! Zak). This means that straight away we are running at something less than fifty percent capacity utilization on a normal day, and so we can gear up, in effect, when opportunities arise as they have recently. Capacity utilization is also kept low by few investments, held for long periods. “

3.Importance of incentives/discounts at all points of time.

1)As the firm grows in size, scale savings are given back to the customer in the form of lower prices. The customer then reciprocates by purchasing more goods, which provides greater scale for the retailer who passes on the new savings as well. The scale economics shared incentivizes customer reciprocation, and customer reciprocation is a super-factor in business performance.

“Scale economics works well in bad economic times as well as good. On the busiest day in the run up to Christmas this year, order volumes at Amazon were 16% higher than the previous year and note these compares to industry-wide US retail sales which declined nearly ten percent in December, according to the commerce department! And at AirAsia revenues per seat per kilometer flown rose 33%, whilst costs per seat per kilometer flown excluding fuel declined 10% in the latest quarterly period. Our businesses are surging ahead, even if, in some cases, their share prices are half what they were twelve months ago. In the last few months Amazon has been priced in the market as if it would not grow in the future, despite some of the best growth prospects we can imagine.”