Sam Zell: 8 lessons

Sam Zell, who recently passed away at the age of 81, was a trailblazing investor renowned for his contrarian approach and ability to spot undervalued assets with intrinsic value. With precise research and a knack for identifying emerging trends, he consistently delivered impressive returns and was one of the world's most famous investors. His adaptability and philanthropic endeavors further define his influential presence in the investment world. Sem Zell inspired a new generation of investors to challenge norms and seize untapped opportunities.

I start by not paying much attention to the market. I think the Street reflects the value of the last share traded, but the true value of the asset may be more or less than what‘s indicated publicly. In the same manner, I don‘t make investments predicated on the assumption that there‘s a greater fool out there who‘s going to buy it from me for more than I paid for it. I look for situations that logically make sense to me.

As an example, in 1985 I took over Itel Corporation. At the time, Itel had been the largest bankruptcy in the history of the United States. Coming out of Chapter 11, the company still owned a subsidiary that leased 17,000 railcars. Business had been so terrible that utilization of the railcars was 32%. While others might have considered this a really horrible situation, I looked at it and said: “These railcars are almost new because they haven‘t been used.” By virtue of this fact, I bought them at dramatically less than their replacement cost. I then looked at the broader rail business and determined how many railcars there were, who had built them, when they had been built and what the general story of the business was. It turned out that in 1979, the US government had changed the tax laws and created a special one year 100% tax deduction for heavy equipment. Furthermore, in 1979, the United States had built 120,000 boxcars. But between 1979 and 1985, the United States had built a total of only 20 boxcars.

In the meantime, demand for boxcars was as flat as a dead man‘s EKG. Therefore, nobody wanted to touch the business because there was no growth. During this same period, 65% of the boxcars in the country were scrapped. I reminded myself that everything is about supply and demand. I knew that when the supply and demand curves for boxcars met, I could make a fortune. So I went out and bought all of the used railcars in America. By the time I was done, we owned 92,000 railcars and became the largest lessor of railcars in the United States. We did extraordinarily well because we had bought these railcars at significant discounts to replacement cost and yet rented them at market rates. Now, you could tell me I‘m a genius but the truth of the matter is that the information I‘ve laid out was available to everybody. All anyone had to do was put the pieces together. For some reason, that‘s what I do well. I see things differently.

Another division of Itel was in the container leasing business. At the time, the container leasing industry was comprised of the “seven sisters”, which were seven container leasing companies that represented 95% of the world‘s container leasing business. The one I acquired through Itel was number four. This business had $100 million of revenue, $50 million of expenses, and $50 million of cash flow. Then I looked at the number three business in the industry, which had roughly $100 million of revenue and $50 million of cash flow. I considered what would happen if I put these two container leasing businesses together.

All of a sudden, I would need only one shipyard in Hong Kong and only one shipyard at the other ports throughout the world, and I would need only one computer system. I don‘t really believe in synergies, such as cross-selling and all the other elements they teach in business schools. The only thing that‘s relevant to me is redundancy. Everything else is if-come-maybe. So, I acquired the number three business in the industry, put the two companies together and the revenue was still $200 million but the expenses were now $85 million instead of $100 million. We picked up a 15% expense difference, which was all profit, and we became the low-cost producer. We then acquired the leasing company that was number seven in market share and became number one in the container leasing industry. By virtue of this, we had the lowest costs in the business and a real competitive advantage.

So that‘s the way I look at things. It isn‘t like there are six rules of investing or something like that – certainly there haven‘t been in my life. One of my criticisms of business schools is that the definition of an MBA graduate is someone who knows how to do the numbers; they just don‘t know what the numbers mean. This is the product of business schools' emphasis on formulas. In other words, business schools teach how the pieces should be put together. But for me, there is no formula. Similarly, I‘m pretty agnostic about industries. We‘ve been in the container leasing business, the railcar leasing business, the insurance business, the real estate business, the agricultural chemicals business, the oil and gas business, and I could go on and on.

We don‘t invest in high tech, simply because we don‘t understand it and because it‘s valued on if-comemaybe. Maybe I‘m a good prognosticator of value but I would tell you that I can do much better prognosticating value on something I understand than on companies that are valued by a third party. That‘s really key to how I look at things. I‘ve never been willing to depend on a third party to value my investments. I have to value them myself and I have to look at my investments as though I‘m going to own them permanently. That‘s a very different perspective than valuing investments as though I‘m going to own them until I determine it‘s the right time to sell. Generally speaking, we start by focusing on the fact that we‘re going to own the investment forever. In some cases we have done this.

As was true for my philosophy of being the first national real estate investor in second-tier cities, I‘ve always been willing to shift my ideas and criteria, but I‘ve also always believed in what I‘m trying to implement. In the early ‘70s, buying apartments became too expensive so I started financing builders to build apartments. By 1972, everyone believed the world was going to grow to the sky; there were cranes on every block. But I knew that supply and demand were out of balance, and I stopped backing developers. Then, seemingly overnight, market sentiment shifted, and in 1973, everyone seemed to believe there was no future. Asset prices plummeted, and I realized that this didn‘t make sense either. So, I began aggressively acquiring property, financed very cheaply, to take advantage of what I thought was a once-in-a lifetime distressed opportunity.

Between ‘73 and ‘77, I acquired $3 billion worth of real estate. The banks had a problem carrying a large amount of distressed real estate with so many properties in foreclosure. They weren‘t looking to make money. They were just trying to mitigate the losses their real estate loan portfolios were expected to generate. In those days, institutions didn‘t have to mark-to-market, so I tried to figure out ways to preserve the principal of the asset for the seller and still make the deal work. It basically amounted to lowering interest rates on the debt to the point where you could almost carry it or you had a defined carry. We realized that if we could accumulate assets - particularly in an inflationary time - with cheap fixed rate debt, it was hard not to make a fortune.

When people looked at our performance during the ‘70s, they always asked, “How did you pick all those ripe projects?” But the truth of the matter was that I created $3 billion worth of 5% fixed rate debt in an inflationary environment of 10, 12 or 13%. In this situation, it was hard for it not to work. And yet, like many others in my career, most people thought I was crazy. I‘ve spent my whole life listening to people explain to me that I just don‘t understand, but it didn‘t change my view. Many times, however, having a totally independent view of conventional wisdom is a very lonely game.

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It starts with replacement cost. In other words, if we take the example of the Anixter pipeline, there was no physical pipeline, but I could figure out what it would cost to replicate that pipeline. I‘ve bought all kinds of real estate at below replacement cost, before considering the value of the land. Ultimately, what does it cost per square foot to build the property and what is your cost basis?

Another question to consider is how difficult a particular business or real estate market is to enter. I spoke a lot about the internet during the ‘90s. I thought it was a lot like an interstate highway except that a highway has limited access. The internet had no limitations to access. Therefore, an internet based business is totally vulnerable. One of my protégés created Groupon and, although he has the first mover advantage, the reality with Groupon is that there‘s no barrier to entry for competitors.

I don‘t know how to answer the question any more concisely than to say it‘s all about replacement cost – whether it be ephemeral replacement cost like the Anixter pipeline or brick and mortar replacement cost – and barriers to entry. You have to ask yourself, how difficult is it for somebody to compete with you and what is your comparative advantage.

 I philosophically believe that if you can‘t delineate your idea in one or two sentences, it‘s not worth doing. I‘m the Chairman of everything and the CEO of nothing, which means that the people who work for me come to see me with ideas all day long. My criterion is if they can‘t concisely explain their idea, then I throw them out of my office and tell them to come back when they can. Simplicity is critical.

Some businesses have lifelines and others don‘t. I think Anixter continues to grow because it provides a very valuable service. This isn‘t always the case. For instance, we started a company called Adams Drugs, which created the over-the counter drug Mucinex. The entire premise for developing that business was that there were a series of drugs, such as Aspirin, that were grandfathered by the FDA. The second largest drug was the expectorant guaifenesin. The FDA stipulated that if you could take a pre-FDA drug and prove efficacy through clinical trials then you were granted a monopoly. Somebody came to us with the idea to conduct clinical trials, we funded them and we proved efficacy. As a result, we were given exclusivity for production of the drug and thus the company did extraordinarily well. But I recognized that this was a business that could easily be subject to competition, and that it was a little bar fly in a land of giants. How were we going to compete with Pfizer or any of the big OTC drug companies? We couldn‘t. As far as I was concerned, selling Adams two or three years after we had proven the concept and generated revenue made all the sense in the world.

Jack Welch once said, “Either you‘re number one, number two or you‘re in trouble.” I certainly endorse that sentiment. I am a great believer in competition and I‘m particularly interested in competition for you. For me, I‘d like a monopoly. If I can‘t have a monopoly, I‘d like an oligopoly. As an investor, I am constantly focused on competition because I think it is not necessarily always rational. As a matter of fact, oftentimes it is irrational. There‘s nothing worse than to be in a competitive situation with an irrational competitor.

Number one, I always seemed to have a lot of self confidence so I didn‘t pay attention to conventional wisdom. Number two - you may have heard the quote, “common sense isn‘t so common” - I‘ve always been a great believer in logic. I have a lot of common sense and I see things differently. Many people see problems, but entrepreneurs see solutions, and that‘s really what I do. I recognize differences that other people don‘t seem to see.

Third, and most importantly, what I have been able to do is to assess risk and reward accurately throughout my career. The definition of a great investor is someone who starts by understanding the downside. You must make the judgment in advance as to how much downside risk you are willing to take. I knew that I could always survive the good days, but the critical element is to be able to survive when the market isn‘t doing well or the investment isn‘t performing. I always focus on how much exposure I am taking. Investors stumble when they take risk and don‘t receive commensurate reward. Investors stumble when they get bull-headed or when they shift to doing something that is outside of their core competencies. My success has been related to being a very good observer, having opinions and being willing to implement them, and understanding and believing in the Bernard Baruch saying “nobody ever went broke taking a profit”. 

Lastly, in the simplest philosophical phrase, I‘ve always believed in going for greatness. I‘m highly motivated and I‘ve always been highly motivated, not necessarily because it translates into dollars, but because there‘s a great satisfaction in achievement. I think, more than anything else, that is what has always driven me and been a major contributor to my success.