Monday, 19 August 2013

Double or Nothing: Not an investment strategy I'm fond of

A few weeks ago I watched a great documentary on ABC's four corners (link here) which went through the spectacular rise and fall of Australian ex-billionaire Nathan Tinkler.  It was an expose as well as having several lessons about investing, keeping what you earn and not blowing it all.

In fact it was almost the quintessential gambling stories.  Those stories of the ordinary people who made it rich winning the lotto and who then lose it all through bad decision making and poor investments.  The episode is really worth watching - I don't know how much longer it will be available at this link so while it is I recommend watching it.

Why is this story capture our imagination?

The reason Nathan Tinkler captured our imaginations so much is that he was an ordinary person, not born into any sort of wealth (unlike the Gina Rinehart's of this world) who made it big.  Further he did it in an extraordinary short period of time and he conformed to all the things we expect of big baller billionaires.

Below is a summary of his rise and fall.  Note that all the information below is from the four corners episode although it gels with much of the news reporting around the time of his risk and fall

  • He started as an apprentice electrician and ended up running a company which was supplying tradesmen and services to the coal mining industry
  • With the help of friends and family he got $1 million dollars for a deposit on a coal lease and then raised another $30 million
  • A year later he sold the company which owned the coal mine to MacArthur Coal for $270 million
    • He opted to be paid in shares instead of cash
    • Soon after the price of MacArthur Coal price spiked due to an increase in the coal price combined with rumours that the company was subject to a takeover offer
  • Tinkler sold out and walked away with $442 million
    • A year later it is reported that Tinkler burned through almost all of this money (see what he spent some of it on below)
  • Next, Tinkler bought the Maules Creek coal deposit for ~$500 million relying almost entirely on borrowed money (from a Singaporean hedge fund)
    • 9 months later as coal prices continued to rise Tinkler floated the holding company for Maules Creek, Aston Resources, for $1.2 billion valuing Tinkler at $1.01 billion
    • A year later Whitehaven Coal agreed to merge with Aston Resources to form one of the biggest players in the coal industry
  • The share price of Whitehaven Coal fell in tandem with the coal price
    • Tinkler had not sold any of his shares to pay back the debt he owed to the Singaporean hedge fund and many of his bills started to go without paying
    • The hedge fund called in their debt which was secured by Tinkler's shares in Whitehaven - his last remaining asset of real value
The summary above is super truncated and I apologise for the information it is missing.  It is really worth watching the whole report.  In the midst of making and losing his money Tinkler spent his money on the things that most of us think rich people spend their money on
  • He spent millions of dollars on horses 
  • He bought fast cars 
  • He bought a soccer team
  • He bought a rugby team
There is a reason people who are making money don't invest in these endeavours.  They are known sink holes for money.  They are where the rich go to dabble in their hobby and they don't intend to make money out of it. However it all contributes to the story of an ordinary person who suddenly had an extra-ordinary amount of money and who did with it what we ordinary folk expect a person to do with it.

Why am I so critical of what he did?

Tinkler was effectively making the same bet over and over again.  He was
leveraging himself to the hilt and making a bet that the coal price would rise which would super-charge the equity he had invested in the project.  The increased value of his investment would then more than cover his debt bill which he had owing.  It was like one big gamble of double or nothing after another.

The Four Corners episode walks through this bet in a great deal of detail and you eventually realise that Tinkler was more a gambler than an entrepreneur or investor. .

Double or nothing is not an investment strategy I'm particularly fond of

Maybe I'm not enough of a risk taker but this double or nothing strategy is not one I am particularly fond of.  This may mean that I'm never going to become a billionaire or it may mean that I would be happy with the first $270 million dollars or it may mean that I don't have the guts to scratch together that first $1 million dollars to put into a single deal but this lies way outside what I consider an acceptable risk and how I think about investment.

The problem, as I outlined above, was that Tinkler was betting everything on the coal price continuing to rise.  He had no special information or insights into what influences the price of coal.  Commodity prices are notoriously hard to forecast and to bet your entire fortune on what you do not truly understand is a recipe for disaster.  

I have no problem with concentrated risk, but a concentrated risk with the main swing factor being something I am unable to control or forecast is not a bet I am willing to take.  If I was ever to make a concentrated bet like this one it would have to be one in which I have to some special knowledge or advantage.  

I believe that the distinction between investing/entrepreneurship and gambling is that in gambling you're leaving it up to chance while in investing and true entrepreneurship your are constantly trying to tilt the board in your favour.  You have to accept some risk but you are constantly trying to minimise the big swing factors.

I wonder if Tinkler will ever be a big name in Australian business again.  I suspect not though will be interested to see if I am proven wrong.

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