Consider my friend with the business plan to buy up laundromats. Let’s say an illiquid, privately held laundromat makes a 25% return on invested capital. Suppose the stock market demands a 10% return for a small-cap company. So $100 million of privately held laundromats would generate $25 million in annual income, worth $250 million on the stock market, 2.5 times the initial investment. But if the laundromat company can finance 75% of the deal at 10% interest, then the cash cost of acquisition is $25 million. The cash flow profits of $25 million are reduced by $7.5 million in interest payments, for a net annual profit of $17.5 million. This company could sell for $175 million on the stock market, seven times the initial cash outlay. For this reason, orthodox financial theory recommends that companies borrow as much as they can get away with and roll over the debt perpetually, to maximize return on equity.
In the long run this subsidy to large purchasers should inflate the market price of inputs for the laundromat industry, simultaneously increasing the market price and reducing the profitability of existing businesses, creating increasing pressure to sell out.
I think even without the “subsidy to large purchasers”, the situation described would have a much simpler outcome: everyone and their mom would start laundromats and drive profitability well below 25%. And the market price of existing laundromats might well fall as a result, not increase as the post says.
How many people do you think have both of these traits?
1 Access to enough capital to execute on that plan and expect it to be positive-EV taking into account not only opportunity cost, but risk.
2 Regularly calculates the ROI on different business categories they interact with, to look for business opportunities.
Seems to me like this number is very small, most people doing this are pretty busy making loads of money, and then their kids don’t execute the same strategy so it doesn’t snowball intergenerationally. And the rest of the post explains why, structurally, we should expect this class to have shrunk quite a bit in relative terms over the last several decades.
I agree that under naive microeconomic assumptions what you predict would happen, and I wouldn’t be seeing what I’m seeing.
I think even without the “subsidy to large purchasers”, the situation described would have a much simpler outcome: everyone and their mom would start laundromats and drive profitability well below 25%. And the market price of existing laundromats might well fall as a result, not increase as the post says.
How many people do you think have both of these traits?
1 Access to enough capital to execute on that plan and expect it to be positive-EV taking into account not only opportunity cost, but risk.
2 Regularly calculates the ROI on different business categories they interact with, to look for business opportunities.
Seems to me like this number is very small, most people doing this are pretty busy making loads of money, and then their kids don’t execute the same strategy so it doesn’t snowball intergenerationally. And the rest of the post explains why, structurally, we should expect this class to have shrunk quite a bit in relative terms over the last several decades.
I agree that under naive microeconomic assumptions what you predict would happen, and I wouldn’t be seeing what I’m seeing.