• Chris Mayer

Extinction & Survival

“Extinction is the rule. Survival is the exception.”

- Carl Sagan

There’s been a lot of talk about how the pandemic has accelerated many trends already in place. The move to digital commerce, for example, at the expense of physical retail. Or the trend toward more people working at home instead of an office.

But the pandemic also creates a totally new environment for many businesses, such as restaurants. Old economic models may not be able to survive the adjustment. For example, those models that depend on diners being packed in at the restaurant, as opposed to those that can adapt to delivery or carryout.

I’ve been thinking about how the sudden shift in the business environment is, in some ways, akin to extinction events in biology.

Economies also suffer major extinction events. If you were invested in a public company listed in China’s stock market in 1949, you got wiped out when the communists took over. Ditto Russia in 1917. There have been other markets that have gone to zero, or near zero, due to some major economic or political quake. Lots of businesses die all at once (or over a short period of time), just as in a biological extinction event.

Of course, there are minor extinction events, too. Bubbles that pop and leave a trail of bankruptcies. Or when governments change the rules of the game in a severe and sudden way so that companies have to scramble to adjust or just go out of business.

One of my favorite stories along these lines is how Anheuser-Busch survived prohibition. Murray Stahl tells the story in his book How They Did It: Exceptional Stories of Great Investors. Ever wonder how Anheuser-Busch survived prohibition? The government made it illegal to sell beer. That would seem to be a big problem for a brewer.

But they did survive. First, they tried to make different products. Ice cream, for example. And non-alcoholic beer. On the latter effort, the company offered a refund if you could taste the difference. Most people couldn’t. But they still didn’t buy the beer. Which tells you something.

Anyway, none of these worked. But management did eventually figure out a response that saved the company. They saw a loophole in the law. You couldn’t make, sell or transport alcoholic beverages. Okay. But it didn’t outlaw making, selling and transporting unfermented malt extract… which customers could then take home and use to make their own beer by adding water and allowing it to ferment. This is what Anheuser-Busch did; they began selling malt extract.

Soon they were selling 6 million pounds annually, which can make an enormous amount of beer. August Busch said, “We ended up being the biggest bootlegging supply house in the United States.”

Murray Stahl, reflecting on this bit of history, wrote how it humbles the short seller, because it shows how “companies, if they are well capitalized, can be very resilient.”

Being well-capitalized alone, though, may not be good enough. In fact, if you pull back and look at the history of markets, it may surprise you to find out that the corporate lifespan is shrinking - a lot. “A recent study by McKinsey found that the average life-span of companies listed in Standard & Poor’s 500 was 61 years in 1958,” Stéphane Garelli, an emeritus professor at IMD. “Today, it is less than 18 years.” [Link]

That’s for the set of the biggest and (often) best capitalized public companies on the market. As Sagan says up top, “Extinction is the rule. Survival is the exception.” I imagine the attrition rate is much higher in, say, the Russell 2000 - made up of smaller companies. Or even worse among private companies, where you’ve got lots of mom and pop businesses without easy access to capital.

But there are survivors, even in the worst events. Relevant to this discussion is an article published in Aeon by Renée Duckworth, an associate professor at the University of Arizona. She writes about the most famous mass extinction on Earth. More than half of all life perished when an asteroid hit the Yucatán peninsula. But something less than half did survive. The catastrophe drove evolutionary change. “Survival required ingenuity and flexibility,” she writes. [Link]

I think the same is true for companies. If Amazon never branched out beyond just selling books, it probably would not have survived as an independent company. If Apple doesn’t create iPods and iPhones, etc., it probably doesn’t survive. Survival is more than just being well-capitalized. You need that flexibility and ingenuity.

You also need a little luck. Let’s be frank about this. It didn’t matter how great your balance sheet was or how wonderful your management team was in 1949 in China. You were doomed.

I’ve been thinking about these issues as I go through my portfolio and my watchlist. Resilience is top of mind right now. There is no way to know how this virus plays out and so many imponderables. How many companies and consumers depend on stimulus spending at the moment? What will happen when flu season kicks in? Will we have more lockdowns and restrictions? How long before a vaccine basically eliminates the virus? Or will it ever? What new pathogens may lie ahead?

As investors, we have to look beyond the virus. One year’s earnings won’t matter all that much. So, we don’t want to obsess too much over the concerns of the day. But as I’ve said before, you gotta get to the long-term. And I think this pandemic is more than just a concern of the day. Besides the risk of future pathogens, I think the present pandemic is like a large quake in the business environment, a permanent shift in the environment, which will wreak havoc with some business models unable to adapt and hasten their demise.

But for others it is an opportunity. I was on a call recently where management called out the weakness of a couple of competitors and how they had definitely taken share from these competitors -- and will likely win more share in the future. (I don't want to name it here because it's small and I may buy more). Market shares that have otherwise been stable, may shift relatively quickly now.

In any case, I want to have a portfolio of businesses that can prosper in a variety of environments. I want to bet on the teams taking share, not ceding it. I want my companies to be able to play offense during tough times like this.

This orientation required me to rethink some positions and I’ve used this rally to shed less resilient businesses. The world has changed. You have to evolve or you know what…

Thanks for reading!


Published August 14, 2020

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