Risk vs. Reward

by JT McGee

“No way! I knew I remembered you from somewhere!”

A few months ago, somewhere between the fifth or sixth pitcher of beer I was sharing with a friend, we got to talking about the bad jobs we’ve had over our short lives with a friendly stranger.

As it turns out, this stranger wasn’t a stranger at all. He and I had worked at the same golf course together in high school. It was closing down, but not because of the reason you might think. Attendance had been relatively good – there isn’t much to do in my small hometown – but bad management squandered the place.

The golf course was owned by the pro who worked on site. He acquired it on a lengthy mortgage that spanned 25 years.

At some point, the new owner saw an opportunity to cut costs. The groundskeeper who had kept the grass vibrant for several years was a significant and unfortunate fixed expense. The owner quickly fired the veteran and made a new, less expensive hire.

Just weeks later, this new hire started the process of fertilizing the course’s many acres of pristine grass. He’d be back in the morning to start the sprinklers, fulfilling a requirement that the heavily-fertilized grass is watered on a strict schedule.

Except he didn’t go straight home to get some rest for what would be a very busy day. He went to the local bar, and in Midwest fashion, drank more than he could handle. His drive home would end abruptly at the hands of a sheriff, who arrested him on sight, clearly too drunk to drive.

The next day, the golf course’s owner and my new bar pal sat in the proshop looking over the course. Neither person had seen the groundskeeper that day, but both assumed he was busy at work finishing the job he started the day before.

By noon, the grass was slowly changing colors. By the afternoon, it was brown. By night, it would be dead.

They called the groundskeeper’s cell phone. No answer. Then they started calling anyone they could think of, until one of them had the bright idea to call the local jail. They found him, and the owner quickly rushed to bail him out.

Unfortunately, it was too late. Emergency action to solve a day of inaction yielded nothing. In just one day, the golf course experienced its worst day in history – a $3 million loss due to the death of every square inch of grass.

Ultimately, in an effort to save an estimated $20,000 in annual operating expenses, the new owner lost the entirety of his investment in the golf course. The previous owner, who had a clause that would allow him to take over the course due to mismanagement, similarly lost a fortune.

To the best of my knowledge, the course is slated to be sliced and diced into a number of lots for future home construction. Families who paid a premium for a home located on a golf course now own homes that are located in a construction zone for at least a few more years.

It’s a really unfortunate thing, but a really good lesson in risk management. Some risks just aren’t worth taking.

I took a cab home that night.


This is a chart of charge-offs on agricultural production loans, which have exceeded 1% in only two of the last 28 years since the “Farm Crisis” of the 1980s. (Click to see a larger image.)

This is a chart of charge-offs on single-family mortgages, which never rose to more than 1% for 17 years from 1991 to 2008. (Click to see a larger image.)


I think Uber is the most incredible business ever made:

Facts about cars:

  • The average car has a utilization rate of 4%, or roughly 1 hour out of a 24 hour day
  • There are 260MM cars registered in the United States.
  • Assuming an average value of just $5,000 per car — truly a WAG — American cars are collectively worth $1.3 trillion. (~50MM cars were sold in the last 3 years, which make up a substantial portion of total car values.)


  • Increasing car utilization to 20% from 4% could theoretically result in 80% fewer cars in the U.S.
  • This would free up approximately $1 trillion of capital currently tied up in mostly dormant vehicles across the United States.

Any large improvement in utilization rates will undoubtedly require something like Uber (car-as-a-service) plus driverless capabilities. But I really do think this the future.

Already, Uber has had a tremendous impact on at least one industry. Guess which one?

After growing at a 9.5% CAGR from 2007-2014, the outsize economic returns earned by the beneficiaries of a government-sponsored monopoly have declined precipitously to 2016. The world is better for it.

Crazy predictions:

  • The Big Three are living on borrowed time. Legacy costs (pensions) will be spread over fewer new cars produced.
  • The glory days of car insurance are behind us, as the combination of safer/fewer cars will result in substantially less risk, and substantially lower car insurance premiums/capita.
  • Car insurance could theoretically be managed via gas tax, as once argued in the book Invisible Bankers, reducing SG&A in car insurance and resulting in lower total premiums.


Not too long ago I told you I invested in a gym run by a friend. As of this week, I’ve effectively sold out.

A group of well-financed individuals wanted in, and I couldn’t help but see the opportunity to realize a gain and move on. The terms were frankly too good to pass up.

With the deal closed, I have:

  • Locked in a gain – I’ll lock in a decent gain on my investment in the gym.
  • Created an option – In addition to realizing a cash return, I’ll also retain a 10% stake going forward, which has an unknown value. (My model is extremely sensitive, due to the inherent operating leverage in the business.)

My reasons for exiting were as follows:

  • The gym is getting a capital infusion that, in my view, funds increased capex and opex in excess of existing demand, which will result in diminishing returns. I see it as unnecessary. But I am willing to concede that my desire to avoid “cosmetic” investments may have been a big blindspot in my thinking — time will tell.
  • The new biz plan will increase operating leverage, which is — again, completely my opinion — unnecessary given already attractive economics with low operating/financial leverage. (In general, I’m of the view that great returns don’t need to be turned into legendary returns if it induces blow-up risk. Too many people are willing to risk turning 25% CAGRs into zeros by getting greedy.)
  • The new investors are independently wealthy due to another venture, and seemingly less interested in economic returns on capital than I am. Furthermore, I believe they may have a bias toward reinvestment, which, in light of a decision to increase capex/opex ahead of demand, worries me. (Fear the landman in every industry.)
  • There will be other opportunities to deploy capital when unemployment is significantly higher than 4.8%, and the cycle is closer to a bottom than a top. This isn’t a macro call, but if you think available investment opportunities are better in 2016 than they were in…say, 2011, please tell me where you’re sourcing ideas!

In short, this exit allows me to:

  1. Realize a cash return.
  2. Hold an option for potential upside in the event this becomes a home run, with no additional committed capital from my personal balance sheet.
  3. Be location independent once again — Charlotte, NC is calling me.

On the industry

In all, I tend to think service-oriented group fitness facilities are excellent investments as they:

  • Generate more revenue per member.
  • Displace capex with opex, which is beneficial in bad economic environments.
  • By my observation and belief, result in lower customer acquisition cost in dollars and cents, and as a percentage of revenue, due to an emphasis on partners/groups.
  • Win customers at the margin with friendly terms (no contracts!) afforded by higher revenue per member.

There are only five figures that matter for the gym industry:

  • CAC – Cost of customer acquisition.
  • Churn – Percentage of members who quit in any given month.
  • Cost per attendance – The best gym members pay, but never show up. (Surely some gyms measure capex/opex divided by attendance over x periods?)
  • Revenue per member – Obvious.
  • Asset turnover – $1 in annual revenue against $10 of equipment is awful, for example.

In the future, I think the gym industry will:

  • Become more corporate, with fewer mom and pops.
  • Develop black-and-white lines by pricing tiers. (Planet Fitness at the bottom, 24/7 in the mid-tier, and independent group studios and barbell clubs at the high end.)
  • Provide lumpy, cyclical returns due to inherent competition, and limited entry/exit barriers.
  • Eventually become part of the health insurance complex, resulting in outsized profits for a chosen few.
  • Remain a playground for roll-ups. With unlevered FCF yields >20%, small time operators can easily run serious PE-style roll-ups in local markets.

On private companies

In my view, private companies:

  • Are way more attractive as investments than public companies.
  • Should be valued with the understanding that, in my cases, you’re buying a job. (Assign a multiple only on profits in excess of your reasonable salaried income across a cycle.)
  • Trade at ridiculous discounts, especially to public company multiples today, even after considering liquidity, cyclicality, etc.
  • Are way more likely to generate FU money.
  • Do not fully appreciate the importance of incentive compensation for employees in the way that public companies do.

Would I invest in another private company? Yes — send me a term sheet!

In all seriousness, I’m willing to invest in probably any type of private company provided that it is relatively simple to understand and there are public comps by which I can get some sense of potential inefficiencies. (I’ve seen enough filings to know that a 50% food cost or 40% labor cost for a restaurant is garbage, for example.)

But, that said, I think my bias is that private companies are most attractive to public companies when there are inefficiencies. I don’t want a top-quartile private company; I want a bottom-quartile private company that needs some TLC. The power to effect change is invaluable for any investor in any company.But, again, that’s just, like, my opinion, man.

I’m semi-tempted to start browsing Biz Buy Sell with more tenacity. Would it be wrong to get a boilerplate document to spam for company financials? Good way to solve an insatiable curiosity…maybe?