It was done by a person with no prior experience or expertise in the airline industry. All you need to do is replace capital with creative thinking and solutions.
Branson found a service gap and went after it. By the time that gap narrowed and British Airways and his other competitors woke up, he had already built a strong brand. Even today, Virgin Atlantic offers a very unique product in a very tough industry. The Virgin Atlantic business model is pure Dhandho.
In , they put a line of electronic products called Vir- gin Pulse into Target stores. Target guaranteed them prime floor space, so Virgin had zero distribution cost or risk.
It had Ecco, a chic design shop, create the line, and they found a Chinese company to manufacture it—retaining good margins for Virgin. The par- ties who took much of the risk were the manufacturers, who had to commit capacity beyond confirmed orders, and Tar- get, which had to set aside valuable shelf space in every store.
To launch it, the Virgin Group leveraged Branson at a New York party dancing with some hot models wearing the Virgin Pulse line on their person.
It put very little money into it—classic Dhandho at work. Virgin Mo- bile does not own or operate a cell phone network. Sprint provides the entire backend and delivers the service under the Virgin Mobile brand. Virgin targeted teens with this service and focused the offering to be very attractive to teens—cool phones and phone skins, prepaid phone cards, and the teen-centric Virgin brand. If it failed, it had virtually no downside. Sprint provided all the technology, billing, and customer service infrastructure.
Virgin provided the branding and product positioning, and it took a large chunk of the profits. If it worked, there was huge upside for Virgin and a negligible downside if it failed. Virgin Mobile scaled very rapidly. Again, Virgin had virtually no investment.
The entire backend was handled by the bank. In return, it got a good chunk of the profits. Needless to say, Sir Richard has had a very spectacular Dhandho re- turn on his vacation home investment over the years.
Venture capitalists ought to look at the Virgin model because the Virgin model is the VC model of the future. Branson is an ultra low-risk, ultra high-return VC. People keep feeding him ideas, and he acts on a select few. In some cases, like Virgin Atlantic, it is a percent stake with very little invested. The Marwaris are regarded by many as being the very best practitioners of the art of Dhandho. Their amazing Dhandho endeavors, in many cases, leave the Patels in the dust.
In the Forbes ranking of the wealthiest humans on the planet, Bill Gates and Warren Buffett took their usual top two spots. But nipping at their heels at number three is a Marwari entrepreneur, Lakshmi Mittal.
He began his Dhandho jour- ney at about the same time as Bill Gates. As we know, Bill invested his energies in an industry that offers among the highest returns on invested capital.
Each time Dell loads Office on any machine, it sends Red- mond, Washington, a few hundred dollars. The return on invested capital is out of sight and the gross margin ap- proaches percent. Unlike Mi- crosoft, in a steel mill you have no control over the selling price of the finished product, and you have no control over the cost of raw materials. Steel mills are very capital-intensive creatures. The steel industry has been one of the worst places to invest capital in the past 30 years.
It is no wonder that all over the globe the players in the space have encountered tremendous pain and large numbers have ended up bankrupt. Mittal started in with a single, small, nondescript steel mill in Indonesia. Despite having all the odds stacked against him, he ended up creating one of the largest and most profitable steel businesses on the planet. How did he do it? There is a simple one word explanation—Dhandho. Take the example of the deal he created to take over the gigantic Karmet Steel Works in Kazakhstan.
The plant was on the verge of clo- sure with its Soviet-era managers forced to barter steel for food for its workers. The Kazakh government was glad to hand Mr. Mittal the keys to the plant for nothing. Not only did Mr. Mittal retain the entire workforce and run the plant, he paid all the outstanding wages and within five years had turned it into a thriving business that was gushing cash.
The workers and townsfolk literally worship Mittal as the person who saved their town from collapse. Getting dol- lar bills at 10 cents—or less—is Dhandho on steroids.
And then he has applied his secret sauce of getting these monolith mills to run ex- tremely efficiently. The people who founded Google, Oracle, Cisco, and Intel were all very talented, but they also had huge tail- winds propelling their net worths into the stratosphere. They all focused on businesses with amazing economics and very high returns on invested capital. Amazingly, it is Mittal, facing massive headwinds, who has a higher net worth than all of them.
The Dhandho framework helped him triumph over all but two members of the Forbes Whether you hail from Seattle, Omaha, or Marwar, the Dhandho framework to business pretty much trounces all others.
A final note on the Marwaris and their ingrained Dhandho ways. Recently, I had dinner with a good Marwari friend of mine, and I asked him how the stereotypical Mar- wari approaches investing capital in a venture? He said, quite nonchalantly, that Marwari businesspeople, even with only a fifth-grade education, simply expect all their in- vested capital to be returned in the form of dividends in no more than three years.
They expect that, after having gotten their money back, their principal investment continues to be worth at least what they invested in it. They expect these to be ultra low-risk bets. Enough said. When I founded my first business, Transtech, Inc. I researched U. If the business went south and I was unable to cover my debts, I could declare personal bank- ruptcy and start over. I was all of 25 years old; the last thing I was concerned about was deplet- ing my retirement assets.
I incorporated TransTech in February while contin- uing to work at Tellabs. I had a paycheck coming in and very little in the way of business expenses. If you look at the approach taken, it was a zero risk ap- proach. The upside was enormous— easily several million dollars. Visa and MasterCard were my venture capitalists funding the rest of it. I was single at the time. There was no family to worry about. Many lunches and dinners back then were comprised of a simple Subway sandwich.
My expenses were pretty low. I considered staying at Tellabs to be a risky proposition. I thought that if I just stayed at the company, it was likely to be a boring and slow corporate path.
If I woke up when I was 35 or 45 and decided to go off on my own, it would be much more complicated. I would likely have a wife and kids by then, which would make it harder to break loose and make a risk-free bet. Being 25 and single, I had available at least one risk-free bet.
My game plan was very simple. I had an arbitrage-based business model. I knew that with the first two customers on board, generating real revenue and profits, the downside was very limited. In , we were recognized as an Inc. Cash flows provided all the growth capital and then some.
Cash was always very tight as we were growing very rapidly and reinvesting all avail- able capital to scale. In late , I found a terrific banker, Tom Harazim, who liked our story. He paid off all my credit cards, got us off the very expensive factoring of receivables I was doing to bring in cash as quickly as possible, and got TransTech set up with a hugely cheaper line of credit based on our pristine receivables.
And then the entire business was sold in for several million dol- lars. The magic word is Dhandho, baby— huge upside with virtually no downside.
The roads we all took, however diverse, all led to similar destinations. Our journeys share a number of core principles. It is these nine principles that constitute the Dhandho framework: 1. When Papa Patel decided to become an entrepreneur, he did not go out and start a brand-new business. He bought an ex- isting business with a well-defined business model and one with a long history of operations that he could analyze.
This is waaaaaaaay less risky than doing a startup. Manilal and Mittal did the same. It is unlikely Papa Patel had ever even heard of Warren Buf- fett in the early s. We see change as the enemy of investments. Capitalism is pretty brutal.
We look for mundane products that everyone needs. My previous business, TransTech, appears to be in a rapidly changing industry, but it too is a simple low-tech business. At its core, it is simply a service business.
While information technology IT has changed dramatically over the years, the underlying nature and economics of the services delivered are virtually the same.
Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results. They were being sold at very cheap prices—all based on their pathetic near-term prospects. Papa Patel knew he was buying during distressed conditions and getting a great price.
Mittal loaded up on assets in se- verely distressed businesses in a severely distressed indus- try in severely distressed countries and geographies. While lecturing a group of students at Columbia University, at age 21, Buffett stated: I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.
In such circumstances, the odds are high that an investor can pick up assets at steep discounts to their underlying value. No one knows that better than Lakshmi Mittal. The products and services that have wide, sustainable moats around them are the ones that deliver rewards to investors. This leads to higher oc- cupancy on a very perishable commodity that he is ped- dling—a motel room for tonight.
This advantage has an en- during quality to it—one that has lasted several decades. Only when a Patel competes head to head with another Patel is the advantage in jeopardy. But with a large country and a small niche population, Patels are careful not to make their own lives difficult by competing directly with another Patel. Part of the moat comes from extending his brand, part of it from creating a truly innovative offering, and the rest from brilliant execution.
The IT services business is a recurring revenue business. The relationship with clients and the knowledge of their business and systems is the deep hidden moat in IT ser- vices.
I want a business with a moat around it. Then I want a moat around that castle. However, on two serial bets made over five years, the odds that both outcomes go against Papa Patel are slight. Even when he loses both bets, since he did not have much to start with, his losses are pretty minimal.
Societal safety nets help him get back on his feet. But when he wins—and the odds are over 99 percent that he wins at least once—he gets over 20 times his money back. Unlike a casino, in horse racing you are betting against other bettors. The house takes a flat 17 percent of the total amount wa- gered. Frictional costs, relative to the stock market, are very high.
We look for the horse with one chance in two of winning which pays you three to one. And you have to know enough to know whether the gamble is mispriced. According to Munger, there are actually a few people who are able to make a living by betting at the race track after paying the full 17 percent. Then, when they en- counter widely misplaced odds in their favor on a horse about which they know a great deal, they bet heavily on that one horse in that one race. After that, they go back to watch- ing the horses and races indefinitely with no bets placed until another good opportunity shows up.
It is not too different from all five of our Dhandho entre- preneurs. Most of the time they either do nothing or place minis- cule bets Branson.
Every once in a while, they encounter overwhelming odds in their favor. At such times, they act decisively and place a large bet. Arbitrage is classically defined as an attempt to profit by ex- ploiting price differences in identical or similar financial in- struments.
While arbitrage spreads are small and sometimes only available for fleeting moments, they are virtually risk free and it is free money while it lasts. Papa Patel is playing an arbitrage game as well. Imagine that there are two towns as shown in Figure 5. Town A has a population of forty thousand, and Town B has a population of thirty thousand. Once in a while, he notices that he gets new cus- tomers who say that they live in the middle of nowhere in Town C, which is 17 miles away.
It looks like a new township is emerging, and these peo- ple have to drive to either Town A or Town B for a haircut because Town C is a brand-new city and there are no bar- bers in the city. He thinks that, maybe, if there were a barbershop in Town C, people would go there. He has no money, so he goes to Town C and finds a run- down, dilapidated storefront. It has just a single barber chair. He hangs up a homemade sign outside and goes to work.
He further reduces downside by working part-time at his old job and part-time at the new business until he has a steady clientele. If it works, he has a shot at being his own boss and having his own little business. Humans are creatures of habit. He could even be slightly inferior or charge a bit more relative to the barbers in the other town, but you might still go to him as a critical time-saver. Gradually, this dilapidated, single-chair barbershop gets packed with cus- tomers.
He improves the infrastructure and ambiance, puts in another chair, hires another barber, and begins to scale the business. He gets so busy after the first few weeks that he resigns from his old job in less than two months. As long as that spread remains in place and Town C continues to grow, he sees a steady increase in revenues—even if he charges higher prices or delivers slightly inferior service.
Over time, like all arbitrage spreads, this spread narrows and then disappears. More barbers open shops like his, and eventually Town C has the same number of barbers per capita as Town A or Town B. However, it could easily take several years before the spread disappears. In the mean- while, our barber has raked in supernormal profits and built a loyal following. He may have to drop his prices to market price and competition will force him to up the ante to market-level service.
However, he has now built brand and has a satisfied client base that is unlikely to take the low bid with their monthly haircut; they are likely to keep returning to him. Even though the arbitrage spread is gone and supernormal profits are gone, the brand and loyal fol- lowing gives him sustaining profits for many, many years ahead.
And he, too, placed a near risk-free, arbitrage-type bet. The moment they take over a motel, operating costs drop.
With the low-cost structure, they offer a very competitive average nightly rate that leads to higher occupancy. That lower-cost higher occupancy gives them an arbitrage spread over all their competitors—until another fellow Patel shows up to compete with them. It might take 15 to 20 years before a fel- low Patel shows up.
So that arbitrage will last for some time. Nonetheless, even- tually that spread is going to disappear.
In the meanwhile, and that can be several decades, Papa Patel and Manilal milk that arbitrage spread for all they can. Eventually, many of his innova- tions get copied by competitors, the moat shrinks, and the arbitrage spread collapses. But again, that spread can last for well over a decade or two. When Mittal picks up assets for pennies on the dollar and then streamlines operations, he has an unassailable low-cost producer advantage.
Over the years, he has devel- oped a second enduring advantage—global arbitrage on labor, raw materials, energy costs, and the best-selling price. With plants in a wide range of geographies, he opti- mizes the type and quantity of steel produced by geogra- phy to maximize this advantage. And now, his tremendous scale and brand gets him a third enduring advantage.
His volumes and capacity allow him to negotiate better prices than his competitors with both buyers and suppliers— driving his costs even lower. Nonetheless, Papa Patel intrinsi- cally understands the concept of minimizing downside risk before ever looking at upside potential.
He had a huge margin of safety when he bought the motel. Ac- cording to Benjamin Graham:. However, the outcome had significant uncer- tainty associated with it. What if gas prices continued to stay high or the recession continued on? Even in that scenario Papa Patel would still be the low-cost provider. Even in the gloom and doom scenario, he comes out looking pretty good.
If the economy booms and the gas prices moderate, he makes a killing. He has very low risk and relatively high uncertainty with the motel investment. Low risk and high uncertainty is a wonderful combina- tion. It leads to severely depressed prices for businesses— especially in the pari-mutuel system-based stock market. Dhandho entrepreneurs first focus on minimizing down- side risk. Low-risk situations, by definition, have low downsides. The high uncertainty can be dealt with by con- servatively handicapping the range of possible outcomes.
The first few Patels paved the way for the thousands that followed. Papa Patel had seen a few of the earlier Patels latch on to buying small motels. In conversations with these pio- neers, the no-brainer business model became painfully clear to him. He did not set out to innovate. He simply followed the path laid out by his peers. The thousands of subsequent Patels who followed did not innovate either; neither did Manilal.
I, too, got the seed of the idea for TransTech from my previous employer, Tellabs. Innovation is a crap- shoot, but lifting and scaling carries far lower risk and de- cent to great rewards.
Treasuries, bonds, stocks, real es- tate, private businesses, gold, silver, platinum, oil futures— the list is endless. If you examine returns from the broad stock market indexes over the past one hundred years, it is pretty clear that stocks do better than virtually all other easily accessible asset classes. The evidence overwhelm- ingly suggests that, over the long haul, the best place to in- vest assets is in common stocks.
Humans have walked this earth for some fifty thousand years and the buying and selling of assets between humans has flourished for thousands of years.
The first stock mar- ket was formed in just in Philadelphia, followed by the New York Stock Exchange in A far better way, suggested by Benjamin Graham, is to think of them as an ownership stake in an existing business. If it were and you bought some of it, now you and Papa Patel are partners. There are six big advantages that the stock market offers versus the buying and selling of entire businesses: 1.
When you buy an entire business, like Papa Patel did, there is some serious heavy lifting required. You either need to run it or find someone competent who can.
This is no small task. Papa Patel did well, but it required tremendous energy and dedication from his whole family for several years to make it work. When you buy a stock, you now have an ownership stake in the underlying business with one huge ad- vantage—the business is already staffed and run- ning.
You can share in all the rewards of business ownership without much of the effort. The stock mar- ket enables you to own fractions of a few businesses of your choosing, over a period of your choosing, with full liquidity to buy or sell that stake anytime with a few clicks on your computer. Papa Patel does not have these advantages, and we have a huge leg up on him with the stock market at our disposal.
The key is to only participate in the stock market using the powerful Dhandho investing framework. When humans buy or sell whole businesses, both sides have a good sense of what the asset is worth and a rational price is usually arrived at.
Sellers usually get to time these sales to their benefit. As a result, you typi- cally end up with fair to exuberant pricing.
The stock market operates like the pari-mutuel system in horse racing—prices are determined by an auction process. Like in horse racing, the auction pro- cess occasionally leads to a wide divergence between the value of a business and its quoted market price in a few stocks.
We can do very well by only placing an occasional bet when the odds are heavily in our favor. According to Charlie Munger: If you stop to think about it, a pari-mutuel system is a market. Buying an entire business—even a small neighbor- hood gas station or laundromat—requires some seri- ous capital.
In the stock market, you can hitch your wagon to the future prospects of any business with what you have in your wallet right now. The ability to get started with a tiny pool of capital—and add to that pool over the years—is a huge advantage. There are thousands of publicly traded businesses in the United States, and you can buy a stake in any of them with a few mouse clicks.
You can buy stocks in a plethora of other countries with ease as well. There is just no comparison. At the racetrack, the track owner takes 17 percent of every dollar bet. The frictional costs are very high.
Ultra-low frictional costs are a huge advantage. Having an ownership stake in a few businesses is the best path to building wealth. And with no heavy lifting required, bargain buying opportunities, ultra-low capital re- quirements, ultra-large selection, and ultra-low frictional costs, buying stakes in a few publicly traded existing busi- nesses is the no-brainer Dhandho way to go. What is the intrinsic value of a busi- ness?
Is there a general formula? How do we figure it out? Every business has an intrinsic value, and it is determined by the same simple formula. The definition is painfully simple. Are we better off buying the gas station or taking our virtually assured 10 percent return?
Alternately, you could use Excel. As Table 7. If we did the DCF analysis on the 10 percent yielding low-risk invest- ment, it looks like Table 7. Using a light, entertaining style, Pabrai lays out the Dhandho framework in an easy-to-use format. Any investor who adopts the framework is bound to improve on results and soundly beat the markets and most professionals.
The Dhandho Investor. Simple Business 2. Existing BusinessExisting Business. Dhandho Investor. Among the many case studies? Readers will be introduced to important value investing concepts such as 'Heads, I win! Tails, I don't lose that much! Using a light, entertaining style, Pabrai lays out the Dhandho framework in an easy-to-use format. Any investor who adopts the framework is bound to improve on results and soundly beat the markets and most professionals.
Tails, I don't lose that much! You are currently using the site but have requested a page in the site. Would you like to change to the site? Mohnish Pabrai. In a straightforward and accessible manner, The Dhandho Investor lays out the powerful framework of value investing.
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He is an unabashed admirer of Warren Buffet and Charlie Munger. Members Only. Please Sign Up or Log In first. Most people think risk and return are related.
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