The Dhandho Investor: The Low-Risk Value Method to High Returns

by Mohnish Pabrai

Dhandho (pronounced dhun-doe) is a Gujarati word. Dhan comes from the Sanskrit root word Dhana meaning wealth. Dhan-dho, literally translated, means “endeavors that create wealth.” The street translation of Dhandho is simply “business.”

Dhandho is all about the minimization of risk while maximizing the reward.

Gujarat lies along the Arabian Sea with a large, desirable coastline and several natural harbors. The Tropic of Cancer cuts right through the state. Over the centuries, it has always been an ideal location for trade with neighboring Asian and African countries—it has served as a melting pot of many different cultures over its rich history. The Parsis, fleeing religious persecution in Iran, landed in Gujarat as refugees in the twelfth century and were warmly received. Similarly, the Ismailis arrived in the first half of the nineteenth century from Iran. For several centuries, Gujaratis were very used to traveling to, and trading with, their Asian and African neighbors.

Patels originally were known as patidars—loosely translated as landlords.

Patels usually had large families, and as the land was subdivided into smaller and smaller fragments for each son, farming became a tough way to make a buck. In the late nineteenth and early twentieth centuries, Ismailis and Patels from Gujarat migrated in significant numbers to countries like Uganda in East Africa. They went as traders or as indentured laborers to help build the railroads.

The Patels and the Ismailis have been a very entrepreneurial community for centuries, and, over the ensuing decades (with their soon-to-be-revealed Dhandho techniques), they came to control a large proportion of the businesses in Uganda. General Idi Amin came to power in Uganda as a dictator in 1972. He declared that “Africa was for Africans” and that non-Africans had to leave. Amin wasn’t a big fan of the Patels who controlled most of his economy. The fact that most of these “non-Africans” like the Patels and the Ismailis were born in Uganda, had been there for generations, had no other home, and had all their businesses and property in Uganda meant nothing to Amin. For him, it was simple: Africa was for Africans. Amin revoked the residency permits of all Asians regardless of whether they had any natural homeland to return to. The Ugandan state seized all their businesses and nationalized them—with no compensation to the owners. A total of 70,000 Gujaratis were thus stripped of virtually all their assets and thrown out of the country toward the end of 1972.

The world had several hot spots in 1972 and 1973 that had a significant impact on the future destiny of these orphaned Patels. With the recent formation of Bangladesh in 1971 and the war with Pakistan over its independence, India was already reeling from a very severe refugee crisis. Millions of impoverished Bangladeshi refugees had poured into India. As a result, the Indian government refused to recognize the Indian-origin population being expelled from Uganda as having any right to enter India.

Amin’s Patel expulsion also coincided with the tail end of the Vietnam War and the United States was dealing with a large influx of Vietnamese refugees at the time. President Nixon and Secretary of State Kissinger were well briefed on the Ugandan situation and were sympathetic to the plight of the Patels, but were limited in the number of Indian-origin refugees they could accept. Being “members of the Commonwealth,” the vast majority of the Patels and Ismailis were allowed to settle in England and Canada. A few thousand families were also accepted by the United States as refugees.

If we examine the history of ethnic groups migrating to alien lands, we notice a pattern: In Chicago, many of the early Irish immigrants became police officers while most housemaids were Polish. In New York City, Koreans dominate the deli and grocery business, Chinese run many of the city’s laundries, and Sikhs and Pakistanis drive most of the cabs. It’s a bizarre sight, but most of the rental car staff at California’s San Jose International Airport consists of older Sikhs—turbans and all. There is a large population of Eastern European cab drivers in Vegas, and most of the prostitutes in Dubai are of Eastern European or Russian origin. The reason we end up with concentrations of ethnic groups in certain professions is because role models play a huge role in how humans pick their vocations.

Papa Patel sees this small 20-room motel on sale at what appears to be a very cheap price and starts thinking. If he buys it, the motivated seller or a bank will likely finance 80 percent to 90 percent of the purchase price. His family can live there as well, and their rent will go to zero. His cash requirement to buy the place is a few thousand dollars. Between himself and his close relatives, he raises about $5,000 in cash and buys the motel. A neighborhood bank and the seller agree to carry notes with the collateral being a lien on the motel. As one of the first Patels in the United States, Dahyabhai Patel succinctly put it, “It required only a small investment and it solved my accommodation problem because [my family and] I could live and work there.”

Papa Patel figures the family can live in a couple of rooms, so they have no rent or mortgage to pay and minimal need for a car. Even the smallest motel needs a 24-hour front desk and someone to clean the rooms and do the laundry—at least four people working eight hours each. Papa Patel lets all the hired help go. Mama and Papa Patel work long hours on the various motel chores, and the kids help out during the evenings, weekends, and holidays.

“I was my own front-desk clerk, my own carpenter, my own plumber, maid, electrician, washerman, and what not.”2 With no hired help and a very tight rein on expenses, Papa Patel’s motel has the lowest operating cost of any motel in the vicinity. He can offer the lowest nightly rate and still maintain the same (or higher) profitability per room than his predecessor and competitors. As a result, he has higher occupancy and is making super-normal profits. His competitors start seeing occupancy drop off and experience severe pressure on rates. Their cost structures prohibit them from matching the rates offered by the Patel Motel—leading to a spiraling reduction in occupancy and profits.

Manilal told me that he was deeply skeptical about handing his money to anyone in any type of business endeavor. However, this was a deal where he was going to manage the motel and, in effect, his investors had handed him the money. I told him Pabrai Funds worked the same way—I don’t need to do too much due diligence on my investors because I’m getting their money and not vice-versa.

Classically, his story is all about “Few Bets, Big Bets, Infrequent Bets.” And it’s all about only participating in coin tosses where “Heads, I win; tails, I don’t lose much!”

Boeing gave him some ballpark numbers, and Branson figured out that his total outlay and maximum liability for starting Virgin Atlantic Airlines (if it failed) was just $2 million. His record company was on track to earn $12 million that year and $20 million the next year.

Branson noted that in the airline business with a single plane, he would pay for the fuel 30 days after the airplane landed and for staff wages 15 to 20 days after the airplane landed, but he would get paid for all the tickets about 20 days before the plane took off. Working capital needs in this scenario were pretty low and, with a very favorable short-term lease from Boeing, there was no need to buy an airplane.

My take on Virgin Atlantic is simply this: if you can start a business that requires a $200 million 747 jumbo jet and a boatload of employees in a tightly regulated industry for virtually no capital, then virtually any business that you want to start can be gotten off the ground with minimal capital. All you need to do is replace capital with creative thinking and solutions.

With minimal downsides, failure rates don’t matter to Sir Richard Branson. Even if half these ventures fail or never scale up, it doesn’t matter. There’s virtually no money put into them to begin with.

number three is a Marwari entrepreneur, Lakshmi Mittal.

Mittal started in 1976 with a single, small, nondescript steel mill in Indonesia.

Take the example of the deal he created to take over the gigantic Karmet Steel Works in Kazakhstan.2 The company had stopped paying its workforce because it was bleeding red ink and had no cash. The plant was on the verge of closure 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.

the Sidek Steel plant in Romania, and the Mexican government handed him the keys to the Sibalsa Mill for $220 million in 1992. It had cost the Mexicans over $2 billion to build the plant.

Mittal’s approach has always been to get a dollar’s worth of assets for far less than a dollar.

Marwari businesspeople, even with only a fifth-grade education, simply expect all their invested 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.

I incorporated TransTech in February 1990 while continuing to work at Tellabs. I took ½ days off as vacation time whenever I had client sales calls. I used to work on the business at home in the morning from 6:30 AM to 8:30 AM, be at work during the day and again work on the business in the evening from 6:00 PM to midnight.

1. FOCUS ON BUYING AN EXISTING BUSINESS.

2. BUY SIMPLE BUSINESSES IN INDUSTRIES WITH AN ULTRA-SLOW RATE OF CHANGE.

buy simple businesses with ultra-slow long-term change.

We see change as the enemy of investments ... so we look for the absence of change. We don’t like to lose money. Capitalism is pretty brutal. We look for mundane products that everyone needs.1 —Warren Buffett

3. BUY DISTRESSED BUSINESSES IN DISTRESSED INDUSTRIES.

Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results.2 —Warren Buffett The entrance strategy is actually more important than the exit strategy.3 —Eddie Lampert

4. BUY BUSINESSES WITH A DURABLE COMPETITIVE ADVANTAGE—THE MOAT.

The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products and services that have wide, sustainable moats around them are the ones that deliver rewards to investors.5 —Warren Buffett

5. BET HEAVILY WHEN THE ODDS ARE OVERWHELMINGLY IN YOUR FAVOR.

6. FOCUS ON ARBITRAGE.

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. As Warren Buffett said, speaking at Columbia Law School: Because my mother isn’t here tonight, I’ll even confess to you that I’ve been an arbitrageur.9 —Warren Buffett

BUY BUSINESSES AT BIG DISCOUNTS TO THEIR UNDERLYING INTRINSIC VALUE.

8. LOOK FOR LOW-RISK, HIGH-UNCERTAINTY BUSINESSES.

9. IT’S BETTER TO BE A COPYCAT THAN AN INNOVATOR.

And that’s the Dhandho framework. To summarize: • Invest in existing businesses. • Invest in simple businesses. • Invest in distressed businesses in distressed industries. • Invest in businesses with durable moats. • Few bets, big bets, and infrequent bets. • Fixate on arbitrage. • Margin of safety—always. • Invest in low-risk, high-uncertainty businesses. • Invest in the copycats rather than the innovators.

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.

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. 2. When you buy a stock, you now have an ownership stake in the underlying business with one huge advantage—the business is already staffed and running. You can share in all the rewards of business ownership without much of the effort. The stock market 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.

discounted cash flow (DCF)

Flow

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John Burr Williams’s definition of intrinsic value is painfully simple, calculating it for a given business may not be so simple.

The Dhandho way to deal with this dilemma is painfully simple: Only invest in businesses that are simple—ones where conservative assumptions about future cash flows are easy to figure out. What businesses are simple? Well, simplicity lies in the eye of the beholder.

Einstein also recognized the power of simplicity, and it was the key to his breakthroughs in physics. He noted that the five ascending levels of intellect were, “Smart, Intelligent, Brilliant, Genius, Simple.”

Efficient market theorists (EMTs) tell us that all known information about a given publicly traded business is reflected in its stock price.

How do we get a list of distressed businesses or industries? There are many sources, but here are six to begin with: 1. If you read the business headlines on a daily basis, you’ll find plenty of stories about publicly traded businesses. Many of these news clips reflect negative news about a certain business or industry.

2. Value Line publishes a weekly summary of the stocks that have lost the most value in the preceding 13 weeks.