Maverick Investor
July 1993


Whether in his role as entrepreneur or investor, Sam Wyly is apt to dismiss his successes with terms like, “I read a lot.” But no matter the secret, for the past three decades he has won a legion of admirers for his uncanny knack of picking winners early and knowing just when to take profits.

There's always been so much more to it than simply timing, insight, or even nerve. In fact, if there really were one reason why Sam Wyly regards big risks as even bigger opportunities, it is that he does his homework. He is as diligent a researcher of individual situations as of entire markets. Over his business career, he's placed huge bets on opportunities few others saw, let alone understood. In
a couple of them, emerging businesses as diverse as computer software or arts and crafts superstores, he's also set about bringing whole industries to fruition. Investors who've followed him early and stayed for the ride have reaped hefty gains.

Like all seasoned investors, Wyly will remind you that he hasn't always triumphed. One Wyly loss has become as celebrated as his wins. In the noble but ill-fated Datran telecommunications venture of the early 1970's, which would have been the first all-digital, software-switched telephone company for computer users, the concept was perfect, just a few years before its time. Datran remains one of the three main entrepreneurial ventures that ultimately brought about radical change
in the USA, from a national policy favoring monopoly to one of competition in the telephone and telecommunications industries. (Other countries are now following the USA's example in moving toward competition and away from government ownership and control.)

Yet even in the losses, there shine through the qualities that make a great many more things go right. What are they? Diligence and persistence, sure. But there's also a good bit of the contrarian about Wyly. More importantly, there is a willingness to put not just money but time into the effort. And then there is this stubborn refusal to ever look back.

Sam Wyly is equally comfortable in his roles as entrepreneur and investor. The substantial gains he has produced, the businesses created and lives affected - not to mention the impressive family fortune built over the years - all testify to a special talent for deploying and growing capital.

Q: How do you classify the differences between your roles as an investor and entrepreneur?
A: There are similarities between investing and the entrepreneur's job of creating and running a company. When I look at a security, I must first ask myself, "Would I be prepared to buy the whole company?" Many times over the past 30 years I have bought the whole company, and then have had to make it pay off. I do the same in looking at an emerging country. Can Argentina's president and finance minister make their economy work? I say they can. Another investor may doubt that. One of us will be wrong.

The late Edward Johnson, Sr., the long-time leader of Fidelity, once said that the best portfolio managers seemed to have the same characteristics as successful entrepreneurs. I agree.

Q: To what factors do you credit your investment performance?
A: Our asset allocation decisions have tended to be as important as the specific stocks or bonds we've picked. The US Congress made a horrible blunder in 1990, for instance, by legislating highyield bonds out of the portfolios of savings and loans. Bands were dumped at fire sale prices. This created a blood-in-the-streets investment opportunity for an entire class of assets - for me and for others who had the courage to act.

I viewed junk bonds as a high income form of equity. We looked through the securities to the intrinsic values of the assets themselves. Bonds were being dumped at distress prices, first by government decree and, second, because of investors' reactions. Junk bonds were being damned in the media. Fear and panic hung heavy over Wall Street. So it was bargain time.

Q: But isn't it risky to take sides against Wall Street or the US government?
A: Perhaps. But the potential reward made the risk worth taking. Fortunately, no government can abolish the laws of economics. I try to be right on something strategically. If I'm right on the strategic points, I can be wrong on some tactical or timing issues, and it won't matter. I didn't know how quickly high-yield bond market prices would come back. But, with the bargains I was getting, it simply didn't matter what the market prices were. We had established a good income stream which we could enjoy for ten years or more. Actually, high-yield bond prices advanced for a month after our first buys, then fell when the Iraqi tanks rolled into Kuwait and oil jumped from $17 to $40.

They declined for almost three quarters. We chose to buy more.

Q: Did you have a high level of confidence that you were right?
A: Yes. It was one of those rare times when I felt I knew something for sure. In 1981, the same thing was true with a totally different class of asset - United States treasury bonds.

My earlier experience, going back to grandmother's buying savings bonds for my schooling, was that the US government will con you into giving up your savings in return for less real money later. For 40 years, since 1941, Treasuries had paid the investor a negative 2 % yield after inflation. Interest rates kept climbing to try to compensate for inflation, so that by 1981 Treasuries hit 15%. That was the first time I bought them. I bought big and I bought the longest maturities, then stripped off the coupons, sold the bodies of the bonds to take capital losses to offset capital gains from the sale of oil and silver assets, and kept assets and kept the coupons. They are still maturing in my children's trust accounts, and the capital gains taxes they are paying today have been deferred for over 12 years.

Q: As you've noted, though, high returns usually require high risks. How do you balance the two?
A: I take greater than Treasury risks in order to realize greater than Treasury returns. The idea is to understand the businesses and take only those risks which are justified by the rewards.

We bought Chrysler bonds for a 16% yield over a year ago. There was speculation about possible bankruptcy, but I was convinced that they had good products in the wings, good managers and could whip the Japanese and Germans in the American marketplace.

Today, Chrysler is going from a $1 billion loss to a $3 billion profit and they are on S& P's Credit - watch for return to investment grade. We did the homework and took a risk that most folks did not wish to take.

That was the icing on the cake. Chrysler didn't have to turn around that quickly for my investment to be okay. I would have been quite happy with 16% and the bonds priced at our cost of 75 until their maturity in 2015. Instead, mere survival turned into success and drove the bid to 109, where I sold because of a call price at 104. At 75 we had call protection. At 109, our success had eliminated our call protection, so it was time to go.

(May 2000 Note: Chrysler, now a part of Daimler Chrysler is back to its old game. History repeats.)

Q: Talk about other major bets you've made that have proved successful.
A: In the 1970's, with silver at $2 on an ounce, we discovered, developed and operated the second largest silver mine in USA. (About 30% of the value of the mine's production was gold.) A sustained rise in prices followed by a real buying frenzy which drove silver briefly up to about $50 and gold to $875. They went from being underpriced to grossly overpriced. An awful lot of jewelry adorning the
necks of women in India suddenly found its way to market. People were selling the family silverware. That's when we sold the mine.

Likewise, the price of oil had risen from $3 a barrel to $12 in 1973, and then to $36 after the Shah of Iran fell in 1979. We had built up Earth Resources from essentially no profits in 1969 to earnings of about $50 million on $700 million revenues in 1980. That was another of those times when I felt I knew something for sure. This gross overpricing of oil was certain to turn scarcity into glut.

I read a lot. Then I decide whether I agree or disagree with what's written. I remember that when American publications were writing about the desperate oil shortage, The Economist in London chose to forecast a coming oil glut. I agreed with their logic. It simply made sense to me that, when a commodity appreciates in price from $3 to $36, people will find a way to make do with less… and, some will find ways to bring forth more supply.

In 1980, one third of all USA corporate profits were being made by the oil companies. Banks were lending to drill oil and gas leases on the assumption of $60 and $6 natural gas. Exxon bet a billion dollars on Colorado oil shale. It was a repeat of tulip bulb mania.

We closed the sale of Earth Resources in November, 1980, the very month that oil peaked at $36 a barrel and oil stocks topped out.

Q: With Bonanza, you built one of the first national steak restaurant chains. What was the investment case?
A: In retail, when you created a good concept, you can multiply it many times over. We built the chain from 20 stores to 600 over 20 years. We were nearly killed in the recessions of 1974 and 1982. Not wanting to take that punishment again, we sold out in 1989, just before the last recession.

Q: In forming University Computing Company, you created the first computer time-sharing business and paved the way for the systems software industry as we know it today. How did you get started?
A: I was looking for a business to go into - for an entrepreneurial opportunity - so as to escape working for a larger company and gain the freedom to run my own show. (I worked first for IBM, then Honeywell.) Getting rich was not really important to me, although I did figure that would come too. I came across an IBM market research study whose goal was to determine whether or not there was a market for large-scale engineering computer services in North Texas. The study concluded there wasn't.

I'd been talking to IBM's customers, however, and my conclusion was to the contrary. Agreed, there was no market at IBM's $3 million capital cost: the monthly breakeven cost was too high. But I found a second-hand computer designed by Seymour Cray that cost only $600,000 and was capable
of doing the same thing IBM was contemplating.

I then bartered with my first two Dallas customers - Sun Oil and Southern Methodist University - giving them computer service in return for free rent, electricity, two-thirds of the maintenance costs and a $225,000 pre-payment from Sun. We expanded to other cities and we grew earnings 100% a year for six straight years.

In September 1965, the public bought 40% of UCC in a one million dollar IPO. In the four years that followed, the initial investors got a 100-to-1 return. During that same four years, the Dow declined and long-term government bonds earned a real rate of return of minus 5% a year.

We started the software products business because we felt it was a logical extension of computer utility services. Of course we had no idea at the time that time-sharing would ultimately be killed by the advent, first, of Digital Equipment's minicomputers and the, of Apple and IBM personal computers.

I remember walking down the hallway of a company in California and seeing the words "Software Products" on a door. I thought, "How could software be a product?" Software to me, as to most people then, was simply a set of instructions that you wrote to tell a computer what to do. I had no notion that this idea would develop into the Sterling Software's and Microsoft's of today. Still, this struck me as an intriguing concept. The very first independent software product I was aware of was a mathematical program created by some small company for use on an IBM 7044. A few months later IBM offered the same product free and wiped that company out.

So, we started the independent systems software business with a healthy level of respect, constantly looking over our shoulders at IBM. Maria Smith and a small team of programmers created the first product, a tape management system which has become the industry standard. Sterling Williams was the first full-time sales representative. Today Maria is a division president at Sterling Software and
Sterling is the chief executive. It was my friend Don Thomson's idea to create a separate division at UCC and see if he could build a sales force and charge customers a separate price for software that helped manage their data centers. It worked.

Q: Twenty years later, in founding Sterling Software, you took a somewhat different approach, including making the software industry's only hostile takeover. What's the story?
A: Sterling was a sort of born-again University Computing. We started by bringing together a few very bright people with experience. The concept itself was simple. We were going acquire key products in growth markets and build marketing organizations, then benefit from the wonderful leverage you get with software when you pump progressively more products through those established channels.

We quickly grew to $18 million a year in revenues, and that's when we got the chance to build real critical mass by going after a company ten times our size. Conventional Wall Street wisdom said you couldn't do a hostile takeover in this industry, because the people were the only assets and they would walk out the door. We bet that Wall Street was wrong, that the key technical and marketing
people would view us not as conquerors but as liberators. They did.

In circumstances like these, however, you have recognize that the people in power are reluctant to give it up. You've got to have a firm belief that you're right, and that you can make the business worth a lot more than it was worth before. The fundamental values have got to be there. Realizing those values requires keeping the best products and selling off or shutting down weaker operations.
I never doubted for a minute that we could pull it off. This was another of those instances when I felt I knew something for sure. And I feel the same way bout Sterling's friendly merger with Systems Center. I'm confident about the future of the combined enterprise because the best and brightest from both companies are focused on aggressive but attainable growth goals.

Q: Have you ever had the uneasy feeling that an idea which you've thoroughly analyzed, carefully evaluated and intelligently pursued might still not work?
A: Yes. One case involved a $3 billion technology company made up of about 14 different divisions which we wanted to acquire. When we began doing the work, in the summer of 1987, LBO money was available at 13%. I started out determined to make this the second time we'd taken over a company ten times larger than us. But, by the time we really understood all the different pieces, our cost of money had climbed to 16%.

We'd invested $15 million at $23 a share for a toehold, intending to bid $35-40. But the market kept climbing and it became apparent that a $45 - 50 offer would be required.

I was troubled. We had a lot of people working on the deal for about four months. My brother saw that I was troubled. I said this thing just didn't seem to be working. Then he said, "You know, Sam we don't have to do anything." I found that a liberating thought.

I immediately gave instructions to sell our stock in the takeover target and disband the task force. I went to Italy for three weeks. I came back mellowed and spent a couple of days talking to software analysts in New York. As we went from one meeting to the next, I couldn't help noticing that these people were turning whiter and whiter. It turned out that this was the Thursday and Friday before Black Monday of October, 1987.

Technology stocks were being killed early. We had liquidated our entire position in the target at $36. The highest price that stock ever traded was $36 ¼. It was $13 a month later. It never came back.

The lesson here is that, after people put great effort into something that could be a real coup, it is very tempting to fool yourself into thinking you can make it work. The entrepreneur in me was saying, “I can find a way to make this work.” But the trader in me kept repeating the lines from Kenny Rogers' The Gambler; “You've got to know when to hold'em know when to fold'em…know when to walk away…know when to run.” The trader was right. It was time to run.

Q: Any other good examples of walking away?
A: I invested eight years and $100 million between 1968 and 1976 trying to create a nationwide telephone company for computers at a time when AT & T held the monopoly on long distance. I named it Datran - for data transmission company. There were major telecommunications innovations involved. We would be the first digital transmission network, when everything else was analog. We would be the first switched digital network, which gave us a 10-1 cost advantage but which required that we make the first digital switch work. Our engineers did exactly that.

But we also had to bring about a change in national telecommunications policy - from one of protected monopoly to one of competition, where customers would have many choices. We, along with Bill McGowan of MCI, Tom Carter of Carterfone and a dedicated group of public servants at the FCC and Justice department got that done… and, in the process, became a small footnote in economic history. Unfortunately for Datran, we couldn't get it done soon enough.

We had started the anti-monopoly battle in 1968 against what was then the world's biggest company. But we didn't get our charter until 1973. In 1974 and 1975 we saw the most severe bear market since the Great Depression. (Actually the 1970's were worse than the 1930's on an inflationadjusted basis.) Wall Street was no longer a place where you could get financing. The "nifty fifty" big stocks had lost 60-90 % of their 1973 value, and small cap stocks lost 80% of their 1968 value. (In fact, the S&P 500 didn't regain its 1973 value, on an inflation-adjusted basis, until 12 years later.) The sum total of venture capital money fell from $1 billion in 1969 to about $50 million only five years later. And the commercial bank window slammed shut.

In the mid-1970's, no matter how determined I was to get it done, it simply wasn't going to happen. So, in 1976 I made my most painful business decision. After eight years, I locked the doors and laid off the people.

Over the next three and a half years we doggedly fought an anti-trust suit against the telephone monopoly and got a $50 million settlement, but this was little balm on the wounds of our loss.

Timing, of course, plays a decisive role. The $500 million of entrepreneurial capital we needed would have been readily available in the late 1960's or early 1980's . In fact, in 1983, just a few years after we hunt down, five different start-up personal computer companies succeeded in raising $100 million each in the equity markets. We all now know today that most of hundreds of billions raised by Wall Street for Dot-Com, Technology and Telecom ventures in 1995 - 2000 were invested in business models far more risky than Datran.

Q: Michaels stores and the arts and crafts business is about as different as it gets from the field of high technology. Yet, even there, you seemingly were able to spot an unusual growth opportunity.
A: Michaels' balance sheet told us somebody was doing something right. Every new store opened was posting strong annual sales gains. The company was offered to us for $8 million and it had $4 million cash in the bank.

You never need to know everything there is to know about a business. If you know the vital few facts absolutely and those facts hold, then everything else there is to know doesn't really matter.

Q: How are Michaels and Sterling doing today?
A: They have very substantially outperformed both the S&P 500 and their industry sectors over the past five years. I'm confident that will continue over the next five years. (May 2001 note: they did.)

Q: Are you to apply the approach of absolutely needing to know only the vital facts to, say, the sovereign bonds of another country?
A: Yes, I think so. Argentina is one example. In recent years, real estate and LBO loans have been busting USA, Japanese and European banks. Before that it was the LDC's or Lesser Developed Countries. In the oil-inflated 1970's , these mostly Latin American nations and their state-owned companies borrowed heavily and spent foolishly, as the state always does. Then they defaulted and brought depression to their people in the 1980's. But following the lead of Chile and its Milton Friedman -taught advisers, Argentina made a fundamental decision about three years ago to go to free markets and away from state ownership and control.

I've bought Argentina and Mexico, and I'm convinced that they are going to be credit upgrades.

A lot of people won't stay with a situation for the time required to achieve optimal returns. We've stayed with investments - whether they're sovereign bonds or new Wyly businesses - because, on the whole, that's how the big gains are produced. You rarely catch the very bottom or very top. We've tried to be right mainly on changes in the tide.

We bought Venezuela par Brady Bonds in 1992 at 63 and watched them drop to the low 50s on rumors of a military coup. This year they've come roaring back above our cost despite having three presidents in three months. We're betting that Caracas will get its act together and return to an investment-grade sovereign borrower. In the meantime, this market will be volatile, but we don't think they will miss any interest payments. Anyway, it's our job to grow income over time…not to
gloat or panic over monthly swings in our net asset value.

Q: What other areas of the world are you excited about?
A: I'm convinced that the three biggest growth areas are Greater China - by which I mean the mainland, Hong Kong, Taiwan and Southeast Asia generally - followed by Latin America and Eastern Europe.

A couple of years ago I was buying Hong Kong Telephone when there was fear in the market about Beijing confiscating all the companies in Hong Kong - as they did in Shanghai 45 years ago. The government of China had invested a billion dollars in it, which I wouldn't do if I intended to confiscate it. The company has a good shot at delivering telephone service to a fair slice of a billion people.

China made the decision in 1978 to free its markets, so there's already been a long process of transferring state ownership and control to the free market. China is well along the road to free markets. And nothing is going to change that.

Q: You sound a great deal more optimistic about china politically than the media and most Congressional Democrats would have us be. Why is that?
A: The images of Tiananmen Square fade slowly. That was a terribly sad incident, but it did little to slow the process. I didn't say China was the most democratic country in the world, but the Chinese have a saying that predates the commissars: "The mountains are high and the emperor is far away." I personally believe that in China, as in Chile, free elections will follow free markets.