An investment lesson from Milo Minderbinder
Catch 22 is my favorite book. It is an American classic and a literary masterpiece, but we've all read it, so I shouldn't waste time praising its literary merits. What I want to say here is that Catch 22 possesses that trademark of a classical novel - everlasting relevance. No matter what field you're working in, classical literature gives you a hint of what to expect in any kind of situation. And I truly believe that Catch 22 should be a required reading for any investor.
Have your doubts? Well, here's a practical situation. You have Imergent (IIG) - a fraudulent company engaged in the business of cheating the would-be Rockefellers out of their $5000 starting capital. The state authorities, the fraud victims, and the hungry class-action lawers are filing lawsuits by the dozen, and the stock is tanking. Should you invest in this pig?
Let's turn to Joseph Heller for the answer. Here's the description of a business model that looks similar to IIG:
"Milo chortled proudly. "I don't buy eggs from Malta," he confessed... "I buy them in Sicily at one cent apiece and transfer them to Malta secretly at four and a half cents apiece in order to get the price of eggs up to seven cents when people come to Malta looking for them." ...
"Then you do make a profit for yourself," Yossarian declared. "Of course I do. But it all goes to the syndicate. And everybody has a share. Don't you understand? It's exactly what happens with those plum tomatoes I sell to Colonel Cathcart." "Buy," Yossarian corrected him. "You don't sell plum tomatoes to Colonel Cathcart and Colonel Korn. You buy plum tomatoes from them." "No, sell," Milo corrected Yossarian. "I distribute my plum tomatoes in markets all over Pianosa under an assumed name so that Colonel Cathcart and Colonel Korn can buy them up from me under their assumed names at four cents apiece and sell them back to me the next day at five cents apiece. They make a profit of one cent apiece, I make a profit of three and a half cents apiece, and everybody comes out ahead."
So, M&M enterprises does look like the IIG of the 1940's. Apart from some trivial differences, the business model is essentially the same: you swindle the low-income people (enlisted men in Milo's case, or the faithful desciples of Robert Kiyosaki in the case of IIG) and pay the regulators to look the other way. So, what does Heller have to say about the viability of this business model? Let us read on...
"Milo was Sir Major Milo Minderbinder in Malta... Milo had been knighted, commissioned a major in Royal Welsh Fusiliers and named assistant Governor General of Malta because he had brought the egg trade there... Milo was Vice-Shah of Oran. Milo was not only the Vice-Shah of Oran, as it turned out, but also the Caliph of Baghdad, the Imam of Damascus and the Shiek of Araby. Milo was the corn god, the rain god and the rice god... "
So, despite its controvercial reputation, M&M enterprices was still a solid business generating gobs of cash for its owners. What is the lesson here? It's this: regulating authorities do not go after businesses that commit fraud against low-income individuals. It's only when you swindle Colonel Cathcart and Colonel Korn that you find yourself in trouble. There is no doubt that Heller would have been an M&M investor if only he could have the SEC confirm the authenticity of that sheet of paper saying "share" that Milo gave to Yossarian.
OK, IIG is now history, not in the sense that it's out of business (quite the contrary: this stuff still floats - it always does), but in the sense that most money has been made on this one. How about we take something more recent?
Here is the latest news about WellCare Health Plans (WCG): http://www.marketwatch.com/News/Story/wellcare-shares-keep-tumbling/story.aspx?guid=%7BBABE42AC%2D0F5E%2D44AD%2DBD7D%2D6C5A23D89B87%7D
OK, another fraud situation, but this time the fraud is against the Federal Government. This is not IIG, so the previous example no longer applies, and now we, as investors, are in the dark again. But keep on reading. You'll see that Catch 22 has plenty to say about our little problem:
"You know, a thousand dollars ain't such a bad price for a medium bomber and a crew. If I can persuade the Germans to pay me a thousand dollars for every plane they shoot down, why shouldn't I take it?" "Because you're dealing with the enemy, that why. Can't you understand that we're fighting a war? People are dying. Look around you, for Christ's sake!" Milo shook his head with weary forberance. "And the Germans are not our enemies," he declared. "Oh, I know what you're going to say: Sure, we're at war with them. But the Germans are also members in good standing of the syndicate, and it's my job to protect their rights are shareholders. Maybe they did start the way, and maybe they are killing millions of people, but they pay their bills a lot more promptly than some allies of ours I could name.""
What a beautiful analogy! An obvious case of double-dealing, and the public interest is at stake. Sounds just like WCG. So, how will this medical billing crisis play out? Again, Heller gives us an excellent clue:
"Decent people everywhere were affronted, and Milo was all washed up until he opened his books to the public and disclosed the tremendous profit he had made. He could reimburse the government for all the people and property he had destroyed and still have enough money left over to continue buying Egyptian cotton. Everybody, of course, owned a share. And the sweetest part of the whole deal was that there was really no need to reimburse the government at all. “In a democracy, the government is the people,” Milo explained. “We’re the people, aren’t we? So we might just as well keep the money and eliminate the middleman.”
So, WCG is safe as far as its balance sheet is concerned, according to Heller, and that's one part of the investing thesis. But there's the other part: calculation of future cash flows. The tricky part is that after paying the damages (if Heller is right, the payment should be zero; but you may want to assume something like $0.99 to err on the conservative side), WCG will still depend on the government for its bread and butter. Yes, gauging future governmental demand for WCG's fradulent services is not that easy. And yet again Heller provides a helpful clue to investors:
"Why don't you sell your cotton to the government?" Milo vetoed the idea brusquely. "It's a matter of principle," he explained firmly. "The government has no business in business, and I would be the last person in the world to ever try to involve the government in a business of mine. But the business of the government is business," he remembered alertly, and continued with elation. "Calvin Coolidge said that, and Calvin Coolidge was a President, so it must be true. And the government does have the responsibility of buying all the Egyptian cotton I've got that no one else wants so I can make a profit, doesn't it? But how will I get the government to do it?" "Bribe it."
"Bribe it!" Milo was outraged and almost lost his balance and broke his neck again. "Shame on you," he scolded severely, breathing virtuous fire down and upward into his rusty mustache through his billowing nostrils and prim lips. "Bribery is against the law, and you know it. But it's not against the law to make a profit, isn't it? So it can't be against the law for me to bribe someone in order to make a fair profit, can it? No, of course not! But how would I know who to bribe?" "Oh you don't worry about that. You make the bribe big enough and they will find you. Just make sure you do everything right out in the open. Let everyone know exactly what you want and how much you're willing to pay for it."
So, thanks to Heller, we already know the resolution of the WCG crisis. I'll repeat it again: reading Catch 22 is as important as reading the works Graham and Lynch. Because you see, classical literature can provide useful guidance in any kind of situation...