A lot of people dog on microcap companies.
For good reason. Many microcaps are run by sleaze balls.
Sometimes, however, microcaps are run by ridiculously astute operators.
👇 Is a crazy story from a guy who built two microcaps into successful businesses.
I’ve never seen a fold like that…[that was] the craziest hand I’ve ever seen.” - three-time World Series of Poker (WSOP) winner Phil Galfond (2012)
Where was this?
During the “Big One for One Drop” $1,000,000 buy-in WSOP tournament. The event became the highest buy-in poker tournament in history.
Galfond had just witnessed the unthinkable. Something you’d expect to see in a movie, but not in real life.
Two table mates were duking it out during the fourth blind level. Mikhail Smirnov - Russian businessman and part-time poker player - sat in Seat 2. Seated next to him in Seat 3 was then CEO of Winmark Corporation John Morgan.
Smirnov had been on a role; he had about 3.5 million dollars in his chip stack, slightly above average.
Then, Smirnov was dealt an eight of hearts and eight of diamonds. The dealer revealed a seven of spades, jack of spades and eight of clubs.
Smirnov, now with three eights, bet $50,000. Morgan immediately called (matched) the bet.
The turn showed an eight of spades, Smirnov’s fourth, creating a potential straight flush.
For those unfamiliar with poker a four of a kind, which Smirnov had, is the third highest ranking hand one can have in poker. The odds of getting a four of a kind is 0.024%.
Smirnov went ahead and bet $200,000.
John Morgan five seconds later called. After the final card, the river, was dealt Smirnov bet another $700,000. Morgan thought for a moment and announced “all in” for about 3.4 million in chips.
Mikhail Smirnov stalled for a few minutes. He contemplated whether John Morgan had a ten and nine of spades, making him the proud holder of a straight flush.
A straight flush beats a four of a kind. The odds of getting a straight flush in a game is 0.0014%. But a seven and eight of spades were already showing. And Morgan was going all in. So there was a good chance Morgan had it.
Or did he?
Smirnov didn’t want to find out. Turning the show into a farce, Smirnov folded his powerful hand boldly, face up for the world to see.
The table of other opponents and the audience were in awe, in disbelief. Such a powerful hand is rarely ever folded.
Whether John Morgan had a straight flush or bluffed, he demonstrated his integrity and class with the whole situation.
When pressed for an answer as to what he had, Morgan smiled at first.
Then, he paused.
Then, he said, “I’m not going to tell anyone, and the reason I am not going to reveal it is totally out of respect for my opponent.”
Morgan’s Track Record
John Morgan’s legendary poker move wasn’t pure luck. Morgan had been a successful poker player since his teenage years.
Moreover, he’s been winning in business and investing for decades. He led two businesses, in different industries and from different stages, to extraordinary success.
The first, a startup, was Northrup Resources Inc. founded in 1982 with partners Kirk MacKenzie and Jack Norqual. With an initial $105,000 investment (each partner contributing $35,000) the three built Northrup into one of the top computer leasing firms in the United States.
The company was sold to TCF Financial in 1997 for $340 million in TCF stock. The partners had significant skin in the game; by then Morgan and his partners each owned approximately 15% of Northrup.
The second, a turnaround, was Grow Biz International (known today as Winmark Corporation). The company was floundering and Morgan stepped in as CEO in 2000. The market capitalization of the company then was $30 million, a nanocap.
When Morgan stepped down as CEO in 2016 the company was valued at $410 million. Morgan at that time owned 22%, a majority of which was purchased on the open market.
How has John Morgan succeeded in business and poker all these years? A healthy dose of shrewdness coupled with a win-win mentality.
Why is one good at chess? You’re trying to analyze how things are going to happen in advance. I’m good at strategy - the same kind of skill that serves one well in playing poker or chess.”
And a bit of luck helped too. Morgan emphasized that
you don’t have to be that smart to make money in business. I was born a white male and I had opportunity. I’ve been lucky to be surrounded by smart, talented people. So, I’ve made a lot of money.”
Born in 1940, John Morgan grew up in Omaha. His father was a truck driver and his mother a part time bank teller and homemaker.
After graduating from Omaha North High School, Morgan earned his bachelor’s degree in political science from UNO (University Nebraska Omaha) in 1969. The prospects, though, did not look too bright for a blue-collar kid from north Omaha. Morgan said, “I was sort of a dead-end kid.”
He was into playing poker, partying and drink- ing. Morgan lived up to his college nickname ‘Bong Hog’.
Morgan didn’t have many choices to get ahead in life. So, during college he decided to become a salesman for IBM. He sold for IBM’s office products division in Des Moines, Iowa. Soon it became clear to Morgan that to make a lot of money he needed to learn about business.
By 25, Morgan began thinking deeply about businesses. According to Morgan:
I was trying to start businesses in my mind. How did they work? What drives this business? First, it was, ‘What do they do?’ Then as I got more sophisticated, it was ‘How do they really make money?’ To break things down in that fashion is the key to good investing.”
IBM helped Morgan polish up his appearance, his salesmanship and learn to take an interest in his customer’s business. Morgan also learned about the nascent computer industry as he sold IBM comput- ers and peripherals. The whole experience would set him on a lucrative path. Still, in the back of his mind, he thought much about business.
After IBM, Morgan worked for a number of businesses in the computer industry. He worked for computer tape and disk drive manufacturer Memorex, an unnamed failed startup, and began working for Dataserv in 1976. Dataserv was a pioneer in third-party computer maintenance, such as buying and leasing used computers. At the time the market was large at $2.5 billion and growing.
To give some perspective, office computers before the personal computer revolution were expensive. New IBM computers, such as the System/3-15, cost as much as $212,000. A used seven-year-old IBM model was a bargain at $125,000. And leasing made acquiring a new IBM even more approachable.
When John Morgan joined Dataserve in 1976, the company produced $12 million in revenues. In three years revenues doubled to $24 million. Except for 1973, Dataserv’s earnings grew each year since the company was founded.
At Dataserv John Morgan met two coworkers who would be instrumental in his future business endeavors, Jack Norqual and Kirk MacKenzie. Norqual had worked his way up through technology companies such as Control Data Corporation, Xerox and Dataserv. By 1982, Dataserv had promoted Norqual to vice president of equipment sales. MacKenzie was vice president of operations at Dataserv. All three men wanted out of Dataserv.
In Morgan’s words, “I didn’t want to travel as much.”
Although Morgan had been interested in business, MacKenzie and Norqual had to convince him to start a new venture. Eventually, the three men started Winthrop Resources investing $35,000 a piece (for a total of $105,000). With an additional $2 million line of credit from U.S. Bank, the men were in business leasing computer and office equipment.
Despite competition from their previous employer, at least 10 large companies and thousands of others, Winthrop earned $390,000 its first year. It maintained profitability every year under the trio’s management. And all but one year, 1987, earnings increased over the previous year. By 1993, Winthrop had a total market capitalization of $60 million!
Winthrop gained significant share, in a commodity business, by operating different and better. Unlike competitors such as Dataserv, GE Capital, Comdisco and others, Winthrop was not a high-technology junk dealer.
Most competitors relied on fooling people into leasing more than they needed, capturing big upfront fees and cooking the books were common within the industry at the time.
In 1993, Morgan described Winthrop’s true business model:
Look at us as a portfolio of customers. We don’t see ourselves as a commodity business. Instead, the company is a basket of assets that has been growing for the past 11 years. And as we grow that basket of assets, we are going to manage it the same way.”
Winthrop never sold its leases to outside investors. This was a first in the industry. Their portfolio of customers were fast growing businesses. Winthrop essentially bet on their customers not wanting to run their leases until the end of their terms.
Winthrop benefited from the fact that their large network of equipment took time to install/uninstall, so customers couldn’t switch or return obsolete equipment. The company ended up with about 80% of leases never reaching the end of their terms.
Not selling its leases allowed Winthrop to be flexible in renegotiating leases as customers grew and equipment needs changed.
The recurring, growing nature of the business model allowed Winthrop to provide new equipment and recapture its own initial investment at the same time. In other words, as analyst Clinton Morrison described,
If you are halfway through the lease and the customer wants to modify [it], what happens is that the transaction gets closed out. Winthrop gets to book the profit and start the clock again.”
Winthrop essentially grew alongside their customers. And the model allowed Winthrop to side step third parties. Customer service, in terms of efficiency and responsiveness, were unmatched.
There was no need for Winthrop to do anything stupid. A common problem in the leasing industry was residual values - the resale value of equipment after the end of a lease.
Most companies inflated that number to increase short term profits but hurt long-term earnings. Winthrop, on the other hand, had the lowest residual values. As Morgan stated in 1994,
Determining whether a competitor’s demise owed to fraud or stupidity can be difficult.”
Still, Winthrop had to fight the poor image others associated with the computer leasing industry. It actually prevented Winthrop from going public earlier than 1992.
Winthrop’s incentives were motivating. So motivating that Winthrop was ranked third in Minnesota-based companies in prof- its per employee, according to Corporate Report Minnesota. In 1992, the company earned $5 million for an average profit per employee of $139,000. That number grew each year. The commissions salesmen could achieve were high and the opportunities large. Winthrop sales- man Coleman P. Griffing earned $460,056 in 1993 and $681,754 in 1994.
John Morgan’s leadership, with the help of Jack Norqual and Kirk MacKenzie, kept the profits rising. Winthrop’s share price responded in kind. And eventually the company was sold to TCF Financial for ~$340 million in TCF stock. The valuation was 1x Winthrop’s assets.
TCF reasoned that, as a bank, they could make even more money because their cost of capital was much lower than what Winthrop had access to by itself.
From 1992-1997, shares of Winthrop increased more than 7 times. The compounded annual return was 40%. The S&P 500 went up only 2.5 times or 14% compounded annually.
Morgan’s decision to sell Winthrop for stock instead of cash turned out to be one of his best business decision of his career. He, and his partners, had significant skin in the game. They maintained 15% posi- tions each in Winthrop by the time of the sale. Morgan recalled:
I had looked at that stock over and over again, and said it was undervalued [at the time of the deal].”
TCF’s stock, by 2004, tripled after Winthrop was purchased. By then, Morgan had sold out of the majority of his 2% stake in TCF.
After running Winthrop within TCF and serving on the TCF board for only two years, John Morgan left the company.
The Next Opportunity - Grow Biz
Morgan and his partners were rich beyond their wildest dreams. But they didn’t stop. The three men set up Rush River Group LLC to invest in private and public equities. It wasn’t long until they stumbled on a unique opportunity in a company called Grow Biz International.
Grow Biz started in the 1983 by a Minneapolis, Minnesota woman named Martha Morris. She had run into a problem: there were no options to sell a large assortment of camping gear she only used once. As we often say great ideas are born out of frustration, not greed. Without any business experience, she took it upon herself to solve the problem. With $15,000 borrowed from a friend’s parents, Morris opened her first Play It Again Sports store in Minneapolis. The store bought and sold used sporting goods. Even though her store looked like a garage sale with hours, Morris sold $120,000 of used goods the first year and continued to grow.
Morris couldn’t help but notice, through customer feedback, that her stores could work across the United States. In 1988 she enlisted help to franchise her business. She hired Franchise Business Systems, Inc. led by Jeff Dahlberg and Ronald G. Olson. Dahlberg drew on his experience of franchising his family’s hearing-aid business, known as Miracle-Ear. The company was sold to Bausch & Lomb for $139 mil- lion in 1993. Olson had two decades worth of retailing experience with companies such as Dayton Hudson Corporation. In 18 months there were 19 Play It Again Sports franchise operations in six states, and revenues reached $800,000.
After two more years of rapid growth Martha Morris decided to cash in. She sold the franchising operation of Play It Again Sports to Dahlberg and Olson for $1 million plus five years of royalty payments. She sold them her two retail stores, as well.
Play It Again Sports franchises spread like wildfire. By 1991, 134 franchise stores were in operation in the US and Canada. Dahlberg and Olson felt the used retailing concept could be expanded to other products. They added three other franchise concepts selling used children’s products, computers, and music. Total sales resembled an often sold Play It Again Sports item, a hockey stick. Sales in 1991 went from $3.3 million to $50 million in 1993! Total franchised stores reached 422. Inc. Magazine listed the company, by then known as Grow Biz International, the fourth-fastest growing private company in America.
A Growing Problem
Grow Biz International went public in 1993. By 1998, there were 1,212 franchised stores in operation generating ~$100 million in annual revenues. Such rapid growth started catching up with the company. Dahlberg and Olson had been handing out franchises to anyone with money. Little effort was put into finding the right partners. Eventually growth slowed and the company had to close or sell 181 stores. Shares of Grow Biz had fallen from a high of $20 to $2 by the end of 1999.
Jeff Dahlberg, then CEO, Ron Olson, and Sheldon Fleck, a large shareholder, needed to fix the situation. They found John Morgan and invited him to take over as CEO. Morgan and his partners with Rush River Group purchased shares of the company.
The Turnaround - From Grow Biz to Winmark
Morgan recalled that the next six months “was the worst six months of my business career.” Morgan had to refocus the whole organization. There were too many franchise concepts and too many stores. He started by selling Computer Renaissance, the used computer franchise concept, and dissolved Retool which sold used tools.
Like Roger Penske’s turnaround of Detroit Diesel in the late 1980s, Morgan met with disgruntled franchisees. He listened to their concerns but made it clear that things were different now.
Employees also had to realize the truth of the situation. As Morgan told them:
It’s just a job for you [employees] here. For our franchisees, it’s their marriage, their kids, and in some cases, threats of suicide. It was a disaster.”
Gone were the days of handing out franchises to anyone with the money. Morgan instituted a thorough system of vetting potential new franchisees. Instead of growing for growth sake, which the Grow Biz name implied, Morgan chose to grow the business “at a reasonable rate for shareholders, management, employees and the franchisees.”
John Morgan ascribed to Warren Buffett on the issue of concentration. He said,
Diversification is overrated. If you find a good idea pile in… we don’t have to get involved in foolish diversification ideas.”
John Morgan piled in on one franchise concept, Plato’s Closet. He bet that the trend of consumers shopping for clothing at resale stores, such as Plato’s Closet, was the company’s best opportunity. Grow Biz had only five Plato’s Closet franchises by the time John Morgan took over the firm. Plato’s Closet bought and sold used and new clothing and accessories geared toward the teenage market. Morgan set out to build Plato’s Closet the right way, by acquiring franchisees with the greatest potential and focusing on the best areas. By 2016, when Morgan stepped down as CEO, Plato’s Closet grew to 456 stores.
Additionally, Morgan financially piled into the company, now named Winmark Corporation. Aside from being issued 600,000 options at $5, Morgan bought the remaining 1.06 million shares of Winmark on the open market. He ended up owning more than 33% of the company by 2012. And he didn’t sell a share until he stepped down as CEO. He continues to own 12.9% of the company in 2018.
Winmark grew its franchises the right way by encouraging a system of support. They’ve properly unlocked the mentor apprentice relationship. Winmark creates opportunities for franchisees to interact. In addition to encouraging new franchisees to reach out to mentors before they open their own store, Winmark has an annual national conference. There, veterans share their experience and wisdom while new franchisees bring new ideas and perspectives. Steve Murphy, president of franchising at Winmark, described:
“What’s worked well for us at our conferences is having workshops with panels that include both new franchisees and veterans. This brings a great mix of new ideas, thinking and training to the table and adds a new level of respect for one another.”
Other ways to foster in-person mentoring, and cross pollination of ideas, are regular regional meetings throughout the year.
Such a culture of support, mentoring and knowledge transfer was not present during Grow Biz’s growth years. And Winmark’s support culture has led to the success of the franchise as a whole. It makes sense why John Morgan liked the idea of a franchising business. Franchising is not capital intensive and cash flows can be reinvested elsewhere. One just needs the right reinvestment opportunities. After Morgan’s five-year non-compete contract had expired with TCF, in 2004, Winmark invested excess cash into what Morgan knew
best, equipment leasing. Like the franchising unit, Morgan wanted “to go slowly and do it right.” Today Winmark has a $43 million equipment lease portfolio and they’ve done it entirely through internally generated cash, no outside equity.
Still, Winmark was awash in cash as Morgan turned the company around. Instead of deworsifying, Morgan chose to allocate into the opportunity he knew best and was trading with a significant margin of safety. Since Morgan took over Winmark, the company has returned nearly $250 million dollars to shareholders in stock repurchases and dividends. 3.5 million shares worth $184 million, 30% of shares out- standing, have been repurchased from 2000 - 2017. And $58 million has been distributed as dividends. Remember, Winmark’s market capitalization in 2000 was $30 million.
Incentives: John Morgan leveraged the power of incentives once again at Winmark. You would expect a CEO to pay themselves the highest salary, right? Morgan, even as the company’s largest shareholder, didn’t believe so. Morgan earned a $100,000 salary until 2004. Every other Winmark executive received a higher salary.
To promote equanimity, starting in 2005, Winmark’s top executives have all received the same base salary and bonus. The only exception is that John Morgan did not receive any stock options, while the other executives did. And during 2009 Morgan reduced his salary.
Morgan explained the reasoning behind paying the same salary to all executives as such:
You don’t do things just because you can. You do things because you have a reason to. And my reason to do this [to pay all executives the same salary] is that this motivates them. It works.”
By 2016, Winmark became the United States’ largest resale franchisor by surpassing $1 billion in system-wide sales. The company had a total of 1,100 franchise locations and each of the five franchise concepts had received top marks from Entrepreneur magazine’s Franchise 500 ranking. Plato’s Closet was also named one of the nation’s top five franchise investments according to Forbes magazine.
John Morgan’s Winmark team created significant shareholder value. Shares in Winmark went from ~$5 in 2000 to $100 in 2016. Including dividends, Winmark generated a 21.6% compounded annual rate of return. The S&P 500 over the same period generated a 2.5% compounded annual return.
One of the interesting things about John Morgan is his poker playing and the parallels with business. He’s demonstrated the same uncanny no-fear attitude, competitiveness and ability to read people in poker that has worked in business. While Morgan doesn’t play poker purely for the monetary rewards, he’s a multi-millionaire many times over, he said:
I think the strategic element in poker is very valuable. Being able to read people is a good trait to have in business as well as poker.”
Since getting into No-Limit Hold’em poker tournaments in 2006, and playing any smaller tournament, he’s caught the attention of some of poker’s elite.
As mentioned prior, he got Russian businessman Mikhail Smirnov to fold four eights. And in 2015 during the Super High Roller Series he got Rick Salomon to fold two kings, which Salomon claims he has never done before.
And during the same tournament Morgan bluffed his way out of a situation against Bill Perkins. Morgan caught the poker pros at the table off guard. Jean-Robert Bellande told Morgan, “You’ve got radar!” And Antonio Esfandiari, one of the top world’s top poker players today, said to Morgan “I would have lost a lot of money on that hand.”
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** This was originally published on Intelligentfanatics.com as a case study
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