Goofy Ideas

I have written in the past about Hans Christian Anderson’s famous folktale from the 1830s, “The Emperor’s New Clothes,” and some recent events prompt me to remind readers about this very instructive lesson in life.

The story relates a tale of two swindlers who arrive at the capital city of an emperor who spends lavishly on clothing at the expense of state matters. Posing as weavers, they offer to supply him with magnificent clothes that are invisible to those who are stupid or incompetent. The emperor hires them, and they set up looms and go to work. A succession of officials, and then the emperor himself, visits them to check their progress. Each sees that the looms are empty but pretends otherwise to avoid being thought a fool.

Finally, the weavers report that the emperor’s suit is finished. They mime dressing him and he sets off in a procession before the whole city. The townsfolk uncomfortably go along with the pretense, not wanting to appear inept or stupid, until a child blurts out that the emperor is wearing nothing at all. The people then realize that everyone has been fooled. Although startled, the emperor continues the procession, walking more proudly than ever.

I am that child … I have spent my entire career looking at trends and ideas through clear eyes, and it has served me well in business and has often led me down a path very different than crowds often follow. The fact that some of these ideas become popularized and develop huge followings despite the lack of substance or value behind the idea has always startled me.

Take, for example, tulipmania in Holland in the 1630s, when the Dutch tulip bulb market bubble was one of the most famous asset bubbles and crashes of all time. At the height of the bubble, tulips sold for approximately 10,000 guilders, equal to the value of a mansion on the Amsterdam Grand Canal. The subsequent crash sent the entire Western European economy into recession. Of course, others like Charles Ponzi came along years later with his famous ploy to entrap investors with his goofy idea in the early 1920s. He promised clients a 50 percent profit within 45 days or 100 percent profit within 90 days by buying discounted postal reply coupons. In reality, Ponzi was paying earlier investors using the investments of later investors. While this type of fraud was not invented by Ponzi, it became so identified with him that it now is referred to as a “Ponzi scheme.” His scheme ran for over a year before it collapsed, costing his investors $20 million.

Ponzi was not alone. Other schemers like Bernie Madoff duplicated Ponzi’s methods, but like the little child at the parade, I always wondered how he could generate such steady returns that barely fluctuated. And today, cryptocurrencies, with nothing backing them, have become popular and a huge market for trading the instruments has emerged. Tulips, anyone?

But one I watched with amazement for years as the poster child for goofy ideas was WeWork, which recently filed for Chapter 11 bankruptcy, and is one of the dumbest business models I have ever studied. Again, a magnetic personality was behind it, and he invented the whole notion of coworking spaces, which has really never caught on. Adam Neuman started the company in 2010, with the idea of leasing millions of square feet of office space, remodeling them into workspaces with cool vibes, and subletting the spaces at a higher rate to coworking tenants. The company would earn the arbitrage between his rental cost and what he charged his tenants. At one point, the equity in WeWork was valued at $47 billion, a market capitalization well in excess of some of the most profitable and well-run companies in the U.S. Of course, Neuman flamed out, was sacked by his Board, and the downward spiral of a goofy and ill-conceived business model that was grossly overvalued finally sank the company.

Couldn’t anyone have seen such a naked idea? How were so many drawn into this scheme? My advice is to think like the little child at the parade, and see the truth for what it is.

Pierre G. Villere serves as president and senior managing partner of Allen-Villere Partners, an investment banking firm with a national practice in the construction materials industry that specializes in mergers & acquisitions. He has a career spanning almost five decades, and volunteers his time to educating the industry as a regular columnist in publications and through presentations at numerous industry events. Contact Pierre via email at [email protected]. Follow him on Twitter – @allenvillere.