Hello friends, in today’s article, we see the new book on value investing from the world-famous and also greater value investor of all time i.e. Mohnish Pabrai. the book’s name is the DHANDHO INVESTOR. In today’s article, we only see the first chapter, which helps you to understand the motel business, and most important Low-risk high return philosophy, in Mohnish Pabrai, words, says, ” if Head: I win, if tail; I don’t lose much”.
so let’s start this book
Chapter 1:-the Dhandho Investor
In the introduction, the author ( Mohnish Pabrai) talks about, how this book, is invented.
the author says, ” this book, the DHANDHO INVESTOR, is a synthesis of ideas lived encountered in my readings, interactions with friends, and various experiences, both visceral and direct.
I have very few original ideas, virtuality everything has been listed from somewhere. if there wasn’t a warren buffet, there wouldn’t be Pabrai funds and there certainly wouldn’t be this book.
It is hard for me to overstate the influence warren buffet and charlie Munger has had on my thinking. their perspectives have, in one way or another, shaped virtually every page. I can never repay my debt to them for selflessly sharing priceless wisdom over the decade’s thanks, warren, and charlie.”
after his grand introduction, let’s start chapter 1 of this book, Patel Motel Dhandho.
Patel Motel Dhandho:-the Dhandho Investor
in this chapter, the author gives the history of Asian Indians and also how the DHANDHO word come, and most important how Patel enters the Motel business in America. so let’s start
the author says,” Asian Indians make up about 1 percent of the population of the united states about three million people. of these, there million, a relatively small subsection is from the Indian state of Gujarat. and very few small subsections of Gujraties, the Patels, are from a tiny area in southern Gujrat.
less than one in five hundred Americans is a Patel. It is this amazing that over half of all the motels in the entire country are owned and operated by patels. what is even more stunning is that there were virtually no patels in the united states just 35 years ago. they started arriving as refugees in early 1970 without much in the way of education or capital.
their heavily accented, broken English-speaking skills didn’t improve their prospects either. from that severely handicapped beginning will all the odds stacked against them, the Patels triumphed.
Patels, as a group, today own over $40 billion in motel assets in the United States, pay over $725 million years in taxes, and employ nearly a million people.
How did this small, impoverished ethnic group come out of nowhere and end up controlling such vast resources there is a one-word explanation: DHANDHO.”
After this, the author explains the Dhandho words,
the author says, ” Dhandho (pronounced dhundoe) 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.” which is business if not an endeavor to create wealth.
However, if we examine the low-risk, high return approach to business taken by the patels dhandho takes on a much narrower meaning. (the Dhandho Investor by Mohnish Pabrai)
We have all been taught that earning high rates of returns requires taking a greater risk. Dhandho flips the concept around. Dhandho is all about the minimization of risk while maximizing the reward.
The stereotypical Patel naturally approaches all business endeavors with this deeply ingrained riskless dhandho framework-for him it’s like breathing.
Dhandho is thus best described as endeavors that create wealth while taking virtually no risk.
Not only should every entrepreneur seek to learn from the Patel dhandho framework, but also the primary audience for this tone-investor and allocators of capital.
Dhandho is capital allocation at its very finest. if an investor can make virtually risk-free bets with 0utsized rewards, and keep making the bets over and over, the results are stunning.
Dhandho is how the patels have exponentially compounded their net worths over the past 30-odd years.
I am getting ahead of myself. sit back, relax grab a cool one, and mellow out. you’re about to begin a remarkable journey-one that I hope is as rewarding and profitable for you as it has been for me and a generation off Patel businessman.” (the Dhandho Investor by Mohnish Pabrai)
then the author gives the history of Patels, I hope you read his history in the book, for that buy this book from the following link(image)
then author explains why Patels choose the Motel business. by taking one the Patel example,
the author says, ” that still begs the questions, why did the first wave of patels who entered the united states go into the motel business? why not delis, laundromats, or drugs stores? why motels? and why not just find a job?
part of the answer lies in another demographic shift that was underway in the early 1970s in the united states. after world war II, there was a huge buildout of suburbia and the interstate highway system.
the automobile had become a middle-class stable and American family-owned motels popped up all along the newly built interstates.
the 1973 Arab oil embargo and misguided American economic policies ( price and wage controls) led to a deep recession across the country.
Motels are heavily dependent on discretionary spending. the recession coupled with rational and sky-high gas prices led to huge drops in occupancy, many small nondescript motels were foreclosed by banks or went or sold at distressed prices. (the Dhandho Investor by Mohnish Pabrai)
at the same time, the kids of their old motel-owner families were coming off getting and saw plenty of opportunity outside of the motel business and left in droves to seek their fortune elsewhere.”
then the author gives the most exciting part of this chapter is the psychology behind buying a motel by Patel.
for that author give papa Patel examples.
Papa Patel:-
the author says, ” it is 1973, papa Patel has been kicked out of Kampala, Uganda and has landed as a refugee in anywhere town, the USA with his wife and three teenage kids.
He has had about two months to plan his exit and has converted as much of his assets as he could into gold and other currencies and has smuggled it out of the country.
It isn’t much- a few thousand dollars. with a family to feed, he is quickly trying to become oriented to his alien surroundings.
he figures out that the best he can do with his strange accent and broken-English speaking skills will be a job bagging groceries at minimum wage.
Papa Patel sees the small 20 rooms motel on ale 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 19 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 state, Dahyabhai Patel succinctly put it, “I required only a small investment and it solved my accommodation problem because ( my family and I could live and work there”
then author explains how the Dahyabhai Patel gets the success and behind their calculated risk.
the author says, ” 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. (the Dhandho Investor by Mohnish Pabrai)
even the smallest motel needs a 24-hour front desk and someone to clean the rooms and do the laundry- at least four people eight our 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.
Dahyabhai Patel, reflecting on the modus operandi during the early days, said, “I was my own front-desk clerk, my own carpenter, mu own plumber, maid, electrician, washerman, and whatnot.”
with no hired help and a very right rain an expense. Papa Patel motel has the lowest operating cost of any motel in the vicinity. he can offer the lowest nightly rate and still maintain the same ( 0r 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 structure prohibits them from matching the rates offered by the Patel motel leading to a spiraling reduction in occupancy and profits.
the stereotypical Patel is a vegetarian and leads a very simple life. most restaurants in the united state in 1970. don’t serve vegetarian meals, so eating at home is all the more attractive and much cheaper for Patel families.
they are busy with the motel day and night, so they have little expenses for this family that are abysmally low. with a single beater car, no home mortgage, rent, or utilities, and zero commutes eating out or spending on vacations or entertainment of any type, papa patels family lives quite comfortably on well under $5000 per year.”
then the author explains, what if they don’t buy the motel and do the job and their living expenses
the author says, ” prices are lower in the 1970s, the minimum wage is just $1.60. the best papa and mama Patel could hope for are total annual earnings of about $6000 per year, if they both take up jobs and work full time.
If they buy a 20-room motel, at a distressed price of $50,000 with about $5000 in cash and the rest finances, even at rates of $12 to $13 per day and 50 percent to 60 percent average occupancy, the motel will generate about $50,000 in annual revenue. (the Dhandho Investor by Mohnish Pabrai)
In the early 1970s, with treasures yielding about 5 percent, the owner or most banks will be delighted to finances the motel purchase at a 10 percent to 12 percent of $5000 and another $5000 to $10000 in out of pocket expenses for motel purchase at a 10 percent to 12 percent interest rate with a lien on the property.
Mr. Patel has annual interest expenses of about $5000, principal payments of $5000 and another $5000 to $10000 in pocket expenses are thus under $20,000
even if the family spends another $5000 year on living expenses ( a grand sum in 1970), Papa Patel nets over $15,000 a year after all taxes and all living expenses. If he had borrowed the $5000 from a fellow Patel he has it full repaid in four months. he could even elect to pay off the mortgage on the motel in just three years.
the annual return on that $5000 of invested capital is a stunning 400 percent ( $20,000 in annual returns from the investment- $15,000 in cash flow and $5000 in principal repayment)
if he borrows the $5000 from a fellow Patel, the return on invested capital is infinite zero dollars, in and $20,000 a year out. that’s all fine and dandy you might say, but what if the business does not work out? what if it fails?”
then author explains what if the motel business is failing
author says,” For this first motel purchase, papa Patel not only has to give a lien on the property but most likely also a personal guarantee to the lender as well. however, papa Patel has only $5000 ( or less) to his name, so the personal guarantee is meaningless.
if he is unable to make the payments, the bank can take over the property but he has virtually no assets outside of the motel. the bank has no interest in taking over the motel and running it. it has no such competency.
it will be very hard for the book to sell a money-losing motel and cover their note.
it is very simple:- If a Patel can not make the motel run profitability, no one can. the bank’s best option is to work with papa Patel to make the motel profitable, so the bank is likely to renegotiate terms. and try to help papa Patel get back on trade. (the Dhandho Investor by Mohnish Pabrai)
It is net, net papa Patel still runs the motel; the family still lives there, and he works as hard and as smart as he can to make it- he has no choice. it makes it work or go bust and homeless.
Remember this is an existing business with a very stable business model and a long history of cash flow and profitability.
It is not rocket science. it is a simple business where the low-cost provider has an unassailable competitive advantage, and no one can run it any cheaper than papa pate.
the motel business ebbs and flows with the economy eventually, conditions are likely to become better, the bank is made current on payment, and everyone is happy most of all papa Patel.”
then the author talks about let’s look at this investment as a bet,
the author says, ” let’s look at this investment a bet, there are three possible outcomes.
First, the $5000 investment yields an annualized rate of 400 percent. let’s assume this continues for just 10 years and the business is sold for the same price as it was bought ($50,000)
This is like a bond that pays 300 percent interest a year with a final interest payment in year 10 of 900 percent. this equates to a 21 bagger on annualized return of well over 50 percent for 10 years.
Assuming a 10 percent discount rate, the discounted cash flow stream is shown in table 1.1
Table 1.1 Discounted Cashflow Analysis of the best case for Papa Patel
| Year |
Free Cash Flow ( $) |
Present Value ( $) of future cash flow |
| Excess cash |
|
0 |
| 1 |
15,000 |
13,636 |
| 2 |
15,000 |
12,397 |
| 3 |
15,000 |
11,270 |
| 4 |
15,000 |
10,247 |
| 5 |
15,000 |
9,314 |
| 6 |
15,000 |
8,467 |
| 7 |
15,000 |
7,697 |
| 8 |
15,000 |
6,998 |
| 9 |
15,000 |
6,361 |
| 10 |
15,000 |
5,783 |
| 10 |
Sale price 50,000 |
19,277 |
| Total |
|
111,445 |
Second, the economy goes into a severe recession, and business plummets for several years. the bank works with Mr. Patel and renegotiates loan terms as described earlier.
Mr. Patel has a zero return on his investment for five years, and then starts making $10,000 a year in excess free cash flow when the economy recovers and booms (200 percent return every year after five years)
the motel is sold in year 10 for the purchase price. now we have a bond that pays zero interest for five years, then 200 percent for five years, and a final interest payment of 900 percent ( see. Table 1.2) (the Dhandho Investor by Mohnish Pabrai)
Table 1.2 Discounted Cashflow Analysis of the Below-Average case for Papa Patel
| Year |
Free Cash Flow ( $) |
Present Value ( $) of future cash flow |
| Excess cash |
|
0 |
| 1 |
0 |
0 |
| 2 |
0 |
0 |
| 3 |
0 |
0 |
| 4 |
0 |
0 |
| 5 |
0 |
0 |
| 6 |
10,000 |
5,645 |
| 7 |
10,000 |
5,131 |
| 8 |
10,000 |
4,665 |
| 9 |
10,000 |
4,240 |
| 10 |
10,000 |
3,854 |
| 10 |
Sale price 50,000 |
19,277 |
| Total |
|
42,812 |
this equates to a seven-bagger on annualized return of over 40 percent for 10 years.
third, the economy goes into a severe recession, and business plummets.
Mr. Patel can not make the payments and the bank foreclose and Mr. Patel loses his investment. the annualized return is 100 percent. these three outcomes cover virtually the entire range of possibilities.
Assume the likelihood of the first option is 80 percent, the second is 10 percent and the third is 10 percent.
These are very conservative probabilities as we are assuming a one in five, chance of the motel performing for worse than projected-even though it was bought on the cheap at a distressed sale price and run by a best-of-breed, savvy, low-cost operator.
We have unrealistically assumed there is no rise in the model’s value or in nightly rates over 10 years. even then, the probabilities-weighted annualized return is still well over 40 percent.
the expected present value of this investment is about $93,400 (0.8 * $111,445 + 0.1 * $42,812)
from papa patels perspective, there is a 10 percent chance of losing his $5000 and a 90 percent chance of ending up with over $100,000 ( with an 80 percent chance of ending up with $200,000 over 10 years.
This sounds like a brainer bet to me.”
so some numbers are coming, please read carefully to understand the wonderful logic behind the motel business.
then the author gives simple race tract examples, on his best advice,
the author says, ” If you went to a horse race track and you were offered a 90 percent chance of losing your money, would you take that bet?
heck yes, you’d take that bet all day long, and it would make sense to bet a very large, portion of your net worth with those spectacular adds. (the Dhandho Investor by Mohnish Pabrai)
This is not a risk-free bet, but it is a very, low-risk high returns bet, Heads, I win; tails, I don’t lose much!
the skeptic in you remains unconvinced that the risk here, is low. you might say that there is still the very real possibilities of going broke if you bet all you have ( like papa Patel has done)
papa Patel does bet it all on one bet, but he has an ace in the hole. If the lender forecloses and he loses the motel, he and his wife can take up jobs bagging groceries, work 60 hours a week instead of 40, and maximize their savings.
At the 1973 minimum wage of $1.60, they earn $9,600 a year. after taxes, they can easily sock away $2,000 to $4,000 year
after two years, papa Patel could step up to the plate and buy another motel and make another bet. The odds of losing this bet twice in a row are 1 in 10. and the odds that it plays off, it’s over a 20-fold return, that’s on an ultra low-risk bet with ultra-high returns one very much worth making!
Heads, I win; Tails, I don’t lose much
with such high cash flow coming in, papa Patel is soon flush with cash. he still has a very modest lifestyle. His eldest son comes of age in a few years and he hands over the motel to him.
the family buys a modest house and goes hunting for the next motel to buy. this time, they buy a larger motel with 50 rooms, the family no longer lives at a motel, but still does not do most of the work, with little in the way of hired help.
the formula is simple: Fixate on keeping, costs as low as possible, charge lower rates than all competitors, drive up the occupancy and maximize the free cash flow.
finally, keep handling over motels to up and -coming Patel relatives to run while adding more and more properties.
there is a snowball effect here and over time we end up with these amazing statistics -half of all motels in the united states are under Patel ownership.
having fully corned the motel market the patels have begun buying higher-end motels and have derived into a number of businesses where they can apply their lowest-cost operations.
Dunkin donuts franchises, convenience stores (7-eleven), and the like. some have even bronched out into developing high-end time-share condominiums.
the snowball continues to roll down this very long hill becoming bigger over time.”
So this is all about chapter 1 from the book ” The Dhandho Investor” on Patels motel Dhandho.
