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Concept

The Capital Cycle

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The capital cycle, as defined by Marathon Asset Management, goes something like this:

  1. Capital is attracted to high-return businesses.

  2. The managers of these high-return businesses become drunk on growth, and expand production in response to their great success. This is rational! It makes sense to pursue growth when there are ravenous customers and large profits for the taking.

  3. There is a lag between this planned expansion and the actual supply in the market. It takes time to build factories, or to spin up new products. Nobody notices that future supply — across multiple competitors that are all expanding production — will soon outstrip demand.

  4. The new supply gradually floods the market, and returns fall below the cost of capital. Businesses slash prices to offload supply; company valuations collapse.

  5. Capital flees the sector because returns suck; companies close down or get bought out; consolidation occurs across the entire industry.

  6. This sets the surviving companies up for future excess returns.

The capital cycle is amongst the most basic patterns that you will find in finance, and one of its simpler ideas — perhaps second only in simplicity to the credit cycle. But of course the question that’s worth asking is: how do you exploit it?

This concept sequence captures cases of businesses navigating the capital cycle — either surviving it, successfully exploiting it, or dying in the grips of it.

Cases

Björn Wahlroos’s Capital Allocation Hat Trick with Sampo

Part of Capital Expertise is expertise in capital allocation. This is the story of Bjorn Wahlroos, a Finnish master.

A Fine Dining Restaurant in a Recession

How Eleven Madison Park — later the #1 Restaurant in the World — survived the Global Financial Crisis.

Roper Technologies: From Manufacturing to Software

A rare company that transitioned from manufacturing to software, and won.

John Malone and TCI: Inventing EBITDA in the Cable Industry

The story of John Malone’s incredible run at TCI ... and the invention of EBITDA.

The Absurd Deal That Lead to Republic Plaza

The world class deal that led Kwek Hong Png to get his own Singaporean skyscraper — for cheap.

A Good Unwinding: Bill Anders and General Dynamics

How Bill Anders oversaw the disassembling of a defence contractor — and outperformed.