Brad Jacobs: Question Deeply, Act Quickly

0:00For Morgan Stanley, this is Hard Lessons, where iconic investors reveal the critical moments that have shaped who they are today. You'll hear about two out-of-consensus calls, one that was on the money, and one that wasn't. We probably lost 500 million bucks, which is a lot of money, and you remember that forever. Today on the show, Brad Jacobs, chairman and CEO of QXO and the founder of eight separate billion and even multi-billion dollar companies. Those include United Rentals and XPO, the sixth and seventh best-performing stocks in the Fortune 500 in the last decade. I usually do one or two things for 10 years, and then I reinvent myself and start all over again.

0:40Brad is the author of two best-selling books, How to Make a Few Billion Dollars and How to Make a Few More Billion Dollars. I remember being interviewed by the Wall Street Journal. The stock had come down a lot. I told the reporter, I think it's going to be the best deal of my career so far. It turned out I was right. He sat down with Eli Gross, global co-head of investment banking at Morgan Stanley.

1:01Brad Jacobs:Brad, great to be together. My pleasure. They met at the Campbell inside Grand Central Terminal. Listen in to hear how speed, synergy, and small conversations have turbocharged Brad's success. So Hard Lessons is about out-of-consensus calls in investing. Hard to think about anybody that's made more calls in investing than you. 500 M &A deals. You've raised over$50 billion of capital as you built up United Rentals, United Waste. As we met each other, XPO and Transpill and Logistics, and now QXO. I've made a lot out of consensus calls. A lot of out of consensus. I've been around a few of those. You've helped me a couple of them.

1:41Brad Jacobs:So let's start with an out of consensus call that you made, and it actually worked out. Well, the first thing that pops right into my head is one that you advised me on when you were a transportation banker. Conway, of course. So that was, when was that? It was 2015, about 11 years ago. And we were looking at Menlo. They had a subsidiary that did contract logistics. Great, great, great little subsidiary. And I wanted it. I wanted it real bad because they had these really blue-chip customers. And I wanted to cross-sell into those customers. So we were talking, trying to get a deal done. And we were going to do this reverse Morris Trust.

2:14cost and then the market cap went up and it didn't work anymore. And the Conway folks said, why don't you look at buying the whole company? I said, wow, it's an interesting idea. I'd never really thought about buying an LTL trucking company. We're a non-asset company at that. We're brokerage for the most part. I said, I'll take a look at it, keep an open mind. And as we looked at it and studied it, I said, wow, there's a lot of costs we can take out of this because they had done three big acquisitions and never integrated them. So they had three HR departments, three IT departments, three sales organizations, three of everything.

2:40So, you know, we didn't need all three. We just needed one. And I saw an opportunity to improve the quality of the service up. And all that panned out. But at the time, very skeptical reaction, as you remember, from Wall Street. Our stock had gone from, I don't remember the exact numbers, for something like 50 or 60 or 70 down to like 20 or 30. Really, really dramatically down. And I remember calling you, actually, and saying, well, what do you make of all this? I said, look, it depends what you think in short term or long term. Short term, you got to tough it out. Because you have a bad reaction here.

3:08If people don't really understand the story yet, it's going to take some time. It's a pivot. It was bold. It was a good move, but it was a pivot. And investors don't like strategy shift. So you have to accept that. But if long term, if you execute on what you plan on doing and you deliver the numbers, investors will love it. And it turned out they did love it because we doubled the EBIT in two years.

3:26Brad Jacobs:But walk us through that because I remember having that conversation. It was a Sunday. You gave me a call. You said, what do you think about this? I gave my initial reaction. It's a pivot. You knew it was going to be a pivot. turn out to be a home run. But as you thought about communicating that pivot to your investors, to the research community, to your employees and customers, how did you think about having those conversations? Well, I didn't think the reaction was going to be as bad as it was. I was expecting people to give us the benefit of the doubt that we actually done a lot of diligence.

3:57We owned a big percentage of the companies. Obviously, we're going to do something that's going to hurt the company. But investors at that moment in time were very short-term oriented. And they were thinking about like this quarter and right away. And I was thinking about five years and 10 years and building up a durable company that was going to work and, you know, be amazing over time. So there was a disconnect there. I probably misjudged how short term the investment community was going to look at that.

4:20Brad Jacobs:And would you say that you have unique ability to do a pivot like that because of the success that you built up over time? Or do you think, no, even at the beginning of my career, if I had conviction around the long-term strategy, I would just go do it and damn the torpedoes, we're going to go make that investment. I don't feel I have unique anything. And I don't have a unique ability at all to do something that's impossible. But I think earlier in my career, it was more challenging because I hadn't proven myself yet. Now I think I get a little more benefit of the doubt because we've done a lot of out of consensus hard calls and they all worked out really, really well.

4:56So I think people will give me a little more slack.

4:59Brad Jacobs:Is there a convincing exercise that you have to undertake? On that particular deal, the board was very skeptical about the deal. So it was my fellow management team for the most part. But I felt really strong about this because I really was in the weeds on the diligence. I understood exactly what we were going to do in order to dramatically improve the profitability of the business. So I stood up to the board and rallied my team around me. And, you know, it was difficult for a few months. But after a few months, the stock doubled and tripled. And today, of course, it's many, many times where it was there.

5:27So it's okay. But I remember being interviewed by the Wall Street Journal. The stock had come down a lot. And I told the reporter, I think it's going to be the best deal of my career so far. Now, we've done better ones since then. But it turned out I was right. So we bought Conway. You might remember this. The operating ratio was 96%. So they were making a 4 % profit margin. Today, Mario and the team, who are running it now, not running it anymore, they got a shot at getting into the 70s. Did you see that at the time of the investment? Well, Conway's growth, the LTL business growth, really took place in two sections.

6:00The first few years was just organizing the organization chart, which is too much of everything, and multiple of the same thing. So getting it lean, getting it so it's a machine that functions and you don't have bureaucracy and you can actually talk to people who are doing things rather than people who are hearing things. I mean, really, it was getting the org chart very elegant, mainly to make it effective as an organization that can communicate with itself in efficient ways. And then once we got that sorted out, then it became LTL 2.0, which was to improve the quality of service. And we said, OK, that's what we got to do.

6:32We got to get our on-time delivery up and we got to get our damages down. So that took a period of a number of years.

6:38Brad Jacobs:When you look at investment opportunities, how often is it for you, it's an under-managed situation versus as part of your businesses, synergies just being better? Is it 50-50 or how would you mix it? I would say only about 20-25 % have been fixer-uppers. There's been great value created from those fixer-uppers after you fix them up. That hasn't been the rule. The rule has been they've been good companies, but we made them even better companies. And we brought synergy. So I was with someone yesterday who's a very big investor, and they were telling me their definition of synergy is 1 plus 1 equals 11.

7:15I like that. That's a good one, 1 plus 1 equals 11. And the ones that really worked the best were ones that we put the companies together, and there were both cost and revenue synergies. We were able to eliminate duplicative SG &A and redundant positions and so forth. But that's kind of a one-trick pony. It's not the gift that keeps giving. The gift that keeps giving is the synergy on the top line, where you can cross-sell services, where you can merge the sales force, give the sales force more things to sell, where you can find best practices from the company you bought and best practices that we have.

7:48Take the best of both. And now you've got a whole new set of best practices that is better than the previous one. Those are the ones that are really the best ones.

7:55Brad Jacobs:When people read your book, I think a lot of people have the reaction and say, wow, it seems so easy. You know, identify an industry. I find companies. I acquire them, I get synergies, and I create all this value. Easier said than done. The one thing that I've noticed as your advisor on a handful of deals and sometimes being on the other side is that the study of the industry and the opportunity set is very deep. The preparedness to act on opportunities is quick. And the speed with which you integrate is phenomenally fast. Is that the secret sauce? I don't know if it's a secret because I wrote two books about it.

8:32But it's the sauce. I mean, the sauce is to know what you're getting into. What are you going to do with this company? How did it get where it is now? What did happen in order to get here? What did they do to get the numbers? How much of that is sustainable? How much of that is just one trick pony stuff? And what can we do to the company now to turbocharge its growth? How can you get price? How can you get volume? How can you please the customer more? How can you really figure out exactly what the customer wants and then give it to the customer so that you get bigger share of their spend, maybe get a little bit more in price, and you get higher organic revenue growth.

9:05That's what really makes them hum.

9:08Brad Jacobs:Having been by your side on lots of transactions, the one thing that I recall vividly is your focus on meeting the people who are running the organizations you're buying. It's not necessarily 100 people. It's the key people at a very deep level. What do you look for when you're having those conversations with the owners or the business leaders? I absolutely do like to meet with the top 15 or so people at a minimum for an hour and a half, two hours apiece, but as long as possible. And I just want to ask them truthfully, would you pay billions of dollars for this company if it was your billions of dollars?

9:47And see how they react to that. And it's amazing what people will say. Sometimes people say, they think about it for a while and they go, well, I guess so. It's not a good answer. It's not a good answer. Well, you want some more conviction. A lot more conviction than that. And I want it to be sincere conviction. I want to hear why. Give me detail. I want to hear what's working in this company that if you were to buy it, we should continue doing it because it works really, really well. What's going on in the company that you would disagree with, that you think we could do something in a different way and have a better result?

10:17And hear what they say about that and then see what patterns emerge, what themes emerge from all the different people we speak with separately. I do Zooms almost every day with small groups, five, ten people from the company. And that's where I learn the most. People relax and tell you what's really on their mind. I find so many times, Eli, because some people have been working in a company for 10, 20, 30 years. Nobody's ever asked them, what's your idea to improve the company? Ask. Ask, yeah. And when you ask, it just like floods out. It's open, just boo, everybody will tell you all kinds of cool stuff.

10:49Brad Jacobs:Is there an example maybe of where you've reached down into the organization and gotten the best idea, not necessarily from your direct reports? I do that all the time. It drives my direct reports crazy sometimes. I'm talking to their direct reports. Sometimes I'm talking to their direct reports. I like talking to the front line. I like talking to the people who are directly interacting with the customers. Customers are very important. They're the people wiring money to us. So we have to always be in tune with what's going on, what the pulse is of the customer. And I find if you get closest to the person in the organization who's closest to the customer, that's how you get the real story.

11:23I do that in raising money, too. I remember we had a call once. We were raising some money with Morgan Stanley. And there was some fellow on your team who was the most junior guy, I think. If not the most junior, the second most junior guy. And he was really smart on the call. He was in the weeds. I remember this. And he started, like, saying, I think you should change this, change this, and like that. So I just started talking to him. I didn't talk to the big shots anymore. I talked to that guy directly. I respect the organization chart, but I also disrespect it. I also cut through it.

11:50Brad Jacobs:And do you find that once your organization sees that you do that everywhere, not just with respect to one reporting line, but you're doing it everywhere, that the organization gets accustomed to that and says, well, this is the pace at which we're running, and that's the modus operandi. Yeah, it's empowering. It's empowering that people feel they matter because they do matter. And their voice is really being heard and taken into consideration at forming the plan. And they say, wow, I was in this meeting. I suggested this, and they did it the next day. It's amazing. And you mentioned we go fast.

12:17We go really fast. We go super, super fast.

12:19Brad Jacobs:I love the Conway example. It's great. I remember it very vividly. We also worked on something more recently with TopBuild. Oh, yeah. There's TopBuild acquisition that we've done with Mornington Health Finance. Thank you for the money. That's an out of consensus call because we were mainly doing distribution of installation. And now we bought a company that does both distribution and installation. So it was a little bit of a pivot again. And the market hasn't yet fully appreciated how good the deal is. I think it's going to be my best deal yet. I really do. Even early days, you kind of feel like it's there.

12:49Yeah, yeah. There's a lot of excitement in the organization and a lot of planning. It's going really, really well. And why do I say that? Remember we were talking a few minutes ago about 1 plus 1 equals 11, according to my friend. I think that's the situation here because now together we've got something like a couple hundred thousand customers. A lot of customers. So we're in the process. It's going to take us two or three months to get the data. figure out each one of those customers, how much are they buying from us of each one of the things we sell? Lumber, insulation, roofing, waterproofing, decking and siding, everything.

13:22Go down the whole list. And how much are they buying elsewhere away from us? And I already know where it's going to come out. It's going to come out saying they're buying a lot of things from other people. In a lot of cases, zero from us. Like Top Build, there's a lot of insulation for data centers. Well, data centers buy every single thing we sell other than windows, because they don't like windows. So we've got to penetrate that. So there's a big, big cross-sell opportunity there. And on the procurement side, it turns us a big overlap between their supplier partners and ours. So we're now over a billion-dollar customer for quite a number of vendors.

13:53Brad Jacobs:So the opportunity you saw, and clearly early days here, but it's materializing. But as not a consensus investment, when you were looking at it, did you know, ooh, this is going to be a tough one to sell? I've got conviction, but it's going to be tough to sell. I try to tune that out. I try to tune out like the short, short-termism because I'm trying to build companies like I have in the past that are long-term, durable, world-class companies that are going to be leaders in the market and be sustainable over time. So if you just go by what's in mode at the moment, you're not going to achieve that.

14:25You can't build the business long-term by the flavor of the day.

14:28Brad Jacobs:Okay, we could spend the whole podcast talking about added consensus calls that worked out. You've done so many deals. Can we spend a minute on something that was added consensus? and didn't quite work out the way you thought it would. You mentioned I've done 500 or probably more than 500 deals now. Probably a half a dozen of them were stinkers. But the biggest stinker of them all was a group of them. This is right around the turn of the century. There was this act that came out in Congress, the Transportation Something Act of the 21st century. And they were going to spend all this money to reconstruct the bridges and the tunnels and the roads in America.

15:05That was in United Rentals at the time. So I said, I got to buy all the rental companies for all that orange stuff on the barricades and cones and striping. I said, I got to dominate that market. So I bought five or six of the biggest ones. Some were strategic. Some were family owned. Some were private equity owned. I put them together. I was like waiting for all the money. The money never came. So Congress never really spent the money.

15:27Brad Jacobs:Kind of a stroke of the pen risk there. Yeah. And it turned out the pen never stroked. So if you go back to Brad at that point in time, what would you have done differently? Would you have underwritten it differently, diligenced it differently? I wouldn't have bet the ranch on it. Well, we didn't bet the whole ranch. We probably lost 500 million bucks. So it's just a lot of money. And you remember that forever. So we could afford it, but barely. We took a write-off on that one. So that was a hard lesson. It's been said that you don't make money as an investor when you're right or wrong. It's how much you invest when you're right and how much you invest when you're wrong.

16:00Brad Jacobs:Well, there's a lot to be said about that. The big multi-strat funds, they're only right like 51%, 52 % of the time. But they do the risk management so carefully that the amount they lose is less than the amount they make. So that ends up to make a lot of money. You've invested through cycles, great cycles, tougher cycles. Today, it's hard not to ask you a question about artificial intelligence. You've written a lot about it, by the way. Some positive outcomes for the world and some darker outcomes for the world. It scares the hell out of me. as an investor, you think it's a big positive for you or a big negative for you?

16:33Depends the time period. It depends what happens with artificial intelligence over time. So I think in the short term, it's a big plus. I mean, I as a CEO am so much more effective now with AI because I get all the meeting notes and the information is collected and analyzed and summarized like same day. These things that used to get to me in three months, if they even got to me, this is phenomenal. One of your big challenges when you're running a company is you have all these offices. We have 1 ,150 locations now. How do you know what's going on in all that? Sure. And AI now is grabbing all this information, data, meetings, and slicing and dicing it and doing sentiment analysis and word clouds and analyzing the CRM.

17:13I mean, it's really amazing. You can get so much more done in so much less time. So I think short term, there's no question that AI is better for you as management. Long term, it depends what happens with the AI. If we end up utilizing AI in a responsible way and we're able to mine the Earth's resources and share it equitably and fairly and eliminate poverty and eliminate ill health and people live long periods of time and we get along with each other, that'd be great. If, on the other hand, AI goes crazy on us and— Goes rogue. Goes rogue and gets a mind of its own and decides, these human beings are not very rational.

17:48Maybe I'll kind of get rid of them. It's not going to be good. or if our adversaries, if the bad guys out there leapfrog us in cyber or bio or nuclear AI base, that's not going to be good. So I try to remain positive about it, but I'm scared about it.