How the SEC Made A Mistake/Overreach In the Mark Robare Case

Since I am in the investment world I find it interesting when the SEC brings forth a case against a financial advisor. The overwhelming majority of the time the financial advisor/investment advisor has stole money, lied to clients, or just outright over promised something to clients like a "guaranteed 12% return per year". Back in May 2019 the D.C. Court of Appeals in the Robare Group, Ltd. vs SEC held the SEC decision that if a financial advisor professional claims there "may" be a conflict of interest would violate the Investment Advisers Act of 1940 (specifically Section 206 (2) which covers prohibited transactions by Investment Advisers) and the SEC claims Robare violated this.

Mark Robare is the president and CEO of Robare Asset Management and from the company's last regulatory filing managed $175 million for clients (as of December 31, 2018). The company grew assets and clients over time. In the early 2000's the company had 150 client households and in recent times had 300 client households. The company worked with retired current oil and gas executives who were approaching or entering retirement. The average account balance of was between $500,000 to $800,000.

The firm also did very little advertising and added clients by referrals from existing (and I might add satisfied clients). In fact the firm had a 97% retention rate over a 10 year rolling period among clients which shows how happy clients were. Clients of the firm were invited to meet with their advisors at least once a year (however some clients visited with their advisor more frequently).

Robare had been practicing financial planning for clients in the Houston area since 1977 (32 years of experience), was a Chartered Financial Consultant (CHFC), a Certified Financial Planner (CFP), and Chartered Life Underwriter (CLU) it should be noted that having all these designations is not typical. In addition to this Robare passed 7 different exams in the investment industry. Clearly, Robare had experience in the investment/financial planning world. Prior to this allegation from the SEC Robare according to his BrokerCheck record never had any type of infraction brought either from a client or any regulatory authority. 

In 2004, Robare entered into revenue sharing agreement with Fidelity Investments (their custodian who would actually hold the securities of clients and provide support for trading and back office needs). Revenue sharing agreements work by allowing financial advisors to invest in different funds for their clients and then the financial advisor gets revenue for investing in those funds (similar to a commission-just like real estate brokers, car sales people, salespeople, and other professions). Robare as part of their financial planning for clients would recommend mutual funds for clients to invest in. Robare created model portfolios of various mutual that didn't contain any transaction fees. Some funds do have transaction fees and many times clients have to pay the transaction fees (there are advisors that do recommend these products). There were some funds that weren't associated with Fidelity that were no transaction fee. For recommending the funds that weren't associated with Fidelity nor had any transaction fee Robare would receive between 2-12 basis points (a basis point is 1/100 of a 1%). However, Robare had to pay Triad (an outside firm) a 10% fee (so the amount Robare would receive was actually 1.8%-11 basis points). So for example if a client invested $100,000 Robare would only earn a whopping $18-$110! Between September 2005 and September 2013 Robare earned $400,000 under the revenue sharing arrangement (which would be around 2.5% of the firm's revenue). It appears on the surface that given the lack of revenue generated from the revenue sharing agreement someone could conclude that these funds didn't change the recommendations from Robare. It is important to note Robare was never recommending the funds based off the fee he would receive. During the financial crisis in 2008 Robare and his firm actually moved money of clients into funds that didn't have commissions to save clients money.

In 2004 when Robare was exploring the revenue sharing agreement they asked Fidelity (their broker/dealer and custodian) if their clients would incur any additional fees and Robare was told no and that the fees would come from the mutual funds on the Fidelity platform (mutual funds will pay custodians like Schwab, TD Ameritrade, and Fidelity in order to get more access to financial advisors). When Robare entered the agreement with Fidelity however it wasn't even clear which funds were eligible for revenue sharing nor was Robare ever given a list of funds that were eligible for revenue sharing. Also given their agreement with Fidelity the advisors attested it wasn't even clear that they knew what funds paid what revenue sharing fees as the amounts would constantly change. Even when Robare asked Fidelity for a spreadsheet of the list of funds and the fees they paid he would testify it was "virtually unintelligible" and "too difficult" to determine what the fees were.

Robare in their 2005 ADV Part II (advisors must provide this to clients at least 48 hours before entering an agreement/contract) which can be found here it is added that that representatives of the firm "may receive selling compensation from such broker-dealer". It should further be pointed out that in their 2003 ADV (even before they entered the revenue sharing agreement) stated that representatives of the Robare sold products for sales commissions. Clearly Robare disclosed that some of the products they sell have sales commissions. Also clients are given this disclosure before they even enter the relationship with Robare they could question or ask Robare how this arrangement worked. Of course with the SEC no amount of disclosure can ever be enough. The SEC would bring their complaint against Robare in 2014 (10 years after Robare entered into the revenue sharing agreement!). In 2016 the SEC ordered Robare to pay a civil penalty of $150,000. 

Now you might ask who was doing the compliance work for Robare? Robare had hired multiple compliance advisors to help him and his firm with complying the with Form ADV. What is ironic is even when Robare was audited for their Form ADV in 2008 the SEC didn't have any concerns (the SEC would letter testify that this was the best result a firm could receive). It should also be pointed out that Robare hired multiple different compliance firms who never found any issues with the Form ADV as well (and any changes the compliance firms recommended were implemented by Robare).

What is even more ridiculous is that clients before they even opened an account with Robare were told 7 times (page 36 if you want to see all the instances) of the possible conflicts of interest. I wonder if telling clients another 7 times would have changed anything. Triad who Robare initially used for the revenue sharing agreement even audited the ADV of Robare and didn't see any issues with it. Even the SEC testified that the firms should not include every possible conflict of interest since "it should be made understandable to the client". 

Now let's get to the heart of what the SEC alleges. The SEC claims Section 206 (2) of the Investment Advisors Act of 1940 was violated by Robare. The Investment Advisors Act of 1940 under Section 206(1) and (2) say that "it is unlawful for any investment adviser..to employ any device, scheme, or artifice to defraud any client or prospective client or to engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client". Clearly Robare was never trying to defraud his clients. In fact he often was looking out for their best interest by ensuring the funds clients purchased didn't have any transaction fees and the amount of revenue earned from the commissions were such a small amount of the overall business that no one could claim this was an influential factor. What did Robare tell clients that was factually untrue? 

Clearly, the SEC overstepped in the Robare case as the company clearly never deceived clients. Looking back even before Robare entered their revenue sharing agreements they always disclosed they may receive commissions  Also clients were informed of this in the forms they received and signed prior to entering a relationship with Robare. Furthermore, none of the 300 clients ever complained about this arrangement! Also even if Robare had disclosed more it wouldn't be beneficial to clients as Robare didn't even know what commissions they were receiving from Fidelity (as Robare asked Fidelity what the commissions were and didn't get a clear answer). The firm during the 2007-2008 financial crises  moved funds for clients into funds that didn't provide a commission to Robare showing the firm was trying to do the right thing for clients. I would even have more sympathy if a client filled a complaint but there is no evidence that a client ever brought forth a compliant.

Mark Robare has been in the industry over 30 years, was knowledgeable amount financial planning and investments, never had a disciplinary action in his whole career, had a 97% client retention rate, and even a judge found Robare and his partner Jack Jones to be "honest and committed to meeting their disclosure requirements. Robare and his firm communicated to clients 7 times that the firm may have a conflict of interest, the firm covered they may have a conflict of interest even before they switched over to a revenue sharing agreement, and even Robare didn't understand the degree to which they were receiving revenue sharing fees from Fidelity. Even if Robare knew what fees they were receiving from different funds under the revenue sharing they wouldn't be able to place it in their ADV as the SEC testified the ADV has to be "digestible" and easy to understand for clients.

As a consequence of what the SEC deemed as deceiving clients for not fully disclosing conflicts of interests Robare will have a disciplinary action on his record that potential clients could find under BrokerCheck or by Googling his name. Not only would the firm loose future clients but may have existing clients start to doubt whether or not they should work with the firm (according to Robare the firm hasn't lost any clients). To add further insult to injury Mark Robare and his firm has faced legal bills that run $700,000. It is quite obvious that the SEC is trying to penalize someone for a problem that never existed or was brought forth by a client.

John Rockefeller Standard Oil Historical Earnings and Dividends vs. Charles Koch: Comparisons, Differences, and Who Was a Better CEO?

Recently I stumbled across a fascinating historical analysis of Standard Oil in terms of the historical dividends and earnings between 1882-1926. It is important to point out that John Rockefeller retired at the age of 57 years old in 1896 and would spend the next 40 years of his life in retirement. Given I have covered Charles Koch and Koch Industries for many years I thought it would be good to compare the two CEO's given: they both are in the oil and gas business (however these days Koch Industries is much more diversified than in the past), they both have been vilified, and they both have a good long term track record of running successful businesses. What is interesting is how in some ways these men are similar and how they have their differences despite between in similar industries and two of the wealthiest men of their eras.

Charles Koch was in his early 30's when he became the CEO and John Rockefeller created Standard Oil before he was the age of 30. Even though Charles had inherited Koch Industries it should be pointed out that Charles was in charge of the engineering division which had $2 million in sales but was just breaking even and the refining business earned $1.8 million on $68 million of revenue (a little under 3% profit margin). Rockefeller who started out as an assistant bookkeeper was known in his younger days for knocking on the doors at the age of 15 of businesses in Cleveland for 6 days a week for 6 weeks until one business made him a job offer. The first year Rockefeller went into business for himself he had revenue of $450,000 and a profit was $4,400 (profit margin of less than 1%). It is interesting that both had businesses early on that were low profit margin businesses.

Rockefeller even though he would work hard  According to biographer Ron Chernow Rockefeller was a "classic workaholic". Although Rockefeller worked very hard he would nap daily after lunch and after dinner doze off in his lounge chair and would spend 3-4 afternoons during the week at home (gardening and enjoying the outdoors). John Rockefeller felt it was better and more efficient to work hard but then to have down time to recoup to improve his productivity (sounds like a work life balance to me). In his younger days Charles was a workaholic who in August 1968 called a meeting at 4 P.M. on a Sunday that ran until midnight and it was expected that executives to work Saturday mornings (when Charles Koch had children he would always "have lunch at Wendy's). Charles would put in 12 hour days at Koch Industries and then work from home some more. Charles according to his wife Liz plays golf 2 times a week but also gets to the office around 7 A.M. and also works until 6 P.M. (he works this late even when he isn't into Wichita). It appears that Charles Koch would be hardcore in his working habits compared to Rockefeller. Also it is important to note that Charles Koch who is 83 years old is still working. Rockefeller retired at the age of 57 years old and had a 40 year retirement. I wonder if Charles would call John a slacker for having so many years of his life in leisure.

Rockefeller was always obsessed with business efficiency. He would study a process and always see if things could be improved to make products cheaper and more efficient. Given the size of standard oil if there could even be a small incremental improvement it could ripple through the organization and lead to massive cost savings. One example of this was when Rockefeller visited a plant that made kerosene and asked a worker if the cans could be sealed with less solder. At the time 40 drops of solder were being used and Rockefeller questioned if fewer drops could have been used. The worker tested 38 drops but that led to leaks in the cans so 39 drops of solder were used and that didn't result in any leaks. Rockefeller in retirement said that small change in the first year saved $2,500 and the company increased their exports of kerosene which ended up saving the company over time hundreds of thousands of dollars. Every cost at Standard Oil was computed to several decimal places (Charles Koch would find this type of analysis useless as he writes in Good Profit "when measuring, accuracy should always be emphasized over precision. As we use the terms, accuracy is the degree of correctness that creates value. Precision goes beyond that, to near perfection. Perfection, thus, is the enemy of progress".

The hard work from both Koch and Rockefeller would be seen in the results of their businesses. Over a 25 year period from 1882-1906 Standard Oil increased earnings on average 11% per year and their dividends 11% per year. It should be pointed out that John Rockefeller retired in 1896 (however the earnings and dividends didn't drastically change after Rockefeller left). Charles Koch continuously grew Koch Industries as he invested 90% of the earnings back into the company. The annual growth rate of the Koch Industries from when Charles took until the present I calculated was about 21%/year. Koch Chief Financial Officer Steve Feilmeier said in this video that Charles Koch took over Koch Industries when the company had a net worth of $12 million back in 1966 and increased the amount by 7500 times. This would say that Koch Industries is worth $90 billion today and the annual compound rate over the past half a century has been 19% per year which would say that Charles Koch had a higher rate of growth than John Rockefeller over an extended period of time. However, it is important to remember that John Rockefeller started Standard Oil from almost nothing. Koch Industries paid out a lower percentage of their dividends than Standard Oil did. Between 1882 and 1906 Standard Oil paid out about 65% of their net earnings as dividends. Koch Industries would pay a fraction of their net earnings as dividends as the company only paid between 6%-7% of their net earnings as dividends which would allow Koch Industries to reinvest 90% of the earnings back into the company.

The hard work and reinvestment paid off personally for both Koch and Rockefeller. Currently it is estimated that Charles Koch is worth $45 billion. The net worth of John Rockefeller adjusted for inflation today would be $395 billion today. It was said that Rockefeller had a net worth that would be equal to 2% of the national GDP. In the 1890's Rockefeller was receiving $3 million per year in dividends which would be close to $80 million per year (in 2018 dollars). In 1918 it was estimated Rockefeller had taxable income of $33 million (or about $555 million in current 2018 dollars) with a fortune of $800 million (or a dividend yield of around 4%). I calculated in this post Charles Koch earns roughly $377 million per year in dividends from Koch Industries which would say the dividend yield on the stock is only 1%. Koch traded a lower dividend yield for a higher growth rate.

Charles still maintains the same home in Wichita (built in 1974) and has a 5 bedroom, 6,000 square foot home (with a caretaker apartment) in Aspen and a home in Indian Wells, California. John Rockefeller had a home in New York City, an estate in Lakewood, New Jersey, and estate called Kykuit, a home set on 3,000 acres of Tarrytown, New York, and a winter home in Ormond Beach, Florida. Rockefeller had two passions God and golf (he played golf every day). He tended to sometimes show Rainman like tendencies doing the same things the same time everyday. John Rockefeller would spend his time working, with family, charity work in his later years, exercising, and gardening. Charles on the other hand still enjoys reading, he does his 90 minute workout (30 minutes on the elliptical, 30 minutes of weight lifting, and 30 minutes of Pilates)

Charles doesn't like to waste any time. Nancy Pfotenhauer once said that if Charles is in the elevator with you he will take the time to make it a learning opportunity. Also when Charles would drive himself to work he would listen to books on tape for his 10-15 minute commute as Charles says "there is so much to learn". Charles was also a voracious reader and at least in the 1990's would spend 2 hours a day reading of economics, philosophy, psychology (he would read Tom Clancy novels for fun).

Charles Koch would be a master negotiator and was said to even negotiate the hyphen on a 50-50 deal. John Rockefeller would always look at the numbers of the business to see how the company was doing (Rockefeller had an accounting background as a bookkeeper). He made sure the company kept track of all the costs for everything it did and could account for all the financial statements. Charles probably wouldn't be as focused on the precision of the numbers but when Charles Koch does deals he looks at the bottom line and looks at the numbers and doesn't get emotional according to Koch Industries Chief Financial Officer Steve Feilmeier.

In terms of management Rockefeller valued employees who were honest, intelligent, hard working, and efficient. In meetings he often would poll other employees first before making a decision and
would make a compromise to maintain cohesion. Also even when employees or others could get angry at Rockefeller he kept calm and didn't yell or loose his cool. Decisions however had to meet unanimous approval before proceeding. It has been said that Charles Koch as a boss can be fair, but demanding, but will give Koch employees the ability to make decisions (and reap the benefits/consequences of those decisions). One of the biggest things with Charles Koch is integrity. Once Richard Fink had someone call for him at Koch Industries and wasn't honest about the reason he could take the call. Charles Koch had a discussion with Fink on the important of being honest no matter how small the lie is.

Charles almost had a nervous breakdown in the 1970's when the company unfortunately had lost a substantial amount of money on oil tankers-it was estimated to be $500 million (Charles would have to fly back and forth between London to renegotiate the debt). John Rockefeller at the age of 55 was on the verge of a nervous breakdown and had to seek medical attention. Rockefeller who was working hard and also getting more involved. Rockefeller's physician Dr. Hamilton Biggar said that "a little more would have killed him". At the time Rockefeller was under a lot of stress (getting some 50,000 "begging letters") and suffered from insomnia. The doctor told John Rockefeller to relax, exercise, and watch his diet. As a hobby John D picked up golf to relax. Breakdowns seemed to run in the Rockefeller family as John Rockefeller Jr. suffered similar issues. His son joined Standard Oil at the age of 26 with the intent of working at the company his whole life. Even before going to work he wrote a letter to his mother stating he didn't have very much confidence in his abilities but was ready to work hard. However, over time John Jr. became disenchanted with the work and the controversies surrounding Standard Oil and at the age of 36 (only after 10 years) left Standard Oil and took took off 6 months to recoup (John Jr. had a history of breakdowns from the time he was 13 years old) to get more involved with philanthropic efforts.

At the end of the day even though Charles Koch and John Rockefeller created wildly successful business in the oil and gas industry that did have some similarities and some differences. Both started with businesses that were large margin businesses. Charles was much more hard driving then John D. was. Even though both have been called tyrants in reality they delegated tasks and never commanded to their workers what should or shouldn't be done. Both almost had mental breakdowns during their tenures of running large enterprises. Both were interested in improving processes to better improve the companies they worked for. Both valued integrity and honesty. Rockefeller had a history of reinvesting earnings back into the company to grow the company, however Koch religiously invested 90% of the annual earnings back into the company. Standard Oil would on average invest 35% of their earnings back into the business. However, adjusted for inflation John Rockefeller had a larger net worth than Koch and more annual dividends. It is hard to compare both head on given they were of different eras and no one could answer how John Rockefeller would do in modern times. Both were brilliant in their methods for running, growing, and preserving their businesses over an extended long period of time. Truly Charles Koch and John D. Rockefeller stand out as two of the best businessman of all time and the ways they ran their respective companies could be learned by modern business people.

Sandy Springs Georgia A Model of a Privately Run City-Will Others Follow?

Something that I recently read about was Sandy Springs, Georgia. Sandy Springs, Georgia is a city in Fulton County, Georgia (about 15 miles north of Atlanta). What is unique about Sandy Springs is the city has for the most part privatized itself which has to led to more efficiency, lower costs, and higher satisfaction from residents, and the city doesn't have to worry about any unfunded pension liabilities, and hasn't had to increase taxes as a result.

Back in December 1, 2005 the city of Sandy Springs was incorporated. Before the city was incorporated a study from the University of Georgia said that 828 employees would be needed. The city has 271 public employees and 200 contractors for a total of 471 employees (about a 43% reduction from what was estimated). All other functions (except for the police and fire department) are outsourced. Despite the few number of city staff workers the town runs very efficiently. The town doesn't have any backlogs for permit requests, offers a 24/7 service hotline (most cities don't even have a line of communication with residents). The 911 is operated by a private company that is based in New Jersey. The outsourced companies also outsourced human resource, finance, accounting, information technology, permitting, trash collection, motor vehicles, back office operations for: police, fire departments, courts, parks and recreation. In June 2005 the city had to find vendors that could support public services. In just six months the city got the contracts it needed. The beauty of the contracts was the city could dictate the types of benefits/services they wanted which would also dictate the price as well. The city had written in their contracts that problems would be responded to within a 48 hour period and someone had to answer 7 days a week 24 hours a day.

For instance for potholes there was a number residents could call and talk to a live person 24/7 (in the contract the city can dictate how many rings are necessary). If there is an emergency the city will respond within 2 hours. The city pays for two people to operate road maintenance trucks 5 days/week but then tweaked the contract to just 9 days and as a result saved $50,000 (the beauty about about markets is tweaking things as conditions change).

When Sandy Springs started to outsource the city saved about $20 million/year (or a 40% reduction of their budget). The city doesn't even have a city hall and rents regular office space like regular businesses do. With all the savings from outsourcing the city was able to save $35 million as a reserve. Sandy Springs had a surplus $45 million during the recession. The city also is in quite good financial good shape, no loans, and no unfunded liabilities for the pensions and other benefits. In 2011 Sandy Springs looked to other providers beside CH2M and as a result saved the city $7 million by dividing the contracts between 6 contractors.

The city has been so efficient that it has been able to set aside monies to actually improve the infrastructure of the city. The savings has led the city to make $72 million in capital improvements since it was incorporated. With the savings the city has repaved 147 miles of streets, worked on 874 storm water projects, and built 32 miles of sidewalk. What is quite interesting is that after the changes were made the lowest vote that any politician in Sandy Springs received was 84%. Clearly, the residents appreciate the service for their taxpayer dollars.

The city of Sandy Springs, Georgia offers hope to other cities who may be wasting billions of taxpayer dollars, hiring more people than necessary, and ultimately not providing the residents of the city the best service (assuming they even offer this in some areas). 

Take the case of the largest city in the United States (New York City). If even a fraction of the changes were made in New York City the city could run much more efficiently using fewer tax payer dollars too. For instance New York City employees with 325,000 employees. The city spends $92.2 billion per year. Recently, just the future health care costs for New York City has an unfunded liability of $98 billion. It is estimated that the New York City pension liabilities is $142 billion and continuing to grow everyday as no changes are in the near foreseeable future. You throw on top of all this a $100 billion of unfunded medical liabilities (NYC employees qualify for free healthcare after 10 years of service). Now let's say New York City started to contract out some of the services like Sandy Springs Georgia (assume for just the moment) did they would be savings billions of dollars per year meanwhile improving the satisfaction of New York City residents. Assume the city could conservatively save 20% per year. Using a budget of $92.2 billion per year the city would save about $18 billion per year which adds up to some serious money. The city could use a portion of the savings to pay down the unsustainable unfunded liabilities, pay down debt, and or use a portion to reinvest back into the city. The number of employees the city would most likely be cut in half and the best and most important feature is New Yorkers would be able to get better service, faster and more efficient service from their local government. 

Of course the political reality of this happening in NYC or elsewhere is very low. Given the political power to make a change let alone a drastic change like this wouldn't be easy. Also many individuals, groups, and unions have a vested interest in making sure certain things don't change since their livelihood depends on it. The only practical feasible way it could work is if certain portions were outsourced (I would be curious to see what people would say when they have a response to a pothole within 48 hours). 

In the end the idea of Sandy Springs, Georgia is fascinating story of outsourcing government services that reduces the cost, improves the efficiency, and most importantly increases resident satisfaction. It should be pointed out that Sandy Springs is a smaller city (100,000 people) so it would be hard to replicate in larger cities. However, if other smaller city starting adopting these strategies it could catch on. Oliver Porter who was a big influence for Sandy Springs published a how to book of how to book (which gives a step by step direction of how to make the changes). Hopefully this idea will be spread and shared to others as local governments are in need of reducing costs and improving customer service. 

Another Update to Koch Industries Profit Margins, Dividends, and Net Worth

In many blog posts in the past I have tried to calculate the dividend, profit margin, and the historical net worth of Charles and David Koch. Recently Koch CFO Steve Feilmeier in an Q&A session (I blogged about the Q&A session here) with Startup Wichita Local stated that Koch has earned about a 13-14% return over time (the company targets to earn a 12-18% return on projects it invests in). Typically large companies have hundreds of possible of projects but allocate so much money to the projects they feel will earn the highest return). My previous analysis has pegged the return of Koch Industries return between 5%-13%. Clearly this higher return assumption would change the amount of dividends, reinvestment, and net worth for Koch Industries in their shareholders.

Historical analysis would show that the Koch Industries had a low profit. The Koch vs. Koch trial showed that in 1982 Koch had revenues of almost $17 billion and had pre-tax earnings of $564.7 million which would say that before tax earnings was 3%. However, these days Koch Industries is more than just oil and gas. The company has invested heavily in technology companies (with Koch Disruptive Technologies), has their own equity development arm (Koch Equity Development, and is much more diversified (and higher return) than in the past.

So if we run the math if Koch now has revenues of $130 billion and they earn a 13% return it would say their annual earnings are $17 billion per year. $17 billion is of course before Koch pays any taxes. If you you assume a 24% tax rate (which is the average for S&P 500 companies). After-tax earnings of Koch would be roughly $12.8 billion. The company reinvests 90% of their earnings back into the company which would say on average $11.5 billion per year is plowed back into Koch Industries. Koch Industries for the past 55 years (according to Steve) has reinvested 90% of their earnings back into the company. This would say that about $900 million is left over to pay dividends to all Koch shareholders. Historically, the company has paid 7% of the earnings to shareholders. Charles and David Koch each own a 42% interest in Koch Industries (although Chase Koch has mentioned he is a shareholder in this Startup Local Wichita Q&A). If we take the after-tax earnings of the company ($12.8 billion) x 7% payout of earnings x a 42% ownership interest it would say that Charles and David Koch each pull in roughly $378 million in dividends alone. If the Marshall family owns the other 16% of Koch Industries it would say they pull in a little over $140 million dividends per year.

Another interesting thing Steve brought up in his Q&A was when Charles inherited Koch Industries the company had a net worth of $12 million and grew it by 7500 times. This would say that Koch Industries is worth $90 billion and Charles Koch would be worth close to $38 billion (and not the $55 billion that currently Forbes has-Bloomberg is closer at $44 billion. The Marshall family would have an estimated net worth of around $13 billion. Historically the net worth of Koch Industries has grown dramatically as Charles Koch has plowed so much back into the company. The net worth of Koch Industries in 1982 was $1.5 billion . Before the Koch lawsuit shareholders Charles, David, and Bill Koch each owned a 20.7% interest (oldest brother Frederick Koch owned a 13.7%) interest. This would say in the early 1980's Charles, David, and Bill had a net worth over $300 million (Frederick would have a net worth of a little over $200 million). To grow their net worth from $300 million to $38 billion in a little over 30 years is quite dramatic.

When you look at the dividend yield on Koch Industries it is quite paltry compared to large companies. If Charles and David earn $377 million in dividends per year and their net worth is each $38 billion would say the yield of Koch Industries stock is around 1%. The average yield of a company in the S&P is currently near 1.92%. Another way to look at this is to say if Charles and Koch sold their stock they could generate almost double the dividends then Koch Industries stock is paying! Koch however has had a policy of reinvesting 90% of their earnings back into the company which has led to dividend growing dramatically over time. When Fred Koch passed away in 1967 the company paid out dividends of $300,000 (according to Sons of Wichita). If the total dividends of the company are roughly $900 million this would say the annual increase of dividends has been a staggering 21%/year.

The interview with Steve Feilmeier cleared up some of the issues I had been trying to calculate (again these are strictly estimates since Koch Industries is not a public company and doesn't have to disclose any of this information) for a couple of years in terms of how much Koch Industries throw off in dividends, the net worth of Charles and David Koch, and the Marshall family. It shows that Koch is quite a disciplined company and by earning a 13-14% annual return has not only earned a good return but helped fuel the growth of not only the net worth but the dividends of shareholders of Koch Industries.

Koch Industries CFO Steve Feilmeier Startup Grind Local Wichita

Recently Koch Industries CFO Steve Feilmeier sat down with Startup Grind Wichita on February 20, 2019. Chase Koch (son of Charles Koch did a similar sit down back in November 2018 which can be seen here and I blogged about here. Koch Industries is making an effort to get executives of the company out in the public discussing what Koch Industries actually does and what they stand for. These days Koch Industries has grown to a company with $130 billion in revenue and roughly 140,000 employees.

Steve currently is the executive vice president and chief financial officer of Koch Industries. He started with the company back in 1997 as a controller for the Koch Chemical Group and then had various roles in controller operations, tax, treasury, cash management, mergers and acquisitions. In the interview Steve said he had 15 different jobs before he became CFO of Koch Industries. Actually Steve wasn't originally groomed to be the CFO of Koch Industries. Koch Industries had identified someone to become CFO and then after 3 months on the job that individual left the company (it was pointed out that Koch was painfully aware Steve wasn't ready for the job). Steve says one of the most unpleasant days of his life was when Dave Robertson and Charles Koch sat down with him to give him feedback about what he needed to work on. Having these different roles within Koch must have given Steve a really good idea of how the company runs internally. Usually if companies are grooming someone to an executive role they have that individual work in different areas to get exposed to understand how different departments function. Steve points out that Charles Koch has been his biggest mentor over the years. At Koch Industries Steve points out that is it okay to say you don't know the answer a question but jokes if Charles Koch asks you then you better have an answer within a couple of hours or the next day.

Steve discussed the inter workings of Koch Industries in terms of how they perform deal making, the culture of the company, and what it was like working with Charles Koch. In terms of deal making Koch treats a $500,000 deal just like a $5 million or a $50 million deal. When performing an investment the most important thing is the quality of the idea, if the idea is actually solving a problem in society. Also when doing a deal with an entrepreneur Koch likes to see if the company will do the right thing (having integrity), if the entrepreneur is are realistic about projections and are honest saying "hey this project actually may cost 2 or 3 times what I project, but I have a backup plan for that", an entrepreneur that is also willing to not take a paycheck for a couple of years and give up their social life in the process. The entrepreneur also has to have a real business plan and it can't be all in their head. The plan has to have real numbers and make logical sense to solving a problem. Also it is pointed out that when Koch creates profit it consuming less resources. Steve discussed how Koch was going to invest $600 million in a project for Georgia Pacific to use technology to improve the quality of the toilet paper (Quilted Northern) while also consuming less resources. The project is suppose to reduce pulp by 20% (which reduces the number of trees cut down), reduce water consumption by 20% (making toilet paper consumes an extraordinary amount of water), and reduce natural gas by 20% (this is used to dry the toilet paper), while expecting to increase the cash flow of Koch Industries by $100 million per year (which would say the project pays for itself in roughly 6 years or has a 17% return on investment).

When actually performing a deal Koch Industries tries to target a 12-15% return on projects that Koch invests in depending on the risk. Back in 2004 or 2005 Koch embarked on a $40 billion investment plan and then came back in 2011 or 2012 and evaluated the progress report of the return on the projects that they invested in. Koch reviewed 13-14 major projects and when they were reviewing the analysis of the overall return of the projects showed a healthy 14% return but Charles Koch with his engineering training called this type of analysis nonsense. Charles pointed out that the average of all the projects were 14% but when you looked at each project (incremental analysis) that comment was not correct. One project may earn a negative return, 0%, 5%, and then some projects may earn an extraordinary return that increases the weighted average of all the projects to a 14% return. After this presentation Koch changed the way they analyzed projects. When Koch evaluates projects the company looks at all the ways it can go wrong and what are the contingencies if it does go wrong. Steve points out that when Charles is evaluating a deal he has doesn't get emotional, is not strategic, and only looks at the numbers to see if it makes sense. Companies sometimes purchase things to be "strategic" and then later have to take a large write down because of a bad deal. What is also interesting is how Koch isn't run with Charles Koch making all the decisions and everyone just executing his plans. Steve remarks that in 23 years being CFO for Koch Industries he has never been told what to do, however he will let management know what is it doing to get ideas and feedback and if he needs "course correction". These days Charles doesn't have to approve everything on the strategies or acquisitions. Charles in a 2015 interview admitted that he used to get involved in every detail in a deal but these days since Koch is so large it is impossible for him to do that.

On April 30, 2004 at 5 P.M. ET Koch purchased Invista for $4.2 billion in cash. Koch purchased Invista for 6 times (12 month trailing EBIDTA) which is not a bad deal. Invista is a textile company that was in charge of making things like carpet, flooring, nylon, fabric that is used to make pillows, mattress tops, bed comforters and many other products that are used in everyday life. Well Charles Koch was thinking after Koch acquired Invista the company would instantly adopt the same market based management philosophy that Koch Industries used. The issue was Invista was pulled out of a large company (DuPont) that had a different culture than Koch. It took Koch 10 years to unravel this and fix all the issues they had. Today, Invista is one of Koch's most profitable companies. Charles reminds CFO Steve Feilmeier that project deserves an F grade on that acquisition.  In 2017, Koch sold Lyrca (a product sold by Invista) to a Chinese company for $2 billion.

Overall, in the long run Koch Industries has done quite well on their investments. Steve mentions that the company has earned a 13-14% return which has led the company to double in size roughly every 5-6 years. The company has reinvested 90% of the earnings back into the company for the past 55 years which has lead to tremendous growth. The company has in the past 6-7 years spent $17 billion on technology capabilities for the company. Part of these monies were spent on Infor which was presented at a forum for the company. Koch was spending $500 million a year on their HR human capital function. Currently, Koch doesn't have know exactly how many employees it has worldwide and has to rely on multiple records and systems to keep track of everyone. Koch purchased Infor which has software that can be stored in a cloud and integrate all the data into one system. Also another positive is that the software constantly updates itself so upgrades aren't required (Koch was generally performing updates every 3-5 years). With the new technology Koch expects to reduce their costs by 20%-40%. Koch also hopes it will reduce the time it takes to hire employees and also help their internal recruiting. Also they hope this technology will improve downtime at plants and refineries that Koch owns as well.

As Steve points out when Charles inherited the company there was $12 million of equity on the balance sheet which has grown by 7500 times since then. This would say that Koch Industries is worth $90 billion and since Charles Koch is a 42% owner of the business his net worth would be $38 billion which is quite different than the figures that Forbes, Bloomberg, and other sources are reporting. However, even as Charles has accumulated massive amounts of wealth Charles is always worried about the business all going away tomorrow. The constant fear or worrying is throughout Koch Industries. Koch executive vice president Jim Hannan has commented that you have to avoid feeling complacent and having the self satisfaction and have to worry about competitors coming in "and then just get dragged down from behind and get our throats slit".

Overall, I thought the CFO Steve Feilmeier handled himself well in the interview, was quite knowledgeable, and also could be personable too. These days Koch has a deep bench of executives that could step in if something were to happen to anyone which is always a good thing. Feilmeier is only 57 years old so he probably still has another decade or so in that role. He mentioned in his role these days he and Charles both mentor other employees and pass on what they have learned over the years. Hopefully in time the results will be passed on to other employees and will allow Koch Industries to grow even more.

Free Market Solution for Medicare: Publicly Funded Private Choice

Medicare was enacted by Congress in July 1965 under Lyndon Johnson. The goal was to provide health insurance to people over the age of 65 regardless of income or medical history. Currently,  roughly 57 million people are enrolled in Medicare. Medicare provides benefits for those over 65 and also for those with disabilities (end stage renal disease and ALS). What is quite interesting even before Medicare was passed 60% of people over 65 had health insurance. However, older people were paying higher prices. Speaking of prices Medicare sets the prices of over 7,500 tasks. You would think Medicare prices are set by the former Soviet Union.

Medicare is funded by a 2.9% payroll tax. 1.45% of this is contributed by the employee and 1.45% is contributed by the employer. Also there is a surtax of .9% on Medicare wages for individuals making over $200,000 or a married couple making over $250,000. These payroll taxes only cover 1/3 of the Medicare costs. Medicare spending in 2016 as 15% of total spending (20% of total healthcare spending). To put these numbers in perspective the federal outlays in 2016 were $3.9 trillion and Medicare spend $588 billion. The spending has continually increased on an annual basis. From 2000-2016 the annual increase in Medicare spending was 9% per year.The United States spends roughly $10,986/Medicare recipient. The spending of Medicare has increased which if if not reformed could lead to drastic consequences in the form of reduced care, wait times, and inability to access care. If you were to look at the unfunded liability of Medicare (or the assets needed in the bank today to fund future obligations) that number would be $43.5 trillion. There are actual some free market solutions that Medicare could implement that would drastically reduce the cost to taxpayers and also increase the quality and transparency of Medicare. Medicare could be publicly funded (through taxpayer dollars) but have the monies privately spent by individuals. Also it is important to note that Medicare has massive inefficiencies, fraud, and waste. $60 billion per year can be chalked up to Medicare fraud.

There have been some market force changes in healthcare in the past couple of years. In the past couple of years concierge medicine has increased in popularity. Patients were tired of waiting months to see their doctors and when they did see them only getting 15 minutes with them. Doctors were tired of taking on thousands of patients and not being able to spend enough time with their patients. One example of this concierge Medicine is Atlas MD which charges patients a monthly rate for medical care (this is not insurance). The pricing is based off age and those 65+ pay $100/month ($1,200 per year). This membership style service allows patients 24/7/365 access to their doctors. Patients also get access to see doctors the same day with little to no wait. The model is different because it allows doctors to only work with hundreds of patient instead of thousands (allowing them to spend more time with patients). Atlas also has a prescription price list that allows patients to access many commonly prescribed drugs at a fraction of the retail price. A similar model from a company called MDVIP allows patients the same 24/7/365 access and patients pay an annual retainer fee for roughly $1,800 per year. This on demand access to a doctor has seen some positive results. In one study with Medicare Advantage patients showed that the MDVIP program reduced spending by $3.7 million. The study showed a 20% reduction in emergency room visits in the first year and a 24% reduction in ER visits the second year. Now if government took the money they spent on Medicare and gave it to Medicare beneficiaries and allowed them to purchase these types of concierge plans would lead to improved health outcomes greater efficiency.

Now one issue you might bring up is how will we have enough doctors to cover all these patients? As part of this plan I would allow nurse practitioners and physician assistants to practice medicine independently without supervision. Currently in 29 states nurse practitioners require some level of physician supervision. According to the American Medical Association (AMA) physician assistants are not supervised by doctors in 3 states. 20 states require a certain percentage of physician assistant charts to be co-signed by a physician. At the end of 2016 there are over 115,000 physician assistants. There are more than 248,000 nurse practitioners. Nurse practitioners commonly diagnose acute/chronic illnesses (diabetes, high blood pressure, infections, etc.), prescribe medications. Nurse practitioners can practice in many areas like gastroenterology, orthopedics, urology, dermatology and many more sub-specialties. Allowing physician assistants and nurse practitioners to see patients (making these changes would empower over 350,000 medical professionals freedom to practice medicine ) without the supervision of doctors would free up not only doctors to do more productive and valuable things but allow more patients to be seen and less time to be wasted.

Another idea Medicare could use is outsource surgery prices to Medibid (of course it wouldn't be run by the government either). Medibid is a website that matches doctors and patients for prices of common medical procedures and surgeries. The website allows doctors to bid on procedures and allows patients to see the credentials of a doctor, the ratings a doctor has, and the number of procedures they have done-to my knowledge Medicare doesn't offer this information to those patients on Medicare. Patients request they need a procedure and doctors try to bid for business. Doctors quote a price that is all in with no hidden charges (let's compare this to the arcane explanation of benefits (EOB) statements we get from different providers when we currently have a procedure).Using Medibid knee replacements and colonoscopies were priced at about 1/3 of the insurance price and half of the Medicare price.  If Medicare used Medbid as a market price for what should be paid there is no question billions of dollars a year could be saved and there would be more: price transparency, less administrative burden for doctors, and doctors would get paid quicker because they wouldn't have to worry about hassling with the health insurance for payment.

Another no brainer to help save Medicare billions is to legalize the selling of organs (especially kidneys). Every year $32 billion is spent by Medicare for dialysis. Dialysis is required to those who have a loss of kidney function. One way to get off dialysis is to receive a kidney. However, currently there are over 120,000 people waiting for a kidney. Close to 5,000 people every year die waiting for a kidney transplant. One way to fix this is to allow people to sell their kidneys. This would add a supply of organs (after all it is your body) to the market allowing sellers to receive cash to-pay bills, start a business, or pay off college tuition or credit card debt. Also if people were selling their kidney would increase the number of surgeries which would allow surgeons to improve the procedure and become even more experienced with the process which would improve the outcome. The buyer would get a kidney and no longer have to continue to receive dialysis which is costly and painful for the patient as they sometimes have to go multiple times a week. Is it moral to allow people who own their own kidney not to sell it? This would save billions of dollars every year, improve the overall health and quality of live for not only the 5,000 people who pass away every year but also give hope for the 120,000 people and their families who have to wait.

A simple way to greatly increase competition is to give the money directly spent on Medicare directly to Medicare recipients (or as they like to say cut out the middle man). In any true market, competitors compete for business by providing a better product or service at a better price. Healthcare is different because there are third parties providers (insurance companies) and the government that picks up the bill for both Medicaid and Medicare. What if however individuals were given the money that was spent on Medicare for them and allowed to spend it for medical expenses in whatever way they saw fit.

If Medicare spends $11,000 per beneficiary and the average 65 (male) needs about $4,500 per year for insurance premiums (of course there would need to reforms in the health insurance market with massive deregulation to drive the premiums down even further). Now if $8,000 could be deposited into each Medicare recipients health savings account (this would be done by a company like ADP or some other payroll company of course-they would have to bid on this contract too) you would allow people to spend money for their own health decisions. Also this program could be means tested (trying to go for bipartisan support here) and tied to income. For instance if someone earned an income of $300,000 they would be phased out of the $8,000 and get only $4,000 deposited. You might say what is to prevent the person from taking the $8,000 out of the health savings account and spending it on something else. Well existing rules on health savings accounts already subject distributions from a health savings that are not for medical expenses to ordinary income plus a 10% penalty (so if your ordinary income is 10% and the penalty is 10% there would be an effective 20% tax on the distribution). It would be costly for someone to take a distribution for something other than medical expenses (I would even be okay increasing the penalty for taking a distribution of non medical expenses from an H.S.A. to 20-30% if needed). The other thing to remember is that earnings inside a health savings account grow tax free (so it would be foolish to take a distribution from this account). If you have $8,000 every year in a health savings account grow every year future health expenses could be covered. Say there are 43 million people on Medicare and if Medicare is spending roughly $11,000 per beneficiaries and $8,000 was deposited into each beneficiaries account (remember if it was mean tested some people would get less than $8,000) then conservatively $129 billion would be saved every year. In addition to this, Medicare beneficiaries would have an incentive to understand what healthcare procedure/care they received and evaluate the cost and benefit. Doctors would no longer bill Medicare and would instead would receive payment directly from a health savings account which would be quicker and the doctor wouldn't have to wait to get paid. The $8,000 would only be for a number of years (4-5 years) and eventually phased out to the next step.

The next step for Medicare would be to allow younger people to opt out of paying Medicare taxes and instead have the monies go into a health savings account (you would have to change some of the current regulations to not require a high deductible plan for a H.S.A.) or the option to save possible for individuals and families to save for medical expenses in retirement. If people were able to start saving for their healthcare expenses in retirement over a 30-40 years it would allow for the effect of compounding growth. For example if someone saved $1,000 per year, for 40 years, at a 6% interest rate they would accumulate close to $200,000 that could be set aside for medical expenses in retirement. If you just increased the amount of savings to $2,000 per year the amount (keeping all other variables constant) the individual could have a little over $300,000 in assets. If you had a married couple this could be over $600,000 in assets for medical expenses in retirement. What is interesting is that it is predicted that in retirement individuals will need roughly $280,000 in retirement for healthcare expenses. Clearly allowing participants to save for their medical expenses in their older years would the way to go.

Now the next logical question is if younger people opt out of Medicare taxes how would would the government earn revenue from Medicare payroll taxes. As I mentioned in this post the government owns billions of barrels of oil and trillions of cubic feet of natural gas (the estimate of just the oil the government owns is $62 trillion and add in another $5 trillion for natural gas and you have ~$67 trillion in government owned assets that could be sold. In 2017, payroll tax revenue from Social Security and Medicare was $1.16 trillion. If you include the value of oil, gas, and coal owned by the government this totals $128 trillion. Clearly selling off these assets to individuals, companies, and foreign companies would be a windfall of income for the government that could be used to replace payroll taxes for both Social Security and Medicare.

The current Medicare situation is quite complicated and expensive. If changes are not made future consequences will unfold that could have a dramatic effect on the quality of healthcare and access provided in the future. The obvious no brainers are allowing physicians assistants to practice without supervision (would allow Medicare patients more access), allowing Medicare to outsource their price system to Medibid (this would save billions), allow individuals to sell their kidney (this would save many tens of billions of dollars). After these were accomplished Medicare could transition to using a portion of the of the money they spent on Medicare recipients ($11,000 per recipient) and deposit $8,000 per year into an individual health savings account (for a married couple this would be up to $16,000). Individuals over 65 would have the ability to determine to shop around for health care and create much more competition and transparency. This program would last 4-5 years (after this Medicare would effectively be phased out) at the start of this program younger folks would be able to opt out of paying Medicare tax and allowed to save this money in a health savings account to finance their future Medicare expenses. To make up for the lost payroll tax revenue a portion of the $128 trillion of assets owned by the government would be sold. These changes would allow for more competition, less bureaucracy, greatly improve access and affordability of healthcare, and allow Medicare to be sustainable.

Chase Koch Wichita Startup Grind Summary and the Future of Koch Industries

On November 14, 2018 Chase Koch sat down with Wichita Startup Grind for an interview that began at 5:30 P.M. (his wife Annie was 15 minutes late since she was working) with many employees from Koch Industries in the audience to support Chase. Chase discussed his younger years, his time of living and playing music in Austin, working at Koch Industries, and his journey to how he got to where he is today.

Chase in the interview mentions how his father Charles Koch really studied philosophy and liked to read Hayek and Maslow and other free market thinkers, however at first this really didn't sink in for Chase. Chase would say the quote he would remember from Maslow is "What you can be you must be" which is something he has tried to carried with him. Every Sunday Chase and his sister Elizabeth would sit down for a 2-3 hours and have their father Charles Koch read to his children Human Action from Ludwig von Mises or have them listen to books on tape from Walter E Williams. Chase admits these days he says he has a "libertarian nature".

In his younger days Chase enjoyed playing tennis (his parents made sure their children lived up to their potential and found something they were good at-his sister Elizabeth was a runner). Chase was actually quite the tennis player and Sports Illustrated profiled him in their "Faces In the Crowd" which usually recognizes some of the best athletes in the country. Although, Chase was a great tennis player he started getting burned out and started throwing tennis matches so he could go home and party with his friends. This led to a meeting with his father where his father told him either he could give 100% on the tennis court or start working (he started working). So in the summer of 1993 when Chase was only 15 an old beat up pick up truck took Chase on a 5 hour drive to Syracuse, Kansas were Koch Industries owned feedlots with 55,000 head of cattle and shoving you know what. For the summer Chase lived on the couch and earned $7.50/hour and worked from 5 A.M. to 7 P.M. and worked 7 days a week and had to pay $350/month for rent for a guy that lived in a double wide trailer. After this summer experience Chase would say in this video he thought there was an evil Koch brother and he joked he almost turned in his father in for child abuse. Overall though he admitted it was a good experience because before this time period he had never worked a day in his life and if he had not worked he would have gone down the path of a country club brat.

Chase graduated Texas A&M University in 2000 (I bet he is a target for donor giving). He was recruited by former Koch president Bill Hanna who attended A&M with a business degree in marketing. He had the music bug and in college played in a band that covered Led Zeppelin, Phish, The Grateful Dead, and Pink Floyd. After he graduated was during the tech bubble of the early 2000's was a difficult time in job market. With the tech bubble burst companies aren't exactly looking to hire marketing (since this is one of the first things they cut). Chase decided to look around and see if he could still get work and decided to offer to work for free for a company (they would eventually pay him) so he could get the learning experience under his belt. Leslie Rudd (who was good friends of Charles Koch) had dinner with Chase and wondered what Chase was doing as Chase in his own words "screwing around in Austin". Leslie suggested that Chase go back to Wichita and go work for Koch Industries were he could learn plenty from Koch leaders and his father. He would join Koch Industries in 2003 starting out in the accounting group, moved to the tax group, then moved to the risk management group, then trading, and then business development. Charles Koch and other Koch leaders had planned out a "Koch-MBA" style training program for Chase. Often times in large companies you get exposed to many different areas in order to understand the basics of how the business operates. Koch admits that learning the basics of how Koch Industries was not exciting but admits he had to learn the business from the ground up. As his mother would say "you can either pay now or pay later". Chase had high expectations of himself which led to anxiety and he felt as if he had to work three times harder than everyone else. When Chase asked his father what percentage of his days should be good his father turned the question around and asked his son what percent of his days were good. Chase responded only 40% of his days were good and the other 60% were not so good. His father thought this percentage was actually pretty good. Running any company is no picnic-especially a conglomerate like Koch Industries that is a $100+ revenue company with so many different companies and subsidiary companies in 60 different countries.

When Chase was placed in charge of Koch Fertilizer he began to crack. He was running 5 different business units (sales, marketing, trading, and other groups). Chase was also working hard-coming in to the office at 5 A.M. and staying late (according to this article back in 2014 Charles was getting to the office around 7 A.M. and works until 6 P.M. ) At this point Chase approached Koch leader Dave Robertson for advice. Dave told Chase that any good leader has to do three things. The first is to set a clear vision of where you going. The next important thing is to get the right leaders in the right role. The third point is to help the team in a way that is mutually beneficial. Chase said he tried to learn from this and constantly apply what he was learning from other Koch leaders.

What is interesting is Chase admits this role was not an easy one for him. He felt as if he had to understand all the details and even admits to micromanaging things (which frustrated him). The group Koch Ag looked at high efficiency fertilizer, high efficiency technologies and he would spend his time in Silicon Valley, Boston, and New York learning how technologies could help Koch Industries. This would lead into Koch Disruptive Technologies (KDT) which was created to look at technologies that are so disruptive that Koch Industries could use these technologies to expand and improve capabilities within the company. KDT is industry agnostic as well. Chase admits the division is pre-revenue which I translate into not producing any cash flow yet (which honestly I am surprised as Dave Robertson in this 2012 article mentioned that "Charles is focused on, really, the present value of the future cash flows, thinking long term". Perhaps when Koch has analyzed these projects they produced positive cash flow over a 10-15 year time horizon. However, the issue is these technologies change so quickly that is hard to model in any analysis. KDT has key criteria for whether or not they get involved. Factors such as how disruptive the company is, has the company demonstrated the idea in the marketplace, how much potential the idea has, if the founder of the company and leadership are proven principled entrepreneurs and if there is mutual benefit. Chase does echo what his father mentions in that any partnership (he uses his wife Annie as an example of this) that you need an aligned vision, assigned values, and complimentary capabilities. KDT is looking and excited about healthcare, industrial use technology (this could help the reliability and safety of Koch owned plants and facilities) and exponential data. Related to this one of the biggest challenges right now for Koch Industries is how much data the company throws off. According to Chase the amount of data at Koch Industries increases every year by 60%. The company is trying to use that data to optimize their businesses processes and use that data to make better decisions.

Chase admitted in the interview that he was a shareholder of Koch Industries which makes me wonder about what Charles Koch said years ago that he "had done estate planning for many many years". It could be possible that Chase Koch owns the stock through some type of trust. Chase admitted that as a shareholder of the stock he is still learning the risk of the shareholder and not to miss any potential opportunities and at times absorb risk in a responsible way.

Chase Koch has been working at Koch Industries since 2003 which would say he has a long history and understanding of how the company works (also he lived with the man who has run Koch Industries for many decades). Right now he is in charge of Koch Disruptive Technologies however, I would be curious to see if over time he gets moved into more executive roles. Chase currently reports to Chief Financial Officer Steve Feilmeier. Also Chase is on the board of directors for Koch Industries. He has been on the board since March 7, 2013  and in addition to being on the board is also a shareholder of Koch Industries stock. What is fascinating is how he went from screwing around in Austin playing in a music band to becoming an executive at one the largest privately traded companies in the country. He said here that "it took me until I was 25 or 26 that "You're an idiot if you don't go back to Koch" and really capture the opportunity to go learn, and stop screwing around in Austin, Texas".

If something were to happen to Charles Koch tomorrow though I think Koch would not select Chase given he is only 40 years old (fun fact his birthday is January 1st) and perhaps may give it to Dave Robertson who has been with Koch since 1984 and served as the Chief Operating Officer and President of Koch since December 2005. Time will tell what happens but there is no doubt Chase Koch has come a long way and has paid his dues with this time, energy, and hard work at Koch Industries. It will be interesting to see how he shapes the future of Koch.

Koch Industries Reinvestment Policy of 90% of Earnings vs. Other S&P 500 Companies

What has struck me as interesting is how much Koch Industries reinvests back into their company. The company has a policy of investing 90% of their net income back into Koch Industries. Koch uses their earnings to improve, build, and expand existing capabilities. This reinvestment policy has led to exponential growth which has lead to substantial increase in the amount of dividends of the years. I calculated in this post that Koch Industries increased their dividends by an average of 19% per year (most large companies may increase their dividend 3-4% (if they even increase the dividends at all)). If any public company increased their dividends 19% per year they would be viewed as crazy. However, the question I wanted to look at is how does Koch Industries reinvestment policy compare to other publicly traded companies?

On the surface a company plowing 90% of their net income sounds crazy from a corporate finance perspective. If you plow so much money back into the company how do you manage economic downturns? Companies like to keep a cash or liquidity buffer in case their economic situation weakens. Koch plows back 90% into the company and pays out 7% of its earnings as a dividend leaving about 3% for cash or liquidity needs. In this post I estimated Koch earned $5.6 billion after-tax and if you take 3% of $5.6 billion it would say the cash left over after paying out dividends and flowing back earnings into the company would be only $168 million! Remember Koch Industries has revenues of $100 billion+ of revenue. Since Koch Industries is a privately traded company the company doesn't have to release their financial statements. However, publicly traded companies have to release their financial statements to the public. Also publicly traded companies have to manage quarterly earnings, manage guidance of future forecasts of future earnings with analysts, and if they company pays a dividend manage that as well. Charles Koch isn't fond of publicly traded companies as is quoted as saying (from this 2006 Wall-Street Journal weekend interview) they have "the short-term infatuation with quarterly earnings on Wall-Street restricts the earnings potential of Fortune 500 publicly trade firms".

Although Koch Industries is a conglomerate and is a mix of many different companies. However, from a 2012 interview Dale Robertson mentioned a large portion of the revenue from Koch still comes from energy related things. In analyzing the reinvestment rate of companies I used Morningstar to analyze the 5 year average of the net income and also looked at the capital expenditures of these companies. Analyzing just integrated oil and gas companies (ExxonMobil, Shell, BP, etc.) it appears Koch Industries actually has a more conservative policy than the integrated oil and gas companies. For example ExxonMobil had an average net income of $20.66 billion and their capital expenditures were $23.75 billion. If you divide the capital expenditures by the net income this would get the reinvestment ratio. In the case of ExxonMobil their reinvestment ratio would be 115%. Now you might wonder how can a company plow more income back into the company than it makes? Well companies can borrow money using debt in order to finance their capital expenditures. Looking at an average for ExxonMobil, Shell, BP, and Chevron would show the average reinvestment ratio is 131% which says the integrated oil and gas companies have been borrowing money (primarily due to lower oil prices/also when you are pumping oil out of the ground you have to worry about constant depletion). Koch tries to stay away from debt. Moody's credit rating agency currently rates Koch Industries debt with a credit rating of Aa3 which is high level credit with a stable outlook. The Chief Financial Officer Steve Feilimer has said that Koch Industries can never have AAA credit (the best credit rating) since the company is not publicly traded.

If you compared it to other companies in the Standard & Poor's 500 tells a different story (using a 5 year average from Morningstar) of their reinvestment policy vs. Koch Industries. Apple who makes iPhones, iPads, and other iProducts reinvests 25% of their net income back into the company. The conglomerate Proctor and Gamble plows back 35% of their earnings back into the company while mega conglomerate Berkshire Hathaway run by mid-westerner Warren Buffett reinvests 50% of their profits back into the company. Investment banking company Goldman Sachs reinvests 35% of their net profits. The best comparison of Koch Industries would be a mix of an integrated oil and gas company (it should be noted that Koch Industries does not explore for oil-however is involved with the refining and the process of taking crude oil and using that to develop other products)/a company such as Proctor and Gamble (given Koch produces so many consumer products)/and perhaps Goldman Sachs (Koch has Koch Equity Development which lends and provides financing for other companies). If you took a weighted average and said Koch is 1/3 the average of the integrated oil and gas industry, 1/3 Proctor and Gamble, and 1/3 Goldman Sachs it would lead to a 66% reinvestment ratio. Again Koch reinvests 90% of their net income back into the company which is substantially more than their publicly traded peers.

According to a 1994 Wichita Eagle article in 1966 (the year before Fred Koch passed) Koch Industries earned $166 million of revenue (the company only had 650 employees at the time) and the company only paid out $300,000 in dividends (according to Sons of Wichita). According to Sons of Wichita during the early 1980's the total dividend pool for Koch shareholders was $28 million. Charles Koch grew Koch Industries dramatically by pushing back 90% of the net income the company earned into the company. This historically high reinvestment ratio is much greater than many large Fortune 500 companies.  Today, Koch Industries is a $100+ billion company and I estimated pays out between $380-$940 million in total dividends to shareholders (this estimate is closer to the higher end given testimony from Preston Marshall in a recent court case). This would say that the dividends are now over 3,000 times the amount after Fred Koch passed! The strategy of reinvesting a large amount back into the company has increase the revenues, dividends, and increase the net worth of Charles and David Koch along with the Marshall family. Although, the policy of reinvest 90% of their earnings back into the company may seem crazy for most public companies Koch has shown that this can be sustained for the long term.

Chase Koch Startup Grind Interview and Q&A

Koch Industries Profit Margins and Dividends Update

I have spent time in the past analyzing and estimating the profit margin of Koch Industries and also estimated how much David Koch, Charles Koch, and the Marshall family pull in from dividends. It has been some time since I looked at all of this and wanted to update these figures given recent information.

A recent estimate shows that Koch Industries earns $110 billion of revenues per year. This brochure from Koch Industries shows that Koch has reinvested $100 billion back into the company since 2003. Koch reinvests 90% of their earnings back into the company. The brochure has a publication date of 2018 so let's assume $100 billion was reinvested over a 15 year period (2003-2018). So if $100 billion represents 90% of earnings that were invested back into Koch Industries this would say that Koch earned $110 billion from 2003 to 2018. The average Koch would earn per year would be ~$7 billion a year ($110 billion/15 years). This is of course is before taxes are paid. The average tax rate paid by S&P 500 companies is 24%. Factoring in 24% taxes would say Koch earns around $5.6 billion per year after-tax. Of course as I mentioned this is an average. The $100 billion was over a 15 year period. So if we use the average amount per year of ~$7 billion and use 2010 as a starting point (the middle of the years in the 15 year period) and grow it by 12% per year (this is the average growth rate of Koch Industries as discussed by Charles Koch and also discussed in this Discovery Koch newsletter) it would say Koch Industries earns ~$18 billion (this estimate would be on the high side).

Now the question is if Koch earns $110 billion in revenue how much is profit (after-tax)? Well under a conservative view it would be ~5% ($5.6/$110 billion) and under probably a maximum amount of roughly 13% ($14 billion/$110 billion). The true profit margin for Koch Industries is probably somewhere in between 5% and 13%. As I mentioned in this post Koch Industries in 1982 had revenues of close to $17 billion and had earnings on that revenue of $309 million. In the prior year of 1981 the company (according to the Koch vs. Koch case) had $15.7 billion in revenue and earned $273 million which would only be a profit margin of 2%. This would say Koch has a razor thin profit margin of 2%. Another way to look at profit margin is let's say there are 365 days in one year. If Koch has a 2% profit margin this means the company is only making profit 7 days out (2% x 365) of the year. Also in a recent article about Koch Disruptive Technologies it is mentioned that this division is a pre-revenue company which to me translates into no revenue, no earnings, and no cash flow. The other thing to consider is the largest asset of Koch Industries is Georgia Pacific. Before Koch purchased Georgia Pacific the company had a profit margin as I mention here of only 3%. According to Bloomberg Georgia Pacific has estimated revenue of $19.4 billion-this would currently represent about 18% of all the revenue that Koch Industries earns.  This would lead me to believe the profit margin is closer to the 5% than the 13%. The average profit margin recently for S&P 500 companies is 11.1%  which would mean many companies have a higher profit margin than Koch Industries.

Now that the revenues and profit margin are better understood the dividends for Koch Industries can be examined. If Koch earns on average $7 billion/year ($5.6 billion after paying taxes) and pays out roughly 7% of their earnings as dividends (the company did at one point did pay out only 1% of earnings as mentioned in this article from the late 1980's) and if Charles and David Koch own each a 42% interest in Koch Industries stock then Charles and David Koch each pull in ~$160 million per year in dividends (once Charles and David receive the dividends they also pay income taxes on that income as well). If we use the average amount of $5.6 billion of earnings (after-tax) and start in 2010 and grow this by 12% per year then the earnings would be ~$14 billion (after-tax) by 2018 and if Koch pays out 7% of their earnings as dividends x a 42% ownership interest would mean over $400 million dividend each for Charles and David Koch. Using these same metrics would say that the Marshall family (who have a 15% interest in Koch Industries) would generate between $60 million and $140 million per year in dividends. This dividend estimate seems quite reasonable as Preston Marshall (son of Elaine Marshall) would testify in court that the trusts that held Koch Industries stock would generate $120 million per year in dividends. Preston handled the administrative work for her trusts (prepare the books, prepare tax returns, facilitate trust distributions for his mother Elaine Marshall) so he would have an understanding of what occurring.

My estimates would show that Koch Industries has a profit margin between 5% and 13%. My estimate is the profit margin is closer to the 5% figure though. Also the company generates dividends for Charles and David Koch between $160 million to $400 million per year. For the Marshall family Koch Industries stock generates between $60 million to $140 million per year. This would say that Koch Industries pays between $380 million to $940 million in dividends it's shareholders. My guess would be the dividends are on higher end given the testimony of Preston Marshall. The growth of dividends came from a company policy of reinvesting 90% of earnings back into the company which would scare most S&P 500 companies. This growth has fueled not only the growth of Koch Industries but also the dividends to Koch Industries shareholders.