How To Turn $100K into $4,000,000 with Distressed Investing

Key Concepts:

• Distressed Investing: Investing in companies or assets facing financial difficulties, such as bankruptcy.
• Stake and Sizzle: A distressed investing philosophy emphasizing both a margin of safety (stake) and potential upside (sizzle).
• Optionality: The potential for significant gains if certain positive events occur.
• Claims Market: Buying and selling claims against bankrupt entities.
• Value Investing: Identifying and investing in undervalued assets.
• Tailwind Returns: Returns boosted by favorable external factors, such as increased institutional investment.
• Co-opetition: Cooperating with competitors for mutual benefit.
• Scuttlebutt: Gathering information through informal channels and direct observation.
• Fool's Gold: Assets that appear valuable but are ultimately worthless.
• Receivership: A state court process similar to bankruptcy, where a receiver manages a company's assets.

1. Introduction to Distressed Investing

• The podcast introduces the concept of distressed investing, prompted by Scott Galloway's investment in distressed FTX claims.
• The guest, Tommy, is described as an expert in this area, particularly in the claims market.
• Distressed investing is presented as a more exotic and less vanilla approach to business and investing.

2. Distressed Investing 101: The Big Idea

• Tommy positions himself at the "bottom of the food chain" compared to large distressed investing firms like Oak Tree, Silverpoint, and Apollo.
• His background stems from his parents being bankruptcy lawyers, providing him with legal process knowledge.
• He emphasizes Michael Price's saying about seeking both "steak" (known value, margin of safety) and "sizzle" (potential upside) in investments.
• The FTX investment is cited as an example: buying claims at 20 cents on the dollar with a potential return of 30 cents plus crypto "sizzle."
• He highlights that financial service bankruptcies, Ponzi schemes, and dot-com cases have historically been good opportunities in distressed investing.
• The strategy involves availing oneself to optionality, buying assets cheaply or for free.

3. Tommy's Business Model

• Tommy describes his operation as a "lifestyle business" with a small team, allowing him flexibility in work hours and location (low-cost jurisdiction).
• He finds distressed deals, convinces rich people to buy them, and takes a cut.
• He also invests his own capital.
• His lower cost structure allows him to offer competitive fees compared to larger firms.

4. FTX Example: A Blueprint

• Tommy was already involved in crypto distressed situations before FTX, starting with Mount Gox in 2014-2015.
• He aimed to create a category of crypto distress investing, anticipating the future of crypto while others were hesitant.

5. Inventing a Category: Examples

• Howard Marks is cited as an example of someone who "invented" the institutional asset class for distressed investing, lowering the cost of capital and attracting new investment.
• Early venture capitalists like Alan Patricof also created a category.
• Y Combinator (YC) created the category of pre-seed investing.

6. Mount Gox Story

• Mount Gox was the largest Bitcoin exchange in 2014 before its collapse due to a hack and cover-up.
• Tommy's firm was the largest buyer of claims in Mount Gox.
• Claims were bought for about a fifth of the market price of Bitcoin (around $80 per Bitcoin when Bitcoin was $300).
• The estate found 200,000 Bitcoin out of 800,000 that were supposed to be there.
• The "stake" was the 200,000 Bitcoin, and the "sizzle" was the potential for finding more Bitcoin and the price appreciation.
• He faced skepticism and was laughed out of a hedge fund pitch meeting.
• He started with a small investment ($200,000) and co-operated with larger firms like Oak Tree to scale the deals.
• The original investor made over 40 times their money over seven years, primarily due to Bitcoin's price appreciation.
• In 2018, the trustee sold a fifth of the Bitcoin, creating a situation where claims could be bought for below the cash value.
• Uncertainty around who would get the uplift in value (the original owner or the customer claimants) contributed to the opportunity.

7. Navigating the Claims Market

• The hosts express surprise that opportunities exist in high-profile cases like Mount Gox and FTX.
• Tommy explains that big firms focus on bonds, which require significant capital and prime broker relationships.
• He operates in the claims market, which is less competitive and accessible to smaller players.
• He describes the claims market participants as not always "super smart," but he enjoys working with them.
• He positions himself as a "little thing that eats the stuff that falls off the shark," benefiting from the larger firms' activities.
• Customer account claims are more accessible for smaller players compared to structured debt.
• He uses leaked lists of creditors to contact potential sellers.
• The work involves finding people, contacting them, verifying ownership, and ensuring the claim hasn't been sold.
• This grunt work is why investors pay a carry or fee to those who do the diligence.

8. Lifestyle and Upside

• Tommy enjoys the flexibility of his lifestyle, working project to project from Italy.
• He can potentially make seven to eight figures in a good year.
• The challenge is overcoming the perception that he's "just a broker" due to not being based in New York or part of a large firm.

9. First Foray into Distressed Assets

• Tommy's first experience was flipping a HUD house with his brother, funded by his mother.
• He also considered buying an entire baseball card shop for $3,000 as a kid.
• He was obsessed with Warren Buffett and melded Buffett's value investing principles with his knowledge of bankruptcy.

10. The Venn Diagram of Success

• Three key elements for success in distressed investing:
  • Knowledge of the legal code (bankruptcy).
  • Deep knowledge and interest in deep value investing.
  • Entrepreneurial hustle to cold call, raise capital, and verify claims.

11. Buffett's Influence and Unique Advantages

• Tommy's first real distressed investment involved Ethnex Energy, where he drove around buying restricted shares.
• He emulated Buffett's approach of using unique competitive advantages.
• He highlights the importance of "scuttlebutt" (gathering information through informal channels).
• He notes that new advantages emerge, such as the ability to invest in Japanese insolvencies using Google Translate.

12. The Importance of Communication and Frameworks

• The hosts praise Tommy's ability to use effective language and create frameworks for understanding distressed investing.
• He emphasizes the importance of valuation and how it's manufactured.
• He acknowledges the communication skills of figures like Howard Marks.

13. Core Philosophies

• Shop Madison, Not Canal: Buy real assets that are cheap, not "fool's gold."
• Start Young, the First Decade is Tuition: Gain experience early, even if it involves mistakes.

14. Investing Strategy

• Tommy's portfolio is primarily active, focused on distressed deals.
• He puts most of his money into his own deals and friends' deals.
• He aims for concentration in his investments.
• He believes he can reliably compound money at aggressive rates (30-50% per year) in the claims market.
• He emphasizes the importance of being selective and not having to constantly find deals.
• He aspires to do a deal that generates significant returns, like turning millions into billions.
• He believes "a position well bought is already half sold."

15. The Ugly Side of Distressed Investing

• As a small player, you can get "totally hosed" by larger firms.
• Distressed investing is transactional and financial, lacking the "starry eyes of the future."
• You're often arguing over a shrinking pie.
• It can take an emotional toll, as you're dealing with people who have lost their life's work.
• It's a "disease" that compels you to constantly look for deals.

16. Addressing Past Issues

• Tommy acknowledges his involvement in a receivership in Delaware and the "nasty headlines" he received.
• He was in charge of marshalling assets for a pump and dump penny stock.
• The court didn't like some of his activities, such as tax positions and moving money around.
• He was "aggressively slapped" by the court.
• He emphasizes that he cooperated with the court and is glad the shareholders received a good recovery.
• He feels responsible for doing everything properly and doesn't plan to do that again.
• He paid a $2 million fine and $750,000 for the special master.
• He gave them claims that they say were co-mingled within my personal investments.
• There was no admission of liability.

17. Reading List

• Margin of Safety by Seth Klarman
• Books by Marty Whitman from Third Avenue Value
• Biography of Kirk Kerkorian (The Gambler)
• Entrepreneur biographies (e.g., Zeckendorf, How to Lose $100 Million and Other Valuable Advice by Arthur Little)
• You Can Be a Stock Market Genius by Joel Greenblatt
• Biography of Edward Plunkett Taylor

18. Sam Bankman-Fried Anecdotes

• Tommy never personally encountered Sam Bankman-Fried (SBF).
• He notes that many of SBF's employees were associated with effective altruism (EA).
• The hosts discuss SBF's calculated image and potential use of Robert Greene's 48 Laws of Power.
• SBF's contracts were insane.

19. Conclusion

• The podcast provides a detailed overview of distressed investing, from the basic principles to the challenges and potential rewards.
• Tommy's insights, personal anecdotes, and reading recommendations offer valuable guidance for those interested in learning more about this specialized area of finance.
• The discussion also touches on the importance of ethical considerations and the potential pitfalls of the industry.