Why MidCos could have saved Lehman Brothers

I was struck by an article on the front page of today's Wall Street Journal which seemed to bemoan the fact that investment banks were being forced to act like, well, investment banks.  The article noted that new regulatory requirements were causing banks to shift from risk-taking endeavors into more "staid strategies" such as "trading securities for clients, processing trades, exchanging currency, managing assets and advising clients on deals and financing."  Last time I checked, these are the sorts of stable, low-risk, cash producing, midstream businesses (i.e., MidCos) that Investment Banks are supposed to pursue.  In fact, if Wall Street had focused more on its MidCos last decade vs. engaging in principal risk taking, much pain and sorrow would have been avoided.  With that, a moment of silence for my first employer...

MidCo Hall of Fame - Google



The MidCo Hall of Fame


In my previous post, I outlined the broad parameters that I use to determine whether a company qualifies as a MidCo.  As a reminder, MidCos matter because it is my contention that they tend to be great businesses and as such are a a great place to pan for investment gold.  As a close friend pointed out, Barry Diller made a career out of buying and selling them (see IAC).  In this post, I will induct the first ever member to my MidCo Hall of Fame.  First up is the king of all private sector MidCos - Google.

"In Google We Trust"

The Theory of the MidCo

"The art of good business is being a good middleman."

Eddie Temple, Layer Cake

The musings of a fictional gangster played by Michael Gibon would, at first glance, appear to have little practical application in  the world of legitimate business. However, Gabon's quote is actually an excellent summation of one of my favorite frameworks through which to view the investable world - the Midco.

The MidCo is the love, respect, community...and the dollars too. Wait...no...that's the kwan.  But there is certainly kwan to be minted by an archetypal MidCo.  So what is a MidCo?  The MidCo can be broadly thought of as a for profit toll collector.  He sits at the intersection of a transaction between two or more parties who are attempting to engage in commerce.  He can take either a virtual or physical form.  The purest form of a virtual MidCo requires almost nothing, save a mobile phone, a Rolodex and moxie (think real estate or mortgage broker).   A physical MidCo generally provides a transportation, communication or logistical function allowing commodities (including information) and goods to move between two points (think toll road or natural gas pipeline).  However, not all transportation related businesses are MidCos.  A physical MidCo must own the permanent infrastructure connecting the counterparites (e.g., telephone network operators).  This eliminates trucking, airline and shipping companies and is a key determinant of profitability and operating leverage (more to come on these subjects).   

So what makes a MidCo a MidCo besides its general role as an intermediary?  There is some ambiguity  in certain instances (i.e., are railroads MidCos? answer - probably) but I wouldn't go so far as to invoke Justice "I know it when I see it" Potter Stewart at this point.  Below are my top 4 "you might be a MidCo ifs" in no particular order: