By Ryan Dolan
“Everyone can see I had a rocky year. This was not a fun personal balance sheet reset.”
John Foley, 2022
Building wealth and sustaining wealth. Two sides of the same proverbial coin, and yet so different. For the self-made, the road to a smooth transition from the first to the second can be challenging. I’ve based this series on the Greek mythological figure Icarus, who famously flew too close to the sun on self-built wings, only to see them melt, causing him to tumble tragically back to earth. I’ve profiled three individuals, each of whom built multi-billion personal fortunes, only to lose most of it in catastrophic fashion, and tried to take some lessons from their journey.
The first profiled was natural-gas fracking pioneer Aubrey McClendon. The founder of Chesapeake Energy, McClendon built a vast fortune in just a couple of decades, only to see it collapse in startling fashion. McClendon’s wealth was overwhelmingly concentrated in assets that benefitted from a rising natural gas price-an infamously volatile commodity. This concentration risk was magnified by McClendon’s wild use of debt. As a local Oklahoma newspaper pithily said, “You can’t spell McClendon’ without lend.” The man was perennially, and wildly, bullish: bullish on nat gas, bullish on his company and bullish on himself.
McClendon levered up Chespeake’s balance sheet to finance continual expansion. In addition, he took huge personal loans against his company stock holdings to finance a lavish lifestyle, including the purchase of the Oklahoma City Thunder NBA team. These loans allowed him to avoid selling low-basis Chesapeake stock and incurring huge capital gains taxes.
When this potent combination (levered assets tied to a rising commodity price with a focus on tax deferral) worked- boy did it work. And just when it seemed McClendon could do no wrong…the wheels came off. Falling natural gas prices, falling land values, margin calls.
Next up: Brazilian mining magnate Eike Batista. Batista burst on the international scene in 2005, and personified a new breed of swashbuckling emerging markets entrepreneur. Batista built a commodity mining and shipping empire that was perfectly positioned to supply the voracious energy needs of emerging China. From almost total anonymity outside of Brazil, at once he was seemingly everywhere, rocketing up the Forbes list with a net worth of $30 billion fortune in 2011. When asked his future ambitions, he said simply, “A hundred billion.”
Fast forward 3 years, and Batista’s empire (and fortune) lay in smoldering ruins. Commodities, Brazil’s stock market and its currency had all collapsed. The boom had turned to bust, the clock had struck midnight, the tide had gone out. By 2017 Batista was serving jail time for bribery, money laundering, insider trading and misleading investors.
Finally, Bill Hwang of hedge fund Archegos. Hwang, the son of Korean immigrants, was an unlikely Wall Street billionaire. Unlike McClendon and Batista, Hwang wasn’t given to wild personal materialism and ego. Despite huge wealth, Hwang gave enormous amounts to Catholic charities, eschewed publicity and public displays of wealth-typically good signs.
A protege of hedge fund pioneer Julian Robertson, Hwang generated incredible investment returns for much of the 1990s and early 2000s. But after a spate of poor investment performance following the financial crisis, Hwang’s ambition seemed to have pushed him into illegal activity. He was ultimately convicted of insider trading and banned from the Hong Kong stock market.
Hwang rebounded quickly, however. He set up Archegos, a less regulated family office, to manage his personal fortune. His highly volatile investment focus (ultra-concentrated growth stocks and heavy portfolio leverage) was perfectly suited to the investment winds at the time, and Hwang went on a huge winning streak, pushing his net worth to an estimated $10-$15 billion.
But in early 2021, cracks were forming. One of Hwang’s largest positions reported poor earnings and fell sharply. The position was so large, and the degree of portfolio leverage so high, that dominos began to fall. Worse, it appeared that Hwang had skirted ethical lines once again, purposely orchestrating short squeezes in his holdings, an illegal practice. Hwang also obscured the total amount of portfolio from the various banks the firm dealt with. With startling speed, the combination of a shift in the investment markets, ethical lapses and massive leverage all conspired to create an enormous loss of wealth in a startlingly short period of time. Hwang’s fortune was crushed, and he was facing regulator scrutiny.
Which brings me to the latest unfortunate chapter in the series: John Foley, the founder and former CEO of fitness phenomenon Peloton.
Foley was not a natural-born entrepreneur and tech visionary. An executive at Barnes & Noble and IAC, Foley was a health-conscious Manhattanite who was an early devotee of in-person, instructor-driven classes like Soul Cycle. However, with a busy work life and a young family, he often found it difficult to trek across town to attend a class. This personal pain point was the spark that led to Peloton: bringing an interactive and on-demand Soul Cycle-like experience into the home.
Foley launched Peloton in 2012 at age 40 with little more than the idea. Overwhelmingly, the big investors he pitched the idea to turned him down. Undaunted, Foley turned to crowdfunding to generate seed capital, and by 2014 was producing an internet-connected bike. Initially, the company grew fitfully, but in time started to gain a cult-like following-for the immersive experience and the quality of its instructors. Within 5 years, the company was on fire. Sales were surging and Peoloton was an unquestionable fitness phenomenon. By 2019, the company went public.
Then Covid hit.
Few companies were poised to benefit more from the pandemic-induced societal convulsion- than Peloton. With gyms closed nationally, demand exploded. Though the company struggled logistically to keep up with demand, consumers and investors were enthralled with the company and its potential. By the end of 2020 the stock was up more than 800% and sported a $30 billion market cap.
There are different ways to respond when the unpredictable financial winds turn to a gale force tailwind. The first is with humility-”I didn’t see this coming, I certainly didn’t plan for it, and though it may be uncomfortable benefitting from this unfortunate event-there is a chance that I’m not that smart, and was at the right place and the right time”. The second, on the other hand, is to view this massive flush of success as validation of your innate business genius-to let the events stock an almost messianic belief in your own vision, acumen.
What seems clear is that Foley, seemingly a very self-effacing and modest guy, lost himself a bit amidst this explosion of success. He was put off when some suggested Peloton was only benefitting from a temporary Covid-bump, and that slowing growth seemed likely. While he conceded that the pandemic may have accelerated the conversion of new customers, this was the beginning of a revolutionary, sustainable trend in at-home fitness. How else can you explain Foley’s decision to invest massively in new production capacity? In interviews at the time, Foley envisioned a trillion dollar company.
Foley also spent money, both the company’s and his own, as if continued success was inevitable. There was lavish company spending even when signs emerged that demand was slowing amidst national reopening. Foley also spent big personally. He put his current Hampton’s home on the market for $5 million and purchased a new one for $52 million. He had a yacht to get to and fro from the city.
Well, you say, Peloton’s stock may have been wildly inflated-but at least he sold some of it to pay for this spending. Wrong. Foley didn’t sell much of his stock at all. He primarily got liquidity by taking very large margin loans against his company stock (purportedly $300 million in loans). Did he do this to take advantage of the well-worn tax deferral strategy to avoid capital gains? Was he concerned investors would be spooked if the founder/CEO dumped stocks? Or was he a true believer?
Flash forward to the fall of 2022. Peloton, having scaled up massively, was hit with a sharp deceleration in demand. Whenever a company invests big for future growth-growth that doesn’t materialize, the pain can be intense. With retrospect, Peloton did benefit from a temporary Covid-bounce, and now faced the prospect of being another in a long line of health-care fads.
The company slashed headcount. The stock fell by more than 90%. And John Foley resigned from the company he founded and built, his fortune and pride massively dented.
A couple lessons come to mind:
Don’t confuse good fortune with brilliance.
No doubt Foley was a very capable guy. Indeed, without his unflappable belief and undaunted self confidence, Peloton would never have gotten off the ground. But once you get traction and success, you need to temper that confidence with humility and objectivity. Foley should have had the composure to recognize the role of luck in driving the company’s success in 2020, but instead he took it as confirmation and validation of his vision. The smartest and most talented wealthy people I know are almost always the most humble.
When massive success comes, change nothing.
Whenever a client receives a large inheritance or sells a business or benefits from any huge financial windfall, my recommendation is almost always the same: don’t change anything. Wild success and fortune is very seductive. It can, and often does, change people-often in unforeseen ways.
My recommendation: park the funds and change nothing-for 6 months to a year. Nothing. No big house, no cars, no large charity gifts, no dramatic new businesses or investments, no changes to your daily life. Give yourself time to adjust and calibrate.
You’ll thank me.
Concentration got you here; diversification will keep you here.
One of the best ways to build wealth is to concentrate: put all your eggs in one basket (hopefully the right one), and WATCH THAT BASKET. It’s very difficult to build wealth quickly without concentration. But concentration presents risks-risks that diversification materially reduce.
Say the company you founded and built has exploded in value and made you wealthy. No matter how bullish the company’s future prospects, the sound approach is to gradually reduce that concentration and diversify. It’s a hedge against the tide turning, unforeseen circumstances-and it’s the rational thing to do.
You need to slowly transition from a sole focus on wealth creation to one of wealth sustainability. Know that this will never be harder to do psychologically than when the wealth-building asset is on a tear. “Why would I sell a piece of this rocket ship-one I know and have control over, to buy something not as good?” I get it.
John Foley is on to his next challenge: a high-end, custom-built rug company. His tagline on LinkedIn says “Hungry and Humble.” I appreciate his resilience, wish him well, and will be rooting for him.