How Thomas and Whitehead Used Synthetic Equity To Build Massive Fortunes, While Simultaneously Creating Thousands of Coca-Cola Millionaires in the United States

Yeah but doesn't Coke hedge it's bets by owning a whole lot of other bottle/can drinks? Including some of these healthy/vitaminy types? You seem quite confident that in 50 years people will still want their sugared water. But growth is mostly in 3rd world countries (wishing to emulate America), but there is only a finite supply of third world countries to conquer. Maybe Cuba and North Korea are holdouts, but Africa will be done in the next 20 years (already stealing China's lunch on the cheap manufacturing front.)

How reliant is the company on its flagship product? I dunno, but I'm guessing, a lot. I smell risk long term there.

"How reliant is the company on its flagship product? I dunno, but I'm guessing" ...

You haven't read the 10k disclosures or analyzed the financial statements and you have an opinion on the business?

I'll leave this right here...

Mine is an educated question based on existing knowledge. It's not an asset class I invest in, so I don't spend a lot of time on it. My question is valid, and besides, I thought that's why we have you here 😉

" I thought that's why we have you here ;)"

That's a bit out of line, don't you think? He's here because he wants to be here. He has a passion for the things he talks about and enjoys sharing his passion with others, in hopes that they will do well for themselves as well.

Sure, like most any blog really, earning a bit of income through advertisements, affiliates and such is a perk. But come on. His reply to you was a push for you to educate yourself further and hopefully grow as an individual to gain further opportunities.

Bro, aren't we a bit uptight this Monday morning?

I'm merely trying to engage in meaningful discourse, as the blogger is keen on. Reading the 10k; A- assumes I have a serious interest in coke. I don't as I don't invest in it. B- assumes I'll just take their quasi-marketing-investor word for it.

My questions were regarding general market observations on drinks, food trends and globalization. No reason this is not valid discourse.

Reading your post again, I see how differently the light in which I read it was, compared to how you intended it. My apologies. I'll chew on my foot for a bit.

You do that. Stupid dragon.

😉

No worries. I know I can come off a bit prickly, but I can't help it. Apparently it's part of my DNA 🙂 (plus it can make for entertaining blog reading, along with interesting perspectives, hopefully.)

I'll also take a minute to give Joshua praise for his blog. I must admit when I ran upon it a week or so ago I was highly skeptical. Most private people that write about wealth are usually trying to sell you something, or at best are inflating their wealth. But in this case I think Joshua is telling it straight, and honestly likes to share his investment philosophies. Probably some part is an enjoyment to expound, some part helping others, and another the dialog and exchanges. No smoke and mirrors, and it adds up for me 🙂

Coke's story is not one of sugar water in isolation. It's a network of bottlers and efficiency that could not be replicated by any existing pool of capital on Earth as it would cost over $100 billion to reproduce. With existing margins so high, even if human biology were to somehow change and cause large non-cyclical drops in soda consumption (something that hasn't happened in a century-and-a-half given the addictive nature of both sugar and caffeine and stimulants), the returns on capital are so extraordinary that in the event of the unthinkable, Coke would be able to continue diversifying away into other beverages, like it already does with Minute Maid juice, POWERADE sports drinks, Honest Tea, Odwalla juices and smoothies, Gold Peak tea, Simply Lemonade, bottled water, etc. And there wouldn't be much risk in it given that this is their area of expertise and something that fits perfectly with the business model that has been in place for more than 120 years.

In fact, Coke was supposed to be the one to buy Quaker Oats and diversify into packaged foods, not Pepsi. There was a board meeting when management had the press waiting, and the executives told, rather than asked, the board of directors about the transaction. The rumor is that Warren Buffett, who owns around 9% of the company and sat on the board at the time, flipped over an envelope, scratched out a few numbers, said something like, "You're paying far too high a price for this - no matter how good the business is, you can't do well on these terms. No." And the executives, who were humiliated (rightfully so) had to go tell the press to leave and break up with the Quaker Oats management who had no idea they hadn't had the authority to be negotiating the merger. Pepsi swooped in and bought it, instead.

Coke has the pockets to buy whatever it wants were it necessary. There is so much cash being produced, so much wealth generated every quarter, that if a decline happened, it would be visible enough on the horizon that management would have more than ample time to react through diversification, which they've been doing for 20+ years, anyway. They'd end up with something that could work with their existing distribution system, which means the high-return packaged food or beverage industry, or they'd be bought out by someone else.

Think of it like the cigarette industry. Sugar doesn't face nearly the problems it did, and the tobacco giants have absolutely blown everyone else out of the water over the past 50 years despite massive lawsuits, declining consumption, etc., because the returns on capital are so insanely high. The more depressed investors got about it, the lower they drove valuations, while the returns on capital stayed high. So there is a precedent for that sort of worst-case, highly unlikely scenario and it still bodes very well; much better than the average company.

Interestingly, in Coke's case, the true power of the company - those enormous returns on capital - are masked by the accounting for acquisitions involving the bottlers (you can't really get to the heart of the business by glancing at the financial statements and comparing net income to the asset base), but it's still there, hidden underneath the write-up of goodwill, etc.

P.S. I know your preferred bailiwick is tangible property, but I would still highly encourage you to learn how to read, analyze, and tear apart a 10K. The things you can learn from the disclosure rules are not minor and relate directly to your field. Many years ago, I once learned about a very interesting real estate structure by reading the disclosures of a teen apparel company that had the founding family setup a side real estate empire involving lease-back transactions that allowed them to collect rents with very little equity capital of their own invested. It's all business, and all connected.

You may not invest in the common stock of the enterprise, but the enterprise itself - the business proper that is described in the 10K - transcends asset class. It is real estate, operating machinery, bonds, cash flow management, profitability, etc. In fact, even if I had no intention of ever buying shares of Coke, I'd still read the 10K if I were going to do business with them, or lease them a warehouse, or park money in their bonds. Those are not just for the stock investors.

In which 10k did you find that real estate structure? I'd be interested in learning about it.

Off the top of my head, I think it was the 2002 or 2003 American Eagle Outfitters 10-K filing with the SEC, plus some of the referenced disclosures not included (you find them in the appendix and have to pull them separately).

The founding family had created a separate real estate holding company. They then infused money into it for equity, then entered into complex lease agreements with American Eagle Outfitters, that caused them (the family) to collect large rental income. This allowed them to avoid paying a dividend (at the time - they do now) on the common stock, while still providing big sums of cash for the family each year. It also gave them some added strategic control without requiring a separate class of common stock as they had ironclad contracts on the distribution warehouses and other buildings that were necessary for the retailer to conduct business.

It wasn't evident at first because the men running it had different last names than the controlling family, but they had married the daughters of the founder. I vaguely remember a flow chart breaking out the entire structure of how they had put it together because I used it to work out exactly how much money they were extracting without having to disclose it on the proxy statement. It was brilliant (especially since the company had to pay rent to someone, anyway; who better than the folks who want to see the business succeed and would be more likely to care for it?). It wasn't in the annual report, though, I somehow found it by going through the 10K real estate holdings, then cross-referencing it with the appendix disclosures. It's been 10 or 12 years, but I'm 95% certain that's where it is if you want to research it yourself.

Thanks for the recollection. Yes a lot of corps use real estate in creative ways, and learning about their particular set ups is always interesting.

For the record I don't dismiss 10k's by any means. And I'm a big proponent of reading tangential information, for normally the most interesting ideas are not the most obvious ones.

The one thing I have found as a major, and natural, advantage to real estate investing is the tax treatment. This is especially true for long term buy and hold (or for 1031 exchanges.) the tax advantages almost encourage you to hang onto high quality property; perhaps akin to your desire to hold coke stock for the long term (not from a tax advantage necessarily, but from an appreciating asset POV.)

So imagine you buy a building and you get to depreciate it, offsetting the income stream. But in reality, the building is appreciating in value. Now IF the property you buy is solid and stable enough to hold for many years, you have little incentive to take a huge tax hit by selling it. Instead, as I do, you can leverage it and borrow against it. But the key is that you can keep the property because it's a strong asset, based on its intrinsic value (and not just because you don't want to take the tax hit or you need it's leveraging power.)

I suppose there is some similarity to certain stock picks. My analogy is more to do with setting up a successful long term position than stock vs. real estate, which is pointless as they are very different animals. What I think is interesting is the mind set an investor creates. I know plenty of RE investors that spin their wheels wheeling and dealing, buy/sell, flip, etc. to me it's all a terrific pain in the ass! If I can somehow set a property up to grow from its initial state of value, once it reaches a certain critical mass it almost perpetuates itself. And that what I like.

Joshua,

This is bit personal question and I figure I would ask knowing you can leave it unanswered if you wish to.
Even through the example here, looking at the grandchildren and heirs and how sad their lives turned out. And I am sure you have read many more cases of great generational wealth not necessarily helping heirs live fulfilled lives, why do you still insist of leaving fortunes to your grandchildren and great grand children? Do you not think achieving things by your own labor, your own brain, own sweat, dedication, showing kindness and respect for folks around you is a better model than living off the millions of your ancestors?
Would you rather your great grand dad leave you huge fortune, or would you rather have the life you had and achieved what you achieved yourself(with loving family, friends and all but largely yourself)?

I think you would choose latter, why not give your great grand children same opportunity to make their own way in the world? (give them funds for education purposes and let them loose to do their own bidding?)

That's a great question! Here's how I think about it at the moment.

1. I hope to build a huge fortune over the next 50+ years and leave most of it to charity, not my children or grandchildren

2. The wealth I do leave to them? I have a lifetime, God willing, to shape, mold, and influence who they are to the extent that is possible. And I'm good at it; it's in my skill set. I know how to make people see the world differently and get to the heart of a lot of things. The money shouldn't ruin them. Even in the Candler case, some branches of his grandchildren are thriving right now, way better off, living much more successful lives, because they were smart about the money. To punish them, in a sense, because of their failed siblings or cousins seems unfair.

I'm also going to be very precise about the structure. In the trusts for my future children, for example, beginning on their 25th or 30th birthday, the trust will distribute up to 3% of its value each year, but only on a dollar-for-dollar matching basis with their taxable income. Let's keep it simple and imagine a scenario. You have a daughter. You put aside money for her in a trust so that, by the time she is out of college and working full time, there is $1,000,000 sitting in it. She gets a job as an elementary school teacher earning $50,000 per year.

In this case, every Christmas, she'd get a check for the greater of 100% dollar-for-dollar matching on her gross income from her own work or 3% of the trust value. In our scenario, the latter would be triggered, so she'd get a check for $30,000, minus Federal, state, and local taxes, leaving her with around $23,000 depending on circumstances.

That's going to be a wonderful augment to her life without any chance of becoming a significant problem. You wouldn't be exercising any discretionary control over it, so there could be no possibility of using money as a way to influence their behavior. It distributes dividends, literally, for living a self-sufficient, productive life.

Any larger amounts wouldn't come until they were in their 40's or 50's and we could see how they turned out as people. By that age, money isn't going to change much.

Beyond that, what if, despite careful planning, somehow you do get a bad Candler heir? They lose it all? Their temperamental and biological problems cause them to constantly fail? In that case, that is the strength and wonder of capitalism. It will rip the money from their hands faster than they can imagine and find its way to more productive uses, to men like me when I was younger, who are providing goods and services that the civilization wants. I would consider it a virtue that they ended up broke. I would rejoice that the cash is back out there in the economy going to whomever deserved it most. The money certain wouldn't have destroyed them - they would have likely been just a big a failure without it, only in less comfortable circumstances.

"the trust will distribute up to 3% of its value each year, but only on a dollar-for-dollar matching basis with their taxable income." - Concept totally just blew my mind.

I haven't looked into trusts much yet, because, frankly, I'm probably one of the poorest people who visit your site lol. But, I hadn't realized you could set up such limitations or that you had that much... customization ability to mold a trust to work in any manner you wanted. That's pretty cool!

Oh, yes, you can customize them. My income is below the American average (although my wealth is at or slightly above), and hope to someday set up a charitable trust. Here is a great article Joshua wrote on a hypothetical $50,000 trust: https://www.joshuakennon.com/creating-huge-wealth-with-trust-funds/

Yeah, trusts are awesome. When I first started studying them, I hadn't realized how useful of a tool they could be for all sorts of situations. Provisions like this fall under a category of "incentive trusts". They can be great but you have to be careful because if it's not written correctly, it can cause problems; e.g., what happens if you said the trust will only pay income based on a specific GPA and the child is in an accident that results in brain trauma? This is a really interesting read on this topic (PDF): Incentive Trusts and the Inflexibility Problem.

The flexibility is huge. Courts typically only set aside trust provisions if they violate some law or are "contrary to public policy". That seems vague but it's a hard test to pass.

The most famous example of an incentive trust dispute at the moment is the case of a Manhattan judge named Robert Mandelbaum. The facts read like something out of a soap opera; you'd have to try and make something up like this:

1. He is married (to a man, his husband, Jonathan, who is a lawyer/MBA specializing in tax laws) and they have a child, Cooper, who was born through surrogacy using the judge's DNA.

2. This judge's father built a fortune in the business world after founding Intelli-Check. He setup a trust fund for the grandchildren - I think it was like $180,000 or something.

3. The provisions of the incentive trust state that Cooper will only be entitled to inherit a portion of the trust if his father (the judge) marries the woman who is his "mother". (That presents an interesting problem - How do you define that - Egg donor? Surrogate?)

The judge is contesting the trust provisions as being contrary to public policy because it would require a Constitutional violation of his fundamental right to marriage (which the Supreme Court has upheld something like 14 times in the past century or two) as it would require him to divorce his existing legally-wed spouse, it would then require him to marry someone of a different gender, which is contrary to New York's marriage equality law that treats the marriages the same (meaning it should be thrown out just as if the trust would only be inherited it had stipulated he married a white woman, which isn't permitted), and finally, it requires the judge to enter into a "sham marriage" solely for the purpose of financial gain, which is illegal.

I'd probably bet 2-1 the judge wins and the trust is invalidated. So there are limits to what you can do or even should do. You can almost get away with anything but it's not so clean cut as, "His money, his rules." if it's considered grossly unfair or abusive.

Then again, it's a crap shoot. The famous so-called 'Jewish Clause' was upheld by the Illinois Supreme Court. It allowed a fundamental violation of free religion by disinheriting anyone who didn't convert to Judaism within one year.

If I am able to leave a trust to my families bloodline, my thoughts are very much along the lines of the post mentioned above in comments on your 'Christmas Trust'. As I was reading your post on it, I kept saying "yes, exactly!" in my head.

My family is mostly working middle class. My mom was a stay-at-home mom and my dad worked at a lumber mill for 34 years. I don't think he ever brought home more than about $45,000 in a year. He never invested any of his money until his mid 50's. But he got a good pension out of it - his take-home pay is almost 50% higher in retirement compared to when he was working.

Quite opposite to how my parents are - I'm very interested and motivated in investing and business. As hard as it is with two kids and no college degree, I've been saving a few hundred a month into a Roth IRA, and am working (~20 hours a week) on building some writing content that I hope will start to yield some descent royalty income to further invest in the years to follow.

Once we move and are settled by next spring, I'd like to return to college and earn a degree. Anyway, that's all far in the future, but I still think about it a lot - it adds to my motivation. With persistence, hopefully I'll be able to pass on a trust to my boys that can help them in life.

wouldn't the 30k be the lessor in this example?

Yes, it should have read lesser, not greater, so the child could never extract more from the trust than he or she earned in a career (the math was right, the word was wrong). I changed the example halfway through and didn't catch that error; thanks for telling me! I fixed it in the previous comment.

Thank you for the reply Joshua. That is a very thoughtful approach.
The last sentence is what I grapple with. I have seen many families use money as a substitute for time spent, love and affection for the kids, they use gifts and buy things to sooth emotional needs, bribe of sorts for not being there. Kids emotional repertoire is pretty slanted and by association feel that if they have tons of cash it will fix all the problems. I am not sure if those kids had loving and affectionate parents (with money or without) they would have had same problems - setting a right example how to raise a child and how to spend time with them seems to be the best life skill they will have.Money is just a gravy after that. My own thinking is not crystal clear on this issue yet, still massaging and pressing it to try and distill it into a workable and rational philosophy. It helps that I don't have kids yet:) Thanks again and have a good one.

Hey, thanks for the link (and thanks Joshua for having wrote it). That's the kind of information my brain loves to soak up!

While on the subject trusts - any book recommendations, Joshua?

For a great lay-of-the-land view that explains different types of trusts, provisions, etc., and would give you enough to explain to an attorney what you wanted at some point in the future, The Complete Book of Trusts, 3rd Edition by Martin M. Shenkman. It's now out of date (published in 2002), especially on the tax laws, but a lot of the basics haven't changed, so it gives you the terms you need (e.g., incentive trusts, QTIP trusts, etc.) to research further on your own, which will lead you down a rabbit hole of several weeks of non-stop reading online as you find papers written by attorneys or guidance published by law offices.

Then, once you are done with that and want to go onto the level of complexity like we talked about when we went over the Royal Dutch Shell corporate structure, get a used copy of Cases and Materials on Gratuitous Transfers (new, it's expensive but there are some left for $5 in the used section), and cross-reference it with the book that was written to make it sensible in plain English, Examples & Explanations: Wills, Trusts, and Estates: Fifth Edition, which has specific reference sections in it pointing to the first book. It has all sorts of new case law including things like what happens when a child is born from frozen embryos after the parent is deceased. You read the second book first, and it has visual aids and charts that point to the text in the first book. They're meant for law students but some of the best reading is from places like that. This wouldn't be interesting to about 99% of the population, but I find it fascinating.

Come to think of it, you're probably one of the only other people here that will appreciate this. You can buy bound copies of regulations, statues, court cases, and other things that are interesting.

Definitely going to purchase those for Christmas presents to myself this year! I appreciate your suggestion on the first book to start to get my feet wet. And I'm also surprised you remember talking to me about RDS lol;

Are the links affiliate? If so, I'll go through them to purchase the books when the time comes.

I bookmarked the website and will check it out further over the next couple days. I appreciate the information, and I always love it when you share the depth that you do - I'm surprised more people don't seem interested in all of it O.o

From the Coca Cola 10-K:

"Bottlers that accounted for approximately 0.3 percent of total unit case volume in the United States in 2012 operate under our oldest form of contract, which provides for a fixed price for Coca-Cola syrup used in bottles and cans."

Is this referring to the original Candler-Thomas-Whitehead contract?

That's the one. It was modified by a court case in the early 20th century that allowed Coke to raise the price based on the cost of sugar, but it still means that those few remaining, tiny bottlers are essentially making Coca-Cola for free and printing dollar bills in their territory.

Once again, another wonderful case study; please don't ever stop posting these - they motivate, illuminate, and educate as well as entertain.

I had a related topic about this: what resources do you normally peruse to gather and integrate your information? As in, what medium do you read, and what specific sources do you use for your case studies? I'm trying to study some companies on my own as a start, and aside from the financial statements and websites, don't have any other sources to go off of.

Anything and everything I can get my hands on if I think it will be useful. Biographies, old newspaper articles, trade journals, Congressional hearing testimony, real estate deeds, probate filings, inter-family lawsuits ....

Today, I had a 30 year old out of print book called "Mr. Anonymous: Robert W. Woodruff of Coca-Cola" show up on my doorstep that details the life of the legendary Coke Chairman. I'm about to finish "The Real Thing: Truth and Power at The Coca-Cola Company", but before I do, I'll likely go through the footnotes in the back that pointed to the original research, track down the most interesting tidbits, and then go from there.

Everything. All of it. Whatever I can get my hands on, in whatever form I can find it. When I get obsessed with something, I become insatiable. Sometimes I'll even write or call people I've never met and ask them about it if they were involved or know someone who was.

Joshua,
Long time lurker, first time poster. Thanks for always providing such informational content. It's an inspiration, because as you always say, it only takes one great idea to create great wealth. I think Coke's main power comes from it's brand recognition. There will always be soda... and that soda will be Coke. It's simply amazing.

I would say welcome to the site, but it seems you've been here for awhile, haha! Nice to (virtually) meet you, anyway =)