Lessons for IPO Success From Starbucks and Howard Schultz

By Markets Fool.com

On this segment of theRule Breaker Investingpodcast,Motley Fool co-founder David Gardner talks about his decades-long interest in the java giant, which the Fool has had in its portfolios since the late 1990s. And the relationship goes both ways: Howard Schultz later invested in the Fool. So it should come as no surprise that those years have produced some anecdotes containing useful nuggets of advice. In particular, Schultz shared some wisdom on the subject of exactly what a company needs to have in hand before it goes public.

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A transcript follows the video.

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This podcast was recorded on Aug. 10, 2016.

David Gardner: When I first encountered Starbucks --I have to admit, since it's summer, I haven't done deep fact-checking -- this is shooting from the hip a little, but I'm going to say that the company came public around 1990. It might have been 1989, it might have been 1991: right around 1990. I remember it back then in 1990 (I was 24 years of age); I remember Starbucks coming public. And the big question -- the dark cloud hanging over this stock -- was a belief among many that Starbucks was a fad.

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The thinking went like this: coffeehouses in America -- a big hit new thing -- lots of Starbucks. Some Starbucks opening up across the street from other Starbucks. They seemed all the rage, but some cynics would ask where the history was of successful coffeehouses in the United States of America. "This is temporary. This is not something that is really going to have legs as a public company." No doubt there was a fair amount of short interest and a lot of skepticism about Starbucks back when it came public.

Well, certainly by the time we picked the stock -- we opened online with The Motley Fool in 1994 with AOL, our website in 1995-1996. We picked Starbucks in 1997 or 1998 for our online portfolio we were running, at the time, for Fool.com. And by then it was already evident that Starbucks was not a fad, so we were not investing in the face of that prevalent belief at the time.

But there have always been questions about how this company can charge three dollars for a cup of coffee that only should cost a dollar most of the time -- that kind of question about Starbucks, and really, about any premium brand. "Why would you pay up for something when you could get it for less somewhere else?" has always been, and still is a question, about Starbucks.

But in particular, I remember first picking that stock. It was longtime advisor Jeff Fischer -- if you're a Motley Fool fan, you know Jeff Fischer's work inMotley Fool ProandMotley Fool Options-- and Jeff and I were in tandem helping manage this portfolio in 1998 or so. And I remember Jeff looking across the desk to me; we had computers right next to each other in those days at Fool HQ.

He said, "Dave: Starbucks!" It was one of those stock picks that seemed so obvious that it hadn't even occurred to us that we might buy shares in it. And I'm darn glad we did, at Jeff's behest, because it's been an absolutely tremendous performer ever since then, despite some rocky times. But credit goes, initially, to Jeff Fischer for saying we should bring Starbucks into our Fool portfolio, our Rule Breaker portfolio at the time.

But now I want to go to a little bit more on Howard Schultz, the founder of Starbucks. And the reason I want to talk a little about Howard is because I've had personal experiences with him, all positive. I've learned a few lessons from him, and I just want to explain how that happened to be.

In the first place, Howard had a venture capital firm (still does) called Maveron. Maveron was Howard's money, and then Howard invited a lot of his personal friends and his extensive business network. That funded the first fund for Maveron, which is today a successful venture capital firm, and some of that money went into The Motley Fool back in the late 1990s.

So we had an opportunity to meet with Howard, both in Seattle and back in Alexandria, Virginia, where Fool HQ is based. We went to some conferences, etc. So we had an opportunity to listen and learn from what I believe to be one of the 20 great living entrepreneurs of our time. And the first lesson I want to share with you -- I've got a couple from Howard -- has nothing to do with Starbucks, really. It has to do with IPOs and IPO investing. Here's how it started.

At the time, we were all considering the possibility that The Motley Fool might, one day, go public. In fact Maveron, at the time, would have loved to see us go public, because valuations were inflated. It would have been a great time in the late 1990s to go public, but we chose not to, and we're all glad today at The Motley Fool that we did make that choice to stay private all the way through. But we were talking about the possibility of being public, and Howard shared his philosophy with us about how to think about going public, because he had obviously done it very successfully himself about 10 years before.

He said, "Guys, here's how it works when you go public. You need to know, with virtual certainty, your next four quarters of operational performance. You need to know ahead of time that you've got it nailed."

Howard [went on to say this], and he might still agree with this today or he might think differently. I haven't updated this story; I haven't seen Howard in some years. But this spoke to me very eloquently at the time, and I'm going to give you an example of how I put this concept into practice in a minute.

Howard said, "It's so critical when you come public. It is your one shining moment in front of Wall Street, and the world, and you darn well better not screw that up." So companies that go public, and then a quarter or two later all of a sudden underperform the numbers that they'd been sharing with the world, was the kiss of death. That meant, in Howard's opinion, that Wall Street will walk away from you. Potentially, forever, you are toast. You made a horrible decision if you brought your company public, and you didn't already know you had your numbers sewn up.

As we all know, companies typically underpromise and like to overdeliver on numbers. It's not really a cynical thing. I think it's pretty much what investors in the world want to see; we all want pleasant surprises in life, so smart managers of companies have consistently done that over time, and certainly Howard is one of those people. So Howard would say, "Let's make sure we have our numbers nailed and let's be conservative with our guidance, and then let's beat it time and time again."

Now how does this actually inform our investing? Let me give an example of what I did -- a rare thing in the Rule Breakers service -- in 2005. In 2005, we had picked Great Wolf Resorts, which some of you may know as a theme park, except it's all about water. It's water rides. You stay at the hotel and then in the morning, everybody puts on their trunks and has fun with all the slides and chutes. I think there was one in Williamsburg, Virginia, not that far away from us at the Fool at the time. Great Wolf Resorts continues to operate today. It wasn't a great stock, which is where I'm going with this story.

The very talented Rick Munarriz is our internal expert about all kinds of theme parks, rides, and amusements, in general, at The Motley Fool: a wonderful long-term follower of that industry. And Rick liked Great Wolf Resorts at the time. So on theRule Breakersteam, I get team input from people like Rick. I always make the final calls for any stock pick that's made. All the good ones and all the bad ones I'm on the hook for, for Motley FoolRule Breakers. So this bad investment is on me, not Rick. I agreed with Rick at the time, and picked that in April of 2005.

Great Wolf had come public very recently. Then in the intervening month or two (I believe it was its first quarter out as a public company), all of a sudden the numbers come out, and they've disappointed all expectations. This is about seven years after I heard Howard explain his philosophy about taking a company public, and how he had done it with Starbucks, and if we ever did it with The Motley Fool, how we should do it, too.

And I thought about what had just happened with Great Wolf. And I decided, then and there, with Rick's agreement, that we were going to sell that stock out of theRule Breakersservice right away -- heavily influenced by the notion that if you're going to go public, it's a bond, it's a trust that you have with new investors and Wall Street; you darn well better live up to your numbers.

Sure enough, Great Wolf did not, and I guess it's kind of a happy or sad ending, depending on your viewpoint here, because that was an excellent sell that we made, just three months after we picked the stock: very rare for me, as an investor, to do that inStock AdvisororRule Breakers. We sold Great Wolf at a loss. We picked the stock around $20. It lost 35% of its value over those three months, so we sold it somewhere at $12 to $14 a share. Seven years after that, Great Wolf was taken private at a price of $5 a share.

So, one of my best sells: one of our best sells we've ever made inRule Breakers. Not something to celebrate, though, because we picked the stock and it lost 35% for us and our members in just three months' time. But thinking back to Howard's wise guidance and directly applying that, in that situation, helped us make better investing decisions. And I know you know this if you're a regular listener of this podcast. That's what I'm here to help you do -- make better investing decisions. That's why The Motley Fool exists. Our purpose is to help the world invest better.

I hope you'll remember that Howard story, and you'll apply that to your own investing. I have no problem investing in IPOs, in companies that are newly public; some of our best stock picks have been companies that have done that. But I very carefully watch those numbers those first few quarters. Because what's the company that nails the numbers? That's usually a company that was locked down: probably well-managed, was ready for it.

What about companies that don't? That suggests to me they're disorganized, not very well-managed. Maybe it was a desperation IPO or a very opportunistic IPO, but not an initial public offering that would have been well-timed, if companies are underperforming their numbers just a few quarters in. So, something always to think about, something I've always thought about, ever since learning that from Howard about 20 years ago.

Another thing I learned from Howard Schultz -- he had a great line. He said, "At the end of the day, people don't want to know you're the best at what you do. At the end of the day, they want to know that you care."

David Gardner owns shares of Starbucks. The Motley Fool owns shares of and recommends Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.