Small- and Mid-Cap Investing in Emerging Markets; China vs. India

January 3, 2022 in Asia, Best Ideas Conference, Equities, Letters

This post is authored by MOI Global instructor James Fletcher, founder of Ethos Investment Management, based in Salt Lake City.

James is an instructor at Best Ideas 2022.

The following article has been excerpted from a recent Ethos letter.

We believe that investing in high-quality businesses with sustainable growth prospects, led by excellent management teams that are purchased at reasonable prices, will achieve excess returns over a complete market cycle. We take a long-term, business-owners, approach to investing and invest only in our highest conviction 30-50 ideas.

Investing in Emerging Markets

Why am I focusing on EM small and mid-cap stocks (SMID)? The short answer is that over my 17-year career in investing, I have found this opportunity set of EM SMID to be the most attractive and inefficient (i.e. opportunistic for alpha) in terms of finding excellent structural growth companies trading at attractive valuations.

Emerging markets is home to 85% of the world’s population, now accounts for over 59% of the world’s GDP, yet comprise only 12% of global market cap and less than 6% of global institutional investors’ allocations.[1] Over time, I expect these numbers to continue to converge in favor of EM. As structural growth trends continue of a rising EM middle class, growth in innovation sectors, and access to capital, EM seems poised to continue its growth trajectory. What is especially exciting to see is that while developed markets have seen the total number of companies listed on exchanges decline over the past decades as fewer companies go public and more delist, EM has seen the number of companies listed in Consumer, Technology, and Healthcare sectors more than triple over the past decade (from 455 in 2010 to 1,622 in 2020).

Over the past 20 years, starting Nov 2001 to Nov 2021, all Indices, both EM and DM have delivered nearly identical annualized USD returns. (EM has delivered 9.85% IRR since 2001, EM SMID has delivered 9.81%, compared to S&P500 at 9.31% IRR, in USD). This is despite the recent underperformance in EM.

In terms of valuations, EM is currently trading at historical record discounts now to their counterparts in US and Europe, trading at over 60% discount on a P/E basis.

I feel that we are getting a great entry point into emerging markets right now and expect we can buy some high-quality businesses with long-term structural growth at good valuations which equates to better than average expected future returns. Of course, there are risks. Rising inflation, heightened regulatory, and geopolitical risks in China and other countries, the ongoing COVID-19 pandemic, and global supply chain shortages are all key risks that we need to weigh in the balance when underwriting any investment into the portfolio.

China vs. India

The underlying dynamics are leading us to have higher exposure than the EM Index in China, Taiwan, and Brazil. And leading us to have lower than market exposure in Southeast Asia, slightly lower in India and lower in Eastern Europe. Below I have highlighted China and India.

China

China, is expected to be our second largest market in the portfolio, behind Taiwan. While 2021 has been a tumultuous year for many listed Chinese equities, with heightened regulatory risks in sectors such as education, e-Commerce, and health care being negatively impacted, the long-term trends in China remain promising. We find that many great, high-quality businesses with low regulatory risks and high pricing power are now trading at attractive valuations in China. I’ve personally been travelling to and investing in China for nearly two decades and having lived in Hong Kong for the past five years, I’ve seen both bull and bear cycles over the period, including the bear markets of 2008, 2015, and 2018 in China. Despite the cycles, China has remained undaunted in its structural growth, rising urbanization trends, investment in innovation and access to capital benefitting from a large consumer market, high domestic savings rates, and low external debt levels. Many are surprised to know that since the year 2000, China has created more unicorns than any other country in the world, including the US.[2]

It has been an imperative that companies are aligned with President Xi’s “common prosperity” goals. As part of our ESG and Quality Scorecards, we do deep dives into the regulatory risks, pricing power, and societal risks of all the businesses that we analyze. This has helped us avoid many of the problematic sectors that were exposed in 2021 such as property and education, where we had no exposure. In the end, China and President Xi have been clear in their statements and 5-Year plans that that will continue to encourage economic growth, but they want businesses and regulators to promote:

  • Fairer competition
  • Reducing income inequality
  • Social well-being
  • Data Protection

In my opinion, these are not absurd goals. In fact, Charlie Munger was recently questioned at the Sohn Australia Conference about China’s crackdown on speculation and corruption, and he said “China is right to step out, step hard on booms and to not let them go too far. The extent that my country doesn’t do that, we’re inferior to China. They’re acting in a more adult fashion”.[2]

Whether “adult” or not, what we can’t dispute is China has undergone incredible economic growth over the past two decades, and we still see a market full of innovation, access to capital, and long-term strategic thinking. There are high-quality businesses in China that succeed in meeting all of Xi’s priorities and that we believe benefit from long-term structural growth trends in the market. And currently, many of them are trading at quite attractive valuations, due to the recent selloff.

India

India has had an exceptionally strong run in 2021, as YTD through 30 November, the India SMID Cap Index is up +41.7% in USD. We believe India has a lot of attractive long-term characteristics: a large and entrepreneurial population, a rising middle class, ongoing structural reforms led by Prime Minister Modi, and global leadership in sectors such as pharma, technology, and healthcare.

We find numerous businesses in India that we think are exceptionally high quality led by great managements with long-term growth potential. We expect our exposure to be slightly underweight India relative to the Index due to heightened valuation levels (India is 15% of the Index). The graph below shows that MSCI India now trades at a 10 year high relative to MSCI China and MSCI EM on a P/Book basis.

[1] Data is obtained from FactSet, MSCI and eVestment, as of December 2020.
[2] https://fortune.com/2019/10/22/china-us-unicorns-beijing-silicon-valley/

Read the legal disclaimer.

Members, log in below to access the restricted content.

Not a member?

Thank you for your interest.  Please note that MOI Global is closed to new members at this time. If you would like to join the waiting list, complete the following form:

A Long-Term Investor’s Perspective on the Opportunity in Cannabis

January 3, 2022 in Best Ideas Conference, Equities, Industry Primers, Letters

This post is authored by MOI Global instructor Aaron Edelheit, chief executive officer of Mindset Capital, based in Santa Barbara, California.

Aaron is an instructor at Best Ideas 2022.

The following article has been excerpted from The Cannabis Manifesto.

Imagine an opportunity to invest in a mythical $100 billion market on its way to $200 billion in which capital is scarce, institutional participation is tiny and where many publicly traded companies involved are not listed in any major index or traded on any major US exchange.

Now imagine that these publicly traded companies have defensible moats, strong management teams and possess ten years of growth and re-investment opportunities ahead.

Then imagine that this magical sector has crazy inefficiencies where similar companies trade at wildly different multiples for no apparent reason and where you can buy industry leading companies growing at over 50% while trading for single digit cash flow multiples with little if any leverage.

This is the reality of the US cannabis industry. Thanks to the conflict between state legality and Federal illegality, a US company that “touches the cannabis plant” cannot trade on any major US exchange and instead trades on secondary and tertiary Canadian exchanges. Add in concerns regarding custody issues with major brokerages and prime brokers, and you are left with little institutional involvement (estimated at a measly 4%), no index involvement and thus a wonderful opportunity.

And it is for this reason, I’m launching the Mindset Value Cannabis Fund, which will be solely dedicated to investing in publicly traded cannabis companies that are focused on the US cannabis market.

The Health and Wellness Benefit to Society is Massive

Cannabis is not just a great investment but is fundamentally a big positive for society. Specifically, we are attracted to the enormous health and wellness benefits of cannabis. Consumers of cannabis have been shown to binge drink less, use less opioids and use less powerful prescription drugs. The medical benefits are numerous including the ability to quit opioid addiction, tolerating powerful cancer medications, migraine pain relief, pain relief in general without the risk of addiction, and helping with insomnia and post-traumatic stress disorder.

Studies show that cannabis users are surprisingly active and recover from injury more quickly. Athletes have long used cannabis and are now becoming more vocal about the surprising anti-inflammatory properties of cannabis and the ability to heal quicker and bounce back faster. It’s interesting to read how ultramarathoners are running faster and longer with cannabis and how cannabis edibles are taking over the running world.

All of this is well documented and might be a shock to most people who grew up in the reefer madness era in which people believed that cannabis led to decadence or worse sitting on your couch and wasting your life away. Cannabis has been falsely demonized mainly for racial reasons, first as a tool to fight Mexican immigration into the U.S. and later to discriminate against African Americans.

But all of that is coming to an end as state after state legalizes either medical marijuana or full adult use and as the benefits to consumers, society and the economy become too powerful to ignore. Cannabis already exists as an illegal market, so why not just tax and regulate it in a safe and efficient manner? This is leading to soaring tax revenue and job creation in every state that legalizes cannabis. An estimated 321,000 Americans now work in the cannabis industry, with growth of 80,000 new jobs in 2020 alone. Many cities and states are seeing cannabis tax revenues make up budget shortfalls. Cannabis taxes are easy targets and take much less effort to enact than other forms of taxation that are deeply unpopular with voters.

Maybe the craziest data point in favor of cannabis legalization is that worker compensation claims go down in states after they legalize cannabis. Why would that be? When cannabis is illegal, people turn to other more powerful, more dangerous drugs such as opioids to self-medicate their ailments and these drugs have significantly harsher consequences to job performance. And finally worries about soaring teenage use are now confirmed to just be worries as teenage use has proven to fall in states that have legalized cannabis.

So, if the benefits are real both to health and to the economy, why not legalize it? In this regard, states are moving faster than the Federal government, but even faster is how cannabis is being normalized. Almost 70% of all Americans believe cannabis should be legalized.

Personally, I’ve benefitted as well. I have suffered from insomnia at different points in my life. It is awful and I wouldn’t wish it on my worst enemy. Now with a cannabis tea or a low dose gummy, I can reset my sleep system and sleep soundly. And that pales in comparison to the relief that some of my relatives who use cannabis creams and other products to help with knee, back and migraine pain feel. We are eternally grateful that cannabis helps so effectively with so few side effects.

Cannabis is Reminiscent of the Beginnings of the Single-Family Rental Industry

The investment opportunity in cannabis is reminiscent of the opportunity in single-family rentals. In 2009, I launched a small fund to buy single-family foreclosed homes, fix them up and rent them out. I started with 16 and ended up buying 2,500 homes. We sold the company in 2015 to a publicly traded real estate investment trust, in what was then the largest single transaction of homes ever in the US.

My investment thesis on buying foreclosed homes was that the US could not continue to produce only 400,000 homes a year, and instead needed to be constructing more than 1 million homes a year. If the country continued to produce such few homes, it would eventually find itself with a massive shortage of homes. The only question was when this would occur. I also quickly realized that this was not a trade but an industry. Yes, scattered site was more expensive to manage, but the turnover was less than multi-family, so the result was similar overall margins to apartment buildings.

It’s fun to watch the whole investment world now recognize and invest in single-family as an asset class when ten years earlier people looked at me as if I had a third eyeball or told me it would never work as an ongoing business.

And the same thing is happening in cannabis. For many reasons, professional investors are ignoring the cannabis space, just like they ignored single-family homes. I hear either indifference or comments that cannabis is an agricultural commodity or even more bizarre is when investors lump it into the same bucket as crypto currencies (maybe this is because there is uncertainty around the regulations of both?).

Regardless, if an investor has patience, you can see what is coming, which is some form of legalization. When that happens, companies will trade at wildly different multiples than where they currently trade, on what will be a much larger industry than it is now.

Consider Verano Holdings (Canada: VRNO, OTC: VRNOF). This company should earn approximately $1.3 billion in revenue and close to $600 million in EBITDA in 2022. At slightly less than $4 billion in market cap, Verano trades at 3x revenue and less than 7x EBITDA unlevered. That is with a company with a 3-year CAGR (compounded annual growth rate) of over 50% with over 40% EBITDA margins and in a net cash position. It’s possible that if the growth Verano is experiencing continues that the company could be trading at 4x 2024/2025 EBITDA.

When Verano is allowed to list on US exchanges, it could easily go up more than five times in value. There are other companies that are similarly well run and undervalued that could go up even more, such as AYR Wellness (Canada: AYR.a, OTC: AYRWF).

Prominent consumer goods companies and alcohol companies are lucky to be seeing 3-4% growth and trade north of 20x EBITDA.

An even better example is sports betting. Once illegal, publicly traded sports gambling companies trade at absurd multiples. Draftkings (NASDAQ: DKNG) for example sports a market cap of over $20 billion and trades at more than 40x 2024 EBITDA. When investors get access and are excited about a sector, valuations can go sky high.

The Longer Legalization Takes the Better for the Top Cannabis Companies

To the patient investor, the longer legalization takes, the better it is for the leading US public cannabis companies. Why? Because they have access to capital that their smaller competitors do not. This means they can grow, solidify their footprint, invest in their infrastructure, acquire smaller competitors, and gain size and scale advantages.

I estimate that there are only a dozen or so publicly traded companies that have access to capital. The longer legalization takes, the more time these companies have to establish themselves, to create footprints and moats and the more valuable they become. Anyone trying to follow them will either be shut out, will have to partner with them or buy them.

Consider all the barbarians at the gate, like Big Tobacco, leading alcohol companies or consumer packaged goods companies are holding off on entering the industry due to fears of reprisal from the Federal government. British Tobacco has a strategic plan called “Beyond Nicotine” and tens of billion in free cash flow in the next five years to invest. Pray tell, what in the world is after nicotine other than cannabis?

When I was buying foreclosed homes on the Gwinnett County, Georgia courthouse steps in 2011, it was a dream. I would compete against mom-and-pop investors, and we would buy homes left and right at prices that seem silly now, like $45,000 for a safe suburban 3-bedroom home. That all changed seemingly overnight when Colony Capital and Blackstone entered in May and June of 2012. Prices increased over 50% overnight. The minute the institutional investors believe it is safe to enter the industry, valuations and prices will change overnight.

Risks

There are many risks associated with investing in cannabis. The greatest is obviously that it is currently illegal federally to sell cannabis or to touch the plant in anyway. So, even though the IRS collects federal taxes (excessive taxes due to rules like 280e) from cannabis companies, the federal government still considers it illegal. This is the reason most institutions won’t touch US cannabis companies.

Beyond that risk, the other risk is one of timing. It may take much, much longer than expected for the industry to become legalized. It could also be legalized in a way that is very detrimental to the industry or the stocks the fund owns.

Summary

When I first identified the opportunity to buy, fix and rent homes, I saw a long-term opportunity to invest in the absolute bottom of housing. My mistake in hindsight was that it would have been much more lucrative and easier to simply research and buy the best housing related stocks like Home Depot (NYSE: HD), Lennar (NYSE: LEN) and others.

The opportunity to invest in the cannabis industry is just beginning. This is a generational investment opportunity in an industry with phenomenal growth and limited access to capital. We aim to invest before full legalization occurs and believe that patient capital will be well rewarded in the years to come.

Access the original document to see all links, references, and disclosures.

Bill Cummings: Lessons and Legacy — A Worthy Path in Business and Life

January 2, 2022 in Explore Great Books Podcast, Full Video, Interviews, Member Podcasts, North America, Real Estate, Real estate (privately held), Transcripts

We had the great pleasure of speaking with Bill Cummings, founder of Cummings Properties, a developer, owner, and operator of commercial real estate. Since its founding in 1970, Cummings Properties has grown to 11 million square feet of commercial real estate in 11 cities and towns north of Boston.

Bill’s charitable foundation has roughly $2 billion in assets. Bill and his wife Joyce are signatories of The Giving Pledge. Read their pledge letter.

Bill is also the author of the book, Starting Small and Making It Big: An Entrepreneur’s Journey to Billion-Dollar Philanthropist, published in 2018.

The interview was conducted by Alex Gilchrist, research director at MOI Global.

Members, log in below to access the restricted content.

Not a member?

Thank you for your interest.  Please note that MOI Global is closed to new members at this time. If you would like to join the waiting list, complete the following form:

Bill Cummings founded Cummings Properties in 1970, serving as president and, later, chairman. Although he is in the office most days, he currently spends more of his time on the work of Cummings Foundation.

Bill grew up in Medford and, in 1958, graduated from Tufts University. After holding sales positions with Vick’s VapoRub of Greensboro, North Carolina and Gorton’s Seafoods of Gloucester, he acquired, built up, and eventually sold Old Medford Foods, a well-established firm manufacturing fruit juice beverage bases. He got his start in commercial real estate with just one small building, which he built next door to Old Medford Foods, and then led Cummings Properties’ expansion into a 11 million-square-foot portfolio, now managed by more than 350 team members.

In 1986, Bill and his wife, Joyce, established Cummings Foundation, which has grown to be one of the three largest private foundations in New England. They were the first Massachusetts couple to join the Giving Pledge, an international philanthropic organization founded by Bill and Melinda Gates and Warren Buffett, and they have been honored to receive dozens of community accolades and honorary degrees.

Among Bill’s many honors are Real Estate Entrepreneur of the Year for New England from Ernst & Young, Edward H. Linde Public Service Award from the National Association of Industrial and Office Properties (NAIOP), and Real Estate Visionary of the Year from Boston Business Journal. He and Joyce were also inducted into the Greater Boston Chamber of Commerce’s Academy of Distinguished Bostonians.

In 2020, Bill released the latest edition of his self-written memoir, Starting Small and Making It Big: An Entrepreneur’s Journey to Billion-Dollar Philanthropist, which includes thoughtful reflections on the lessons he has learned about business, entrepreneurship, and philanthropy.

S2E14: Superforecasting and the Good Judgment Open | Biggest Lessons of the Year 2021

December 21, 2021 in Audio, Podcast, This Week in Intelligent Investing

It’s a pleasure to share with you Season 2 Episode 14 of This Week in Intelligent Investing, co-hosted by

  • Phil Ordway of Anabatic Investment Partners in Chicago, Illinois;
  • Elliot Turner of RGA Investment Advisors in Stamford, Connecticut; and
  • John Mihaljevic of MOI Global in Zurich, Switzerland.

Enjoy the conversation!

download audio recording

In this episode, Phil Ordway, Elliot Turner, and John Mihaljevic discuss

  • superforecasting and the Good Judgment Open; and
  • the biggest lessons of the year 2021.

Follow Up

Would you like to get in touch?

Follow This Week in Intelligent Investing on Twitter.

Engage on Twitter with Elliot, Phil, or John.

Connect on LinkedIn with Elliot, Phil, or John.

This Week in Intelligent Investing is available on Amazon Podcasts, Apple Podcasts, Google Podcasts, Pandora, Podbean, Spotify, Stitcher, TuneIn, and YouTube.

If you missed any past episodes, you can listen to them here.

About the Podcast Co-Hosts

Philip Ordway is Managing Principal and Portfolio Manager of Anabatic Fund, L.P. Previously, Philip was a partner at Chicago Fundamental Investment Partners (CFIP). At CFIP, which he joined in 2007, Philip was responsible for investments across the capital structure in various industries. Prior to joining CFIP, Philip was an analyst in structured corporate finance with Citigroup Global Markets, Inc. from 2002 to 2005. Philip earned his B.S. in Education & Social Policy and Economics from Northwestern University in 2002 and his M.B.A. from the Kellogg School of Management at Northwestern University in 2007, where he now serves as an Adjunct Professor in the Finance Department.

Elliot Turner is a co-founder and Managing Partner, CIO at RGA Investment Advisors, LLC. RGA Investment Advisors runs a long-term, low turnover, growth at a reasonable price investment strategy seeking out global opportunities. Elliot focuses on discovering and analyzing long-term, high quality investment opportunities and strategic portfolio management. Prior to joining RGA, Elliot managed portfolios at at AustinWeston Asset Management LLC, Chimera Securities and T3 Capital. Elliot holds the Chartered Financial Analyst (CFA) designation as well as a Juris Doctor from Brooklyn Law School.. He also holds a Bachelor of Arts degree from Emory University where he double majored in Political Science and Philosophy.

John Mihaljevic leads MOI Global and serves as managing editor of The Manual of Ideas. He managed a private partnership, Mihaljevic Partners LP, from 2005-2016. John is a winner of the Value Investors Club’s prize for best investment idea. He is a trained capital allocator, having studied under Yale University Chief Investment Officer David Swensen and served as Research Assistant to Nobel Laureate James Tobin. John holds a BA in Economics, summa cum laude, from Yale and is a CFA charterholder.

The content of this podcast is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction. The content is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth on this podcast. The podcast participants and their affiliates may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated on this podcast. [dkpdf-remove]
[/dkpdf-remove]

Highlighted Tweet by manualofideas

December 16, 2021 in Twitter

S2E13: Michael Mauboussin‘s Expectations Investing | The Right Amount of Lying

December 14, 2021 in Audio, Podcast, This Week in Intelligent Investing

It’s a pleasure to share with you Season 2 Episode 13 of This Week in Intelligent Investing, co-hosted by

  • Phil Ordway of Anabatic Investment Partners in Chicago, Illinois;
  • Elliot Turner of RGA Investment Advisors in Stamford, Connecticut; and
  • John Mihaljevic of MOI Global in Zurich, Switzerland.

Enjoy the conversation!

download audio recording

In this episode, Elliot Turner, Phil Ordway, and John Mihaljevic discuss

  • the new edition of Michael Mauboussin’s book, Expectations Investing; and
  • the “right” amount of lying — prompted by Rohit Krishnan’s essay, “How Much Should You Lie?”

Related Links

Expectations Investing, by Michael Mauboussin
How Much Should You Lie?, by Rohit Krishnan

Follow Up

Would you like to get in touch?

Follow This Week in Intelligent Investing on Twitter.

Engage on Twitter with Elliot, Phil, or John.

Connect on LinkedIn with Elliot, Phil, or John.

This Week in Intelligent Investing is available on Amazon Podcasts, Apple Podcasts, Google Podcasts, Pandora, Podbean, Spotify, Stitcher, TuneIn, and YouTube.

If you missed any past episodes, you can listen to them here.

About the Podcast Co-Hosts

Philip Ordway is Managing Principal and Portfolio Manager of Anabatic Fund, L.P. Previously, Philip was a partner at Chicago Fundamental Investment Partners (CFIP). At CFIP, which he joined in 2007, Philip was responsible for investments across the capital structure in various industries. Prior to joining CFIP, Philip was an analyst in structured corporate finance with Citigroup Global Markets, Inc. from 2002 to 2005. Philip earned his B.S. in Education & Social Policy and Economics from Northwestern University in 2002 and his M.B.A. from the Kellogg School of Management at Northwestern University in 2007, where he now serves as an Adjunct Professor in the Finance Department.

Elliot Turner is a co-founder and Managing Partner, CIO at RGA Investment Advisors, LLC. RGA Investment Advisors runs a long-term, low turnover, growth at a reasonable price investment strategy seeking out global opportunities. Elliot focuses on discovering and analyzing long-term, high quality investment opportunities and strategic portfolio management. Prior to joining RGA, Elliot managed portfolios at at AustinWeston Asset Management LLC, Chimera Securities and T3 Capital. Elliot holds the Chartered Financial Analyst (CFA) designation as well as a Juris Doctor from Brooklyn Law School.. He also holds a Bachelor of Arts degree from Emory University where he double majored in Political Science and Philosophy.

John Mihaljevic leads MOI Global and serves as managing editor of The Manual of Ideas. He managed a private partnership, Mihaljevic Partners LP, from 2005-2016. John is a winner of the Value Investors Club’s prize for best investment idea. He is a trained capital allocator, having studied under Yale University Chief Investment Officer David Swensen and served as Research Assistant to Nobel Laureate James Tobin. John holds a BA in Economics, summa cum laude, from Yale and is a CFA charterholder.

The content of this podcast is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction. The content is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth on this podcast. The podcast participants and their affiliates may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated on this podcast. [dkpdf-remove]
[/dkpdf-remove]

Howard Marks and Chris Goulakos on Tech Disruption and Value Investing

December 14, 2021 in Diary, Equities, Featured, Full Video, Interviews, Invest Intelligently Podcast, Latticework, Latticework Online, Member Podcasts, Transcripts

Chris Goulakos, Managing Partner of Balius Partners, and Howard Marks, Co-Chairman of Oaktree Capital Management, joined members for a fireside chat at Latticework on December 15, 2021. Chris and Howard explored the topic, “Tech Disruption and Value Investing in the Digital Age”.

This conversation is available as an episode of Invest Intelligently, a member podcast of MOI Global. (Learn how to access member podcasts.)

Replay this virtual fireside chat:

printable transcript
related graphs audio recording

The following transcript has been edited for space and clarity.

John Mihaljevic: It is a great pleasure to welcome everyone to this fully online version of Latticework. Normally, we hold this event at The Yale Club of New York City every year, and we hope to be back next December in person. For now, this format allows us to continue having fascinating conversations with thought leaders in the business and some of the best investors in the world, including some of our MOI members.

Chris Goulakos is someone who has given back generously to the community, and he also has a great relationship and rapport with Howard Marks. Thank you both for doing this.

Chris is the founder and managing partner of Balius Partners, an alternative asset manager applying value investing principles in the digital economy. He’s also a board observer and investor or advisor at several companies and specializes in M&A, capital allocation, and capital markets policy. Prior to starting Balius Partners, Chris worked at MidOcean Partners, a $9-billion alternative asset manager in New York. He’s also the co-chair of the Hellenic Initiative’s New Leaders Group and a member of the Milken Institute Young Leaders Circle. He is a graduate of the value investing program at the Ivey School of Business and lives in Washington, DC.

The theme of this year’s Latticework is intelligent investing on the right side of change, specifically tech disruption and what it means for value investing in the digital age. Chris, I’ll turn it to you to introduce Howard properly and get us started.

Chris Goulakos: Thanks, John. It’s truly an honor to be opening this conference, especially alongside Howard, who hardly needs an introduction. Howard is the co-founder of Oaktree, a legendary investor, and author of the famous memos that have taught and provided inspiration to all of us.

The idea for this fireside came together a couple of weeks ago when I was catching up with Howard in Los Angeles at another conference. We observed there was a particularly pronounced difference as far as the content themes went, moving away from value towards growth and different topics around innovation, entrepreneurship, and disruption. Building on some of the latest memos that Harold put together, we thought it could be fun to share that conversation with the community at large.

Before we get into that, Howard, it’s 5:00 am on the West Coast, and we have the Fed’s open market last meeting of the year. Is that keeping you up at night? What are your thoughts on the market of late?

Howard Marks: First of all, Chris, I want to thank you for doing this with me. You and I have been discussing these things for maybe 15 years. You have a great understanding of investing, especially value, and you’ve integrated it with your investment practice, which is based on technology. I think you’re the perfect person to lead this discussion.

As for the Fed, first of all, I sleep like a baby. I don’t believe in forecasts and don’t have expectations for what the Fed is going to do. I have an opinion, but I don’t bet my life on it. Whether they’re going to do it or not doesn’t keep me up. They’ll do what they’re going to do, then the economy will react, the market will react, and we will react.

One of my favorite sayings is from Einstein – “I don’t worry about the future. It’ll come soon enough.” I pretty much tend to focus on the present and not worry too much about the future.

Goulakos: As for the present and some of the events moving the markets of late, we’ve seen a resurgence of Omicron; there are geopolitical flashpoints, with Russia, Ukraine, and NATO; employment numbers and inflation numbers are moving in interesting directions. How are you thinking about 2022? You recently raised your largest fund. What should that signal as far as where we are in the cycle?

Marks: There are several moving pieces for 2022. The main ones are the disease, our progress against it versus the evolution of new variants, and how these things will affect primarily the economy and our daily lives. Then we will worry about inflation.

I would imagine we’re largely over with big giveaways of money, but you never know. The government has done a huge amount. There have been four, five to six billion of spending bills – depending on how you count them – to combat the voluntarily induced economic downturn. They wanted to be very generous, to really kickstart the economy. I say that because up to 20% of people were probably directly affected economically by the pandemic. In the later rounds, up to 80% of the population got checks. The government giveaways were not merely to make up for the economic consequences, but they went far beyond that.

For that reason, 2020 was the best year for disposable income in two decades. It was estimated that roughly $2 trillion of money was piled up because (a) the government gave out money, and (b) most people couldn’t spend it because they couldn’t go to stores, go on vacations, or hold events. I would hope we’re finished with that because those four or five or six trillion of spending bills added to the liquidity injected by the Feds bond buying and the treasuries and activities, contributing to inflation that is running close to 7%, the highest we’ve seen in in many years.

I lived through the 1970s. They were an unpleasant period because of persistent inflation and our uncertainty as to how to fight it until Volcker came along and raised rates. You have to raise rates higher than the rate of inflation to choke it off, and he did, which is why he was a hero. If inflation stays high, they’ll have to do that again. It will probably bring on a recession as it did in in the early 1980s.

Inflation is uncertain. Disease is uncertain. Geopolitics is always uncertain. I think the economy will continue to be good unless there’s a massive shutdown again, which I doubt will happen, especially because Omicron doesn’t seem to be as serious in terms of hospitalizations and death. Still, as I end most of my writing these days, there’s only one thing I’m sure of – we’ll see.

Goulakos: Speaking of what we’ll see, do you worry at all about a hard landing or a soft landing, and where are you looking for opportunities across this broader range of potential outcomes?

Marks: As of now, I’d say we’ll have a soft landing. By the way, we may not have a landing at all. If Omicron becomes the dominant strain, if it is less serious in terms of hospitalizations and death, and if we don’t have a full close – and I assume we won’t because there are fewer patients infected with it – then I think the growth will slow, but it won’t turn negative negative. When you talk about a landing, you’re mostly talking about negative growth in the economy. I don’t think we’re going to have a hard landing, but it’s one thing to have an opinion and quite another to believe it’s right and act on it strongly.

At Oaktree, one of the six tenets of our investment philosophy is that our investment decisions are not driven by macro forecasts. Thus, no matter what I think about the landing, we are unlikely to do much about it in investment portfolios. We had the final close for our fund a month or so ago, so I can talk about it. It’s $15.9 billion, our largest fund ever. These funds used to be called distressed-debt funds. We’ve broadened our charter to the effect that we’ll do anything we consider opportunistic, so we now call them global opportunities funds.

Roughly 70% of that $15 billion has been invested so far. The fund is only about a year and a half old, and we’ll continue to invest. We hope to get to finance some companies that made it through the pandemic thus far through bailouts and the capital market’s unstoppable demand for paper, which made large sums of money available and reduced the likelihood of default. We imagine that if we have a slowing of the economy and a cessation of government check writing, we will get some more companies in need of financing. You might call it rescue financing. It will have more to do quantitatively, and it’ll be better in terms of quality and, in particular, expected return, but that’s just a hope.

Goulakos: So, 70% deployed, or $10 billion in a year. One thing getting a lot of conversation in my world is the pace of deal flow. We have seen a two-standard deviation jump as far as the pace of private equity exits since 2001. Does that signal anything to you or remind you of past periods or past cycles?

Marks: I don’t think we’ve ever had money spent at this pace. People spent frenetically in the 1980s, but in much smaller deals. In those days, a billion-dollar deal was considered huge. What you’ve seen in the past 20 years is the result of the fact that stocks did so badly in 2001 and 2002 with the bursting of the tech bubble, a serious recession, the downgrade of telecoms, and the Enron scandal, among other things. It was the first three-year decline for the S&P since the days of the Great Depression.

A lot of people got turned off to stocks, saying we need an alternative. Maybe that’s where the term “alternative investing” came from. In 2003 and 2004, many turned to hedge funds. Hedge funds that used to be $100 million became a few billion. In my opinion, that onrush of capital and the changed behavior it brought signaled the end of hedge funds as a big thing. There are still many hedge funds, and there’s trillions in them, but nobody talks about hedge funds anymore. They’re not the magic they were 20 years ago.

If you need alternatives and can’t count on hedge funds to give you high returns, the next best candidate seems to be private equity. Private equity is probably the biggest alternative asset class and has been around the longest. KKR, Apax, and one or two others started doing what we would call buyouts on leverage using other people’s money to buy companies or parts thereof. This started around 1974 with KKR, as I recall. It’s been around almost 50 years, which is interesting. Of course, it’s not necessarily a household word.

By the way, there was no such term as private equity in the 1970s or 1980s. It was called leveraged buyouts, and we used to talk about LBOs all the time. You don’t see LBOs in the press anymore. I think the main reason for that is they did so horribly. The leveraged buyouts in the 1980s in particular brought in some large companies – Federated Department Stores, Macy’s, Campo up at Canada, National Gypsum, US Gypsum. These were roughly billion-dollar companies, which was considered a lot of money in the 1980s. I think all the ones I named went bankrupt.

RJR Nabisco, which was a $27-billion transaction at a time of billion-dollar transactions, almost went under and scared the heck out of many people, probably including the owners over at KKR. So, they had to change the name, and in the 1990s, they invented the term “private equity.” LBO used to be ubiquitous, but you don’t hear it anymore.

The great thing about the private equity business is they can create their own deal flow. If you’re an opportunistic lender or a distressed-debt investor like us, you can’t create deal flow in that you can only lend money to the companies that default, those in bankruptcy, or those in extremis. The private equity industry can create its own deal flow because it can go to any company in the world and try to buy it. They’re getting much larger quantities of money now. In 2005, we started seeing $5-billion buyout funds. In September 2006, I wrote a memo called “The New Paradigm.” They’re investing large quantities of money, and they’ll keep doing so.

Goulakos: In what ways has the disruption and the accelerated pace of technological innovation sped up the pace of disruption and the opportunity set for you? Are you seeing incumbents struggling and requiring incremental capital, or is it risk that you’re not prepared to assume given the technology? How do you incorporate that into your process?

Marks: First of all, we’re not tech investors. During lockdown, my son and his family lived with us for three months, and Andrew and I discussed tech growth and crypto ad nauseam. In a way, I think tech is harder now in the sense that you have to know more about it. You need to have more subject matter expertise. Tech began to be an important part of investing in the 1960s. In those days, we called it growth investing. Of course, there were other aspects to growth than just tech, but tech meant Xerox, IBM, Hewlett Packard, PerkinElmer, and Texas Instruments – those companies were part of the NIFTY 50 which got its start back in the 1960s. I studied Xerox in those days. I felt I knew enough to do so.

Today, you need to have more technological expertise to know which companies will succeed, which will fail, and which will thrive. That’s a change.

Number two, we used to talk about companies that were either stable or defensible, consumer staples, and we talked about moats. I think it was Warren Buffett who coined the term “moat,” but I may be wrong on that one. In my second book, Mastering the Market Cycle, I talk about the newspaper industry. It was the perfect thing to invest in. It had the world’s greatest moats. If you had the newspaper in your town, you owned it. You didn’t worry about competition from the newspaper in the next town because you gave the want and the used car ads for your town – maybe legal notices and stuff like that – and the person in the next town did the used car ads and the notices for that town. There wasn’t much crossover because why would somebody in that town advertise in your paper and vice versa?

The other thing is that everybody bought the paper. My dad used to read two papers a day – one on the commute to work and one on the commute back. The paper was a dime, which didn’t strike us as a lot of money at the time, like pennies today. The great thing about the newspaper from the point of view of the publisher is that if you buy it today, you have to buy it again tomorrow. There’s no shelf life. It doesn’t continue to be relevant. There was no worry about TV – it was national, so it didn’t handle local things, so there were lots of reasons why a newspaper had great moats.

Warren invested extensively in newspapers. He’s famous for his investment in The Washington Post, but he did a lot of other papers. Today, most newspapers are fighting for their lives. If it wasn’t for the fact that the political arena has turned into some cross between national emergency and entertainment, I think many more newspapers would be out of business.

We don’t invest much in technology. About 20 years ago, we did a tech investment in the distressed-debt funds. We found a distressed tech company, and we got our heads handed to us because of the ephemeral nature of the value of tech, especially if you don’t feed it money to keep developing it. By the way, 20, 30, or 40 years ago, it was a steady mantra that you don’t put leverage on tech companies because the underlying businesses are unstable. If you lever them up, they become highly volatile. In the search for investment opportunities, the buyout industry has gotten away from that rule.

What’s my answer, Chris? We’ll see.

Goulakos: Specialized tech, private equity funds, Silverlake, Thoma Bravo, and Vista brought to the private equity space as far as tech investing goes this idea that the SaaS contracts are almost as good as any contracted revenue stream, which lends themselves – albeit asset-light – to balance sheet leverage. Is that something you see as an opportunity, or is it something you stay away from, from the perspective of the creditor? Do you think it’s somewhat imprudent that venture debt is being raised? It’s such a hard case.

Marks: On the one hand, there’s nothing wrong with lending against a money-good long-term contract. To give you an extreme example, if you go back long enough, sometime in the 1980s, the most popular TV show was called Dallas. It was an evening soap opera of enormous popularity.

I learned about the TV model. You make a show and get a contract to put it on the air. You may make or lose a little money in the first season, but if you can get into syndication and can sell the episodes to somebody for showing over and over, you can really clean up. Dallas was sold into syndication with some extremely strong contracts. I gave Lorimar, the company that made Dallas, a loan against those contracts.

It doesn’t have to be hard assets. There’s nothing wrong with a solid long-term contract. Now, it may take software expertise to assess the longevity and the renewability of those contracts, but I don’t rule it out per se.

Goulakos: In Mastering the Market Cycles, you use a lot of analogies from betting – be it backgammon, poker, or blackjack. In situations like that, there’s a pit boss, there’s a dealer, you know how many cards are in the deck, you know how many dice there are, and the permutations, so you could, to a certain extent, handicap the risk. In today’s world, where the Fed is more active, the government is involving itself in markets, and innovation continues to change the structure of the system, how can you properly handicap? How can you define the margin of safety? How do you invest in a changing landscape?

Marks: That’s a damn good question. Before I answer, I’ll say that you were extolling the virtues of gambling and how fair it is because the odds of the dice are known. This also keeps the game honest. Also, our industry isn’t regulated as much as the Las Vegas casino industry. There are lots of, shall we say, good things about gambling. I enjoy gambling. I’m great at playing blackjack for $10 a hand.

That’s different in our industry, but if you look at the gambling industry with all the investor protections, most people still leave all their money at the casino. I don’t think that, financially, gambling is a good model for us because we hope not to leave our money at the casino. We’d like to end up with some at the end of the year, hopefully more than we started.

The tech aspects of the investment industry are less regulated. The odds on a pair of dice are absolutely known. You say, “There are 36 possible combinations of two six-sided dice.” You know, for example, that six of them will result in the number 7 – 1,6; 2,5; 3,4; 4,3; 5.2; 6,1. You know six out of 36 – or 17% – will give you the number six. It’s essential to bear in mind that even when you know the probability distribution, as you do to perfection with dice, you still don’t know what’s going to happen.

The probability distribution with technology and software isn’t even known in advance. Some people know it better than others. That’s the key. If you know more about the subject than other people do, you can invest in it intelligently, maybe even with something approaching safety, but only if your knowledge is superior.

I know you and I have talked about this ad nauseam, and I talk and write about it ad nauseam, but people have to realize that investing is this weird field where it’s incredibly easy to be average and incredibly hard to be above average, and being above average is my definition of success in investing. Superior performance does not come from being right about the future – it comes from being more right than others. In other words, you think GDP is going to grow at 2%, and it does grow at that rate, but if everybody also thinks it’s going to grow at 2%, your forecast is not a valuable one.

The only valuable forecasts are non-consensus correct forecasts. It’s extremely hard to make a non-consensus forecast because, usually, for example, extrapolation is correct, and most people do it. Then, having made a non-consensus forecast, it’s hard for it to be right because of extrapolation, and consensus forecasts are right most of the time, but it is the non-consensus correct forecasts that make the holder a lot of money.

It all goes to making better judgments. I wrote a memo, maybe in September of 2015, entitled “Not Easy.” When I was putting the finishing touches on my first book, The Most Important Thing, I got to talking with Charlie Munger, whose office is in the building next to mine in downtown LA. We talked about this at length, and when I got up to go, Charlie said, “Remember, none of this is meant to be easy, and anybody who thinks it’s easy is stupid.” It is. It can’t be easy. Everybody wants to make money. The money will go to the people who do a superior job, not to everyone. What’s the definition of superior job? In my opinion, it’s making superior judgments. Before making a tech investment or any investment, you need to ask yourself, “Might I know more about this than most others? Am I more likely to be correct in my judgments of the future than most others?” If you’re not, there’s no reason to expect that it will bring you superior investment results.

If funds that do venture lending have an edge in assessing the technologies on which they’re putting their bets, they could win consistently. We know there are firms in Silicon Valley that win consistently. Some of that is because of superior knowledge. I would imagine some of it is due to a self-fulfilling aspect to their success because that means more young companies come to them to get financing – they know that (1) fund XYZ will give them the seal of approval, and (2) the folks at XYZ can probably give them some help.

Again, the average venture funds, the average buyout fund, their performance is no great shakes. It all comes from being above average. One of the greatest questions for investors who look at these funds is whether there is persistence in their success, but in venture there certainly seems to be because a few firms are better situated than the rest.

Goulakos: In today’s economy, it’s all about buzzwords, like network effect and platform businesses. The NIFTY 50 shaped much of your thinking and your career trajectory. How do you contrast the quality of business today to the NIFTY 50? What were the buzzwords that seduced investors back then? Should we be cognizant of any of that as we look at these businesses?

Marks: We always had to be on alert as investors. Look, you make the most money in assets that have merits which have not been discovered. You lose the most money in investments whose merits have been overstated – or demerits, faults that others have not figured out. This truth is eternal. Back in the 1960s, when I came into the industry, I remember sitting in my family’s apartment – probably around 1964 – reading the first brochure on growth investing. I think it came from T. Rowe Price. That was when the NIFTY 50 was flying. The NIFTY 50 did phenomenally in the 1960s.

The buzzwords were that these were companies where nothing bad could happen. Since nothing bad could happen, and since they grew faster than the average company, there was no price too high. There was no concern with valuation because people said, “These companies are growing so fast that if you buy them and the price turns out to be a little high for today, wait a couple of years, and the earnings will grow and will be priced fairly then.”

I came to work full-time at Citibank in 1969 after grad school, and if you held those stocks firmly for five years – the greatest companies in America – you lost almost all your money. First of all, a lot of the companies where people said nothing bad could happen either faltered or simply disappeared. My favorite whipping boy in those days was Simplicity Pattern, a company that sold patterns to people who made their own dresses. Who do you know today that makes their own clothes? Everybody had a sewing machine in those days; nobody does today. Obviously, things can happen.

Much more simplistic, Xerox had a lock on the dry copying business. “Xer” is from the Greek for “dry.” Before that, all copying was wet. You would take your document to a shop, and they would make a photostat through a photographic process involving chemicals. Xerox created the first dry copying machine, and it had a lock on that industry. I followed the company as an analyst. What it did is the machines were so big, Xerox priced copying very high, and that brought in competition from abroad with small machines and low prices. I forget if Xerox went bankrupt or almost went bankrupt.

Number one, in many of the companies where nothing bad could happen, things went bad. That shows you the limitations of investors’ foresight. Number two, they were priced too damn high. The P/E ratios on those stocks ranged up to 80 and 90. Five years later, they were selling at P/E ratios in single digits. That’s a good way to lose most of your money. If nothing else changes, you’ll lose 90% of your money. If the multiple goes from 80 to 8, that’s what we call higher math.

Whenever merits are overestimated, the scene is set for investors to lose money. It happened then, it happened in 1999 and 2000 with the TMT bubble, and it happened with housing in 2006 and 2007. I would imagine that some of the tech companies today attracting investors’ attention and loans from the credit community will turn out to have been overestimated. One of the things that happens – we could say bubbles – in times of popularity is that investors discover an industry they hold in high esteem, and they act and invest as if every company in it has a chance of being successful. You find a company selling for a billion, and you say, “That’s an awful lot for a company without any sales or revenues or profits.” People say, “Yes, but it has a 5% chance of being worth $100 billion.” It has a $5-billion expected value. It’s only selling for a billion, and you could make 5X, so it’s justified on the basis of a low probability of a huge outcome.

We call that lottery mentality, and that’s what takes over in bubbles, especially in new fields. Most bubbles occur in new fields because the newness of the subject matter is (a) seductive, and (b) there are no precedents to limit investors’ imagination.

Goulakos: You wrote a great memo, “Something of Value,” where you highlight the evolution of your thinking. When you think back to the past year or two of living under COVID, what bad ideas have you discarded as far as investing? What new mindsets frameworks and mental models have you adopted?

Marks: That, Chris, is a very diplomatic way of asking what my big mistakes were. One of the things Andrew pointed out in our discussions is how the markets have changed. As growth investors, we’ve all heard Warren Buffett talk about buying dollars for 50 cents. If you go back 50, 60, or 70 years, when he was doing it, it’s fair to say the world was a stupid place. Most people didn’t know anything. They didn’t know how to make money and where to look for good investments because they didn’t have computers. They were not interconnected, and they didn’t have easy access to data, so it was hard to find the companies whose one-dollar value securities were selling for 50 cents. As I said in the memo, Buffett did it because you could imagine him sitting in the backroom in Omaha and leafing through Moody’s Manual to find these bargains lying there in plain sight if you only looked. He did the hard work.

One of the things Andrew pointed out – with maybe the most fervor – was that, today, unlike those days, you can’t expect to make money only on the basis of readily available quantitative information regarding current activities. That’s because everybody has it today. Everybody’s got a computer and can get all the information they want.

Andrew made the great observation that, in my youth, if you wanted to study a company, you had to write it a letter asking for the annual report. They may put you at the back of the line. Two weeks later, they get to your letter, and they send you the annual report in the mail. Maybe it takes a month to get the annual report of a company you want to follow. In the interim, there’s not much you can find. There’s no Google, no information online. The search for information was much more challenging. Some people would get this quantitative information regarding current activities, and others couldn’t get it or wouldn’t go to the trouble, so it wasn’t that readily available.

Today, everybody has it. If you want to find a company of this size and this growth and this the P/E ratio, you can find it all in two or five minutes.

Goulakos: Ten seconds on Bloomberg.

Marks: Exactly. The world’s a very different place. What that means is you should not expect to be able to beat the market on the basis of readily available quantitative information on current activities. You have to either go for information which is not available – like the distribution of sales for a company – or which is about the future and not the present, which is not reported by the companies but a matter of conjecture regarding the future. Clearly, the profits from thinking about future results are going to come to the people who know that subject better. Like I said in “Not Easy,” it always comes down, in my opinion, to people who have superior subjective judgment.

Goulakos: Going back to where we are in the cycle, there was an article in The Wall Street Journal on December 9 entitled “Elon Musk and Other Leaders Sell Stock at Historic Levels as Markets Soar.” Howard, you can’t predict the future, but you look at what other people are doing as a signal to what and where we could be in the cycle. What does that tell you as far as insiders selling at a record pace?

Marks: I think a lot about such statements because they always say, “The inflation is as high as it’s been in 20 years. The prices are the highest they’ve been in 20 years. The stock market has made the biggest move since October or whatever it might be.” A lot of these comparisons are not significant.

With regard to a steadily increasing number of insiders selling large amounts of stock, it was 30 insiders back in 2019 and 65 in 2020. The question is simple: did the value of stocks double? If the value of stocks doubled, then you would think the number of sellers of a certain amount of stock would double. That doesn’t tell you anything. The number went from 65 in 2020 to 90 in 2021. Did stocks go up a half? Lots of stocks did go up a half. Certainly not a lot of tech stocks went up a half. The mere fact that more people are selling doesn’t tell me that much, but we know the market’s way up. We know a lot of people want to take some money off the table. For an entrepreneur who has his whole net worth and more in one stock, it’s totally reasonable to sell some as they rise.

I wrote in the memo “Something of Value” about my time with Andrew that he is not by nature a seller. Many people sell because they want to take profits and lock them. Andrew doesn’t have that nerve in his body. He’s not a seller, but that’s because he’s just a money manager for our family and for his VC clients. However, if you have all your net worth in one company, it’s perfectly understandable to sell some.

Mihaljevic: How has disruption changed your credit analysis process?

Marks: The main effect is that you have to think about disruption. You can’t look at a company and say, “That’s stable consumer company like a newspaper, so it’s probably free from the threat of disruption.” Almost everything can be disrupted today in your industry by people who do it better and use tech better and in terms of competition from outside your industry, as we’ve seen with the newspapers.

I would dare say that, 50 years ago, when you looked at the NIFTY 50, probably nobody had on their list (a) can this industry go out of existence as it did with Simplicity Patterns? and (b) can our industry be competed or disrupted by people from other industries, other technologies, and other means of doing business? Is technology going to be a big factor in our industry? Who’s going to have the best tech? For example, in the NIFTYS 50, in addition to Simplicity Pattern, we had maybe Avon or Sears. Sears never thought it would be disrupted by companies that didn’t even have stores or printed catalogs.

We all have to think more about the likely longevity of our industries, companies, and technologies. You have to be adult enough to say, “Technology could be really important in this industry. I’m not that good on tech, so I’m going to pass.”

Warren and Charlie talk about putting this or that on the too-hard pile. There’s a lot in today’s world today that is too hard, much more than there was 50 years ago. With the exception of Hewlett, Perkin and TI, which were in the NIFTY 50, there were very few companies or industries where you would say, “You know what? I don’t understand that industry. I don’t understand that product. I don’t think I can invest in it because it’s beyond me.” Today, there are lots of things on the too-hard pile for most of us. I would not like to invest in a tech industry doing battle with a bunch of people who know much more about a technology than I do, so we have to include the question of disruption in our credit scoring and refuse to participate when it’s above us.

Mihaljevic: That’s a truly profound statement, Howard. Even though information is everywhere and there’s more of it than ever, there are also more things on the too-hard pile than ever. That’s quite interesting.

Marks: You have to understand, John, everybody now has a million times more information than we had 50 years ago, but superior investing comes from a superior access to information or superior analysis of information. Information is not knowledge; it is the raw material for knowledge. It’s possible to have so much information that you have less knowledge than you used to because it’s distracting and confusing.

My favorite commercial 20 years ago was from an online brokerage firm. It simply said, “If you want to make money, just sign up for our brokerage firm and get our data.” They show the person doing three keystrokes and say, “Just analyze it.” How do you do that? The implication is that by looking at a screen, the average person can figure out whether a stock is going to go up or down. This is so crazy. You can’t get away from the fact that in order to make more, you have to know more. To think that you can produce superior profits without superior expertise and superior judgment seems nutty.

Mihaljevic: Could you recommend a book you’ve read recently and found valuable or enjoyable?

Marks: Chris mentioned my tendency to compare investing with gambling because of the presence of randomness and unknown information and a wide variety of possible outcomes. There was a book I read and discussed at the beginning of 2020. I wrote a memo called “You Bet” based on a book by Annie Duke titled Thinking in Bets. In the latter parts, it gets into other kinds of decision-making, but I thought the first part of the book was very valuable for investors. Then, I must confess, I have to show my human weakness. My favorite book of 2021 was The Caesars Palace Coup about the buyout of Caesars Palace and the ensuing legal machinations because, normally, in a bankruptcy, the old owners are wiped out and the old creditors become the new owners. The owner of Caesars Palace did not want to see its equity wiped out and took steps to avoid that process. Since we were among the creditors, a couple of the creditors decided to fight them, and the book is about the battle.

It shouldn’t surprise you to find out that Oaktree and David Tepper’s Appaloosa were the big winners in Caesars Palace’s restructuring, and the equity owners were the big losers. I’ll read any book in which we’re the winners, but a lot of people have told me that it was a great book. It’s quite technical when you get through the machinations of the transactions they engaged in to try to preserve their equity, but it’s a fun outcome as far as I was concerned.

Mihaljevic: Chris and Howard, thank you so much for such a wonderful conversation. I feel truly privileged to have been a part of it.

Marks: Thank you, John. It was a pleasure to be here again. I want to say one last thing about the book before I say goodbye. What makes me happy is not merely the fact that we won, but I think it’s clear from the book that Oaktree in particular – and I think Appaloosa – engaged in the most ethical possible way. Our fight – which won us a lot of money – was based on solid principle. It was really the triumph of right.

I’m immensely proud of my Oaktree colleagues. I didn’t do the heavy lifting on Caesars; people like Ken Liang and Kaj Vazales did, and it’s a great outcome in a great way. Whatever we do in our professional and even our personal lives, the only thing that matters is not what the outcome was but how it was achieved. I’m very proud of being able to achieve great outcomes on the high road.

About the session host:

Chris Goulakos is the Founder and Managing Partner of Balius Partners, an alternative asset manager applying value investing principles in the digital economy. He is a board observer at Odeko and an investor/advisor at Flexe, Varda, Cameo, PIPE, ActionIQ, Autograph and Echodyne, specializing in M&A, Capital Allocation and Capital Markets policy. Previously, Chris worked as an associate at MidOcean Partners, a $9 billion alternative asset manager in New York. He serves as the co-chair of The Hellenic Initiative’s New Leaders Group and is also a member of the Milken Institute Young Leaders Circle. Chris is a graduate of the Value Investing Program at the Ivey School of Business and he lives in Washington DC with his wife, Stephanie and two children.

About the featured guest:

Since the formation of Oaktree in 1995, Howard Marks has been responsible for ensuring the firm’s adherence to its core investment philosophy; communicating closely with clients concerning products and strategies; and contributing his experience to big-picture decisions relating to investments and corporate direction. From 1985 until 1995, Howard led the groups at The TCW Group, Inc. that were responsible for investments in distressed debt, high yield bonds, and convertible securities. He was also Chief Investment Officer for Domestic Fixed Income at TCW. Previously, Howard was with Citicorp Investment Management for 16 years, where from 1978 to 1985 he was Vice President and senior portfolio manager in charge of convertible and high yield securities. Between 1969 and 1978, he was an equity research analyst and, subsequently, Citicorp’s Director of Research. Howard holds a B.S.Ec. degree cum laude from the Wharton School of the University of Pennsylvania with a major in finance and an M.B.A. from the Booth School of Business of the University of Chicago, where he received the George Hay Brown Prize.

Savneet Singh and Scott Miller on Winning in Enterprise Softwaret

December 14, 2021 in Diary, Equities, Featured, Full Video, Interviews, Invest Intelligently Podcast, Latticework, Latticework Online, Member Podcasts, Transcripts

Scott Miller, Founder of Greenhaven Road Capital, and Savneet Singh, President and CEO of PAR Technology (NYSE: PAR), joined members for a fireside chat at Latticework on December 15, 2021.

Scott and Savneet explored the topic, “Spotting Winners in Tomorrow’s Enterprise Software Ecosystem”. Savneet talked about the evolution, business model, and strategy of PAR Technology.

This conversation is available as an episode of “Gain Industry Insights” and “Discover Great Ideas”, member podcasts of MOI Global. (Learn how to access.)

Replay this virtual fireside chat:

printable transcript
audio recording

The following transcript has been edited for space and clarity.

John Mihaljevic: Welcome all to this live session at Latticework 2021. It is a great pleasure to welcome Scott Miller, founder of Greenhaven Road Capital, and Savneet Singh, president and CEO of PAR Technology.

Scott is somebody I admire and have had the opportunity to get to know over the years. In my book, he is a model of how to succeed in business and investing. Scott, the firm you founded and the letters I read periodically show why a lot of emerging managers and capital allocators gravitate toward you – it’s because you make sure everyone gets value from their interactions with you.

Greenhaven Road Capital is a boutique investment partnership that seeks off-the-beaten path investments modeled after the early Buffett partnerships. It’s built on a belief that a focused investment manager can outperform an index by limiting fund capacity and concentrating exposure on a few great ideas over the long-term time horizon.

Scott has experience as an owner-operator himself. He co-founded Acelero Learning and grew that company before switching his focus to investing. He has an MBA and a master’s in education from Stanford University.

Today’s guest is a great case study and example of Scott’s investment approach. Scott, I will turn it over to you to set the stage and take it away with this fireside chat.

Scott Miller: Thanks, John. Let me start by saying that you do a great job with Manual of Ideas. A lot of investors are sprinkled around the world, and they’re hard to connect with, so this is an excellent forum for convening people and teasing out thoughts and ideas.

Getting to this session with Savneet Singh, full disclosure: Greenhaven Road is a shareholder in PAR Technology. We have some frameworks that I talk about in my letters about making jockey bets and having this notion of Fight Club. We’re investing in people managing assets versus assets managed by people, and one of the more flexible thinkers out there, one of the jockeys we have bet on is Savneet Singh.

I have more of an operating background than many fund managers, and I think you, Savneet, have more of an investing background than many CEOs. Do you want to set the context, give a bit of your background and maybe hit some finance-related pieces and ways to help us get into this investing conversation?

Savneet Singh: I started my career in a very traditional finance path. I spent two years doing investment banking at Morgan Stanley and then worked at a large hedge fund because I had this dream of learning to invest like Warren Buffett. No disrespect to Scott and all the amazing entrepreneurs out there, but I realized that wasn’t the place to learn to be Warren Buffett. I had always had a strong entrepreneurial bug, so I left and started a company in the financial technology space. It was an incredible experience. I did it for seven and a half years, learning how hard it is to be an operator but also how rewarding it is to get it right and to win.

After that experience, I left and went on a journey of trying to build a set of investment businesses. Early on, I had observed the power of great software businesses. I had seen that once you build a great product and integrate it into large organizations, you’re building businesses with gigantic moats. My favorite line has always been, “If Warren Buffett was 30, this is all he’d be looking at.”

I said, “If you were going to envision the next Berkshire Hathaway, you’d probably think about building it around great enterprise software businesses, so let’s go try to find that,” except our angle was to find growth assets. This comes back to the foundation of you question, which is we were operators in nature. We didn’t want to be merely passive allocators. We wanted to have some operating influence. Thus, we went on this journey. It’s a very long story, but we stumbled on PAR. Originally, we tried to carve an asset out of PAR. Later, I stumbled my way onto the board and eight months after that, I ended up becoming the CEO. It’s one of those things you couldn’t have predicted. It wasn’t meant to be that way, but it turned out that PAR was the asset we wanted to build into our little mini-Berkshire Hathaway. We’re focused on serving one constituent, which is restaurants.

Miller: Can you tell us a bit about what PAR does?

Singh: The company was founded 54 years ago as a defense contractor selling IT services to the DOD. Think of it as data scientists before they were called data scientists. In 1978, the founders of PAR invented the point-of-sale terminal because the mother of one of them was a McDonald’s franchisee. Two years after they invented it, McDonald’s adopted it as an approved system to be sold within McDonald’s. Maybe more interesting, the company mandated in 1982 that if you were running a McDonald’s, you had to run on a PAR system. On that news, PAR went public. It took off in the next five or six years as restaurants moved from cash registers to point-of-sale systems.

Unfortunately, in the subsequent 25 or 30 years, the company went the wrong way. It was primarily because it missed out on building and shipping software. As customers started realizing that it wasn’t the device in the store that mattered but the software inside that helps you run your operations, they would buy the software from third parties and then bundle it onto PAR hardware. Thus, PAR got stuck as this cyclical hardware and services company while Oracle’s MICROS, Aloha, and other amazing software products grew quickly and built the higher-quality model.

To rectify that, PAR bought a small SaaS product called Brink. The way to think about this is that Toast and Square and these amazing businesses were built to re-envision how you ran your small restaurant. All of us have been to a coffee shop and had that Square experience. You see how easy it is on the consumer side. What we don’t see is how amazing it is on the operator side. It’s a “wow” experience if you’re working at that restaurant and upgrade to a modern software product.

Brink was that version for the enterprise restaurant, which is incredibly complicated and much harder. When PAR bought the business, the idea was that the same innovation, the same technology revolution happening in small coffee shops and small restaurants is going to happen in enterprise. That was the rocket ship PAR attached its future to. Since then, we’ve grown a lot. Today, we have gone from a company that sold point-of-sale systems to being the fastest-growing and certainly the largest pure cloud operating enterprise in the space of restaurants, and we also have a back-office product.

The way we’d like to think about PAR is we’re giving you a platform to run your enterprise restaurant. We are absolutely the wrong solution if you’re a single-store restaurant, but, if you’re an Arby’s or a Five Guys, we are the platform you want to run your restaurant.

Miller: Can you parse that out a bit? You’re in restaurant technology, like Toast, and then you’re making the distinction between SMB and enterprise. What are some of the actual nuance differences there?

Singh: The way to think about the distinction between SMB and enterprise is that if you run a single-store restaurant, your needs are literally defined by the four walls of your establishment. If you’ve got one store, you don’t need a great loyalty app, right? Your people are coming in because they come to that one store. You don’t need modern labor software, and you certainly don’t need a robust online ordering system. You can literally use anything off the shelf. You don’t have a massive supplier network, massive supplier software, franchisees, and reporting systems. You’re not using Snowflake or mParticle. You’re literally a single-store operator.

Compare that to running Arby’s and think about all the stuff that runs through an Arby’s. The way I mentally frame it is you’ve got everything I just described happening in the store, but then you’ve got franchisees, cybersecurity rules, and 20 different pieces of reporting software. It’s an incredibly challenged way to look at a system.

The way we think of Brink – our core product – is that it’s a great product to run your in-store operations, and that’s relatively similar to what a Toast or a Square would do. You’ve got to process transactions and push that data out to all sorts of systems. You also have the above store functionality, which is everything you need for franchisees, suppliers, and all that comes outside the store. Then we have a third module called integrations, which is all the entry points to an enterprise restaurant that you wouldn’t have in a small business. That can be everything from your drive-thru to something more complex like the robotic delivery services some of our chains are testing out. The work to service enterprise is 5 to 10 times more than it is to service a small restaurant.

Miller: I think it’s implied in all of this that churn is lower. For you guys, it should be.

Singh: Of course. People always say, “You know restaurants are crappy businesses, right?” I always reply, “They are, but franchised restaurants are amazing businesses.” These QSR chains are truly incredible businesses. They are capital-light. The returns on capital are super high. Part of the reason we chose this vertical to be in was we knew the end market was very strong. I think that was a little misunderstood. The churn in the enterprise market is extremely low. Our churn is low single digits every year because the business is the same business, and it is extremely hard to rip it out. Not to sound terrible, Scott, but when I was looking at software stocks back in the day, I would say, “I’d rather buy a basket of the lowest NPS stocks than high NPS stocks.” That’s because if you’re around and you’re growing as a low NPS product, it simply means you’re stuck, and the opportunity is so high. PAR was a bit like that.

Miller: Enterprise versus SMB has these implications for churn. It has implications for different products you can integrate with, but also the competitive landscape, right? Most of us have seen and interacted with Toast. That hasn’t historically been the primary competitor. What are your primary competitors?

Singh: Let me add one thing to what you said. There are product differences we just described, which is you’re serving so many more constituents when you’re an enterprise product. There are also business model differences. How we go to market is dramatically different. Our sales cycles are a year or a year and a half. When you’re selling down market, you can sell something on Instagram, ship them the software and the point-of-sale terminal, and they’re up and running. Their go-to-market is different. The pricing is different. I look at it as almost completely different end markets as you evolve down the road.

Our first sale to the enterprise customer is relatively small. We’re selling them point-of-sale software. That product is $2,000, $2,100, and sometimes $2,500 a year, and that’s all we charge. From there, over time, we’ll upsell them loyalty. Eventually, we’ll upsell them online ordering, and we’ll move up that stack of more extremely sticky products. On that first sale in down market, you’re bundling point-of-sale, probably bundling online ordering, bundling payments, you might bundle labor, and you get a big sale upfront.

Early on, the CAC to LTV in down market looks incredible, which is why venture capital ran to it. It’s like, “Wow! You can bundle $10,000 a year software to a small restaurant. You can only do $2,000 to that enterprise restaurant up market.” Over time, though, the enterprise market has longer term LTVs because it’s so sticky. That’s the bet we’re making. Yes, the CAC to LTV down market is great because you’re going to sell more upfront, but over time, I think you’ll end up better. As you mentioned, the churn is lower, but the number of products needed in an enterprise restaurant will grow and grow. In the last five years, there have been more restaurant technology companies created than there were in the history of time. In the next five years, it’s going to happen all over again, and most of that will go to these enterprise restaurants.

Miller: Makes total sense. In terms of your competitors?

Singh: One of the great things about PAR is who we compete with. Without a question, our biggest competitors are NCR with its product called Aloha and Oracle with its product called MICROS. There are other companies, like Xenial. There are tons of legacy companies, many of them bought by payment companies, and these are solid, stable products. They’re not dead products, but they’re older products. They’re not modern, and they’re all owned by organizations where they are a minority of the business.

The reason why this is important is because their not being the primary focus, those large companies can’t turn on a dime and say, “You know what? We have these great businesses that generate lots of cash. We’re going to reinvent the product now,” because you’re not the focus. I imagine at PAR, if we had a 5% revenue line generating 35% cash flow margins and, all of a sudden, that manager came to me and said, “Can I take that down to zero because I want to reinvent the product?” I’m just going to be like, “That’s too much brain damage. It’s too much distraction for a 5% product line.”

As a result, these companies are the perfect pool for us to fish in because we’re not competing in Silicon Valley 2.0. This is Silicon Valley 1.0. I have immense admiration for Square and Toast. I think these are world-class companies, but we’re not really competing against them, not today. We’re competing against these older legacy-type companies. You see it every day in the market. You look at the sales folks, and you’re like, “I feel like I’m going back 10 years.” You look at the pace of product development; it’s nowhere close to what a Toast or a Square is doing. We look at those as our core competitors. Over time, the competitors will become Toast, Square, everybody, but today, we have a beautiful competitive moat, and we’re not really competing against the best developers in the world.

Miller: To give you a sense of how important MICROS might be within the overall Oracle landscape, I think Oracle has mentioned the business in a public setting one time in the last seven years.

Singh: If you’re a customer and you’re excited, try to find it on the website. It takes some time.

Miller: Another thing I wanted to discuss was team. I teed you up as kind of Fight Club and a jockey, but in terms of winning and the importance of team, can you talk a little about what you’ve been doing and some of the changes you’re trying to make on the team level?

Singh: When we stepped into PAR three years ago, it was a very challenged business. To me, every business problem is a people problem. In the end, businesses are merely organizations of people that have decided to do something. Early on, we got obsessed about building a great team at PAR. The first thing we did was come out with a set of simple values. We value speed – people who run up the escalator, who don’t wait for the elevator, who run upstairs, and who are ready to go. We look for owners, not renters, and people who focus and are absolutely about winning.

The reason we wanted that intense, rigorous culture was because we were in a really challenged situation. We’ve obsessed over building a talent factory and a talent engine at PAR. Prior to working at PAR, our CPTO Raju was the CTO of Salesforce Marketing Cloud, one of the largest marketing software businesses in the world. The guy before him was an awesome person. He was managing 13 people and then he became the CTO of PAR. Think of that step function of talent – we had a guy working with 13 people succeeded by a guy who had run Salesforce Marketing Cloud. You can’t imagine what that does to an organization from just the quality of what we’re building. You’ll see it throughout PAR. For the first two years of the business, the talent was better than the business. We were acquiring, and we were attracting people who had worked for the likes of 3G Capital, Google, and Blackstone. Today, we’re sure the business is catching up, and that’s always how it works. We worked hard to build that, and it’s not easy. It’s not a bunch of fun. It’s a lot of hard work, but that’s what we obsess over.

This has been the year of the great resignation, and it’s certainly hit PAR and every other company, but we haven’t lost one senior person, and I take a lot of pride in that. That wasn’t because it was a fun and fluffy year, but because I think people felt proud of what we’ve accomplished and how we got here, and they feel great about building something for the long run. The results will tell, but in general, we tend to think that, if there’s a problem, it’s generally a people problem, and then we try to find the best talent we can and bring them on board.

Miller: I want to talk a bit about qualitative things that don’t necessarily show up in numbers, like the competitive landscape. In your case, I think you benefit from going up against some legacy providers. If you’re a software investor, we’re trying to look at things like billings and growth, but you guys have what I would call a shadow backlog, which is a real asset. Can you talk a bit about what that is?

Singh: Dairy Queen is one of our largest customers. It has around 4,500 to 5,000 stores. Dairy Queen – the institution – is highly committed to having PAR run in every single store. It’s very simple. If the company has the same IT stack in every store, its ability to move quickly as an organization increases dramatically. If it decides to update its website, loyalty system, and back-office systems, it’s plugging into one system, whereas today, if you’ve got 25 different systems, it’s a ton of work to redo every integration. Every time you make a change, make an upgrade, or change a vendor, you’re doing 25 integrations versus one.

The corporates are incredibly incentivized to have one platform to run their own organization. When we sign a customer, they are committing nothing more than saying, “We want to roll PAR out.” We then have to go convince all these franchisees to sign up for PAR.

The beauty of our business is that at some point, we know everybody will come over – almost everybody – because they have no choice, but it takes some time to roll them out. At the end of Q3, we were installed in around 15,000 stores, but if you look at our large logos, we’re barely half-penetrated through the vast majority of our large logos. The way to think about it is if Dairy Queen is 5,000 stores and we’re in 2,500 of them, there’s another 2,500 of shadow backlog that are going to come over time. That shadow backlog is probably another 10,000 stores that we haven’t even booked yet. The beauty of that is we could get rid of our direct sales team and still keep growing the business for the next two years very comfortably without signing new logos. We’d never do that, but it builds this awesome momentum in the background which is “I can create growth by signing new logos, but I can also create great growth by making a massive penetration into our Arby’s and Dairy Queens and so forth by signing up existing customers.”

There is an extremely lucky part of this, which is that the corporates we work with are now seeing the value of this technology. They’re realizing that during the pandemic, if only half their stores had access to the new loyalty product, those stores did a lot better, so they truly want more stores to get that, and they’re going to put incentives. We have organizations today that are saying, “If you switch on to PAR by the end of 2022, we’re going to cut your royalty points for that year.” That’s massive savings. We’re benefiting from our customers seeing the value of our products, and that shadow backlog provides great foundation for growth for the next few years.

Miller: Thank you for explaining. That’s a truly positive hidden asset in that it’s not so clear from doing a quantitative screen that it’s there. On the negative side, I think you inherited a fair amount of technical debt, which had some implications for your growth. Can you talk a little about what investors might not have seen, but what’s going on on the inside when you got to PAR and where you are now?

Singh: When you looked at PAR from the outside at the end of 2018 when we stepped in, it looked like it was this legacy hardware company that has a very fast-growing software asset. You assumed that the software asset was just like any other software business – it’s got great growth, there’s great retention, it’s a clean shop. When I got to the job, I think what scared me the most was that the NPS on this thing was like negative 50 or so. It was truly awful. The sad thing was, at the time, it was the same as the employee NPS, also negative 50 or negative 60.

It didn’t make sense, though. The business had been growing 50% to 100% a year, and the employee NPS and the customer NPS were horrendous. I thought, “What’s going on here?” What I observed and I think we saw was that while the product was growing very quickly, it was going in the wrong way. It was a cloud product that had 37 different versions running. It was a cloud, but it wasn’t a real cloud product because instead of actually building the product and having your changes built into your releases, you were just copying and pasting and building new versions for customers’ needs. You were losing all the benefits of being a cloud product.

That wasn’t done because the prior team was dumb but because there was a lack of capital and lack of people. It’s a lot faster to say, “You know what? I don’t want to take the risk of putting that into next release. I’m just going to make a new version for that customer and put them on their own stack.” So, we built up an incredible amount of technical debt – an incredible amount. You can’t scale at that pace and ever think that you could solve that problem. What we did is we made the very strategic decision to go to our investors early on and say, “We need to bring this growth down considerably, and we’re going to take all of our resources and put them towards hardening and scaling our product, not in new product development. We’re going to figure out new product development through M&A.”

That’s specifically what we decided. That was a two-year journey of getting it to the point. A great example here is one of our largest customers would have me fly to their offices once a month just to scream at me for 30 minutes, and then I would fly right back. I did that for six months, back and forth. It was terrible but on that first meeting, I came to the office and said, “I’m the new guy. We’re going to try to fix this thing.” He comes out and prints me a piece of paper. It says, “Here’s all the stuff that was promised to me when I signed this deal in 2016 or 2017.” I looked at it and I said, “I’m going to be honest with you. We’re not going to get to any of this in the next two years. Let’s do this. Why don’t we stop billing you today and create a plan for you to go back to Oracle? You’ll have a great experience with your old vendor, and we’ll focus on making ourselves better, and I’m going to go into your business two years from now.” The guy was like, “Whoa! You’re still so much better than what we had before. I want to work with you.”

In my mind, I was like, “Okay. There’s something to build here, and I have to explain to my customers that we need that time to make the product great.” That same customer who would scream at me is now mandating that every store get on PAR by the end of 2022. It’s such an amazing change to see that our customers now believe in our product. Our product is rock solid. It doesn’t go down.

I went from every board meeting being like, “How many times did Brink go down? How bad is NPS? Who’s leaving?” to now like, “Why aren’t we building this?” It’s an amazing transition for us to understand that two years of my life, we had investors clamoring for growth, and I was like, “I just want to keep things from breaking.” We’re never going to be done with that. It’s always technical. You always have to address it, attack it, and have a plan, but we’ve gotten the product where it works, and we can think a little more about where we want to be as opposed to just surviving. That was a very fine balance because as investors, you just don’t get that motion, right? It’s like, “Wait, is the product bad? Is it not working?”

Having lived in enterprise software, I know that no product is perfect. There’s no product without technical debt. It’s a mountain to climb, but you can only do it if you go all in on it. If you do it in the background, it’s never going to happen. We made that hard decision, and it cost us a lot. It gave competitors opportunity. We lost talent. If you’re a great engineer, do you want to come to a company that’s like, “Hey, there’s this amazing opportunity, restaurants building software companies, but all your work is going to be fixing this product.” That’s why I say that our culture hardened too because it was about fixing this challenge.

The thing I’m most proud of is that our two largest customers, our two most angry customers mandated it, and that’s huge because it doesn’t happen in restaurants. The investors that financed our large acquisition went from hating us to financing us. We’ve seen this transition of the product starting to work.

Miller: Thanks for telling that story. You did make a decision to build payments. Can you tease out your thought process a little on build versus partner, in particular, why build payments?

Singh: Payments is a highly commoditized business. My advice for those investing in software is not to get so excited about businesses that leverage payments because this is truly a commodity product. I get excited about this idea of, “You know, if payments race to the bottom, then you should be the one to race it there and come up with the product to do it.” So, how do you sell and say, “I’ll give you payments for this, but I’m going to have to sell you a software product on top of it that will do X, Y, and Z.” If you chose any of PAR, Toast, Square, WorldPay, or First Data, there’s no difference in your payment experience as the operator. It’s integrated into your point-of-sale system, and that’s where you see the observable changes, and it’s integrated into your financial statements, but there’s nothing there.

My vision of payments was, “If that’s it, then you’ve got to build a product on top of that payments business for it to be a great money generator, and the only way we could do it is if we built it ourselves. If I’m just taking a bunch of pieces from third parties and then saying, ‘This is PAR payments,’ I can’t reinvent that on top.” So, we took that decision.

I’d also say it was incredibly financial-driven, too. If you’re the payment facilitator, and you’re taking on the risk of that transaction, your margins are much higher. The beauty of selling to fast, casual, and quick service restaurants is that they’re very low risk from a fraud perspective. Nobody steals a credit card to buy a burger. It was part financial, but for us, it was also one of those things which if we can build it out ourselves, we’ll have the ability to create new products on top of it, but if we collected a bunch of third-party stuff, we never would be the ones to innovate in that market. We wanted to be innovators here, not just copy what everybody else was doing.

Miller: Let’s shift gears a little and put on your investor hat. I’m curious, if PAR is taken away from you for whatever reason and you’ve got to go start a fund, how would you approach investing?

Singh: I think being an operator has made me a better investor. Part of that is you have no time to look at stuff. You buy stuff you know and trust, which has been a good play, but part of it is you do understand how businesses work and how hard it is to make those changes.

We’re in the M&A business. We’ve bought a lot of businesses, and we’ll continue to do that. I look at myself as being an allocator maybe a bit similar to how you invest. I start on three levels. Let me discuss them in reverse.

Maybe the biggest flaw of investors is that they don’t understand the TAM of the product they’re investing in. There are so many investments I see where people assume growth rates continue forever without doing the real work and understanding that end market. If I was a professional investor, I’d be obsessing on that end market. Let’s use a quick anecdote here. There are 750,000 or 800,000 restaurants in the United States, half of them applicable to PAR. You say, “Your product is $2,000 bucks.” I say, “Okay. Take $2,000 bucks times about 400,000 restaurants, you get a TAM.”

I used to tell people that’s the TAM today, but every time we buy and build a new product, we’re expanding that TAM. We’ve got the loyalty product, we’ve got a back-office product, still selling to the same customers, but it works the other way, too. I could have told you, “I’m selling a widget to restaurants. There’s 4,000 restaurants, and I’m going to be the point-of-sale guy and then the loyalty guy,” and you would have been wrong. Really understanding the end market and those dynamics is exceptionally important because they drive your churn. You’ve got the best product in the world, but if you’re selling to businesses with high churn, you’ll never have a great business. In my view, it’s about truly understanding that end market. I think so much about that now because I can see that when I’m making deals in these businesses. I’m like, “Listen, you’ve got 100% growth rate, but that’s going to end, and that’s multiple I’m going to pay for you.”

The second one is product. I find that all of us have been influenced by the great value investors of our time, and they always tell you that you should be in a circle of competence and know the products. I would challenge everyone. “Have you seen a demo of the company’s product that you’re investing in? Have you gone into a store and seen it work?” That true legwork and understanding the product is so valuable. I’ve met CEOs of our competitors who have bought products. I always ask a very specific question to see if they know anything. I’ll ask, “How long is their sales demo?” and they reply they don’t know. I’ll be like, “You bought a company without watching the demo. You just trusted a bunch of other people to make that decision for you. That’s instructive for me because everything crystallizes when you see that product.”

The most important thing I’ve learned is the people side. All you have to do is look at the people coming to PAR. Look at Raju’s background, and you’ll think, “That guy has got a lot of options. He can make a lot of money anywhere he goes, but he chose this rinky-dink company.” You look at some of these people that are leaving 3G and Google and coming to PAR and wonder why they are joining a $250-million market cap company. Today, we announced the CIO of the Atlanta Hawks has joined PAR to run our smallest business unit. Before that, he was the CIO of Church’s Chicken. That’s kind of instructive because you’re thinking, “This guy was the CIO of 1,000-1,500-store restaurant chain, and he’s coming to run PAR’s smallest division? Why?” He’s here to build something big, and we’ve given him a great platform to be something great. We think he’s awesome, and he’s going to be amazing.

When you are able to attract that type of talent, you can do all the work you want, but the people that live in the business know it better. Just following where the people are going is a great thing I’ve learned. When we’re buying businesses at PAR, I myself go through every person on LinkedIn, see where they work, see who their references are, and call them up. It’s so easy to see sometimes. You’re like, “Gosh! That team is just loaded with talent” Other times, you can say, “You know what? That’s a team that built the entire product offshore, and it’s just a services company pretending to be a software company.”

Talking purely from a software perspective, if you’re buying or investing in a software company, go look at the bios of every salesperson. If those salespeople came from Accenture, Deloitte, and KPMG, it’s not the company for you. What I mean by that is in services, you get paid to say yes. In product, you get paid to say no. Your sales guys are saying no, and they still have to sell the product. It’s extremely hard to do, but that means your identity is a product company, and your margins will get to 70%, 80%, 90%, like a great software business versus those that have hired people who come from great service companies. They dilute the product so fast because they start saying, “Yes, yes, yes, yes, yes!” and the product becomes bastardized because you’re doing customizations left and right. I really look at that.

Another nugget I can share is don’t run away from low NPS companies. How many products do you absolutely hate, and then they’ve had a great stock market return? Look at the cable companies. Pretty obvious, right? Software is no different. Look at ADP. How many people love the ADP product? We’re on ADP at PAR. It sucks to use. I hate it, but I’m not getting off of it because it’s got 50 years of PAR’s payroll records and we need that data.

My point is that you can learn so much, so I look very deeply at that. Part and parcel of that point on NPS is always ask for telemetry of the product – how much time people spend on a product is absolutely tied to the quality of the moat of that business. You can find so many widgets within restaurant technology that have massive growth, perfect retention, perfect customer base, and I’ll be like, “Give me your telemetry.” You’ve got all the stuff, but people spend 12 minutes on your product a day? All that means to me is that you’re simply filling a small acute need for that business, but if I swapped you out for somebody else, you’re not that important.

In a letter I shared a couple of years ago, I wrote, “Software is not software is not software.” Everyone thinks, “I look at growth, retention, churn, and the quality of the end market, and I make my investment.” It’s a truly horrible way to invest because not all products are the same. You come back five years later and you’re like, “Holy crap! How did you have this step function of growth fall off?” It’s because you didn’t do that work early on and didn’t realize that product with great growth all of a sudden lost its channel partnerships. SAP said, “Sorry, we’re not promoting anymore, and you’re lead side up.”

We’ve got a playbook. We go through all of these things, and we say, “Does it hit all the boxes?” As an investor, because we’ve operated in the business, we know what questions to ask, how to get deep in the weeds on these things. The engineering teams are like, “How fast are you publishing software? Oh, you’re publishing like this. How often is it going to actually be into customer hands?” You say, “Wait. You told me you publish stuff every 10 weeks, but you release to customers every six months?” What does that mean? It means you’ll be able to recruit great talent because great talent wants to see the thing they build into customer hands as soon as possible.

Miller: Do you have any investors asking you questions around how often you’re publishing software?

Singh: There are a few. I think there are a few that get in the weeds and understand it really well. Those are the best conversations we have because they understand. When we started PAR, we were publishing software to customers once or twice a year. You could have known there were some problems.

Miller: Do you see some mistakes investors make when they’re interacting with PAR? Do you feel like they go down the wrong path for certain reasons?

Singh: I’m not one to judge how people get their answers. I’ve seen people buy PAR because they love it and believe the product will do great. I’ve also seen people buy PAR because they’ve known me for a long time and know how obsessed I am with winning. I’ve seen people bet against PAR because they’re like, “How are you going to beat Oracle and NCR? They have 25% of the restaurant market. They have more power.”

I don’t know if I have the answer on the right or wrong way to look at it, but I would say that every single investor who has spent more than a few hours understands what we’re building and why the opportunity is so large, and then it’s all about us as a team to execute on. I think people get caught in the weeds of looking at very small indicators, and this is the big picture. You’re not buying PAR, Square, Toast, or anyone in restaurant software because you’re looking at the last quarter against this quarter’s numbers. Those are important, trust me. We don’t pay bonuses if you don’t hit your numbers, but you’re buying it because you fundamentally believe that the restaurant is being eaten by software, and these are the platforms that will be able to benefit the most from it. If you don’t get that macro, it’s not worth it because there will be clearly bumps in the road as you go.

Last quarter, for example, we couldn’t book customers because I couldn’t get products shipped from Korea to the United States. Those things happen, but I promise you that if I wasn’t the CEO of PAR, this thing is still going to grow very comfortably simply because the market is there.

I am not someone who say, “Close your eyes and hope for the best.” We’re super in the weeds. My bonus is tied to margin and revenue, not just to growth. Everything is set up the right way, but you have to buy that and that end state, or it’s hard to get there. Let me give a specific example. When I became the CEO of PAR, our ARR was $10.7 million. Three years later, it was $80-something million. I couldn’t have predicted that when I started. Maybe that’s your Fight Club analogy. You can never do that. That was like a crazy transition. If I had gone in and said, “Brink’s gross margins are in the 50s, so you’re a services company and a product company. You can work through that, work through that, and work through that.” You would have missed that, right? The right way would have been, “It’s $10.7 million ARR. There are all these challenges, but the business is still growing. Why?” Then you’re like, “Wait. They got this guy Savneet? He just recruited all these guys from great backgrounds to come here.” Then you say, “I called five customers. They all say PAR sucks, but it’s getting a little better.’” You’re like, “Yeah, you could have figured it out, right?”

Then you could have seen. “We’re pretty smart capital allocators. We did a convert. We didn’t do an equity raise because we hit the equity price. We make good decisions on who we bought.” I think this is an amazing story and will go down as one of the great things we’ve done. We acquired an amazing business in Punchh, but Punchh was larger than PAR from an ARR basis. It had faster growth, higher retention, great talent for a third of our market cap. We were good allocators there.

The point I was making was not that we’re patting ourselves on the back for going from 10 to whatever it is today, but that it is very hard to get in Excel model. I think folks who have trouble with that have a little trouble with PAR.

Miller: Can you talk a bit about what the opportunity might be in usage-based pricing? This doesn’t show up in historical numbers.

Singh: I’m a big believer and, hopefully, our shareholder letter gets approved by compliance, and you’ll see a whole write-up, but usage-based pricing is this theme you’re just starting to hear about. To me, it’s really outcome-based pricing. We live in a world where software is automating everything that we do. I say software is eating the restaurant because you’re finding that every problem with the restaurant – and it’s the easiest example to get to the point – needs to be solved by a human being. If there are too many people in a drive-thru, send somebody out with a tablet to take your order.

As all those workflows move to software, you, the software company, are charging fees. It’s not aligned. If the product sucks, you’re still paying that. Conversely, there are certain software products – like PAR’s – that I truly believe are incredibly underpriced. You’re paying us $170 a month, but for that money, we literally are sending data to every system you have. If we go down, your entire store goes down. It can’t operate. I’ve been to these restaurants, and I always say, “I love you guys, but for $170 a month, if I go down, your entire operations go down, but you’ll pay $200 a month for the Wi-Fi connecting app? How does that make any sense? If it goes down, you’re still running.” I’ve said that I’d rather give our product for free and charge for every transactional process or, over time, say, “Here are your old transactions for the old company. Put this new product in. If we create more revenue for you, we take a piece of that.”

In the end, I think software will move from license spaces to SaaS to some sort of transactional-based pricing – Twilio is a great example; you use it, you pay for it – to eventually outcome-based pricing, which is we, as a software company, create a better outcome for your business, and we want to take a small piece of that because we delivered on it. Conversely, if we don’t deliver on it, we don’t make anything.

I envision that’s what’s going to happen next. To give you a super simple example, if you’re a restaurant company today and you’ve got 20 people calling – FYI, phone is still a huge channel for restaurants – and you don’t have someone pick up the phone, you should just ship that to an AI bot. If Siri can process that order, it’s free margin that came your way. I shouldn’t pay them $20 a month. I should pay 5% on that order. This transition is going to move that way. That’s where we’re building at PAR, which is if we can deliver better outcomes, we should get paid more. If we can’t, we shouldn’t. It’s super intense, and I love that.

Miller: You talked about seeing the migration of people. I think you didn’t have to be that close an observer of PAR with Ron and what they did. Can you tell that little story?

Singh: One of our customers is a firm called CAVA Grill. It’s one of our fastest-growing chains and an amazing organization. It was a customer at PAR, an angry customer, truly unhappy. When I got to PAR, they said, “We’re bringing in Toast and a couple of other companies because we’re going to rip you guys out. We love the thesis, but you have not delivered for us.” I said, “Give us six months. I’m not going to tell you the answer now, but let us get better and then make your decision. Don’t make your decision on the past. Make it on what we can deliver you now.” It was a hugely challenged relationship. I’d have to say sorry a hundred times and apologize, but we got it right, and we fixed it.

When we made the decision to acquire Punchh and make it a core part of the platform, we needed third-party financing. Lo and behold, we went to our customer CAVA. Ron Shaich was the founder of Panera and Au Bon Pain, an incredible operator, compounded at 20%-plus for 20 years. His group chased us down and said, “We didn’t think you could fix this thing. Our restaurants were struggling greatly. You were taking our restaurants down. It wasn’t working. So, we want to get behind that horse and that jockey, behind that team. We believe you can build this platform for the restaurant that no one has ever delivered on. It was always our dream at Panera to create that platform. We think you’re the guys to do that, and we’d love to invest in that transaction.”

It was an amazing experience. We had a customer that hated us, truly despised us, going from not only saying, “We love you, and we’re going to continue to sign up and renew with PAR” to “We want to invest in your company because we believe you’ve delivered on your promises, and we can help you build something great together.” I would just say that having Ron Shaich on our board has been an incredible experience because he’s not an investor who’s patting you on the back or yelling at your numbers. He’s so in the weeds of what’s wrong with the culture and the operations. He’s so intense, and I truly loved it because he’s been in our shoes, and he’s delivered for a long time. I think he looks at this as if PAR doesn’t deliver, it’s on him.

Mihaljevic: Let’s wrap up with a question about the stock. PAR trades at a material discounts to Toast and Lightspeed, yet their business trends are getting worse and yours are getting better. How do you think about this and your ability to execute future M&A?

Singh: It’s super important. One of the things I’ve learned is that you do have to care about stock prices as a CEO. I was a bit ignorant to this. When I first got to PAR, people said, “Why don’t you do a lot of IR?” I got rid of all PR and marketing at PAR. The only thing I’ve done is four or five podcasts because I enjoy the long conversation. I don’t like being promotional. I’m a millennial and don’t really use social media. The only thing I fight about with shareholders is the lack of promotion. I think I was wrong about this because our currency is our stock, and since we’ve been acquisitive, we need that stock to work. Otherwise, it limits the pool of stuff we can buy in.

I’d like to think that PAR is oriented to deliver shareholder return. As an organization, we look at ROI. We think about it a lot. We do believe we work for you. I say at every meeting, “The best person on PAR is the person who can drive the most long-term shareholder value at PAR.” We’re trying our best to deliver that value, and we understand that the stock price is important. It’s our job to espouse the value and not be promotional. Hopefully, our execution leads that stock price, but I’d say it’s been a learning for me in that you can’t simply pretend it doesn’t exist.

About the session host:

Scott Miller is the Founder of Greenhaven Road Capital, a boutique investment partnership that seeks out off the beaten path investments, modeled after the early Buffett partnerships. The firm is built on the belief that a focused investment manager can outperform an index by limiting fund capacity and by concentrating exposure on a few great ideas over a long time horizon. Experience as an owner-operator of businesses influence Greenhaven’s approach towards partially-owning companies rather than merely picking stocks. Prior to founding Greenhaven Road, Scott co-founded Acelero Learning, serving in a variety of roles over a decade from CFO to CTO, to Chief Strategy Officer to his current role of Board Member. Additionally, Scott managed a manufacturing business, with responsibility for hiring, firing, planning inventory, negotiating with suppliers and acquiring customers at a reasonable cost. Scott holds an MBA and a Masters in Education from Stanford University.

About the featured guest:

Savneet Singh is the President & CEO of PAR Technology Corp., and President of ParTech, Inc. Savneet is a partner of CoVenture, LLC, a multi-asset manager with funds in venture capital, direct lending, and cryptocurrency. He has served as a partner of CoVenture since June 2018. From 2017-2018, Savneet served as the managing partner of Tera Holdings, Inc., a holding company of niche software businesses that he co-founded. In 2009, Savneet co-founded GBI, LLC, an electronic platform that allows investors to buy, trade and store physical precious metals. During his tenure at GBI from 2009-2017, Savneet served as GBI’s chief operating officer, its chief executive officer, and its president. Savneet serves on the Board of Blockchain Power (TSX:BPWR) and PAR Technology. Savneet received his B.S. in Applied Economics and Management from Cornell University.

MOI Global