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WCM Investment Management | Insight | Beach Reads 9 - 15 | Welcome to Beach Reads. There have been some notable M&A deals as of late: it looks like TikTok (in some shape or form) is going not to Microsoft, but to Oracle , and that Nvidia will grab ARM Holdings .
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Beach Reads

September 15, 2020

Welcome to Beach Reads. There have been some notable M&A deals as of late: it looks like TikTok (in some shape or form) is going not to Microsoft, but to Oracle, and that Nvidia will grab ARM Holdings. Below, I break from the day-to-day news flow to share some articles with longer half-lives. This haul features a number of investment theses (including ones on private companies), thoughts on shareholders vs. stakeholders, a piece on the evolution of platforms, and arguments debating the pros and cons of the work-from-home trend. Below, I outline the articles covered in this edition of Beach Reads.

  • Analyzing companies: Stripe, Unity, Halma and roll-ups, and Bessemer's memos
  • Understanding public and private markets: what "stakeholder value" means, and how platform businesses are evolving
  • High Fashion: Hermes, LVMH, Tiffany, Farfetch, and the New Guard Group
  • What the future of work may look like – thinking about the corporate office and the home office. Including Reed Hastings' thoughts on the topic

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Conor Deveney

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ABOUT Beach Reads

Welcome to Beach Reads, a collection of interesting links that we at WCM have come across and want to share. The goal of this publication is to engage with a broader audience in order to better ourselves and others. Feel free to email us at insights@wcminvest.com with any thoughts or feedback, and click here to subscribe!

01. Company Analysis: Private Companies (For Now) and Roll Ups

Stripe: The Internet's Most Undervalued Company

The June 23 edition of Beach Reads featured a fantastic interview with Stripe co-founder John Collison. For those less familiar with the payments platform, this write up from a substack provides a thorough introduction to the company and importantly describes the company's moat (through the lens of Hamilton Helmer's book 7 Powers). "Stripe's 7 Powers work together to build moats around a business that is reliant on acquiring young customers, keeping them as they grow, and expanding the capabilities it offers them," the article says. Stripe has reached a private valuation of about $36 billion, according to the author, by leveraging its core payments moat to develop new products: "In a decade, Stripe has gone from accepting payments, which is now a commodity business, to providing an increasingly comprehensive suite of products that make it easy to start and run an online business." Wide moats and new products build "a double compounding advantage – Stripe's revenue grows both as its customers' revenue grows and as they buy more Stripe products." In many ways, the Stripe playbook sounds similar to some other internet-native platform businesses. With no immediate plans to go public, Stripe remains mysterious and its eventual S-1 will be fun to go through whenever it decides to file.

Unity: Analyzing the First Game Engine IPO

The previous edition of Beach Reads mentioned the large number of companies coming public soon. One is Unity, a game engine that competes with Epic's Unreal engine. By delving into Unity's S-1, this "Mastering the Meta" blog post provides a good overview of the company and the growth opportunities it is pursuing. "Unity has shown mastery in executing a gaming-centric land-and-expand strategy," the post concludes. "It has amassed a strong competitive position, a large high-value customer base, and a proven ability to upsell/cross-sell every year...In other words, it's laying the foundation to not only stay relevant but become an even bigger and more profitable company." For those who don't have time to read the ~300 page S-1 but who want to learn more about Unity, this overview is a good jumping off point.

How They Did It: Halma, PLC

This analysis of Halma, PLC by Woodlock House Family Capital outlines how investors might build a framework for finding other successful roll-up businesses. For those unfamiliar with Halma, the author highlights that it has 44 operating companies (built primarily through acquisition). When analyzing roll-ups, the four key attributes to look for, according to the author, are 1) share counts that don't increase much through time, 2) acquisitions funded using internally generated cash flows, 3) acquisitions of the same or similar businesses, and 4) a focus on quality/ROIC. As an example of point one, consider the following: "Do [roll-up businesses you look at] acquire other companies mostly using internally generated cash, or do they borrow the money and/or issue shares? Just off the top of my head, some very successful acquirers do it the way Halma does: Heico, Constellation Software and Brown & Brown." A stellar list of peers for sure. With this in mind, the four point framework outlined in the article, built from studying Halma, may be worth exploring more when analyzing roll-ups.

Bessemer Venture Partners: The Memos

OK, this isn't a write up of a specific company, but even better: the link includes a bunch of theses! Specifically, it provides a look under the hood at Bessemer Venture Partners and illustrates how the VC firm approaches investing. Including write ups on public companies, such as Shopify, and companies that were acquired, such as Twitch, the theses show how a VC firm analyzes risk and opportunity. Take a look at the list of memos and see if any are interesting – I've read a few and enjoyed them all. Also, as a public equity investor, it is fun to pencil out some of the returns VC firms achieve (e.g. BVP invested in Shopify at a $20M valuation!).

02. Investment Philosophy

Michael Mauboussin: The Great Migration from Public to Private Equity (Podcast)

Another great podcast from Patrick O'Shaughnessy. This time around, he interviews Michael Mauboussin, adjunct professor of business at Columbia Business School. Throughout the podcast, the two discuss a white paper Mauboussin recently published, available here. Two topics that I found most interesting were: 1) how to account for investments in growth/ how R&D expenses might not be terribly accurate and 2) (something that Mauboussin touches on at the very end) the idea of exploit vs. explore (meaning how much time a company spends on exploiting what it does well vs. exploring something new). This podcast and Mauboussin's white paper also cover public vs. private markets and how these have evolved through time, something that is important to understand as we reflect on the large pipeline of upcoming IPOs and very large private companies.

Understanding Stakeholder Value: Where do Profits Come From?

Intrinsic Investing recently published this piece that juxtaposes the familiar notion of "shareholder value" to an interesting term called "stakeholder value." In short, the authors highlight that given the (increasing) interconnectedness of the world, it makes sense that companies evolve to not only serve shareholders, but also the broader group of stakeholders that includes groups of people like customers, employees, and even regulators. "The future success of a company is dependent on the organization creating value across its entire stakeholder ecosystem," the article says. "Just as shareholders benefit from supporting value creation across the company's other stakeholders, so do those other stakeholders benefit from supporting economic value creation for shareholders." Intrinsic's definition of stakeholder value echoes the ideas of authors such as NZS Capital and W. Brian Arthur, which may indicate a growing awareness of, and interest, in this "ESG-Plus" approach to investing in companies that exhibit win-win outcomes for all the communities they serve.

Platform Economies

How do platforms differ from other businesses and how are they evolving? First and foremost among six key observations in this Medium article is that platforms are becoming increasingly important as aggregators of small businesses. However, the author sees the "value capture" moving away from the platforms toward the actual businesses they support. "The value capture still asymmetrically rests with the platform itself, but value has started to shift towards the commercial actors on the platforms," the article says. "This will continue to happen as (i) the platforms compete with each other for talent and (ii) the new small businesses take audiences initially captured via a platform, use the audience to build a brand, and start generating organic traffic." This alludes to a degree of disintermediation, or at least a change in platform industry structure. To continue to capture value, platforms will likely pursue win-win strategies so that creators do not leave when they reach sufficient scale. As an example: "Does the platform monetize on behalf of the small business? In the case of YouTube, yes — because the programmatic ads create revenue for the YouTuber who only needs to entertain an audience. In the case of Instagram, 'not yet,' since programmatic ads with creator revenue share have not been rolled out at scale to Instagrammers." Platforms that have strong network effects and set up win-win situations seem more likely to scale than those that are extractive.

03. High Fashion and the Future

How Hermès got away from LVMH - and thrived

Bernard Arnault, CEO of fashion conglomerate LVMH, tends to get what he wants. Having built the business largely through acquisition, Arnault is sometimes referred to as the "wolf in cashmere" as he occasionally pounces on targets to bring them into the LVMH fray. One company that escaped is Hermès, despite Arnault building a stake in the company that was worth north of 17% of the business. This Economist article details how the family-owned Hermès defeated Arnault and kept its business. "The first step was to keep the wolf at bay. Though listed since 1993, most of Hermès's shares belonged to 60 or so descendants, split into various branches...Ultimately, Hermès family members eager to remain in charge created a structure which pooled just over 50% of shares, committing themselves to owning their stakes come what may until 2031. By 2017 Mr Arnault had given up." Arnault is again dealing with drama as LVMH reneges on its offer to buy Tiffany. It'll be interesting to see how Tiffany will perform as a stand-alone company. According to the Economist, "the Hermès clan can draw satisfaction from the fact that their investment in the family firm has yielded returns of over 400% since 2010—even juicier than if they had traded their stakes for LVMH shares." The story may be different this time around, though: Tiffany was open to be acquired, while Hermes was not.

The Four Futures of the Platform That Birthed Luxury Streetwear

While the article above details how Hermès escaped the clutches of LVMH, it appears that a smaller, new-age luxury roll up has been having success acquiring brands in an LVMH manner. New Guards Group has been instrumental in creating "luxury" streetwear as a fashion category and is rolling up a portfolio of companies to support its growth in existing and new product categories, according to this article in High Snobiety. "New Guards Group's sharp ability to identify credible talent who already have big, loyal followings, paired with its internal infrastructure to launch, scale, and foster independent brands fast (from design and production to distribution and management) has enabled the company to grow its brand portfolio...at an unprecedented pace." New Guards' strategy and success has caught the attention of bigger companies and "Farfetch, the London-based online retailer and owner of Stadium Goods and Browns, purchased New Guards Group in August 2019, in a cash-and-stock transaction worth a staggering $675 million." With new approaches to marketing, fashion calendars, branding, and customer relationships, New Guards Group seems poised to continue to redefine what luxury is.

04. WFH and the Future of Offices

Is the office finished?

With varying degrees of COVID-19 containment, companies are experimenting with some workers returning to work in person at offices. There will likely be a hybrid office/ work from home (WFH) approach going forward, according to this Economist article that ponders the long-term impact of the extended WFH experiment. "This era holds promise but also brings threats, not least to companies' cultures. Instead of resisting change, governments need to update antiquated employment laws and begin reimagining city centres." There is clear demand from workers for more flexible schedules, and over the last six+ months the "bureaucratic hurdles to remote work have been blasted out of the way." In figuring out the right way to work in the future, there are many competing interests: corporate culture, healthy work/ life balances, the theoretical existential threat to commercial real estate, city economies, etc. Those businesses that manage this transition best will likely build competitive advantages around employment (is this the right or wrong approach?).

Netflix's Reed Hastings Deems Remote Work 'a Pure Negative'

One executive who isn't a fan of WFH is Netflix co-CEO Reed Hastings, who is on a bit of a media tour to promote his book, No Rules Rules: Netflix and the Culture of Reinvention. "I don't see any positives" in WFH, Hastings says in this WSJ interview. "Not being able to get together in person, particularly internationally, is a pure negative." Hastings does see some evolution of the workplace, though: "If I had to guess, the five-day workweek will become four days in the office while one day is virtual from home. I'd bet that's where a lot of companies end up," he says, though only time will tell whether the prediction turns out to be true. For more on Hastings' thoughts on WFH and corporate culture (which he sees as opposed), see this NYT article and this Economist article.

Generation Work-From-Home May Never Recover

Anybody working from home can immediately tell you about its pros and cons. As time away from offices drags on, the downsides of WFH are becoming more clear. Specifically, the physical workplace served as a cultural engine for a firm and a social place for workers. With these gone, both companies and workers are left scratching their heads as to how to move forward. This article from The Atlantic looks at some of the negatives associated with WFH, comparing issues new graduates face to ones encountered by those entering the workforce around the 2008 recession. "Those who were just starting out during the financial cataclysm of 2008 and the recession that followed have had their fortunes stunted by it, and many will never recover," it says. "For recent graduates beginning work via Zoom in the twin chaos of a pandemic and a financial crisis, the impact could be even more profound. The negatives are not only a result of limited opportunity in terms of employment, but also the crucial social element: "Workplaces are complex social ecosystems just like all other places humans inhabit, and decentralizing them can obliterate the things that make them satisfying." This could be why Hastings sees employees returning to work 80% of the time – while perhaps not true for all employees, the allure of the office is real.


 

Disclaimer: To the extent that Beach Reads discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. The companies and or securities referenced and discussed do not constitute an offer nor recommendation to buy, sell or hold such security, and the information may not be current. The companies identified and described do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the companies identified was or will be profitable. Beach Reads does not constitute a recommendation or a statement of opinion, or a report of either of those things and does not, and is not intended, to take into account the particular investment objectives, financial conditions, or needs of individual clients.

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