00:33:43 · Dean Pernas
[00:33:43] S2: Sure. It's it's same thing as what causes CEOs to miss inflections. It's it's very difficult. Some inflections can be very obvious, like the Internet or AI, but some inflections could just be due to just a a confluence of factors that's very hard to kinda get get a get a grasp on. Kind of what Andy Grove alluded to in Only the Paranoid Survive. One example was Endor, for instance. We can we can also jump into that one, right now with with Endor. So Endor was a company that essentially created the sim racing industry. It was led by founder and CEO, Thomas Jackermeier, created in 1997. And they spearheaded this industry, and and, they absolutely crushed it for twenty years. And then COVID came, and demand just went up six, seven x. So sim racing equipment's essentially high fidelity racing equipment that people have indoors. And because of COVID, demand demand inflected. However, they were much the victim of their own success, kinda like kinda like Peloton. Essentially, it went from being just a niche, Cimaras equipment to now having to service way more customers, and their operations couldn't... Couldn't handle that. And the CEO just had a a different lens on. He wasn't he wasn't an operator that could handle that much to me. He was more of a marketer and engineer for very high fidelity equipment. And just... It was... You could see it on the customer service boards. You could see it on red... Reddit forms. People were just extremely upset that there were delays of several months for for their equipment. And when they finally got it, it was it was mixed. And there's just a lot of negative goodwill being being being... Or negative goodwill increasing. And anytime there were investors asking these questions on earnings calls, he essentially just... It was like an ostrich in the sand type of approach. He kinda kept pushing back. Like, no. It's not really that big of a deal. Customers are still gonna want Fanatec. We created this we created this brand. And he... Yeah. It was just very, very almost dictatorial with it. And the second thing that occurred was Chinese competitors came into the mix. So before, it was like, hey. This is a real high fidelity engineering equipment. Chinese competitors can't enter. Like, this takes years to to master and to create.
00:35:52 · Dean Pernas, Mikk
All of a sudden, Moza, a Chinese competitor called Moza, started making very high fidelity equipment. And, essentially, they just started... Customers started going to them. They were getting locked in their ecosystems. And, yeah, it was... It went from... Like, for instance, Fanatec, it went from them not having enough chips to them having, warehouse issues to ERP implementation. Like, everything was just everything was just screwed up. And he hired a CEO, got rid of him, hired another CEO. So it seems like he was just a very... He just wasn't adaptable to the times. You need someone... You need a CEO that's that's extremely adaptable, knows when to have a different lens with the company due to the problems it's facing than than before and, yeah, willing to just... To to to change. And so having that having that kind of... Having that mindset ultimately led to the company going bankrupt when it essentially created the industry and had the most beneficial environment that it could ever have. [00:36:48] S0: Talking about the management team, CEOs, what comes to mind when I say the word incentives?
00:36:48 · Mikk, Deiya Pernas
[00:36:48] S0: Talking about the management team, CEOs, what comes to mind when I say the word incentives? [00:36:56] S1: Yeah. I think that what comes to mind immediately is how are they incentivized both on short term incentives and long term incentives. Usually, what's standard for mature companies is some sort of EBITDA or you know, maybe mix of EBITDA, revenue growth or something like that in the short term, you know, just like to pay little cash bugs at the end of the year, then you have long term incentives, which are usually tied to maybe stock price, appreciate... Total shareholder return or something something in that nature. What we like what we like to see is something we rarely see when you have a combination of different metrics on the short term side of things. And we do like to see total shareholder return as a long term kind of metrics for their long term, you know, equity plans, you know, for their for their grants, you know, for for... From when it gets granted to when it gets, you know, our investment and so on. So, yeah, for us, when we think incentives, we think how the management team is... What their incentive structure is like for short term for the short term and long term. [00:38:05] S0: And which structure structure scares you when you see that?
00:38:08 · Deiya Pernas
[00:38:08] S1: I don't know. I... EBITDA is one where if they're just focused on EBITDA... Like, own a company right now. I'm not gonna say the name of it. Oh, well, didn't say the name of it. It's Paysafe. It's company's trading at very low valuations. And all they have to do is pay down debt and it's gonna be a home run. The company has stated, they've declared that they're gonna get down to, I think it's around 3x EBITDA or 3.5 or something like that in a period of you know, a low period of over two years. And they, but they have stated intentions of what levels of debt they're paying down, but their short term incentive plan is tied to EBITDA. So, you know, a lot of times a management team may not have incentive to pay down debt, because it doesn't really do anything for EBITDA. And maybe the capital they're using to pay down debt, they could use to make an acquisition or they could use to make some sort of investment that isn't that great in order to kind of grow EBITDA. So there's a tension there between what we want the company to do, what they say they're gonna do, and how they're how they're getting paid on the short term. Even though paying down debt is definitely the right move for this company. It is... If you're focused on, again, increasing intrinsic value relative to per share price, you're gonna be focused on paying down debt because the company's overleveraged. You want them to maintain flexibility in certain environments. It improves their ability to kinda survive and grow share going forward. But, Dean, I I don't know if you have anything else to add on incentive comp or what comes
00:39:43 · Dean Pernas, Mikk
[00:39:43] S2: I would just say incentives aren't really a panacea for management making good decisions. Like, you can't be like, oh, because they're well incented, they are going to make the right strategic decisions for this company. Endo, for instance, the CEO owned 40% of the company. Like, he was as well incentivized as anybody on the planet, and yet he made just horrible decisions. And so, yeah, you can be incented to kingdom come, but but that still won't save you. Unless it's truly egregious, it's it's really not a a huge signal. It's like... As long as a comp has has got some share... Shares, some owner... Some some options, and there's some key KPIs there, total shareholder return, As long as it's in that ballpark, it's... You can have an entire range of combinations, and it's it's okay. [00:40:27] S0: Now I also read that you guys pay unusual attention to working capital. Why is that?
00:40:27 · Mikk, Dean Pernas
[00:40:27] S0: Now I also read that you guys pay unusual attention to working capital. Why is that? [00:40:34] S2: Yeah. So working capital is... It's it's vital in two in two different scenarios, and the other one's not so much. It's it's one's small companies that are growing very quickly that don't really have access to the credit markets, and so they have to rely on their own cash flows to to kinda survive. An auction is is or cash flow is like auction for those companies, especially for very small ones. So, essentially, a small company is growing very rapidly. They have to take all their free cash flow they generated and then plug it into working capital to support future revenue growth. And so if there's any type of hiccup in demand, they run out of cash very quickly. And then number two, it's for companies that have a lot of working capital needs relative to the revenue of the business, and working capital needs are going to change due to some step change. So it could be COVID, for instance, the supply chains... Because supply chains got disrupted. All of sudden, retailers needed to have two x as much inventory on hand as they did before. And so all of a sudden, they need to plug that up with cash because they require more inventory days on hand. And so those are the two instances in which it's pressing to care about working capital. [00:41:46] S0: Deiya, you learned bankroll management from poker. Could you could you talk more about the lessons and using this while analyzing those businesses today?