Invest Like the Best with Patrick O'Shaughnessy
· Patrick O'Shaughnessy, Mitchell Green
[00:00:00] S0: I want to talk about the price you're willing to pay for companies and how you would plot yourself on the – so much of this sounds like a private equity strategy, but you mentioned Toast and it's not like the high growth rate. [00:00:00] S1: Toast was $25 million of revenue growing 150% a year. And it was – we paid like $500 million, it was 20 times revenue. People were like, that's crazy. Not when it went from $10 to $25. So we just try to build a forward model and you're like – look, you can pay as high a price as you want. You just gotta be right on your exits. You gotta be right on your multiple. How people got in a bunch of trouble in 2020 and 2021, and I think how they're going to get in trouble today on all this AI stuff, is they just assume the exit multiple is 20 to 25 times. That's insanity because when your exit multiple collapses – you can pay 20 or 25 times revenues, and if you're right, like some of our companies have been, then it's fantastic. But you can also be wrong like some of our companies have been and you look like an idiot. I think investing in OpenAI at $800 billion is a little insane personally, but I don't know. If it goes on to do a trillion dollars of earnings, yeah, I’m going to be very wrong, I should have invested. It's almost like shorthand where if you're like, "If this company grows and doesn't decel much for 18 months, am I in the money and can I make a decent return for what I'm paying?" And if the answer is, "Oh, am I even in the money in 18 months or 24 months? Yeah, you're paying way too high a price."
· Mitchell Green, Patrick O'Shaughnessy
[00:00:00] S1: Toast was $25 million of revenue growing 150% a year. And it was – we paid like $500 million, it was 20 times revenue. People were like, that's crazy. Not when it went from $10 to $25. So we just try to build a forward model and you're like – look, you can pay as high a price as you want. You just gotta be right on your exits. You gotta be right on your multiple. How people got in a bunch of trouble in 2020 and 2021, and I think how they're going to get in trouble today on all this AI stuff, is they just assume the exit multiple is 20 to 25 times. That's insanity because when your exit multiple collapses – you can pay 20 or 25 times revenues, and if you're right, like some of our companies have been, then it's fantastic. But you can also be wrong like some of our companies have been and you look like an idiot. I think investing in OpenAI at $800 billion is a little insane personally, but I don't know. If it goes on to do a trillion dollars of earnings, yeah, I’m going to be very wrong, I should have invested. It's almost like shorthand where if you're like, "If this company grows and doesn't decel much for 18 months, am I in the money and can I make a decent return for what I'm paying?" And if the answer is, "Oh, am I even in the money in 18 months or 24 months? Yeah, you're paying way too high a price." [00:00:00] S0: So right now there's this seismic thing. You can look at the Constellation Software stock price or something as the perfect visual indicator of what's been going on. [00:00:00] S1: Looks like a ski slope.
· Mitchell Green, Patrick O'Shaughnessy
[00:00:00] S1: Looks like a ski slope. [00:00:00] S0: Which is this intense skepticism of the market, that boring traditional high-growth margin software businesses are worth much at all. But I'm curious how you process this moment, where I'm sure a lot of the companies you're looking at are software companies that have a lot of the components that make people fearful of those similar kinds of companies in public markets.
· Mitchell Green
[00:00:00] S1: Our belief, for right or wrong, is that the competitive advantage of a software company has never been about R&D. We're not building semiconductor chips. We're not building biotech and pharma companies. This isn't that. It's to build like Chamber of Commerce software. You too could build this. My mother couldn't, but my brother could. No problem. He's an engineer. So could Microsoft. Any of our companies in our portfolio, if Microsoft took 500 people and gave them a month, each one of our companies could be out of business, but they just don't care about the Chamber of Commerce market. They don't care about the price optimization market for manufacturing companies. They don't care about the tax software market for a very specific niche product. So the software companies are really about distribution, sales and marketing, customer success, client services. We believe that it is the incumbent's game to lose in software today. I'll give you a couple examples. Workday has like 98 or 99% gross dollar retention. It grows 10 to 15% a year. Oh, it only grows 10% a year. I'm sorry, it's like $10 billion of revenue. It only took like 20 years to get there and it does like $3 billion of free cash flow. Exxon or your hospital system or Warburg Pincus or KKR or Procter & Gamble probably spent 3 to 5 years implementing the software. If you think they're going to like start building their own HR software, you're outta your mind. Now the GUI and how you access it is gonna be far different, but actually, they already have the customer relationships. And the only reason they built it is because Dave Duffield and Aneel realized 20 years ago that Oracle and SAP had really crappy products. They have thousands of engineers that are trying to build the product much better and are gonna use Workday versus Mitchell Green's cousin vibe coding his way to build Workday. The flip side, why did Coupa get built? And the reason it was able to be built is SAP bought Ariba and they just left it for debt. So they built this big business, they took it public, and now it's been sold to Thoma Bravo. So what I actually worry about Thoma Bravo or any of these big private equity funds, if they're putting a bunch of debt on it – it's not growing that fast anymore if they're putting a bunch of debt on it, and then what they do is they bribe.
· Mitchell Green, Patrick O'Shaughnessy
They're like, oh yeah, we drive all our companies to rule of 50 businesses. Now, do they end up cutting a bunch of people in R&D and sales and marketing and product, that if you were being run by an entrepreneur with no leverage, you would've kept. And now, I worry that a bunch of these private equity owned assets that are overleveraged are ripe for disruption, versus independent software companies that are focused on growth, that are trying to innovate. And I like to remind people that if you look at e-commerce in '99 and 2000, everybody thought every big box retailer was going out business. But if you look at the top 50 largest e-commerce companies in the United States, Amazon is number one. 2 through 10 are Walmart, Home Depot, Lowe's, Macy's, Target. I mean, Saks is a crappy company. Their online business is actually pretty good. Neiman Marcus, same thing. A lot of the incumbents will win. Now again, Montgomery Ward, Kmart, Sears went bust, they were either overlevered, didn't innovate. So for us, that's what we're constantly thinking about. [00:00:00] S0: Does that mean that right now feels like an especially opportune time for your style because entry multiples are lower? [00:00:00] S1: I think the best risk-adjusted returns right now are in public software names. By the way, Warren Buffett says buy when everybody is fearful and sell when everybody's super excited. [00:00:00] S0: Blood in the streets, yeah.
· Patrick O'Shaughnessy, Mitchell Green
[00:00:00] S0: Blood in the streets, yeah. [00:00:00] S1: People hate software. When we bought a bunch of our ByteDance stock 2 years ago when everybody hated China. I mean, Alibaba's doubled off its lows and doesn't grow and trades at 15 times earnings. [00:00:00] S0: If you think about the CV, very specialist type buys that you'll do, can you explain an example of one of those?