00:21:23 · Brian Neider, CJ Gustafson
It's not to say that every time you do that, it's gonna work, and it's not to say that there can't be outliers on either end. So you can have a situation where you have a company. It's the best company you've ever seen. The valuation feels insane and nuts, but it just works. It just keeps getting better. But on the whole, probably it'll be difficult. You know, you could have difficult situations, of junky companies that might be unbelievable investments. So you can have, like, an f minus company. Let's say an f minus house. You could have a house on that block that you love where it's totally dilapidated. Nobody's lived in the house for a really long time. It's just completely run down. But you're willing to do the work. You're willing to do the remodeling, and now all of sudden it could be pretty compelling. And so in that case, maybe I have sort of like an f minus asset, but you're getting in an a plus price and you're willing to sort of do that because that's the type of investment that you're looking for. And so really what it is is it's a framing of what is generally the quality bar that you wanna get over in terms of the quality of the company that you might be evaluating, and then where does that need to intersect from a value standpoint to get you excited? [00:22:33] S1: Which of those two offsetting scenarios where you may have really good on one side, really bad on the other? Are investors or even yourself more willing to get into bed with and take a chance on?
00:22:33 · CJ Gustafson, Brian Neider
[00:22:33] S1: Which of those two offsetting scenarios where you may have really good on one side, really bad on the other? Are investors or even yourself more willing to get into bed with and take a chance on? [00:22:46] S0: Completely depends upon the investment firm and their mandate. I would say more often than not in the growth equity ecosystem, you're gonna see funds that are willing to take on really high quality businesses and just pay up for them. I think that if you go into, like, the industrials ecosystem or, you know, you look at some of the buyouts that were done in, the nineteen eighties and, you know, businesses like that, you're gonna see a lot of interest in doing deals that are... There's a lot of hair on the asset. There's a lot of problems with it. But, man, there could be some excellent underlying value there. And then, you know, imagine you could throw some leverage on it. You could make some really, you know, exciting returns. [00:23:25] S1: How has your own definition of expensive changed over the last fifteen years?
00:23:25 · CJ Gustafson, Brian Neider
[00:23:25] S1: How has your own definition of expensive changed over the last fifteen years? [00:23:29] S0: It's hard. I think that we've maintained relative consistency, but it vacillates. Right? There's points in time, like, you look at how the market's traded, where, you know, the multiples were for SaaS companies in 2020 or 2021 relative to where they might be today. There are periods of time where things get really expensive all at one time and then get really cheap all at one time, and you have to have some opinion as to where you are on the continuum to be, you know, ultimately investing. But for us, I think we've been relatively consistent underwriting an investment opportunity. You could pay a lot higher price if you're gonna assume that on the back end five years from now when you're exiting the investment, you're gonna exit at 25 times revenues or something like that. If you keep it consistent and, you know, no matter what the market looks like, you're kind of underwriting to a six, seven times outcome because that's what it's always been. You feel comfortable that that's where it's gonna be in the future. I'm not making any proclamations in that regard, but if you felt that way, you might have a more consistent underwriting framework and a more consistent view on value.
00:24:32 · CJ Gustafson
[00:24:32] S1: Brian, we have this friend of the show. Their names are and they do some amazing stuff on the audit and consulting side, and they encourage me to ask better questions. So I'm gonna try to ask a better question here. This one, I don't know if this one will get by the auditor. So I actually consider myself somewhat of an EBITDA historian. Maybe you could even say an archaeologist. I run around the house wearing my Indiana Jones hat. You had written about this one company that was simultaneously a 58,000,000 cash EBITDA business, also a $38,000,000 EBITDA business, and arguably a 25,000,000 business after capitalized expenses. How should an investor decide what to take here and what's real?
00:25:15 · Brian Neider
[00:25:15] S0: That is a really good, and I've gotta tell you a very, very difficult question to answer. So I have my own beliefs, which is you sort of wanna look at the EBITDA minus any legitimate add backs to get to some type of adjustment, and then you want to subtract out some of the capitalized expenditure... You know, capital expenditures to the extent that you think it's warranted. I do think that a lot of investors want to suspend disbelief to some regard, and it allows them to kind of jam things through their investment committees. So it's funny, like I've I've talked to friends who, you know, very large firms in many cases, when they talk about these businesses, it's like you spend a bunch of time talking about the merits of the business, but you're not really getting into the weeds on it. And what you're doing is you're relying on evaluation relative to an EBITDA multiple, but the EBITDA like isn't real. It's just sort of a made up number. And I think a lot of times, especially at firms where younger investors are trying to push things through, I think that it's often easier for them to like use a bigger number and it just looks better, it looks cheaper, it looks more reasonable. But to me, part of this is like, you know, you have to be reasonable about it. You have to understand and pick through all of the adjustments. You have to understand really where the cash is actually going. And that's the funny thing. You know? I I can't tell you how many companies we look at that are not actually levered because, you know, once a company's levered, then you've got situations where you have significant interest expenses, and you gotta really understand what's going on there underneath the EBITDA line. But I see a lot of companies that are not levered, and they had significantly positive EBITDA metrics for, like, years, but they've never produced a dollar of cash. Like, you look at the balance and it like never grows, and they've never issued a dividend. And so there's some of that... It's sort of like tied up or eaten up in working capital or whatever it might be. Over some period of time, it just... It's like wonky accounting, And you've got to say to yourself, like, what is actually going on here? And those are the most frustrating ones to me.
00:27:20 · Brian Neider, CJ Gustafson
So, ultimately, like, what we end up doing oftentimes to almost normalize it is we're looking at some type of EBITDA multiple in the way in which we might define it, which would include some light adjustments based upon things that we feel are reasonable, specifically calling those out. In many cases, I'm doing some type of EBITDA minus CapEx orientation. That's one. But at the same time, we're actually gonna look at the revenue multiple because a lot of these businesses, they look somewhat similar. You could get your arms around them. And if you're looking at both, that's a good thing to be doing. And what we see a lot of is, you know, people just throw out numbers. Oh, this should be valued at 20 times EBITDA. Okay. Well, like, that's great, but it's very different if the business is a 40% EBITDA margin business that's not growing versus a 20% EBITDA margin business that's growing 40% a year, is EBITDA even the right metric to be looking at? So we try to look at both revenue and EBITDA, and in some cases, even gross profit just to get our orientation or bearings about us. [00:28:20] S1: How do you decide if a company trades off a revenue multiple versus an EBITDA multiple?