Has The Internet Changed Value-Investing Forever?

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During his recent interview with Tobias, Marcelo Lima, managing member of Heller House, discusses whether software-as-a-service has changed value investing from what Warren Buffett had traditionally done? Here’s an excerpt from the interview:

Tobias Carlisle: How do you make the leap to value investment from there?

Marcelo Lima: Yeah, great question. When I was in the real estate finance job, so I… long story, I was trying to raise money for a consumer products company that I had started on the side with a friend, and I was trying to raise money for it. And I came across this real estate investor who was doing tremendously well and he said, “Hey, come work with us. It’s a great opportunity.” And that’s when I jumped into real estate finance. While on the first month on the job, I read Warren Buffett’s biography. And-

Tobias Carlisle: The Lowenstein one?

Marcelo Lima: Exactly. And completely fell in love with this idea that you could invest in different businesses. You didn’t have to be tied to software or consumer products, or real estate, and that you could analyze things and pull the trigger when it made the most sense to do so. I just became a huge Buffett fanatic and learned everything I could about first Ben Graham and then Buffett read all of his letters and started going to Omaha and attending the value investing congress, et cetera.

Marcelo Lima: In a way, that was a very positive experience obviously because you learn a lot. In another way if you look at it, if you invert it, it also, I think, crystallizes in your brain a way of thinking that sometimes is hard to break, right? So I’ll give you an example. I saw, and this is something we’ll get into later perhaps, but I saw more than one short pitch for… on salesforce.com, at the Value Investing Congress. Famous investor goes on stage, says, “This company’s dramatically overvalued. Look, they’re losing money. This makes no sense. It’s a short.” And of course now we know that was incredibly wrong.

Marcelo Lima: But all of us were nodding and saying, “Wow, yes, of course, this thesis, this guy is so smart, this thesis is airtight, makes a lot of sense.” But we were fundamentally misunderstanding the change that came about with the rise of the internet and the delivery of software as a service. So that is all to say that being in this crowd of value investors and going to Omaha and listening to Buffett is a great education, but it can also perhaps prevent you from having a more open mind and embracing something that’s new.

Tobias Carlisle: Buffett’s own style though has always been more towards finding something that compounds and finding something that’s at a very high return on invested capital sustainably. And then you look at the growth of that over an extended period of time and try and buy that at a meaningful discount that you get a margin of safety. What has software as a service changed to what Buffett had traditionally done?

Marcelo Lima: Well, I wouldn’t say that it’s software as a service. I would say it’s the internet. The internet has created a world where all of a sudden you have something that never existed pre-internet, which is zero marginal costs. So I can create a product and let’s say in the pre-internet world, let’s say I am Procter & Gamble and I create a do type of detergent. I control distribution, so because I’m Procter & Gamble, I have my distributors, I have the slots in the supermarkets and I can… I own some shelf space. I own perhaps the end caps and I can place that new detergent.

Marcelo Lima: I can advertise it on television, and just for the purposes of this discussion, let’s be very extreme to make a point. And let’s go back to the 1950s. There’s three T.V. channels, call it, right? And so I can advertise, I have primetime advertising spots. I control all of them because they’re all… there’s only three channels. And I also advertise on radio, I advertise in print and the customer will go the shop, go to the supermarket, buy the product, have that brand recognition and go home, and rinse and repeat. And so the cycle continues.

Marcelo Lima: Now imagine all of a sudden the internet happens, right? And we have an explosion in the number of channels available. In fact, the whole concept of channels disappears when you have YouTube, and Facebook, and Instagram, and Twitter, et cetera. The barriers to advertising are no longer there. Again, the concept of primetime advertising to a large extent disappears. A lot of it is programmatic on Facebook and Instagram, et cetera. And the game becomes one.

Marcelo Lima: And now you have of course, this theme of software consuming more and more of what we… of the goods and services that we consume, right? So software is eating the world as Marc Andreessen says, and software can be delivered at zero marginal cost. Now, a company that has… let’s pick on Proctor & Gamble again and Procter & Gamble is a great business. I’m just contrasting it with this new world. The skills that Procter & Gamble has to, in terms of controlling distribution in the slots at the supermarket are less and less relevant or valuable perhaps in this new world.

Marcelo Lima: Again, if you e-commerce, right? You have infinite shelf space or practically infinite shelf space, and so the winner isn’t necessarily the incumbent. Business dramatically changed with the advent of the internet and it’s created a lot of dislocation and disruption is a very overused term, but it created a lot of disruption of incumbent businesses. And so I think that that’s what really changed. And it’s not something that Buffett was really onto until very recently.

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