Gavin Baker’s Software Contracts, First-Lien Debt And Reality

During their recent episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle discussed Gavin Baker’s Software Contracts, First-Lien Debt And Reality. Here’s an excerpt from the episode:

Tobias Carlisle:
Are we going to see more indiscriminate selling when people see dark clouds again, or are the cheap businesses just going to be the worst ones? I guess that’s a question, like the first time around, Value got smashed up more or less than anything else. I mean, just the deep value stuff, the stuff that I like, rather than the intrinsic value type stuff. DCF has been dumped.

Jake Taylor:
Generic value partners.

Tobias Carlisle:
Where does generic value partners fall? Because I feel like I’ve picked up a lot of generic value partners now.

Bill Brewster:
Probably in the middle.

Tobias Carlisle:
It’s a little bit more deep value these days. I guess…

Jake Taylor:
Generic value partners?

Tobias Carlisle:
Berkshire, Bank of America, Markel, I think-

Jake Taylor:
I was thinking [inaudible 00:54:37] a little bit and FANG still.

Tobias Carlisle:
I think if it’s in my portfolio, it’s the junky, cheap stuff. That’s not true.

Jake Taylor:
Shopify.

Tobias Carlisle:
Undiscovered quality.

Bill Brewster:
Oh my God, that thing has just gone nuts.

Tobias Carlisle:
What’s it like, 80 times earnings? 80 times sales earnings.

Jake Taylor:
[inaudible 00:54:55] not earnings.

Bill Brewster:
December 2018, and I was like, it’s a little rich. Here it is up 4.5, five times?

Tobias Carlisle:
Putting your ass where your mouth is, phrasing-

Jake Taylor:
I know.

Tobias Carlisle:
I guess the question is what happens in this next downdraft? Who knows? If there’s another downdraft, that’s one question.

Bill Brewster:
I’ll tell you what happens. I would lay odds on this, big time, I would lay odds on this. People right now, there are some of these big tech companies, for instance, I think Microsoft is truly actually insulated. Now, to the extent that businesses close, you’re going to lose licenses, but that is systems of record type stuff. Some of these names, I don’t know which ones, if I did, I’d be short them. People are going to realize, this actually was not that essential of a product, or it actually does depend on sales.

Bill Brewster:
Gavin Baker’s written about this in Medium. Some of these names are going to get slaughtered. Minion Capital is writing about how he thinks some of these things are overvalued. You got Sharp Money saying that there’s going to be some pain in some of these names. I think that’s probably where you see the next leg of a lot of pain.

Jake Taylor:
Some of these did not show increasing returns on like you would expect of a good tech economies of scale type of business.

Tobias Carlisle:
How are you measuring that?

Jake Taylor:
Just like unit economics. Look at something like Grubhub or Uber even, I think, these are not-

Tobias Carlisle:
[inaudible 00:56:35]

Jake Taylor:
Well, I know, I’m just saying representative sampling of you don’t get the same type of economics and the scale that… I think that it was just a good story that is called tech even though there’s not really that much tech there, I don’t think.

Tobias Carlisle:
There’s clearly [crosstalk 00:56:55] Microsoft-

Bill Brewster:
My beloved Splunk gets destroyed. I lost $4,000 whole dollars on that thing.

Tobias Carlisle:
I’ve been short that dog in the past.

Jake Taylor:
You gave your money to Toby.

Bill Brewster:
I don’t care. Good. I’m glad somebody that was just everything got it.

Tobias Carlisle:
I’d probably trade it at… Probably we didn’t overlap, but I think we probably both got it wrong. We should probably swap positions.

Jake Taylor:
But you guys are Eskimo brothers.

Bill Brewster:
Oh God, that’s too far.

Tobias Carlisle:
There’s definitely different types of… I would make a… In my mind there’s a pretty big distinction between Microsoft and Netflix, and there’s a big distinction between Google and I think Facebook too. Facebook went away. If Google goes away, that is a bit of damage to my… That’s a big damage to my private life and my business life mostly. If Microsoft goes away, that’s huge damage to my business life in my private life. Netflix goes away, I’ll watch something else.

Tobias Carlisle:
I think that I make a big distinction between… There’s some names out there that I think are genuine like JT and I discussed. This is mostly JT’s idea, I’m just adopting it. But there are businesses out there that are woven into the fabric of life that you cannot, you just cannot extricate them without… You can’t copy them, you can’t compete with them, you can’t extricate them from life. There are other ones if they go away, it might be like, that’s annoying, but who cares?

Tobias Carlisle:
I think you got to make the distinction between, tech’s not a monolith. There are some things in there that are really incredibly valuable. Just too expensive for [inaudible 00:58:34] like me.

Bill Brewster:
I think what value guys in general may underestimate is the amount that some of these companies are overstaffed for growth and how much that flows through the income statement and how that hits your cash flow statement today, versus finance capex in the past. There’s a lot of adjustments and there’s a lot of art when you have to value growth. But I think where some growth people are probably going to get slapped in the face is they’re going to find out that what they thought was an essential service is actually just something that’s frivolous. When the economy is great. You can buy a lot of it and then when push comes to shove, it actually doesn’t matter all that much.

Jake Taylor:
There’s more cyclicality in this secular trend, I think.

Bill Brewster:
Well, and Gavin’s point, Gavin Baker’s point was a lot of people, their brain is thinking, okay, well, software doesn’t get cut. Well, that heuristic was true when software was 9% of IT spend. But now when you combine software and the cloud, it’s something like I think he may have said even up to 50%, I might be wrong. Let’s call it 30%. You start to cut real fat at that point.

Bill Brewster:
If your IT department needs to cut real cost, maybe in the past, it was on premise software, or servers that maybe you differ. Today you look at your software budget, it might be there.

Tobias Carlisle:
We’re coming up on time, fellas. I got one last question for you, where do you put Twitter in that bucket?

Bill Brewster:
Crack; absolutely essential and too cheap. I don’t own it, but I should.

Tobias Carlisle:
Well, now Elliott’s in that too. It’s Elliott, right?

Bill Brewster:
It’s an interesting asset. It’s a very interesting asset.

Tobias Carlisle:
If it gets run for money, if it gets run as a financial, it’s interesting what happens there.

Bill Brewster:
Dude, you live online, man.

Tobias Carlisle:
Because I do think it’s a better social network than Facebook or maybe not Instagram but TikTok because it’s hard to use. Once you’ve locked into it, it’s hard to get out, too.

Bill Brewster:
The problem is… Scott Galloway put it a very good way, Twitter sells to your brain and that’s harder to monetize than selling to your heart and you’re penis.

Tobias Carlisle:
You can’t just stick ads in there?

Bill Brewster:
I think you can, but lust is a much more… You can monetize it better than you can your head.

Jake Taylor:
It’s pictures versus letters. When are you going to move your little chimp brain to want to buy things? It’s like status stuff, not like whoa, that idea blew my mind.

Tobias Carlisle:
Instagram has great ads. I don’t mind getting the ads on Instagram.

Bill Brewster:
Many of [inaudible 01:01:21]

Tobias Carlisle:
Why can’t Twitter figure that out?

Bill Brewster:
Well, I think my man Elliot Turner would tell you that they’re working on their stack right now and that they’re going to.

Tobias Carlisle:
What have they been doing for the last decade?

Bill Brewster:
Messing around, I think. Here’s the other thing, I guess you could argue you have a duty to your shareholders and I would buy that argument. But if you’re Jack Dorsey, why do you care? You’re worth a billion dollars, all your employees are super happy. Your platform is growing like crazy. What’s your incentive to change it?

Jake Taylor:
Some hedge fund guy with his foot up your ass, I don’t know.

Bill Brewster:
Yeah, well, maybe now the incentive exists.

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