(Ep.76) The Acquirers Podcast: Mike Puangmalai – Dark Arts, Corporate Governance, Activism, And Tech With NonGAAP

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In this episode of The Acquirers Podcast Tobias chats with Mike Puangmalai, owner of The NonGaap Newsletter, and master in the dark arts of corporate governance. During the interview Mike provided some great insights into:

  • The Dark Arts Of Corporate Governance
  • Ben Horowitz Avoided An Options Backdating Scandal
  • Corporate Governance And Picasso’s Turpentine Effect
  • Companies Will “Spring Load” And “Bullet Dodge” Equity Grants To Benefit Insiders
  • Sexing Chicks And World War 2 Spotting
  • J. Crew, TPG Co-CEO Jim Coulter, and TPG’s Infamous Takeout
  • Stamps.com And One Of The Greatest (Alleged) “Bullet Dodge” Grants Ever Seen
  • “How To” Read A Proxy & Examining GreenSky’s Equity Grant Practices
  • No One’s Going To Grant Equity Into A Falling Knife
  • How DoorDash’s Breakthrough Unit Economics May Break The Company
  • Gig Economy Companies – Fake It Till You Make It

References In This Episode

Profiting from Corp Governance “Dark Arts”: Part 1

Profiting from Corp Governance “Dark Arts”: Part 2

Profiting from Corp Governance “Dark Arts”: Part 3

Profiting from Corp Governance “Dark Arts”: Part 4

The (Vax)Art of Well-Timed Insider Transactions

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Full Transcript

Tobias: Hi, I’m Tobias Carlisle. This is The Acquirers Podcast. My special guest today is Mike Puangmalai. He writes Non-GAAP, the newsletter, great Twitter account. He’s a master in the dark arts of corporate governance, comes from a background in activism. Now doing some software engineering development. I’m going to talk to him about what the nexus is between tech and finance right after this.

Hi Mike, how are you?

Mike: I’m pretty good. How are you doing?

Tobias: I’m really well, thanks. In full disclosure, we spent 20 minutes chatting, I didn’t record it. We’re going to have to get you to take 2. I know a little bit more about your background now. So, let me guide the conversation a little bit. You went to USC for your undergrad?

Mike: I did. I went to USC, studied international relations and international business. Sounds fancy, but it was really just a great excuse to spend a lot of time overseas studying abroad. Had a great time there. Unfortunately, I skipped out on all the traditional recruiting. So, came back without a job. I’ve arguably been meandering ever since.

Tobias: You were in government for a little while. How do you describe it?

Mike: When I came back, I originally was going to go back overseas to Thailand for a job but that got rescinded because of a government coup, which is its own interesting story. So, ended up actually doing one of my other passions, which was social enterprise and nonprofit. Spent a bunch of time, working on charter schools and trying to build businesses that also have social missions.

Today, that’s pretty hot, and it’s pretty on-trend, whatever that means. But back then, there weren’t many people working on that sort of stuff. It was really cool, learned a lot. The world of nonprofit is just as interesting, arguably cutthroat in their own way, especially when it comes to fundraising, as the corporate world. So, actually learned a lot more from that power dynamic, decision-making framework than even I expected at the time. Did that for about a year. As everyone who gets into investing seems to do, they all read about Warren Buffett and the lightbulb turns on and you decide you want to be an investor.

Me being as naive as I was at that age, I thought I could just go from nonprofit to investing straightaway. So, I quit and then ended up doing a lot of door-knocking and cold emails until I forced this fund in Pasadena, First Wilshire Securities, to give me an interview. Somehow, someway, they gave me a job, and I was a deep value, small-cap analyst intern for about six months or so.

Tobias: And what era, vintage is that?

Mike: Oh, this was the heart of small-cap value.

Tobias: It was just ripping.

Mike: Ripping. We’re talking 2005-2006, where I think anyone and their mom had a hedge fund, and all the hedge funds had just quirky, cool names. It’s funny because back then, small-cap deep value had a different meaning. Back then, in the early 2000s, you could find these unfollowed stocks that are– I mean they’re small, but they’re growing EPS 20% year over year and are trading single-digit P/E. Literally, you’re just looking around like, “Is this for real?” Obviously, that strategy worked for a long time. So, this was very much the heyday of that style and probably the most desired type of strategy, I think, at the time for the value cap.

Tobias: Yeah. Small-cap activism was just red hot. Everybody was a small-cap activist on the back of like– I think Dan Loeb writing the nasty letters which he says– or Robert Chapman said, he got it from him who was another LA-based guy at the time. But you’ve managed to transition from small-cap value into pretty big activism with Relational. How did that come about?

Mike: I think a recurring theme of my life and my career is, I don’t think anyone has actually hired me through the front door of anything. Any question around how did that happen, it was probably because I accidentally or serendipitously met someone who made an introduction and took a shot on me.

One of the more interesting random observations I’ve had in life is, when it comes to investing– my background’s all over the place. It’s kind of eclectic. It’s not one of those McKinsey, Bain, Goldman for a few years and MBA and just that pattern recognition of what you look for an analyst. I was all over the place. But what I’d learned is, I don’t know how they do it, some of the best investors in the world that I’ve interacted with just seem to know how to extract the pattern. They don’t need the pattern recognition per se, but they can suss out and pull out an interesting insight that maybe I didn’t even contemplate or I don’t assume someone would recognize, and then they’re able to build a view of, “Okay, this person is good for the job or not.”

And back then, you didn’t have much of a choice if you’re a PM. It wasn’t something you can call up a bunch of– Well, kinda you could call a bunch of headhunters. But back then, you still had to find talented people wherever they were. A PM’s ability to interview a candidate for me seems to align with their ability to figure out stocks, just as a random aside.

Tobias: Just for folks who don’t know, Relational closed down in about 2014-15, but they had raised some backing from CalPERS, were sort of contrast to many of the louder forms of activism at the time, more constructive behind the scenes. Probably more listed private equity rather than that just sell yourself or pay out the money or we’re going to embarrass you until you do the right thing. What was your experience at Relational? And is that a fair characterization of who they were?

Mike: You could probably break up Relational into different eras. They started in the mid-90s as part of a CalPERS initiative to get more governance-centric investing into the market, so they had their focus list, CalPERS did and they wanted to elevate that into a more productized investment-type strategy and they seeded a bunch of funds. Relational was one of them. So early on, a lot of the agenda and activism was event driven in the sense that– you’re talking mid-90s, there were a lot of companies that had the classic good business/bad business model. Literally, all the money was made in one business, all the losses were in another. Spin it off, stop it. Literally, very basic strategy, but they were all over the place. I would say a good chunk of Relational’s early years were tied to that kind of investing and agenda. They were probably more in your face back when they started, but over time, the strategy got arbed out. Even today, it’s not like you can find a company that has just this conglomerate discount where you do the–

Tobias: Oh, there are a few of us around. [chuckles] Mike: Well, there is, that’s true. I laugh because it’s a running joke like, don’t come in and pitch us some the parts discount to a fund, but Relational is probably one of the few places where you can get away with that because you were the catalyst. Actually, yeah, you can pitch that here because we’re going to be the ones that work with them to try to unlock that value. That was very much a traditional bread-and-butter-type strategy for a long time. But to complement that, we try to work with companies behind the scenes. Help them with their investor communications, how they convey the story to the street, how to think about capital allocation, all the good stuff that investors are looking for when it comes to management teams and discipline capital allocation. We try to work with them behind the scenes.

Tobias: Your note on Relational has these two nice charts in it that are very similar to something that Buffett has said in the past. Basically, there’s a return on invested capital and a growth rate that justify these valuation multiples. And if you’re sitting outside that optimal point on a structure, you shouldn’t be growing, and you should be trying to do something else. You should be trying to pay out some capital, sort of right size. Was that the way that Relational thought about those positions before they went in?

Mike: I think that’s a fair assessment. I think if you were to capture what is an overarching concept that we’re trying to think about, it’s that friction between growth and return. If you overoptimize return, you’re not properly investing in the company, you’re potentially killing your innovation pipeline which hurts you longer term. We don’t want you to do that. If you chase growth or if you over optimize your growth, you get into these highly dilutive transactions that destroy a lot of value. And suddenly, the market begins to assume– well, if you’re going to keep burning money and doing bad deals or chasing bad R&D projects, we’re just going to assume you’re going to do that projected out and apply a discount to that incremental capital allocation.

The friction is, what is the right balance there? I would say the market is generally pretty forgiving up to a certain extent, but if you start doing– if you’re an executive and you’re running your strategy, you’re trying to prioritize highest and best use of your capital, you can get away with risk. You absolutely can. And sometimes the market will actually forgive you on a few bad deals. But at a certain point, if you’re doing bad deals and there’s just not a proper framework in place to justify the risk you’re taking on, the valuation starts getting a pretty punitive multiple.

Our job, at least at Relational, was to go, “Listen, we’re not experts in what you’re doing and what you’re prioritizing. So, work with us, help us understand what you’re trying to do, and where we can be helpful is, we can help you communicate, how those priorities are important. Or on the other hand, we can also put together an investor communication program that helps the market understand what you’re trying to do.”

On the other end, if we try to figure out what’s going on, and we just recognize, “No, you’re just actually burning capital here. We’re going to insist that you stop,” or try to reassess how you want to do that. Otherwise, you’re taking the ownership’s perspective as a shareholder, we’ll see board representation. If we can’t figure it out from the outside, then maybe we can work together from the inside to come up with a cohesive plan.

The Dark Arts Of Corporate Governance

Tobias: You’ve got this great series, which we’re going to go through in a moment, on your blog about corporate governance and the dark arts of corporate governance. Is that the basis for that series? Is that where you learned about the dark arts of corporate governance?

Mike: It’s an interesting question. When I started at Relational back in 2006, I would say the first– at the time, I didn’t really enjoy it. I don’t think anyone enjoys reading a proxy. If they tell you they enjoy reading a proxy, they’re either lying to you or I haven’t met you, which is weird because I’m probably the only person that likes reading proxies at this point.

Tobias: There are a handful of folks. Once you read them and you start finding little tricks and traps, they start getting a little bit more interesting. But they’re hard to read cold, but that’s why I think your series is so good.

Mike: The first four years at Relational, I would probably say 80 plus percent of my time was reading proxies, going through governance, trying to understand incentive structures and doing comps, and doing all that. Now, in hindsight, that was a blessing. It was one of those things where it actually helped me as an investor longer term, but at the time when you’re 20 something years old, you’re starting your investing career, you want to build financial models, you want to value stuff. I want to build the Excel breakup model in this company, why am I looking at proxies?

To keep myself entertained– at some point, you’re going to go crazy reading a proxy. You’re right, if you’re reading a proxy just for the dryness, you’re going to go crazy. So eventually, you start to realize there’s a whole narrative behind what’s going on and what’s is expressed in those filings and in those governance documents, and it really doesn’t get hammered into until you actually go on to these boards.

At Relational when we go on a board, we have board representation but someone like me would be completely in charge of going through every board document that would be given to the director. To break down and do an analysis and to understand, from a board levels perspective, what are the priorities going on at these companies. As you understand organizationally how companies operate, and how they govern, you start to realize the intersection and the relationship between what you’re trying to prioritize as a business and how you want to allocate capital, and how that gets expressed in the incentive structures and governance. At least after four years of doing that, you begin to realize, “Oh, there’s a story to be told here.” There are subtle adjustments that people make when good news is on the way. There’s subtle adjustments you can make when bad news is on the way. There are subtle adjustments you can make to retain talent. There’s all sorts of different tips and tricks you can do.

What you learn is, as a board member, you can’t really do much to drive change in the organization. So, there are only so many levers you can use. But those levers are very powerful. They’re really powerful because you change an incentive structure on a management team, you’d be surprised how much change occurs within an organization. It just cascades down. It leaves me speechless sometimes, like, “Wait, you’re telling me if I just changed the compensation hurdle from, say, revenue growth to a blend of revenue growth and ROIC, that this is actually going to change your priorities in an organization?” The answer is, yes, it does. It’s remarkable.

Using those experiences and realizing that proxies are probably one of the last few places where your boards express their intent and management teams express who they are, it becomes a very interesting source of reading, but also a source of understanding what is the true story of this company.


Ben Horowitz Avoided An Options Backdating Scandal

Tobias: I love your approach to it where you say that reading these things is very dry but if you understand the dark arts, you understand why things are being done, that it does become much more interesting and you can dig through to find the story. You say that they’re dark arts because compensation can be used to distort the alignment of incentives and can be used to control what goes on in the company. You’ve got the great story about Ben Horowitz and the option backdating scandal. Do you want to tell that story?

Mike: Sure. I think one of the recurring themes you’ll come across when it comes to governance or even decision-making at the highest level– so I focus on governance because I find it interesting, but I think this is just decision-making in general at a lot of these companies. What you’ll find is, more often than not, you’ll come across a situation where the correct answer isn’t straightforward. It’s not black and white. You might even feel uncomfortable from a moral dilemma or ethical perspective. And more often than not, the pushback or the response you’re going to hear from someone is, “Well, this is best practice. This is standard practice. This was signed off by the lawyers, the advisors. X, Y, and Z peers do it.” And that makes it okay suddenly.

The Ben Horowitz story is basically– this is second hand because I’m just going off the blog he wrote, but he talks about a time when he brings in new leadership and from a competitive retention perspective, this person recommends more or less options backdating. This is a way to incentivize and keep employees motivated because their strike prices will be based on some lower price backdated than when they actually grant it. At the time, the argument was, this is signed off by everyone, the industry does it, it’s okay.

Tobias: PwC blessed it, I think, in that particular instance.

Mike: I think Pw– yeah, blessed the accountants who sign off on these things. So, what he did– you come across this all the time, he said, “You know what? This sounds great but let me talk to my general counsel on this and see what he thinks.” What ends up happening is the general counsel who Ben described as this strong, moral backbone– I think he was like a Berkeley based, your values-driven guy and he was like, “I’ve looked at this every single angle. I just don’t think you can do this. I’m not signing off on this.”

This is a great lesson for a lot of people. Make sure you have that person or that voice you trust, that’s willing to be the straight shooter and tell you how they think it is and you trust him enough. He doesn’t have an agenda. He believes in this and it’s great Ben had that resource and they ended up not doing the backdating and saved them a lot of trouble.

It’s interesting that it was the general counsel that does it because a lot of times when you get into the dark arts or just fluid judgment within governance, morally fluid judgment, odds are you’re going to run into a general counsel that made the call to sign it off. I always joke that there’s always one fixer or they’re usually a lot of fixers within these corporations and more often than not, the general counsel is the fixer and gets stuff done both good and bad.

Tobias: He had an interesting construction because the general counsel reported directly to him rather than through the CFO. And it was the CFO who was recommending this particular option, backdating blessed by PwC and standard practice in the industry. Ultimately, she went to jail for something that had happened at her previous employer where they had been using this for three and a half months. They missed it because they didn’t implement it. I read that and I was shocked. I didn’t realize that folks actually ended up going to jail for that. It was shocking, but it reinforces how important it is to understand that it’s more than just a box-checking exercise and there’s some nuance to reading these things which you seem to have done really well.


Companies Will “Spring Load” And “Bullet Dodge” Equity Grants To Benefit Insiders

Tobias: You talk about using compensation. The two mechanisms are spring-loading options and bullet dodging. There’s this great part in your note where you say, this is why we use– you illustrated all three case studies. And you said the reason we use case studies is because there’s– I’m going to mangle what you wrote and folks should go and read it because it is so great. But you say that there’s some of these things are so nuanced, it’s impossible to articulate them. The way that you have to learn about them is just by doing lots of reps reading, lots of case studies, participating — The two examples you give sexing chicks and World War 2 spotting. Do you want to tell those stories?

Sexing Chicks & World War 2 Spotting

Mike: [chuckles] This is my personal opinion when it– You can probably mechanically get a lot of the spring loading and bullet dodging dynamics down but compensation analysis is very vague theory-type approach where you have to blend what is the investor perspective? How does management thinking about this business from a strategy execution operations perspective? And then blend it in with governance and blend it in with compensation. Going back to sexing chicks or recognizing the right bombers are coming in– at least for me learning, to really appreciate what is signal versus what is noise, it really comes down to recognizing when are these grants truly telling you that there’s some bullishness or bearishness going on. The only way for me to learn that was to literally research the companies, do fundamental analysis, do all the things that all the investors do to try to understand the company and the value opportunity there. Then, take that experience and then blend it into how do you incentivize management teams to do what you think is necessary to execute.

That dynamic is open-ended. If I were to ask you, okay, you’re the board member on some company you want to incentivize or reward management for certain things, what can you do? The answer is very broad. So, when we talk about sexing chicks or recognizing the sound of bombers, it’s literally you’re taking out bats and you’re looking at pitchers. It’s almost teaching someone to recognize how to recognize a curveball. It’s like you can explain it but best way to do is get in the batter’s box, I’ll stand here from the umpire’s view and throw the pitch like, “What do you think that was?” “Oh, that was a fast ball.” “Okay, what’s his pitch?” “Oh, that’s a curveball.”

So, you get this dynamic where it’s like, okay, now you recognize what the pitch is. Can you anticipate what the pitch is? That’s a little bit harder. That requires a little bit more mentoring which like, “Okay, well, what kind of pitch do you think if you get 2-0 count?” Well, they’re probably not going to throw a curveball. It will probably be a fastball. It’s that anticipation, that endgame situational awareness that requires a little bit more training, or at least for me it required a little more training.

Tobias: It’s just that it’s too subtle to articulate. With sexing chicks, you can’t tell somebody what to look for. They just have to guess on the first few and then after a while, the apprentice understands, with the master standing over their shoulder, saying that was wrong, that was right, that was wrong, that was right. After a while, they can understand what it is they’re doing and they’re getting it right more often than not, even if they still can’t articulate what it is that is the difference between one than the other. I just thought it’s a fascinating example.

Mike: Yeah. I think at a certain point– and this is where when people ask, “Well, how can I get better at this?” It’s like, “Well, what industries are you comfortable with?” “Okay, we’ll start there and start looking at those compensation programs.” Over time, you’ll start to connect how you’re familiar with the strategy in the business with how they’re compensating people and then you start picking up different nuances like, “Oh, yeah, the stock is struggling because there’s expectations– demand is going down,” but all of a sudden, they move grants up six months, and it’s like, “Why would you move grants up six months on compensation? I thought demand is weak.” And then you realize, “No, the stock is pricing [unintelligible [00:27:51] demand is weak. They just told you that–”

Tobias: There’s something coming.

Mike: Yeah, there’s is something probably not as weak as you think. So, you bring it together. In hindsight and after the fact, it’s easy to explain with the hope that, okay, eventually you can start picking this stuff up in real-time because if you do it correctly– and this has been true, even as I openly talk about this stuff, for whatever reason, it’s still true, you will find situations where stocks will just pop 10%, 20%, 40%, 50% on this sort of stuff. It’s hard to take a systematic approach to it, at least for me, but you get a hint. You identify a handful of those situations every year. I think it’s fair to say your portfolio is going to do fine.


J. Crew, TPG Co-CEO Jim Coulter, and TPG’s Infamous Takeout

Tobias: You give the example of TPG and J.Crew. The first thing that TPG often does is they chair the compensation committee. And then you look at the equity– the key thing is equity grant dates and you have this great analysis on it. Do you want to take us through that example?

Mike: We can’t have a podcast without talking about TPG. So, going back to my early years at Relational, just talking about looking at a bunch of proxies, that’s where but Relational takes a very concentrated approach to the portfolio, so we might only hold like 8 to 12 names across two funds. It’s very concentrated, which means for me, I might only get maybe one name into the portfolio a year, if I’m lucky.

There’s a lot that ends up on the cutting room floor. There are a lot of stories, a lot of situations that never met the light of day. The funny thing is TPG and J.Crew– this was 2010, 2011, this was years ago. That was one of the situations where I just observed from Relational, saw what happened in the proxy, and I thought it was fascinating. I like to joke, years after being at Relational, that’s when my eyes really opened as far as what this stuff was all about.

Using the seat of compensation committee chair to help shape and influence, not only what a company does, but also potentially use it as a way to encourage or influence a deal to go your way, it’s a very powerful realization when you figure it out. It was from that point on, I was like, “Okay, I need to keep track of these guys and study these guys because clearly, A, they know what they’re doing, and, B, they’re willing to push the envelope a bit.” I’m not saying they’re doing wrong or illegal, but you do enough of these things, you start developing a list of folks and organizations you should probably keep an eye on because at some point, they’re going to give you an opportunity to participate alongside.

Tobias: You point out that they’re very good at timing, their option grants. So, it’s a good example of spring loading that they’d make a grant and then often there’d be an event that occurred after the grant, like very close to the grant where they’d get this pop in the price. But making equity grants seems to be a gray area where you’re allowed to do that because the SEC investigates one of the guys who seems to be aware that the buyout of J.Crew is coming up and he transacts on that basis, but there are equity grants around the same time that don’t attract any attention at all.

Mike: It’s funny, isn’t it? They’re very clear, stringent insider trading laws, and even companies have very clear insider trading policies, but they don’t have– insider equity grants is, for whatever reason, one of those categories and topics that just don’t really get– it doesn’t get much scrutiny. Like you said, there’s a lot of gray area. Just going back to that J.Crew example, J.Crew, their compensation granting policy was pretty much, “We’ll grant you equity on–” I’m going off memory, “We’ll grant you equity on the 15th of the month.” So if they approve a grant, it gets granted on the next month on the 15th. If you actually have visibility that, “Hey, they’re going to kill earnings pretty soon here. We can actually approve grants– that will be granted out on the 15th of the month right before earnings.” So literally, if you were to study the grant patterns at J.Crew during that time, that’s literally what they did. If there was good earnings on deck, they granted equity right before and it was like clockwork. Going back to that SEC investigation, I think this was 2009.

Tobias: Yes. It’s the 2009 one.

Mike: 2009. They granted equity, I want to say like April 2009, which I think anyone who was around that time– that’s the bottom of the market in general. They granted equity only to see the next earnings was, I think, May where the stock popped 40% on earnings because they had really good numbers. As you mentioned, around the same time– I don’t want to say a J.Crew executive, but someone high up who had access to the same numbers, did a transaction knowing that the numbers were going to be good at earnings and they got caught by the SEC. But to your point, it’s funny because the compensation committee and the board saw the same numbers, decided to grant equity on that information, no problem. A manager sees the same numbers, tries to do an options trade, you’re getting barred by the SEC, you’re settling, you’re paying fines, and the only difference is, he tried to buy equity whereas a compensation committee approved this equity grant.

Then going back to our conversation, that equity grant was signed off by general counsel, by all the advisors. It’s okay. It’s legal, and same information.


Stamps.com and One of the Greatest (Alleged) “Bullet Dodge” Grants I’ve Seen

Tobias: You’ve got a similar story with stamps. I think the takeaway is play the man, not the cards.

Mike: Yes. Over time, going back to recognizing the sound of engines and sexing chicks, who knew that would be a theme of this podcast? Eventually, when you look at enough of these situations– and I’m about to violate my recommendation of mosaic theory and the focus on industries you understand, eventually, you just recognize behavior. Whether it stands for– I think more recently, I did one on Vaxart, which was a biotech and I don’t cover biotech. But at a certain point, you just recognize behavior and you recognize some decisions or some grants just seem out of place and it becomes a game. If you’re really good at poker, and I’m terrible at poker, you can to a certain extent start reading the man and not the cards, where if you understand what they’re trying to do and the tells and the quirks of that decision, you can just start drafting off of that decision-making. It’s not perfect all the time, but you can definitely nail the intent of some of these grants.

The point being is, I might have no idea what’s going on in this industry or what’s recovering or what’s improving, but I can recognize someone who believes something good or bad is about to happen here. You see a guy goes all in– I’m assuming they’re a very amateur player, you can tell the difference between if they’re trying to bluff you or like, “Oh, yeah, they got pocket aces.” And governance is a lot like that to a certain extent, because, at the end of the day, people just can’t help themselves sometimes


“How To” Read A Proxy & Examining GreenSky’s Equity Grant Practices

Tobias: The third example is the GreenSky, the busted IPO. What’s GreenSky do?

Mike: GreenSky is a fintech company which, I think, anyone who covers fintech like immediately roll their eyes. When you see a fintech company with a growth multiple, lookout. GreenSky helps provide loans to consumers who want to do home improvement projects. You want to put on a new roof, they provide the ability for these contractors to offer these loans to consumers to help pay for that project initially. As a consumer, that makes sense. I had to replace a roof recently and I couldn’t take out a home loan to do that. I was like, “Oh, man, I have to take out cash and pay it for myself.” I was like, “Okay, this is a useful product.”

The challenge is fintech and how to fund these businesses– these are very difficult businesses to operate from a funding, growth, risk perspective, and you’re balancing all these things. And as you deal with this dynamic of trying to fund these transactions, GreenSky trying to fund– because they have to get money from somewhere to fund their loans, you get into situations where if you lose a deal with one of your financial institutions, that’s going to hurt the stock because that implies you can’t hand out more loans, which means growth is going to slow down and you might have to take on a different lending source with more punitive terms and it becomes this spiral.

GreenSky, ever since they’ve gone public, it’s always been this dynamic of trying to pursue this greenfield opportunity while you’re dealing with the realities of financing operations. When you study the challenges of that, you start to see that, “Okay, well, this thing’s a busted IPO. You’re the leader of this company. How do I get my people incentivized?” Well, you’re probably going to give them retention grants at some point. “Okay, well, I know I’m going to have to give them retention grants. When do I give them retention grants?” Well, you probably want to give them retention grants when you have good visibility on something positive that is about to happen. There’s nothing wrong with that. That could be good practice for the people that you value and your company.

Well, if you’re going to do that– hypothetically, I’m CEO and I want to keep you, I’m gonna go, “Listen, I know the stock is messed up. but I think we’re about to turn things around. We have some really nice new things on the way, and you’d be aware. Let me grant you some equity to keep you around and keep you incentivized because I know your grants from the IPO are underwater.” This is just qualitative conversational type. You can envision this conversation happen over and over again in corporate America, and you do it. But if you know that’s the dynamic from the outside, you’re like, “This is a busted IPO. They just gave retention grants out of the blue. They’re talking about these priorities that they need to fix. It’s not perfect, but there might be an opportunity here to trade alongside this situation.”

Tobias: You gave that as an example of, you can’t manipulate the strike, but you can manipulate the number of target shares that are issued.

Mike: [chuckles] I’m starting to realize you can actually manipulate the strike, but that’s a totally separate company. First principle is, when you’re doing equity compensation, normally what companies do is, they come up with a target value for your shares. And based on that target value, then they determine how many shares to give you based on the grant date, price. If your target is a million bucks and divided by the grant date, there’s a number of shares. In the case of a place like GreenSky, there’s actually a lot of flexibility as far as when you want to determine the share count. In the case of a company like GreenSky or anywhere else, let’s say your target value is a million bucks, but you also know that you have good news on the way. Well, the stock is trading at five bucks, let’s use five bucks to determine the number of shares to give you. And then, okay, now that we’ve locked in the number of shares, we’ll officially grant you the shares after the good news comes out when it’s 10 bucks or 7 bucks.

So, it’s a very subtle, quirky, decision to do it that way. And you don’t figure it out until after the fact until– you can’t figure that out in real-time. I wouldn’t be able to figure it out, but come proxy season, you see how they do the incentive structure and the calculation and shares, you go, “Oh, wow, that is one way to juice– you can get an extra 20% of shares by doing that, that way.” You can’t trade on that information but the lesson there is, depending on who is on that compensation committee or who made that decision, you lock that away for future reference. Now, you know going forward, people affiliated with that company or with that committee might be compelled to do certain things at other places.

So, you start seeing that pattern recognition of– when you start seeing dark art style decisions at one place, it doesn’t stay there. You’re on the board of multiple companies, you’re going to certainly make a suggestion. Going back to the Ben Horowitz comment recommending backdating. It’s like, “Oh, yeah, we did it at my old firm. A bunch of companies do it. PwC signed off on it. We should do it here.” It’s the same dynamic happening right now with spring loading and bullet dodging and then these quirky calculations.

No One’s Going To Grant Equity Into A Falling Knife

Tobias: The practitioners of dark arts, you follow the practitioners. I guess one of the takeaways is you got to look for these out-of-cycle equity grants. That’s a pretty good signal that maybe there’s something coming.

Mike: I don’t even actively look for out of cycle. I like looking at situations where there’s a massive selloff, because in general, when there’s a massive sell-off, there’s a lot of focus at these companies to turn around the operations, to focus and right size priorities and strategies. This is fundamental analysis 101.

Complimentary to that refocus is you also reassess how you want to compensate your team for this new go-forward plan. When you have a dynamic where you see a massive selloff, you know that intuitively, they’re going to want to make changes to their operations because, listen, anyone running a company that sees a 30%, 40 trade down, they’re going to make changes. Even if you have conviction on the strategy, you have to make changes because your shareholders are yelling at you, and you’re feeling the heat.

So, you take that dynamic and then you realize, okay, there’s off-cycle grants going on in addition to the sell-off. You know that they’re going to be incentivized to make sure the grants are more around the time of the turn than– no one’s going to grant equity into a falling knife. We have to take that chance, we hit a falling knife, you’re not going to grant equity and then pull the band-aid and reset expectations and cause the stock to obliterate another 40%. You’re not going to explicitly do that. You might do it after the fact because that’s just the dynamic of the situation and things got worse than you expected, but you’re not going to voluntarily do that stuff.

When you’re looking at off-cycle grants, the first thing you should ask is, what is the fundamental business case for why the company would be bullish to grant around this time? From there, you can figure out, okay, these are very interesting or not.


How DoorDash’s Breakthrough Unit Economics May Break The Company

Tobias: Let’s, let’s change tack a little bit. Talk about DoorDash. Got an IPO, potentially coming up here in the near future. Food delivery is a really tough business, food delivery sucks, as you say, but they figured out some interesting wrinkle with the service fee and tax. Can you explain what DoorDash is and what they figured out?

Mike: Yeah. The funny thing about starting Substack is, I’ve learned it doesn’t take too much to become a topic expert and things apparently. Now, I’m a governance and food delivery guy. But DoorDash, it’s a funny story just because– so food delivery sucks. And full disclosure, after Relational, I actually worked at a long-short hedge fund called SQN up in San Francisco and probably my top idea there was to short Grubhub. The thesis at the time hasn’t really changed all that much as far as like, “Hey, you have these really punitive commission rates, 20%, 30%. Restaurants are already razor-thin margins. This is very difficult, unsustainable-type unit economics. Put it all together, Grubhub is overvalued,” This was, I want to say 2015. Obviously, I ended up changing my mind. This is one of those stocks that at any given time have been either incrementally bearish or bullish depending on the impact. But it was a formative experience to study the space.

So, fast forward to today, DoorDash, knowing that the economics of this business can be very, very brutal, just studying someone like Grubhub, it was always interesting to follow those guys or even Postmates, and just see how they got by. DoorDash, one of their innovations– I don’t know if you want to call it innovation, but they’re the ones that brought along with the notion of a service fee. The Twitter meme, you’re ordering a $10 burrito and service fee is 20 bucks. They introduced that concept. Part of the reason they introduced it was, before you could just mark-up food to make your margin and then lawsuits and consumer complaints happen, as a form of transparency, they pulled it out into a service fee. Where things, I guess, got quirky, and what actually caught my attention was, to make the food delivery economics work, there are only so many levers and if you’re not taking commission from a restaurant, which there are a lot of DoorDash’s deliveries, they weren’t, how do you actually fund these deliveries? There were two levers that I’ve figured out, and the only reason I figured it out was, I was a big DoorDash order person and I used to– if you ever wonder why I’m so knowledgeable of food delivery, it’s because one day I realized that DoorDash was doing this very aggressive gratuity tipping scheme and I felt taken along for a ride, like, “How dare you use my tips to subsidize these rides?” I think I wanted a $12 refund for my tips and they wouldn’t give me the refund. And out of curiosity, like “This is weird. You won’t give me a $12 refund?” This isn’t a diff– Normally you deal with Domino’s or Grubhub, they’ll just give you a refund. It’s not a big deal, but it’s like, “You won’t give me a refund? What’s going on here?” And literally that led me down the rabbit hole to figure all this stuff out. If DoorDash is wondering why in the world I wrote about them, it’s because they didn’t give me a $12 refund.

Tobias: Let that be a lesson.

Mike: They changed their gratuity policy. Back then, I want to say even a year ago, what would happen is they tried to make the income drivers earn more stable, which I think is a great idea. The challenge is, how do you implement it? The way they implement it was, we will guarantee you some amount, five bucks minimum, but if you end up getting tipped more than the five bucks, then you’re really only just getting the tip. But if the customer isn’t tipping, then you get the five bucks. They gamified it in a way where– they knew how much the tip was upfront, but they gamified it where it’s like, “We promise you at least five bucks,” knowing on the backend that the tip was going to be eight bucks or whatever.

That was a big deal because if you can reallocate delivery fees and those dollars to other deliveries, suddenly, you have just much more sustainable unit economics, which even they were able to help drive their growth and for them, it was the right decision. I don’t know where they’re at right now, $15 billion valuation. Literally, if you lined up when they started doing that with their valuation, they went from billion to $15 billion. A lot of it on that, but they’ve had escape velocity as well.

But the other lever they use was sales tax and how do you calculate sales tax? This is actually one of those like unsettled things. Grubhub will charge you sales tax on all your fees, more or less delivery fees, service fees, the cost of food. In California, I think it’s 8% to 10% sales tax. They’ll apply it for everything. Someone like DoorDash will only apply it to your food. I don’t think they apply it to their service fee, if my memory is correct. So, depending on the order size, it could be 50 cents $1 delta on some of this transition head to head, same restaurant, same order between a Grubhub and DoorDash. And that delta in savings typically was enough for them to squeeze in their 10% service fee, or whatever service fee they had in place versus at the time Grubhub doesn’t charge– Well, they charge one now, but at the time, they didn’t charge a service fee. But somehow, some way, DoorDash was always competitive with Grubhub on these orders and part of it was, how do you treat your sales tax? If you treated it a little bit more differently, you can get away with charging a 10% service fee, and having the same out-of-pocket cost versus Grubhub who didn’t because they were collecting a commission from the restaurant.

It was one of those things where it’s like, “Whoa, that was really interesting,” and I think it’s still a little bit of political football for DoorDash. Especially with COVID-19 happening, assuming Grubhub’s approach to sales taxes correct, there is potentially an argument that the largest sales tax evader in San Francisco might be DoorDash during this COVID-19 stay-at-home broo-ha. I don’t know if that’s the case, but it just depends on how you treat that sales tax. But you can see how this could turn into political football very quickly, no different than drivers or employees and all these other quirks. So, I don’t think they’re necessarily out of the woods with this arbitrage that they’re still doing.


Gig Economy Companies – Fake It Till You Make It

Mike: There’s a saying that I have where people celebrate “fake it till you make it,” in the startup world and a lot of these grayer decisions, it’s a dynamic of “scale now, settle with society later.” It’s like, “Yeah, okay, maybe this isn’t the correct interpretation, but we’re now a $15 billion company and we can settle it for less.” For them, that’s the right economic decision.

Tobias: Something like the Uber model where they just do it and then after the fact, they’ll just figure it out.

Mike: Well, they’ll figure it out or they’ll settle it, or they will work with the regulators to come up with the right resolution. Uber, to break up the hold the taxi industry had on all these cities, it took a little bit of moxie and vision and a willingness to take that risk. Once customers get used to pushing a button and a car shows up, that’s not going away. You can try to regulate that or say rideshare is going to be hit hard or whatever, but you’re not going to take that fundamental feeling of being able to open your phone and have the car show up [crosstalk]

Tobias: It’s the superior experience. There’s no doubt about that.

Mike: Superior. Now it’s like, okay, well, yeah, they ignored all the laws and they screwed over the taxi industry but here we are, they’re not going to go away so we’re going to have to settle and that was probably the right outcome, in hindsight.


Corporate Governance And Picasso’s Turpentine Effect

Tobias: Yeah. I love it. I love a lot reading through those posts of yours and I’ll make sure I link through to all of them in the show notes, but I just wanted to leave it on this final point. You got the great Pablo Picasso quote about turpentine. Do you want to give it? Do you remember it?

Mike: [laughs] I love making Picasso references only because when people look at his paintings over the years, we’re all inspired or we love looking at his art, but when you think about his history– when he first got started, he painted you would think [unintelligible [00:56:08] just lifelike, very specific, very real paintings. Over time, he took a lot more creative license on what he was seeing in his eye and expressing things.

I always love that quote he talks about, “When critics get together, they talk about form, structure of these paintings. When artists get together, they talk about where to get the cheapest turpentine.” The point being, you have critics and observers who are trying to apply very rigid checklists, structures on how things are supposed to be, and the artist isn’t constrained necessarily to the rules. They just want to keep doing what they’re doing and express themselves and do their art. Their limiting factor is turpentine. It’s the building blocks.

Governance in a lot of ways, when you study these decisions it’s– I’m not going to say it’s art, but there really is something to be said about your casual observer, the ESG person who’s trying to checklist best practices and what’s right and what’s the best way of doing things, and the reality is the real practitioners of governance, they’re kind of artists. They realize there’s a lot more gray area here. It’s not necessarily right and wrong. I mean there’s arguments that things are inappropriate, but it depends. If you’re staring into the abyss as a company, and you need to keep people motivated and get certain things done, that’s a tough dilemma. The turpentine is the grants, the equities, the incentive structures, how you want to bring in people and rally them around something. So, I’ve always loved that quote as far as how to look at these things

I guess this is my last thought, but when you achieve a certain level of expertise, you’re genuinely given two choices. You can either be a critic because you’re the expert, you know what’s right, you know what’s good, so you can criticize. Or you can evangelize. You can try to make it a little more accessible to people. Celebrate. Don’t be a gatekeeper and discourage people or criticize people because they’re trying to do something. And that’s, at the end of the day, what I’m trying to do with writing about governances. I know this stuff, I could have been a critic like– [crosstalk]

Tobias: You could be a dark artist too.

Mike: I could be a dark artist, but I want to evangelize. I want to share and show people there’s some interesting things here and you can learn a thing or two. Not only about governance, but at the end of day, it’s a reminder that these mindless companies– from the outside, they look like these mindless machines but they’re people pulling the levers behind the scenes. Just remember they’re pulling levers. They have their own behaviors, aspirations, fears, interests, and they get expressed through these companies.

Tobias: Yes, it’s absolutely fascinating, Mike. If folks want to follow along or get in contact with you, how do they do that? Make sure you mention your Substack.

Mike: Yeah. I guess I’m on Twitter a lot. My username @NonGAAP. N-O-N-G-A-A-P for the non-finance/accounting people.

Tobias: Great Twitter account.

Mike: Yeah. I also own nongaap.com, which is why I chose @nongaap as my Twitter handle. And then you can find me on Substack, I think nongaap.substack.com.

Tobias: Well, thanks so much for spending time with me, chatting about this stuff. It’s absolutely fascinating. Mike Puangmalai, Non-GAAP. Thank you very much.

Mike: It was a pleasure.

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