The Value Spectrum | The Acquirer's Multiple®

During his recent interview with Tobias, Matthew Sweeney, Managing Partner at Laughing Water Capital, discussed The Value Spectrum. Here’s an excerpt from the interview:

Tobias: Let’s take a step back and talk a little bit about your philosophy. So, we know that it’s a value-based philosophy. You’re currently focused in small and micro, and perhaps using special situations as the trigger to look into positions. But it doesn’t sound like you’re necessarily constrained to small and micro. And you’re not necessarily constrained to the special situations either. So, you’re just looking for along the value spectrum, something that is undervalued to simplify it as much as that.

Matt: Yeah, that’s from a high level, that’s a good way to think about it. One of the things I mentioned earlier, the value spectrum, I do think it’s notable that I diversify across that spectrum. So, there are some things in there that are definitely much more asset plays, cash-rich balance sheets on exciting businesses, that kind of stuff. Like Aimia, for example, fits in that bucket. That’s when I know you spoke with Chris Mittleman about a number of weeks ago. And that portion of the portfolio, if I’m being honest, has been a notable drag versus like the bulk of the portfolio, which is middle of the road businesses that are just under-appreciated and cheap for those special situation reasons. And, of course, there has been a drag versus the more growthy the edge of the portfolio.

I think it’s important to think about diversifying across that spectrum to be intellectually honest because we all know, there’s a number of, I guess, for lack of a better term famous value investors from 10 years ago, or 20 years ago, that have really struggled in recent years. I don’t want to say most of the, but a lot of the best performers, the golden age of value coming out of the tech crash and that sort of stuff. Those guys, a lot of them I’ve really struggled in today’s world. And it’s probably only a matter of time before the same can be said from the people that are extremely on the growth side now.

One of the things I think about some of the growth names and I’m not sure if any of these names or anything like that, but you see these stocks with 20 times or 30 times or 40 times revenue or something like that, and you need a really long DCF to justify that. And invariably, it seems like the thesis is that over time, they’ll get leverage on the sales and marketing line. And that might be true. But for most of these businesses, too, they’re really first movers. So, they have a huge first-mover advantage. There’s definitely a, I guess, generational shift underway in terms of cloud computing and stuff like that. So, their first-mover advantage, but eventually that first-mover advantage is naturally going to erode. And to me, it seems incongruous to claim that you’re going to get leverage on sales and marketing, just as new entrants are approaching the market.

So, you have to assume that at some point, margins are going to really widen out. And you have to assume that those margins are going to widen out by cutting sales and marketing, but how are you going to cut sales and marketing when for the first time you’re facing real competition? The pushback against that is like, “Oh, well, switching costs are really high.” And, again, that might be true. I mean, there’s certainly going to be some winners in the space. But I question how intellectually honest that is to claim that there’s going to be super high switching costs from a company that is a disruptor right now, because the switching costs are not too high for the incumbent– [crosstalk]

Tobias: Demonstrably so.

Matt: Yeah. So, there’s definitely going to be some winners and there’s definitely going to be some huge successes. But I think if you look at people where their whole portfolio is these fast-growing fast names and whatnot, I don’t necessarily believe that it’s intellectually honest to say that that’s a strategy and a process that’s going to endure for the long term because it seems like at some point, there’s going to be some very natural roadblocks to those businesses now.

So far, it’s worked really well. And I get shame on me for not being more invested in those stocks. And for lack of a better expression, I guess I’m picking the wrong dartboard. But for me, where I’ve put up returns that the prospective LP said to me earlier today, you’ve put up tech like returns, but I’ve been underweight tech, I feel pretty good about that because I think that that’s intellectually honest. And I think that this is my strategy, my approach is going to be timeless, because so much of it is based on taking advantage of the failings of human nature and market structure. So, it’s not every day that Ron Perelman has troubles with his debt stack, but it happens. And it happens fairly often, where you could take advantage of it. And that’s not tied to any of the macro factors that may be fueling a lot of the growth success right now, so it’s not tied to low-interest rates.

And there’s some risk that many of the sexy SAS stocks are really just interest rate players in the skies. And there’s some risk that people are really exhibiting recency bias when they assume that all these things are going to grow to the sky because you look at Google and Amazon and Salesforce and others that are truly dominant businesses. And people take that framework and apply it to the next company that just says SAS and their name.

Again, I’m not sure any of those names or anything like that, I’m just more cautious than most. And I think that, for me, and my partners, as I think about the next 30 years is, I want to have a strategy in a process that is repeatable, and repeatable, and repeatable and repeatable and not interest rate, timing in disguise or anything like that because I have no doubt that at some point, there will be the next group of investors that fit into the mold we see today of– I don’t want to use any names, but I’m sure we all know a number of the best value investors from the 2000s that have really struggled for the last 10 years.

At some point, we’re going to see some examples of the “best growth investors of the 2010s” or “2020s.” And they’re going to really struggle. And, for me, all I’m doing is trying to take advantage of human nature and market structure to find cheap securities. And that’s going to be timeless, I think.