High-Growth Reinvestment | The Acquirer's Multiple®

During their recent episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle discussed High-Growth Reinvestment. Here’s an excerpt from the episode:

Tobias: Yes. I’ve been looking at some of the better-performed businesses out there, just try and back into some of the valuations and see what’s interesting. Basically, the way that I did it, I just went through a list of the guys who’d been on the podcast and the names that they had thrown out. Got a really interesting one coming up with Elliott Turner where he talks about Twitter. I don’t want to talk about that one too much, but I think that he’s found something super interesting in Twitter, because it’s been– I love the product. I think lots of people love the product.

It’s just been hilarious how badly managed it seems to have been, part-time CEO– the lesser of the two companies that he’s part-time CEO of. He’s clearly very smart guy, though, he is probably still doing quite well. The business behind it has been, what looked like a bit of a shambles and it sort of turned into– Maybe with Elliott, who’s a very scary hedge fund, and Silverlake, who’s a very smart kind of private equity, VC tech, kind of private equity firm, probably something good is going to happen there. Elliott demonstrated I think that that’s the case. I don’t want to give too much away there, too.

I went through the list of names, like Trade Desk was one of the ones that I was just sort of– Trade Desk is interesting, but, wow, it’s expensive. We’ve talked about this before. The question I have is, do those base rates continue to apply to the sort of businesses that in networks? Is this time different? That should make everybody really nervous when they hear those words. I think you introduced to JT on a podcast a few months ago, where we were talking about Mauboussin’s base rates, that he brings out– it’s like revenue growth, return on invested capital. What proportion of companies can sustain these?

If you’ve got $50 billion in sales, what’s the likelihood that in one decade you continue to have extraordinarily high growth rates? It’s hard when you look at these things, because they’re all expensive, but they are all very good businesses, too. If you assume that they can maintain their rate of reinvestment, and they’re very high rates of reinvestment on very small capital basis. Even though they’re expensive, they can continue to grow very rapidly. If you just assume that there’s no fade in any of those rates, then they’re probably going to be– you’re going to make a lot of money out of these businesses. But if you assume any kind of fade rate, so they don’t continue to be exceptional businesses in a decade.

Basically, if you assume 25 years, that’s no fade. There’s no fade at all in the margin. So, there’s somewhere between 25 and say a decade, do these fade to kind of reasonable businesses. I just found that basically, the entire decision rests on how quickly these companies fade to average. That makes me a little bit nervous. Some of them are clearly going to last the 25 years. I mean, I don’t know which ones. Amazon is still a beast, even at the size that it’s at. I don’t know if it can continue to grow at the rate that it continues to– it’s still got a very high return on invested capital, it’s still an exceptional business, it’s hard to see how anybody really competes with it, other than maybe Shopify doing a– Shopify has.

Jake: Rebels against the empire.

Tobias: Yeah, the funding the rebels against the Empire. I think that Shopify has a very, very robust approach to it. Shopify is growing rapidly, massive returns, again–

Jake: [crosstalk] –so expensive.

Tobias: –like crazy expensive. It’s hard to see how you make much money out of that over the next decade, even if it keeps on doing what it’s doing.

Jake: You got to get rid of that limiting belief that valuation matters.

Tobias: Well, that’s entirely true. If I just ignore that, the returns will be much better over the last few years. There’s a good question on the board. How long before cloud becomes a commodity? I don’t know the answer. It’s not forever, 25 years, that would be a long time. 10 years?

Bill: I just don’t know what you’re bitching about-

[laughter]

Bill: –because I have this up here and it’s only trading at 22.7 times 2024 gross profit.

Tobias: Shop?

Bill: No, the Trade Desk. You just need to extend your time horizon. That’s the problem.

Tobias: Well, we’re always a little bit facetious about this, but you put interest rates to zero, it’s probably not entirely unreasonable to think that you bring all that forward without discounting it.

Jake: Okay, let’s actually go into the constituent parts that make up that number. How do people get comfortable coming up with a revenue number that far out? And a margin, that’s even harder because a lot of that has to do with competitive dynamics, right?

Tobias: Yeah.

[crosstalk]

Jake: You’re just like know what the number you need to get to and then you solve for– “Well, I need 80% gross margins.” All right, plug that in.

Bill: I think that I can almost understand the 2024 number. It’s the 2030 number that you have to believe in that I really can’t get to.

Tobias: I think you can see it– not see, but there’s probably not much diminution in a business over five years, or there’s not much of a change, it’s just assumed some models fade over five years of. After 10 years–

Jake: None of these numbers work if you do that.

Tobias: That’s right. Well, after 10 years, they certainly don’t. That’s the problem. 10 years, I think it’s pretty modest.

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