Smead Capital: The McNealy Problem

Johnny HopkinsSmead CapitalLeave a Comment

In his latest paper titled – The McNealy Problem, Cole Smead at Smead Capital tests Scott McNealy’s thesis regarding the euphoria surrounding Sun Microsystems, using a modern day company DocuSign. Here’s an excerpt from the paper:

We are using the corporate history of Microsoft and Cognizant Technologies to understand what other businesses like DocuSign will need to have in order to produce huge corporate success. The only question that remains after you look at their balance sheet, income statements and cash flow is, what price would you pay? At 27-times revenue, it looks like a greater probability that DocuSign will stumble short of the 13.8% compounded return we calculated. This is the McNealy problem. Price doesn’t account for anything short of ideal. Scott was right.

Does that mean that DocuSign can’t succeed individually in today’s financial euphoria? No. The McNealy problem speaks to the psychology and mood of the participants in the market, not necessarily to the corporate success.

“’Gold rushes’ wrote Bill Gates in a prophetic conclusion to his book, ‘tend to encourage impetuous investments. A few will pay off, but when the frenzy is behind us, we will look back incredulously at the wreckage of failed ventures and wonder, Who funded these companies? What was going on in their minds? Was that just mania at work.’”

The last thing the cynic is thinking with the McNealy problem is that we are using the past as a guide with Microsoft and Cognizant Technologies (the past) to look at DocuSign (the future). We are also speaking to financial euphoria that we haven’t seen since the late 1990’s, when Scott McNealy was the CEO of Sun Microsystems.

The cynic would say that those past instances are irrelevant and you must look at how great these companies are. They will utter the four most damaging words known to investors: it’s different this time. Let us not forget this is an American specialty. “As the nineteenth-century financial writer William Fowler observed, ‘Imagination in this country, lives in the future rather than the past.’ Only in America could a man declare that history was bunk.” This is the McNealy problem.

Fear stock market failure.

You can read the entire paper here:

Smead Capital: The McNealy Problem

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