Buffett; Tech & Inflation; IKEA #138
Reflecting on a few interesting reads and listens over the past week
Preparing for Interviews #138
Given the focus on Elon's takeover attempt on Twitter and their corresponding response, I thought I'd take a different approach and share a few articles/interviews that I thought didn't get the attention they deserved.
Interview Between Charlie Rose and Warren Buffett
I found this to be a great interview to watch. It's quite inspiring to see Buffett deeply engaged in his day-to-day job of managing Berkshire Hathaway and ultimately becoming a master of his craft. His unbridled optimism for the U.S. despite all the noise today really puts everything we're going through in perspective. As an investor, it's easy to get caught up in the headlines vs. paying attention to the underlying fundamentals. From my observation, the ones that focus on the fundamentals (e.g. the actual business) vs. trying to predict the future based on headlines usually end up building a winning process.
While I'm sure Buffett needs to be quite careful around what he shares publicly at this point, I thought this interview is a great reminder to focus on what's in front of you vs. getting caught up in events outside of your area of control.
There is No Playbook
This is another great interview from Gavin Baker, founder of Atreides Management and an extremely seasoned tech investor. I've often enjoyed his podcasts on Invest like the Best with Patrick O'Shaughnessy. This particular interview with Christoph Gisiger was quite good. Here are a few excerpts that I found quite useful:
Mr. Baker, you are one of the very few tech investors who lived through the dotcom crash in the year 2000 firsthand and remained active in the sector afterwards. As a battle-hardened industry veteran, how do you assess today’s market environment compared to back then?
Here’s the big thing: A lot of non-profitable tech companies with under $100 billion market capitalization just experienced a similar crash in valuations as we saw in the year 2000. But from a fundamental perspective, I don’t think the burst of the dotcom bubble has many parallels to what’s happening today. At that time, after the bubble burst, the fundamentals of every tech company imploded, they missed their earnings numbers by thirty, forty, or fifty percent. Many had significant year-over-year revenue declines, and then their stocks went down more.
And how do things look today?
I do not believe that the fundamentals are going to crash in a similar way. In the year 2000, nobody knew which business models were going to work on the internet. The buildout in telecom equipment, data centers and software was not based on a consumption basis. It was built in anticipation of demand that took much longer than expected to materialize. In fact, we added so much telecom capacity that it took 15 years to absorb the amount of fiber and optical components we put in the ground. Every bank, every retailer and almost every other company was in a huge hurry to go online. They spent all this money to put up a website, but then they were like: «Wow! Why did I do that?» Today, you don’t see that degree of overbuild or excess on the supply side, because it’s all sold on a consumption basis. I promise, if the big cloud hyperscalers stopped spending on CapEx, they would run out of capacity in twelve to eighteen months. It’s a very different environment.
What does this mean for tech stocks?
It creates opportunities because today’s unprofitable tech companies are so much better than the ones back then. Many of them are Software as a Service companies where we know that the business model works. They have immense control over their P&L. You have seen some of them take their free cash flow margins up 80-90% in two quarters. They can be profitable whenever they want. They’re making a conscious trade-off between growth and profitability, and when they tilt towards more profitability, they don’t stop growing, they just grow slower. So it’s wild to me that you’ve had a move comparable to the year 2000 crash in non-profitable tech companies. Their forward multiples have compressed at least as much if not more, but they are great businesses, they’re not missing their numbers.
However, many of these companies were notably highly valued. As interest rates have risen, their shares have now come under pressure.
If you’re unprofitable, you’re essentially a long-duration asset. Hence, it’s natural that you take some pain as interest rates go up. But I think you’ve taken all the pain in the terminal valuation now. I don’t see much more multiple compression. Thoma Bravo, a private equity firm, just took out a software company at 12x forward sales. Today, you can buy a lot of software companies at roughly half that multiple, and they are growing faster with better fundamentals than the asset acquired by Thoma Bravo. So if you’re a software company trading at 6x sales, and an inferior company just got bought out at 12x sales by a very knowledgeable private equity buyer, I think that’s enough of a discount. That’s why I don’t see much more multiple compression. What will drive performance is growth and the relative operational performance of these businesses, and they should do reasonably well in an inflationary environment.
IKEA: Physical to Omni-Channel Furniture Retail
This is an interview from the folks at In Practise and Catherine Bendayan, the former Deputy CEO of IKEA France and Germany. I'd recommend going through this interview if you're interested in the supply chain and retail. Here are a few excerpts that I stood out to me as it helped explain why they have a superior and unique in-store experience while struggling to build a similar online presence.
Can you briefly explain how the IKEA franchise model works?
The store manager is a fantastic position because you have a strong concept delivered to you as a franchisee. The range has a strong identity with all the goods, and when you sell one item, it is replenished, but you don't only sell one item. You have to manage 350 people with a management team who perform different functions, and you have to monitor your P&L, develop turnover and reach development goals.
Could you compare IKEA’s franchise model, with three different businesses, to traditional furniture retailers?
IKEA is stronger than traditional retailers because almost everything they produce or source involves huge volumes, and they distribute to consumers. That means there are no intermediates so they are able to produce from A to Z, and deliver A to Z. It is a really interesting business model because you don't have to pay intermediates as you do in food hypermarkets.
Is there any advantage in having three distinct Range, Supply, and Franchise businesses?
Until now yes, but it might be challenging in the future because it's difficult to excel at each step of the supply, from the factory to the customer.
Why?
Last-mile delivery is a challenge to all retailers in general, but IKEA has to transport both small objects and large furniture, which is more costly. They are trying to find solutions but it's not easy because it's a complex issue.