Revisiting unprofitable businesses from the '20-'22 era (pt. 2)

Retrospective

[part 1 here]

As long as I have been professionally active in markets (ten years roughly) there has been a class of investment professionals that lamented the lack of opportunity. Multiples for any long ideas are all stretched, there are no obvious bargains and anything that has any hint of quality trades to >25x earnings or >10x EV/S or whatever. Short-sellers bemoaned the “Fed put”- any dying, worthless business had multiple chances at life thanks to zero interest rates. Cash yielded nothing, everything was overpriced, misery for the prospective investor for ten years.

These strawmen were mocked - correctly - for not adjusting to their environments. PIMCO famously published their “permanently higher plateau” treatise on why interest rates would stay low forever. Investors rationalized paying high multiples for all sorts of specious value propositions. Very simple arithmetic- uncertain cash flows that were further out in the future were far more valuable in a world where long-term rates were effectively zero.

These observations were all correct! Every day the financial media explore a new product of the end of ZIRP: ARKK, SVB, vacant office buildings, secondary market write-downs in PE/VC, LDTI; these blowups all have different flavors, but history will bucket this as simply The End of Zero Rates Forever. We’ll understand what’s going on perfectly ten years from now with the benefit of hindsight.

Both sides of these ten-year trades can be “right”, of course. The ZIRP investors were factually correct- zero rates should jack up the price of everything, especially future growth. And the ZIRP-forever crowd was right too- you must adapt to your surroundings, interest rates affect asset prices and there’s a business to be run (asset management!). So you torture the numbers a bit, quote a TAM and CAC/LTV, and you get “bargains” in a zero-rate environment.

I must end my analysis of the 2020-2022 era because it simply doesn’t interest me that much. I’ve analyzed what I can in the world of software where too many products are claimed to be “sticky” or “mission critical” that simply aren’t. This isn’t an indictment of the software business model as it stands currently today, it’s just an indictment of my capability of evaluating management teams and talking to customers and suppliers about the true product value-add, competition, and the real costs of switching out software. I have a suspicion that many of the market share statistics are deceptive; despite seemingly stable market shares in the CRM software business space, for example, I see a lot of volatility, and new entrants taking share:

Market share volatility is a decent proxy for stickiness, but of course it is not perfect. I simply hate trusting management, because they rightfully should be pumping their product to investors and clients. So that’s my way of saying its too hard; same goes for alternative valuation metrics, including EV/gross profit, which I think is a nice place to start when evaluating software businesses. I just don’t know what multiples are correct. Do I value the company at what Thoma Bravo will pay? Or what I think is reasonable? Or do I try to estimate the LTV of a customer and just do simple multiplication? No matter what I’m guessing, and I think everyone else is too.