Some things I read this week: 19/8/18

The Warren Buffett Yardstick

  • To get a general sense of market valuations, Warren Buffett likes to check the total market value of all publicly traded securities as a percentage of Gross National Product
  • At the height of the dot com bubble, this ratio measured 150%; today, it stands at very similar (all-time high) levels

Constellation Software Annual Report, 2018

  • Constellation Software is a diversified software company whose growth strategy is to acquire and hold software startups that focus in vertical markets as opposed to a wide variety of markets. The company has acquired over 260 such companies and currently has a market cap of over $20B.
  • To track performance, CEO Mark Leonard has historically used the sum of Return on Invested Capital (ROIC) and Organic Revenue Growth (OGr) as the company’s KPI.
    • Leonard notes that this combined metric was suitable for Constellation because it rarely re-invests capital into its portfolio businesses; rather it takes the acquired company’s earnings and allocates that capital into new acquisitions.
    • In many other industries and companies, this metric would be inappropriate; capital-intensive businesses, for example, generally require incremental investment for cash flow generation and therefore ROIC + OGr would be double-dipping.
    • Leonard notes that as competition for acquisitions and cash flow intensifies, the company’s ROIC + OGr performance will face headwinds. As a result, he is considering alternative metrics for performance. It is unlikely that the company will be able to reinvest all of its FCF at attractive rates of return in the future. As such, he is looking to alternative metrics for performance. Some of his thoughts
      • Incremental return on incremental invested capital is telling, but very volatile and easily thrown off by share repurchases or issuances
      • Increase in Net Maintenance Revenue per share is interesting, but easily abused as it can’t be derived from a company’s audited financials
      • Strong candidate: growth in FCF per share. This metric accounts for changes in the number of shares and isn’t overly sensitive to debt and cash.
      • Another alternative: growth in adjusted net income (ANI) per share. Less volatile than FCF metrics because of smoothened changes in working capital.
  • Leonard criticizes one of the “tools-du-jour” of fixing boards: term limits. Leonard reminds that if your directors are competent and in good health, term limits are akin to “firing a high performance employee on their tenth anniversary.”
  • “If Constellation had started in 1895 instead of 1995, we might have had the objective of being a great perpetual owner of daily newspapers. The newspaper industry underwent a long period of high growth which attracted many new entrants, followed by local consolidation, conglomeration, and eventual decline. I anticipate that the VMS industry will evolve similarly.”
  • “I find there is no magic to managing and leading. If you are smart, work harder than everyone else around you, treat people fairly, do not ask them to do anything you would not or have not done, share the credit, keep learning and keep teaching, then pretty soon you have followers. If you make sure that the team members are intelligent, energetic, and ethical people with whom you would want to work for the rest of your career, it won’t be long until you are running one of our BU’s.”
  • The Journey from Craftsman to Compounder“: you start by specializing and becoming a master of the industry you’re in. Say ambition drives you to acquire a sizable business (another geography or vertical). After a series of these acquisitions, you become a portfolio manager. “If the PM is good at finding acquisitions, and helping them learn relevant best practices, and continues to deploy at least the FCF produced by their portfolio, then we refer to them as a Compounder.”
    • “At best, a PM is an advisor: they fly in (usually clocking hundreds of thousands of airmiles per annum), gather information, share ideas, provide referrals to others within Constellation who have dealt with similar issues, and then they move on to the next portfolio company.”
    • “The difference between a Craftsman and a Compounder is often one of personality. Successful Craftsmen can be autocratic or consultative, brilliant or average intelligence, introverted or extraverted, mercurial or imperturbable. Lots of different personalities and styles work. Successful Compounders have no choice but to be (or become) more hands-off and trusting. They can be curious and driven, but they can’t be directive. They can nurture, goad and suggest, but they can’t order.”

An Interview with Steve Jobs at the App Store’s Launch

  • The app store is to the iPhone as iTunes was to the iPod… “It’s the same exact strategy as the iPod. Enhance the device with internet-delivered content”
  • On the app store’s infrastructure moat… “It’s built on the same iTunes infrastructure, including all the storage and all the billing and getting email receipts and all of that kind of stuff. The downloads are fast and reliable because it’s the same system as iTunes. Customer reviews, buying with one tap, just like one click on music and stuff. No one’s ever duplicated iTunes in over five years. This’ll be even harder because it’s built on top of it.”
  • On building a developer platform… “We think we’ll attract great developers to write great apps because our platform is so advanced, they can write way better apps on an iPhone than any other mobile device. When they get done, we have this frictionless marketing distribution transaction engine where they can get them right in front of the customer’s eyes.”

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