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Bill Gurley on competitive advantages


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Great find. What I find interesting is comparing those EV/revenue numbers (which curiously are 2012 estimates, as he writes the post in May 2011) to today's market. I looked at some of today's highly-valued (EV/rev) R1K names, and was surprised to see Heico at 8x revenue! Gross margins have hovered around 35-40% over the last 15+ years, revenue growth has averaged 13% annually ($171 mm in 2001 to $1.9 bn today, boosted via $2 bn cash spent on acquisitions).

 

Quite the ramp in EV/revenue over the last six years. Not sure what's different about the business over that time. EBITA margins are a bit higher in recent years, but they're 25% today vs 23% in 2001. The market historically valued the business at 2-3x revenue, now 8.6x. Not meaning to pick on Heico in particular, just a name that jumped out at me that seems hard to justify valuing at nearly 10x revenue (plus, the 10 year today is roughly where it was in 2011-2012)...

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The problem with his thesis is he says the 10x revenue club is evidence of those moats. But they could just be - most likely are, some sort of gross enthusiasm and overvaluation. Some may have some of those moat effects but it isn't any proof. High revenue multiples can also mean startup growth and burning capital and in no way implies any sort of moat - or at least - not enough time has passed to pass a verdict yet.

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Great find. What I find interesting is comparing those EV/revenue numbers (which curiously are 2012 estimates, as he writes the post in May 2011) to today's market. I looked at some of today's highly-valued (EV/rev) R1K names, and was surprised to see Heico at 8x revenue! Gross margins have hovered around 35-40% over the last 15+ years, revenue growth has averaged 13% annually ($171 mm in 2001 to $1.9 bn today, boosted via $2 bn cash spent on acquisitions).

 

Quite the ramp in EV/revenue over the last six years. Not sure what's different about the business over that time. EBITA margins are a bit higher in recent years, but they're 25% today vs 23% in 2001. The market historically valued the business at 2-3x revenue, now 8.6x. Not meaning to pick on Heico in particular, just a name that jumped out at me that seems hard to justify valuing at nearly 10x revenue (plus, the 10 year today is roughly where it was in 2011-2012)...

 

I believe the increased valuation in some stocks is due to the rush into compounders. I believe after one of the longest economic expansion in modern history, a lot of companies look like compounders, but are more cyclical than they seem. We will see after the next recession.

Since many of them are roll ups (albeit well run roll ups), there is also reflexivity at work, such that a high valuation enables faster growth through acquisitions, due to lower cost of capital.

 

Example are Heiko, ROP, DHR, TDG, ROK. They are well managed companies well worth keeping an eye on, but the valuation is a couple of bridges too far, since investors now discount many years of current growth rates into their stock prices.

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Great find. What I find interesting is comparing those EV/revenue numbers (which curiously are 2012 estimates, as he writes the post in May 2011) to today's market. I looked at some of today's highly-valued (EV/rev) R1K names, and was surprised to see Heico at 8x revenue! Gross margins have hovered around 35-40% over the last 15+ years, revenue growth has averaged 13% annually ($171 mm in 2001 to $1.9 bn today, boosted via $2 bn cash spent on acquisitions).

 

Quite the ramp in EV/revenue over the last six years. Not sure what's different about the business over that time. EBITA margins are a bit higher in recent years, but they're 25% today vs 23% in 2001. The market historically valued the business at 2-3x revenue, now 8.6x. Not meaning to pick on Heico in particular, just a name that jumped out at me that seems hard to justify valuing at nearly 10x revenue (plus, the 10 year today is roughly where it was in 2011-2012)...

 

I believe the increased valuation in some stocks is due to the rush into compounders. I believe after one of the longest economic expansion in modern history, a lot of companies look like compounders, but are more cyclical than they seem. We will see after the next recession.

Since many of them are roll ups (albeit well run roll ups), there is also reflexivity at work, such that a high valuation enables faster growth through acquisitions, due to lower cost of capital.

 

Example are Heiko, ROP, DHR, TDG, ROK. They are well managed companies well worth keeping an eye on, but the valuation is a couple of bridges too far, since investors now discount many years of current growth rates into their stock prices.

 

I'd agree with that. As an example, ROP has spent $11 bn on acquisitions in the last ~9 years to grow FCF from $471 mm in 2010 to $1.3 bn today. Meanwhile, EV/rev has more than doubled (~8.5 now from ~3.5x in 2010) and EV/FCF has nearly doubled (upper teens in 2010 to low 30s today).

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I'd agree with that. As an example, ROP has spent $11 bn on acquisitions in the last ~9 years to grow FCF from $471 mm in 2010 to $1.3 bn today. Meanwhile, EV/rev has more than doubled (~8.5 now from ~3.5x in 2010) and EV/FCF has nearly doubled (upper teens in 2010 to low 30s today).

 

This kind of napkin math misses a lot. What are the assets that they bought? Do they have different economic characteristics than what they used to own?

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I'd agree with that. As an example, ROP has spent $11 bn on acquisitions in the last ~9 years to grow FCF from $471 mm in 2010 to $1.3 bn today. Meanwhile, EV/rev has more than doubled (~8.5 now from ~3.5x in 2010) and EV/FCF has nearly doubled (upper teens in 2010 to low 30s today).

 

This kind of napkin math misses a lot. What are the assets that they bought? Do they have different economic characteristics than what they used to own?

 

Suppose it depends on whether or not you include intangibles and goodwill in your ROIC calcs...yes they've bought more software/higher ROIC assets, but that's still $11 bn in cash out the door...what would the FCF CAGR have been without those acquisitions over the last decade? Is 8.5x revenue a reasonable price to pay?

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Valeant had all kinds of BS reasoning about how great their assets were - "cash pay", not government insured, "brands", "low-R&D", "big pharma does not participate here", etc. One fine day, Philidor appeared in the news.

 

Whether the purchased assets are truly long-lasting like a railroad, or whether they need to be replaced in a few years will be known only to people who work in that industry IMO.

 

I'd agree with that. As an example, ROP has spent $11 bn on acquisitions in the last ~9 years to grow FCF from $471 mm in 2010 to $1.3 bn today. Meanwhile, EV/rev has more than doubled (~8.5 now from ~3.5x in 2010) and EV/FCF has nearly doubled (upper teens in 2010 to low 30s today).

 

This kind of napkin math misses a lot. What are the assets that they bought? Do they have different economic characteristics than what they used to own?

 

Suppose it depends on whether or not you include intangibles and goodwill in your ROIC calcs...yes they've bought more software/higher ROIC assets, but that's still $11 bn in cash out the door...what would the FCF CAGR have been without those acquisitions over the last decade? Is 8.5x revenue a reasonable price to pay?

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I'd agree with that. As an example, ROP has spent $11 bn on acquisitions in the last ~9 years to grow FCF from $471 mm in 2010 to $1.3 bn today. Meanwhile, EV/rev has more than doubled (~8.5 now from ~3.5x in 2010) and EV/FCF has nearly doubled (upper teens in 2010 to low 30s today).

 

This kind of napkin math misses a lot. What are the assets that they bought? Do they have different economic characteristics than what they used to own?

 

Suppose it depends on whether or not you include intangibles and goodwill in your ROIC calcs...yes they've bought more software/higher ROIC assets, but that's still $11 bn in cash out the door...what would the FCF CAGR have been without those acquisitions over the last decade? Is 8.5x revenue a reasonable price to pay?

 

The question is, going forward, are those businesses of higher quality? Do they have stickier/more recurring revenues, higher margins with room for operating leverage, fewer needs for capital to grow or even negative working capital dynamics, self-reinforcing network effects in their industries, larger TAMs/higher terminal value, more opportunities to do accretive bolt-ons, etc. Some businesses are worth higher multiples than others because they'll produce more cash over their lives, and you can't know that by taking just a snapshot and looking at the short term. You have to understand the businesses, not just look at aggregate numbers, to understand a company like this one.

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Valeant had all kinds of BS reasoning about how great their assets were - "cash pay", not government insured, "brands", "low-R&D", "big pharma does not participate here", etc. One fine day, Philidor appeared in the news.

 

Whether the purchased assets are truly long-lasting like a railroad, or whether they need to be replaced in a few years will be known only to people who work in that industry IMO.

 

Every acquirer is like valeant. Noted.

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Great find. What I find interesting is comparing those EV/revenue numbers (which curiously are 2012 estimates, as he writes the post in May 2011) to today's market. I looked at some of today's highly-valued (EV/rev) R1K names, and was surprised to see Heico at 8x revenue! Gross margins have hovered around 35-40% over the last 15+ years, revenue growth has averaged 13% annually ($171 mm in 2001 to $1.9 bn today, boosted via $2 bn cash spent on acquisitions).

 

Quite the ramp in EV/revenue over the last six years. Not sure what's different about the business over that time. EBITA margins are a bit higher in recent years, but they're 25% today vs 23% in 2001. The market historically valued the business at 2-3x revenue, now 8.6x. Not meaning to pick on Heico in particular, just a name that jumped out at me that seems hard to justify valuing at nearly 10x revenue (plus, the 10 year today is roughly where it was in 2011-2012)...

 

I believe the increased valuation in some stocks is due to the rush into compounders. I believe after one of the longest economic expansion in modern history, a lot of companies look like compounders, but are more cyclical than they seem. We will see after the next recession.

Since many of them are roll ups (albeit well run roll ups), there is also reflexivity at work, such that a high valuation enables faster growth through acquisitions, due to lower cost of capital.

 

Example are Heiko, ROP, DHR, TDG, ROK. They are well managed companies well worth keeping an eye on, but the valuation is a couple of bridges too far, since investors now discount many years of current growth rates into their stock prices.

 

I'd agree with that. As an example, ROP has spent $11 bn on acquisitions in the last ~9 years to grow FCF from $471 mm in 2010 to $1.3 bn today. Meanwhile, EV/rev has more than doubled (~8.5 now from ~3.5x in 2010) and EV/FCF has nearly doubled (upper teens in 2010 to low 30s today).

 

 

ROP acquisition targets aren’t cheap - the last one was done at around 17x EBITDA, so that keeps ROIC down. However, their return on tangible capital is very high due to the asset light business model. They can pay the high prices, because their cost of capital is  very low, due to their high  valuation and because debt is very cheap.

 

Nevertheless, the comparison with Valeant doesn't hold water - ROP leverage isn’t high and they don’t buy cigar butts (at least they haven’t so far)  to milk cash. my concern is simply with the valuation and the suspicion that some of their business lines may be more cyclical than thought.

 

The one company they I am a bit suspect of is AVGO, especially after their pivot into acquiring software companies (and low quality one at that - CA Technologies).

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Great find. What I find interesting is comparing those EV/revenue numbers (which curiously are 2012 estimates, as he writes the post in May 2011) to today's market. I looked at some of today's highly-valued (EV/rev) R1K names, and was surprised to see Heico at 8x revenue! Gross margins have hovered around 35-40% over the last 15+ years, revenue growth has averaged 13% annually ($171 mm in 2001 to $1.9 bn today, boosted via $2 bn cash spent on acquisitions).

 

Quite the ramp in EV/revenue over the last six years. Not sure what's different about the business over that time. EBITA margins are a bit higher in recent years, but they're 25% today vs 23% in 2001. The market historically valued the business at 2-3x revenue, now 8.6x. Not meaning to pick on Heico in particular, just a name that jumped out at me that seems hard to justify valuing at nearly 10x revenue (plus, the 10 year today is roughly where it was in 2011-2012)...

 

I believe the increased valuation in some stocks is due to the rush into compounders. I believe after one of the longest economic expansion in modern history, a lot of companies look like compounders, but are more cyclical than they seem. We will see after the next recession.

Since many of them are roll ups (albeit well run roll ups), there is also reflexivity at work, such that a high valuation enables faster growth through acquisitions, due to lower cost of capital.

 

Example are Heiko, ROP, DHR, TDG, ROK. They are well managed companies well worth keeping an eye on, but the valuation is a couple of bridges too far, since investors now discount many years of current growth rates into their stock prices.

 

I'd agree with that. As an example, ROP has spent $11 bn on acquisitions in the last ~9 years to grow FCF from $471 mm in 2010 to $1.3 bn today. Meanwhile, EV/rev has more than doubled (~8.5 now from ~3.5x in 2010) and EV/FCF has nearly doubled (upper teens in 2010 to low 30s today).

 

 

ROP acquisition targets aren’t cheap - the last one was done at around 17x EBITDA, so that keeps ROIC down. However, their return on tangible capital is very high due to the asset light business model. They can pay the high prices, because their cost of capital is  very low, due to their high  valuation and because debt is very cheap.

 

Nevertheless, the comparison with Valeant doesn't hold water - ROP leverage isn’t high and they don’t buy cigar bits (at least they haven’t so far)  to milk cash. my concern is simply with the valuation and the suspicion that some of their business lines may be more cyclical than thought.

 

The one company they I am a bit suspect of is AVGO, especially after their pivot into acquiring software companies (and low quality one at that - CA Technologies).

 

You can look at some of the older businesses that ROP owns, mostly the old industrial/energy stuff, and even after like 20 years of no acquisitions in those segments, the businesses keep getting better. They have like 30%+ EBITDA margins on these industrial businesses, and they didn't start there at all. These segments that haven't had any M&A have also grown organically a lot during that period (the energy stuff was hit in the recent crash, but that's normal in more cyclical industries.. over the cycle they did well). So the idea that they're buying declining assets and somehow hiding that like Valeant did doesn't make much sense.

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