Right now, value investing in enterprise SaaS is like “jumbo shrimp”, “Kentucky senior”, or “random order”— an oxymoron. SaaS companies sell on the basis of top-line growth rates—not much else matters. If investors believe current growth rates can be sustained, stock prices are stratospheric by any value investing yardstick. In SaaS stocks, the best value you can hope to find is usually “growth at a reasonable price”.
By nature, I’m a value investor. I grew up worshipping Warren Buffett and sitting on the board of Ariel Investments (run by great value investor and friend, John Rogers). I love overlooked businesses with a wide moat, but which are undervalued. How do I reconcile value investing with fast-growth enterprise platforms that are potentially building wide moats–but stacking up enormous losses on a GAAP and non-GAAP basis? Usually by missing out on all of the profits—that’s how! (Just like Buffett and Rogers who, to be fair, still have great records.)
Value Investing Themes for Enterprise SaaS
I have had a few winners in lower-priced, enterprise SaaS companies. I find they tend to fall into one or more of the following themes, each with their own nickname:
- Transition to SaaS Stocks (Jenners)
- Network at a Reasonable Price Stocks (NARPs)
- Misunderstood Stocks (WTFs?)
- Poor to Great Execution Stocks (GYSTs)
- Dreamland/Short-sell Stocks (NFWs)
For each theme, I’ll provide historical examples and some stocks I currently hold. My three disclaimers are:
- I view investing in individual stocks as a legalized form of gambling. (My father taught me to read the Daily Racing Form at about age 7, so I learned to love handicapping horses, but the Wall Street Journal is cheaper than the Form and Charles Schwab’s offices are nicer than the track.) I invest in these stocks for fun, not to make a living.
- I especially love micro-and small cap stocks where the data shows market inefficiencies are more likely to exist.
- Most of my investing in these stocks started in 2011. Almost everyone has done well since then!
Transition to SaaS Stocks (Jenners)
As Bruce Jenner will tell you, transitions in the public eye are difficult. Public investors do not like to wait for a licensed software company to transition to SaaS. Loss of license revenue comes faster than the build-up of subscription revenue. The rest of the cultural and technology transition to SaaS is also difficult—not unlike gender transitions. But, if you can find a company that has the right people, buying during the transition and being patient can be very rewarding.
I saw this phenomenon at Concur (CNQR) (and did not buy), Ariba (where I worked and did buy), and Intuit (INTU) (which I did buy, thanks to Peter Goldmacher formerly of Cowen, now of Aerospike). Along this theme, I currently own ClickSoftware (CKSW), which is an Israeli company in the field service management market (think ServiceMax), but is making the transition from license to subscription. (George Soros bought into CKSW after me, so I have a good investor on my side.) I’m not sure if CKSW can execute, but the 2.25% dividend made me a little more willing to accept the risk.
Network at Reasonable Price Stocks (NARPs)
Enterprise SaaS companies are great, but those building a defensible network are even better. The Holy Grail in business as Warren Buffett has taught me, is pricing leverage. A company that can raise prices, still keep their customers and attract new ones, can generate future profits predictably. For Buffett, great brands or great scale provide this leverage. For Enterprise SaaS companies, industry dominance can also provide pricing leverage. There are only a few cell networks, ATM networks, cable networks, search engines, PC/Mobile operating systems, rail networks, etc. Any time you can own one of the future winners in a market with “winner-take-all” characteristics, you are going to do just fine.
When Google, MasterCard, and Visa went public, they were examples of dominant networks at a reasonable price. (Remarkably, these networks were also poorly understood). I sat out these IPOs, even as my wife told me to step up and be a man. On the other hand, I bought Medidata (MDSO) given its dominance in clinical trials and DealerTrak (TRAK) in auto retailing (again, thanks to Peter Goldmacher). I made good money on both, but gave both to charity way too soon. No good deed goes unpunished.
Right now, most of the stocks in this theme are expensive. The only stocks I own from this theme are:
- Amadeus (AMADY) (one of three GDS systems)
- NationalCinemedia (NCMI) (ad network owned by a movie theater consortium; great yield)
- Inovalon (INOV) (which I think was underfollowed; may have a big data moat in healthcare)
- Premier (PINC) (which is not as much software, as it is the largest healthcare GPO)
The rule of thumb for this theme is simple: Will the FTC ever want to review this company’s activities or proposed mergers? If so, you have a winner. (See Sysco, Google, Microsoft, Visa, MasterCard, Amex, NCMI, and Premier.)
This post is getting a bit long, so I’ll continue with the other three Enterprise SaaS Value Investing Themes in the next one.