In my last post, I covered the first two of five themes for value investing in Enterprise SaaS stocks–which should strike you as a bit of an oxymoron–and is. Nevertheless, here are the remaining three enterprise SaaS value investing themes:
3. Misunderstood Stocks (WTFs?)
4. Poor to Great Execution Stocks (GYSTs)
5. Dreamland/Short-sell Stocks (NFWs)
Misunderstood Stocks (WTFs?)
In hindsight, it’s always easy to identify an enterprise SaaS company that was misunderstood. If the stock went up, it was misunderstood! A more useful approach is to determine the root causes that cause stocks to be undervalued in the first place. I find several consistent themes as to why stocks can be misunderstood:
- Poor investor relations and few or no analysts covering the stock. This is common in the micro-cap sector.
- Multi-sided platforms are a relatively new phenomenon. Often their monetization potential is not well understood. Google, Visa and MasterCard, and LinkedIn, initially suffered from this. (For instance, few people outside the credit card industry understand how much credit risk and grunt work Visa and MasterCard have successfully “pushed out” to the rest of the ecosystem.)
- Multiple businesses, with different economics and where one of the businesses is a buried treasure/network are one of my favorite finds. (This was the case at Ariba.) The market often overvalues a clean story and undervalues a more complicated one.
- “Time Capsule” Problem. This is where the public has “anchored” on an old description of the company from (perhaps the bubble era) but the company is, or has, transitioned to something new. (Ariba was again a good example starting in 2005 until it was taken over in 2012 by SAP.)
Examples of misunderstood stocks I have owned (or still own) are:
- Pervasive Software (hat tip to David Maley, a great value investor at Ariel Investments and my brother-in-law). Pervasive was poorly followed and had multiple businesses, including a slow-growing old one and a new, big data tools business. Alas, they were taken over too early.
- Descartes Systems Group (DSGX) is poorly followed and has the time capsule problem from its bubble era implosion. (I still own this one.)
- ICGE now Actua, owned SaaS businesses and an outsourcing business, but was selling at a sum less than the two were worth. ICGE also had a bubble era stigma. (I sold this one when they sold the outsourcing business.)
- INTL FC Stone (INTL) is in multiple businesses, but has an interesting cross-border payments network. I still own this one.
- Cass (CASS) competes in the commercial payments space, but until a few years ago also highlighted their St.Louis commercial bank and church lending divisions.
- Avista (AVA) is a utility which paid me a nice dividend while I waited for it to sell the interesting software business, Ecova it owned. It’s been a reasonable buy, but AVA sold Ecova for less than I had hoped. Turns out Ecova was more managed service than software, oops.
Poor to Great Execution Stocks (GYSTs)
This theme applies to companies executing poorly in a fundamentally attractive market. (GYST stands for “Get Your Sh-t Together”). I do not have many examples of investing along this theme, because you really need to know the management involved intimately to trust their ability to turn it around. One example that worked out decently was Constant Contact (CTCT). CTCT was brought to me by Peter Goldmacher formerly of Cowen. (This is the third good one he gave me, Intuit and DealerTrak being the others.)
CTCT was in the SMB e-mail marketing space, a crowded, but fast-growing space. CTCT was making the transition to broader marketing automation, as everyone in that market was. The rest of the players were getting all of the attention, while CTCT was falling behind. CTCT was selling at revenue and EBITDA multiples of 1/2 to 1/3 the other players in the market. Goldmacher convinced me that the management team had changed and was going to use their data to figure out how to cross-sell the new modules and raise ARPU and retention. They did.
I bought CTCT at the end of 2011, which was a little too soon. It took a year for the new team to demonstrate results, which I should have known, but it still ended up fine. Here are two charts: one of their stock price over that time frame versus the NASDAQ and their ARPU over the same time frame.
Dreamland/Short-Sell Stocks (NFWs)
I almost never short-sell stocks. It’s not nice and I do not like to root against management teams building enterprise platforms. It’s a tough slog to build one of these companies; additional naysayers are unwelcome. Occasionally, though, an enterprise SaaS stock’s valuation reflects growth rates that are just not possible in B2B. (B2B SaaS plays can grow for a very long time at 30%+ rates but 80% rates are impossible to sustain.) If I feel management has over-hyped a stock, I’ll see if I can sell some.
At one point I was successful selling Textura (TXTR) short. I had no beef with management, the stock had just gone crazy in a very tough space: construction management and payment software. (Dumb luck had it that a nasty short-seller accused management of all sorts of crazy stuff right after I sold short. That experience soured me on short-selling even further.) The same fate befell Tungsten on the London Exchange. I was unable to short a London traded stock so I missed this one. When unprofitable, $30 million companies growing at under 50% annually, start to sell at 20x+ EV/sales ratios (true in both of these cases), it is at least time to stay away.
Summary: Value Investing Enterprise-Style
Since it has been over two blog posts, I’ll summarize the five themes I’ve found in trying to reconcile value investing with the ever-so-hot enterprise SaaS sector:
- Transition to SaaS Stocks (Jenners)
- Network at a Reasonable Price Stocks (NARPs)
- Misunderstood Stocks (WTF?s)
- Poor to Great Execution Stocks (GYSTs)
- Dreamland/Shortsell Stocks (NFWs)
Please add your own examples!