We didn't work
The news that Adam Neumann is stepping down as CEO of WeWork and that the initial public offering is delayed, provides me the perfect opportunity to weigh in on a subject that has been well discussed by the media in recent months, that of private company valuations. It should come as no surprise that our perspective on this subject is slightly different than what is currently being discussed. There are two private markets.
My thoughts on the evolution of the public equity markets also influences how we analyze companies. I am not referring to the actual construct of the markets, rather I focus on the theoretical interactions between two individuals on either side of an investment transaction. Say an individual came up with a plow that was superior to any at that time, and would save the farmer time. His neighbor likely asked him to build him one. As word got out about this superior plow, demand increased. The plow inventor did not have enough capital to buy all the product to build them, nor did he have the time. He therefore approached his local bank and got a loan. The bank did it's due diligence focusing on the risks of non payment. Soon the inventor became concerned that if another better plow came along, that their family would be at risk for the repayment of those loans. Not being the greedy type, he realized that he could sell part of his profits/company to his neighbors and bring in money to offset the liabilities he had to the bank. When he approaches the neighbor the response he gets is likely, how much will be my share of the profits, not can we sell this to someone else for a higher price later. When the plow inventor ran out of neighbors, someone figured out there is a business connecting owners and capital, and an infrastructure developed underneath it to support the transactions.
The other private market that may not have immediately come to mind is that of public companies being taken private. Most transactions are based upon the cash flows available to shareholders. We believe that those cash flows should provide a return equal to, or exceeding, the expected risk based returns of equities as a whole. This is a very important component of our philosophy and process. That is why we focus so much on fundamental analysis and manage focused portfolios. The pre-ipo private markets are focused on what the next investor will pay, thus making the two very disparate. I mentioned in a previous blog how I am by nature very fiscally conservative, and thus our philosophy is born. I do believe, however, that our philosophy and process is the more repeatable over time as it is less subject to behavioral overlays, and math is math.