Introducing Maven Funds Management

Thank you all for your support. Over the past year many of you have written in to express your interest in what I will be working on next. I have always said that as a subscriber to this website, you will be the first to know when I have something to release publicly. That time is now.

I have founded the investment management company, Maven Funds Management, where I will be the Chief Investment Officer. I will be investing the majority of my family’s total wealth in to the fund, alongside our clients. 

Introducing Maven Funds

As I prepared to leave my prior role as Portfolio Manager of Motley Fool Pro I expected to only manage investments on behalf of my family and close friends. Perhaps over time I would advise a few private clients. 

When I officially announced my departure from Pro that plan began to change. I was blown away by all the messages of support and thanks. Many of you wrote in to share how much you’d developed as investors, and how your family’s financial well-being had improved. Several of you emailed personally to share how your investment portfolio had allowed you to give back to your community, including some incredibly generous gifts to charity. It is a privilege to know that our investment advice had contributed to that in some small way. 

I was honoured and deeply humbled to receive those messages of support, which were easily the highlight of my professional investment career. They also planted the seed for creating something new.

I wanted to take my time to design my ideal investment vehicle for long-term investing. First, because it is important to get the right structure for you, our clients. But also because I knew I would be investing the majority of my family’s wealth in to the fund, and that I would plan to operate it for many years to come. In our view, there are a few problems with the traditional investment management industry that we wanted to address. 

The problem

As the recent Royal Commission demonstrated, the financial services industry is deeply conflicted. Most advisors will happily sell their clients a product that they won’t invest in themselves. Most fund managers are more concerned with protecting their salary than creating value for clients. Most portfolio managers lack the patience to hold for long-term gains, because they are impatiently chasing quarterly returns. 

Setting aside the conflicts, there is also a problem of strategy. Many portfolio managers that invest in growing companies, have no method for how to value a business. They end up overpaying, or over-trading, jumping from one hot momentum stock to the next. Meanwhile many traditional value investors have not adapted to a changing world where wealth-creation is driven by intangible assets like software and networks. Both of these strategy mistakes negatively impact their client’s returns. 

I also knew that I wanted to keep all of the strengths of the Pro portfolio: our investment approach, our patience and long-term focus, our combination of a growth-mindset with valuation discipline, and most importantly our savvy client base. However I wanted to address the challenge of entering and building positions while limiting our price impact.

Our Solution

Maven is different. We adopt an investment strategy that combines high-quality growth businesses, with valuation discipline and smart portfolio management. We invest the majority of our investment team’s personal wealth in to our funds, right alongside you, our clients. Lastly, we will closely monitor the capacity of our fund, and limit our capital base when necessary. 

There are four pillars of our investment approach that you can read more about at the Maven Funds website. For those of you that are former clients, or have been regularly reading this blog, the investment strategy will be very familiar. 

There is one pillar that I would like to dig in to further, which is you, our clients. We are extremely grateful for the support that we have received over the past year. Your long-term focus is the bedrock of our ability to find and hold the champion companies of tomorrow. We have many business owners, professionals and other domain experts amongst our subscriber base. For those willing to share, we will be finding ways to put that collective knowledge to work for the benefit of all of us.

Finally, I am very pleased to share that Travis Mays will be joining us for the launch of Maven Funds as a Research Analyst. Trav has a huge amount of energy and a passion for investing. He also brings an engineer’s first-principles approach to investment problem solving and research that is very valuable. You can read more about Trav’s investment style in the Team section of our website.

Register your interest 

If Maven Funds Management sounds like it may be of interest to you, I would like to invite you to register your interest today.

Over the next few months Trav and I will be releasing a lot more investment research, analysis, attending investment conferences, and sharing video insights. We’ll also get into all the specifics of our fund closer to launch. 

Thank you all for your support and interest, and if you have any questions please don’t hesitate to contact us here: contact@mavenfunds.com.au.

How to Catch A Monster

Over the past 22 years, the shares of Monster Beverage (NASDAQ:MNST) — best known for its large cans of Monster brand energy drinks — increased in value by a mind-numbing 2,300-fold. That is almost too big of a number to wrap our heads around, so let’s put it like this: for every $10,000 invested in 1997, a shareholder that held on would be sitting on $23,200,000 today.

In 1997 that $10,000 could have bought a decent second-hand car. Today, after investing in Monster Beverage it would buy them a helicopter to go with their cliff-top mansion.

Monster Beverage is one of my favourite investment stories of the last few decades. It’s not just because of the spectacular returns. It’s because it was an easily understood business, and at several points in its journey, clearly undervalued. Monster Beverage demonstrates a particular path to massive wealth creation for shareholders. A path that doesn’t require lucky flukes, or taking huge risks. 

Monsters

While most of the market is mired in mediocrity, there is a small group of companies that generate insane returns for shareholders. I call these companies Monsters for the way they dominate their industries and transform portfolios. A few years ago I set out to study these huge monster winners, reading books like ‘100 to 1 in the Stock Market‘ and trawling through Standard & Poors data to see if I could identify any common traits. Most importantly, I wanted to see if it was possible to identify these winners early, before they started their huge run, and the rest of the market caught on. 

The Four Steps

As I see it, there are four steps to catching a Monster:

  1. Choose your hunting ground – avoid pretenders to the Monster throne.
  2. Catch your monster – identify key traits.
  3. Watch closely – continuously monitor and sell quickly if your thesis is broken.
  4. Hold on – be able to stomach the volatility without selling too early.

I’ll talk through each step in turn.


Watch this Space:

In the next few weeks I will be announcing an exciting new project. I will also be sharing more detailed breakdowns on the investment lessons behind these companies. If you know someone that would be interested to follow along, invite them to subscribe for updates. And if you haven’t subscribed yourself yet, get cracking!


Choose your Hunting Ground

Investing is an art of negative space. What you don’t buy is at least as important as what you do. The best investors say no to potential ideas early and often.

The vast majority of companies have no shot at generating monstrous returns. These businesses should be avoided entirely. They are either struggling to keep the lights on, or they have already begun their long descent into obscurity. If you buy mediocre businesses you’re not going to be able to capture the kind of returns we are seeking.

But there are also four other types of companies that can generate big returns, that I don’t count as Monsters. These are companies that rely on luck or high risk. And for that reason, even though they can deliver high returns, I still avoid them:

Lucky speculations

If these companies had a motto, it would be: ‘it’s better to be lucky than good’. There is nothing wrong with being lucky, but it’s not a repeatable strategy. Winning the lottery 5 times in row is pretty rare.

Speculative mining companies are the archetypal example. Every now and then some bonfire for shareholder capital actually manages to strike oil/gold/lithium and hits the big time. There’s a reason Australia is called the Lucky Country, and there are plenty of these stories around. The problem is that there are several hundred speculative miners on the ASX. The vast majority of these businesses are cash-infernos. Accurately forecasting winners in that space is almost impossible. 

Speculative biotech and pharmaceutical research companies are a similar breed. At least they are attempting to do something more useful than put holes in the ground. But good intentions don’t equal a good investment. 

I avoid these speculative ‘lotto tickets’ entirely. Good luck to all players. Not my game. 

Commodity price swings

These are companies that soar due to a sharp change in the supply-demand ratio for a basic commodity. The commodity price rockets, taking the company’s shares with it. 

This tempts many otherwise smart investors: use your big brain to identify some commodity that will be in high demand, and buy the producers of that commodity before the price rises. In practice, it is extremely difficult to forecast these commodity price swings, and even harder to profit from them. Increased demand typically brings in legions of new suppliers, which ultimately send prices crashing back to earth faster than a lump of unwanted coal. 

If you think you can forecast commodity prices well enough to pull this off reliably, you should probably be day-trading commodity futures. Good luck with that. 

Highly-leveraged businesses

Companies which have a huge amount of debt can have some interesting properties. If the debt is large enough, and the business manages to avoid being crushed under its own weight, it acts as a big amplifier of returns, good or bad.

The math of leverage explains why. If a business has total debt of $90m, and a market cap of $10m, we would say it has an enterprise value of $100m. If the business doubles in value to $200m, this extra $100m of value would all go to the equity i.e. to shareholders. So a 100% increase in business value results in the company’s market cap increasing ten fold to $100m, and the shares soaring 1,000%. 

On the other hand, if the business’ value falls by even 10%…

These highly leveraged companies can be very profitable for shareholders, but the leverage is a double-edged sword. If things don’t work out these companies’ share prices face a large ‘crash risk’, and the sword stabs its owner in the leg. The debt can even overwhelm the company and push them in to bankruptcy.  

I like my thai food spicy, but not my shares. Pass.

Back from the brink of bankruptcy

These are zombie companies that were once on death’s door and have now re-entered the land of the living. Buying companies that are going through a panic, or financial distress, can be a winning strategy if the business makes it out the other side.

In times of significant market panic even great companies can be priced like they are going out of business. That would get my attention. But generally speaking, I will leave the zombie wars to others. 

That’s four categories I avoid, now let’s talk about true Monsters.

Catch Your Monster

Monsters are businesses that deliver huge shareholder returns by compounding high returns on invested capital. These businesses generate strong free cash flows, and most importantly, the business is able to reinvest those cash flows at high rates, and for a very long time. That reinvestment has a compounding effect over time, with the company’s value building up faster than a snowball rolling downhill. 

Altium, Appen, a2 Milk etc. all fall into this camp. I have found there are four key traits these monsters tend to have at the start of their journeys: 

#1: They start out small

This might be an obvious one, but it’s important. It is much easier for a company to increase in value 100-fold or more, if it is starting from a low base. Today Amazon is valued at $900 billion. The shares are up 1,200x because the company started off small. For Amazon to increase another 1,200x from here would give it a market cap of over 1 quadrillion dollars. That’s a sum so large it is greater than the value of every financial asset on earth. Jeff Bezos has some ambitions for Space exploration so perhaps we shouldn’t write it off. But it is safe to say that growing gets tougher the bigger you are. 

This is why I focus on fast-growing small companies with long growth-runways ahead. 

#2: Unique edge

The company must have some kind of durable competitive advantage that forms a barrier to competition. This barrier allows the company to earn those high returns on invested capital, and to ensure that those returns are not eroded over time by new competitors. 

These advantages can come in many forms. They include consumer brands, patents, intellectual property, switching costs, economies of scale etc. The most powerful edge usually comes when a company combines both demand advantages and supply advantages. The very best businesses are then able to link these two edges together in a positive feedback loop or ‘flywheel effect’. 

My goal is to identify companies with these competitive advantages, and where the advantages are increasing over time. 

#3: Superior Management

The importance of high quality management is magnified in a small fast-growing company. If the captain of a large ocean liner steers the boat off course, it takes a long time for the effects to be felt. But if a small speed-boat captain turns the wrong way, they can quickly find themselves on the rocks. 

We need a management team that thinks long-term, and has the vision to understand their competitive playing field. This is why we focus on identifying high-quality and aligned management teams. Ideally the founders are still in charge, or management at least hold a large number of shares and behave like owners. 

Assessing management is so important to my process that it is very rare that I haven’t met with a management team before buying shares, and often I meet with them several times before becoming comfortable enough to initiate a position. 

#4: Misunderstood

I left this for last because it is the most important. There is no business so beautiful that it can’t become an ugly investment at the wrong price. 

To achieve truly spectacular returns, a company has to start off with a valuation that does not fully reflect its market-thumping future. Ideally it will begin its journey with a valuation that is downright cheap, and then the market’s rising expectations will add a multiplier effect to its growth. 

Ultimately the most important step in determining whether to add a potential Monster to the portfolio is to assess its intrinsic value and then to buy at a significant discount to that valuation. And to be undervalued is to be misunderstood. 

Whenever we are deciding to buy a business we are asking ourselves what our variant perception is compared to the market. What do we believe that the market disagrees with us on? Perhaps the market doesn’t think that growth will stick around for as long as we do. Maybe it’s not giving credit for new products or geographies. Whatever the reason, their mistake is our potential to profit. 

Buying companies at a discount to their intrinsic value is at the core of all sensible long-term investing, Monster-hunting is no different. 

Watch closely

The price of catching monsters is eternal vigilance.

Once you have caught your monster, the next step is to clearly articulate your thesis at the time of purchase and then regularly review that thesis as new information comes to hand. Actually writing out your thesis is important.

Not every company that I thought had Monster potential actually delivered. So a core part of my strategy has been to sell quickly when my investment thesis has been invalidated. Class Software is the clearest example of being willing to cut bait quickly when a thesis is broken, as I covered in detail in The Selling Blindspot

Hold on tight

Catching Monsters takes patience. But even more than that, it requires conviction. 

Holding on to a company is much tougher than just passively waiting for the cheques to come in. It means enduring the pain of seeing your company’s share price fall and fall, and maintaining the conviction that it will come out the other side stronger. There is a critical tension here between holding on and selling quickly. The deciding factor is your investment thesis. If it is intact, hold on and ignore the market’s price swings. If the business’s quality is eroding, be prepared to sell quickly.

This is what I like to call a ‘pain chart’, inspired by a Morgan Housel article, for a2 Milk. This chart shows when, and by how much, a2 Milk shares were below their all-time high. (Periods at 0% show when shares hit a new all-time high). Remember, this was during a period when shares increased more than 1,600%:

There have been five times when a2 Milk’s share price fell 20% or more. And on two occasions the shares fell by 30% or more. To enjoy the monstrous gains to date shareholders needed to avoid giving in to fear and selling during those troughs of despair. Those shareholders also needed to avoid the temptation to lock in a profit when the shares were up 30%, 100%, 500%, or even 1,000%. 

To hold for that wild ride, investors need to develop, and maintain, a high level of conviction that their investment thesis is correct. Then, ultimately, they need to be proven right.

Most of the market is incredibly short-term oriented. This applies to individual traders as well as large fund managers. These investors are always trying to own the hottest-stock-this-quarter while missing the 100x Monster that is growing beneath their feet. 

If you can tune out the market’s noise you will separate yourself from the others. 

Vision, Courage, Patience

Catching Monsters is hard. Our view of the future is cloudy at best. The power of compounding means that the biggest winners will create most of their value many years, or even decades, from today. Forecasting that far in to the future is not easy.

Investors need the imagination to be able to think big. To visualise how the company could be performing in the distant future. But then they also need the discipline to bring that big vision back to the reality of the present day, and value it appropriately. That marriage between lofty big picture thinking, and the cold hard facts of present day valuation, is tougher than it sounds. 

“To make money in stocks you must have ‘the vision to see them, the courage to buy them and the patience to hold them’. Patience is the rarest of the three.”

100 to 1 in the Stock Market author Thomas Phelps expanding on a quote from financier George F. Baker.

If you can demonstrate those three qualities: vision, courage, and patience, you have a shot at aligning your portfolio with these unstoppable engines of wealth creation. The ride can be bumpy, but it’s also a heck of a lot of fun.

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Disclosure: No part of this report, or disclosure, should be considered to be a recommendation or financial advice. At the time of publishing, Matt holds shares in a2 Milk. Holdings are subject to change at any time. 

Pushpay: The Art Of the Deal

Most acquisitions fail. Yet a few serial acquirers have created immense value for shareholders. What makes the difference? Can we separate the good deals from the bad eggs before they are announced? Let’s take a look at a live example.

Pushpay’s Profit Inflection Point

Pushpay tipped passed a fundamental inflection point earlier this year as the business scaled in to cash flow positive territory. The market’s reaction has been positive: the shares are up 43% from their December lows. Most of the Church giving software provider’s operating costs are fixed, so when revenue continues to grow from here, Pushpay is set to gush cash.

Source: Pushpay Annual Presentation

Pushpay gave operating profit (EBITDAF) guidance for the first time this year. Last week the company upgraded that guidance further to be between US$18.5 to US$20.5 million. Not bad considering that we are only three months into Pushpay’s financial year.

Pushpay has signaled that they will be using these cash flows to fund the acquisition of other software businesses in the faith sector. The platform is now at scale, so any incremental revenue Pushpay can add will fall to the bottom line faster than one of Scrooge McDuck’s money bags.

At Pushpay’s AGM earlier this week, the company’s new CEO Bruce Gordon, noted that the company is looking at several potential acquisitions that could add to Pushpay’s product suite and scale. Australasian banks have indicated they will be comfortable lending up to 3 times Pushpay’s EBITDA, which indicates a potential acquisition war-chest of US$60 million. Pushpay also has a few options to increase their firepower such as issuing the vendors with shares based on how the acquisition performs after purchase.

The Art of the Deal

News that a company is about to start making acquisitions should be taken with caution for one simple reason: most acquisitions fail.

Cultures clash, synergies no-show, and shareholder value is squandered. McKinsey found that only 17% of mergers deliver the revenue synergies that management were forecasting at the time of the deal. Meanwhile a KPMG study found that over 80% of mergers and acquisitions fail to create shareholder value. Those are rough odds. Statistically speaking, you’d get a fairer shake from a spin of your local pokie machine.

But acquisitions can be extremely successful. One of the best performing companies in the world has been built on a virtuous cycle of continuous acquisitions. Constellation Software’s shares are up 3,700% over the past 10 years alone, thanks to a smart, disciplined, and well-executed acquisition strategy.

So what separates the good deals from the bad eggs? Super-achieving acquisitions tend to share a few common traits. Typically the target company:

  • Has an employee culture that matches the acquirer (or can be successfully operated in a completely separate silo).
  • Delivers a new technology/product to the acquirer that saves development time, or adds scale.
  • Has sticky customer relationships with high switching costs (so that the newly acquired customers don’t run away if there are any stumbles).
  • Has genuine revenue and cost synergies with the acquirer.
  • Provides a new competency or other strategic value.
  • Is available at an attractive valuation.

That last point, valuation, is always the most important. Choosing the right target company matters a lot, but paying too much can turn even the sweetest milkshake sour.

So let’s review six of the company’s most likely acquisition options.

Option 1: The worst deal

The worst possible option in my view would be to purchase a business from Ministry Brands.

Ministry Brands is a private-equity backed holding company that has rapidly acquired a collection of 31 different faith-based software companies over the past few years. Ministry Brands is big. It reports to have 55,000 church customers and in 2017 generated over $100 million in EBITDA. That size is the result of an aggressive slash-and-burn acquisition strategy that is straight out of the private equity playbook. Ministry Brands buys a software company, cuts staff numbers to the bone, reduces investment, strips out any costs it can, and raises prices for customers.

That is never a beloved business model, and is particularly despised in the principles-driven faith-based software sector. Ministry Brands has a poor reputation with churches, and rock-bottom staff satisfaction. The approach is so disliked that some church software companies now publicly reassure clients that they are ‘not for sale’.

The private equity company that owns Ministry Brands is now looking for potential buyers, so the whole collection is potentially up for grabs. The entire package would be too big for Pushpay to purchase outright (excluding some insanely leveraged deal). However Pushpay could be tempted to purchase one or two of the 31 software companies that form part of the collection.

This would be the simplest deal to get done, since Ministry Brands is both experienced at these types of transactions and is a willing seller. But it would likely be a bad move. Pushpay would be buying from a sophisticated private-equity seller that has already done everything legally possible to squeeze all the juice out of the lemon before they sell it. It’s possible that there are some gems hiding in the dirt, and any asset can become attractive at a low enough price. But this deal should come with a big ‘Buyer Beware’ sticker. Avoid.

Deal rating: 3 out of 10

Option 2: Tackle the Innovator’s Dilemma

For many years Pushpay had a broad brush, signing up churches of all shapes and sizes. But in mid 2017 the company narrowed its approach, restricting its sales efforts to what it termed ‘Medium and Large’ sized churches. Medium churches are defined as those with over 200 weekly attendees, while large churches are those with 1,100 or more. The largest U.S. churches can have over 40,000+ weekly attendees.

This shift was probably the right call. At the time Pushpay was still in heavy cash-burn mode, and its internal analysis found that larger churches were vastly more profitable. These customers had bigger budgets, so could afford to pay more for Pushpay’s software, and generated higher payment processing fees. The bigger churches also tended to fully implement Pushpay’s giving solutions and admin platform, and so they had much higher retention rates. Pushpay calculated that small church revenue retention rates were just 80%, compared to over 100% for large churches.

Lastly, the weekly attendance of the largest ‘mega-churches’ has been growing fast as younger people prefer the energy and scale of a bigger church. That growth has come at the expense of the smallest churches, which typically see their weekly attendance slowly decline. Roll it all together and the large church segment is vastly more attractive for Pushpay.

So Pushpay stopped selling to small churches and focused their energy exclusively on larger clients. This allowed Pushpay to get to profitability faster, as has been demonstrated in the latest results.

But by doing so, Pushpay opened the door for a lower-cost competitor to target this small-church customer segment. This presents Pushpay with a potential Innovator’s Dilemma: when a small competitor is able to challenge a much larger incumbent by offering a lower-cost product. Initially the low-cost product is inferior, but over time, and with enough scale, the new upstart can sometimes challenge the incumbent on quality too. When a low-cost competitor can also sell a high-quality product, it’s often game over (just ask any business that has tried to take on Amazon head-on).

Enter Tithe.ly. Founded by a former pastor, Tithe.ly has a similar modern digital approach to donations management as Pushpay. I have been monitoring the company since 2016, and for many years Tithe.ly was not a concern. It was sub-scale and severely under-funded. The company’s low prices and small church clients meant that it could not afford to invest in sales, product, systems, or customer support on nearly the same scale as Pushpay. Tithe.ly had not raised meaningful capital, and as of April 2017 was processing just ‘tens of millions’ of dollars in donations, compared to the billions that Pushpay was processing each year.

Pushpay’s exit from the small church segment changed all that. Pushpay’s sales machine was no longer targeting the small churches, which allowed Tithe.ly to hoover up thousands of these customers over the following years. Tithe.ly has used this new found momentum to raise meaningful capital, starting with two US$2m funding rounds in 2017 and 2018. Then in March of this year Tithe.ly raised a USD$15 million funding round, which valued the company at USD$129 million. Tithe.ly plans to use the cash to hire up to 30 more engineers over the next year to build out its platform.

Today Tithe.ly counts over 10,500 churches as customers and is reportedly growing fast. These small church customers are significantly less valuable than Pushpay’s, so in total giving and revenue terms Pushpay is still many multiples larger. But the recent funding round, and the potential for Tithe.ly to disrupt from the low end, makes it a very credible threat to watch.

Pushpay could respond to this threat in a few ways. It could continue to focus its energy on robustly defending the Medium and Large church segment. If Pushpay can make its product sticky enough, it may be able to avoid low-end disruption altogether. Some of the other acquisition options we will talk about later can help this.

Alternatively, Pushpay could launch its own low-cost brand. Airlines have been using this strategy for years (think Qantas and Jetstar) with mixed success. This has the advantage of being cheaper, but could easily distract management.

An even bolder move would be to acquire Tithe.ly outright. But given the culture clash of premium Pushpay and low-cost Tithe.ly, the acquisition would likely flop unless they were able to run the two businesses independently. Also the tech startup scene is frothy, so Tithe.ly’s valuation may already be outside Pushpay’s budget.

This deal would have the potential to solve a major long-term challenge, but it would come with a lot of risk. Whether it is by acquisition, or other means, Pushpay need to be taking this Innovator’s Dilemma threat seriously. One to watch.

Deal rating: 6 out of 10

Option 3 – Go vertical: Buy a Church Management System

At the core of every large church is a Church management system or ChMS. These are similar to an enterprise resource planning system. A ChMS allows the church to do everything from manage their services, keep track of child check-ins, and roster volunteers. It’s an integral system of record, with very high switching costs.

Pushpay’s giving solutions integrate with numerous ChMS’s. Until now, Pushpay has avoided offering its own ChMS so that it is not competing with its own distribution channel. But as the market has matured it has become more common for payments providers to do both.

There are numerous potential ChMS’s that Pushpay could acquire. Church Community Builder (CCB) is a ChMS that Pushpay has had a longstanding relationship with, and which serves over 4,000 church clients. However CCB’s software stack is outdated and generally not up to the premium quality of the rest of Pushpay’s products. The move here would be to acquire the business primarily for the sticky customer relationships. Pushpay could cross-sell its giving product to those CCB customers that don’t already have it, and then modernise the software itself over time.

Another approach could be to buy a ChMS which is smaller but has more modern tech. The software would be up to Pushpay’s standard much more quickly, but with the trade off that there are fewer customers on day one.

The dream purchase in my view would be a ChMS like Planning Center which is growing fast, has over 50,000 church customers, and a very clean and modern user interface. Planning Center has no sales team, it reinvests all its cash in to product development. Planning Center’s product is modular with nine different products that can be sold individually. This makes it a great complement to Pushpay who could let their formidable sales team loose with a high-quality product suite. It does raise the risk of a culture-clash, but given the other strategic similarities this may not be such a big deal. Unfortunately Ministry Brand’s slash and burn approach to acquisitions has led Planning Center to publicly declare to clients that it is “not for sale” so it may be tough for Pushpay to win over the founders.

In any case, acquiring a ChMS would significantly deepen Pushpay’s relationship with its customers, boosting retention rates and increasing switching costs. It would also give Pushpay the opportunity to market a new product to its existing clients.

Overall it’s a solid acquisition opportunity. But I would caution against purchasing a sub-standard technology product with the plan to improve it. When a team of developers need to constantly patch over holes in a leaking ship, it can be tough to take the time to build a new, modern software product.

Deal rating: 7 out of 10 [Add one point if Pushpay buys a modern ChMS, add two points if they somehow pull off acquiring Planning Center]

Option 4: Buy a competing Engagement App

Pushpay is more than just a payments processor, it also provides churches with ‘systems of engagement’. In other words, apps for churches. These apps become core to the church’s interaction with their members. The attendees can watch past sermons, follow along with bible verses, and register to attend a particular session. Most importantly for Pushpay, these apps also integrate a giving button which then allows a user to make a one-off or recurring donation.

That last feature is key. Most church app providers make the vast majority of their revenue from providing the software. Pushpay charges for the app software, but generates most of its profits from the donation processing fees. This leads to some sweet alignment as Pushpay is incentivised to maximise both engagement with the app, and total giving. Churches win because they receive greater donations, and Pushpay wins by receiving a cut of the increased processing volumes.  

There are two main competitors that Pushpay could look to acquire here, Subsplash and Aware3. These companies are both currently the app providers for thousands of church customers. However neither are meaningful players in donation processing. That means that the customers of both Subsplash and Aware3 are more valuable to Pushpay than they would be to the companies themselves. That’s an attractive feature when making an acquisition. Pushpay could acquire either business, and use it’s more advanced sales team to cross-sell their giving solution to thousands more churches.

One wrinkle is that both Aware3 and Subsplash have been trying to emulate Pushpay’s donation processing business model (without significant success), so they may be reluctant to sell out and give up on the big prize for themselves. Also Subsplash and Pushpay have battled aggressively in the past in their marketing, so there is the risk of a culture-clash if Subsplash is acquired.

If Pushpay are looking for a safe bet for their first major acquisition, the purchase of Aware3 would be a leading candidate.

Deal rating: 7 out of 10

Option 5: Buy a Catholic software product

To date, almost all of Pushpay’s customers have been evangelical and Protestant Christians. That leaves a very large denomination where Pushpay has yet to gain traction: the Catholic Church.

Catholic churches are large, with just 20,000 churches serving 59 million attendees (that’s around 3,000 attendees per church). That should be a good fit for Pushpay’s product. But the Catholic church tends to be slower to adopt new technology. It is also more hierarchical in its decision making. One high level decision can see a certain software solution adopted by an entire region. That makes any new deal harder to win, but potentially much more valuable.

By acquiring an existing Catholic software company, Pushpay would gain a foot in the door. It could then leverage that existing trusted relationship to demonstrate its full suite of giving and engagement products. It won’t be an automatic win, but the potential is big enough that it is worth serious consideration.

Deal rating: 7.5 out of 10

Option 6: Buy an adjacent product

Pushpay currently has two products: giving and engagement (apps). It is also working on its own donor management module so that it can deepen the relationship with its customers. But there is a big church software world out there with many other new products that Pushpay could develop or acquire.

A strong acquisition for Pushpay would be to buy a fast-growing small software company that provides one of these adjacent products. For example Brushfire provides an events management and ticketing product that helps churches manage events outside of their usual weekly service. The product itself doesn’t have the incredible unit economics of Pushpay’s giving solution, but it would make Pushpay’s customers even more likely to stick around. It would also provide a new product that Pushpay’s sales team could sell to their existing customers, and earn some high-margin incremental revenue for their trouble.

There are many products like this that Pushpay could acquire, significantly reducing their time to market. These companies would likely be well within Pushpay’s budget, add a lot of strategic value, and are likely to be a good cultural fit.

Deal rating: 8 out of 10

Pushpay’s Next Adventure

Pushpay has tipped past a fundamental inflection point, and its strong operating leverage means the business is set to gush cash. Pushpay can now put that cash to work on some smart acquisitions. The core platform has reached scale, so any new high-margin revenue will generate additional free cash flow. That could enable further acquisitions and accelerate the value-creation flywheel.

Pushpay will need to avoid the traps, and find a business that fits both strategically and culturally. Most importantly in this frothy market, Pushpay will need to maintain valuation discipline and pay a reasonable price. If it can do all that, a smart value-creating acquisition could be a match made in heaven.

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Disclosure: At the time of publishing Matt has a position in Pushpay. Holdings are subject to change at any time. This report, and disclosure, should not be considered to be a recommendation. 

Rocket Lab’s Peter Beck: The Uncut Interview

A few months back I wrote about an incredible kiwi start up Rocket Lab: The Kiwis Winning The New Space Race. As part of researching that article I had the pleasure to interview Rocket Lab’s Founder and CEO, Peter Beck.

Peter is a pretty incredible guy. When he was eighteen he built a rocket in his garden shed, strapped it to a custom-built bicycle, and took it for a spin in a local parking lot (and hit speeds of over 150km per hour). If you don’t know much about Peter, this quick four minute video gives a great overview.

With plenty of other news outlets already asking about Peter’s extraordinary background, I instead focused my attention on the company’s business model. Due to size limits, most of our conversation could make it in to the final article. So for the folks that have asked, here is the full length interview:

I know your story pretty well. I am keen to hear in your own words, your story, and why you decided to start Rocket Lab?

Peter Beck: So, for me it was always very obvious that Spacecraft were going to shrink. So when you analyse what is in a spacecraft there is a bunch of electronics, batteries, solar panels, and a sensor . And all of those things are on rapid trajectories either down in size or up in performance. So it was always really obvious to me that small spacecraft were going to become a key element to building a space infrastructure in the future. So really their limiting factor and enabler for that future was the ability to get those spacecraft up in orbit regularly, affordably and frequently. So there is a good reason why we’re currently the only small launch vehicle delivering spacecraft to orbit and that’s because we saw that before others did. And also we were able to rapidly develop the capability. That’s what it is really all about.

It’s a super exciting time in space right now when you think about it. The best way I try to explain it to people is go back to when the Internet was brand new and somebody had just sent their first email. It was obvious that was pretty handy as a messaging tool. But if you went and sat beside that person at that time who sent the first email and explained to them all of the things the Internet was going to create it would largely seem like fantasy. And really with space, we have just sent that first email. That’s pretty much where we are at. Because space has been a domain that has been so hard to get to. So closed. So expensive. That it’s a domain that’s very hard to innovate and do these things in.

It’s an incredibly, incredibly,- exciting time. The biggest thing to be done in space is yet to even be thought of. People often ask me what do you think about are the various aspects of what is going on in space. What do you think of earth observation, and all these things. I think they are great. But the application of what they are providing is going to be dwarfed when we have full access to the domain of space.

I am keen to talk to that, and the economics that go with it. What do you think has sparked the small satellite revolution. What are the big enablers that have come together to allow Rocket Lab to work, and cubesats, and everything that goes with it?

There are a number of things that have combined at the right point in time. First there is the technology. That’s obviously a key enabler. That’s kind of a no-brainer. But technology by itself doesn’t necessarily enable a revolution. There are all kinds of different aspects.

Silicon Valley really saw it very early that space was something that was right for disruption. If you think of all of the domains where you build infrastructure: in the sea, on land, in the sky. Those have all gone through all their major disruptions. And its very incremental from here on in. But space is one of those things that hasn’t had a giant disruption. You could draw a line on a piece of paper that could show where you could create a disruption that didn’t require development of crazy new technologies or the usual billions of dollars that governments need to shell out to do these kind of things. So you had a perfect storm of technology that was ready to be used, investors that could see the opportunity and were ready to take the leap in to space, and a new generation of engineers and entrepreneurs who weren’t afraid of the space. Who broke out of the mold of space as a domain for governments to be in. it was kind of like, screw that, we can go there too. So I think that’s pretty much what has resulted in this industry.

So the Silicon Valley guys started investing in spacecraft very early on and in the very beginning it was earth observation because there was really only one giant monopoly company that was providing earth observation services, that was a printing press for money. So it was ripe for disruption. A number of companies started down that road, and build space craft. And then they tried to launch them. And that’s when it all fell to bits.

So when all the investors in Rocket Lab had [previously] felt the pain of launch. They all invested heavily in to small satellite companies. Only to have the satellites sit on the shelf for years. So when we turned up and said, hey look there’s a really big problem and there is a really big pipeline of spacecraft coming, and they go I know! We’ve got some of them. So it was a very very short line to draw to a launch vehicle that provided regular and rapid service to orbit.

What was your pitch to Venture Capital investors? You have been very successful targeting some top end VC firms. Was it ‘this is the world in 40 years’? Or was it, we have the technology now, and you already know the problem?

I was very targeted with who I wanted to invest in the company. It just so happened that the VCs I wanted involved in the company had big aspirations for large companies and large projects. But they also had felt the pain of launch. So that bit of the pitch didn’t need explaining. But you also have to realise that I had turned up, a New Zealander, from the country that had no space heritage. We had obviously done a lot at Rocket Lab, and we were going to build a small orbital launch vehicle. It was going to be using materials that nobody had ever used before, technologies that nobody had ever used before. From a launch site that required a bilateral and a whole regulatory framework to come together to make happen.

Launch vehicles are an enormous challenge. We often joke that the medical guys think they have a hard time getting a product in to market, boy you want to try a rocket. You’ve got everything against you from physics to regulation.

How do you think being from New Zealand and something of an outsider to what was happening in the States change the way you approached the problem?

Something that we did that was very different was we looked at the problem holistically. We said, it’s not just about the rocket. Basically I wrote two requirements on a piece of white paper: must be launched weekly, and must be affordable. And the affordable bit is relatively simple to model and understand. The launch regularly bit is the bit that everybody misses. So the only reason why we have operations in New Zealand even though we are a U.S. company, is because of the launch site.

We went to every single launch site in America and said look we want to launch ever 24 hours, and while everybody agreed that’s what needed to happen, they also reminded us that every time you launch a rocket you delay national air travel. So when Elon’s Falcon Heavy flew earlier in the year, there were 562 commercial air flights that were delayed or cancelled. So people get a bit antsy about that kind of stuff, and when you are trying to do it every 24 hours, ironically it was one of the few things that didn’t scale in America.

So I tell everybody that Rocket Lab is a third the rocket, a third regulatory, and third infrastructure. And the infrastructure and regulatory bit aren’t as romantic and sexy like a rocket, but they are actually more the enablers than the rocket itself.

Thinking through segmenting your customers, who is the typical Rocket Lab customer, and what are they trying to accomplish?

Yeah, look, I wish there was a typical one to be honest with you. It is very varied. We have at one end of the spectrum a high school student with a 1U* cubesat which we are flying on this next mission, through to a government trying to build a sovereign capability, and everything in between.

*[Matt’s note: Cubesat’s are the new generation of tiny satellites. As you might guess they are cubes, and 1U here denotes one ‘Cubesat unit’ which means a satellite that can fit entirely within a box with the dimensions of 10cm x 10cm x 10cm. Rocket Lab is taking bookings for cubesats of all sizes, with one rocket ride containing up to 82U worth of cubesats. A single launch can carry 20 different cubesats, each ranging in size from 1U to 12U. In addition Rocket Lab also offers bespoke flights for just one satellite with a typical payload capacity of 150kg. ]

So what are the current use cases today? Is it mostly imaging? Experiments? Without going in to the specifics for any particular customer. What are the use cases that you are seeing?

Sure. I think statistically based on the manifests next year we have a majority of weather spacecraft. So you know weather is something that has typically needed to be done by governments, at a pretty low government-type level of technology sophistication. So its one that is really ripe for disruption. So the high-fidelity that you can provide, not only am I get married today. They will make decisions like, am I going to build this infrastructure project this month. So really big decisions get made on weather data. So statistically speaking weather is probably next year, our biggest flight rate. Imaging is definitely there. Also a lot of technology development. So we have got a NASA payload that has 13 payloads on board, and all of those are basically technology demonstrators and sensor experiments and things like that. And that’s probably the vast majority that would be one of those three things.

Okay cool, and putting the Sci-Fi hat on, do you have any sense of where you see it ten or twenty years? Or are you trying to avoid any crazy predictions? Where do you see it could potentially go? I think you talked about a space Internet previously?

I am not even going to care to guess because like I said at the beginning, I think the most significant thing that is going to be done in space is yet to be even thought of. The most interesting thing for us is we see ourselves as the enablers of this. We already see it now. People are designing spacecraft for the Electron environment. It’s a very very smooth ride to space. Smoother than any of the other rides out there. It’s a big fairing volume and they can design spacecraft in a totally different way. And we already see that occurring and we see some really really unusual missions. So another example is that the traditional way that spacecraft are getting to orbit right now is that they are ride-sharing on the side of big rockets. But those big rockets only go to certain orbits. Now with our launch site we’ve got a huge range of orbits. So all of a sudden totally new missions are being developed. Totally different weather missions are being developed. Different earth observation and comms missions are being developed. Because all of a sudden you have access to all these different trajectories and all these inclinations to provide different services to different countries. So it’s already starting to happen. And that to me is one of the most exciting things is to see payloads that have been designed specifically for Electron, and those payloads would not have existed without the vehicle.

Absolutely. I think you mentioned that a lot of people are designing to the Electron specifications now which is pretty cool to see. What do you think are the top say 3-5 most important factors for a Rocket Lab, in rough order of importance? I’m guess frequency is pretty high up there, but what do you think is number one most important roughly and then down the list?

It’s control of destination and timeline. That’s the number one thing. “I’m going to this orbit on this day” because that’s one thing that [traditional] ride share can never offer. Because you just don’t know where you are going to go, when you are going to go. So that’s pretty much the order of conversation when someone comes and sees you is “I have got this spacecraft that requires to get to this orbit on this day, is that good?” Then other discussions occur later, like the environment of the vehicle and price, and all of that kind of stuff. But really that’s the number one thing that people need.

For us its a huge responsibility because a lot of these, especially these early stage guys, they are building their business plans off the back of us. They’re building their business off the back of us, to get them in to orbit and to get them generating revenue quickly.

Morgan Bailey (Rocket Lab’s Communications Manager): Just to point out too, those two factors are something that we offer a wider range of than anybody else. Not to mention that we are the only ones that have made it to orbit so far, but if you are looking at launch schedule, as well as where you want to go in orbit, we’ve got the widest range of orbital inclinations that you can reach from one site in the world. We also have the most launch frequency out of any site in the world and we are upping that and developing more schedule freedom by developing a U.S. launch site. So we have heard the market and really responded to that.

Peter I’d be keen to hear your thoughts on Rocket Lab’s ‘Master Plan’ thinking ten, or twenty years in the future, where would you like the company to be at that stage?

Well the first point here is that everybody thinks we’re going to build a bigger launch vehicle [rocket]…

I wasn’t going to ask that question… I think you’ve been asked that one too many times, and might be sick of answering it…

No, good, good, good good good. Yep. So the definition of success for me is that we are able to enable these companies to get on orbit to do the things that they want to do. And the things that they want to do are going to have a huge effect on everybody down here on earth. So you know, we don’t have aspirations of going to other planets, or taking humans in to space. Where I honestly believe we can move the needle for the human species in the most significant way, is actually to create space as an accessible domain for people to innovate. So if everything has gone well in 5-10 years, the world will be a totally different place. And we’ll be able to trace some of the origins at least, back to our program.

I’m keen to ask about the economics. So you have Space-X going in the opposite direction building a very large rocket. Do you see that [Space X] being the option if someone was looking at a launch and not worried about frequency and control of destination for whatever reason, it might be the low-cost option, versus Rocket Lab’s [more premium option]. You once talked about a freight train vs. a Fed-Ex truck. Do you see Rocket Lab more serving the more frequent and more targeted end of the market? Is that how you see the market breaking out?

The ironic truth is that we are pretty much the same price. You know the cost of a ride-share. We targeted the cost of the vehicle to basically equal the cost of a ride-share. So there is not a whole lot of advantage…

So there’s not that much price difference in it is what you are saying?

No! There wouldn’t be a whole of advantage for anybody to do that. And we are reaping the rewards of that decision right now.

Have you ever had contact with Space X or Elon Musk? You’re often compared to Elon. Is there a Space Club that you guys all hang out at?

A Space Club?! (laughing) No, no, there’s not a space club. Obviously the community is relatively small so we all kind of know each other, or know of each other.

[Matt’s note: Clearly it was foolish of me to ask about Space Club. As a good friend later pointed out, the first rule of Space Club is ‘Don’t talk about Space Club!’]

How have you found it building a lot of the R&D in New Zealand. How have you found that process? Was there a pool of engineers waiting for something like Rocket Lab to come along? Did you bring in a lot of expats? How was that recruiting process?

Yeah I don’t think it’s unique to New Zealand, but any company that grows at the speed that we have grown at struggles with that. We have recruited from all around the world, and New Zealand, and in our U.S. operations. It’s three to five new starters a week for us, pretty consistently. So its always a struggle. And I can say that operating both Rocket Lab USA and Rocket Lab New Zealand. It’s not unique to either one of those sites. There is a lot of competition for the talent up in the U.S. with Space X and Blue Origin. So it doesnt matter where you are in the world, it’s always a challenge.

How would you describe the culture at Rocket Lab? What kind of culture are you trying to build?

This is a place where you come if you really want to see what you are capable of. This is not a biscuit factory. This is a place where we try and attract the very best talent in the world, we give them all the resources, and the most amount of time that we can, and ask them to go and do incredible things. And the wonderful thing about Rocket Lab is we are at a size where you can still come here and own a really significant thing and be in charge of it and responsible for it. Once you get up to Space X and Boeing and those kind of sizes you end up being very siloed on one particular project or outcome. The one thing here is people can come here and own as little or as much as they want to, and really reach their full potential as an engineer.

I’m keen to dig in the economics. The price of a launch at the moment is around USD$5.7 million. When you are at scale, what kind of gross margins do you expect to generate?

Generally as a private company we don’t talk too much about that. But the starting price is $5.7 and depending what service you want service you want that changes. Like we said before it’s pretty competitive to rideshare. And we are anticipating being cash flow positive this year. So that should give you an indication of the financial footing of the company, and the financial performance of the product.

Something that is interesting about Rocket Lab is how much work you have done on the foundations. It’s not just vertically integrated, you’ve got your own monitoring sites around the world, you’ve built your own launchpads. So I am keen to hear more about that strategy? I imagine you have got a lot of fixed costs but after that you are able to pump out as many [rockets] as you can?

Exactly. There is nothing like owning it in my experience. Once you have got to ask somebody to borrow theirs, or rent theirs, then that gets a little more difficult. So the strategy is always to be as vertically integrated as possible. Owning that infrastructure is a key element because we have complete control over our launch windows, we have complete control over, basically everything. Whereas when you go on to somebody else’s launch range, and there is other people there and other customers there, and other activities there, you are always in a compromised position.

But like I said its from the vision from the beginning, which is, how can we get to a launch every 24 hours, or more. Really that comes down to, you have to own it all, you have to have these dedicated assets that serve your business and nobody else’s.

And once you are at scale, what do you think most of the cost of each rocket launch would be? Is there a lot fuel component there, is it a lot of man hours going in to construction? Whats the biggest driver of your costs once you are at scale?

Great question. So, fuel is irrelevant. So basically the cost of fuel is a rounding error. That’s because liquid oxygen is cents per kilogram. The kerosene we use, we use almost, bugger all of it. So that’s kind of in the weeds. The way we have designed the vehicle, its designed for manufacture. So while we use very expensive and exotic materials such as carbon fibre, and inconel superalloys and things like that, we don’t use very much of them. And the processes that we use, like the 3D printing of the rocket engines, means that while the material itself is very expensive, because we 3D print them, there is no wastage in the material. It’s additive manufacturing rather than subtractive manufacturing.

So the cost of the vehicle is pretty well equally broken up between raw materials and labour. Labour would be the higher cost component to the vehicle. But the great thing about that of course is that because the vehicle is designed for production, there are just huge automation opportunities just designed in.

I think you mentioned somewhere else with the batteries, you have already seen a 2X improvement in the size and cost over time. So that’s a driver for Rocket Lab as well, you are positioned to benefit from all those scaling effects in different technologies.

Yeah exactly. We stood back and said well what are the technologies that are either going to reduce in cost or improve in performance. Composites is one of them. 3D printing is another one. And batteries is another one. So there is no coincidence why a lot of the solutions we have chosen align with the trajectories of those either materials or technologies.

Something you’ve addressed elsewhere that I am sure our audience is interested in is the idea of [rocket] re-usability and why doesn’t that work so well for Rocket Lab, and why you haven’t pursued that to cut costs?

Yeah so the vehicle has been designed for manufacture from day 1. So to re-use a vehicle you end up making a lot of trades with propellant and mass. So some things scale very well, a reusable on something like a Falcon 9 scales very well. It’s important to note though that on a Falcon 9, the average payload mass that vehicle lifts is 3 tonnes. Yet it’s capable of a 13 tonne lift. And when you re-use a launch vehicle it takes about a third of all of your payload capacity to do that. Which is fine when you have a very large vehicle that can lift a lot and you are not lifting very much with it. But something like a small launch vehicle, that doesn’t scale very well.

Yes and as you say there is one third [of the business that is] infrastructure, all the other stuff that potentially goes with it if you have a robotic drone-ship out there trying to catch it [the rocket] and that probably doesn’t scale too well either.

Yep, exactly.

This is a tough question because it is likely so varied, but what do you think the cost that Rocket Lab presents to your customers as a percent of their total costs. So if a customer is trying to put a satellite up, how much do you think Rocket Lab represents of that? Is it half the cost of the program for what they are trying to do? Is it a quarter? I’m trying to get an idea of Rocket Lab’s position in the economics of the business.

Yeah, you’re right Matt it really depends on the spacecraft. So if you’ve got a 3U cubesat that costs nothing to build, then you’ve got the launch element that is a much larger section of it. But when you are talking a government payload you are a small fraction of the cost of the development of that payload. Simply because of the cost of doing business as a government, or the complexity of the payload itself. So I am not sure where that would sit on an average. I would just say that it varies quite widely. So if you are an early-stage startup, then we’ll probably represent a significant portion of your costs. If you’re an established large Corporation or a Government that is flying one-hundred to two-hundred million dollar payloads, then we represent a relatively small section of the cost.

Something I noticed while browsing your website [www.rocketlab.com] which is very cool and lets me imagine I can buy a cubesat slot itself, it looks like you are significantly booked out already. I’m curious to hear, is sales much of a role at your company given the demand that you have now? What is the sales process like for Rocket Lab?

Not surprisingly this has been talked about and dreamed about, this capability, for many many years in the community of small spacecraft. So when something turns up, it’s greeted with much [excitement]. And there are so many people out there that have promised it for so long and never even made it to the pads, let alone to orbit. That it’s like pulling the path on a bathtub. We’re very busy and next year we’ve had to put more rockets on to try and meet the demand of our customers. And going out to the later years as well its still incredibly busy for us. But this is not surprising to us. This was always, this is the plan. For us it’s just about scaling up as fast as we can to service those customers. So that they can do the incredible things that they do on orbit.

You’ve made a lot of improvements that others are now following, with 3D printed engines, carbon fibre. What’s next in tech? Are there any other big step changes that you see? Or are these the main things and it’s just refining and cutting costs as it goes?

Oh look we’re not done yet. Not by a long shot. So, you would have seen the kick-stage which we announced on the second flight. That is hugely enabling for a lot of our spacecraft customers, we can deploy multiple spacecrafts at different orbits. So expect to see a steady stream of innovation from Rocket Lab. That’s what we’ve built ourselves on.

Great, one techie question I wanted to ask about. I was reading up on cubesat propulsion so once a small satellite is up there, there is actually a lot more opportunity than I realised. I am curious to hear your thoughts on that in terms of use cases. I saw that NASA was looking at doing a cubesat that was going to go all the way to Mars after getting to earth orbit. How do you see that, is that something that is happening already, or more going in to the future?

[Matt’s note: you can watch a video about the epic Mars cubesat project here]

Oh yeah look there is a lot of growth in that field right now. I just came back from the small satellite conference in Utah last week, and there must have been a dozen companies doing cubesat propulsion systems. Either electric ion thrusters, or chemical. And look it makes perfect sense. You put an asset up there, that assets lifetime is determined by how quickly it re-enters so you can increase its life by doing station keeping burns but then all of a sudden you can do all this other stuff, you know, like go to Mars. So this is kind of what I am talking about at the beginning, that the biggest thing is yet to be done or even thought of. Because we are just now seeing some of those innovations. Even five years ago if you would have said to me that you are going to put a hall thruster on a cubesat and take it to Mars you would just think: what!? But now that’s just like, oh ok, that makes sense.

On funding, do you have any plans in the future for an IPO, or are you quite happy not having to deal with all that side of things right now?

Oh well never say never. Right now we are fully funded and on a great trajectory. We’ll see what the future brings. It would be interesting to see a rocket company IPO’d for sure. I’m not sure if Space X is no doing that any time soon.

Peter, what’s been your proudest moment with Rocket Lab so far?

Oh jeepers…well the cop out answer is going to orbit. When we put that spacecraft in orbit, there were a lot of firsts there , first carbon fibre rocket, first private launch site, first 3D printed engine and blah blah blah. That was a defining moment for the industry. You know to do it out of New Zealand was great. You can imagine that not many people ever thought that the first one ever was going to be coming out of New Zealand. If you were a betting man ten years ago, that one would have been long odds.  But that certainly is [a proud moment] but there are so many highs and lows that it’s hard to say. But really I guess I am proud for the team is the real answer there, because you know you take a couple of hundred of the brightest people on the planet, jam them in a little room, and feed them pizza and coke, and watch the magic happen.

I guess the humanity star was potentially quite a full circle moment given your origins as a kid looking up at the stars and deciding to get in to it?

Yeah that was bitter-sweet because not everybody liked that.

Yes that was a bit of a bizarre reaction.

Yeah but for every negative comment we saw on that, we got probably two positives. It makes a better story to have some tension there. But still I maintain I would do that again in a heartbeat. That was a great mission. And to see just the thousands that wrote in and actually that overview experience where they looked up and it was like ‘oh okay I am on this rock in the middle of the universe, maybe some of these things aren’t as big of a deal as I thought’. So that was a wonderful project.

Last one from me. What do you think is most misunderstood about Rocket Lab?

It depends if you are in the industry or out of the industry. If you are in the industry then we are pretty well known and understood. The easy one is that we are actually a U.S. company, not a New Zealand company. The New Zealand bit is really about launch. But out of the industry you’ll see Space X and Blue Origin and Virgin Orbit and those companies really talked about a lot. But out of all those companies it’s only Space X that has ever been to orbit. So that’s probably the one thing. There are two private companies in the history of this planet that have been to orbit and it’s Space X and it’s Rocket Lab and that’s it.

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3 Lessons from the Kiwi Tech Revolution

Kiwi technology startups have reached a tipping point. In everything from rockets to Saas software, the tech tinkerers that used to hide away in their garden sheds are striding out proudly, building big companies, and taking their place on the world stage.

I recently returned from a research trip to New Zealand. I was fortunate to be able to meet with CEOs, founders, CTOs, angel investing groups, and major private investors. Those meetings demonstrated the revolution that is happening in kiwi technology businesses.

From Sheds to Startups

New Zealand has a proud history of resourcefulness and ingenuity. The country sits in a remote corner of the South Pacific. If something wasn’t working, generations of kiwis took it upon themselves to fix it. If you did not grow up in New Zealand it is entirely possible that you are completely unaware of this. But for those of us who did, New Zealand’s list of innovations, from splitting the atom, to the jet boat, to the electric fence, has been hammered in to our brains since before we were old enough to bungy.

New Zealand might have been a nation of backyard tinkerers. But most inventions never became businesses. There was a culture of innovation and invention, but little commercialisation.  

A few years ago that began to change. TradeMe’s sale in 2006 was a seminal moment (for Australians, imagine one business that combines Gumtree, REA Group, Carsales, and Seek all in to one). A business started in 1999 was sold for $NZ750 million to Fairfax just seven years later. Kiwi entrepreneurs began to realise that they could build a big technology business too.

3 Key Lessons From Xero’s Big Win

If Trademe unlocked the door to New Zealand’s tech success, Xero knocked it off its hinges. The cloud accounting software company’s founder, Rod Drury, was a technology veteran. Before starting Xero he had already created and sold two software companies (Glazier Systems: $7.5 million, Aftermail: US$45 million). This time was going to be different. This time he wasn’t going to sell, he was going to take on the giants at their own game.

Today, thirteen years after founding, Xero has over one million small business customers, and a market cap of over $6 billion.

Xero had three major impacts on the NZ tech scene. First, it demonstrated that to build a massive global company required a new skill-set: sales and marketing. Second, it raised the bar. Kiwi entrepreneurs now aimed to build global scale businesses themselves. Third, the wealth created for early investors, and the skills developed along the way, meant that there was a new group of sophisticated technology investors. 

Lesson #1: The Power of Story

“Our only option really was to tell a big story, and explode early from day one” — Rod Drury

Xero developed some pretty great cloud accounting software. But Xero’s biggest innovation wasn’t their tech, it was their sales and marketing strategy. Xero turned accountants in to raving fans.

Accountants could see how much easier Xero made their lives, and so they pushed their small business customers to sign up. Xero brought them in on the deal, with accountants effectively earning a cut of the monthly Xero subscription. It was a masterstroke. Xero invested heavily in the relationship, developing new features to make sure that accountants remained the company’s biggest cheerleaders.

Pushpay, a payments and engagement software company for the faith sector is another kiwi success story that understood the power of sales. Pushpay’s technology was highly innovative, but it was their sales team that really drove their success over the past few years. In just eight years the company has gone from an idea, to processing over US$4 billion of donations annually, and with 55 of the 100 largest U.S. churches as customers. That was only possible because the company developed a sophisticated sales and marketing process.

New Zealand’s culture of humility means that selling is an underdeveloped skill set for many businesses. But companies miss this lesson at their peril.

One small publicly listed software company that I met with had been close to running out of cash after multiple failed sales strategies. The original founder had wasted millions on ineffective international sales teams that did little more than book meetings. A new CEO has stepped in and is currently rebuilding the business, and the marketing process, on a surer footing. I am watching with interest.

Lesson #2: Think Global, Scale Global

It used to be that kiwi tech startups would only think about international sales once they had exhausted their local opportunities. Today the best New Zealand tech companies are global from inception.

But thinking global is only half the story. Companies can’t be everywhere, so they must pick a few key markets, and ensure they scale up aggressively there before then expanding further. That means delivering on customer needs, and building depth in every geography you enter.

Xero serves customers in dozens of countries, but focuses on just three major markets: Australasia, the UK, and the U.S. Pushpay similarly realised early on that there isn’t enough large churches in New Zealand and Australia to reach their ambitions. The company set up their headquarters in Seattle, and built an efficient U.S. sales machine that employs hundreds.

When companies lack a scalable sales and marketing process, thinking too big can actually be a trap.

I met with the very smart founders of kiwi tech startup StretchSense. The company develops sensors that can be stitched into clothing to measure body movement – with fascinating applications for everything from precise Virtual Reality gloves, to biomechanical measurement. Early in its life StretchSense had won a major contract with a Japanese retail giant to develop a suit which gave customers exact body measurements to check if products bought online would fit them.

The agreement would have valued the company at over $100 million. But the demand was vastly greater than the small startup was able to deliver. The deal eventually fell through, and StretchSense had to lay off 140 staff. The company pivoted quickly and has been able to rebuild with a new business model, but the near-death experience highlights the lesson: think global, scale global.

Lesson #3: Sign up Sophisticated Tech Investors

Early in its journey Xero was able to secure investment from billionaire, and Silicon Valley legend, Peter Thiel. That stamp of approval put Xero on the map and attracted both top talent and further capital. Rocket Lab followed a similar strategy, heading straight to Silicon Valley to fund the business, and attracting one of the world’s leading venture capital firms, Khosla Ventures.

For a long time New Zealand struggled with a lack of experienced technology investors. But today’s tech success is creating a virtuous cycle. The wealth created by early investors in Trademe, Xero, Pushpay, and other startups, and the skills developed on the ride, mean that there is now a growing pool of skilled and wealthy technology investors.

As these investors gain experience from multiple technology investments, the companies they invest in are able to benefit from this accumulated knowledge. Taking one example, the Huljich family have had a string of successful technology investments from pre-IPO all the way through to multi-million dollar exits. They have invested in several Saas software successes, from Diligent, to Pushpay, and recently Valocity. Other early investors in Pushpay such as the Bhatnagar family have likewise gone on to fund further tech startups. These sophisticated technology investors thereby ensure that lessons are passed on from one generation of startups to the next.

Conclusion

The Kiwi tech ecosystem has reached an inflection point. Pioneers like Xero have pointed the way, and a new generation of startups are striking forth on to the world stage. Kiwi tech companies are taking on the world by understanding the power of story, the need to scale globally, and the value of attracting sophisticated technology investors. The revolution is fun to watch, and with most of the world still to pay attention, a lucrative place to find new investment opportunities.

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Podcast #15: Appen, a2 Milk and more

Following a big week of half-yearly reports on the ASX, the guys cover six of their favourite stocks — and all in under 40 minutes!

Stocks covered: Appen (ASX:APX), MNF Group (ASX:MNF), Nanosonics (ASX:NAN), A2 Milk (ASX:A2M), Webjet (ASX:WEB) & ProMedicus (ASX:PME).

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The Selling Blind Spot

Selling is a big blind spot for investors. For every thousand articles about when to buy a company, we’re lucky to find one about when to sell. Yet selling has a huge impact on our long-term performance. And the evidence is clear: most people are no good at it. But this weakness also provides the opportunity for a massive competitive advantage.  

The Problem

It’s well known that a lot of individual investors suffer from selling biases like loss aversion. Recent research shows that the professionals struggle too. An impressive study found that professional fund managers, although pretty good at buying, are terrible at selling. It was a landmark study, so let’s unpack the findings.

“We document a striking pattern: while the investors display clear skill in buying, their selling decisions under-perform substantially…selling decisions not only fail to beat a no-skill strategy of selling another randomly chosen asset from the portfolio, they consistently under-perform it by substantial amounts.”

The sell decisions of professional investors are so bad that they performed worse than chance. That’s rough. But the buy decisions did add value, so it’s not that fund managers have no idea about investing. Instead the authors found a flawed process where selling doesn’t receive adequate attention:

“We present evidence consistent with the discrepancy in performance between buy and sell decisions being driven by an asymmetric allocation of cognitive resources, particularly attention…We conjecture that PMs [Portfolio Managers] in our sample focus primarily on finding the next great idea to add to their portfolio and view selling largely as a way to raise cash for purchases”

“PMs in our sample have substantially greater propensities to sell positions with extreme returns: both the worst and best performing assets in the portfolio are sold at rates more than 50% percent higher than assets that just under or over performed. Importantly, no such pattern is found on the buying side – unlike with selling, buying behavior correlates little with past returns and other observables”

Most professionals have no good process for selling. They focus on buying, and only think about selling when they are fumbling around to free up cash. When they do sell, it is with little research. So they sell whatever sticks out the most: the biggest gainer or the biggest loser. It’s not logical, and they don’t think about the future prospects. The result is decisions that are so bad, they would have been better off throwing darts at a board to pick a position to sell.

This focus on past returns is also mirrored in much of the folk wisdom that floats around about selling:

  • ‘Sell when a stock doubles (or is up 20%, or 30%, or whatever arbitrary number)’
  • ‘Never sell at a loss’
  • ‘Nobody ever went broke taking a profit’
  • ‘Sell anything that falls by 10%’
  • ‘Water your flowers and trim your weeds (sell companies whose share price has fallen)

Intelligent investing is supposed to be forward-looking. It’s the future that counts. Yet all these rules of thumb, and the trading of the average fund manager, is based on past price movements.

The core problem is that most people’s sell process abandons all that is good about their buy process:

buysellprocess1

It’s a big problem. But there is a better way. My style of fundamental growth investing, led me to adopt two core selling principles:

Principle #1: Sell quickly when a thesis is broken

This principle has been a core driver of investment performance for me. Selling quickly when a thesis is broken allows you to ‘lose small’ when you have made a mistake. More importantly, it allows you to quickly re-deploy your precious capital in to a new high-conviction idea.

Like running a marathon, it is simple, but not easy.

There are five steps:

  1. Identify your thesis (actually write it out)
  2. In that initial thesis, identify what would cause you to sell
  3. Continuously monitor the company, its competitors, customers etc.
  4. Update your valuation estimate and avoid thesis creep
  5. Sell quickly if the thesis is broken

Let’s work through those steps with a real-world example: Class (ASX:CL1). Class provides a SaaS software product that helps Self-Managed Super Funds (SMSFs) manage their accounts. It’s a sizable industry in Australia, with over 500,000 SMSFs. It’s a growing market: each year more people’s retirement balances hit a size where it becomes worthwhile to consider managing it themselves.

Step 1: Identify your thesis (actually write it out)

Few investors clarify their thinking on why precisely they are buying a company. Even fewer take the time to actually write down that investment thesis. If you do, you will be ahead of the pack.

We must have a clear idea of what our logic is in the first place, so that we can know when that thesis is broken.

We first bought Class shares shortly after the IPO in early 2016. It was a simple thesis. Class was disrupting traditional desktop software – an inevitable shift to the cloud was underway. At the time of purchase, Class was dominating the new cloud-based market, and winning over two thirds of new cloud customers.

Even better, Class’ major competitor, the incumbent BGL Super, had stumbled with their first launch of a cloud product. We initiated a position and over the next two years Class’ share price rose over 80%.

It looked like the ideal investment, a scalable software business that was dominating a sticky niche, while a sluggish incumbent failed to adapt.

But that would change.

Step 2: Identify what new evidence would cause you to sell

The moment before you buy a stock is the last time you will be thinking objectively. It is crucial that you use this moment to write down precisely what new evidence would cause you to sell in future.

We identified multiple risks that could have befallen Class. The government could have changed the rules around SMSFs. A major security breach could have broken client’s trust in Class’ cloud service. Neither of those came to pass.

Another risk was that a competitor could somehow crack the market and start stealing share. Class would not be so lucky on this count.

Step 3: Continuous monitoring

Eternal vigilance is the price of superior returns.

We must continuously monitor for thesis-breaking evidence. That means keeping tabs on the company, its staff morale, its new products, customers, competitors, regulators, suppliers, etc. There are many tools that can help this along: Glassdoor, Google Trends, product forums, Google Alerts, investing forums. But that should be just the beginning. Superior returns require superior portfolio monitoring.

In the example of Class there was one obvious source of intelligence that most of the market somehow missed. Remember that big incumbent BGL? Well BGL would regularly release announcements about how their new cloud based product was progressing.

For a long time these press releases were mostly hot air. Every company claims that their products are market-leading, next-generation, cutting-edge. But in early 2017 it became apparent that BGL’s new cloud products were gaining traction. Talking to BGL’s customers, it seemed that the incumbent may have started to get its act together.

No company goes without serious competition forever though. So we were careful to avoid a knee-jerk response.

That all changed in October 2017.

Step 4: Re-evaluate and avoid thesis creep

Thesis creep is one of the great traps that ensnare investors, particularly value investors. The company reports some bad news, and rather than recognise the mistake and sell, the investor holds on.

The share price has usually fallen by this stage, which can allow the original thesis to sneakily creep its way to something new: “Sure, we originally thought the company would do XYZ, and it clearly hasn’t, but it’s just so darn cheap now, we couldn’t sell at this price”.

There were two new pieces of information that were released on the 5th of October. First, Class’ reported its latest quarterly update. It showed that the company’s net new account additions had fallen, dramatically.

In the comparable quarter a year earlier Class had added 11,880 new SMSF accounts. The same number in 2017 showed just 6,232 new accounts. A fall of 47%. And this was after a soft June quarter, which the company had guided would quickly rebound. To make matters worse, the chart the company usually reported which would have shown this fall clearly was no longer included.

Something had changed.

Later that day it was confirmed. BGL announced that it had now surpassed 100,000 accounts on its own cloud-based product. Worse still (for Class), their biggest competitor had added 23,402 accounts during the latest quarter.

When we first purchased shares, Class was winning approximately 66% of new cloud accounts. Now it appeared to be winning just 20%. That’s a huge swing in competitive position. We updated our intrinsic value estimate with the new information. Lower growth and higher acquisition costs meant the shares were significantly overvalued.

It was time to face a tough truth.

Step 5: Sell quickly when the thesis is broken.  

Class had been a star of our portfolio. I had even interviewed the CEO in a fireside chat at a client event. It wasn’t easy to reverse course and admit that we were wrong. But when a thesis is broken, we must be decisive.

We reached our sell decision on the same day the news broke. Although the shares were already down slightly, it would take many months for the market to fully absorb the new competitive paradigm. We were able to exit our position for a 67% gain.

It worked out well. Today, almost 18 months later, the shares are now over -50% below where we sold.

Sell quickly when a thesis is broken.

Principle #2: Sell if you would not be buying today

Holding is an active decision, not a passive one. It just doesn’t feel like it.

Each day the market offers us the opportunity to buy or sell our shares. Every day that we hold a position we are effectively choosing to ‘re-purchase’ it at today’s prices, and in today’s position size. If we don’t think that the current position size is the best possible allocation of our precious capital, we should sell.

This principle – to sell if you would not be buying today – includes those situations mentioned in the first principle. But it also adds the hard edge of a valuation-based sell. If the share price has risen so much that you would not be buying the shares today, it is time to sell. No business is so great that its share price can’t rise high enough to render it an unattractive investment.

It sounds simple, but again the execution takes work. It requires maintaining an accurate estimate of the company’s intrinsic value, and being willing to trim the position, or even sell out entirely, when share prices rises too far above intrinsic value.

My personal approach to investing in high growth businesses is to sell slowly when the motivation is purely based on valuation. This is to reflect the ability of truly superior businesses to consistently outperform even the most optimistic estimates. It is both an art and a science, but ultimately we must be disciplined: sell if you would not be buying today.

Conclusion

Selling is a big blind spot for most investors. But that weakness means we have a huge opportunity to improve. If you adopt a sound selling process, based on the future and not the past, you will gain a massive competitive advantage over other investors. 

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Rocket Lab: The Kiwis winning the new Space Race

The world changed on Sunday afternoon.

“There are two private companies in the history of this planet that have been to orbit and it’s Space X and it’s Rocket Lab and that’s it.” — Peter Beck, Rocket Lab Founder and CEO

From a remote peninsula on the East Coast of New Zealand, Rocket Lab launched its second commercial rocket into space, carrying spacecraft for NASA. By this time next year Rocket Lab is planning to launch a new rocket to space every week.

Transport to space, space, is about to become as regular and reliable as a flight to Bali. Earth’s next trillion dollar industry has just started, and a company launching out of New Zealand is leading the charge. Not only that, Rocket Lab is doing this with a rocket, the Electron, that is a fraction of the size of Space X’s monstrous Falcon Heavy:


(Source: The Economist)

You’re probably wondering how little Rocket Lab can possibly compete with the gargantuan Space X?

I was curious too. I dug into the economics of the launch vehicles, micro-satellites and the industry itself. I was also fortunate enough to be able to interview Rocket Lab’s Founder and CEO Peter Beck. The answer involves cutting edge technology, deeply customer-centric design, and more than a dash of Kiwi ingenuity.

Space Economics

Rocket Lab’s level of technical innovation has been incredible. But it is their economics that are about to change the world.

Return on an investment always matters, and space is no exception. In 1969 humankind set foot on the Moon for the first time. Three years later, we set foot on the moon for the last time. How is that possible? Forty-six years have passed since and… nothing. Why? Economics.

We could technologically go to the Moon in the Sixties. However that exploration came at a cost: at its peak the U.S. government was spending over 4% of its entire Federal budget on the space program. And with little return to show for it, aside from bragging rights.

Today’s Space 2.0 revolution is about space travel being possible not just technologically but economically.

Rocket Lab is at the forefront. The company has adopted a recursive cycle of continuous improvement that is putting daylight between it and its competitors. Let’s call it Rocket Lab’s Cost-Frequency Flywheel:

#1: Cost minimisation

“I started with one piece of paper and on that piece of paper it had two requirements. Must be affordable. Must launch weekly. And everything has been driven by those two requirements.” — Peter Beck

Every part of the Electron has been designed for regular and reliable space transport. The result is a rocket system that looks strikingly different to other rockets. First of all, it’s small. The Electron stands just 16 metres tall, compared to the 70 metre tall Falcon Heavy. Rocket Lab has very intentionally decided to serve the small space craft market and has zero intention to ever build a bigger rocket.

When Peter Beck created Rocket Lab, he could see the future, and the future was small:

“The big geobirds [large geo-stationary satellites] are declining. And you’ve got Space X and Ariane, ULA all competing for those big geobirds. But if you look at what’s happening in the Lower Earth Orbit market, in the small spacecraft market, it’s 200% growth year on year on year. And it’s something like 2,500 spacecraft that need to launch in the next few years. So the real needlemover in the industry is frequency. That is what is going to fundamentally change the way we use space and ultimately, life on Earth.

Technology is on a continual path of miniaturisation. If you need a reminder, look at the smartphone on your desk (or that is buzzing away in your hand right now because you’re as tech-addicted as the rest of us) and compare it to the lounge-full of equipment that this cool dude used to need to do the same job:

Peter Beck saw the same trend happening in spacecraft and built his company around it:

“For me it was always very obvious that spacecraft were going to shrink. When you analyse what is in a spacecraft there is a bunch of electronics, batteries, solar panels, and a sensor. And all of those things are on rapid trajectories either down in size or up in performance…Their limiting factor and enabler for that future was the ability to get those spacecraft up in orbit regularly, affordably and frequently.”

Many of the new generation of spacecraft are much smaller than Rocket Lab’s lift capacity of 150kg. These micro-satellites are known as Cubesats. One ‘Cubesat unit’ (1U) is a tiny satellite that can fit within a 10cm cube. A larger cubesat could be 10U or 20U large.

Rocket Lab is taking bookings for cubesats of all sizes, with one rocket ride containing up to 82U. Don’t let their small size fool you, these micro-satellites punch above their weight. For example, NASA is currently planning for a cubesat with an ion-thruster that will self-propel all the way to Mars.

Focusing on small spacecraft mean the rockets themselves can be smaller. Smaller rockets means less complexity, higher reliability, easier mass-manufacture, and ultimately lower cost.

(Inside Rocket Lab’s Auckland factory. Source: The Everyday Astronaut)

Rocket Lab also sought to align its cost base with humanity’s relentless march of technological progress. As Peter Beck explained:

“We stood back and said well what are the technologies that are either going to reduce in cost or improve in performance. Composites is one of them. 3D printing is another one. And batteries is another one. So there is no coincidence why a lot of the solutions we have chosen align with the trajectories of those either materials or technologies.”


(Source: The Economist)

The Electron contains the world’s first battery-powered rocket engine. Traditionally the main fuel of a rocket (liquid oxygen and kerosene) is mixed together by a gas-powered rocket engine. But those gas powered engines are complex and expensive. Although the industry thought it impossible at the time, Rocket Lab was able to make a battery-powered engine work.

Rocket Lab thereby aligned itself with the rapid decline in battery prices, and equally rapid increase in battery efficiency. Every decline in battery costs, and reduction in battery weight means lower launch costs for Rocket Lab.

ELaNa19-engines-Photo-credit-Brady-Kenniston

(Full thrust. Photo credit: Brady Kenniston)

The company’s Rutherford rocket engine is also the first oxygen/hydrocarbon engine to use 3D printing for all primary components. 3D printing meant Rocket Lab’s engineers were able to create complex but lightweight structures that would have been impossible to achieve using traditional techniques.


(Rocket Lab’s Rutherford Engine)

3D printing reduced the build time from months to days, and significantly lowered costs. As Peter Beck explained:

“The way we have designed the vehicle, it’s designed for manufacture. So while we use very expensive and exotic materials such as carbon fibre, and inconel superalloys and things like that, we don’t use very much of them. And the processes that we use, like the 3D printing of the rocket engines, means that while the material itself is very expensive, because we 3D print them, there is no wastage in the material. It’s additive manufacturing rather than subtractive manufacturing.”

Aside from its size, the other striking feature of the Electron rocket is that it is black. That’s not a nod to the All Blacks (although I might like to pretend). It is because Rocket Lab has pioneered the use of carbon fibre as the primary structural material. For those keeping score at home that is three world firsts in one little rocket.

ELaNa19-liftoff-Photo-credit-Trevor-Mahlmann

(Liftoff. Photo credit: Trevor Mahlmann)

Using carbon fibre was immensely technically challenging. Rocket Lab was helped by New Zealand’s world leading carbon fibre industry. The same one that builds America’s Cup yachts. Using carbon fibre means that the Electron rocket is far lighter, stronger, and crucially much easier to mass-produce.

All of these innovations add up to significant cost savings. A single Cubesat slot can be purchased for as little as US$80,000, while an entire mission starts from US$5.7 million. Those prices mean that access to space is now affordable for even the smallest startups.

As a private company Rocket Lab keeps its financials, well, private. However, I estimate that its marginal costs are likely to be a fraction of the sticker price. The company expects to be at cash flow break even shortly, even with just a few launches under its belt. I expect Rocket Lab to gush cash once it hits scale because most of its costs (engineers, launch facilities) are fixed, and its marginal costs continue to decline. Which brings us to the second secret of Rocket Lab’s success: launch frequency.

#2: Launch Frequency

Rocket Lab’s greatest competitive advantage is the frequency and flexibility of its launch schedule. It is incredibly valuable to customers, but also something that its much larger competitors will struggle to achieve.

“The launch regularly bit is the bit that everybody misses. So the reason why we have operations in New Zealand is because of the launch site. Every time you launch a rocket you delay national air travel. When Elon’s Falcon Heavy flew earlier in the year, there were 562 commercial air flights that were delayed or cancelled.

The East Coast of New Zealand is a beautiful place. But the reason Rocket Lab is based there is not the unspoiled coastal vistas, or the proximity to Hobbiton. It’s the huge flexibility of launch windows. Rocket Lab can launch regularly and with the widest range of orbital inclinations of any launch site in the world. All thanks to the limited aircraft and marine traffic. In fact, while the entire United States only managed to launch 26 rockets in 2017, Rocket Lab has approval from the New Zealand government to launch a new rocket every 72 hours.

Still-Testing-8

(Launch Complex 1: Mahia Peninsula)

That frequency and flexibility of launch allows customers to precisely plan when and where their spacecraft will enter Earth’s orbit. The orbit determines how fast the satellite travels, which part of the Earth the satellite passes over each day, and what time of day the pass-over occurs. It’s not much point building a mesh network of communication satellites if they’re all circling the Earth on random trajectories.

F4-NASA-Fairingfall-1

(Fairing separation. Source: Rocket Lab)

This launch control is the primary consideration for Rocket Lab’s customers as Peter explained:

“It’s control of destination and timeline. That’s the number one thing. ‘I’m going to this orbit on this day’ because that’s one thing that [traditional] rideshare can never offer. Because you just don’t know where you are going to go, when you are going to go”

#3: Flywheel effect

Rocket Lab’s low cost and high launch frequency are powerful in isolation. But it is the way that each positively reinforces the other that provides Rocket Lab’s moat. Lower costs mean that more customers can afford to launch more rockets, which provides the cash to fund higher launch frequency.

Increased launch frequency allows Rocket Lab to continuously iterate new innovations, and to achieve greater scale of rocket production. Both of those lead to lower costs. Those lower costs lead to greater demand. Which increases launch frequency. Which lowers costs. And the flywheel spins ever faster.

Peter Beck describes Rocket Lab as not being in a rush to launch one rocket, but rushing to launch one-hundred rockets.

The easy thing to do would be to just say ok, let’s just build a launch site in the U.S. and live with one [launch] a month, and we’ll work out how to get frequency later. We didn’t do that.

Rocket Lab took the pain of heavy investment up front, whenever it would result in better performance later on. It meant taking the time to develop multiple world-first technologies; building their own private launch facility and monitoring stations; and going through the regulatory burden of getting U.S. government approval for the export of sensitive rocket technology to a foreign country. As Peter Beck describes it:

“Owning that infrastructure is a key element because we have complete control over our launch windows, we have complete control over, basically everything… I tell everybody that Rocket Lab is a third the rocket, a third regulatory, and third infrastructure. And the infrastructure and regulatory bit aren’t as romantic and sexy like a rocket, but they are actually more the enablers than the rocket itself.”

If that long-term strategy sounds familiar, it is the same relentless approach that has been the cornerstone of Amazon’s success globally. The strategy is summed up by Amazon’s founder Jeff Bezos in the motto: ‘step by step, ferociously’.

Despite its smaller size, Rocket Lab can offer its customers the same price as a rideshare on a much larger rocket. And thanks to the flywheel effect, that cost is continuously falling. Plus, Rocket Lab provides a level of precision that rideshare will never be able to match. Combining low cost and vastly better service is a customer value proposition that is tough to beat – just ask Amazon’s competitors.

The first email

Rocket Lab’s success to date has been awe-inspiring. But speaking with Peter Beck, it’s clear that the company is just getting started:

“It’s a super exciting time in space right now when you think about it. The best way I try to explain it to people is go back to when the Internet was brand new and somebody had just sent their first email. If you went and sat beside that person at that time who sent the first email and explained to them all of the things the Internet was going to create it would largely seem like fantasy. With space, we have just sent that first email.

Rocket Lab is doing far more than holding its own in this new space race. In fact, when it comes to the hyper-growth small-satellite segment, Rocket Lab has so many competitive advantages that we may actually have the question backwards. We shouldn’t be asking if Rocket Lab will be able to compete with SpaceX.

We should be asking whether SpaceX can compete with Rocket Lab.

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The Hidden Power of Inflection Points

My investing was never the same again after I discovered this. Realising the simple power of fundamental inflection points started me on a journey toward a new (and thus far, fairly successful) investment approach.

Some lingo

But first, let’s get clear on what we mean by a fundamental inflection point. The Investopedia definition will suit us fine:

An inflection point is an event that results in a significant change in the progress of a company, industry, sector, economy or geopolitical situation and can be considered a turning point after which a dramatic change, with either positive or negative results, is expected to result.

To be super clear, we are talking about changes in the fundamental cash flows of the business, not ‘charting’ share price changes.

There are many types of fundamental inflection points. Here are just a few of the types I like to look out for:

  • Turnarounds (with a major catalyst sparking the revival)
  • A new fast growing product/segment, ideally whose early growth has been hidden by a larger flat or declining segment
  • A major demand side break-through such as a new distribution agreement
  • Growth company tipping in to profitability (with strong operating leverage)
  • Hyper growth company that has has just ‘crossed the chasm’ (a topic for another update)
  • Corporate spin-offs

All of these have one thing in common, which is a very rapid rapid acceleration in the rate of improvement in fundamental performance.

Today I’ll talk through just the corporate turnaround example, as it is where I first got started as a value investor.

Turnarounds

Imagine a company that has been generating steady revenue and profit when it suffers a setback and its performance takes a dive:

TheTurnaround

There can be a thousand causes. It could have been: a failed product launch; a botched acquisition; or a newly assertive competitor. Revenues slump, and profits plummet.

But whatever the cause, in this example, the declining business finally gets its act together and makes a rapid recovery. Note that this only occurs when there is a specific cause of the slump that can be quickly rectified.

The share price response to both the slump and the recovery is normally exaggerated. Here’s the typical share price moves we’d see in this situation:

TheTurnaround1

This simple chart sums up a lot of ‘classic’ value investing.

Value investors look for businesses that have had some fundamental setbacks (the dip in revenue and profit). But more importantly, they are looking for situations where the market has over-reacted to the bad news (the share price plunge) and the shares are undervalued. They purchase shares during the troughs of the market’s despair and hope to sell later, when the market’s mood has improved.

TheTurnaround2For many years this was my investing modus operandi: buy something cheap, usually watch it continue to get cheaper, finally (hopefully) a rebound arrives, sell.

It can be painful. Value investors are cursed with being early. That means suffering through significant further price falls before the company’s performance improves. Classic value investing doesn’t really have an answer to this painful process, aside from developing the stomach to hold your nerve (always good advice).

And that is actually the best-case scenario.

“Turnarounds seldom turn” — Warren Buffett

In plenty of cases the turnaround never comes. The traditional value investor is left holding the bag on to a company that looks cheap, but where performance continues to decline. The ‘cheap’ often just keeps getting ‘cheaper’. This slow-motion train wreck is known in the industry as a value trap.

But what if we could cut out most of the pain of suffering through falling prices, and almost all of the value trap blow-ups?

A better approach

Instead of purchasing purely based on an estimated discount to intrinsic value, we can also wait for indications that a fundamental improvement is already well under way. We can wait for the fundamental inflection point:

TheTurnaround3

By waiting until the inflection point has already started we avoid the worst of the losses that long-term holders have suffered. In turn we also miss out on some of the gains, since we are unlikely to be buying at the absolute bottom. But that also means we join in just when the fun is really getting started.

Most value investors arrive for the party two hours early and make awkward chit-chat with the hosts over a bowl of dip. We arrive a half-hour late, a couple of other guests have already arrived and the conversation is flowing. Soon the party will be in full-swing. Later on, when Mr Market has gotten drunk and starts making a scene, we’ll make a polite exit.

Here is a zoomed-in version:

Outcome

My preferred spot is to wait until *after* there is already some compelling evidence that the company has hit an inflection point (the black line). This has the added benefit that we rely more on observation of the world as it currently is, than solely on forecasts of how it could be in future.

When executed well, this focus on inflection points can radically enhance our expected returns:

  • Reduce the number of severe ‘value trap’ blow ups. This helps us win big, lose small.
  • Reduce behavioural biases: less pain from holding falling shares means less temptation to sell at the worst possible time.
  • Shorten the average holding period. This is a key part of generating high annualised returns i.e. it is better to make 50% in six months than to wait two years.
  • Higher ‘hit-rate’ which allows greater concentration i.e. the number of profitable trades as a percentage of all trades increases.

So why isn’t everybody already doing it?

Why it works (a.k.a. why it’s hard)

Thankfully, there are several challenges to successful inflection point investing.

First: anchoring. “I’ve missed it” are three of the most dangerous words in investing.

By the time the inflection point is already underway, the share price has likely rebounded off its lows. Investors that have been watching the stock often anchor to the lows, instead of reassessing the current value. They avoid buying, thinking that they have missed the gains.

Second: cognitive biases. The changes that happen at inflection points tend to be extremely rapid. We humans are not great at exponential thinking.

Our brains evolved to be very good at linear forecasting. That lion is running towards me. I predict that if this continues I will be his lunch. I better do something. That is very helpful linear forecasting. But it is less helpful in the modern world of finance.

When it comes to forecasting rapid change, our brains are slow to adapt. The market tends to forecast based on a linear extrapolation of recent results:

estimates

The market repeatedly under-estimates how quickly the company will improve. Then finally, the market actually overshoots to the upside. The stock then becomes overvalued. Smart investors sell, and the whole glorious cycle of expectations can start again.

Third: the search is hard work. No one rings a bell to tell you an inflection point is underway.

Small-cap and micro-cap companies are often a good place to look for these opportunities. Often nobody else is watching closely. Or more precisely, nobody else that is managing enough funds to move the price.

In these ‘under-followed’ cases it is often possible to identify the inflection point simply by following the company’s latest financial reports. But it is not always that easy. Often by the time the inflection point is readily apparent in the published financials, it is already too late. Smart investors need to be doing the hard work of equity research to identify a fundamental inflection point before it is obvious in the reported results. That means digging through every piece of information about the company, it’s competitors, suppliers, customers etc. Investors also need to ensure they aren’t being fooled with a false positive. Or as Buffett calls it, a ‘turnaround that keeps on turning’. It can be an incredibly rewarding process, but it’s hard work.

Fourth: patience. Or rather, being extremely selective. It is hard enough to find a company that is undervalued. Inflection point investing means holding off, and only investing when you have found undervaluation and a positive fundamental inflection point.

Thankfully none of that is easy, or everybody would be doing it, and the magic would disappear.

Conclusion

Understanding the power of inflection points can significantly enhance a ‘classic’ value investing approach.

We’ve only scratched the surface of inflection point investing. We talked through just one example, the corporate turnaround. But there are dozens of others. In fact, we didn’t get a chance to talk about about my favourite type of inflection point (a hyper-growth company that has has just ‘crossed the chasm’). That will have to be the topic of another update!

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