a2 Milk: The Story of the 2,200% Monster Next Door

This is the story of how a little company from New Zealand grew to become a 14 billion dollar giant, the signs that indicated a big future ahead, and the tale of one of the greatest blunders in Australian business history. It is also the story of how we can apply the principles of what I call monster hunting to our own investing, and use the lessons on our quest to find the next potential winner while it is still small and undiscovered. 

The Monster next door

I first purchased my shares in a2 Milk (ASX:A2M) in late 2015. It’s been a fun ride. In just four and a half years the shares have delivered a 2,200% return for shareholders. In annualised terms that is an incredible 99% per year. Past performance is no guarantee of future returns, both for our stock selection, and the business itself. Also, as we’ll talk about later it’s been a wild ride too. Holding on required enduring multiple occasions where the share price slumped, up to 30% or more, sometimes for more than a year. 

It’s no secret that A2 Milk has generated strong returns for long-term shareholders. Bloomberg even named it as the best performing stock in the world:

It may have been the decade of smartphones, on-demand everything, and Instagram memes, but the prize for the world’s best-performing stock in the MSCI World Index goes to a dairy company in New Zealand.

But what a lot of this coverage misses is an understanding of how the company did it. A2 Milk is my favourite applied example of monster hunting. It’s not because of the returns (although sure, those are nice too). It’s because of how the business delivered those returns. 

This was a company that could be purchased at multiple times throughout its growth journey for a very reasonable price. Its business is simple and its customer value proposition is easy to understand. Most of all, the returns were not driven by price swings, they were primarily driven by astounding organic earnings growth. 

When I first purchased shares in late 2015, the total market capitalisation of the entire company was approximately $560 million NZ dollars (note: for simplicity I will refer to NZ dollars throughout this article unless otherwise noted). In 2015, a2 Milk had recently tipped past break-even and was generating $1.2m of EBIT from $155m of revenue. 

Source: a2 Milk Financial Reports, analyst estimates.

Fast forward to today and the business is forecast to generate $560m of EBIT this year. Approximately the same as the company’s entire market cap in 2015. Revenue is now forecast to be $1.725 billion at the midpoint of guidance. Not only that but the company now holds $618m of cold hard cash and has another $260m worth of listed investments in its supplier Synlait Milk (ASX:SM1) representing a 19.84% stake. 

Source: a2 Milk Financial Reports, analyst estimates.

In five years a2 Milk increased its revenue by 1,000%, its operating profits (EBIT) by 46,000%, and now holds significantly more cash than its starting market cap.

A2 Milk exemplifies what we should be trying to achieve as investors. Finding the large dominant businesses of tomorrow while they are still small. Luck plays a role in every business success, but this wasn’t a speculative lotto ticket like a mining explorer or biotech. This was a hyper-growth consumer brand that delivered eye-watering returns from consistent and steady improvements in fundamental performance. 

What’s more, these stellar returns were primarily driven by fundamental growth, not by a big increase in the multiple that investors are willing to pay. This is best illustrated by this chart of the forward p/e multiple that a2 Milk has traded at over the past five years:

Source: S&P Capital IQ.

Despite many commentators saying that a2 Milk was overvalued along the way, it has typically traded at a fairly reasonable valuation given the incredible growth that it is experiencing. This is not a story of a huge multiple expansion, it is a story of compounding high returns on invested capital.

How to Catch a Monster

As I wrote in How to Catch A Monster, 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. 

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.

We’ll step through each in turn, in the context of a2 Milk.

The 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. As I wrote in The Bizarre, Weird and Beautifully Inefficient World of Aussie Small Caps it means saying no to a lot of companies. Thousands of companies in fact. But that process of elimination leads us to a precious few companies with very attractive underlying economics.   

What made a2 Milk so special – and what most of the market missed – is the power of its business model. 

At first glance in 2015, a2 Milk looked like just another commodity food producer. At that time the significant majority of its revenues were from fresh milk sales at supermarkets in Australia. Its now famous infant formula had only just started to take off. 

What really set a2 Milk apart is that it isn’t really a food producer at all: A2 Milk is a marketing business. All of a2 Milk’s products are produced by external suppliers that the company holds a close relationship with, in particular the New Zealand dairy company Synlait Milk. A2 Milk’s job is to create demand, maintain customer relationships, and manage the supply chain. Their partners do the hard work of building out factories and converting cow herds to be able to supply a2-protein-only milk.

As a result, A2 Milk is incredibly capital light with high returns on incremental invested capital. The company expanded from selling $136 million worth of products in 2015 to over $1.7 billion today. How much did a2 Milk spend on capital expenditures over the past five years, while it added over $1.5 billion in revenue? A paltry $9 million dollars. How is that possible? Their partner Synlait Milk did the heavy lifting for them, investing over $560 million on capital expenditures over the same period. Synlait has other customers than just a2 Milk of course, but it gives some sense of the scale of capital-intensive investment that a2 Milk avoided.

The real cream (sorry) in a2 Milk’s business model is the combination of being capital light with the premium margins that it generates as a trusted consumer brand. Once a customer has selected a2 Milk’s products, particularly its infant formula, they are reluctant to switch. As anyone who has tried moving their infant away from a formula that they are happy with knows, there is a big downside risk (tears, sleepless nights) for very little payoff. This loyalty gives a2 Milk the ability to earn an incredibly healthy operating profit (EBIT) margin of 32%. When we roll together limited capital costs, sticky customer relationships, and strong pricing power, a2 Milk generates a mouth-watering return on equity of 42% – and that’s while sitting on over $600m of cash.

As I wrote in How to Catch a 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. 

Running down the list of everything else that I look for, a2 Milk has extremely high-quality earnings, a rock-solid balance sheet, strong demand and supply side competitive advantages, incredibly attractive unit economics, unknown or misunderstood by the market, and is well led. Meanwhile the business was also tipping past some fundamental inflection points that I’ll touch on in a moment as well.

Safe to say that a2 Milk was, and is, very much the type of business model that we are hunting for. Now, on to Step 2.

Catch your Monster

Every monster is different, but I have found there are four key traits that 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 by many multiples, if it is starting from a low base. 

A2 Milk started this epic run from a market cap of around $560m, much smaller than the big blue chips that get most of the market’s attention.

#2: Unique edge

A lot of people got this wrong about a2 Milk. They thought that the company’s unique edge was that it was selling a particular type of dairy protein. This confuses the raw materials with the product. The value add for any brand isn’t its raw ingredients, it’s the associations that are formed in the minds of its customers. Red Bull doesn’t just give its customers caffeine – there are much cheaper caffeine pills that do that – it gives them wings. Consumer wellness products are the same: brands first, and health products second. 

By 2015 a2 Milk had a strong and steady market share of around 10% of the entire Australian fresh milk market. But most importantly it had positioned itself as the premium branded alternative to home-brand milk. For a lot of Australian consumers it was trusted as a healthier alternative. That set the scene for what would become a2 Milk’s home run product: infant formula. 

In 2008 hundreds of thousands of Chinese infants were fed infant formula that had been poisoned by the industrial product melamine – the stuff that we make those shiny white table tops out of. It was a devastating scandal, with over 50,000 infants hospitalized and at least six killed. Chinese food safety standards were not up to par, so wealthier Chinese mums sought out trusted overseas brands. 

Over the following years, demand for high-quality internationally-sourced infant formula soared in China. Australian supermarket shelves were often stripped bare as Chinese personal shoppers – daigou – bought all that they could and then on-sold the products in China at much higher prices. 

It was against this backdrop that a2 Milk launched its infant formula product and leveraged the success in the fresh milk category. The Aussie mums that were used to buying a2 Milk’s premium fresh milk now started buying the infant formula. The product was priced significantly above competitors, and supply was tightly managed. This provided a powerful signalling effect to Chinese mums that only wanted the best for their children: the health-conscious and more affluent Australian mums were buying a2 Milk so they should too. The strategy worked and a2 Milk infant formula rapidly became the market leader in Australia. 

A2 Milk is also, in its own way, a disruptive innovation. The large dairy incumbents struggle to launch an a2 protein only product and market it aggressively because by doing so they would risk hurting the image of their much larger existing traditional dairy business. It poses a fun twist on the classic innovator’s dilemma and it meant that once established a2 Milk was largely left to own the a2 protein category.

Whatever your personal take on a2 Milk’s wellness benefits, millions of people love the product — and that is what counts. A2 Milk’s unique edge was the power of its consumer brand, sticky customer relationships, and then the ability to use its growth to fuel more marketing spending, turning the flywheel even faster. 

#3: Superior Management

A2 Milk’s management team have executed very well on a number of important fronts. The most important of which was management’s ability to build and maintain the premium brand position of the product. 

A2 Milk’s management team often described their strategy around the supply chain as ‘keep the channel hungry’. This meant ensuring that no one distribution channel or partner ever had surplus supply that might lead them to discount a2 Milk’s products and thereby tarnish the premium positioning of the brand. Just as the owner of any expensive nightclub knows, you always want to keep a line waiting at the front door. 

Management also continued to invest heavily in marketing and distribution. Almost every earnings release saw the company post incredible results, but also partially disappoint analysts by flagging another big step up in marketing spend. Meanwhile the company also built out its direct selling strategy into Chinese Mother and Baby stores – thereby building another major distribution channel and reducing reliance on daigou shoppers. 

#4: Misunderstood

Finally, to have a chance of being a huge multi-bagger winner the company needs to start off being misunderstood by most of the market. The only way for a company to be significantly undervalued is for most of the market to not understand what the business is truly worth.

Whether it was the business model, or its unique edge, or the power of the brand, a2 Milk has been significantly misunderstood throughout it’s journey. 

The fundamental inflection point

All of those traits were incredibly important to the purchase decision. In a2 Milk’s case it also ticked another box that I love to see before I purchase: it was just tipping past several fundamental inflection points. 

In late 2015 the Australian Financial Review released an article that included a chart of pharmacy sales data. It showed that a2 Milk had, in just a few months,  rapidly taken market share and was gaining ground quickly. 

As I wrote in The Hidden Power of Inflection Points, there are several different types of fundamental inflection points that I like to look for. The updated pharmacy data showed that a2 Milk was tipping past not just one, but four:

  • 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 just ‘crossed the chasm’ (a topic for another update)

The infant formula product was experiencing explosive hyper-growth thanks to the new distribution channel of daigou shoppers. The demand for a2 products as a category had crossed the chasm from early adopters into a mainstream segment. The growth in infant formula was being partially obscured by the slow and steady fresh milk segment. Finally, a2 Milk was just tipping in to profitability with strong operating leverage – laying the foundation for the spectacular operating profit growth that ensued. 

A lot of finding monsters is about spotting anomalies and then digging deeper. I often wonder how many other people read the same article that I did in 2015 but couldn’t put it into the context of the incredible value creation that a2 Milk was about to deliver. It’s rare for a business to be hitting one inflection point, let alone multiple points simultaneously.

When you find one it’s time to pounce. 

3) Watch Closely

The price of catching monsters is eternal vigilance. 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.

For a2 Milk that meant a big focus on how it was managing its supply chain. There was the constant threat of simply running out of stock – so we were continuously checking supermarket stores to make sure that there was adequate supply. But also, as management said, we wanted to make sure that the channel was ‘kept hungry’ and that there was no large glut of supply that might lead to discounting. 

One other method that we stumbled upon after many hours of staring at tins of formula was that we could track the production and expiry dates on tins to keep track of how quickly the stores were turning over the product. 

There were plenty of other things to watch along the way too: China’s forever shifting regulatory framework, larger competitors entering the market, the dependence on the manufacturer Synlait, and the role of the large e-commerce platforms in China to name just a few.

As I wrote in The Selling Blind Spot we need to be prepared to sell quickly if our thesis is broken. But if it is not, then we need to have the patience to hold on.

Hold on

“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.”


Holding on requires 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. 

This is what I like to call a ‘pain chart’ 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 2,200%:

There have been five times when a2 Milk’s share price fell 20% or more. And on three occasions the shares fell by 30% or more. In most instances, it took a long time before the share price made it back above its previous high. To enjoy the monstrous gains to date, shareholders needed to avoid giving in to fear and selling out during those troughs of despair. It’s also a challenge to hold when the shares are soaring higher. As I wrote in The Selling Blind Spot if the shares run a little ahead of our intrinsic value estimate the smart move is often to trim the position, rather than to sell out entirely.

It is easier said than done. At the start of this article I said that this story would include one of the greatest blunders in Australian business history, here it is. In late 2015 Freedom Foods (ASX:FNP) had a close partnership with a2 Milk and owned almost 20% of the company. Freedom Foods even made a takeover attempt to buy all of a2 Milk in partnership with a U.S. Foods business. 

But then the milk turned sour. After the takeover attempt failed the relationship between the two businesses deteriorated. Despite presumably loving the long-term outlook for a2 Milk just a few months prior, Freedom sold all 117 million shares in a huff in two tranches for A$70c and A$85c each in October and November 2015 – coincidentally right around the time that I was buying. All told Freedom Foods received A$93 million for their stake. 

Today that stake would be worth over A$2.1 billion dollars. Freedom Foods had left over A$2 billion dollars sitting on the table. To put that into perspective, the entire market cap of Freedom Foods, a 30 year old company, is today only A$1.2 billion. Ouch.

That transaction was also a great reminder to always do your own deep research, and never automatically assume that you’re wrong just because somebody else has sold. Even if they are a knowledgeable strategic investor in the same industry.

What’s next?

This strong and enduring fundamental growth has proven even more valuable during the current crisis as a2 Milk again demonstrated its resilience. When Chinese mums became more concerned about the health of their little ones than usual, they stocked up on a2 Milk. 

Catching monsters is hard. Our view of the future is cloudy at best. A2 Milk has proven incredibly resilient during the early phases of the current crisis, but this could always change in future. Or there could be supply disruption, or regulatory changes. Any number of potential bear theses always lie in wait, as usual. We must continually monitor for any changes in the company’s fortunes.

Above all the story of a2 Milk highlights that we should not spend too much time worrying about the general swings in the broader market when we could instead be doing deep fundamental research. When a business like a2 Milk increases its revenue by 1,000%, and its operating profits by 46,000% over five short years, then it matters very little whether the market goes up, down, or sideways.

Nothing is guaranteed, but if you can demonstrate those three qualities: vision, courage, and patience, you have a shot at aligning your portfolio with these incredible engines of wealth creation that I call monsters. The ride can be bumpy, but it’s also a heck of a lot of fun.

Disclosure: At the time of publishing Matt has a position in a2 Milk. Holdings are subject to change at any time. This report, and disclosure, should not be considered to be a recommendation. 

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. 

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.


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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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.


(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.


(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.


(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.


(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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