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Intensity is the price of excellence, bull sh!t EBITDA adjustments, how to beat the S&P 500 and being called a "dumb doofus idiot"
October 2022 Monthly Wrap
Every month I share an update on this newsletter and a summary of what I’ve read, seen or heard that I’ve found interesting. If you have any feedback, please hit me up! If you missed the September Monthly Wrap, you can find that here.
If you are not already you can follow me on Twitter here (@tlginvestor). Keen to read a bit more, you might enjoy:
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The Long Game Update
No new posts this month. I’ve been travelling across the US and am actually heading back next week. Unfortunately that means writing takes a back seat, but it does leave a lot of time to read, so a couple of denser reads in this months wrap. I am still working on a write up for SQ 0.00%↑ and I hope to release that this month (but no promises).
So far, the readership of this newsletter has far exceeded my expectations, with subscriber growth continuing to grow nicely. In the last couple of weeks, I’ve had a couple of people reach out asking when certain write ups (i.e. my SQ 0.00%↑ write up) would be made available. I’m pleased that people like reading the investment notes, but If I’m honest, I write this Substack for myself and as such the cadence of posting will be sporadic. Some times I start working on a company, and get side tracked and I’ll end up researching something totally different. Other times my investment process means I can spend over a year casually researching a company before i am ready to start writing it up. For example, I started to first look at SPOT 0.00%↑ in 2020 before finally deciding to write it up in 2022. Writing is not one of those things that comes naturally to me, so I spend most of my time reading and thinking. Maybe one day this Substack will turn into something more, but for now I have other priorities.
I continue to remain (mostly) uninvested
Other than a few very small "moonshot" bets in the public markets, I have been holding cash. I generally think we are in for a tough 12-18 months, so continue to focus on paying down our mortgage over investing. When the opportunity arises, I will look to move quickly and initiate positions in a handful of companies I am watching closely.
In June Matt Prince, CEO of NET 0.00%↑ spoke at the Jeffries Software Conference where he talked about his views on the current macro. I found the below quote telling:
And I think that we are in for a difficult next few years. In our last earnings call, we said Q1 of 2022 was by far the hardest quarter we have seen since Q1 of 2020, which was the COVID quarter. And I think one of the things that was – is unique about us is because our sales cycles are so fast measured in less than a quarter typically. That let us see some of the kind of early warning signs late in 2021 and early in 2022. And that’s allowed us to adjust and adapt. But I think companies that may have looked like they were doing very well in Q1 that have longer sales cycles, you are going to start to see them having pipeline problems in Q2, Q3, Q4.
What I have been reading, watching and listening to:
"Dear Parag and Ned" - An Open Letter to Twitter Leadership: With Elon closing the TWTR 0.00%↑ acquisition (the bird is free), I came across this open letter to Parag and Ned (now both ex CEO and CFO respectively) late last year. Ironically, the advice in the letter specific to Twitter ("moving fast and decisively, but with the efficiency of an entrepreneurial startup rather than the inefficiency of a bloated media business”), is the opportunity that Elon is seizing on, but what struck me most was how relevant the advice in this letter is to almost every company. For example, stock based compensation is one my biggest gripes. While it’s not a cash expense, it increases the number of shares outstanding (diluting existing shareholders), and is basically a mechanism to increase remuneration in lieu of additional cash salary. I am firmly of the view the continued acceptance of financial metrics such as adjusted EBITDA (which backs out Stock Based Compensation and other valid expenses) continues to be to the detriment of longterm owners of companies - at some point this house of cards is going to collapse. Management need to realise at some point the market is going to catch on to this bulls!t. The continued use of SBC and other adjustments is destroying long term share holder value.
Of course, the point of investment is not revenue growth: it is growth in intrinsic value PER SHARE, to which revenue is but one important input. As the last two years have shown us, the vicissitudes of stock price movements cannot be our measuring stick. Rather, we must stay focused on the inputs that drive intrinsic value per share: the sum of all future cash flows, discounted back to today. Ultimately, share price moves toward intrinsic value, even if its short-term moves seem manic….
…..One of Warren Buffett’s lesser-known quotes is apt: “intensity is the price of excellence.” For Twitter to fulfill both its mission and its owners’ expectations, you will be required to make hard choices and provide sustained effort. My hope is that you two lead a balanced company, moving fast and decisively, but with the efficiency of an entrepreneurial startup rather than the inefficiency of a bloated media business. In the near-term, I believe Revenue and Moat continue to deserve primacy. But that can no longer come at the expense of shareholders via wasteful spending and an ongoing deluge of share issuance. Intensity truly is the price of excellence. The world needs an excellent Twitter. It’s time to decide if #OneTeam burns with the requisite 🔥.
Earnings and Cash Flows: A Primer on Free Cash Flow: That last rant dovetails nicely into this fantastic piece by Aswath Damodaran on measuring and understanding free cash flows.
Free cash flow is one of the most dangerous terms in finance, and I am astonished by how it can be bent to mean whatever investors or managers want it to, and used to advance their sales pitches. I have seen analysts and managers argue that adding back depreciation to earnings gives you free cash flow, an intermediate stop, at best, if you truly are intent on computing free cash flow. In the last two decades, I have seen free cash flow measures stretched to cover adjusted EBITDA, where stock-based compensation is added back to EBITDA, and with WeWork, to community-adjusted EBITDA, where almost all expenses get added back to get to the adjusted value. I will use this section to clarify what free cash flows are trying to measure, how they get used in investing and valuation, and the measurement questions that can cause measurement divergences. (Emphasis added)
Mark in the metaverse - Facebook’s CEO on why the social network is becoming ‘a metaverse company’: The META 0.00%↑ stock price continues to be punished by investors who are upset by the amount of cash being burned on Zuck's big bet on the metaverse. This is a really great interview by Casey Newton of The Verge, where Zuck explains this thinking behind the pivot. Love or hate the idea, its an interesting read (or listen if you'd prefer), and you have to respect vision.
As June came to an end, Facebook CEO Mark Zuckerberg told his employees about an ambitious new initiative. The future of the company would go far beyond its current project of building a set of connected social apps and some hardware to support them. Instead, he said, Facebook would strive to build a maximalist, interconnected set of experiences straight out of sci-fi — a world known as the metaverse.
The company’s divisions focused on products for communities, creators, commerce, and virtual reality would increasingly work to realize this vision, he said in a remote address to employees. “What I think is most interesting is how these themes will come together into a bigger idea,” Zuckerberg said. “Our overarching goal across all of these initiatives is to help bring the metaverse to life.”
How to beat the S&P 500 - I just loved the thought behind this post on reconstructing the index to beat the S&P 500. Humourous and enlightening at the same time. Pretty cool how poeple’s minds work and this piece was just a really well thought out body of work in my opinion.
The next day Ben walks proudly down to CNBC headquarters and informs them he has once and for all figured out how to beat the S&P 2 Index. He explains his process while writing the following on a whiteboard:
Start with the index itself.
Remove the shitco
Reinvest the money you get from the shitco back into the remaining company
Cloudflare (NET 0.00%↑ ) CEO Matthew Prince presents at Jefferies software conference: In the section above, I referenced a quote from Matthew Prince at the Jeffries Software Conference in June. For anyone interested, you can read the full transcript here. For the record, I rate Matthew Prince as one of the best CEO’s going around. I previously had the privilege of being an owner of the company since the IPO and sold only because I thought the valuation got overheated towards the end of last year. Matt generated a ton of value for shareholders and is building a pretty special company. I am hopeful to re-enter the stock in the near term if an opportunity at the right price arises. Wonderful company, great CEO but wrong price.
Tweet of the Month
Every month I will share a Tweet I came across that I found interesting. For October it was the first time I have been trolled on Twitter. This one made me smile.
Stay patient, focussed and rational.