07 Oct An option under Guise
As published in “Calcalist”.
When buying equity in young growth companies, what you’re really getting is an option; an option to take part in the company’s future growth. Growth companies have a window of opportunity that depends first and foremost on the human advantage.
Even in the tech world, it is the human advantage that makes a difference.
Many investors, especially experienced and seasoned ones find themselves at odds with valuations of technology companies; promising young companies are assigned valuations on the basis of revenue multiples, not earnings.
By now it is common knowledge that emerging technology companies operate at a loss, and that valuations are a function of revenue multiples. As a result, these companies trade at legendary values.
Tech companies with high valuations first appeared on the scene in the nineties and were considered rather risky. For the most part they compromised a small part of a balanced portfolio. Today however, they have become a significant component of investor portfolios, making their effect on overall performance critical.
When we buy shares in a high growth company, we think we’ve bought equity, but what we have in fact is an option to participate in the future success of the company. As with an option, we are paying a premium to the present value, and its trajectory over time is rather volatile, with large swings in both directions. In the case of a company in its early stages, we are getting essentially a product that provides a specific technology. As the company matures, it will endeavor to provide a platform with multiple solutions. This is why young technology companies have a limited window of opportunity to growth into a platform provider. It’s really an option, in the guise of equity.
One noteworthy example is the comparison between Check Point to Palo Alto. I recently participated in an investor call with a leading analyst at Oppenheimer. There were several veteran investors on the call as well, who insisted to inquire about Check Point, and for good reason; Check Point is undoubtedly a stellar cyber company with excellent products, but one who has not, as of yet, established itself as a platform company. As enterprises today seek a wider cybersecurity offering, they are not able to find this with Check Point and therefore migrate to competitive companies. For this reason, Check Point has underperformed as it is losing market share. On the other hand Palo Alto, another cyber security company, embraced an acquisition strategy and has built out a platform of offering, enabling the company continued growth that justifies its high valuation. As I learned early on in venture capital, “you have to pay to play”.
In my experience as an investment manager, in many cases management and the CEO’s personality make the difference between a company with a leading product, to one which has taken the next leap to become a platform offering several solutions. An iconic example is a man recently retuned from space, Jeff Bezos; he has turned a losing online book retailer to a mega predator taking bites out of several verticals, including eCommerce, cloud, groceries, advertising, and as of late even payments; Amazon continues to forge additional areas, and the market’s regard for Amazon stock is accordingly positive.
Therefore, every time I buy equity in a growth company, it is in fact an option in disguise, and so my assessment of management and the CEO. As an investor, even in a world that is becoming more and more technological, it is the human advantage that makes a
Michael (Miki) Jakoby is the Managing Partner of Defender Funds, a hedge fund investing in U.S markets.