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GREENLEA LANE Presentation for Seminar On Value Investing And The Search For Value July 21, 2017
GREENLEA LANE
Presentation for !Seminar On Value Investing And The Search For Value!
July 21, 2017!
THIS DOCUMENT SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF ANY OFFER TO BUY. NO PART OF THIS DOCUMENT IS
A RECOMMENDATION OR A SOLICITATION. THE INFORMATION AND BELIEFS CONTAINED HEREIN ARE BELIEVED TO BE CORRECT, BUT
THERE IS NO GUARANTEE.!
Greenlea Lane!• Investment partnership founded in 2007!• One-person operation, based in New York!• Mission is to be a world-class investment that makes
a difference for a group of Limited Partners with whom I feel a personal connection!
• Strategy is to identify the most exceptional companies that I can understand, buy cheaply, and hold on for the long haul, ideally forever!
• Currently hold 11 investments!– Mentioned in this presentation: Alphabet, Amazon.com,
Markel, Trupanion!
Agenda!• Investment approach!
– Compounding machines!– Select business models!– “Quality”!
• Unconventional things!– Valuation rules of thumb!– Investing in change!– Intangibles!
• Two key lessons from my first decade!– The map is not the territory!– “Long term”!
• Trupanion! ! !!
Compounding machines!• I invest solely in compounding machines!
– Long runway to rapidly grow earnings power!– Large opportunities to reinvest at high returns on capital!
• Reason #1: Alignment with my personality!– I approach investing as participating in extraordinary
enterprises à natural and rewarding!– Buy and selling securities à not interesting to me!– Buy with the hope of holding forever!
• Reason #2: Secondary effects of long-termism!– Low pressure for new ideas à better ideas à improving
portfolio à less pressure for new ideas…!
Agenda!• Investment approach!
– Compounding machines!– Select business models!– “Quality”!
• Unconventional things!– Valuation rules of thumb!– Investing in change!– Intangibles!
• Two key lessons from my first decade!– The map is not the territory!– “Long term”!
• Trupanion!
Select business models!• My circle of competence is very focused and
specifically defined!• I invest only in select business models!
– Models that I understand, deeply believe in, and have experience with!
– Not industries or sectors, but models for how the company creates value and grows earnings power!
• Two examples of models:!– Volume-price virtuous circle!– Network effects!
Select business models!• Volume-price virtuous circle!
– Cost advantage à invest into customer value proposition à grow volumes à enhance cost advantage à invest in customer value proposition…!
– I like this model because earnings power growth and moat widening are one and the same process!
– Archetypal examples: Walmart, Costco, GEICO!– Greenlea Lane example: Amazon.com!
Select business models!• Key evaluation factor: How long is the runway to
meaningfully lower costs and improve the customer value proposition?!
• It is important to understand the mechanisms for unit cost reduction!
• Example: Amazon’s retail business!– Supplier leverage à volumes!– Fixed cost leverage à volumes, frugality!– Process improvement à know-how, data, tech, frugality!– Customer acquisition à brand/mindshare, data,
membership!– Cross-subsidization within the Prime bundle!
Select business models!• Network effects are when the value delivered to
users increases directly with the number of users!– Greenlea Lane example: Alphabet (Google)!
• Two key evaluation factors:!– How long is the runway to improve value based on
incremental usage? !• Google might be an “infinitely” scaling network effect!• Not as strong: diminishing returns (e.g., restaurant delivery apps)!
– Are there high costs to being involved in multiple networks?!• To the extent there are high costs, users will participate in fewer
networks, which limits the number of networks and competition!• For example, Amazon merchants managing multiple inventory pools!
Agenda!• Investment approach!
– Compounding machines!– Select business models!– “Quality”!
• Unconventional things!– Valuation rules of thumb!– Investing in change!– Intangibles!
• Two key lessons from my first decade!– The map is not the territory!– “Long term”!
• Trupanion!
“Quality”!• “Quality” is a critical intangible ingredient in a
Greenlea Lane investment!• Our companies intuitively think of themselves as a
small part of a vastly larger system (the world)!– Every component of the system is interconnected!– The only way to flourish is to add value to the system!– The opposite would be to exploit the system!
• This mindset manifests as a mission-driven culture!– A mission is something done for its own sake, as opposed
to for extrinsic rewards!
“Quality”!• Alphabet à To organize the world’s information and
make it universally accessible and useful "
• Amazon.com à To be Earth’s most customer-centric company"
• Markel à To build one of the world’s great companies"
“Quality”!• A mission-driven culture is a powerful advantage!
– People perform better when they believe in and identify with their work!
– As opposed to viewing their work as a means to an end!• Over the long term, companies always evolve, for
better or worse, because the world changes!– A mission serves as a propelling and guiding force!– Evolving successfully entails making tough decisions,
taking pain today and deferring gratification!– Mercenary companies are far less likely to do this!
• Example of mission-driven innovation/adaption: Amazon’s marketplace!
Agenda!• Investment approach!
– Compounding machines!– Select business models!– “Quality”!
• Unconventional things!– Valuation rules of thumb!– Investing in change!– Intangibles!
• Two key lessons from my first decade!– The map is not the territory!– “Long term”!
• Trupanion!
Valuation rules of thumb!• There is a remarkably consistent pattern in the way
investors think about valuation multiples of earnings or cash flow:!– 10x or less is cheap!– 15x is average!– 20x+ is expensive!
• These rules of thumb are reasonable on average"• This is an anchoring effect (powerful cognitive bias)!
– When we ask ourselves what the right multiple might be for a particular business, we are influenced by what the right multiple is on average"
Valuation rules of thumb!• One cannot apply what is correct on average to
individual cases, unless one is dealing with a homogeneous set!
• Companies are not a homogeneous set!– They wildly differ in terms of incremental returns on capital
and reinvestment opportunities!• Therefore, it makes no sense to be influenced by
valuation rules of thumb when analyzing a specific company!
Valuation rules of thumb!• Common yardsticks such as dividend yield, the ratio
of price to earnings or to book value, and even growth rates have nothing to do with valuation except to the extent they provide clues to the amount and timing of cash flows into and from the business!
• I don’t think price-to-earnings, price-to-book, or price-to-sales ratios tell you very much !
• People want a formula, but it’s not that easy!
Valuation rules of thumb!• All of this might sound radical…!• …But all of the quotes on the previous slide are
attributable to Warren Buffett (emphasis added)!• WEB: To value something, you simply have to take
its free cash flows from now until kingdom come and then discount them back to the present using an appropriate discount rate."
Valuation rules of thumb!• I use a DCF when:!
– The business has a large growth runway relative to its current size!
– The margin structure will meaningfully change over time!• DCFs do not have to be complicated!
– Revenue!– Margins !– Capital intensity!
• I try to generate an appropriately (read: very) wide range of intrinsic value estimates!
• Invest at a large discount to the low end of the range!
Agenda!• Investment approach!
– Compounding machines!– Select business models!– “Quality”!
• Unconventional things!– Valuation rules of thumb!– Investing in change!– Intangibles!
• Two key lessons from my first decade!– The map is not the territory!– “Long term”!
• Trupanion!
Investing in change!• Within the value investing community I believe there
is:!– An affinity for investing in constancy (future is like the past)!– An aversion to investing in change (future is new)!
• The classic value investing playbook is to bet on a reversion to the mean when a company stumbles !
• By contrast, investing in change is consciously or unconsciously regarded as risky!
Investing in change!• I believe that neither constancy nor change is
inherently more or less probable—it depends on the situation!
• Change can be as certain and predictable as you need it to be to safely invest!
• Frameworks for “inevitable” change:!– A new way of doing things that is simultaneously superior
and lower cost (online retail, cloud computing)!– A new way of doing things that is win-win for all parties
with no losers !• In each case the primary risk is execution (which is
always a risk)!
Investing in change!• Investing in change often involves paying a
statistically high multiple, which is another reason that value investors tend not to do it (anchoring on valuation rules of thumb)!
• Caution: there is still a longer way down from a high multiple than from a low multiple!
• Nonetheless, the risk can be low if:!– The change is “inevitable”!– The company has a track record of executing and has
large tangible and intangible advantages!– Purchases are made at a large discount to the range of
intrinsic value estimates!
Agenda!• Investment approach!
– Compounding machines!– Select business models!– “Quality”!
• Unconventional things!– Valuation rules of thumb!– Investing in change!– Intangibles!
• Two key lessons from my first decade!– The map is not the territory!– “Long term”!
• Trupanion!
Intangibles!• I place enormous emphasis on intangible factors—
management and culture (“quality”)!• I think these factors are generally underappreciated
by investors!– Do not appear in the financial statements!– Cannot be quantified or modeled in Excel!– Difficult to screen for!– Do not make for an exciting investment pitch!
Intangibles!• It can be difficult to convey a genuine understanding
of management and culture in words—sometimes you just have to do the work yourself!– Investment rationale must be conveyed from one person to
another—for example, from analyst to portfolio manager or investment manager to client!
– This creates a subtle but powerful pressure to base investment ideas on factors that are easily described and communicated!
– This dynamic favors tangible, quantifiable factors and makes it more difficult to place weight on intangibles!
Agenda!• Investment approach!
– Compounding machines!– Select business models!– “Quality”!
• Unconventional things!– Valuation rules of thumb!– Investing in change!– Intangibles!
• Two key lessons from my first decade!– The map is not the territory!– “Long term”!
• Trupanion!
The map is not the territory!• What this means to me is that the mental models we
use to navigate the world are not reality itself"• It is all too easy to be trapped by our mental models!• We must be willing—even committed—to step
outside of our mental models, to change them, or to discard them!
The map is not the territory!• Example: A common mental model is brand
franchise vs. commodity"– Brand franchise = consumer preference that confers
pricing power (Coca-Cola, See’s Candy)!– Commodity = no consumer preference and therefore a
price taker (oil, insurance)!• Years ago, I was visiting a P&C insurance company,
and the executives claimed that their brand was helping them in the marketplace!– “Our brand is winning ties”!
The map is not the territory!• This claim did not fit my mental model, because
brands are not supposed to have value in a commodity business—so I dismissed it!
• The episode stuck with me, and over time I realized that in fact the brand franchise vs. commodity model is incomplete!– By paying attention, with a more open mind, I was able to
see something new!– Trust plays a critically important role in business—so
fundamental that it is easy to overlook!
The map is not the territory!• New mental model: tiebreaker brand"
– High-stakes purchase decision, so trust is critical!– There is a limited number of brands that stand out as the
most familiar, widely used, or respected!– All else equal, why use a less trusted brand? No brainer!
• “No one ever got fired for buying IBM”!– Deloitte, E&Y, KPMG!– Fidelity, Vanguard!– Amazon Web Services!!
The map is not the territory!• Tiebreaker brand is a middle ground between a
brand franchise and a commodity!– Tiebreaker brands cannot be assumed to have pricing
power (but sometimes do)!– However, if they offer a leading value proposition, they can
enjoy strong consumer preference on the basis of trust!
The map is not the territory!• Lesson: When reality conflicts with your mental
model, keep an open mind!– This is harder than it may seem, because the mind tends
to immediately judge everything it encounters—necessarily based on existing mental models!
• Quieting the analytical mind to make room for clear observation is a key for learning!
Agenda!• Investment approach!
– Compounding machines!– Select business models!– “Quality”!
• Unconventional things!– Valuation rules of thumb!– Investing in change!– Intangibles!
• Two key lessons from my first decade!– The map is not the territory!– “Long term”!
• Trupanion!
“Long term”!• What does it mean to be a “long-term” investor?!• When I first started out, I thought it was a decision—
something you do once!• Quickly, I realized it is not a decision but a discipline:
something to which you must recommit constantly, in the face of pressures to do otherwise!– Behavioral and external pressures to be short term!
“Long term”!• Then after a few years, I realized that true long-
termism is not even a discipline!– It is impossible to completely recognize and resist in real
time the pressures to be a short term!• True long-termism is a way of being"
– Being calibrated in such a way as to not experience the pressures in the first place"
“Long term”!• People are naturally calibrated to take action and
crave feedback in the very, very short term!– This can be seen by trying to sit doing nothing for a few
minutes!• Long-term investors are calibrated to the timescale
of business!– In business, it takes years to accomplish anything and
decades to accomplish something big!
“Long term”!• Going a step further, certain individuals and cultures
manage to adopt a perpetual viewpoint!– Simultaneously immediate and eternal!– Amazon à “It’s still Day 1”!– Markel à “Forever and right now”!
• This perpetual viewpoint is Greenlea Lane’s aspiration!
• Lesson: Cultivate long-termism as a way of being—it can be the most powerful competitive advantage a value investor can have!
Agenda!• Investment approach!
– Compounding machines!– Select business models!– “Quality”!
• Unconventional things!– Valuation rules of thumb!– Investing in change!– Intangibles!
• Two key lessons from my first decade!– The map is not the territory!– “Long term”!
• Trupanion!
Trupanion!• Trupanion (TRUP)!
– Pet medical insurance company, headquartered in Seattle!– IPOed in summer 2014!– Greenlea Lane invested in early 2015!
• I found it by reading the S-1 (I read a lot of S-1s)!– “As our business continues to scale, we expect to be able
to increase the value we share with our members.”!– It seemed like it might fit the volume-price virtuous circle
business model!
Trupanion!• First phase of research: Collect information, with an
exploratory attitude!– Interview veterinarians!– Interview former employees!– Phone calls with investor relations!– Phone calls with founder/CEO!
• Key conclusions:!– Pet medical insurance is a valid product!
• There is a meaningful probability of having multiple thousands of dollars of veterinary costs, and a large portion of pet owners love their pets and need help affording or budgeting these costs!
• The market in North America appears underpenetrated: only 1-2% of pet owners have insurance (25% in UK)!
Trupanion!• Second phase of research: Immerse myself in
analysis, formulate the thesis!– Historical Excel model!– Statutory statements!– More interviews of industry participants!– Visit company, meet management team!– Ride along for a day with Territory Partner!– Work with insurance counsel to understand regulatory
environment!
Trupanion!• Key conclusions:!
– It is a volume-price virtuous circle!• Accurate pricing à data network effect!• Fixed cost leverage à volumes, frugality!
– It is a mission-driven company!• “To ensure the pets we all love get the best veterinary care”!• Excellent founder/CEO, with majority of net worth invested!• Strong culture and management!
– Unique go-to-market strategy à acquisition cost advantage + tiebreaker brand!• Territory Partners are dominating vet mindshare!• Trupanion is cementing its position as the most trusted brand!
Trupanion!• Key conclusions:!
– Pet medical insurance represents “inevitable” change!• Win-win for all parties with no losers!• Pet owners à peace of mind & protection (lucky pets),
reimbursements (unlucky pets)!• Pets à protection (lucky pets), better medical care (unlucky pets)!• Vets à Practice at the highest level, 2x revenue from Trupanion
clients vs. uninsured clients!• No one is worse off"
– Long runway!• If 25% of 170 million North American pet owners become insured,
25% Trupanion market share would imply >10 million enrollments!• This represents almost 50x growth opportunity relative to 230K
enrollment base !
Trupanion!• Valuation via DCF!
– The company was losing money !• Investing heavily in marketing, which is economically lucrative but
produces current-period income statement losses!– Enrollments growing at ~25%!
• Investing in a technology project (Trupanion Express), which would roll off in the near term!
• Breakeven expected in just over 1 year, ample cash from IPO!– At ~$8 per share, I believed Trupanion was selling for ~1/2
of the bottom end of my intrinsic value range!– The stock was cheap because:!
• Lower-than-expected gross margins in the first 2 quarters post IPO!• GAAP accounting masks underlying economics!• Unique business model is not easily categorized and has no publicly
traded comparables !
Trupanion!• Trupanion currently is one of our largest positions !• If you want the best medical insurance for your dog
or cat!– www.trupanion.com!– (855) 210-8749!
Thank you!
