Invert, Always Invert

Charlie Munger frequently talks about inversion, meaning that you need to look at something from an inverted point of view, thus giving yourself a better chance of understanding it from a different perspective.  A good example he uses, is that he wants to know where he is going to die, so he never goes there.

Along these lines, I think it is helpful to invert investment opportunities, or more specifically identify those investments that you do not like.  Being able to easily identify what does not make a good investment, you can more easily identify what the characteristics of a good investment are.

As I have previously mentioned, I don’t really use screens for finding ideas, but instead I like to just go from A-Z.  I thought I would use an example from the letter “A” to illustrate an investment I don’t like.

A–Active Networks

I recognized this company from its name because of my  sporadic participation in triathlons and thought I would investigate further.  It takes about 5 minutes to realize this isn’t the type of investment I like.  Recent IPO, short operating history, business largely driven by technology infrastructure.  Approximately speaking, profit has been the opposite–a loss totaling $85m over the past three years and free cash flow is similar, totaling negative $45m over the past 3 years (also, you don’t need an elaborate spreadsheet to tell you this, reading the 10k and using a pen and notepad is all you need).   But who focuses on these numbers?  One other tidbit that I hadn’t seen was how much the Form 4 filings (disclosures of insider transactions) dominated the filings on the SEC website (sneak peek–they were all insider sales).  Reading about this company, it had all the buzz words, “industry is fragmented and ripe for consolidation,” “great story–Americans are participating in 5k & 10k races at record levels,” “scalable with high growth rate,” and of course, the always compelling “network effect.”  This reminds me of the phrase, “story stock.”  I always chuckle at this description because most of the stories I read are of the fantasy version that I read to my kids at bedtime.

When I first looked at this company, it was valued around $300m, a far cry from its IPO valuation of roughly $1.1B, but just because something costs a lot less than it previously did, does not mean it is a bargain (there are a lot of things at garage sales that you couldn’t pay me to take home).  Just this past week, however, Active announced that they would be taken private by Vista Equity Partners for roughly $900m.   There are a few takeaways from this company.

1.  Shorting is too hard for me.  This company had never made a profit or had free cash flow.  It had lost over 50% of its value from its IPO, yet along comes Vista to triple its value in under 6 months from when I first looked at it.  Just because something is a bad investment (in the end, this may work out great for Vista), does not mean a “greater fool” won’t come along and buy out the company at a large premium.

2.  Shareholders who bought when I looked at this company will make an annualized return of “a lot of money.” (how’s that for precision).   Did I make a mistake not investing?  I am happy to admit my mistakes, but this was not one of them.  When someone else makes money on an investment that you passed on, this doesn’t mean you were wrong.  I think this concept is crucial to remember.  If I think this was a mistake, then I will try to understand what went wrong and change my investment principles–Should I start investing in battered down IPOs, with long-running losses and negative free cash flow on the hopes that a private equity buyer will come along?  No, that’s just not my style.  It may work for others, but its not a game I want to play.  Just because the knuckleball pitcher Tim Wakefield has a great season, doesn’t mean every pitcher should take up the knuckleball in the offseason.  I am happy to make money the way I know and let others invest how they want.

All the best to Active Networks, Vista Equity Partners and those shareholders who made a lot of money!





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