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Scott Miller on Value Investing and Capital Allocation

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Scott Miller on Value Investing and Capital Allocation Scott Miller on Value Investing and Capital Allocation Kevin Harris from SumZero sat down with Scott and I was tired of trying to get portfolio Miller to discuss Greenhaven Road Capital, small managers to hire me and validate me. If I had a cap investing, and value investing. traditional pedigree, I don’t think I would have needed to start Greenhaven Road because it Kevin Harris, SumZero: What is the story would have been easier for someone to hire me. behind the founding of Greenhaven Road Capital? How has your work background as an The reality is, I think my years working as CFO entrepreneur impacted your investment career? of a fast-growing company are very valuable to me as an investor. I have sat in management’s Scott Miller, Greenhaven Road Capital: The shoes. I have raised capital. I have quick bio for me, is that after college I worked at communicated good news and bad news to a small manufacturing business, not Goldman investors. I have “missed” a quarter on several Sachs. After that, I went to Stanford Business occasions. I can tell you from experience that School, worked in a private equity setting, and sometimes customers do just delay a purchase then went back to the operating side, starting a decision. I interpret management actions and business that manages Head Start centers on management statements through the filter of long term contracts with the Federal my work experiences. I suspect I have more Government. This business grew to well over empathy for management teams than people 1,000 employees, so I spent a lot of time on the who did an analyst program at Goldman, operating side including as CFO doing things jumped to SAC, and eventually started their own like hiring, selling, managing cash flow to make fund. I also think my time on the operating side payroll, and raising capital. This kind of hands has given me an appreciation for the difference on experience actually building a business and talented managers can make to the trajectory of facing the associated challenges is fairly unique a company. in the money management world. During my time working as a business operator, This business [I founded] grew to I was investing my savings in public markets “ well over 1,000 employees, so I with great success. Eventually, I decided I spent a lot of time on the operating wanted to invest in public markets full time, but my operating experience and personal investing side including as CFO doing things experience did not translate well on a resume like hiring, selling, managing cash targeted at fund managers. I had been on a flow to make payroll, and raising different path than the typical candidate, which I think made me somewhat of an ugly duckling. capital. This kind of hands on The only interviews I got were favors. experience actually building a business and facing the associated However, after a year of hunting, two friends from my business school class who had started challenges is fairly unique in the a fund, and who I had gone through the money management world. investing track with took a chance on me. Then the financial crisis came along, the fund blew up ” for reasons we can discuss later, and I was back KH: Could you describe the types of businesses at square one. Again, nobody in asset that you invest in? management valued my background, or perhaps I was just not able to communicate it SM: I manage two funds. The first is a long- effectively. Either way, I wound up back in an biased hedge fund called Greenhaven Road operating role, and continued to invest personal which I refer to as the main fund. We also have a capital. I was up over 150% in 2009, but literally fund of funds called the Partners Fund which we could not get a job in the investing world. can discuss later. In the main fund, we typically Eventually I decided to start Greenhaven Road own about 15 companies. Half are “special because I thought I had faith in my own ability, For more SumZero buyside research, job placements, cap intro and more visit sumzero.com ! situations” such as spinoffs, rights offerings, SPACs, or turnarounds. The other half are high SM: The beauty of investing is that there are quality companies that we hope to own for many ways to make money. Renaissance years. In both cases, I have a strong preference Technologies has one of the best track records for high insider ownership, recurring revenue, of any fund using any strategy, and they are expanding margins, and the ability to grow using a quantitative strategy. I actually want without additional capital. These businesses quantitative strategies to proliferate. I want tend to be asset managers, software companies, money to pile into them, gobs and gobs of it. and platform businesses. For example, we own The more money into quant strategies the Etsy which is a two-sided marketplace for better, as I think they are likely to create unique items, TripAdvisor which is the leading distortions that I can take advantage of over platform to research and book travel, and time. You can have your backward looking Interactive Brokers which is the highest margin quantitative data and use that for the and lowest cost “brokerage” business. I put foundation of your decisions. I would rather brokerage business in quotes, because I think it understand the product, market, and is ultimately a software company with a massive management team of the companies I am market. investing in. Quantitative strategies tend to scale well allowing for large AUM, have a large number of holdings, and have short holding I think the inadequacies of GAAP periods. Greenhaven Road is effectively the “ accounting create opportunities… inverse of that. I want to be small, concentrated, and have a long holding period. I want to The future value of the customer understand qualitative factors such as the base [you] are building does not competitive landscape, the customer value show up on the balance sheet proposition, and the incentives of the team. under GAAP. However, if you treat a KH: What do you hope to accomplish with the portion of the marketing spend as Partners Fund? growth capex the financials are far SM: Through my experiences running the Main more attractive. Fund I learned first hand that generating very good returns is not enough to attract capital. I I think the inadequacies of GAAP accounting also recognized that this created an exploitable create opportunities. For example, we own a ” inefficiency. Simply stated, there are investment tiny software company, SharpSpring. For every managers out there that are incredibly talented, dollar they spend on marketing, they generate but they have great difficulty raising capital seven dollars of lifetime value. As long as the because they are not proven quantities. marketing spend is that productive, they should Incredible talent combined with small AUM is be spending every dollar they can find on the best recipe for market beating returns. The marketing. Profits should be zero, or less than trick is getting comfortable with the portfolio zero. The future value of the customer base manager and the operating business of the fund they are building does not show up on the early in their lifecycle. We are attempting to balance sheet under GAAP. However, if you treat build something that can take advantage of a portion of the marketing spend as growth these incredible managers before they have capex the financials are far more attractive. The been discovered by the wider world. If I am adjustments matter, the qualitative matters, the right, the Partners Fund can generate attractive setup matters, customer value proposition risk adjusted returns over time. matters, network effects matter, but these items are frequently obscured by GAAP accounting or I am fortunate that over the years I have built a lost in a simple P/E or price to book ratio. strong network of like-minded investors that follow a similar strategy to the one that is used KH: What are your thoughts on the rise of by the main fund. Essentially, simply getting to quantitative strategies at the expense of more know these people was a multi-year diligence traditional value and activist strategies? process. This process is strengthened by a For more SumZero buyside research, job placements, cap intro and more visit sumzero.com ! simple framework that I think tilts the odds in I think the way capital is allocated is favor of success. Namely the funds that the “ Partners Fund invests with are characterized by: broken. Way too much value is 1) One-Person Investment Committee placed on funds being large. I have 2) Concentrated holdings sympathy for folks tasked with 3) Reasonable amounts of capital (AUM) allocating billions of dollars to 4) Significant personal investments (“skin managers. It is hard. They have to in the game”) write big checks and the money 5) Original thinking they are investing is typically not 6) Mindset: Getting Rich is Not the Point their own, so they have real career risk. Their incentives and the A fund of funds focused on small managers realities of size dictate that the does not really work as a standalone business majority of their funds must flow to model because the small fees charged by a fund of funds requires a large amount of capital to the largest of managers. gain scale. However, the Partners Fund fits very well within the ecosystem that Greenhaven be first. Nobody wants to be wrong. I am not ” Road operates in.
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