What's Your Prior?

Private Equity in portfolio management software: the ultimate micro-cap / low-liquidity / growth / activist investment strategy

March 30, 2021 Damian Handzy Season 1 Episode 7
What's Your Prior?
Private Equity in portfolio management software: the ultimate micro-cap / low-liquidity / growth / activist investment strategy
Show Notes Transcript

In this episode, I speak with our new Private Equity owner and our new CEO about the plans to bring Style Analytics into Investment Metrics:


Damian Handzy:

In 1881, Canadian-American astronomer and mathematicians, Simon Newcomb, noticed something really weird when he reached for his reference book to look up the logarithms of numbers. After years and years of use, he noticed that the smudge marks his thumb made while flipping through the edge of the pages, those smudge marks were much darker for numbers starting with one than for those starting with two. And two was darker than three and so on and so on. In other words, the probability that a multi-digit numbers starts with one is actually greater than the probability of i t starting with any other number. Now why on earth aren't they all just as likely as one another? Well, the answer came 57 years later in 1938 when American physicist Frank Benford noticed the same strange phenomenon, except he went a step further and he examined the sizes of 335 rivers, the population of 3,259 towns, 104 different physical constants and so on. He looked at lots of numbers in 20 different categories. The resultant mathematical law that he found is now known as Benford's law, and it shows that the probability of a number starting with a given digit is equally distributed according to the logarithm of the number, rather than according to the number itself. Now, the explanation lies in the nature of growth. Smaller numbers are more common first digits because all natural phenomena, things that grow, they all have to get through a size that starts with one before they can get to a size that starts with two, they have to get through the ones a nd twos before they can get to sizes starting with three. There are just more smaller things than larger things. Said differently, it's a lot easier to grow when you're small.

Introduction:

Hello and welcome to What's Your Prior?, the podcast for the adaptable investor with your host, Damian Handzy.

Damian Handzy:

Anything that grows, like the rivers and town populations that Benford examined, now, they follow his law. And so do companies - the revenues, costs and profits also follow Benford's law, which brings me to today's topic of private equity investing. While we're all more familiar with buying and selling of shares in public companies, private equity firms specialize in identifying and investing in smaller private companies and helping them grow until they eventually sell them. The typical investment timeline for a private equity deal is about five to seven years and private equity investors sometimes take a minority interest and sometimes they take a controlling interest in the companies they buy. They often provide liquidity for a founder. That's a way for the founder to finally make some money off the company she or he started. And their investment usually starts a more aggressive growth phase in that small company's life, bringing a more disciplined and professional approach. They often bring in a new CEO, COO and especially CFO, all of whom are usually experienced at growth phase investing. Now last December Style Analytics, the company I worked for, which was owned by a London based private equity firm called Horizon Capital, it was sold to Investment Metrics, a US-based financial technology firm, that itself is owned by another private equity firm, Atlanta based Resurgence Technology Partners. My guests today are [ Adi Filipovic, who's the Managing Director of Resurgence Technology Partners and Brent Burns, CEO of Investment Metrics. Hi guys. How are you today?

Adi Filipovic:

Hey guys doing well. Good to see you both.

Brent Burns:

Yeah. Good, good afternoon. Good to see you guys.

Damian Handzy:

So Adi, can I ask you to just tell us a bit about Resurgence?

Adi Filipovic:

We started a firm just over four years ago and $200 million fund exclusively focused on investing in primarily vertical software companies.

Damian Handzy:

Okay. And Brent, can I ask you to introduce yourself please?

Brent Burns:

Sure. Brent Burns, CEO of Investment Metrics, have been with Investment Metrics since April of 2019. Prior to that, 20+ years of FinTech executive positions and multiple FinTech related companies.

Damian Handzy:

Okay, guys, thanks. Let's just jump right into it. So most of the time we talk about investing in public markets and , Adi, you've built a career in the private markets. Can you help us understand how is private equity investing fundamentally different from public equity investing?

Adi Filipovic:

Yeah, I mean, in some ways the fundamental differences , liquid nature of the security that you're investing in, as opposed to say the public markets where we can buy a security one second, and if we're a quant shop, we can sell it millisecond later, in private equity once you make an investment decision , you'll live with an investment decision for a period of time by design, whether it's a good decision, neutral decision or a bad decision, you're quote - unquote, stuck with it for better or for worse for a period of time. Furthermore, the ability to make certain changes to the underlying company are well within your control is that you very well might not have as a kind of a classic passive public investor. On the private equity side, you exert a very different level of control over the investment and you also don't have to answer really to numerous other shareholders that may have very different interests in terms of time duration and other goals versus a private equity investor, where you can take a longer-term view. You can sacrifice some short term gains or benefits for the long term. So I think the amount of control that one has over the investment, as well as the kind of classical liquid nature, probably two of the fundamental kind of differences in the market.

Damian Handzy:

Okay. So liquidity and control are two big differences. Let's talk about some similarities if we can. So we've done a lot of discussing on previous episodes of this podcast about value, growth, momentum, different styles of equity investing. And of course that's what style analytics kinda does for our clients. Are those concepts of factors or style investing, are those applicable to private equity or is that really only a public equity type analysis?

Adi Filipovic:

No, I absolutely do think the private equity industry has matured over the last , really over the last four decades. The pockets, the specialization within private equity is starting to look in some ways, a lot like public markets from a style perspective, you alluded to a few of them: there's the Value, there's the Growth. You know, I would argue there's even though we don't call it that, momentum investing. There's sectors, you know , it wasn't quite that the private equity was that focused on sector investing, but they were the newest form of segmentation within the market that is emerged really over the last five to ten years.

Damian Handzy:

Adi - How about classical factors like, you know , Size and Value, things like that, do those apply?

Adi Filipovic:

To some extent the original private equity was very much formed around those two factors, right? I mean, small was always better than large. And people always believed that smaller companies yielded and in private equity world had a better value creation potential. Now we can debate why that is. Is it a risk factor or there was something else that had to do with small, but people always wanted to invest in smaller companies and always believed that there was a bigger potential to have a better return. Same thing, Value. I mean the classic private equity style investing, you know , from the seventies and eighties is you're looking for, you know , value and undervalued assets.

Damian Handzy:

Okay. So Adi, what exactly do you look for in a company that would help convince you to invest in them?

Adi Filipovic:

We're looking for recurring revenue businesses that have a very high retention rate that is the universal at a 50,000 foot level. That is a universally accepted metric for sort of durability of a software business that many of us that have chosen to specialize in software, private equity that fallen in love with software companies because of their resilience, mission criticality and therefore durability. The other thing that has made the software industry software, private equity, as big as it has, we didn't use to have $10, $15, $20 billion funds focussed on software buyouts, which we do. And we have numerous ones in an industry has all emerged in the last 10 years has largely been driven by the new business model . So software centered around recurring revenue while software 20 years ago was bought, it was a one-time purchase, almost all of these business models and software subscription models, which caused a very predictable revenue stream. And combined with this mission, criticality aspect creates a businesses that are very durable and predictable over time.

Damian Handzy:

Okay, so you've put all that into practice in the acquisition of Style Analytics, Brent, you now run the combined organization. What , did you see in Style that made you want to acquire it and bring it into Investment Metrics?

Brent Burns:

Well, you know, first of all, I just have to say, we're very excited about bringing these two organizations together, and the opportunity we have to leverage the success that both of these companies have had a nd experienced. First thing I, you know, I want to make clear a nd you k ind o f touched on it was these, these companies are very complimentary, not really competitive in any fashion. And what do I really mean by that? We only have a few similar customers. There really is no overlap i n product. You know, IM is very established - when I say IM I mean Investment Metrics - i s very established in the US, you know, with, well over 200 clients. Style is very established in Europe while growing in the US but they were headquartered in Europe and, a nd established in Europe with hundreds of clients. I think the total 26 countries, something like that. Both companies have been very focused on providing solutions in the institutional investment marketplace, but IM had traditionally been focused on the asset allocator community, investment consultants in particular, but Style had traditionally been very focused on the asset manager side of the business. The products saw very different business challenges. I think the, the company and the product set fit very nicely into our strategy of bringing additional functionality to our own existing clients, providing enhanced data analytics platform, to leverage our data set and accelerating the expansion of our global footprint, bringing together the deep domain expertise was also something that we viewed as very attractive , is, you know, smaller companies are always looking for more expertise and brain power. You know , I think finally the company's financial profile was very similar to our own and their client first focus in everything that they do was certainly very important for us.

Damian Handzy:

Adi - Anything to add to that?

Adi Filipovic:

If you think about institutional investing and you have been thinking about institutional investing for a very long time, it's a highly, highly complex world and the stakes are really high. People have fiduciary duties to protect their endowments, to protect people's pension funds grow their pension funds t o meet their liabilities. And so the stakes from a financial perspective, which is not the only thing i n l ife that matters obviously, but the stakes are really high institutional investing world. When we've been given a chance to make a step function change i n that mission, like expand a product suite, something like Style Analytics that was very compelling to us on that sort of journey a nd that mission. Software in and of itself, we're in the knowledge economy. And so one of the compelling things was the IP within the product and obviously the IP and the domain expertise within the people. If you're talking about being in a knowledge economy and being within one of the verticals where the knowledge spikes, even relative to the rest of the software industry, y ou k now, you better be in a knowledge acquisition game, both from a product and people perspective. And we certainly thought that Style Analytics was compelling in that regard.

Damian Handzy:

So Adi, I want to follow up on something that you hinted at, and that is what this company does actually kind of, I think, matters in the bigger picture sense. A lot of our clients are pension plans, right? Both public and private. But if you think about the people who rely on us providing information to help manage those funds, they're relying on that for their retirement. These are policemen teachers, firemen , you know , public employees and what this company does matters to their safe retirement. Now, I'm not saying that this is all done out of altruism. I mean, this is a for-profit business, but the stuff we do, I think really matters,

Adi Filipovic:

I think you're spot on in that regard. And we're looking at our, for profit business that does it have a reason to exist. It has a really big reason to exist. People's pensions depend on the insights that it generates. And so while on one hand, we make our mandate is to make investments. On the other hand, the mission, what our customers are doing. Now you can't run one of these companies, tou can't be invested in one of these companies, if you're not consumed by your customer's mission. And the mission here is really important as you said. So anyway , so I'm glad you called it out.

Damian Handzy:

Okay. So Brent, how are we going to do this, right? How are the customers going to benefit from the combination of these two firms?

Brent Burns:

You know, there's obviously some natural synergies between the two firms, right? And the activities that are there. And, and a lot of times you'll see companies come together and they want to integrate everything and bring them all together. The reality of it is here that we , we very much see Style continuing to stand on their own, but at the same time, the data, the functionality that is within Style, we have significant plans to leverage that capability within our own. When I say our own, Investment Metrics, performance analytics, and reporting solutions, you know, both companies maintain really valuable differentiated data sets. And we believe that these can be leveraged by both organizations in both sets of customers as we move forward. There really are no plans to go through a complicated merger of platforms that you might see as simply wouldn't make sense. Our plans are for Style to really be able to leverage many of the datasets that Investment Metrics has , uh , as a result of, of its business. We certainly see being able to leverage from the Style portfolio of products, for example, is providing ESG exposure analytics into the PARis platform. The opportunity to incorporate the factor analysis into the analytics and reporting platform of Investment Metrics is also something that we have clients that are very, very interested in understanding what that looks like and how they can leverage that to again, make better investment decisions with the portfolios that we talked about earlier. But I want to be very clear that we not see this disrupting either of the customer sets that we have. In fact, we see this as an enhancement.

Damian Handzy:

So Brent , thinking about all the data that this firm now has to offer its clients, we've got all this massive database of fees, of asset flows, different funds, returns, factor analysis on the underlying investments. It seems to me that this almost forms a complete set. I mean, what else is out there that needs to be added?

Brent Burns:

Yeah, well, that's interesting Damian , because, you know, if you think about, as we bring these companies together, the combination really at the end of the day, results in us having what I would consider over 400 blue chip customers globally, a strong recurring revenue from two companies that have demonstrated a really good track record of customer retention throughout their life of both of the organizations. And, you know, it goes back to that really important point is it's a rich product offering that will continue to grow given the product innovation plans that we have both for both organizations.

Damian Handzy:

Okay, so given that here we are a combined entity owned by a private equity company, which is in the business of making investments, what's the chance that we're going to have another acquisition in our near term future?

Brent Burns:

Well, at the moment, we're obviously very focused on successfully integrating Style into our overall organization. And we believe there are excellent short and long term synergies, which we are obviously focused on , on maximizing. That being said, we are always open to looking at opportunities that we believe would bring greater efficiencies and capabilities to our clients. Let's face it: the institutional investment marketplace can present, as we've talked about some very complex and at times inefficient challenges to asset allocators, asset owners, asset managers, you know, in firms that concentrate in this space, we continue to be focused on helping address those challenges. And whether that's through future innovation that we drive ourselves or adding additional capabilities through those acquisitions, I would say that we're very open to either.

Adi Filipovic:

We will make another acquisition, but we're only going to do it if it's deliberately within the strategy of what we want to do, not just for the sake of transacting and just slapping something on top of the existing Investment Metrics. But only if it's really what we as a group of investors and management team decide that, Hey , this fits the mission and the goal and is going to advance the cause.

Damian Handzy:

Brent , what's the one thing you want everyone to know about investment Metrics?

Brent Burns:

The one thing I will say is that our ultimate vision is that Investment Metrics becomes the destination for organizations who rely on institutional data to make strong decisions on behalf of their clients.