Companies that dominate the corporate news cycle often make the simple act of a customer parting ways with their money in exchange for goods or services seem so straightforward. The cream of the crop during a phase of an era proverbially “sells itself.”
However, we all know that the reality is it’s a dogfight for most other companies to simply keep the whole clown car together. Financials-first investors often have no idea what a functioning mess companies are internally. I think they would be horrified to experience that reality firsthand. Securing that near-term revenue dollar, let alone ensuring some measure of long-term value, is a difficult proposition at best.
The quality and security of future revenue vary greatly. Mainstream clothing retailers’ revenue varies dramatically by season and fad, as purchasing is ad-hoc, selection/competition is wide, and preferences change quickly. In contrast, the local utility provider is the only game in town, and you have to purchase to keep the lights on. As such, on average, people tend to pay a higher premium for utilities versus clothing brands, for example.
Lately, I’ve been looking into a certain line of business mostly known to a small niche of folks. Each “sale” generally guarantees revenues for decades, with an average duration of those revenues in the range of 10-15 years. The transactions are lumpy and happen a handful of times annually, though the market is growing quickly and likely peaks around 10 years from now. Only a handful of players can participate in this market, as participation requires substantial internal capabilities, arduous regulatory blessings, deeply investment-grade credit ratings, and a track record that is convincing to the customer.
The companies serving this niche have, to date, generally recouped the money they invest to secure the revenue back in approximately 4-5 years and aim to generate 15-20% returns on that investment for the life of the revenue stream if things go according to plan. All in all, I would consider this a highly attractive revenue stream on face value.
However, the profit stream doesn’t come without risks. One may not receive the above returns if a certain macro factor veers materially off-course. They also won’t make their returns if they didn’t appropriately configure the revenue stream against their costs, a very difficult mistake to correct in this line of business. Lastly, this sort of revenue stream is more episodic, as mentioned, driving more uncertainty about incremental revenue and thus can be viewed as lower quality than one that has better-defined future growth.
All told, the goal of the above is an example of how I attempt to think about business models without bias. How is one to think about things differently than the market if one takes the market narrative as gospel first? The above business line sells for a single digit multiple on supposed profits which may, or may not be the right price. But in a search for value, it certainly is an interesting place to expand one’s portfolio of knowledge.