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In this episode of Recession-Proof, Alex Song is joined by Ken Suchoski, Equity Research Analyst at Autonomous Research. They discuss the impact of inflation, how payment and FinTech businesses could benefit from it, and what your management team should be doing now.
Welcome to Recession-Proof - a podcast by Ramp. Join us for in-depth, thought-provoking conversations with finance leaders, executives, and investors on the current state of the market and what this means for your business through 2022 and beyond. Hosted by Alex Song, VP of Finance & Capital Markets and Kimia Hamidi, Head of Savings at Ramp.
Ken Suchoski Transcript
[00:00:01] Ken Suchoski: Demand for services is going to continue to increase and outpace goods going forward. What that could mean is that there could be hundreds of billions of dollars of PCE that needs to shift back from goods to services. That would have implications for goods-focused businesses, e-com players, et cetera.
[00:00:23] Alex Song: Welcome to Recession-Proof, a podcast by Ramp. Join us for in-depth, thought-provoking conversations with finance leaders, executives, and investors on the current state of the market, and what this means for your business through 2022 and beyond. I'm your host, Alex Song.
Hi Ken. Welcome to the podcast.
[00:00:46] Ken: Hey, thanks, Alex. Great to be here. Thanks for having me, and look forward to having a good discussion.
[00:00:51] Alex: Absolutely. Today's episode is going to be a little different. As you probably know, our podcast here at Ramp, we generally focus on interviewing practitioners, a few investors, a few entrepreneurs and whatnot, but in today's episode, we're joined by Ken. Ken Suchoski is an Equity Research Analyst at Autonomous Research. We are very, very glad and very fortunate to have you, and I know that we're going to have a lot to talk about.
We're going to talk about probably corporate spend, obviously, we'll talk about potentially recession planning macro indicators, and obviously, we also just want to hear a little bit more just about that life of a research analyst. I think a lot of that is going to be very, very interesting to some of our listeners, so really good to have you.
[00:01:38] Ken: No, absolutely. Looking forward to it, and hopefully, all the listeners can take something away from this conversation.
[00:01:45] Alex: Very cool. Ken, to start, why don't you tell us a little bit about your background, how you found your way into this particular industry, your career path, and also a little bit about Autonomous Research?
[00:01:57] Ken: Absolutely, Alex. I graduated from Middlebury College in 2011. I actually started working out at an investment management firm in New York called First Eagle Investment Management. It's a very value-focused firm. I actually started out in a role that was in between research and sales. Through that experience, I was able to listen to analysts and portfolio managers at First Eagle talk about businesses, talk about industries in which they operate, and I really just got hooked.
I love trying to figure out what makes a good business, looking at the returns on capital, the margins, the growth opportunity, and more broadly, how these businesses can survive the tested time and sustain a competitive advantage. I started working in their family office for some time, and then transitioned into equity research. I found myself at Autonomous at the end of 2015, so I've been with the firm for about seven years now.
Initially, I was supporting two senior analysts, I've transitioned from that associate role to more of an analyst role over time, and now I cover various sub-sectors within payments from the networks, to merchant acquirers, to B2B companies, which I'm sure we'll talk about more going forward. In terms of Autonomous Research, we're an independent equity research firm. We service the top, call it 200 investment management firms and hedge funds in the US, and the goal is really to partner with those clients and help them analyze companies, industries in which they operate, emerging trends.
Autonomous was actually founded during the financial crisis. One of the top-ranked financial analysts at the time, a guy by the name of Stuart Graham, worked at Bank of America, he decided to start his own firm. He took some of the best talent with him and quickly had success. They launched in Europe in 2009, they expanded into the US in 2012. Really what he wanted to create, Alex, was this independent research shop. We don't do any M&A advisory work, which allows us to publish on things like executive compensation, for example.
Actually, on that point, the CFO of one of our companies that we cover, I'm not going to name any names, actually called us about an hour after we published a report on synergy-related compensation. We're free to publish on a wide range of topics, and that really attracted me to the firm. We focus specifically on financial services companies. We cover banks, insurance companies, asset managers, et cetera.
My team, we're a team of four, we cover the payments and a FinTech sub-sector within financial services. You know this, we host meetings with different companies in the FinTech space, and we write research on them. That's a little bit about my background. Oh, one other thing I should mention, Autonomous Research was acquired by AllianceBernstein back in 2019. We're part of the Sanford C. Bernstein Research Group, but we maintain our separate brands. That's a brief overview of my background in Autonomous Research and how we fit into the world of payments.
[00:05:17] Alex: That's really cool. Let me ask you this. Is the difference between, let's say you guys and maybe someone like Morgan Stanley or Goldman Sachs Research, is the idea that because they're not independent, they do have a broker-dealer, they do M&A advisory, stuff like that. From what I understand, whenever there's a transaction, an analyst who works at one of these firms literally has to stop coverage, then after the transaction, whatever it may be, maybe an IPO or whatever, then they have to wait a quiet period before they publish. Is that the main difference between those folks and you guys?
[00:05:54] Ken: I think it's a great point, Alex. That is one of the main differences. Our roots are in independent research. First, we could write on essentially whatever we find interesting, whether that's public companies, or private companies. We just wrote a deep dive on Stripe recently looking at the business and understanding where it fits into the payments ecosystem. Those big banks, they can't actually publish pre-IPO research. That is one area of differentiation.
I think our focus on financial services is another thing that differentiates us. Within our New York office, across the research team, we sit within 20 yards of each other. We're sharing ideas, working closely with each other, we collaborate. One example would just be, the banks, for example, had their earnings updates last week and early this week. One thing that we look at is making sure that we're understanding the payment volume trends across the different banks, and so we could work closely with our bank's team to understand that. I think the lack of a conflict of interest is really important, because our clients know that we're giving them our honest opinion, whereas I think in some cases, the research could be influenced by investment banking initiatives.
[00:07:25] Alex: That's fascinating. Then putting my practitioner's hat on, I obviously have interacted in the past with investment analysts, and research analysts, and whatnot. Looking at it from your perspective, when you are out there meeting management teams, or you're meeting some of these operators, and founders, and entrepreneurs, who exactly are the people that you're seeing? Is there a specific persona? Is it typically investor relations, or does it go all the way to a CRO or a CMO? Who are you actually in front of day-to-day when you're getting to know a team?
[00:08:02] Ken: It's a great question. I think if we're trying to break into a new company, and try to understand that business, it's really anyone that would allow us an in into that company. I think it varies. That first point of contact I think varies a little bit more than the established companies. Then, we're usually engaging with investor relations or somebody who is maybe heading up the strategy team, for example, if we're really trying to understand the business, and where that business fits into the industry.
Sometimes if it's a really early-stage company, Alex, we'll get put in touch with the CFO or the CEO because they're still handling some of those meetings, some of those communications. I think it really varies. For the really large private companies, I think it's hard to get in touch with their management teams relative to these smaller companies. At the end of the day, we're really trying to understand the business, whether that's a CRO, a CEO, or the head of sales. Anyway we could really understand that business, and learn more about the business, it would be super helpful to us.
[00:09:17] Alex: Understood. That's awesome. Pivoting the conversation a little, and we definitely were going to get to this at some point, let's talk about the macro. Are we in a recession? What's going on here? Obviously, we see a lot of this firsthand with respect to our customers, and corporate spend, and some of these things, but from your perspective, you obviously see a lot of data points both on the macro front as well as on the corporate front. Do you have a take? Is there a house take and is there a can take?
[00:09:49] Ken: Absolutely. First off, I think I have to say that we're bottom-up investors, but I think understanding the macro is becoming increasingly important. We're not trying to forecast the macro precisely down to the second decimal point or anything like that, but we do follow the macro. I think it's probably important Alex, to separate I guess what we're seeing in terms of current indicators versus what we might see in the future. What I mean by that is, things are chugging along at the moment, and what we hear from a lot of companies is that there's stability in spending, there's resiliency, but we may see the macros slow down a little bit over the long term.
Let me just unpack this a little bit. In the near term, what we see, there's excess savings, there's wage growth that remains robust. Debt servicing for consumers remains in check. I mentioned the US banks reporting volumes last week. They grew volumes 11% year-over-year this last quarter. It's still fairly robust on a year-over-year basis. Credit volume growth continues to outpace debit volume growth. That's just the normalization of some of the mix shift that we saw during COVID. On the other hand, I think even the banks are in disagreement over their economic outlooks.
For example, I don't know if you listen to the JP Morgan call, but Jamie Dimon has been sounding the alarms ever since our Bernstein Strategic Decisions conference back in June, because he's been talking about a hurricane coming to the US economy, whereas Bank of America, they were pretty upbeat this quarter. Messages are mixed, I would say. What we're seeing is increased layoffs across tech companies, and companies more broadly are pulling back from hiring as well.
When we talk to investors, I think there's a lot of concern about the potential for a so-called white collar recession. Then we look at some of the retail sales data, Alex, we're seeing some deceleration in real growth. If you strip out the inflation benefit, you're seeing real growth decelerate after a period of above trend growth. Another headwind that we're tracking potentially is this shift from goods back to services.
What's happening here is pre-pandemic, the percentage of PCE that was goods-related was about 31%. Pre-pandemic is pretty stable. That's increased to about 34% or so recently. We're going to have to see some normalization of that over the coming years. I think demand for services is going to continue to increase and outpace goods going forward. What that could mean is that there could be hundreds of billions of dollars of PCE that needs to shift back from goods to services. That would have implications for goods-focused businesses, e-com players, et cetera.
It's a mixed picture in the US, I would say. Outside the US, things don't look as encouraging. You look at trends out of the UK and Europe, it looks like economic activity has come to a halt there. All in, I think our view is that the US, the way I describe is, it's probably the prettiest house in a very ugly neighborhood.
[00:13:28] Alex: That makes sense. That makes sense. That's fascinating. There's a lot to unpack there. There's definitely a lot to unpack there. I think the first thing is, we actually do see some of these macro currents in our internal spend data as well. I know that you and I have jammed in recent weeks about our quarterly spend report in which we break down by segment, by industry, by merchant composition, the evolution of corporate spend over the last couple of quarters.
I actually think a lot of those trends that you just discussed certainly is apparent in our data as well. I think one thing to to note is actually with respect to a pocket of weakness, I think hardware spend. We certainly saw that over the last, actually two quarters in a row where I think maybe some folks were a little bit more tepid about hiring, and adding headcount. A proxy for that is simply, how many laptops are you buying? How much electronics and hardware are you purchasing?
We definitely did see that as one area where there was a little bit of a temporary in spend. Whereas I think in some other areas, services, for example, some of the areas that you spoke of, there was definitely some continued strength there across the various segments.
[00:14:45] Ken: Absolutely. I think my view, Alex, is that in this time of uncertainty, businesses do need to put more of their spending under scrutiny. If you're facing inflationary pressures and your costs are going up, you need to be able to manage that. I think that's what we're seeing, and we're hearing when we talk to companies, even our own company, we couldn't send everyone out to Money20/20.
I know we're going to see you out in Money20/20 next week, but we couldn't send everyone out there. I think these businesses are tightening up their budgets a little bit more, and being careful when it comes to spending. Then I think there's just a broader uncertainty in the market. I think some of the trends that we've seen is the number of jobs or job openings in the economy that has come down with some of those layoffs businesses pulling out those additional spots. You could have the labor market normalizing a little bit here.
[00:15:50] Alex: Yes, normalizing is a good way of putting it because, obviously, we have through several years of historically tight labor markets, I think labor shortages up and down the various different industries, whether it's blue collar, white collar services, manufacturing, et cetera, et cetera. I think normalization is probably a good way to describe it. That actually is a good segue for another topic I want to do a little bit of a deep dive on, which is inflation.
I think inflation is interesting because, we're in an interesting state of the world. There is a lot of inflation, there are a lot of people who are in camp transitory, so maybe it'll be there in a few months or a few quarters from now, maybe it won't. It's also interesting because, the Fed is tightening maybe as they should be. If you want to fight inflation, that's your thing. That's what you got to do.
In addition to that, you also have simultaneously this really strong labor market and everything. Sentiment seems to be weak, but then there's some fundamental strength in the labor market. What is your take around just how inflation is percolating through its way through the economy?
[00:17:10] Ken: It's a great question. What we're seeing right now is, you're seeing it everywhere. You're seeing it in food inflation. Core inflation is elevated, remains elevated. You're seeing companies talk about wage pressures, Alex. The companies that we cover, they're having to reset their budgets higher when it comes to maintaining their personnel, and making sure their employees are taken care of. We're seeing it in infrastructure, and networking costs, things that payment companies and FinTech companies rely on to run their businesses.
I think the one thing, our view on inflation is that it's really not good for any business, but payment companies are generally better positioned to face inflationary periods, at least when compared to companies that are outside of the financial services sector.
[00:18:07] Alex: When you say, "Payments," you just mean, if you're in the business of processing payments, inflation probably helps you at least somewhat because just the ticket sizes are larger. Somebody buys something that was a dollar yesterday, today it's a dollar-eight, because of inflation, and because of that, a payments business makes its money through take rates and whatnot. As a processor, and because of that, we're basically almost resetting your revenue based in tandem to inflation. Is that what you mean?
[00:18:39] Ken: Yes, that's exactly right. One point before I comment on that, I think what's going to be interesting to see how this plays out is, do these inflation expectations get anchored across the economy, and does that lead to persistent inflation? Because, if that happens, then I think that that becomes more problematic for a lot of companies in the market.
Whereas I think expectations are for inflation to come down, and there's long term deflationary forces at play here, whether it's slowing population growth, or lower productivity growth because companies are reinvesting less. I think longer term, we'll see how that plays out, but I think payments in FinTech, it's a good place to be if you're concerned about inflation, I think you hit the nail on the head, Alex, where these companies usually generate revenue as a percentage of the transaction value.
As the average transaction size increases due to the inflation, if you're charging a take rate, if you're charging 2% on whatever that transaction value is, your revenues are going to go up as that transaction size goes up. I think there's a couple other key points to think about here when it comes to which businesses might be in a better position to survive an inflationary environment, and it's companies that have pricing power because of some reason, whether it's a strong franchise, or you have a dominant position in the industry. As their expenses increase, they can raise price to make sure that their revenues increase and maintain their earnings power of the business. That's extremely important.
Then third, most payment companies are capital light business models, with high returns on capital. You don't need a lot of tangible capital to run your business. You're not going out and buying a manufacturing facility or a factory to produce goods. That's really important because, when costs go up, these manufacturing companies, they have to put out additional dollars to buy that factory. That's another benefit that the payment companies have. Overall, I think inflation is bad for pretty much every company in the long run, but in the near term, I think it just depends how much you can survive that environment.
[00:21:03] Alex: That makes sense. Certainly, I think on the expense front, I think everyone's seeing it, and we're certainly seeing it, everything from contractors, to even how much we're paying our auditors, to various service providers. Obviously, everyone's, you're at the next refresh cycle, and all of a sudden it's like, "Hey, guys, wages are up 5%, 6%, 7%, 8% year-over-year. We got to rethink the contract." Definitely, it's probably something that a lot of our listeners, a lot of folks are managing through right about now.
[00:21:38] Ken: Yes, totally. Also, that's an important point because I think some companies, they might benefit from inflation because average ticket prices are going up. Other companies have longer term contracts. In some cases, they have inflation escalators, Alex, where the revenue that they generate from those contracts are automatically resetting higher based off of some inflation index that they track, while other companies didn't have that in place. I think that's something that we might see as well. If you aren't generating a fee-based off of the transaction size, maybe there's some lock or some clause that you could put into your contracts to insulate you a little bit.
[00:22:20] Alex: This doesn't have to be inflation, it could just be macro, or just corporate performance. Obviously, we're all inundated every day with headlines, and corporate earnings, and everything else that's coming. Are there any indicators that you would consider to be a bellwether, or something of a leading indicator that you pay a lot of attention to?
[00:22:41] Ken: Yes. Leading indicators, we try to track real-time spending data sets. The large payment companies like Visa, MasterCard have actually provided certain data sets along those lines. You get a sense--
[00:22:55] Alex: They do the monthly reports, right?
[00:22:57] Ken: That's exactly right. We look at the monthly trends, how are those developing? I think one thing to keep in mind, if you think about the health of the consumer it's, they have an income statement. It's their revenue minus their cost. If you break that down a little bit, their revenues are going to be the paycheck that they're getting from their employer. If unemployment ticks up, that's going to be a problem in terms of consumer spending. I think if inflation persists, you're going to see costs rising, and so that's going to squeeze the consumer potentially, unless they're offsetting that with higher revenue. I think you could get some commentary out of the banks.
JP Morgan was talking about, I think their expectation, Alex, is for consumers to exhaust some of the excess savings that have been in their accounts from all the stimulus-related payments during COVID sometime next year, and I think they said by the middle of next year. Bank of America has been pretty optimistic about the health of the consumer. I think those are things that you could look at to try to get a sense for how this might play out. But, yes, I think like the balance sheets of a lot of these consumers were certainly helped by the excess stimulus payments, and then the stimulus payments that were provided during COVID, but we'll see how it plays out.
I think in certain economies, I think the consumer's going to be in a tougher position, like in the UK, for example, where inflation is higher than the US, and apparently, I think 40% of the mortgages in the UK are variable rate versus 20% I think in the US. In the UK, you're getting squeezed on not just your core inflation, but also your housing costs. We might have another leg up in terms of expense growth for certain economies like the UK come next year.
[00:24:52] Alex: It's insane, and not only the adjustable rate mortgages, but also I think the utility, gas, heating, et cetera. I think folks are paying anywhere between 4, 5, 6 X what they were paying on a runway basis last year, which is interesting.
[00:25:05] Ken: Yes, absolutely. I feel sorry for our colleagues in the UK, because we do have a UK office. Hopefully, that doesn't come to the US.
[00:25:16] Alex: One other area, a similar note is, as you probably know, this is some of the secret sauce here at Ramp, but basically, we keep pretty close track of the cross section between where folks come from and where they spend, and we keep track of, I guess something along the lines of a same source sales concept. We rigorously go through that, and we go through the different segments in the industries, and we also track how, obviously, these trends are evolving. Across the different industries, I think there's probably five or six buckets where actually we've seen maybe six if not more consecutive months of almost consecutive growth in same store sales.
As you can probably guess, these are all T&E-related buckets. Parking, gas, fuel, hotels, airfare, lodging and whatnot, just six straight months of, and I think very few other buckets saw that much strain. I think other buckets, you'll have some seasonal ups and downs, and some months you'll see pluses and minuses, but I think T&E inflation is a topic that seems to be very top of mind right now. What gifts? What's the reason for that? I think oil prices maybe can explain some of it, but why would a hotel room be more expensive now than it was six months ago, or a year ago?
[00:26:40] Ken: Yes, listen, it's a good question. I think just comes back to supply and demand. There's so much pent-up demand, and we see it in a lot of the data that we track. Whether it's passenger traffic in the top 10 airports in Europe, or the TSA passenger numbers in the US. They put a cap on the number of passengers in certain European airports just because they couldn't handle that demand. I think it really just comes down to, everyone was locked in their house for basically a year or two years. You had these excess savings because you couldn't go out and really spend it. You spent some of it online, so now you have an economy that's reopening, you have borders that are reopening, and people want to go out and travel, and move around, and experience things.
I think you're seeing that shift back to services that's been in place for some time. Yes, and I think what we're seeing is the spend in the discretionary services was certainly there. Whether it's lodging, travel, entertainment, restaurant sales, we're seeing strong demand there. Those are the categories that are seeing that demand, but they're also the categories that might pull back quickly if we go into some sort of a downturn.
[00:28:03] Alex: Yes, definitely. Maybe switching gears a little bit, and maybe let's pivot the discussion a little bit more specifically to FinTech companies, and your coverage of the space. Obviously, saw that you guys had initiated coverage of Stripe, which is really cool, really interesting. They're a partner of ours obviously, but would be very curious to hear, what was the impetus for that? Obviously, you guys cover public companies, but now you also cover some privates. Is there a particular reason for that? Are clients asking you about them, or is there another reason why you just decided to pick up coverage of some of these private companies?
[00:28:44] Ken: Yes, it's a great question. Yes, that's one of the things that is, it's one of the nice things about working at autonomous because, we're able to publish on private companies like Stripe, like you mentioned, Alex, and we don't have official coverage of Stripe. It's more of, we call it a primer on the company. Helping our clients better understand what is Stripe, what's the business, et cetera. I think it's becoming increasingly important for our clients and investors more broadly to understand these private companies. I think one of the reasons we wrote about it is because Stripe had $100 billion valuation. Just last year, I think it was, and so, that's a really big company in the payments and FinTech space.
It's bigger than a lot of the public companies that are out there. In terms of understanding it, why we want to understand it, first if we're an investor and we're following the space, and you want to understand the competitive landscape well, which is impossible without understanding all the competitors, whether they are incumbents or disruptors. This is particularly true for payments. Every public payment company out there, for every company out there, it seems like there's another one that's private. I think that's important to understand. In the B2B space, for example, there's a few public companies out there, but many of the competitors like Ramp, for example, you're still private, so we have to get to know you a little bit more.
I think one trend that we're seeing, Alex, is private companies are now staying private for longer, meaning that, if you don't learn about them, you might miss out on truly understanding how some of the larger players operate, not just the startups or the early disruptors. Then, lastly, this has implications for the public companies. We've seen private companies like Stripe take share from some of the publics over time. I think as investors, it's truly important to understand why that's happening, and how that impacts the competitive landscape.
That's why the Ramp benchmarking report is extremely helpful, because we can learn more about your business, we can understand where you fit into the ecosystem. Thank you to you and your team for [unintelligible 00:31:11] that was super helpful.
[00:31:13] Alex: Yes, absolutely. It is interesting. Obviously, just over the last I would say half decade, if not decade, more and more public markets-focused hedge funds have, or just public markets investors overall have become crossover investors, and now they look at more private deals, private companies, private opportunities. I think probably due to many of the trends that you just noted just now, it's an interesting observation because, obviously, sometimes people can come in with different, just how they think about the company, different investment frameworks.
Are people more prone to calling the quarter and trading on very high frequency indicators, or are some other folks more like, yes, at 5, 7, 10-year holds, and just want to understand the business model? I think just seeing the diversity in investment frameworks has been very, very interesting to me.
[00:32:05] Ken: Yes. I think that's spot on, Alex. You could have a shorter term investor who's looking to get the latest trends out of your business so they can use that as a read through to other companies, or you might have a long term investor who looks out 10, 20 years that is really trying to understand the business, "Can this be a company that gains market share over the next decade, and build a solid franchise, and become a $20, $30, $40, $50 billion company over time?" There's different perspectives. We get to interact with both types of investors. It's certainly interesting.
The private space is becoming more popular. I think some of that too is just the amount of capital that has flowed into private equity. There's a lot of capital there. I think there's still a lot of dry powder, and we're already seeing companies get gobbled up. A company like Billtrust's that was acquired for, I think it was around $2 billion, maybe a little bit more, I think it was like 10, 11 times gross profit for that asset. I think as these valuations have come down, I think you'll probably see more private equity companies stepping in.
[00:33:17] Alex: Yes, that's very interesting. Putting my practitioners hat back on. All right. As a management team, I think there are probably a few things that are top of mind when navigating through potential recession, or a macro-volatility and whatnot. Two questions for you, and not to put you on the spot, but two questions for you. You look at a lot of companies that there's a lot in your coverage universe. Question number one is, what defines a good management team?
When you look at some of these companies that you cover, you've gotten to know some of them for years and years, I'm sure, what are some of the characteristics of just a good, solid management team? That's question one. Question two is, not withstanding are these people good or bad, what should folks be doing now in 2022? Is it share buybacks? Is it cost cutting? Is it all of the above? Functionally, what should be on the roadmap for some of these management teams? A two part question. I know that it's a complex and very nuanced subject, but would love to hear your perspective on this, just because, I'm sure you come across tons of these folks just through work.
[00:34:27] Ken: Totally, yes. That's a great couple of questions there, Alex. I would say, so what makes a good management team? You have a business that is producing cash flow, I think the management team is responsible for being stewards of allocating that cash flow and the earnings that the business generates. When looking at a business, from the investor side, you really want a management team that you can trust in doing the right thing. What I mean by doing the right thing is allocating that cash flow that's being generated to high return projects, whether that's expanding organically into new product categories or new geographies, or maybe doing acquisitions if it makes sense and it's done at the right price.
You want a management team that you can trust at the end of the day. You want a management team that could foster a really attractive culture. I think there's certain payment companies that have really good cultures, and employees want to work there. That's another thing I think that's becoming important at least the last couple years, is how do you build a good culture, a good business where you're going to attract talent? That's been very important. That's what I would say.
There's different ways to gauge if management has done the right thing, at least from the public side, and that's looking at, how have they allocated capital over time? How have they treated their shareholders? Are they buying back their stock at reasonable prices? Do they run the business with a lot of leverage? Do they own some ownership of the business where their incentives are aligned with equity holders? Those are a lot of the things that we look for from the investing side.
In terms of what management team should be doing now, I think most companies in this environment, this macro uncertainty, I think you should be focusing on cash preservation and expense management, which seems reasonable, and not to preach to the choir, but this could actually be a really good opportunity for spend management and back office automation companies, as they can pitch the excess savings to the C-suite. I think you should have an easier sell now than before, especially if there's wage inflation, that trade off, the unit economics actually look more attractive.
I don't know. First, I think you try to find areas within the business where you can not only take out a good chunk of the expense base, but you can also increase productivity. Focusing on things like spend management, API automation and the like, and then so you get the immediate savings, and then you can actually have those employees transition into more higher ROIC functions, more important functions, whether it's cash flow forecasting, et cetera.
I think secondly, while times are uncertain, I think for the public companies buying back stock in the public markets can make sense if your intrinsic value is above the current stock price, or potentially expanding through M&A, et cetera. There's a really good book, Alex, if you wanted to read, I suggest your listeners to read it too. There's a book called, The Outsiders by William Thorndike, who talks about--
[00:37:50] Alex: Love that book.
[00:37:52] Ken: It's a great book, talks about eight unconventional CEOs, and how they've created value for shareholders over time. There are different blueprints for success. Some companies have done really well repurchasing stock with their excess free cash flow, while others have issued equity to buy other companies if their stock is expensive. There's different ways to create value. That's one recommendation I would give to your listeners.
[00:38:16] Alex: Yes. Interesting. Play that back. It sounds like, obviously, focus on key operating metrics, focus on ROIC, potential cost cutting, improvements in efficiency, and just making sure that you're cognizant of that. One thing I actually did want to ask you about, and this has come up quite a bit when I speak to other CFOs, or other customers of ours actually, this actually has been coming up quite a bit, which is ability to forecast. Ability to forecast right now is just a very front topic just because I think everyone is re forecasting.
No one has any idea of what the economy is going to do. I think there's probably just incrementally probably more uncertainty or more volatility and assumptions. I actually want to put that question to you is, one, is stability of earnings intrinsically a good thing for investors? Is this something that's valuable that people look for? Two, are investors a little bit more forgiving at a time like this when you don't necessarily know what's going to happen with recession, not recession, high inflation, transitory or not?
What does that say? What does that mean, because a lot of companies obviously offer guidance? Does the confidence interval of the guidance, does that impact how you view a management team, or a CFO, or a company?
[00:39:41] Ken: Those are great questions, Alex. I would say, listen, I think stability is better than volatility when you think about, if you have a business, just any cash flow that's more stable, I think is going to be valued more than a cash flow that is more volatile, assuming the growth rates at the end of the day are similar in the long run. I think if you have stable cash flows and earnings, you could take advantage of times of macro uncertainty. What I mean by that is, if you're a business that generates strong cash flow, and you have a downturn, and a clean balance sheet, you're not worried about going out of business.
You can actually put some of that capital to work, whether it's buying out your competitors, improving your market position, potentially raising price if you have a nice franchise. There's different things that you can do if you have that stable earnings and stable cash flow. The second part, I just forgot your second part of the question, it was on the confidence.
[00:40:44] Alex: The confidence interval of guidance, or are people more forgiving, dream macro volatility around the guidance?
[00:40:52] Ken: Yes, listen, I think a couple of things. One is, investors like to see management teams that are realistic and honest with their investors. You don't want a management team that is sandbagging the guidance. You don't want a management team that's super aggressive in the guidance. You could look historically and see how management has guided, and how the business has performed relative to that. I think anytime there's a wider range of outcomes, that just means more uncertainty. Management doesn't know how the business is going to perform, but for a good business, that's okay.
Because, again, going back, if they could deploy some of that excess free cash flow in times of uncertainty, they can actually strengthen their position in the market and come out of this downturn even stronger. Yes, there's debates I think from investors as to whether or not companies should guide or shouldn't guide, but at the end of the day, there's a range of outcomes, and we're trying to guess what that potential range of outcomes is. Management teams are trying to do the same. I think that's something that we'll see how they guide. My guess is that a lot of these companies will say, "Our macro assumptions are X, Y, and Z, and this is how we think about what the results could be for 2023," for example.
[00:42:10] Alex: That's interesting. That's stellar. Yes, that's stellar. It's just been one of those things. It was never that sexy until now everyone talks about it. Everyone I'm talking to is thinking about forecasting, and is thinking about how I can make sure that I can navigate my company through the coming months and quarters, and folks are looking at metrics they've never really had to pay attention to before. Now, by the way, now I'm telling folks with debt on the balance sheet, debt service coverage ratio, you got to start tracking your DSCR. If you weren't already doing that, you should definitely start doing that going forward just so you can match assets versus liabilities, and manage cash flow.
[00:42:48] Ken: Totally. I think this environment, it's creating a lot of uncertainty. It's creating a lot of volatility, whether it's in interest rates or FX rates. If you look at the British pound or the Euro, they're at almost historical lows versus the US dollar. I think it becomes tricky in this environment. One thing that we did recently, Alex, I don't know if a lot of payment and FinTech investors, at least a lot in the public markets, look closely at the balance sheet, especially of these incumbents. Because it's like, you don't necessarily need to understand-- like, they're well within range of the debt service coverage ratios, their net debt to EBITDAs are not breaching covenants.
What's happened recently is that some of these companies have variable rate debt on their balance sheets. Interest rates have gone from 50 basis points up to 400 basis points, so their interest expense is increasing. A lot of investors that we speak to have had to sharpen their pencils when it comes to understanding the balance sheet, understanding how these variables are going to impact the performance of the business. Yes, and it's making I think everyone's lives tougher, not just investors, but management teams as well.
[00:44:03] Alex: Definitely. I don't want to leave this podcast on a completely pessimistic note, but here's a question I try to ask all of our guests, which is, in the midst of all of this macro volatility and whatnot, are there any things that you're personally optimistic about going into the rest of the year and into next year, whether about the economy professionally wise, companies in your coverage universe, or even personally, anything that you're especially optimistic about?
[00:44:32] Ken: Yes, I think for our companies, we're lucky enough I think to cover a sub-sector within financial services that is a growth industry. There's a lot of secular tailwinds when it comes to payments. That's one thing that we were really excited about, that these are good companies, that they will become bigger businesses over time. There's a lot of interest from investors, and these are high-quality companies that should compound over time. I'm excited about the long-term opportunity. There are always bumps in the road.
I think with that comes opportunity both for our companies, but both for us to try to help tease out who's gaining market share, who's not, which businesses are coming out stronger rather than weaker. I think volatility creates opportunity not only for us but the companies we cover. Then, yes, listen, personally, I'm excited to get back to traveling a little bit. My wife and I, we were supposed to go on our honeymoon back in 2020, and it got postponed a few years, so we still haven't gone on our [laughs] [unintelligible 00:45:39] I'm hoping we can do that next year. I'm excited about that.
[00:45:44] Alex: That's awesome. Well, Ken, it's really good to have you on the podcast. I will say, I have had a tremendous experience just getting to know you, talking to you, comparing notes with you around the industry over the last year, and really admire how articulate you are. Love reading your research. I think your clarity of thought, and all of your insights, and your research reports have been tremendous. It helps me a lot in terms of thinking about how I can manage my own financial reporting, how I think about capital allocation and whatnot. I have been looking forward to this podcast and this recording for quite some time, and it's been absolutely tremendous having you here.
[00:46:24] Ken: Yes. Awesome. Well, thanks so much, Alex. I really appreciate the kind words, and I echo a lot of those comments. It's been great to meet you and interact with you over the last couple years, and look forward to doing more of that in the near future, because we'll see you at Money20/20 next week.
[00:46:41] Alex: There you go. Looking forward to it. Thanks so much.
[00:46:44] Ken: All right, thanks Alex. Take care.
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