Rebooting Businesses for the Entrepreneurial Age
Today: Modest Proposal with Patrick O’Shaughnessy, transforming legacy businesses, Ian Hathaway.
The Agenda 👇
A great podcast about the future of value investing
Remembering The Family Reboot and Sébastien Romelot’s prowess
Why it didn’t work out from a financial perspective
Why it could still work in the future
Ian Hathaway on the problem with VC databases
A recent edition of Patrick O’Shaughnessy’s podcast Invest Like the Best features Modest Proposal, the pseudonym of a seasoned value investor who’s very active on Twitter.
I encourage you to give it a listen. It’s a fascinating deep dive into the present and future of value investing, and the change of paradigm imposed by the shift to the Entrepreneurial Age. It echoes some of my past essays such as The New Strategic Deal in Value Investing and 11 Notes on Berkshire Hathaway, albeit resonating through the large reach of Patrick’s podcast.
One part of the discussion in particular caught my attention. It’s about legacy businesses becoming more of tech companies so as to create more value with existing assets. The focus here is a category Modest Proposal characterizes as “heterogeneous services”:
The challenge with [a local business] is you need frequency to really build a marketplace… Without high frequency, the aggregate gross dollars per customer is simply not enough to overcome the cost of building that network.
[Home services, for instance] is a very interesting category. A number of folks have tried to do the traditional de novo startup. It has not worked, and the reason it has not worked is you have the cold start problem: you have to spend a ton of money acquiring demand; you have to spend a ton of money acquiring supply; and even if you do bring a 10x better product to bear, the frequency has historically not proven high enough that you can make enough money doing this.
What if you start out with an existing asset in place and you don’t have to do the cold start problem? That’s what ANGI Homeservices is trying to do. They own a business called Home Advisor, which in a sense is a marketplace. It’s a 2-sided network where consumers come in and they submit a bunch of information about the type of project they’d like to work on. On the other side of that, you have 250 000 service providers who are trying to access that demand.
What you have in place is an asset, so you don’t have the cold start problem: you have the demand side. So the question now is: can you fulfill that demand in an on-demand environment and build the product that everyone knows is 10 times better—and further own the demand in a way that over time, this becomes the go-to?
As Modest Proposal mentions, it so happens that last year ANGI Homeservices acquired Handy, one of the few remaining players in the on-demand home services space.
I know Handy: my wife Laetitia and I tried to use it to have our house cleaned when we arrived in London. The experience was terrible. Each week, they would send a new person to clean the house, which means we had to be there, explain everything, point out where the cleaning products were… and that’s if that person, who was likely very badly paid and not highly motivated, ever showed up at all. We ended up dealing directly with one of the cleaners who had done a fantastic job, and they became our go-to provider for taking care of our house over the following years.
(To be fair, the transaction that Modest Proposal talks about is obviously centered on the US, where the network effects might be easier to generate, and where Handy might be less of a failure from a customer perspective as compared with London.)
However, what I find especially interesting here is this idea of using an existing asset and refurbishing it so as to deliver a service that clears the bar in terms of what customers expect in the Entrepreneurial Age: more convenience, less friction—the Amazon way! It resonates because it reminds me of an early experiment we conducted back when we launched The Family in 2013: The Family Reboot.
The idea was simple: buy an incumbent business which owns assets that can be used in a different way, build up a new company by adding tech talent and resources on top of those assets, and make a hefty multiple on the initial investment by selling the resulting company to a higher bidder.
Through a local investment bank that employed a former colleague, we had the opportunity to consider buying out a major Paris-based retail franchise that had been on the market for years, so The Family Reboot was more than a theoretical idea. We actually conducted a very long due diligence on this particular business, shaped up a turnaround plan as well as a roadmap to turn it into more of a tech company, and spoke to many investors so as to line up the capital necessary to conduct the whole transaction.
The inspiration behind the project was Sébastien Romelot, a former investment banker with Lazard and now the CEO of outdoor advertising specialist Phenix Groupe. Sébastien is not just a friend: he’s the very dear friend who first introduced me to my cofounder Oussama Ammar in 2011, so we actually owe the existence of The Family to Sébastien!
At the time, Sébastien had left Lazard to build a startup focused on digitizing outdoor advertising, with the goal of selling hybrid (billboard + digital) campaigns to advertisers in retail—all with a proper measure of returns on investment, and hopefully much higher ones.
In the process of building that business from scratch, Sébastien was discussing a partnership with an old-style company named Insert, a leading player in outdoor advertising in French city centers at the time. But then something happened: Insert, a highly indebted company, went through financial difficulties and the discussions with Sébastien collapsed overnight, threatening to kill his own startup as well.
Fortunately, Sébastien, being an investment banker, saw a way out: he raised funds to buy Insert for close to nothing (due to the poor state of the company’s finances), then merged it with his nascent startups and acqui-hired a few other tech startups in the advertising space, and then completely rebuilt the demand side of Insert’s business under the umbrella of Phenix Groupe, effectively turning it into more of a tech company.
You can see why Modest Proposal’s mention of the ANGI-Handy deal caught my attention: it’s exactly the same thing as what Sébastien did with Insert, building on a legacy asset (except in Sébastien’s case it was the startup buying the incumbent rather than the other way around). The Family Reboot was about emulating that approach at a larger scale, starting with that retail franchise we were considering.
In the end, however, it didn’t work out. My take is that we were probably too early, both as The Family and in the process of the entire economy shifting to the Entrepreneurial Age.
At the time, I wrote out a postmortem, recognizing that buying out a faltering incumbent to turn it around and build a tech company is effectively three transactions in one:
You don’t want to buy the incumbent if it’s in too bad a state, so the business would typically be slowing down but still profitable. That means existing shareholders would demand a price that reflects future cash flows. That wouldn’t necessarily be expensive, but it’s still some money, and that kind of money (buying out existing shareholders to pursue the same activity in a more efficient manner) would typically be provided by a buyout firm.
Then you effectively need to kill the existing business. Transforming the company’s strategy requires that you renounce future cash flows by implementing a radical repositioning. That comes with a price: you need to cover the cost of operations while you’re cleaning house and restructuring the organization so as to generate revenue within the new strategy. That kind of money would typically be provided by a firm specialized in turnarounds.
Finally, you need to build a new tech business on top of existing assets, which is money typically provided by a venture capital firm.
All in all, you have to pay a price that’s likely to be three times higher (buying out existing shareholders, then turning the business around, then building a new business on top of the assets):
It’s possible that, at least in some sectors (like Modest Proposal’s home services or outdoor advertising in Sébastien’s case), starting out with existing assets rather than opting for a cold start generates a return that’s more than three times higher than what you would get if you started from scratch like Handy. So the intuition I had at the time remains intact: it seems like such an operation can work from a financial perspective.
The main problem is that it’s impossible to find an investor to fund such an operation. The Family didn’t have enough capital (either on balance sheet or under management) at the time to go it alone, so we had to talk to investors. The problem was always the same: people were interested in funding a buyout, funding a turnaround, or funding a startup. But no investor was willing to fund the three actions together in a single transaction.
This is why what Modest Proposal has in mind can only happen in three cases:
Either it’s a random transaction, like the one Sébastien stumbled upon by chance as he was negotiating this partnership with Insert.
Or the incumbent realizes the potential and does it by itself using its own balance sheet, as in the case of ANGI Homeservices acquiring Handy.
Or you can raise a dedicated fund specialized in this kind of transaction, as David Wei has done with Vision Knight Capital in Shanghai.
This is what I wrote about David in The Future of Consulting (Round 1):
When I visited Shanghai in 2017, I was honored to be introduced to David Wei, a former executive at Alibaba and now a successful general partner with his private equity firm, Vision Knight Capital. David’s model was simple—and compelling: he would approach legacy corporations and offer them consulting for free; then, if the ‘client’ was responsive enough, David’s group would make an offer to invest in the company; then they would take control of the business and transform it from top to bottom to make it competitive in the Entrepreneurial Age.
(By the way, this is what Mitt Romney was tasked with when he was invited to found Bain Capital back in the 1980s. But then he quickly switched to traditional buyouts, which were much more lucrative back then.)
What do you think? Do you know of other similar operations? If yes, do the maths work? If no, should we try it again?
My friend Ian Hathaway, co-author of The Startup Community Way, reacted to my recent writing about venture capital slowing down during the pandemic with a warning:
About your newsletter [Two Things About Venture Capital These Days], note that venture deals are severely lagged in real time, so what might be a slowdown... may not be. I've written a ton about this:
The Relative Resilience of Venture Capital Deals During COVID-19 So Far (September 2020)
US Venture Deal Activity during the COVID-19 Pandemic (October 2020)
Lagged Deals and the Dynamic Nature of Venture Capital Databases (2019)
🎙 Speaking about Ian, definitely give a listen to his very recent conversation with my other friend Ben Robinson, of Aperture, about the book The Startup Community Way:
If you’ve been forwarded this paid edition of European Straits, you should subscribe so as not to miss the next ones.
From Bordeaux, France 🇫🇷
Nicolas
