From Ph.D in Math to Wall Street Analyst to founder of a successful venture company, Mike Kwatinetz has become pretty good at predicting winning companies over the years. Listen as he shares what it is he looks for as well as some of his predictions for 2017.
Alan: Welcome back I'm visiting here today with Mike Kwatinetz, Mike welcome to today's show.
Mike: Thank you I'm glad to be here
Alan: So Mike, for the listeners can you give us some background of your path and how you got to where you are today?
Mike: So I come from a lower middle class family. My father was an immigrant and couldn't even graduate high school because he had a work. So we're the first generation that went to college- my brother and myself, my sister didn't. Very fortunate in there were so many great schools I got to go to that were supplemented by the government- Stuyvesant High School which is 1 of the great high schools in the country, just got rated number 3 and 47 percent of the people there are sub income. Brooklyn College and University of California Berkeley and then I did an MBA at NYU so quite a bit there.
Alan: But I think when you left you had a Ph.D.-
Mike: -Yeah, Ph.D. in Mathematics from Cal and that qualified me for very little, so I went to work for Ernst and Young and enjoyed working there. And that launched me to get recruited to be CEO of a start up. We did pretty well, sold that to a public company. When my time was up for the contract I agreed to with the company, went to Wall Street and I had very good success on Wall Street. So I think I'm the only one ever to be top 3 ranked in hardware and software in the same year and I did it that last 7 years I was there.
Alan: And that was as an analyst?
Mike: As an analyst, I was first in the hardware, second in software and Institutional Investor even picked me as the number one stock picker across all of Wall Street. And that was lucky, I was following Dell and Microsoft and liked them, so that mattered a lot. And a group of us decided to leave and start a venture firm, Azure Capital. And Frank Quattrone who I was working with, and I ran the research for him, asked, 'why are you leaving?' I said I think the market is going to blow up.This was in early 2000 and there's going to be a search for who to blame. And I don't want to be here when that happens.
Alan: Smart guy.
Mike: And he said, you're out of your mind, who would do that? and then he went through all that BS because he was an innocent guy and they just wanted a high profile guy to go after.
Alan: So Azure Capital, when you sat in there how many came with you?
Mike: There were 4 of us who started it and very stable, 15 years, same four guys and then one of the guys left a year ago to go back to Wall Street. So same 3 partners who started it. And we also brought with us a few other people and we've been very stable. So even our assistance, we had two assistance, they've been with us since the first year, and our financial group, our CFO that's with us now has been with us now for about 7 years. It's a family type thing and we're doing well so everybody's enjoying it.
Alan: Now is it typically early stage, is it for a managed account, what's your target market?
Mike: We raise funds and we're investing out of fund 3 now and we invest in post seed stage, and A rounds is where we first come into companies. We try to help the companies a lot, we have a number of ways which we do that and we have the events that help them as well. We have a CEO day where we attract about 60 different large corporate and investment banks and all of our CEO's come and we have great speakers at it- like the chairman of Microsoft, the CEO of Citrix, you know and so on. And then the big thing in that day is we arrange speed one on one meetings between our CEO's and the corporate and investment banks that are there and last year we did about 241 on ones. So while I was quite a bit, it was about 8 or 9 per company.
Alan: And the typical fund size raises how much?
Mike: Well we're targeting around $125 million funds. Our first fund was a lot larger and it really was too large for this style of investing.
Alan: I'm visiting here today with Mike Kwatinetz and we'll be right back after these messages.
Alan: Welcome back and visiting here today with Mike Kwatinetz, he is a founder of Azure Capital and that Mike in the first break we're talking about your timeline, your history and we left off with the question, where are we at in the industry today, the state of the industry?
Mike: The industry goes through cycles and everyone has to realize that. And the cycles are too much money comes in, valuations get very high for private, people get psyched up and then there's some kind of correction, and we have a correction in 2001 we had a correction in 2009 after the correction it's actually a very good time to invest. We're at a pretty high value now offer for a lot of companies and we've pushed into post seed because there's so much seed money now. So many companies are getting funded at the beginning. And then a lot of them can't find money. Before they're A, they're not ready for an A round and they can find money so we found that that's a hole in the market right now and you, know supply and demand works well if you find good holes in the market you get better companies at reasonable valuation. I I think there's gonna be more falling out of companies that have been funded to grow unprofitably forever and I don't know which ones for sure, I mentioned a few in my my top 10 of 2017 and the reason is that business models don't work. So it's a very interesting time in the industry because this so much creativity I get really excited by the entrepreneurs we meet and we see over a thousand a year that we have opportunities. Are we invest in about one out of 100. So there are a lot of great entrepreneurs, great companies that don't meet the cut because the somebody a little better in our opinion. And so you're finding that about 65 percent of companies that seed funded can't get another round the funding, so there's a big drop out rate. And then there's some that get anointed and probably get over funded and are often spending a little wildly, so one of my predictions way back when I was on Wall Street was, I was not a fan of Sun. And I kept expecting Sun to rollover. And what happened was- And the reason was that the value proposition they offered was not a good one- that you were paying 3 times as much for the same value as a Wintel server. But in '99-2000 profitability didn't matters to anybody- spend wildly- so Sun stayed up there until that market correction and then Sun went down really fast. So you have some things like that going on now and I think they'll be more of the so called unicorns that fall off, but there's a lot of really legitimate ones and we're in a transition that's exciting, the web is offering a tremendous opportunity, analysis of data is just so important now and robotics is another interesting area that's taking place and I personally at Azure have been investing more in the commerce space. I just because I think we're early in the transition and the old line is not adapting well.
Alan: Yeah I noticed that, a lot of companies- it's like moving a big battle ship, it's trying to get them over-
Mike: It's really hard, and if you're Macy's you can't keep closing stores into profitability at a certain point you have to fix the problem. And if you're reluctant to change, you're never gonna fix the problem. So yeah you'll survive another 10-15 years but eventually you're going to be Sears. So you have to adapt. Walmart has had a lot of trouble competing with Amazon. And when they bought Jet, I think they overpaid tremendously but they're desperate to try to figure out how to compete online and maybe they got some strength out of that, it's hard for me to tell, but I think that was a diving save for the investors in Jet.
Alan: So that leads to the next question, when you're looking at a company and you're deciding, do I go into this company or not, what do you look for, what are the key attributes?
Mike: First of all the team is Paramount. A great team can move the ship and if they've made some mistakes they can fix them so that's the most important thing. But you want a large market opportunity, and so we assess that, and it may be an existing market that's right for change or could be a new market that we see developing. You also want a winning business model. I think we're unusual as a firm in that we pay a lot of attention to business model. And the business model means, what is their long term gross margin going to be? How does that compare and what's the lifetime value of a customer and how does that compare to the cost of acquiring the custom and if that ratio isn't right then the company's gonna be in trouble at some point in time. It can keep losing money and maybe it gets financed, but at some point you have to figure out a way to make money. So we look at those things and you know, we look at a potential operating margin and then do they have some kind of competitive advantage that will allow them to do well compared to existing players or new players that try to copy them and so on.
Alan: I'm visiting here today with Mike Kwatinetz, and I need to take a quick break and we'll be right back after these messages, and when we come back I want to get into the predictions that you're looking at for the future as you see it.
Alan: Welcome back I'm visiting here today with Mike Kwatinetz, and Mike before the break we talked about delving into your predictions for 2017 and do quite a bit of blogging in this area, so what do you see happening in the public sector?
Mike: So when I do these predictions a few of them a stock picks for the year and I've been fortunate in that they've worked out pretty well, I've only had one wrong over four years, and that was a slight down, and the others have been going up on average about 60 percent and so this year, the 3 stock picks are Tesla, Facebook, and Amazon. They were already up a bit you know early in the year and each one meets the criteria I spoke about earlier, great management, large market, and a very interesting business model. In Tesla's case what's interesting, a lot of people focus on Tesla and focus on the car itself, and you know the car is way ahead of the competition in terms of the electric aspects of it as well as the automated features in it, so all this discussion of Google and others for automated car- there's only one company that really has an automated car in the market and that's Telsa. And you know they'll keep improving it, other companies have announced that in 2020-2021 they'll have an automated car, about a dozen that have said that. But the other part of Tesla is the business model, they have eliminated dealerships. They basically have what I call a guide store. So the stores that they open up don't have inventory. A guide store is a store that doesn't have inventory, it allows you to see the product. Check it out and then buy it online. And that's what Tesla is. Now because they have a guide store rather than dealership with couple 100 cars on the lot, they have a very small footprint that they meet. That small footprint means they could be in the Stanford mall. They could be in other malls they can be in high density shopping areas no other car company can do that. It also means that they control the customer experience. No other car company controls the customer experience. And it's a much better customer experience. It also means for servicing the car they can consolidate into individual areas. So they can have 10 different guide stores and one place where you do your maintenance of the car. Very efficient business model. Like Dell they don't produce a product until it's already been bought. And you buy exactly what you want, you don't buy what the dealer has on the lot with all kinds of stuff on it that you don't want. You decide what you want that's what you buy, you wait to get it and Tesla doesn't carry inventory so very different model.
Alan: The thing with Tesla, the thing that's interesting is this deal with Solar City has been kind of controversial, people have felt, is this the right direction? and also the multiples where it trades for every 10 shares of Solar City, it goes 1 to Tesla, but it's not it's not equal math. In other words, Tesla is trading at a premium versus solar city is lagging, what's your take on that.
Mike: So if you're a company that trades at a significant premium, acquire things that don't trade at a premium. It's real simple math. If you trade a multiple of revenue and now you bring in more revenue at a lower multiple that your trade at, chances are you're gonna have the stock appreciated. I also think that Solar City is in the front- we're goning to convert more and more to solar, you know so I think it's a much better acquisition- by the way, the other thing that's gonna happen is the electric companies are gonna fight back, you know like we're in the middle of putting solar in our house and people selling it say, well you sell back to the electric Company- it's $0 you but the electric company keeps tweaking what they let you do, so what are you gonna wanna do, you're going to want to put panels in the house that store the electricity. And it makes you less dependent on doing anything with the electric company. Guess who the leader is going to be in that- Tesla. It's really interesting and they already have product but it's expensive right now. With technology the cost comes down every year. And that's what's gonna happen with that product, so not only are they gonna sell you the solar system for your house, they're going to sell you the storage system, and they're also leader in battery technology. So they're a very interesting company, and one of the reasons why I am confident that this is gonna be a big year for Tesla- and it's unbelievably predictable, they have 400,000 model threes back ordered. And it's going up every day. They're building plants to produce 500,000 cars in 2018. How many cars do you think they're selling in 2016.
Alan: That says something,
Mike: 500,000 so 5x the units, now the average price will be lower- so probably 3 times the revenue in '18 that they had in '16. Should the stock go up over that, I think probably and and by the way increases in revenue drive earnings faster. So earning will go up faster than 3x between now and '18.
Alan: What do you think about Amazon.
Mike: I always have loved Amazon
Mike: We were at a meeting when we first started Azure and we had this brilliant advisory board, the who's who of the industry. And at the time Amazon stock was $5 a share. And I said, well why doesn't Walmart buy Amazon. And everybody in the room but me thought they shouldn't. And they may have messed it up if they did. Amazon not only has brilliance in terms of shopping; What other company has been able to come out of their sphere and have the best cloud offering, who would've thought that would be from Amazon, that would be driving revenue and earning. And by the way the efficiency of that is getting better each year, so the margins are going up in their cloud. They launched the kindle, now they own E-books. They launched a subscription service for that, in the first year they lost money which is the way Amazon does it to get the market share, now they have the market share and they've tightened up what they're doing and the earnings on that is going to go way up. The echo is unbelievable. In my blog I compare the echo to 5 other launches. The iPod, iPad, the iPhone so 3 apple products, but also a DVD players, CD players and how did they progress from year one to year 2. They all grew at least 100 percent and in fact most of them grew at least 200 percent. In the second year in the market, and by the third year they were between 300 percent and over 1000 percent of the first year. The echo I think is a big product for them, and even for this Christmas I think you're gonna hear big numbers when they announce. So I think they have a lot of legs for the story, but what's interesting is they understand the consumer. And they give you an unbelievable experience as a consumer.
Alan: So Mike I'm running up against the break. Your blog is where?
Mike: It's soundbytes2.com. And if you just Google sound bytes2 you'll find it.
Alan: I need to hold you over for another segment, we'll be right back after these messages, we're visiting here today with Mike Kwatinetz.
Alan: Welcome back I'm visiting here today with Mike Kwatinetz and Mike, before the break, we're talking about a few of the predictions that you made, but I want to jump over to new and upcoming technology. There's something in the robotic field that you're involved with.
Mike: Yeah there's a company called Megabots and it's a really interesting company. So they are the first company that can efficiently build a giant robot. They've had their prototype robot around for the last year, and now they've challenged this company in Japan that's building a giant robot to a fight. And they're in process of completing their giant fighting robots the robots gonna be 16 feet high. Weigh 20,000 pounds, be able to fire a paintball and 120 miles an hour which is fast enough to pierce armor. So it should be very interesting.
Alan: So the robot wars have now scaled-
Mike: Well all of the things you've looked at have either been animations like in Star Wars and so on or they're really small robots, So this is the first time we actually are gonna have a very very large robot. Think of it as NFL meets transformers, we can have live events, but you also can have all of the licensing and things you do because people are gonna wanna own little replicas of this and so on.
Alan: So there would be teams that would actually by the robot?
Mike: They're going to have teams at a certain point and form a league of giant fighting robots and they'll own the league and people will buy franchises in the league, you know, kinda like NFL type things and they have to come up with all the rules of what the franchises get and so on, but they'll be live events and I'm pretty sure they'll be able to fill a stadium of 60-70,000 people pretty easily. If you think about it, people want to see combat, but they don't want to see anybody hurt. So this is an ideal solution to get our that type of experience without anyone being injured. Now they're piloted robots so one of the technologies, things they have to do is make sure the pilot is well protected.
Alan: The pilots are inside these then.
Alan: What else you see coming up?
Mike: Alright, so we have another company that's pretty interesting called La Tote. And it's a Netflix like subscription that you pay monthly, and you get a box and a woman goes on the site and creates a virtual closet. And puts about 80 items in and they get their first box which is 3 clothing items and 2 accessories, can ware it as much as they want, when they're done, send it back, get the next one. Similar to the old Netflix model, and we then clean it and press it and use it again for someone else. This thing is taking off, it saves women a tremendous amount the money, in a single year, a woman has access to 120 items in a year, are they're paying $720 for that. And normally the amount of product they have access to is 10 times what they're paying in value. So it's pretty, and they don't have to clean it, we do that. So that's a very interesting one that's it's ramping very very quickly. I think you're gonna hear more and more about them, we have another one called Chairish, which is a company that is a marketplace for vintage furniture and decor- also doing really well arm, and there's nobody quite competing with them, although now they've launched the second product, Picasso which is competing with 1stdibs. A third one, Vida is very interesting what they are is, a next generation Etsy is the way to think about it. They allow people to design products, using their technology. And they have partnerships, ShareNow is designing products on their site, they have fine art products, products are things like scarves, tops for women and dresses and so on. And they're in some museum stores now because they can have a Van Gogh on a scarf, and they manufacture in countries outside the U.S. primarily but some in the U.S. And again they don't hold inventory they produce to order. When I say ramping fast, I'm saying over 100 percent a year.
Mike: And some of them are 200-300 percent a year
Alan: So Mike it's been fun having you with us today on the show if a person wants to follow your blog how would they do that once more?
Mike: Just Google sound bytes and bytes is B-Y-T-E-S, so soundbytes2.com and you'll find it.