While the DCF is hocus pocus, where you make a bunch of stuff up to justify a bull thesis today, it is incredibly insightful as you think about managing an investment firm.
“Terminal value” = (some made up multiple * cashflow proxy 5-10 years out) generally accounts for 80pct of today's PV. So while PV is mostly a function of made up assumptions and doesn't tell us much, 80/20 math highlights a really important question: WHAT IS THE TERMINAL VALUE OF THE FIRM? Will there be any?
Most hedge funds are about a Key Person. When this key person retires or attempts to transition their investment oversight duties, the franchise crumbles. A "team" of one true investment genius has No Terminal Value. This one Key Person can generate a ton of cashflow over a hands-on 5-10 year period, but then POOF... there is No Intangible Value of the Franchise. (Some older mid-market private equity firms founded in the early 90s face the same fate.)
Conversely, today's institutionalized PE/GE/VC firms are carefully structured around a Process and Culture. Many of the founders have retired, and today's managers train are training the next generations to follow a time-tested process (which may slowly be tweaked).
This is frustrating for a lot of people who think they are much better than their peers. While a firm's EV is maximized by recruiting a team of very smart people, who have the IQ and EQ to perpetuate a process and culture, an individual who thinks they really see the ball differently can feel suffocated by this.
If you really are extraordinary like Buffet, Loeb or Jim Simmons, it can make a lot of sense to hang your own shingle, deliver outsized returns, and let most of that cashflow accrue to you, while paying your gilded minions enough to keep them around (who inevitably complain they're not paid enough).
However, for most "investors," it's a much better risk-adjusted lifetime value bet to join a firm with an amazing process, culture, and history of consistent returns for LPs.
At firms with significant Terminal Value, an Investment Committee screens opportunities through the lens of the firm's investment process, which it has consistently communicated to LPs, and used to generate consistent returns over time. Anything outside the lens of what's traditionally worked faces a high bar, and is generally nixed. As we see some of the traditional buyout firms style shifting to "growth" - understandably LP antennae go up.
While an Investment Committee may stifle the genius who sees it differently, it also kicks out a lot of the riskier bets or investments outside their traditional space. While this might kill a 5-bagger in an unfamiliar area, it also prevents the disasters.
What are you honoring each day at work? Where do you direct your attention? Are you the star? Or are you part of a team who is honoring a process? How does this make you feel? It's hard to tell the ego, that at great firms, it's team playing that matters most.
#privateequity
Howard Marks https://www.oaktreecapital.com/insights/memo-podcast/fewer-losers-or-more-winners