On the Hunt for Great Companies

SIMON KOLD is the founder of Kold Investments, a Copenhagen-based investment firm. He was previously at Novo Holdings, one of the world’s largest investment organizations, with assets worth €149 billion. He is one of the few fund managers who also has a degree in theology and had a stint in stand-up comedy.

Acknowledgments xiii

List of Figures xv

List of Tables xix

List of “Let’s Sniff Around” xxi

Introduction 1

Part I What Makes Some People Create Exceptional Long- term Per-share Business Performance? 7

Chapter 1 Passion 9

1.1 Perseverance and Internal Motivations 11

1.2 Focus on All Stakeholder Constituencies 14

1.3 Decision- making Time Horizons 17

1.4 Career Path and Tenure 18

1.5 Retention of People 23

1.6 Authenticity Indicates Passion 25

Chapter 2 Long- term Incentives 35

2.1 Board of Directors 38

2.2 Disincentives 40

2.3 Transactions in Own Shares 42

Chapter 3 Capital Allocation 45

3.1 Value- accretive Buybacks versus Buybacks 47

3.2 Hurdle Rates Should Be Determined by Alternatives 50

3.3 Value Destructive Acquisitions 52

3.4 Unsung Capital Allocators 53

3.5 Metrics and Vocabulary 54

Chapter 4 Reliable Communication 57

4.1 Past Predictions and Ex Post Outcomes 59

4.2 Genuineness as Indicator of Reliability 61

Part II What Makes Competitive Advantages Intense and Durable? 65

Chapter 5 Economies of Scale 73

5.1 Relative Scale and Relevant Market 75

5.2 Prohibitive Costs 76

5.3 Evaluating the Intensity and Durability of Economies of Scale Advantages 77

5.3.1 General analyses 77

5.3.2 Distribution network density 84

5.3.3 Purchasing scale advantages 86

5.3.4 Marketing scale advantages 88

5.3.5 Production scale advantages 89

5.3.6 Related concepts 90

Chapter 6 Switching Costs 93

6.1 Sticky Customers, Add- on Products, and “Cost of Switching” 95

6.2 Switching Cost Multipliers 97

6.3 Evaluating Intensity of Switching Cost Advantages 98

6.3.1 Costs of switching 98

6.3.2 The arbitrage of switching costs 100

6.3.3 Churn, retention, and cohorts 101

6.3.4 Risk of standardization 104

6.3.5 Risk of excessive value extraction 106

Chapter 7 Network Effects 107

7.1 Boundedness 110

7.2 Critical Mass and Relative Scale 110

7.3 Evaluating the Intensity and Durability of Network Effect Advantages 111

7.3.1 General analyses 111

7.3.2 Protocol network effects 122

7.3.3 Expertise ecosystem network effects 125

7.3.4 Two- sided networks 128

7.3.5 Data network effects 132

Chapter 8 Brand Advantages 135

8.1 “Identity Creating” or “Uncertainty Reducing” 138

8.2 Brand Time Constraints 140

8.3 Luxury Brands 141

8.4 Evaluating Brand Advantages 142

8.4.1 Brand benefits 142

8.4.2 The Lindy effect and brand longevity 143

8.4.3 Geographical boundedness 144

8.4.4 Analytical risk of over- interpreting brand loyalty data 145

8.4.5 Counterfeiting risk 146

8.4.6 Brand experience control risk 146

8.4.7 Brand dilution risk 146

Chapter 9 Proprietary Resources 149

9.1 Favorable Access to Raw Materials 150

9.1.1 Locking up favorable sources 151

9.2 Proprietary Technology 152

9.3 Favorable Locations 154

9.4 Favorable Government Treatment 157

Part III What Makes Some Companies Less Risky and More Valuable Than Others? 161

Chapter 10 Fair Value Extraction 163

10.1 Tapped and Untapped Pricing Power 165

10.2 Lack of Value Capture 169

10.3 Determinants of Choosing to Withhold Value Extraction 169

10.4 Risk of Extracting Excessive Value from the Supply Side 170

10.5 Evaluating the Risk of Excessive Value Extraction 171

Chapter 11 Staying Power 175

11.1 The Pace of Technological Change in the Industry 178

11.2 Exposure to External Foundational Technological Shifts 181

11.3 Cultural Embeddedness 183

11.4 Cost- effectiveness 184

11.5 Demographic Exposures 185

11.6 Exposure to Industry Channel Changes 185

11.7 Age of Technology/Product Category 186

11.8 Staying Power Versus Growth 187

11.9 Evaluating Staying Power 187

Chapter 12 Proven Business Model 191

12.1 Geographical Replicability 197

12.2 Expansion Investments 199

12.3 Lifetime Unit Economics 201

Chapter 13 Predictable Demand Drivers 205

13.1 Line of Sight of Revenues 208

13.1.1 Backlog of orders 209

13.1.2 Upgrade cycles and replacement sales 209

13.1.3 Contractual recurring business 210

13.1.4 Aftermarket services and spare parts 212

13.2 Predictability of Longer- term Industry Demand 213

13.2.1 Determinants of predictability beyond line of sight 213

Chapter 14 Reinvestment Options 217

14.1 Product Line Expansion 220

14.2 Territorial Expansion 222

14.3 Increased Capacity 223

14.4 Customer Acquisitions and Brand Building Investments 225

14.5 Buying Other Companies 226

14.5.1 Consolidations of fragmented industries 226

14.5.2 Cross- selling with switching cost multipliers 227

14.5.3 Acquihires 228

14.6 Lack of Reinvestment Options 230

Chapter 15 Scalability and Low Incremental Costs 231

15.1 Determinants of Marginal Cost 233

15.2 High Break- even Point 235

15.3 Scalability of Infrastructure 236

15.4 Operational Leverage Magnifies Cyclical Risks and Exit Costs 238

15.5 Capital- light Versus Capital- intensive Businesses 239

Chapter 16 Cyclical Risks 241

16.1 Cyclical Company: Good or Bad? 243

16.2 Degree of Cyclicality 244

16.2.1 Historical cyclicality 246

16.2.2 Historical managerial behavior 247

16.3 Minimizing Analytical Risks Caused by Cyclicality 248

Chapter 17 Other Risks 255

17.1 Dependency Risks 256

17.2 Diversity of Income Streams: Risks and Benefits 257

17.3 Leverage Risks 261

17.4 Geopolitical Risks 264

17.5 Regulatory Risks 265

17.6 “Unknown” Risks 267

Chapter 18 Final Remarks 271

18.1 Analytical Errors 273

18.2 Price Matters 275

18.3 Predicting Quality 276

Appendix: Banana Peels of Inductive Logic 281

Prediction Based on Past Experience 281

Argument from Cause 282

Argument from Generalization 283

Argument from Analogy 284

Argument from Authority 285

Anecdotal Argument 286

About the Author 289

Notes 291

List of Companies Profiled 301

Index 303