Hedge fund manager Jeffrey Ubben, the cofounder and CEO of $19 billion investment fund ValueAct Capital, has been investing in companies where there’s an opportunity to cut out the so-called “middlemen.”
Middlemen, or intermediaries, help facilitate transactions between companies and customers. They can be agents, brokers, or wholesalers.
These go-betweens can in some cases be cut out of the equation, or disintermediated. Companies can save the money they otherwise would have paid out to those “middlemen” if they find a way to do business without them. This is a key trend that ValueAct has picked up on.
ValueAct takes a bottom-up fundamental value approach to investing. The fund spends a lot of time on the details and they describe themselves as “business model-centric, not industry-centric.”
“This is evidenced by the amount of time we spend analysing business models, including how companies produce goods and services, how they interact with customers, how they get paid,” Ubben wrote in a letter to investors dated February 4. “These dynamics change slowly, but their impacts are profound on the companies’ returns on capital, can very often overwhelm macro-economic cycles and be more long-lasting in effect.”
From the letter (emphasis ours):
We are pleased to see structurally improving business models at most of our portfolio companies. One common theme we have explicitly chosen to invest in across multiple industries is direct customer engagement and disintermediation. Said another way, we look for opportunities where a company can remove intermediaries that distribute, resell, install, service and maintain their products. In the case of a company with diffused customers and limited internal resources, the “middlemen” can be extremely helpful. However, this help comes with a cost as the middlemen need to get paid, extracting economics from the industry. They also own the customer relationships, often leaving the supplier in the dark as to the customers’ identities, locations, behaviours, preferences and level of activity. In the case of intangible goods, such as software or media, this loss of control can lead to widespread piracy. A direct relationship with the customer can enable more specific market intelligence, fostering faster, iterative product development cycles that work to further align interests between companies and their customers.
Cloud computing has enabled Adobe Systems Incorporated (“Adobe”) and Microsoft to build two of the largest software as a service (“SaaS”) businesses in the world with Creative Cloud and Office 365. Importantly, with each, a direct connection with the end user has been established allowing a real-time study of usage patterns, near-continuous product updates and a host of other features. This was not possible when their software was indirectly distributed and ran on the island of a PC or a corporate data center. Today, files can sync seamlessly in the cloud across devices and offices. The cloud processing power also allows for heavy duty computation, including de-blurring photos and videos, 3D simulations, fast search queries across disparate data sources and almost limitless data storage. Adobe and Microsoft are now benefiting from the information that comes with having direct insight into what the customer wants, empowering them to continue to improve their products, giving the customer more and then getting paid more as a result.
ValueAct fell 1.3% in the fourth quarter to end 2015 down 2.2%. The average hedge fund fell 2.76% in 2015, according to data from Hedge Fund Research.
Since the ValueAct’s inception in 2000, it has produced annualized net returns of 15.5%.