Mike Kwatinez or Azure Capital

November 19, 2019

 

Mike Kwatinetz is a founding General Partner with Azure Capital Partners where he specializes in consumer companies, software and related infrastructure technologies. His current board memberships are Chairish, Education.com, Le Tote, Medsphere, Open Road and Silkroad and he led Azure's investment in FilterEasy, GotIt, Maker Media, Coffee Meets Bagel, Luma, Sprinklr and Tripping. He also served on the boards of Bill Me Later (acquired by eBay), BlogHer (acquired by SheKnows), Cooking.com (acquired by Target), Julep (acquired by Warburg Pincus), Rooftop Media (acquired by Amazon.com), TripIt (acquired by Concur), TopTier (acquired by SAP), Wildseed (acquired by AOL), Prospect Park, and Woodbury Computer Associates (acquired by JWP).  Other representative investments include VMware (acquired by EMC).  Mike’s blog, SoundBytes II, is a continuation of his widely read technology investment strategy newsletter.

 

Prior to Azure, Mike was Group Head of Technology Research, a Managing Director and the senior software and hardware analyst at several major investment banks, including Credit Suisse First Boston, Deutsche Bank Securities and PaineWebber. Mike was also a senior research analyst at Sanford Bernstein & Co.

 

Prior to his career in technology research, Mike was CEO of Woodbury Computer Associates, a software products and consulting firm, which resulted in a 160x cash-on-cash return.

Mike, prior to Azure, has provided research coverage and strategic advice to numerous technology companies and has consistently been viewed as a top resource on many, including Microsoft, Compaq, Dell, Apple, Hewlett Packard, VA Linux and Gateway. His coverage universe also included e-business software and internet devices and infrastructure. His theories on the shift of industry control to Microsoft and Intel, "The 4th Wave of the Web," the advantages of Linux, and the need for PC vendors to go "Beyond the Box" were considered agenda setting for the investment community and contributed to his upgrade of Apple to a "Buy" in 1999.  He was top-ranked by Institutional Investor in PC Hardware and ranked second in PC Software and was the only sell-side analyst to ever be top three rated in both software and hardware, doing so for six straight years before leaving to form Azure in early 2000. In 1997 and 1998, Mike was rated Institutional Investor's No.1 Large-Cap "Home-Run Hitter" for stock selection among all Wall Street analysts and remained among the Top 5 in 1999. Furthermore, Reuters and the Wall Street Journal have selected him as the No.1 PC analyst.

Mike received his M.A. and Ph.D. degrees in Mathematical Modeling from the University of California Berkeley and his M.B.A. in Finance & Accounting from New York University. He sat on the Financial Accounting Standards Board (FASB) advisory committee for a number of years. He is also author of "The Big Tech Score," published by John Wiley & Sons.

Bio Source: azurecap.com

 

Transcript:

Alan 

For the listeners, can you give background on your expertise and business?

 

Mike 

I'm one of the weird people in the world. So I started off and have a PhD in mathematical modeling. And then I also have an MBA in finance and accounting. So I kind of know the accounting side, the modeling side and so on. I went to Wall Street and I was ranked as the top analysts in hardware and second and software, the only one to have that double ranking. So have pretty good and then after 10 years on Wall Street, a group of us left and formed Azure, which is our vc firm and I've been there since then.

 

Alan 

So what's an ideal client for you?

 

Mike 

Well we have investors in our funds and then we invest in startups. So a couple of the successful ones- we had a company bill me later, which I invested in, and they were the first successful online credit card. And they were acquired by eBay, eventually for a billion dollars. So I was very happy with that. I was one of the I think we were the only VCs that invested in VMware. And that was pretty successful. And today VM is probably worth $30-$40 billion. Unfortunately, we didn't get to all of them through today. So they sold much earlier. So those are, you know, examples. And right now we're investing out of a fund where we're investing in post seed, which means a company has about a million dollars in revenue run rate, but has proven out its business model.

 

Alan 

And so pretty much it's just series A investments?

 

Mike 

Yeah, we're series A or Pre A right now

 

Alan 

So, in addition to that you also do some money management.

 

Mike 

No, I don't, I only manage my own money. But I write about it in my blog, I do some writing about recommendations that I share. And I do that at the beginning of each year. And, you know, it's gone pretty well.

 

Alan 

So Mike, in looking at companies and deciding do I invest? Do I not invest? What process do you run through?

 

Mike 

Are we talking about private or public talking about private?

 

Alan 

Okay,

 

Mike 

so what we think about a lot, I especially want to have proof on the business model that was out of Vogue for a long time. You know, people love Uber and Spotify and Lyft and so on. And now I'm seeing articles from VC saying business model is the latest thing. Of course, that's how I've been investing from the get go, you know, and when I say business model, I mean that the company has a path to profitability that is visible. So the first thing you look at is something called contribution margin. What that is, is you take the gross margin dollars and subtract the marketing that they spend to acquire customers. And that's contribution margin. When contribution margin is good, then as the company scales, there's more dollars to cover other expenses, and it kind of gives an indication that scaling will help the company be successful. If contribution margin is bad, then scaling doesn't help the company that much and you know, we've seen that with Uber and Spotify and some others. The one that was the clearest to me was Blue Apron. You know, they had terrible contribution margin, which meant as they scale they just burnt more money. So you, you can't get the profitability if your contribution margin is zero or negative or very low. So I think a lot about that with the private companies

 

Alan 

As a fund, how large is as your capital?

 

Mike 

We probably manage close to a billion dollars.

 

Alan 

Mike, when you're looking at today's market and the valuations, a lot of these IPOs are coming up fairly rich, what's your take on what's happening in the markets?

 

Mike 

Yeah. So there is an enthusiasm, which goes back to the 90's. You know, we had a similar kind of thing. I would say, mostly, it's better today. But you do have exceptions where, especially where it's almost like a household name, you know, again, like a Spotify or an Uber or Blue Apron, guys like that where people know the company and they feel comfortable that they understand why it's a good thing to buy and  again, I go back to the same, you know, measurements, what's the contribution margin percentage? And you know, is it going to get better? And how did they get to profitability? So when I look at public companies, you know, I think a lot about that. And, you know, companies that I like are like DocuSign. They are companies that have recurring revenue streams. And there's something called revenue retention. And what that is, is if you have a subscription based company, especially, you compare a set of customers that existed the year before, and are you getting the same amount of revenue from them the next year, or less or more. So, if your revenue retention is over 100% that means that the companies that you have as clients are spending more money with you They did the year before, and very few of them are exiting from working with you.

 

Alan 

And what's happening in the market today?

 

Mike 

Yeah, so I think one of the issues that has happened with some of the IPOs is that the company's waited much longer to go public. In the past, companies would go public, you know, with 300 million in valuation. Now you have companies that are getting 10 billion or more in valuation when they go public. It was very rare in the past that companies waited that long, but the private markets have much more capital now. And in many cases, the private markets will fund them at a higher valuation than the public markets would. Then when they go public, they tell the investment banks, we have to get a minimum of this valuation. So they're often going out at a little bit inflated valuation. Whereas the thinking process in the past was, have the company go public at a little bit less than it's worth, so that they would be a little pop in the public markets. And it would help the stock longer term. It would be better for the company to leave a little on the table in terms of their money they raised and get a better long term following of investors into the stock.

 

Alan 

what companies are you currently involved with?

 

Mike 

On the private markets? We have one of the companies is a company called Le Tote. And that's a subscription company for women to rent everyday clothes. So they get a box each month that has a set of clothes that they could wear as much as they want. And when they're done, they can buy some of the clothes or they just can send them all back. The average woman has over 20 items in her closet that she will never wear, and about 100 items that you'll wear two times or less. Well, why not rent those items instead of buying them? Look tote, just announced that they acquired a traditional retail of Lord and Taylor, which is a much larger company and the transaction closed last week. So pretty interesting. Another company that I find very interesting, and is a company called Cherish and they're a marketplace for vintage furniture, decor and art. So people list things with them. And then they help, you know, a potential buyer find those things. And they'll arrange all the shipping and be the middleman to help consummate the transaction. A lot of designers, they have about 20,000 designers using the site now. And most of the products on the site come from power sellers, individuals list some products, but that's probably only about 10 or 20% of the inventory on the site. And they now have over 400,000 items on the site. So search technology is very important, so that if you're looking for something, they can help you find it quickly, without sorting through hundreds of thousands of items. So that's another one that is really interesting. And, you know, again, a very good business model. And then the third one I'll mention is we have a company called med sphere, which has electronic health record software for both hospitals and physician practices, that's allowing the whole patient record to be electronic which in the past hospitals didn't do and it actually cuts the number of errors wrong procedures misdiagnosis, so on. And so it increases the quality of healthcare and the US government is very supportive of hospitals going on it.

 

Alan 

Amazon has made their mark in in the economy today. A lot of retailers are jumping into the market. But what do you see with the trends where will Amazon be five years from now and you know, what's going to happen to that whole online community?

 

Mike 

So just that aside, my firm took Amazon public when we were on Wall Street, and the first conference Bezos spoke at was the conference I ran. So but you know, the thing that Amazon has done very effectively is they have invested in technology. So people would say, well, Amazon's not a technology company. Yes, they are. They're an unbelievable technology company. And so part of the thing that they've done the better than anyone is logistics. And if you can bring the cost of logistics down delivering a package to someone's home, then you have a huge competitive advantage. There's a lot of technology and how you do that. And Amazon also has taken on third party stores that can be on Amazon. Part of the benefit of that is they have more packages to deliver, and that makes them you know, better. Amazon also uses a lot of technology in terms of when to price things a certain way. And you know, so on. They also invented the Kindle. And so when I was on Wall Street e-reader were talked about All the products out there were terrible. The Kindle has made e-reading really good.

 

Alan 

So Mike, I need to take another break. Okay. And when we get back, I'm going to I'm going to talk about stages of which companies should acquire their funding. Okay. We'll be right back after these messages. Welcome back and busy here today with my quad Nicks. And in the last segment, Mike, we were talking about Amazon and we ran up against the break. What's the next step for Amazon? Where do you see that company going? Right?

 

Mike 

Well, let me mention one thing that they've done that unbelievable. Yeah, they are super customer centric. And other companies aren't necessarily as customer centric as Amazon. So you know, I bought something on eBay. And there was some problems with it. And basically, they left me on my own to try to rectify the thing. We buy a lot on Amazon one time, the thing didn't get delivered. We contacted them. They said, we'll send you another one didn't ask anything, get the other one. And then about a week later, I find the first one it was under a bush, you know? So we contact them and said, What do you want us to do? You know, we found that they said, just keep it. Now, when you do things like that you create tremendous customer loyalty. A lot of the other brands don't know how to do that. So that's an important thing to be customer centric and think that way.

 

Alan 

So Mike, where do you see Amazon heading right now?

 

Mike 

Yeah. So I had a prediction in my blog. How five years ago that Amazon would have Let's start going offline. And it's a very simple reason for that. Amazon wants the majority of the market 75% of purchases are still offline. So they had to think through what is it that that means for us. So they started a few years ago opening some Amazon bookstores. And but the bookstores work differently, where they using all of their online data to decide what books to stock in the store. And you could also buy online at the store. So they're trying to blend online and offline at the store. Second thing that they've done more recently is they opened something called the Go Store, which I'll say it's kind of a competitor to 711. You can get a sandwich there, you can get kinds of goods that would be in a 711. The difference between them and 711 is there's no people. It's all 100 percent automated. So you download the app, you can't get into the store without it. And the door will open if you have the app, when you pick something off of a shelf, it knows that it goes into your cart without you're telling it anything. So you have no manual things that you have to do other than pick your food or pick the you know, whatever else you're buying there. And then when you walk out the store, it charges you for it. So they have re envision economics of a physical store. I'm expecting them to also open broader stores that have samples of product in the store. But you don't actually pick you know get it when you're you know in the store except for a few very fast moving items. And they'll just get it to you the next day. So you're not waiting and this way you can get to try on shoes you can do you know anything that requires you to have a look and feel of it, it'll benefit Amazon by having that their distribution is so strong now that, they're ready for that that they haven't done yet. That would be for a host of items that currently, you know, wouldn't go with the Go Store or the bookstore. But they're trying to sell everything.

 

Alan 

In today's market, we see companies delaying going IPOs. You mentioned in the earlier segment. In your opinion, when should a company seek private funding versus go IPO? What's the ideal time?

 

Mike 

Well, first of all in companies early, you know they can IPO. And you have to also, you know, one of the things that government did after the meltdown in 2000 to 2002, is they created a set of laws that I felt at the time were wrong. They were more politically motivated than beneficial to the community. And it made it much more costly to IPO. So whereas a company could have IPO'ed, with 30-40 million in revenue in the 90's. Now, the company's valuation needs to be much larger, because they're going to have millions of dollars of extra costs when they IPO. So that's one reason that there's been a delay. The second reason is the private markets have been much friendlier to certain companies and the public markets would be, and we're seeing the effect of that when some of these companies IPO now, and the cost of that companies have waited much longer to IPO. So if they can get the funding privately, it's less of a hassle for them. There's less oversight on them. And you know, the valuations were very, very good. So, you know, companies decided, Hey, I can get to be $30 billion in value before the IPO and we've had a couple of those You know, that are very high valuation, certainly in the billions, you know, whereas in the past, that was not the case. So, starting off a company should seek funding from friends and family before they have a product. There's also a couple places you can go online where you get crowdfunding. And usually it's you say, here's what my products going to be, pre buy it before it exists. So that how get, you know, orders early and know that it's there for me. And it's a way of testing out whether there's interest in the product. But you know, so the first stage typically would be friends and family type funding. And then when you have a product and you can demonstrate it, some companies can get seed funding from VCs. There's also incubators that they could go to, where they get taught how to be a company, and how to raise money and what their Board of Directors should look like and have their accounting should work. So going to an incubator is a good thing if you don't have experience, but the incubators, don't take everybody. So you have to apply. And they wind up owning part of you, but also putting a little bit money in. And then at the end of this, you know, couple months, that is part of your group, they host the thing for VCs, so you get a lot of exposure to VCs to get funding. Then when you get a little further along, we have revenue, and you have proof points, then you could do an A round. So they can be depending on the profitability how long it takes. That could be a lot of rounds of funding before you get to IPO.

 

Alan 

Mike, you run a fairly successful blog. How did the listeners find more information on becoming part of that blog?

 

Mike 

Soundbytes2.com and you could register, you know, to get sent the blog, but you can always go on it and look at it online, but we would email it out to anybody who you know, asks for that way. And, you know we have a fair number of people who are getting it and I think they've benefited at least I hope.

 

 

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