Letter to Saturn Five Investors about Coronavirus
Dear friends,
Last week I wrote a note to our investors explaining our perspective on how our company, Saturn Five, is positioned in this market environment. I thought you might be interested.
Despite the market gyrations, it is an exciting time for us: 1) We delivered distributions to investors last month; 2) Our venture Icon was just named one of the most innovative companies in the world by Fast Company; 3) We have three new businesses, each positioned to deliver cash-on-cash returns in the 20–25% range each year; and 4) Our newest fund is about to be oversubscribed. (We have a little space left. Let me know if you are interested!)
Thanks for your friendship. Stay healthy!
Best,
Max
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Dear Saturn Five investors,
It is a tumultuous time in the world. Covid-19 has shaken the markets. This weekend’s oil price shock is creating more turbulence. We are watching these events with great interest, as people who care about the health of our friends and families, and also as investors. Since you have placed money with us, we wanted to share our perspective on Saturn Five in the midst of the disruptions.
As you know, Saturn Five is seeking to build value through long-term investments in both new and established companies. Unlike traditional private equity, we aren’t looking to flip positions in three to five years. We are looking to buy and build companies with fundamental strengths that will hold their value for years and years. Our model is to buy businesses at low multiples and operate them in a consistent manner to realize high cash-on-cash returns. We keep things simple and believe you will win in the long run if you buy businesses with high intrinsic value for low prices.
In a market like this, the biggest risk with a portfolio like ours is over-leverage. If business activity drops precipitously, a company with very high monthly debt obligations may soon find itself in distress and unable to pay its bills. Saturn Five often employs debt as part of the financial strategy when buying a new business. However our debt levels are far lower than most PE deals and lower that what you might find in companies in the S&P. According to a recent study by Bain & Co., the average PE deal in the U.S. last year had a Debt to EBITDA ratio of 7 to 1. According to Yardeni, the average for the S&P is 3.5 to 1. By comparison, the Saturn Five portfolio Debt to EBITDA ratio is 1.4 to 1. What does this mean? Saturn Five has less debt to worry about than the largest publicly traded companies and far less than typical private equity deals so we have a lower hurdle to jump over every month. This is not a fail-safe but it is good news.
A coronavirus related-risk particular to our portfolio is that many of our businesses do not lend themselves to a telecommuting option. A company like Apple may encourage employees to work from home but several of our businesses do not have that option. You can’t telecommute to pour concrete or do landscaping. A big drop in demand and/or productivity may create a sharp decline in revenue across the portfolio. Hopefully, demand will then bounce back and create V-shaped or U-shaped financials, as my old boss, Ray Dalio (of Bridgewater Associates) predicts. But this is a risk we are susceptible to. To prepare for it we are working with the CEOs at each of our companies to assess our exposure and do what we can to mitigate the risks.
The good news is that our long-term approach helps in a moment like this. We don’t have pressure to sell off our assets at discounted prices because our fund life is ending or because we need to relieve debt. Unlike others, we can sit tight without realizing the losses others are facing by selling into the drop. Second, if the market enters a longer-term bear cycle, there may be an opportunity for us to buy assets at discounted prices. To paraphrase Buffet, we could get “greedy when others are fearful.” As a rule we are avoiding buying “turnarounds” and companies in distress. But if presented with the opportunity we may opportunistically buy deeply discounted assets (equipment, customer accounts, etc) for our already viable businesses.
The most significant change we are making in response to this economic environment is that we are growing more conservative about new acquisitions. We are under contract with three new deals at the moment and are actively evaluating whether to go forward, walk away, or renegotiate terms. Our new bias is to remain cash-strong for the short-term. On the other hand, we don’t want to give up on great long-term acquisitions because of short-term fluctuations. The net is that we will continue pursuing deals, but will keep the bar very high for any individual deal to consummate in a buy decision.
I hope this note is helpful for you to understand our perspective and approach. We’ll keep you posted as things progress. We are grateful for your partnership and wish you and your families good health.
Best,
Max
