TDM reveals the importance of culture for investing


It’s the sort of investment a traditional fund manager would never make. But when TDM Asset Management teamed up with Atlassian founder Mike Cannon-Brooks and US hedge fund Tiger Global to back fintech company Tyro, it provided another example of this Sydney-based firm’s very different approach.

Where most money managers focus on a niche with a single asset class – small cap shares, for example – TDM, which manages $400 million, is open to any investment, public or private, an early-stage firm or a mature business, Australian or international.

By investing on their own terms and timelines, partners Tom Cowan, Hamish Corlett and Ben Gisz have built an investment firm that is challenging the norms of funds management.

But they are also questioning the status quo of doing business in Australia, from the corporate board structure to private equity’s sometimes toxic combination of lipstick and leverage to flip businesses for a quick buck.

What guides the fund, Cowan says, is a clear set of qualities that it seeks in an investment, one of which is to challenge norms.

“You might ask someone why they do something a certain way and they’ll tell you that it’s ‘market practice’,” Cowan says.

“They haven’t thought about why they do something. The culture of businesses we are involved in is to question why you do things a certain way and look to do it better, to ask ‘how can we provide a world-class offering?'”

The fund has delivered its investors more than 25 per cent a year since 2004, and TDM-backed floats of dental chain Pacific Smiles (floated in late 2014) and infant retailer Baby Bunting (in October 2015) have been rare bright spots for investors, with the stocks up 63 per cent and 76 per cent from their issue prices..

Focus on management

Over takeaway coffees in their small boardroom above Sydney’s Rockpool Bar & Grill, the team explain how management culture trumps industry and geography, and whether a business is listed or private.

Gisz says the first question they ask management is about their culture. If they get a ‘blank stare’, it’s time to move on.

That wasn’t the case with Tyro, which was started 12 years ago and has already snared $8 billion worth of transactions from its larger competitors.

“The CEO articulated it well in that it’s a culture of outstanding software engineering, coupled with a passion to deliver better products and services to the SME community. All the key people we spend time with are driven by a combination of those two things,” Corlett says.

Within days of meeting with TDM, Tyro CEO Jost Stollman posted on the company’s blog his response to being asked by the fund why he gets up in the morning.

“If we don’t see it from the CEO then … a good constructive culture filtering down is improbable,” Corlett says.

He cites a former TDM investment, RiskMetrics – a data analytics business that was bought by MSCI in 2010.

Chief executive Ethan Berman’s letter to his board explaining why he shouldn’t get a bonus was leaked to The Wall Street Journal, and to Corlett. It’s a must-read on how the ideal manager leads by example.

The emphasis on culture was learnt the hard way.

TDM’s investment in CSG, an Australian-listed technology firm, was in serious danger after the management lost its way.

“The initial mistake was misjudging the people, no question. The business had outgrown the entrepreneur and the systems processes, and people weren’t in place, so when something went wrong it fell apart,” Cowan says.

“Our process changed dramatically after that. The businesses we are involved in are all looking at the business in five or 10 years’ time and investing as they go, to make sure it achieves sustainable growth. If you’re just thinking short term, why would you make that incremental investment?”

The focus on “management first” best explains how a small team can swing between public and private companies, but also between old world businesses that Buffett-type value investors love, and high-growth tech companies, many of which have stretched valuations and don’t yet make any profits.

Take Pacific Smiles, the dental clinic business which makes $74 million of revenues and a healthy $18.4 million of earnings before tax, and Yodlee, a Nasdaq-listed data aggregator that makes hundreds of millions in revenue but not a dollar of profit.

TDM has owned them both, selling Yodlee in a recent takeover bid.

Cautious approach to tech firms

Gisz says when it comes to investing in technology, not all firms are created equal. “There’s just a subset that are very, very interesting.

“If you think of what makes a business high quality, it’s a leadership position or a clear path to leadership, stickiness of the customer base, and often it is built into a customer’s daily work flows. Also, we look for businesses with a big end-market and an ability to generate good cash flows, which is something not all technology companies can achieve.”

TDM is keen to back promising Australian tech opportunities, but is wary of those firms chasing the bright lights of Silicon Valley, only to return with high headline valuations before later realising they’ve made fortune-busting concessions.

“We’ve found that a number of Australian private companies chasing US investors are disappointed by the experience,” Gisz says.

“In the US you get a lot of convoluted structures and preferred equity, ratchets and comprehensive rights to hire and fire executives.

He adds TDM is prepared to back the privately owned tech companies on simple terms without asking for controls.

TDM has been active in the US and its team spend several months of any given year in London, New York or San Francisco. Corlett dialled into the interview from New York.

“There are the odd occasions where Australia leads,” says Cowan, noting that stock exchange demutualisations was one, and online real estate classifieds another.

“But the vast majority of the time we do the work globally and then we bring it back here.”

US sharemarket

The US public sharemarkets are a fruitful opportunity for TDM for two reasons. One is just a numbers game.

“What is a small company to them is a good-sized company to us,” Gisz says.

The other factor is the destructive power of ultra-fast money, which leads share registers to turn over four or five times a year. Chief executives of good companies can witness half the value of the company wiped out on a 1 per cent quarterly revenue miss.

“It is certainly getting worse in the US. The Australian market is more resilient for high-quality businesses. The short-termism in the US is a whole other level,” Corlett says.

If fast money is creating investment opportunities in the US, TDM also argues local boards need to be better aligned and more active.

“We have spoken to enough people from other big boards to know the system doesn’t work,” Cowan says.

“The system is flawed generally and a key part of that is not having enough skin in the game and enough interest. If you look at the boards we have come into or help recruit, we’ve set them up with high-quality people that want to be involved in the business, roll their sleeves up when required, and are happy to help and – surprise surprise – have equity ownership.”

Private equity floats

Then there’s the issue of private equity. In recent weeks Dick Smith and Spotless have joined the growing list of private equity floats that have gone horribly wrong once they’ve been flipped to the public.

Gisz and Cowan bite their tongues when The Australian Financial Review brings up the issue. What they do point to is “flaws” in the private equity model, which essentially gives funds a limited amount of time to gather assets and sell them so that they can repeat the process and raise another fund.

“All they care about is moving through the process so that they maximise price – whether it’s at the IPO or at escrow, it’s an exit event,” Cowan says.

“We don’t see it as an exit event. We see it as a step in the evolution of the business and we look to help the business transition from private, through the IPO process, to the medium to long term.”

But the obvious question is, how and when do they eventually exit from long-term investments such as Pacific Smiles and Baby Bunting?

“We want to be in an investment for as long as possible, and the hardest thing to do is to find a new investment with new people in a new business,” Gisz says.

“We want a minimum 20 per cent per annum return on investment. Most investors don’t, so there will be a natural point in time where the company is still a great investment for someone else.

“Remember, people are expecting 6 or 7 per cent from equities in the long term. There is a big gap in the middle where we would think about reducing exposure, and others would come into that space.”

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