The Exchanges

Q What are other examples of, you could call it compounding knowledge that you gained from one investment led to another?

A There are countless examples. We're always talking internally and externally about the through lines between different investments. There's a whole host of investments that are about the transition from analog to digital. You could put Microsoft in that category, selling physical PCs with Windows and Office licenses. You could put Adobe in that category, selling Creative Suite as shrink wrap software. On a CD-ROM transitioning to subscription, Xbox was our first exposure to the video game industry, and that went from being a very difficult industry with lots of boom-bust cycles, huge inventories required to distribute the software to a much higher quality business because of digital distribution and subscription. Probably the place we applied that insight the most, again, in the analog to digital example was at Nintendo. Historically, very closed off Japanese company with, we saw the best IP library in the video game industry. Because of a variety of different factors, they were behind the times in terms of adopting digital distribution, subscriptions, in-game monetization. We called on a lot of the things that we learned at Microsoft with the Xbox team. To develop insights on Nintendo and to try to provide some insights to them on what the potential would be for their business. If they could go from selling 20% of their games through their own eShop to 60 or 70% like Microsoft…

AI assessment note: “We called on a lot of the things that we learned at Microsoft with the Xbox team”

Q Rob, what was your first paid job, and what'd you learn from it?

A I worked for a house painting crew when I was 15 years old and growing up in Massachusetts. My parents were very focused on that I have summer jobs and actually do manual labor. I thought that as a house painter that on the spectrum of manual labor, that was going to be a little bit easier, but I didn't understand that when you're the most junior member of the paint crew, your job isn't to put the paint on, it's to take it off. Up on the ladder, 95 degree heat, scraping paint all day, inhaling paint chips despite the mask I had on. It was the first lesson in hard work. Also, we had a foreman who was an excellent leader of the crew and patient with me and made it fun. He kind of set the tone, got everybody working hard in some very hot summer Massachusetts days, so seeing that benefit of leadership was also key.

AI assessment note: “I worked for a house painting crew when I was 15 years old”

Q How do you get the sense in advance if a management team is likely to engage with you on your vision of what could change at the business to improve it?

A We try to do it in a Socratic way. We're asking questions and they're responding, and then we're getting to a shared understanding. When we do analysis on a business line's potential, we're going to put that in front of the management team and get a reaction. In that reaction, we're either figuring out, are we right or wrong, which is really important. And also, if we're onto something, how does management respond? Are they defensive or are they Nodding and saying, yeah, this is right. It's an interesting way of looking at it, but it's important that what we don't do is we don't show up with a fully baked investment thesis after six months and a big stack of PowerPoint presentations and memos and say, here's your strategy. The best thing is for the company to lead the discussion of strategy publicly. They have to execute the strategy. So it's much better to get there in a back and forth iterative way. And then they're in a position to go out and make it happen.

AI assessment note: “We try to do it in a Socratic way. We're asking questions and they're responding”

Q Among those criteria, when you mentioned getting the right CEO in place for the succession, or just having the right team in place, everyone's trying to figure out getting the right people. What does that mean? And have you figured out if someone in the seat is the right person to bring it forward?

A Our orientation is to try to work with great management teams from the outset, so we're going in as part of our evaluation of a situation. We're hoping to prove out the existing team has a high level of capabilities. We get involved with companies for long periods of time. We say three to five years is our typical investment cycle. In some cases, it's five, 10, even longer. CEO succession sometimes During that investment cycle is relevant. There have been 27 cases where we've been involved in CEO succession. The approach we take, we try to be quite deliberate about it. We start with the strategy, as Mason said, and we create a scorecard of success. What does the company need to achieve to reach its potential over the next three to five years? Be very specific about what the One to five key things are that the CEO needs to lead the company to achieve. When looking at internal candidates, external candidates, we're assessing, have they accomplished similar things in their roles in the past? It's about track record. Obviously, ethics are extremely important. Creating a performance culture is extremely important. In each company's unique situation, there's usually A few key value drivers, and we're super focused on finding the CEO who we think is best able to achieve those objectives.

AI assessment note: “We start with the strategy, as Mason said, and we create a scorecard of success.”

Q customers call it miraculous, game-changing, and an awakening. If that's not how you would describe your investment management tech, request a demo at ridgeline.ai. And now, back to the show. Research is something you might be interested in investing in. There's less information than say it was a private equity type company and you're behind the wall. What does that process look like before you get involved in a company?

A Mason has many strengths and geniuses, but the thing that first struck me about Mason's abilities as an investor was my first investor relations call when I was an analyst and Mason was a partner leading the call was how quickly he got from The reported financials to the actual cost structure and the actual unit economics. It's segment by segment. What's the pricing model? What's the mix of customers? The fixed and variable costs. Specifically, where are factories located? Where are people located? That analysis of let's just ignore what you see in the 10 K. Let's just build up zero base. What does this business cost structure look like? That is by far, I think the most important exercise that we do early in our due diligence process. And there's lots of different examples that bring it to life. Mason mentioned the office three 65 example where you could just say, okay, this is the number of users. Here's what the annual subscription could be. Where could that go over time? What's the direct cost against that? And you could create a profit pool. We do that in every single case. And that's usually just primarily with the company. Management and the IR team itself as a first step, and then we're validating it with people in our network who work in the industry. The second key thing is the evaluation of the people, the board, the management, the strategy, because as I mentioned, w…

AI assessment note: “That is by far, I think the most important exercise that we do early”

Q This idea of feeling like you need to help make a change paired with doing it quietly. How does that play out in the companies you're involved with?

A We believe everybody wants to get fit, and that's a different mindset that we have compared to others who are more cynical, who see and focus on the conflicts of interest and question motives. We honestly think that every management team wants to do well. Every board member wants to do well. As a result of that orientation, it leads us to have conversations about Issues at a company in a generous way. Yes, we want the company that we're investing in to achieve its potential, but getting there is often quite hard. Tough decisions need to be made about strategy. CEOs have been saying yes to a lot of things. Sometimes need to start saying no to a lot of things. Sometimes there are carve outs or restructurings. These things are quite difficult. So we try to approach those conversations in a empathetic way. I say empathetic because we've worked on these issues over 25 years at different companies and situations, so we can say, here's how we've worked with a company on the same problem in another situation. It generally also inspires trust on the other side.

AI assessment note: “leads us to have conversations about Issues at a company in a generous way”

Q Through several of those examples, you described two quite different investments in Japan. Nintendo, which was pulling the same thread, and then Seven and I, which turned into this proxy contest. How have you thought about the aspects of the playbook that you've applied in the US now being much more involved in Japan?

A We've been looking at Japanese companies since 2013. It's been a long time of looking at companies and engaging with them. We've seen a lot of change during that period of time. We made our first investment in Japan in 2017. What attracted us was that there are so many great companies. If you look at the companies in the world with over 40% gross margins, 40% gross margin is our proxy for pricing power, business quality. The number one market Is the U S with about a thousand companies with over a billion market cap and above 40% gross margins. The number two market is Japan with 250. After that, you get to numbers around 50 to a hundred in countries in Europe. A lot of people talk about Japan and they talk about the valuation, the low price to book. We talk about the quality of the businesses. There are lots of great companies there. The issue was that there was not a shareholder-oriented corporate governance system. We talked about the diseases of abundance. Great companies have lots of opportunities to say yes. They get distracted and unfocused. In Japan, under their corporate governance system prior to 2012, 13, when the corporate governance reform kicked off, disease of abundance was everywhere, and there was no really corrective mechanisms in the public markets. But that all started to change in 2012, 13, Abe came to power. He emphasized corporate governance reform. There …

AI assessment note: “By 2017, we thought there are great companies. Let's see if our model can be successful.”