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Greg Tuorto and the Art of IPO Investing

By 

Rob Ward

|

Jun 2, 2020

A few years ago we asked the CEOs and CFOs of our public portfolio companies who were their most favorite and least favorite public market investors. There was little consistency in the least favorite category - everyone had their own unique buy-side horror story. But there was a striking level of agreement as to the names of the public investors who were the most knowledgeable, the most helpful and the easiest to work with. One of those universally well-regarded fund managers was Greg Tuorto, who at the time was at JP Morgan Asset Management and, in 2019, moved over to Goldman Sachs Asset Management. We have had the pleasure of interacting with Greg in a number of situations over the years and we couldn't agree more with our executives' high opinions of him. So in the turbulent and volatile world we find ourselves in, with public market valuations as inscrutable as ever, we thought it would be extremely helpful to hear Greg's thoughts on the current equity markets.

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Thank you so much for joining us today, Greg. Tell us about your background and what types of investments you make at Goldman Sachs Asset Management:

I am a unicorn in the space as I have been on the buy-side for 26 of my 27 years in the business. All of that has been in the small-cap space and I have seen several interesting cycles. Before Goldman, I was at JP Morgan Asset Management. In the last 5-6 years at JPM I co-led two large products: a small-cap growth fund and a technology-focused fund. Our growth fund invested across all sectors. That’s one thing I wanted to bring to GSAM when I started in 2019. I was given the shot to run a $2B portfolio and build a team of 6 professionals across sectors and disciplines. We invest in companies with less than $12B of market cap and look for growth ideas that have a lot of upside. We only make equity investments and only buy public companies. We might have to decide to get into the private markets at some point, but not today. It’s becoming increasingly hard to differentiate ourselves when we don’t have a private fund.

Help us understand what is going on in the public markets right now. We have a 15% unemployment rate, no signs of COVID-19 abating anytime soon, consumer spending dropping, small businesses barely surviving - and yet public stocks, and tech stocks specifically, are booming. Why the disconnect?

If you have family members or people around you that have been impacted negatively, it’s a hard conversation to have because people think that you’re in some cases benefiting from the misfortunes of others.

The first dynamic is "don’t fight the fed" - low rates are driving investors who have historically been tourists in the equity markets to now try and make a home in the equity markets.

Another dynamic is that technology companies are enabling digital transformation which we never thought we would see. I hosted an event with George Lee, who runs engineering at Goldman and is the former Head of Technology Banking. When I reached out to George, I asked "how did you get 60K knowledge workers working from home?" They always thought it was possible but never thought it was probable. Still, Goldman decided to “overbuild” on infrastructure. We are starting to figure out that digital transformation is going to have a long-lasting impact. There is freedom of being able to work wherever and however you want with the same level of productivity. It’s not just how hard you work, it’s the tools you have, whether it’s conferencing software, security, collaboration or back-end infrastructure. I have five endpoints on my desk that are connected to Goldman Sachs infrastructure. The suppliers of these technologies are benefiting from this environment.

Finally, the S&P is not yet back to pre-crisis levels and we live in a world with compressed cycles. The downturn in February and March of 2020 was the fastest that anyone has ever seen. The up-turn has been more uneven and more focused on healthcare, technology and some consumer services. It is moving slower than an elevator but faster than the stairs, almost like an escalator right now.

What’s your prediction for tech stocks for the rest of the year? We haven't seen a technology IPO in a few months - do you think the tech IPO market will re-open anytime in 2020?

I sure hope so. I think that tech stocks will continue to do well. There was a view that a lot of the SaaS companies were riding on air. However, as companies have reported, they've given detail around ARR and what the rebound might look like, effectively letting the buy-side build their own models. Management teams are doing a really good job of giving the data investors need and haven’t been holding back metrics. For example, 2021 might not be a very high growth year, but 2022 could be. That’s a reason why many of these high-growth SaaS companies have a tailwind behind them. The models have shown resilience. As an investor, you can be rewarded by looking out 4-5 quarters and trying to understand the rebound after a negative event.

Another thing, and one I’ve always been obsessed with, is talking through sales productivity and the sales models at SaaS companies, hiring people, having the right content marking, etc. The marketing piece has always been mystifying for me because because beyond billboards and events it’s hard to measure ROI. I was always skeptical of companies that said they were good at marketing. Now, as marketing spend is compressing massively, if a company can show it can grow 25% with marketing spend of ~7% of sales, and were previously planning to grow 31% with marketing spend at 22% of sales, is it worth spending those dollars? Without spending it, some of the free cash flow you expected can come in sooner.

On the IPO front, I have seen 10 biotech IPOs since the quarantine orders began. They have been high quality and well-banked. If these companies can get deals done, there has to be something in software that is ready to go. You need something that is profitable or break-even and has 4-quarter visibility. There is a risk appetite out there and investors want to see disruptive companies. Maybe a collaboration vendor to lean into the distributed workplace dynamic – there are at least three of them ready to go public.

What advice would you give to a private company CEO / entrepreneur on when is the right time to go public? Is there a hard and fast rule as to what size a company is too small/too early for your fund?

For our fund, I don’t have an exact answer on size, but we look at companies with market caps as small as $500M up to $12B. That's a lot of white space and we don’t have to sell things until they get to $15-$20B. If a deal is bigger, we can get a larger position sooner, but otherwise I don't worry about size as much. For the IPO markets in general, it used to be $100M in ARR, then we saw that increase to $200M in ARR. But for us, it’s always about the structure of the company as opposed to the size: Do you have 75-80% of jobs filled that you need? Do you have the CRO in place that can hire hundreds of new employees? The companies that go 0-60 in the public markets and reap the benefits are the ones that are ready to be bigger.

How long before a company goes public would you prefer to first meet with the management team? What are you looking to learn in those initial meetings? Will you invest in an IPO if you haven't met the team prior to the IPO roadshow?

Like I mentioned earlier, we don’t invest privately so we never see the financials before the IPO. With that said, I think meeting companies about 18 months to 2 years before they go public is a good rule of thumb, and in that time-frame I will meet them 2-3 times. We build a qualitative model and look at the progress of the business over time. What were the inflection points? Was it a new VP or SVP? A particular partnership? What happened when important people left the company? Was there other turnover? If they have 200 sales reps, how many of them are productive? How do you make the rest productive and who is managing that? A new CRO, or one that’s been there a while? For example, if someone poached a VP of engineering from a company, did that lead to increased or decreased spending in R&D? We have to do qualitative work since we don’t have the quantitative data at that point.

Let's talk about the buying decision. What are the most important attributes you look for in a newly public company? Are there any attributes that are under-appreciated by the buy-side in your opinion? Do you care more about upside potential or downside risk? Do you more heavily weigh metrics or investment themes?

The ECM [equity capital markets] desk wants price targets and feedback early on in the roadshow process. I think the price target process is a bit useless because good deals get to the price targets in two days of trading. Morgan Stanley has a great process with the bull, bear, and base methodology of valuing companies, and we have adopted some of that in how we look at IPOs. We build a 3-scenario model to help inform us where a company could go if we are completely right or completely wrong. You can also take the qualitative build-up and turn it into a unit economics model.

The first day IPO pop is always interesting. I tell my young investors that when a stock goes up, it’s because a lot of people got it wrong, not right. The headlines say that “investors applauded” but it is usually a lot of shorts covering. I’ve been trying to figure out the new retail component or “prosumer" investors and how impactful they are to stock prices. I think they are a growing piece of retail demand.

We don’t flip deals and if we do invest, we will hold on to it for a long time. If we cannot build a large position early-on, we tend to take our time to build up our stake.

Have you done an analysis of your decisions to invest or not invest at the IPO, and if so, is there an example of a tech IPO that you wish you had invested in but decided not to? What did you get wrong in that case? Do you "risk adjust" for valuation, i.e. invest less in situations where valuations seem high?

I think this is an interesting question, but my answer does have an essence of recency bias; it is an endpoint security company. I love the CEO, but I got buried in the endpoint market and I was paying attention to the wrong things.  I was looking at episodic weakness in publicly traded security companies at the time. I wasn’t looking at the merits of the company but the broader peer group. Another mistake I made was listening to the sell-side. One of the bankers said that the market cap is already 3x the size of what the entire legacy endpoint market was, so it can't get much bigger. I allowed myself to not look at the company itself and I've regretted it ever since.

What size position do you look to have at IPO pricing? What does that typically look like a year after the IPO? Is it more a function of a percentage of your assets under management or a percentage of the float/total cap table? As a long-term investor, how do you think about your holding period?

This is a boring answer, but it tends to be 1%. 1-1.5% is a full position for us and that’s what I do. If we can’t foresee these companies being that size – then we probably shouldn’t bet there. When I think about the riskier companies, around 1% of the total portfolio and I think about getting to a half position. As it relates to follow-on liquidity events - I like organized offerings and not distributions. I tend to think that distributions can come sloppily into the market, and not be handled efficiently.

What is the best way to run an earnings call and what specific guidance is most valuable to you? Is there a public company you think does an exceptional job of this? Common wisdom in Silicon Valley is to be very careful what you tell the street, because once you mention a metric, public investors will ask for it every single earnings call thereafter - true?

There are a lot of them out that are great at it and some of the best disclosure comes from larger public software companies. They give out a massive amount of data on customers, deal sizes, and upsell. There is real depth to what they deliver and present. They show how long it took a customer to get to $400K, then to $1M, and so on. As an investor, you can see the way the customer base evolves and build more predictable models.

Related to the question above, what are the most important KPIs for a SaaS company to disclose in their S-1 and what do you pay most attention to?

I like looking at the number of salespeople, but it’s become competitive and some companies have stopped reporting on that. I used to look at all the salespeople on LinkedIn and when they joined. I would compare and contrast how long it took to get a sales rep productive. LinkedIn got smart and took away some of the ability to get that data but when you had that data, that salesforce “age” was a magic bullet.

I also like metrics like time to renewal, which companies never like to give out in filings, and usually only show in the pre-IPO process. If you find out it’s 26-27 months, you can find out what renewal rates mean and how that’s transformational to the P&L since renewals are much cheaper than new deals. You can see that cascade throughout the P&L and the free cash flow.

Companies inevitably miss a quarter. What's most important to you after that happens to a company whose stock you hold? Could you share some examples from the most resilient companies you've seen and what has made them so successful over the long haul?

My favorite miss the quarter story is MuleSoft and least favorite is Rally Software. I use them both in marketing meetings and both are instructive. Matt Langdon, CFO at MuleSoft, was someone that I knew since his time at TIBCO and had a lot of respect for him. He talked us through some of the growing pains they might have and they were open and honest about their growing pains and roadblocks they had reached, and also some of the things they needed to do to accelerate. They were consistent and I thought the consistency with the messaging was really important. If messaging changes and a company over-reacts, that’s when it makes us uncomfortable.

When Rally Software was early and a lot less consistent in terms of their messaging. In the first quarter they missed, their process was not as clean and they didn't provide clarity around when they might rebound out of it. It’s all about consistency and if you can build that consistency from the time you first meet the company, it's a lot easier to identify.

What is the tech market or theme you're spending the most time on today? Are there sectors that you are desperate to put more money to work in, but can’t find enough ways to play that trend?

In 2018 and 2019 we had the DevOps revolution. We ended up with a lot of these companies in our portfolio. They really have transformed investor's understanding of how important the “plumbing” is.

I think that collaboration tools are a great place to invest. There are great freemium models and there is an elegant expansion potential. I think another area I would like to see more companies is the small business enablement stack. I believe they will do quite well coming out of this pandemic. Security could be spotty, and I think the AI companies must really prove themselves.  

What’s your investment philosophy as a firm and as a group? What sets you apart as an investor from the many other IPO investors?

We do what we say and we say what we do. We treat companies fairly and we will never blame management teams for a mistake. We are honest when we ask questions and don’t ask questions we know the answers to. George Lee mentioned a poll that they did in banking, and I was rated one of the nicest people to deal with, which I'm not sure is a good or a bad thing. I tend to be very intellectually curious and I will never try to ask you a question just for the “gotcha”. We focus on the company we are talking to, not peers, not competitors. We’re just normal people.

Thank you so much for your time today Greg. Stay healthy!

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