The Capital Allocation Playbook (Part 1)

Exceptional Returns

I recently came across 50xpodcast.com, alerted via the Colossus newsletter. The 50X podcast is hosted by William Thorndike, who had earlier written one of the best business books I have read, “The Outsiders.” The podcast’s brief: “We track the often circuitous route to exceptional long-term returns, exploring the foundations of value creation and how that rarest of investment commodities—conviction—is created, maintained, threatened, and sometimes lost… From the seat of the professional investor and occasionally the CEO, we explore its origins, evolution, and eventual outcome, studying key themes around long-term value creation ranging from operations, capital allocation, and culture to pivotal buy and sell decisions.”

I have written about the book’s big idea in my Proficorn series #49: “The book answers a simple question: “What makes a successful CEO?” Thorndike’s answer: “it is the returns for the shareholders of that company over the long term… What I like about Thorndike’s idea is that it distills success down to a single, measurable number – with a focus around capital allocation.” The one metric to measure CEO performance: increase in a company’s per share value. Besides the obvious track of winning via product, sales and marketing strategies and execution, what the book discusses is about capital allocation. In a way, long-term success hinges on combining ideas from authors like Jim Collins (Good to Great, Built to Last, and other books) and Thorndike.

Back to the podcast. The first company discussed was Transdigm: “Since inception in 1993, TransDigm has returned over 1,750X its primary equity and a remarkably evenly distributed 36% IRR.” I had not heard of Transdigm before. It is in the aerospace industry. As I listened to the conversation with Nick Hawley, the founder and executive chairman, I realised that there was a lot to learn on company building and delivering superior performance. When I reflected on the conversation between Thorndike and Hawley, I determined that I should also apply the ideas to Netcore going forward.

Netcore is a private company. We have never raised external capital. However, I can estimate our returns through our 25-year journey. I will skip the first 10 years because we did not grow much. In 2012, we had an acquisition offer with a clear valuation. Compared to that offer and factoring in my estimate of Netcore’s current valuation, in the past 10.5 years Netcore has delivered an 11X per share increase for a CAGR of 26%. If we can sustain this for the next decade, the returns would exceed 100X. (In comparison: my first successful company, IndiaWorld, had delivered 2500X return in 5 years.)

At $100 million annual revenues, Netcore is still relatively small. I have written earlier about our past journey and future expectations. Consistent compounding, capital allocation, multi-decadal growth are not ideas I had thought much about. But as we start thinking about our future as a public company with external investors, I decided to probe more into what creates great companies (and capital allocators) like Transdigm, Teledyne, Berkshire Hathaway, Constellation Software, and others: companies that have delivered exceptional returns to investors over long periods of time.

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Rajesh Jain

An Entrepreneur based in Mumbai, India.

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