More Thoughts on AVs; Terminal Values; Update on Medpace
How to think about step-change innovation; Should we be worried about Medpace's culture?
The following is an excerpt from KNA Capital Management’s fourth quarter investor letter (please see disclaimers):
After Christmas, my family spent a few days in Southern Arizona, including two days hiking in Saguaro National Park. The desert landscape is majestic. Unforgiving, but majestic.
Our last two days were spent in Phoenix. This had the added benefit of letting me experience Google’s Waymo autonomous vehicle (AV) taxis.
We ended up taking four trips in a Waymo AV taxi. My wife was initially anxious about it – understandably so - and the kids (10 and 7) were excited. Indeed, the first minute or two in an AV are pure magic – “How is this thing driving itself?!”
After that, it’s quite normal and you settle in. Any anxiety and excitement dissipate as it becomes just like any other car ride.
Price wise, Waymo was in-line with Uber X (the lowest price option), but you did not have to include a tip or give a driver rating – or worry about a driver rating you. My wife astutely observed that it’s nice to have the space to yourself in a Waymo and you don’t have to worry about bothering a driver with your entertainment or conversations.
All this is to say that AV technology is here, and I think AV taxis could scale rapidly in the next decade, especially in cities with good weather. I’m not sure how the cameras would operate in snow or ice or deal with salt on the roads obscuring the visual inputs.
AVs may benefit Domino’s, as deliveries would no longer fully depend on human driver availability. It’s not unreasonable to think that some Domino’s could operate 24/7 alongside automated kitchen technology.
On the other hand, AVs may be a negative for Copart, which connects buyers and sellers of damaged and salvaged cars. As more AVs hit the road, it’s likely that accident frequency will decline, leading to fewer damaged and salvaged cars. I don’t believe this impact will be material for over a decade, but it’s a risk that I’m monitoring closely.
In my estimation, Copart is a top 1% company in terms of quality, with a wide moat and a top-notch management team, so I am confident that they can navigate this potential challenge. Indeed, they have diversified into selling used and wholesale cars and are not completely reliant on salvage vehicles.
More broadly, riding in the Waymo taxi and spending more time using artificial intelligence (AI) in my daily life has increased my belief that we are likely to see a step-change in technology in the next decade – and without as much fanfare as you might expect.
AVs and AI are amazing technologies that are also quite boring once they are initially experienced and that’s why I believe they could continue to scale rapidly.
On the Apollo 11 mission to the Moon, for example, astronaut Michael Collins commented to Buzz Aldrin and Neil Armstrong, “Amazing how quickly you adapt. Why, it doesn't seem weird at all to me to look out there and see the Moon going by, you know?”
Once the initial magic wears off, it just becomes part of the routine.
Yes, there’s justifiable apprehension for AVs and AI and regulations and laws will need to be rewritten to properly manage them, but after experiencing them it’s hard to imagine that it’s possible to put the genie back in the bottle.
As a Midwesterner, I have a natural skepticism of new technology. Indeed, when the locomotive was introduced in Cincinnati in the 1840s, city leaders insisted the first terminal be built three miles from downtown as the locomotives might disturb the horses pulling carriages.
As an investor, however, I have to think about how innovation might present risks and opportunities to my companies over the coming decade and beyond.
Depending on the company, the terminal value in a discounted cash flow model can account anywhere from 60-90% of the company’s intrinsic value. And while forecasting those out years should be done with intellectual humility, it’s worth considering how your company might adapt to (or be threatened by) new technology.
Here are some of the ways I think about long-term impacts of new technologies on my companies:
Will the technology increase or decrease the relevance of the company’s products and services? As mentioned above, an expansion of AV technology could help Domino’s franchises generate more revenue per location and reduce labor costs. On the other hand, AVs could pose a threat to Copart’s relevance.
Is the company’s culture strong and pliant enough to adapt to new technology? Netflix essentially reinvented itself three times in the last 20 or so years. Starting as a DVD distributor, moving into digital streaming, and then into producing original content. Many companies would struggle to successfully navigate these changes, including most of Netflix’s competitors. Look for companies with a track record of embracing and adapting to change.
Is management incentivized to care? The median CEO tenure at an S&P 500 company is five years. By the time an emerging technology begins to scale, many CEOs will have retired or moved onto the next role. It stands to reason that CEOs who see themselves as stewards of shareholder capital and are intrinsically motivated by their work are more likely to encourage a forward-thinking approach to technology.
How might competition use the new technology? As important as it is to consider how a company might adopt new technology to improve its offering, we must also consider how its competitors might use the same technology to level the playing field. For example, AVs might be great for Domino’s, but they might also be great for smaller competitors, so it’s important to understand why the technology would be particularly beneficial to a national chain versus a local independent restaurant.
After spending some time in AVs last month, I became more convinced that AVs will have a material impact on transportation in the coming decade and beyond.
To what extent that’s the case remains to be seen, but if you own companies in the transportation sector or companies that regularly use physical transportation to deliver products, it’s time to think about how AVs at scale might impact those businesses.
Medpace update
A reader recently asked about Medpace’s low employee review scores on popular sites like Glassdoor and Comparably. While the scores are concerningly low, there’s more to the story than meets the eye.
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Todd Wenning is the founder of KNA Capital Management, LLC, an Ohio-registered investment advisor that manages a concentrated equity strategy and provides other investment-related services.
At the time of publication, Todd, his immediate family, and/or KNA Capital Management, LLC and its clients own shares of Copart, Domino’s, and Medpace.
Please see important disclaimers.