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Invest in the power of compounding

Nirgunan Tiruchelvam
Nirgunan Tiruchelvam • 4 min read
Invest in the power of compounding
Yardi Systems, founded by Anant Yardi, is described as the Microsoft of property managers / Photo: Yardi Systems
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Investors have much to learn from Anant Yardi, a soft-spoken, 78-year old engineer. He arrived in America in 1968 with less than US$100 in his pocket. He was from India, which was then an austere, socialist economy. The young man had never seen colour television.

Yardi is now a tech billionaire in California. He founded Yardi Systems, a provider of software for property managers. The company could be called the Microsoft of property managers.

Last week, he grabbed the limelight by taking over WeWorks, a co-working space operator now on the verge of bankruptcy. Yardi is taking a controlling stake worth US$450 million ($605.6 million).

Yardi’s manner is different from the style of WeWork’s founder Adam Neumann, a 43-year-old who has destroyed more value than he created. Neumann used private jets to attend birthday parties. According to the Wall Street Journal, the marijuana smoke in the jets became so thick that the crew had to put oxygen masks on.

Neumann already has a Apple TV serial featuring his antics. In contrast, WeWork’s new owner is tight-fisted and focused. Yardi is an obscure character but has created immense value.

Yardi’s success is not just a lesson in simplicity. His company’s success is a prime example of the power of compounding. Compounding is a feature of B2B SaaS. The ugly acronym stands for “Business-to-Business Software-as-a-Service”.

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Most investors use B2B SaaS but only a few are familiar with its magic. It refers to software solutions that are delivered over the internet. These solutions are designed to help companies operate efficiently.

A company is not required to purchase and install software on their computers. Instead, the company can access these applications through an online subscription.

For instance, a property manager like CapitaLand needs software to monitor its vast array of buildings. It needs to keep track of the maintenance. CapitaLand can subscribe to Yardi Systems software without physical installation.

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The B2B SaaS operator collects a monthly subscription. This fee covers the cost of maintenance and software support.

The solutions are easy to use. The software can be accessed anywhere in the world and at any time. The provider does not have to be in Singapore. Most of Yardi Systems’ customers are not even aware of its location.

B2B SaaS also removes the need for upfront investment. It means that the user does not have to pay for maintenance.

The B2B SaaS operator sector has mastered two mathematical rules. The first is the rule of 72. This is a simple formula to estimate the number of years required to double the value of an investment at a fixed annual rate of return. You divide 72 by the annual interest rate. For instance, at an interest rate of 7%, your money will double in 10 years.

It is of immense importance to the B2B SaaS sector. Salesforce is one of the most famous B2B SaaS companies. It helps companies keep track of its customers. Salesforce has a projected annual recurring revenue (ARR) growth of 15%. This means that it would take about five years to double its ARR.

The customers have a low tendency to churn. I have been using Microsoft Word to write for decades. I wrote my school essays over three decades in a rudimentary version of the software.

The second mathematical rule that B2B SaaS companies are adept at is the rule of 40. This is a metric that combines the revenue growth rate and profit margin. The sum of these two metrics should be at least 40%. For example, if a B2B SaaS company has a 20% revenue growth rate and a 25% profit margin, the rule of 40 score would be 45%. This is a strong performer. The metric helps investors find winners.

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B2B SaaS valuations are 6.8x price to ARR. This is 30% below the 2021 peak. The AI boom could increase the need for B2B SaaS. The sector could be like the manufacturers of picks and shovels during the gold boom.

There may even better value in the private market, where valuations are much lower. Rami de Marchi, the founder of Lumens Capital, has launched a fund to power B2B SaaS. The fund would provide operational support to find the next generation of B2B SaaS winners. As Yardi’s ascent shows, quiet accumulation may win in the end.

Nirgunan Tiruchelvam is head of consumer and internet at Aletheia Capital and author of Investing in the Covid Era. He does not hold any position in the stocks mentioned in this column. This column does not constitute investment advice of any kind

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