A Market Like This

We've waited twenty-six years for a market like this. When the equations of future expectations for an industry appear to be careening toward zero. When dollars are on sale for pennies. And the whole world appears to agree, but the feelings don't match the facts.

Software is essential. Like tissues, toilet paper, and hope, it hides in the cabinets of our subconscious and emerges violently as a need once it's gone. There you are, an hour before your presentation, frantically pulling slides together from disjointed data sets. You lean on your new best friend, Claude, to pull off an F1 pit stop of a presentation. Claude keeps working. A few minutes pass and the nervous sweat starts. You grow restless. The hair stands up on the back of your neck, as if someone were watching from the shadows. The risk of an outage never crossed your mind. You're stuck on the pot without a wipe and now you've got a mess to deal with.

Everything essential eventually attracts the attention of financial engineers. They probe and prod and find the edges. They research the past and memorize case studies. With clear eyes and full spreadsheets, they securitize the essentialism through hope.

This hope drives a few common errors that surface in every cycle. They treat the map as the territory. They bound the future to the pattern of the past. And they assume logic rules over emotion. But they're wrong.

Maps are a great way to understand a territory. They abstract something complex or broad into something comprehensible. They can shape a path, but they aren't a substitute for the territory. Maps give paper cuts. Life and limb are lost in the territory.

The maps these engineers use are benchmarks. They lock in variables like customer acquisition cost. Useful in practice, but too distant from the sales rep on the road with two young kids at home. They can't represent the messiness of life. Just before that rep lands the deal of the quarter, a Cloudflare outage kills Claude. Why wasn't the rep prepared for that? Why didn't he prep earlier? Maybe it was the chaos at home, or the decision the night before to relax in the hotel room. Either way, the territory hit the performance.

History can be depended upon to rhyme, if not repeat. That's not a bad expectation. Cycles come and go. Trends repeat, but usually in unforeseen ways, and a guarantee that it won't happen the way you think is if everyone else expects it to. Just ask Jeb Bush.

Humans are complex creatures. We love logic but see it through a veil of emotion, which is why your truth differs from mine. It leads us to illogical actions that march toward a future we don't want: rampant credit card debt, lottery tickets, an epidemic of loneliness brought on by the social networks that were supposed to end it. We fall into these traps because emotions lead us there.

The securitization of software expected operational reality to be expressible in spreadsheet form. It walked the territory staring at a map. It rested brazenly on past multiples, ratios, and returns to determine the same in the future. And it depended on every actor to read the logic of the cash flow and price it the same.

This led to extreme financial leverage. In some cases companies took loans exceeding 400% of revenue. In the cold light of day, the deeds of darkness are seen in all their ugliness. How could a company service debt when the interest burden is more than 60% of revenue?

The steady climb of software multiples from the early 2000s to 2022 seemed a law of nature, divorced from gravity. Then rates changed. Inflation picked up. Future cash flows became worth less and the debt cost more to service.

None of this engineering changes the essential nature of software. It only changes its current value. And when that value can no longer justify the calcified valuations on which banks draped extreme layers of debt, the result is financial loss.

Bending Spoons (Nasdaq: BSP) is the latest in a long line of software investors who, like us, wait for times like this. They buy cash-flowing software companies at durable prices. They buy good companies that had bad engineering. Their latest acquisition, Airtable, is a good example. It boasts a compelling product, a pristine brand, and extreme scale. And yet its investors got pennies on the invested dollar. The long-hoped-for, always-hyped IPO never arrived. What did arrive was the territory.