First published in the Sunday Times on 20th September 2015.
Growth is great, but it isn’t everything. Most investors prefer to focus on expanding industries, although in economies like Britain perhaps 80% of businesses operate in what might be called mature sectors. As a result, companies in sexy, booming sectors can become significantly overvalued because buyers are queuing up to back them. By contrast, dull, stagnant sectors receive scant attention — and little investment demand. That is why they can be interesting.
Another disadvantage of growing sectors is that they require relentless investment. Whether it is R&D spending, working capital or new capital capacity, dynamic industries tend to absorb cash — not generate it. By contrast, unloved sectors should throw off cash for shareholders, since there is likely to be spare, unwanted capacity already available. Even in tough sectors, there will be winners that can take advantage of depressed conditions to do well.
In the past couple of years I have backed two companies in what are almost certainly ex-growth sectors — but where I believe profits can still be made. Most of my capital is still deployed in areas with seemingly better prospects, but I have bet a fraction of my resources on at least partial recoveries in sectors that are deeply out of favour. It will be fascinating to see, in the coming years, if my contrarian wagers pay off.
First, I have gone back into the nightclub business, 35 years after my initial involvement. I started at Oxford in 1980 hosting one-night events for students. It gave me a taste for the entrepreneurial life that I have pursued ever since. Now I have re-entered the fray by becoming chairman of a business called Eclectic Bars, which operates about 20 venues across the country.
The industry has changed a lot. It has shrunk in the face of competition from pubs with licences for later opening, and has also suffered from the smoking ban and a sharp fall in the amount of alcohol drunk by young people. More aggressive policing and poor planning laws have played a part too.
Among 16 to 44-year-olds, frequent drinking has fallen by two-thirds in the UK since 2005. The public still like going out and dancing, but the nightclub sector is facing rising costs such as those for security and music licensing, while losing much of the lucrative entry money that used to be charged on the door. According to the trade body ALMR, the number of clubs has fallen by half in 10 years, from 3,144 to 1,733.
I hope this market decline is stabilising, and that there will be consolidation opportunities at sensible prices. Typically, I find that the purchase multiples in zero-growth sectors are half those in what are seen as buoyant sectors. Meanwhile, a static industry should encourage managers to rationalise, cut costs and become more efficient.
Another neglected sector is bingo. Ten years ago it was seen as highly cash generative and resilient, and assets changed hands for full prices. Acquirers took on lots of debt, and a number of deals were done by private equity. We built up, and sold profitably, a company called Mayfair Gaming — luckily getting out just before the bingo business unravelled owing to the rise of online gaming, the recession and so on. After years of decline, the industry appears to have reversed its slump. I recruited one of the key managers who worked in our previous bingo operation, and so far we have bought and merged two companies to create Majestic Bingo. We now have 15 bingo halls and hope to buy more.
My philosophy for investing in such mature industries is to offer better service than local rivals; try to be a low-cost operator; and remember that, with cash cows, capital projects should achieve a very swift payback. I look at measures like free cashflow generation, actual payback and return on capital — not growth. As long as there is reasonable underlying demand, then if a business is deeply unfashionable, all the better.
One might say the opposite of a business like bingo is the electric car market. This is seen as the future of transport and is absorbing a decent chunk of the annual $70bn (£45bn) in R&D spending by the automotive sector — which is on top of the billions of dollars of government subsidies expended every year on helping electric vehicles.
All manufacturers lose large sums of money on electric cars — even after state interventions. They represent less than 3% of all new cars sold. Yet Tesla Motors, which has always lost money and burns through cash at a remarkable rate – is worth $32bn according to the stock market. To me its valuation is preposterous: it is based on fantasy projections of revenues that must carry huge risks. Of course Elon Musk, Tesla’s chief executive, is an impressive inventor, but sadly pioneers typically lose money for their equity providers. It is those who come later who reap the rewards.
Investing experts say diversification is everything — which is why I don’t only believe growth stories. Boring, mature companies have their place in every portfolio.