Introduction​ – Ryan Reeves

On this episode of ​The Investing City Podcast​, we have Bluegrass Capital. He runs an
anonymous Twitter account called “Bluegrass Capital” [big surprise], and he has garnered a bit
of a following. I think the last time I checked, he had over 26,000 Twitter followers, and he really
just posts a lot of great content related to businesses and stocks, so I'm really excited to jump in
here.

We start talking about the evolution of his research process and how he filters information, then
we talk a lot about food delivery networks because he did a deep dive recently on them. We
talked about Uber Eats, DoorDash, GrubHub, all of those companies, and then we end with
some questions from Twitter, including his biggest investing mistakes, companies that he thinks
are incredible for the long run, and then we dive into two in particular, and finally we end with a
company he thinks is very misunderstood.

So enjoy this one I'm sure you'll learn a lot about different industries, different business models,
and it was just a blast talking with Bluegrass Capital. Enjoy.

Ryan Reeves
Thanks for being here.

Bluegrass Capital
My absolute pleasure man like I was just telling you. I really enjoyed the group of people you've
had on before so happy to be here and hopefully, it can be useful.

Ryan Reeves
Great. So, just want to start off on Twitter, the amount of content that you produce, and that you
put out is just mind-blowing. So I want to spend most of our time talking about your research
process and how you filter information. So just to start off, I want to hear a little bit about your
investing background and the evolution of your research process.

Bluegrass Capital
Sure, obviously a big topic and I'll try to filter it down to maybe what's most interesting. I've
backed into this goal where I'm trying to own businesses for as long as possible. Probably not
forever but, at least in theory, I'm trying to say, “Hey, I want to learn about this business
because it's something I can own and participate in for a long time.”

So I backed into that unintentionally, but some of the qualities around that, or drivers around
that, that I've taken to help me get there. I'm really focused on owner-operators founding
management teams or founding families that still control a big chunk of their business and
control the board or run the business. They just seem to have a really long-term perspective,
versus other types of management teams. Lots of investors talk about this. Russo is one that
comes to mind.
So that's one thing and then the corollary to the owner-operators, I’m looking for a business that
has a long runway to reinvest its capital into. So a couple of thoughts there. I used to be very
interested in focused on more special-situation type investing. And I would very much like to buy
something and say “hey this is 30 or 50 cents on $1. And there's an event that's going to
happen and that is going to unlock this value and then in 12 to 24 months, if everything goes
right, my investment is going to double or three times whatever.”

And that's definitely good and still a good place to fish, so to speak. But for me, over time, I think
you can have two or three winners and then have one stock blow up. , you lose half your capital
and maybe you net out 10 or 20% or an even better overall return, but I really just like to focus
on things where the learning curve for me is: I don't have to learn a whole new business and a
whole new management team and a whole new industry every six or 12 months to make a new
large investment. I like things where I'm confident. If I invest in consumer or internet or various
technology infrastructure businesses, or pet and vet or travel, I mean these are all huge
industries that should be growing consistently for the next 10 or 20 years so anything I learned
today will hopefully still be relevant over time.

Ryan Reeves
Yeah, getting that big runway so that your information can just compound and soak in your
knowledge. So I want to dig into those two things you said: the owner-operator is really
important for you. If you see a business without an owner-operator, do you ever withhold from
investing? Is it that big of a red flag, or do you have a more flexible approach on that?

Bluegrass Capital
Yeah, it's definitely not all-or-nothing. It's like, you're just looking for, as an investor, we all have,
let's just say three or four or five or 10 qualities we're looking for. And you don't have to have all
those qualities present to make a good investment. But the more of them you see, the better
your interest level is. So that's just what I look for, because when there's an owner-operator,
they tend to do all the other stuff that I want, like reinvestment and have a long-term point of
view and these types, and have good incentive structures, etc. So it's definitely not a gating
item.

But the first thing I thought of when you said that was actually this: it's very common that you'll
find an industry that's an oligopoly, and there are three or four main players and you read about
all the businesses. And it turns out one is an owner-operator management team, or the county
family has run the business for three generations. So I would say, in that situation, if I could buy
two or three equally competitive businesses that have similar market shares and similar
economics. I just tend to lean towards the one who has more skin in the game.

Ryan Reeves
Yeah makes a lot of sense. I wanted to piggyback off of this idea of aggregating information
because, like I said, on Twitter, you can post so much information so I'm interested in your daily
source of information: where you go, are you just reading 10 K's and then going down the rabbit
hole? Or how do you think about that?

Bluegrass Capital
Yeah, absolutely. So I have a standard process that I've again backed into that works for me.
And it just ticks off a lot of boxes of maintenance work for your existing portfolio, your on-deck
book or your watch list names, but also learning about new businesses. And what I do basically
three things every day, or at least I try. I try to read one annual report, which would include the
shareholder letter. And if things look interesting, I might just open the proxy and look at what the
incentives are. And then I try to read one transcript for a recent earnings call from various
businesses. And then I tried to spend at least one hour of a book and I'm constantly reading,
probably three or four books at a time. And so I'll just try to read a chapter or 50 pages,
something like that.

And what that does. And my friend Jake actually gave me this analogy, so what I'm doing is
staggering timeframes. I'm looking at the really short term here like a transcript or recent
earnings call, they're talking about what happened to the last three months, what new
competitors have come in, those things and then if you look at the annual report you're looking
at a broader timeframe, you're looking at 2, 3, 4 years in a lot of trends and then if you look at a
book, it's telling you something that's very valuable, that's not changing fast at all. If you're
looking at an industry commentary or a profile of a business leader that happened 20 or 30
years ago that hopefully can be timeless and you can learn from that stuff.

Ryan Reeves
So I'm also interested in how you decide what to prioritize. So you have this structure, the
shorter time horizon, then the book with the longer time horizon, but how do you decide which
transcripts or which 10-ks to read?

Bluegrass Capital
Yes, I have stocked up for all three of those categories, it's just constantly turning over. And, we
were talking about this offline, for example, this last week, I did a dive into the food order
network companies. So I probably had 10 or 15 names in my queue of annual reports I want to
read, but it's not like something I have to do. So if I want to prioritize something, I'll just go to two
or three names at the top. And that's what I did this week.

It's very efficient sometimes when you're learning about a new industry, then you can just click
through all the annual reports, day after day of the same guys, and just listen to what they say
differently or the same. So I've got a list and probably starting next week I'll go back to my
normal queue of what I'm going to read, probably some of the recent annual reports that were
published among portfolio companies, but it's a constantly evolving process.

Ryan Reeves
So let's drill in a little bit. How did the delivery networks come across your radar? And then what
makes you want to start digging in? Talk about those thoughts leading up to pushing that to the
top of your list.

Bluegrass Capital
So when I start looking at a company or an industry usually, I have some understanding of it
beforehand because I've used the product in the real world, or I've read Wall Street
Journal/Bloomberg articles people talk about Uber or Lyft or whatever the business is. I just
know about the business. These businesses I was really not familiar with at all. And I'd spoken
to several other thoughtful investors and they gave me the nudge that “hey there's some
interesting stuff going on here you need to look at these. And I was like okay.”

When I'm not familiar with the industry at all, I will go through all the public filings. So all the
recent annual reports of the public competitors, I'll go through all the past 12 months or so of
their comments in transcripts, I’ll try to find profiles and trade journals of the industry or the
management teams, I'll go through the sell-side research and then the most fun part, and the
most additive part is: I will try to find as many investors on the buy-side as I can, who are
actively interested in these businesses who've already started looking at the businesses, who
may have already invested in some of them and just try to get their takes. And I'll tell you what's
interesting and I was just thinking about this because it applies really well with the food
networks.

I'm looking for two things really when I'm going through all this information. I'm trying to look for
things that everybody thinks is true, like what everybody says, “oh this is absolutely what's true”
and what that tells me is that's the bedrock, the basis of the industry. Like what are the
economics for the businesses? What are the competitive factors everybody agrees on? So you
have to have that knowledge to understand what you're going to read next. The second thing I
look for is where everybody has disagreement. Sometimes, in stages or industries that are in
maturity, nobody disagrees on anything and you look at Visa and MasterCard and they're priced
at 30 times earnings because people pretty much agree that they're really good businesses and
they have a long runway for growth, etc. But on the food networks, there's a lot of disagreement
all over the place. I can give you 5 or 10 different examples where very smart investors are
telling me the exact opposite things. So that is very interesting to me and that is when, as an
investor, you can add a lot of value. If you can look at these things where everybody else
disagrees on and you can come to your own conclusions and say “I'm not going to put a gun to
my head and say this is true, but I think this is true. And I think I could bet on this.”

Ryan Reeves
Yeah, that's a great mental model, this spectrum of disagreement where your agreements differ
is just the inefficiency. And so, let's drill in on the food delivery network… so you said 5 or 10
examples where people just vehemently disagree. So can we talk a little bit about maybe one or
two of those and then maybe how your mind has changed as you dive into the industry?
Bluegrass Capital
Yes, I like the way you said that the last part, because I definitely had a shift, I definitely had
some biases coming into my reading and I feel pretty much the opposite now, which that's
always fun when that happens. I just assumed, and this is probably because it's a US-centric
view, I assumed that a food order network needs to have an integrated logistics and delivery
function for it to be successful. Long term. So you have a two-sided marketplace with the
customer ordering from the restaurant; that's the basic network. In the US, it's becoming a lot
more popular for an integrated delivery service to be attached to that. So, for example,
DoorDash is probably the best example. And you see Uber Eats starting as a logistics player
but entering through the side-door with their logistics service and now having a food order
network to differentiate themselves or I guess remain competitive to bolster their existing
marketplace. If you look at other parts of the world, the way the businesses have evolved are
very different. And I don't know that I've done this recently but what you what you really have to
do with these businesses, and maybe this is obvious because we're talking about food, food is
very basic and natural. It's sociological and it’s cultural, right?

The food cultures are just so different in different parts of the world. So that's something that I
think is important that I realized, and other people have helped me realize also that's a
differentiating point of view. And I'll give you an example. If you live in London or in New York.
The weather, most of the year, is cold and rainy and what are most of the people work in high
rise buildings. It's a very dense living environment, you can walk to your takeout restaurant from
your apartment building or your office building. So if you just think about those qualities I just
described, that is radically different from a market like Nashville where the majority of people
really live outside of the city, and there historically hasn't been much of any delivery of food,
other than pizza. And there's no dense logistical network last-mile delivery other than Uber
which didn't exist for us two, three years ago. So the point is you have to break down city by city
country by country, culture about culture, density of population, climate, whether people work in
office buildings, or whether people were in suburban areas or whether it's an agrarian economy
and all those things you throw those into a big pie. And that impacts what the delivery or takeout
culture is in a different country. I'm rambling hopefully that makes sense.

Ryan Reeves
Yeah, definitely. So I'm trying to get my head around the positioning of all these companies,
right, because DoorDash, Postmates, Uber Eats, GrubHub, there are a lot of players and there
are even more overseas. So, give us an overall landscape and maybe some of the
differentiating factors between some of these companies.

Bluegrass Capital
Yeah, so just building on the rambling, I was just trying to articulate about different cultures and
different norms in different countries. Well in these larger urban cities like London or New York
or parts of continental Europe, you have an established culture of people who want food taken
out. What you have, it's already commonplace that consumers frequently order out food, and it's
also commonplace that there's a large part of the restaurant industry that offers delivery
themselves that are primarily just takeout and delivery restaurants. So that culture is not
prevalent in the United States, at least outside of like New York markets.

So based on what I'm saying, one of my biggest takeaways is, in these European markets are
these dense urban markets that already have restaurants that provide delivery and a culture of
consumers that want takeout that already actively go get takeout. What these businesses are
trying to do is channel shift. Instead of you picking up the phone, they're trying to make you
order online. So the same behavior you're currently doing, just shift the channel. This will be
easier for you, it's a better value proposition, it's a better service. That's an easier runway for me
to bet on and think, “Oh yeah, I don't have to pick up the phone and the person on the other end
is going to write down the order and maybe they'll get it right, maybe they won't. Maybe they'll
order it directly into their order system maybe they won't. The online experience is just better, it's
more efficient for everybody. So that's a channel shift and that's what I would characterize as
Europe. Now, the United States is a behavior shift. It's true that the majority of takeout orders
still come over the phone. But what these companies in the US are trying to do is they're trying
to create a behavior shift, they're trying to say to people who live in suburbia who have never
had a delivery opportunity, who don't order takeout with any frequency at all, we're trying to
change your behavior.

So it's night and day what is going on. And I think, because of that, you see a lot of earlier
success and penetration of these markets in Europe because the consumer they're targeting is
basically used to the same behavior.

Ryan Reeves
I was doing some research to prepare for this, and I noticed that before 2015, GrubHub had
actually just been an aggregator, so they would literally just be a marketplace where people
could order. Restaurants basically put their menus online and GrubHub would aggregate them,
but they weren't actually in the delivery space. So I'm just curious to get your thoughts about
why GrubHub felt forced to get into that space, and maybe the differences between that
aggregator model versus this last-mile delivery where you see with DoorDash and Uber Eats.

Bluegrass Capital
Yeah, certainly, I mean that's probably the most important question for investors in this space,
so good for you for bringing it up. And I don't know that I have a great perfect answer, but it's
really just competitive threat. I mean from GrubHub’s perspective, you have DoorDash and Uber
Eats entering and taking, they've taken half the market share away from GrubHub in the past
two years, in the US, right? And they've done it because they have this integrated logistics and
delivery function.

And what that's allowing is, in these suburb suburban markets, it's allowing a lot more consumer
choice. So it's in the markets that those new delivery services are entering, they're delivering for
the first time, from a McDonald's or from the Yum Brands chains, but more interestingly, they're
delivering from independent restaurants like your local favorite family restaurant. When your
wife feels the need to go get takeout now, DoorDash will deliver that independent local
restaurants’ food to your door. So that's something that's new that consumers are responding to
really well.

But from a growth standpoint, they're just trying to defend their turf and they historically had the
biggest two-sided marketplace. And they're just trying to claim back some of that share.

Ryan Reeves
Gotcha. And so I'm really curious about this aspect, you mentioned two things that you look for,
owner-operated businesses and a big runway that you can see down the line, and just talking
about food delivery network, specifically, we have this huge runway that I think a lot of people
can see, but also with a big market you get a lot of competition. How do you think about the
trade-offs between a big market and the competition? How would you assess that if you're
looking to invest in one of these companies?

Bluegrass Capital
Yes, another really good question. It is hyper-competitive especially in the US. With this market
share shift that's happened over the past 24 months, it's pretty wild. I think these businesses, in
every geography they're in, will be either oligopoly or monopoly. If it's not just one player than
the number one player is still going to have like 70 or 80% market share. So they should evolve
to like a classifieds type business or online travel or Amazon with e-commerce. I think that's the
way these businesses are going. So what you have in the stage between now and then, is in
certain markets you have these competitors just going at it, and they're spending all their
marketing money on new customer acquisition, and you have a lot of venture capital money
funding ongoing losses. And these businesses are basically spending 50 to 100% of their
revenue on new customer acquisition marketing costs so that they have negative 30-50%
EBITDA margins at present.

I'm not saying that's appealing, it actually scares me away. But you have some of the markets
in Europe, specifically the Netherlands, and probably Germany soon, where one competitor has
emerged, and all the other competitors that were the number two and number three, went from
having 30 or 40% market share to 10% market share. And then they basically just sold their
businesses to the number one player, and the European guys and girls are acting a lot more
rational because the markets are shaking out where a number one is emerging. And those
businesses are also just two-sided marketplaces because the restaurants in those markets do
their own delivery. You're seeing the businesses do 40 and 50% even margins.

So, I think can be really attractive. As far as really investing in the future growth runway, if you
look at all restaurant spending in these markets. So the US is like 550 billion, in Europe, it's like
600 billion. That's all spending on restaurants. Okay, including dine-in and dine out, online
ordering is currently 3% penetrated in the US. It's currently 4 to 5% penetrated in continental
Europe. It's 7% penetrated in the UK, and it's 11% penetrated in China. So I don't know what
the numbers are going to be but if you compare those numbers, I just gave you like 11%
penetrated versus ecommerce right now in the United States is like 15% of retail sales, hotel
reservations are now 40 to 50% online.

So I don't know where these things go but they can easily triple or quintuple their penetration
over the next five or so years in their market. If you're the number one winner in your market,
and you don't have to spend a lot of money incrementally on new customer acquisition, and
your incremental dollar revenue goes to 50% EBITDA margins. I mean they're going to look
pretty good.

Ryan Reeves
So I want to ask a hypothetical question and you don't have to necessarily have a laid-out
answer, but I think it's timely because the morning of recording this, Uber IPO’d and it was a
lackluster IPO. But if you pretend you're an executive at DoorDash or GrubHub and you see
Uber IPO and they raised however many billion dollars, and now they can essentially keep
losing money and try to gain market share with Uber Eats, and I believe it is the fastest growing
food delivery network, so if you're an executive at GrubHub or DoorDash, what are you thinking
and what are you what decisions are you making with strategy; because Uber just has this war
chest of cash now?

Bluegrass Capital
Yeah, I would agree with you. Uber Eats seems like it's become a really valuable part of Uber.
So totally agree with that. They had zero percent of delivery market share three years ago, and
that's now at the 25% in the US and 8 or 10% of the UK. Yeah one [point] on Uber and then I'll
give you one on DoorDash. I really think they're in a good position. Not sure about what their
unit economics are. And that's an important part, I just don't know what they are, but I’ll put it
this way. So the biggest challenge these businesses in the US have right now is awareness.
They're trying to change behavior of consumers. So consumers just don't know if you live in a
suburb, you can get a delivery of 30 or 40 bucks for your family for dinner tonight at no takeout
fee or like a two or $3 for dollar fee, they just don't even know they can do that.

So awareness is one of the biggest challenges for adoption. If you think about what you are
aware of as a consumer, like what do you already have? You already have the Uber app
downloaded at the top of your home screen on your phone. So it's literally already there. If you
want to talk about awareness. There was a stat, so UberEats is available in 75% of the cities
that Uber currently provides ride sharing, but only 15 million of Uber's 90 million monthly active
users have signed up for Uber Eats. So, they are currently 15 or 17% penetrated into their
existing rider base. I mean, so how easy is it going to be as a consumer for them just to flash
you some offer and say, “hey your next 10 orders or your next 5 orders are free from Uber Eats,
sign up and they already have your credit card information.”

So I just think they're really well positioned. I definitely can't get into the minds of DoorDash
because they're private, but I would just say one thing that I think is interesting on DoorDash. So
nine months ago in the US, DoorDash released a subscription program, which is a new revenue
model for this sector. When they say for now $9.99 a month. As long as you order food orders
that are over $15, you get all of your all of your deliveries for free.

Since they've done that, just in the summer of 2018 to now, just since then, their market share,
has grown by 50% in the US. So it's almost like a third of market share. Now, they've taken that
directly from the Amazon Prime model. So now, DoorDash is getting cash upfront monthly on a
recurring basis, so they have negative working capital. They have operating negative working
capital coming in the door before they even do anything, before they even have an expense,
and they can take it. So it's just like Prime, people sign up and pay their Prime membership
ahead of time. Amazon has all that money sitting there like 4 or $5 billion in January, February
to just do whatever it wants for the next year. So it's not that dramatic but same thing with
DoorDash. They are working their way to a sustainable model to get off venture capital money
where they have this negative working capital come in the door, and they can take that and
invest in building out their network. Their logistics network and suburban markets. And another
thing that's interesting about DoorDash is, since they unleashed the subscription model for
consumers, consumers are using it as much as 7 or 8 times a month. So they're really taking
advantage of the model. $9.99 a month won't work; it has to go over time but right now
consumers are really using a lot. And so that's 7-8 times a month, that compares to some of the
other services like Takeaway, for example. Their average customer only orders 10 times a year.
So anyway, that's what I know about DoorDash and Uber.

Ryan Reeves
Yeah, super interesting and appreciate your thoughts on just the delivery network, but I wanted
to switch gears, because you put out a message on Twitter just asking for questions from
followers just interested to hear from you. So, want to go through a few of those. And let's start
off. What are some of your biggest investing mistakes? Maybe just one or two examples.

Bluegrass Capital
Oh yeah, always fun to think about. For me, some themes jump out. So businesses that have
declining revenues. They're just in decline. Even if I can buy the business at what I think is a
cheap price, like a 10% free cash flow yield or something, those have worked out poorly for me.
Regulated industries, heavily regulated industries. I have a background working in the
healthcare industry. So I've seen that a lot of firsthand it's just a challenging industry so heavily
regulated industries with a lot of government involvement. They tend to produce bad headlines
frequently, so I've tried to steer away from them. The same thing has also applied a little bit to
financial services.

And I guess I don't know how to frame this the right way, what a good example would be, but I
definitely try to keep my investment thesis very simple. I want to bet on two or three big ideas or
concepts and not get really complicated, 20 tabs in my spreadsheet and make 50 assumptions
in my model to have an edge. I'm trying to just figure out through three key themes, know why I
have a different point of view, and avoid complexity, if I can.
Ryan Reeves
There's power in simplicity for sure. Just keeping the thesis at the top of your mind. And I think
that leads pretty well to the next question. Some followers are asking about your blind-trust
portfolio. So are there any stocks or any companies that you've just been following for a long
time that you would throw in the blind trust portfolio because you think those two or three points
of your thesis are just rock solid?

Bluegrass Capital
So blind trust means maybe like buy and hold forever? Yeah sure, I'll just start throwing out
names and you cut me off: Loreal and the beauty companies, the credit rating agencies,
Moody's, S&P Global, the architectural paint companies, Sherwin Williams. Branded spirits, so
Brown Forman. Ecolab, which does a lot of stuff, but water resource management/water
conservation for businesses. LVMH, so the luxury companies. Anything that's precision
measurement, or weighing, or analysis instruments for Life Sciences, all those businesses are
really good. Mettler-Toledo is an obvious one. The waste removal companies like Waste
Connections. I can't imagine any way how those businesses are going to be disrupted while
people won't keep producing more trash, unfortunately. Pharmaceuticals for pets so Zoetis. Pest
Control businesses, specifically the ones that are more weighted towards emerging markets.

Ryan Reeves
Yeah, great. We can we can start there and then we can continue on later. But what I find
fascinating about all these industries is they're not flashy right? Like you they're just good,
probably owner operated, businesses with that big runway that you're talking about. So, just to
give us some context let's go through one of them. I'm curious about Sherwin Williams. What
are your thoughts about their moat and what keeps them attractive versus an upstart?

Bluegrass Capital
Oh man, I really wish you hadn't asked about this. People are going to hate me for it because I
love paint. You're not gonna find anybody that loves paint more than me. I know that's so stupid
but it's true. It's an amazing business. So one thing I would throw out. And I've gotten some
people look at me like I'm crazy. If you write an investment thesis for the credit rating agencies,
and you just black out the names of the companies. Like you just write one paragraph, what the
industry is, how they make money, what the profit loss statement looks like, recurring revenue
as a percentage of revenue, capital intensity, cash generation and dividends.

If you write that up for the credit rating agencies and you just block out the names, you could
insert the paint companies. You can insert Sherwin Williams into that, and it would be the same
exact thesis, which is crazy but I'm sorry. You got me excited. So why do I like Sherwin
Williams? So architectural paint, if you think about it, is an industrial business. What you really
want to look at is the installed base.

For example, you produce these like small pieces of aircraft parts. So every time an aircraft flies,
every so often, it has to have maintenance, it has to have parts that are replaced. Just like how
they sell into that installed base of however many airplanes there are in the world, that's pretty
big. So you would look for a big installed base, and you want to look for how often the install
base needs to get turned over and then what their gross margin is on selling their product into
that basis. Right, that's industrial logic.

If you say, what's the installed base of paint? I mean, the installed base of paint is like every
building, every structure, every bridge, every boat, every airplane on Earth. So, if you're looking
for installed base, this is the best one I can find. If you really want to dig into their model a little
bit, so what the install base does, by the way, it gives you a runway, there's a predictable
runway for demand. The paint everyday gets older on a house and however many years, 10
years or something, it's gonna have to be repainted.

The thing, when you think about it from the customer's point of view, if you're the homeowner,
for example, for architectural paint, that's the customer. If you pay for a job to get your house
painted and you outsource it, you pay somebody else to do it, which is the trend, it's about 60%
of consumers paid for a third party to paint your house or repaint your house. 90% of the cost of
that job is labor. It's not the paint, 10% of the cost of the job is paint. And the person who buys
the paint is the professional contractor. Okay, so that person, their professional painter, that is
the customer for Sherwin Williams, that's why you see so many Sherwin Williams stores in
different geographies. It's the professional painter that goes in that store.

And the reason they like the Sherwin Williams paint is number one, they want to buy the highest
quality paint they can, because a thicker higher quality paint is going to require less work,
they’re going to have to do less applications, less number coding, so they can do their work
quicker. And number two is, with these well-located Sherwin Williams stores, I think they've got
400-500 stores across the US, they do delivery. So if you're a high-volume professional contract
painter, you can just call them, and you can say “Hey, I need this, I had this job going right now,
I need to finish this today.” And they’ll just send this truck over there. Now, in addition, they will
also offer you working capital. So they help professionalize your business a little bit, and also
give you some ability to invest in your business if you're the contractor. So that's the customer’s
perspective, the customer is the professional painter.

If you want to call it the revenue model side of the business model, they also control all their
own manufacturing. So they are completely vertically integrated. So they're not going to be
disrupted. You can't start a new paint company and start selling your paint through Amazon,
because first you don't control any factories and there's no factories for sale because Sherwin
Williams and RPM and other players own all the paint manufacturing, and you can't just build a
chemical manufacturing factory close to downtown LA or something because there's all kinds of
environmental risk.

So they're vertically integrated, own their own manufacturing, control their own retail distribution.
So they do sell into they sell lower quality products through Home Depot and Lowes, but they
basically control the hospitality part of their customer chain by selling through their direct retail
stores. I could keep going, but I mean they have 60% gross margins, they have consistent
pricing power, raised prices at least 2 to 3% about every 18 months or 12 months so they
consistently outrun any cost of goods materials inflation.

They're consolidated. The top three guys have about half the industry and they continue to.
Every three or four years, there's a large transaction and somebody bounces up another 10%
share. So yeah, great, great business.

Ryan Reeves
Yeah, I find that super interesting. So, if you're all right with it, let's go into another one that you
mentioned, maybe Ecolab, if you've done any research on that one.

Bluegrass Capital
Yeah, absolutely. A very interesting company, and the runway for that company is also one of
the longest ones that I've come across. And they actually do different stuff but maybe just to
keep it simple. Their core legacy business, about half of their revenue is they provide
outsourced cleaning services for commercial restaurants and commercial hotels. So basically,
they have a dishwasher that they will sell you or lease you and that dishwasher has better
efficiencies than anything else on the market. And they will sell you like a razor blade model,
they will sell you the detergent that goes into that dishwasher. And they do better an internal
research and development function where they're constantly rejiggering the formulations and
trying to make the most efficient solutions. So basically, they sell you or give you for free this
dishwasher. They sell you on a recurring basis, a very high margin, higher price than the
competitors, higher price detergent, or liquid cleaning material. But overall, when you put those
two things together, they are a very small cost of your expense base in your kitchen. It's
something you can't do without. You have to have a constant clean supply of dishes and plates
and stuff. And if you don't, and you run out, it's a big bottleneck for the kitchen.

And basically what they do over time, or their value proposition is that they're going to charge
you, let's say $1,000 for their service, and that might be their competitors service might be $300
or $500, but they're going to save you two or $3,000. So it works out where it's a very high
return on investment for the consumer, even though the products are more expensive than their
competitors. So that's what they do. That's how they started out, and they land in your kitchen,
they land in the dishwasher and then they expand.

They offer other products, they offer safety products, they offer pest control, they do training of
your employees, they also first aid products, and stuff like that. So they basically attack a
customer base, and just try to keep taking more and more and more of that customers overall
spend. And they do that organically and they also have made acquisitions for tangential
products. They have a salesforce that's 27,000 people, which is a factor of four or five times
bigger than their closest competitor. So people are just going to restaurants and hotels every
week or every month, talk to the customers, and listen to what they say, and they see when the
customer needs a new product or what they're buying a lot of.
Ryan Reeves
27,000 is a lot of people around different restaurants. Curious about this company, it had a first
mover advantage, which created that scale, but if you had an upstart and you replicated the
playbook of giving away a free dishwasher and then landing and expanding, how would that go?
Or is it really just the scale now that is creating that moat for Ecolab?

Bluegrass Capital
That's a good question. I think it's both. I mean the business was started I think in 1920, or so.
They’ve looked like their current state for at least 30 years with this core business they have. So
they're already somewhat entrenched and that they've got into the business, and they've
expanded outside of the original thing. But then what retains that model is just the huge
salesforce, that's just constantly checking in on the restaurants.

And I guess one thing to that. Because it's obvious in my mind, but maybe not obvious to some
of your listeners, so what that salesforce does, if you think about it, what their high margin
products they sell on a recurring basis, is a lot of chemicals. It's either chemicals or it’s a
service. So that's really easy to replicate and you have a lot of other companies like Johnson
Wax, for example, you have other companies that make like cleaning products, they just sell to
consumers. And those businesses, over time, they've tried to enter this market and say “hey
commercial restaurant, I’ll sell this cleaning product to people to wash their kitchen and their
home. This will work for you too. But they basically never been able to get over the salesforce
issue, because they would have to build out a sales force to go out and attack this space. And
unfortunately, it's also explainable, the way public markets work now. And hopefully we can
come back to this because I would love to throw out a hot take.

If you're a CPG company, you can't really invest through your balance sheet or your income
statement that way. Public investors aren't going to let SC Johnson go out and build out this
huge sales force to compete with Ecolab and take their profit margins down 2 or 3% over the
next few years. Their stock would nosedive. So, this is what it is.

Ryan Reeves
Yeah, let's, let's jump right into the hot take because that is actually my next question. So just go
for it.

Bluegrass Capital
I was taking notes to try to prepare for this and one of your questions was, “most controversial
opinion or most misunderstood companies.” If you're a business person, if you've worked inside
of a company on a project, if you're a sales manager and you're working on sales territory or if
you're a construction manager or a real estate, site developer, and you're working for Dollar
General or Costco or something and you're thinking about building a new store. I think it's
interesting to think about what those people think and how they frame their ideas. So it's
corporate finance 101. What's your return on capital, what's the payback period for the project,
these types of things?

I don't see investors in public markets, thinking about businesses that way. So we're talking
about unit costs of a business. I don't see investors thinking about businesses that way. Very
often, and even if they recognize that that's the way you should most fundamentally look at a
business, there's still a disconnect between going from A to B.

If you have a high profit margin, like a 50 or 60% EBITDA margin, that margin is an output. And
I would say it's even a failed output, it's a failed process because you basically ran out of ways
to reinvest your capital. And as a quick sidebar. I don't even want to say this because I'm gonna
get assaulted on Twitter, but I think I'm giving MasterCard too hard of a time. They have 15 or
10% margin differential with Visa and I’ve always looked at that and thought to myself “man Visa
just has such better capital allocation.” So I give credit to the MasterCard management team. I
mean maybe they're not making the best acquisitions or service additions, but they are
absolutely trying to reinvest in their business and trying to touch their existing customers in
different ways, so there's something to be said for that.

But yeah, so another way to think about that is, as a management team, you shouldn't be saying
“right now my profit margin is 10%, and in five years I wanted to be 17%.” I mean nobody really
does that, if they do that, it's just people talking on an earnings call. What you really do is you
say, “I have $100 in profit today in cash, I want that $100 to grow over time. I don't care if my
margin goes up or down a few hundred basis points I just want the absolute dollar number to go
way up, if I can. And I would think about it like that if you're an investor. Imagine we had
$100,000 portfolio or a million-dollar portfolio. And we wanted to invest in real estate. Okay.

If you invested in real estate, I promise you, the first year or two after we met, let's say we found
a really incredible deal on an apartment building. And we bought it for 70% of its replacement
costs and we got really great bank financing, we're just so tickled, right? Me and you were like
“oh we're gonna make so much money and it wasn't leased up and then we leased the whole
thing up etc.” And two or three years later, you and I were doing our tax returns. We're not going
to sit around and be like “what's the NOI margin on our apartment building. We're making 60%
net operating margin on this apartment building, but we really should be making 75% margin.”

People don't think about businesses that way. When you're really an operator, what you think
about is, “I've got $100,000, I've got a million dollars. I don't care what the margin is going to be
I just want that pie to get bigger.” So I guess, to summarize all this, investors give enough credit
to thinking about the unit cost of a business. So that can be for a physical piece of real estate,
like a Costco store, a Dollar General general store, how much does it cost to build it versus how
fast it takes to pay back. And for a Costco or a Dollar General Store, it's like a two-year payback
period.
For a digital company or a software as a service company, its customer acquisition costs versus
long term or lifetime customer value. If you can put $1 into acquiring a new customer, and you
can get 3 to $5 back in gross profit on that relationship over the next few years, it does not
matter if your current EBITDA margin is negative 10% or positive 20%. It does not matter, like
that's a relevant statistic. So, I just don't see people realizing that.

Ryan Reeves
Yeah I'm 100% on board with you, they're actually on Twitter, probably a month ago I did a unit
economics series on software, because you're right, I think software, it's becoming more
understood now where people are getting the whole customer-acquisition-cost/lifetime-value
thing, but for a while there, people would just say “I would never touch an unprofitable
company.” But if you look at the lifetime value, some of these companies are getting like return
on investments of 100%. So, yeah, I'm with you on that just looking at the unit economics of the
business is so undervalued, and it really can give an advantage to an investor.

Bluegrass Capital
Ya, that recent S1 filing for Zoom, the video conferencing software. That's just insane. I mean, I
had to stop reading it, it was just upsetting. I mean their statistics and their customer metrics
don't even seem to make sense. I mean in a positive way in a good way. And maybe just one
caveat, so we both don't just get roasted on Twitter about the LTV versus CAC. You can't do
this blindly, obviously.

I mean you have to understand the customer value proposition; this has to be a good product. It
has to be low penetration in the market, you have to have a good management team, that has
to be credible. I'm not saying just go out there and do this on blind faith. I'm sure people, some
venture capitalists or some startup management teams will take advantage of consumers if they
let this type of behavior go too far. I mean you can't be GAAP unprofitable forever. I'm sure
Amazon would try if they could. But again, I think your profitability and your profit margin is just
the result of an output, it's not an input. You don't say I'm going to have a 20% margin; your
margin just goes to 20% because you run out of stuff to reinvest it.

Ryan Reeves
Yeah, good nuance there. So just want to end with one more question. And this is also from
Twitter, so just curious what you think are some of the most misunderstood companies?

Bluegrass Capital
Despite the conversation we've had I'm really passionate about asset-heavy bricks and mortar
type businesses. I don't know why, maybe it's just my background, and some of what my family
does, but I really like physical real estate and physical assets and infrastructure, these types of
things. I think the data center companies remain very misunderstood. There are a variety of
models out there, but I think most investors just look at a data center and they say, “That's just a
big warehouse, and it has an overly expensive electricity bill, and they have these huge HPC
systems and they're coming up all over the country and there's capital flowing into the space,
and there's no barrier to entry.” Yeah those are some good ones.

So I think the nuances are something that investors should realize. This business model actually
started through an industry mutualization. So just like the payment networks and MasterCard
were utilized in the same thing. Not the same exact thing but sort of the same thing to the credit
rating agencies. Anytime you've had an industry mutualization. And by that, what I mean is,
you've had a not-for-profit business that was run as a collective for the benefit of all the other
businesses in the space, like Visa was part of Bank of America for 20 or 30 years or whatever.

Once you unleash that, and once that business transitions from a mutual business to its own
private business, its own business that has capitalistic intentions and can earn a return on
capital, sometimes things can get really good and that's where I see these data center
businesses. Specifically the ones that were that were owned by the legacy carriers, like Verizon,
like CenturyLink, they would own this business. Like in the core of San Francisco or the core of
Dallas or the core of DC or the core of New York/Chicago, and they basically had all these
demands from customers to link together. They wanted to link their computers together so they
could talk to each other so they would have low latency.

Wat evolved was, you have the customers, people who are putting their servers in these data
centers and the data centers were owned by the telephone carriers. They could see a lot of
value being created, forming this network, putting all these servers beside each other and were
connecting those servers with wire so it's called interconnections. And that's value. There's a lot
of value like this network springing up, like at first there were three servers and then there was
10 servers, and then all the people that were there, decided they wanted to connect with each
other. And so you added 15 more wires and, hopefully, I'm painting a picture that makes sense.

But you see there's a lot of value there between this new communications network that was
developing, and they said we don't want this telephone carrier to have control over this network.
Then there became a demand for what's called carrier neutral data centers. And that's where
this business model is growing up, where the carriers sold all of their own data centers to an
industry collective, that was thought of as independent.

So Verizon can put their server beside Google and Google put their service on Amazon.
Amazon could put their server beside JPMorgan Chase. And eBay put their server in there and
Facebook and put their server in there and nobody has power, they can all have their servers
talk to each other as efficiently as possible. But nobody's staying in between to charge them a
huge tax to do that. So that's how these models started, they started in the best markets that
had the highest intensity of technology firms and communications, they've evolved since then.
Several of the businesses have gone public. My favorite is Equinix and I'll try to articulate the
value of this business model. It's a network. It has amazingly huge network effects that grow
literally every day, every time somebody puts a new server into their data center and connects
to somebody else's server.
It literally creates a domino effect of demand for everybody else to connect the new server. And
they charge for that, and the revenue of the interconnection piece goes up like 15 or 20% a year
every year, I mean for the past 10 years. So people look at these businesses and they say “oh
this is real estate, this is like an apartment building. This is a warehouse. It should trade it like
15 or 20 times and so and give me a three or 4% dividend.” And I'm telling you, they are
network effect businesses, and just totally misunderstood.

Ryan Reeves
Yeah, I think that's a great way to end this because it's just clear you have so much knowledge
into different business models and different industries so just want to thank you for your time
man.

Bluegrass Capital
Absolutely. Thank you so much and look forward to listening to the other podcasts of yours that
I haven't got a chance to yet, appreciate it.

Ryan Reeves
Thanks again for listening. You can find more information at​ ​www.investingcity.org​, where you
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