The Platform Thesis

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There is no “free lunch.” Consider the Platform thesis, a distortion in investor behavior enabled by Quantitative Easing (“easy money”), cheap debt, and low stock market volatility over the last four years.

The Platform thesis, popular among hedge fund managers, is as follows: A company owing to some perceived advantage (a superior management team, lower tax regime, economies of scale) embarks on a roll-up campaign buying up other companies large and small, funding the acquisitions with “cheap” debt and over-priced equity.

The valuation math is non-trivial and often requires a spreadsheet.  Importantly, the “flywheel” effect of buying other companies with debt and equity, then issuing more debt (and selling more shares) to buy even bigger companies can translate into enormous “blue-sky” price targets for the acquiring company.  The often cited risk to the thesis is that of rising rates driving up the cost of debt. The Platform thesis is both elegant and complex and therefore intellectually appealing to otherwise smart money managers.

The Platform investment thesis tends to work spectacularly at least initially … before failing in equally dramatic fashion as the following charts demonstrate. 

What’s troubling is that the Platform bubble burst was not accompanied by a rise in interest rates.

 

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