Would You Rather
Here are two companies. Ignore what they do for a moment.
Company 1 will earn $100 next year and grow 10% for the next five years. It'll earn 66 dollars in gross profit next year and keep that same margin for the whole five years. Its other operating expenses will stay at $25. This leaves it earning $359 in profit and hitting 50% margins by the end of five years. It'll invest $304 over the five years to support its activity.
Company 2 will make a bit more revenue next year, $125 but only grow 8% for the next five years. It will expand its gross margin from 53% to 57% over that time. That's still below company 1's 66%. Its operating expenses will stay at $25 just like company 1. Its operating profit margin only reaches 44% by the end of five years. It spends a bit less on investments, $154.
Which company is the better investment?
Investing O.G. Ben Graham loved this exercise — "would you rather invest in one or the other?" Company 1 grows faster, makes higher margins. But company 2 makes more money. Company 2 earns much more over the five years. It takes less investment for it to make its profit. It makes $205 versus $55 for company 1.
Whether company 1 or company 2 is a better investment though, depends on price. Here's the thing: they're the same company. The choice between being company 1 or company 2 recently landed in the C-suite of Planet Labs. Management could take route 1 and keep its existing higher growth/higher margin profile or it could choose to be slower growth, lower margin company 2, but make more money. That's what it did in a deal with SKY Perfect JSAT.
Deal Perfect
Planet announced that it would sell a constellation of ten satellites to SKY Perfect JSAT, a Japanese satellite and intelligence company. JSAT would pay for the satellites and get exclusive use of their imagery over and near Japan, BUT Planet would get to sell that satellite capacity over the entire rest of the world. Japan is less than one quarter of one percent of the earth's land surface area. That leaves a lot of interesting stuff for Planet to sell to others.
The cost to the business is its image. SKY Perfect JSAT will pay Planet for the satellites — this will be revenue. Planet's cost to build those satellites will be on its P&L rather than booked as an investment on its balance sheet. It won't make as much margin on these as it does on the rest of its operations.
Planet isn't in the business of building satellites and selling them. It's in the information and insight business. It's still in this business. But when the opportunity came up for a customer to fund the expansion of its satellite fleet at the cost of some margin, it jumped at it. A slightly worse looking P&L was a small price to pay for someone else funding its satellites — an investment it would otherwise have to foot itself.
More accounting misfires
Lamplighter's walked through what happens when companies invest through the P&L a couple times. Investors can interpret lower margins as being a worse business. In the case of Planet, it could end up with lower growth too. This is the story accounting tells.
But what's actually happening with the business?
Imagine you wanted to start running an ice cream truck. You had an enthusiastic customer who offered to buy all your pistachio ice cream, but everything else you could sell to anyone. She’d also pay for the truck and the ice cream machine. Spending customer’s money to build your business is obviously better than spending your own.
Planet doubled down on investing through its P&L with this creative customer cooperation. The partnership will fund its satellite development expenses, establish a long-term customer arrangement for that capacity and enable it to go and deliver that capacity to customers all over the rest of the world. The real cost to Planet is a slightly worse looking income statement. Planet's unit economics for a customer funded constellation — and its long term overall economics — are much, much better.
Disclaimer: None of this is investment advice. It's meant to illustrate ways LCM thinks about investing. Things that LCM decides are good investments for LCM and its clients are based on many criteria, not all of which are covered here. Some or all of LCM's ideas may not be suitable for other investors. LCM does not recommend investing either long or short any position mentioned. LCM may own positions in some of the companies mentioned. Some of its ideas will lose money — investing entails risk. See full disclaimer here.