TIP706: The Founder's Mindset w/ Cristiano Souza
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On today's episode, I'm joined by Cristiano Souza. Cristiano is the founder of Zeno Equity Partners and spent the majority of his career at a firm called Dynamo, which is based in Brazil. From 1994 through 2015, he was on the team that managed the Dynamo Cougar Fund, which invested in high-quality equities in Brazil. During that time, the fund compounded at 24% per year in US dollar terms. In 2022, Cristiano started his own firm, Zeno Equity Partners,

which primarily invests in North America and Europe, and has compounded at 19% per year since the fund's inception, which is in line with the return of the S&P 500. Brazil has gone through a number of periods of economic turmoil, which to Cristiano, taught him the importance of a business's resiliency and willingness to be opportunistic during the difficult times.

Given that Cristiano runs a concentrated investment strategy, he also learned the importance of risk management in minimizing the chance of permanent capital loss for every investment he makes. During this conversation, we discussed the three things that Cristiano looks for in a business, what the founder's mindset is and why it's so difficult to find, why Cristiano believes that LVMH has this significant opportunity to continue to grow, the mistakes Cristiano has made in assessing management teams,

why Linde PLC is a core position in his fund, why AppFolio is well-positioned to continue growing in the property management space, and much more. With that, I bring you today's episode with Cristiano Sousa. Cristiano Sousa

Since 2014 and through more than 180 million downloads, we've studied the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Now for your host, Playthink.

Welcome to the Investors Podcast. I'm your host, Clay Fink. And today I'm happy to welcome Cristiano Sosa. Cristiano, thanks so much for joining me here today. It's a pleasure to be here. Thanks for the invite.

I've been really excited to chat with you here on the show. You spent the majority of your career at a firm called Dynamo and worked on the team that managed the Dynamo Cougar Fund. Over a 21-year time period, the fund compounded at 24% per year in US dollar terms, investing in high-quality businesses in Brazil, which is the primary strategy you've implemented with your portfolio that you now manage with Zeno Equity Partners as well. How about we start with what enabled such a stellar performance with Dynamo investing in Brazil?

Brazil is far more industrialized than most other emerging markets, even back then. It had gone through a very heavy industrialization phase in the '70s. So there's a large internal domestic market. But most importantly, just like anywhere else in the world, there were company builders. There were people who decided that they wanted to start a business or that they wanted to run a business.

The truth is, whenever we can find great businesses to invest in, then it doesn't really matter that much what's happening around us. And it's interesting because when you're living in that place and you grew up there like I did, you kind of don't think about the environment that much, right? You don't think about the peculiarities of the place where you are compared to other places. You're just there. And

And within that environment, you know what you're looking for and you're looking for these great companies. And there happened to be great, great companies that people really didn't care much about.

And one thing I would probably mention is that in an environment that is maybe more unstable than something like some developed markets today, I think it can teach you the importance of just how to identify a resilient business model and how those tend to weather through just more difficult economic periods. So maybe you could talk more about that aspect of what types of companies you are looking to invest in.

It's interesting because for the most part over the course of the last 30 years, if you were an equity investor in the US, even further than that, 40 years, you had the wins at your back. Everything was sort of conspiring in favor of equity markets. The environment that we were sort of growing up in Brazil was the exact opposite. We basically had a huge win against our sales.

We had just come out in 93...

probably 10 years of hyperinflation, six or seven different currencies that were tried to try to stabilize the economy that didn't work. And then finally, there was one economic plan that ended up creating the currency that is still valid in Brazil today, the real, that actually worked. But at the time, nobody knew if that thing was going to work or not. I think the analogy that I make is Brazil in 94 was probably very similar to what Argentina has been over the course of the last 12 months, where

There's this great experiment going on right now that is actually working, but you never know. So in that environment, the only thing that we could really count on was the businesses that we were investing in. It was the ability of that business to reinvest capital at high rates of return when times are good and to protect itself from the vicissitudes of the market when times are bad. Resiliency and risk management were probably

far more relevant variables in our decision-making process than thinking about growth, for example. There wasn't really any bias or any predetermined bias to any industry that we should be paying attention to. It was so bottom-up. It was all about curating each company and understanding the quality of that business. And there were three things that from the start, they still worry me at everything that I do today when I'm looking at a business.

that really matter. The first was understanding if that company had established a dominant position in the market where they operate, which we call market power, which basically allows that company to generate high returns on capital, right? The second one is the ability of the business to reinvest that capital at high rates of return.

And the third one, which is probably the more subtle and the hardest one to find, is that this company had to be managed by people that we could trust and that we thought behaved like real long-term owners.

So basically, we were trying to answer these questions. We could find companies with those characteristics across a number of different industries, all the way from a car rental company to a beer company to a bank. As long as we could identify clearly those traits, and we thought there was a discrepancy between value and price, then we could own that business.

And you previously mentioned to me that the results at Dynamo were very much a team effort. I'd be curious just to learn more about this and how this process worked internally and how your team was able to identify great businesses and manage a portfolio of them.

I think it was very serendipitous in the sense that it worked because we were lucky that small group of people got together. And I don't know if it's replicable over time, but there are a few things that stand out. The first thing is whenever you walk into the office, and I make this point to everybody that works here at Zeno as well, is you got to check your ego at the door. It doesn't matter who you are. It doesn't matter where you come from. It doesn't matter how experienced you are.

Be ready to have every single thing that you say challenged, questioned,

And everybody understands that one of our main missions is to falsify hypothesis that someone else is bringing up, not because we have the objective of poking holes on that person's idea where we want to steal the limelight, but just because that's how you make the process better. And I think everybody who was working there understood that. So the first thing is there's no place for ego and humility is probably the number one trait that you need if you want to be a good investor.

The second one is that from the start, we were a genuine partnership. There was no hierarchy. And everybody understood that we were in this together and we were starting from basically scratch. Then that translated into an environment where everybody could speak freely and say what was on their mind all the time. And everybody was respected equally, irrespective of how young or how experienced you were.

And we ended up developing this culture where collaboration is highly incentivized, where the people who really do well in the partnership over the years are the people who not only are competent themselves, but who go out of their way to make other people better.

So that fosters an environment where everybody feels at the same time incentivized and protected. We had a bit of a sort of consensus-driven decision-making process where we had to build consensus on almost every single position that we had in the fund. Sometimes that didn't work. Sometimes we missed opportunities that somebody felt very strongly about it, but we couldn't build the consensus. But when you put

it all together, I think the trade-offs were very, very positive.

You started Zeno in 2022, and largely you're replicating the strategy of owning high quality companies, the strategy that you learned at Dynamo. And you had explained to me that you had used a data scientist to filter down your investable universe to around 300 stocks. And you narrowed that down to around 75 to 100 stocks after doing more of the qualitative work and due diligence. In one of your shareholder letters, you wrote about the

the benefits of capitalism and the prosperity that capitalism can bring to society. And I'm sure you're familiar with the study that was conducted by Hendrik Bessenbinder, which found that just 4% of companies in the US have generated all of the net returns since 1926. So when I hear about your filtering process, I just sort of immediately think of that study of trying to narrow down the best of the best long-term winners. And I think this fits pretty well into framing why

why you approach investing the way you do. So how about you talk a little bit about this filtering process and how that fits into the Besson Binder study and the way you think about the world of investing?

It's interesting, when I came across the Besson Binder conclusions, I was surprised that people were so surprised. I didn't know if it was going to be 4% or 8% or 10% or whatever, but I intuitively knew that most of the results are driven by a very small number of companies. And that makes sense, linking back to the comments I made in the letter I wrote about capitalism. Because

The reason why capitalism works and the reason why free markets and all that stuff that generated so much prosperity for the world over the course of the last 200 year works is because there's a driving force behind it, which is competition. And it's the only reason why we have so much prosperity in the world is because most of the value created by most companies is transferred to society.

And the vast majority of companies are lucky if they're able to earn above their cost of capital.

And that's great. That's amazing. The problem is that that same driving force of capitalism is the worst enemy of the equity investor. The worst enemy of the equity investor is not interest rates, it's not economic growth, it's not geopolitics. The worst enemy of the equity investor is competition. It's what kills the returns of an equity investor. So

If you understand that capitalism works and you agree with the assumption that capitalism works because there is tremendous competition and in spite of tremendous competition, people wake up every day and they think about starting a new business and they think about developing a new technology, even though they know that most likely they're going to get competed away, then the only logical conclusion of that is that there are going to be very few companies that are able to sort of escape the gravitational pull that

that competition exerts on returns on capital, right? So if that is the case, it's only those companies that will really generate outstanding returns over very long periods of time. We kind of call them the discontinuities of capitalism.

The companies that have not only escaped the power of capitalism, but that are managed by people who understand how important it is to do whatever it takes to stay there. And who have the wisdom to also understand what needs to be done to stay there.

So there are very, very few companies in the world that would really fit that criteria, that have escaped capitalism and are managed by people who are able to sustain a culture that will keep them there for a very, very long time. So we end up saying that there are probably 70 companies in the world, maybe even less.

that are really extraordinary, that if the markets were to shut down for the next 20 years, you could own these companies and you wouldn't come out of those 10 years and your money would have compounded at very good rates of return.

So we're looking at, say, the 300 stocks that were filtered down, filtered down again to around 70, and then you have a portfolio of 15. What do you think are some of the key things that stand out, say, in some of the companies you own relative to, say, the other 70 that didn't make the cut in the portfolio? What are some of the things that stand out the most, whether it's the market power and the level of competitive advantages with these companies you own, or is it the founder mindset, or

It's the founder's mindset. You find extraordinary companies when you look at their track record over the course of the last 10, 20 years that have generated very strong returns because the business is phenomenal, but they don't necessarily demonstrate the right cultural aspects that give us comfort that they will stay that way for a very long time.

There are a few names I wanted to touch on today. I think one that is probably one that a number of listeners are going to be familiar with that you own is LVMH. It's led by Bernard Arnault, who I've described as the Warren Buffett of luxury. Just a fantastic capital allocator. He has this big conglomerate where he's buying up different brands and perhaps making changes to some of these businesses in terms of how they're allocating capital and whatnot. But I think with a company like that, I think a lot of people are concerned, hey, this company has just gotten so big.

how much more room do they have to grow and generate high returns? So perhaps you could just talk a little bit about LVMH and why it made the cut for your portfolio. David Stein : There's not a lot to be said about market power and founders' mindset. So the question here is whether the reinvestment opportunity is good enough that if you're paying 23, 24 times earnings for this business, you're going to be able to generate the kinds of returns that we would like to generate when we deploy capital. Right? David Stein :

What drives demand for LVMH is a very straightforward, very simple thing, which is the number of millionaires in the world.

There are about 58 million millionaires in the world today. That number back in 2000 was, if I'm not mistaken, like 12 million. And the number is expected to grow to 85 million in 2028. These are people that have at least a million dollars in assets. On average, they probably have about three, four million dollars. Today, probably around 45% of all millionaires in the world are in the US.

From here, for the next 10 years, the vast majority of new millionaires are not going to come from the US. Take a place like India, for example. India has like 800,000 millionaires. We're not going to revert the trends that we've seen over the course of, I don't know, the last 50 years where income is becoming less equally distributed.

You're going to continue to see as everybody gets elevated from poverty, as we've seen over the course of the last 200 years when capitalism really started to work.

you're still going to see the top of the pyramid growing fast. And those people that are coming into the level of wealth where they start to consume luxury are probably more prone to consuming luxury than the ones that are currently doing it. If you think about places like Brazil, like India, like Indonesia, like Thailand, like Malaysia, China,

There's nothing that we can find that would point out to the possibility that they're not as, at least as eager to consume luxury as the Americans or the Europeans. And it's a funny thing because rich people, they all want to be able to recognize each other and identify each other.

And there are codes that they use to do that. And those codes are luxury, right? And those codes are represented by a very small number of brands that can be characterized as luxury. So if you think that trend is going to continue and the number of millionaires in the world is still going to grow 6%, 7%, 8% a year, as it has been growing for a long time, and you believe that these people are going to continue to behave the same way that everybody that came before them behaved...

then the growth is there. Is it cyclical? Yeah, next couple of years, they're probably going to have pretty mediocre growth because they're coming off of a very high growth period where they probably, they and everybody else in industry probably overdid it with price. If you think about it long term enough, the opportunity to continue to service these people and their needs is there.

Like I said, from a market power point of view, there are probably four or five luxury brands, luxury conglomerates, and a few more brands in that, that control that space. So we kind of look at this, and as long as they continue to deploy capital responsibly, as long as they continue to take care of the brands in the right way, everything is in their hands to prosper. And today, you're paying probably like 23, 24 times earnings that drop straight through cash flow.

that they will allocate properly or they will give it back.

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All right, back to the show.

That all makes a lot of sense to me. And it's nice to bet on some of these structural trends that are going to be really difficult to make an argument against those sort of trends turning the other way. And Bernardo, I know it's interesting to think he's 75 years old, worth nearly $200 billion, and certainly an embodiment of the founder's mindset, I would say. So if we turn back to what you're looking for in a company, I find it fascinating that you've spent the majority of your life living in Brazil, and then you

you moved to London in 2015. And today, the majority of your portfolio is actually invested in the US with the remainder of it in Europe, such as LVMH. Is this simply a matter of your filtering process, mainly finding a lot of US companies, or what do you think is at play here?

It's not preordained, so it's not something that we decided up front that we're going to focus on the US. We've been able to find a lot more companies in the US where as we go through

their behavior over time, they behave more and more like the companies that we like to invest in, in terms of how they think about the long-term perspectives of their businesses. And this is a very important aspect of the way we think, is that once you've reached that point where you've escaped capitalism, quote unquote, the vast majority of people, once they get there,

their natural incentives are to maximize short-term profits. So great, I've achieved this dominant position in the market that I operate in. I'm going to start raising my prices. I'm going to expand my margins. I'm not going to invest on my product anymore. I'm not going to be as much of a partner to my suppliers or my distribution as much.

I'm not going to focus so much on hiring the best people because I've made it, right? And I probably have a stock option that's in three years. So I want to pump up the profits of my business so that I can invest my stock options and make a lot of money. There are very, very few exceptions.

which is really what we mean when we talk about a founder's mindset. That once they reach that position, they're much more worried about the compounding effect that you're going to get from staying there for a very, very long time than whatever they're going to make over the course of the next three years. So instead of letting up on the quality of their product, they actually invest more in the quality of their product. Instead of raising their prices because they can,

they actually leave some money on the table for the consumer. Because the moment you shift from creating incremental value to your customer to taking a predatory approach, that's when capitalism is going to start working again. And either you're going to see competition coming, or you're going to see the states knocking on your door, or you're going to see your addressable market being hampered by your own behavior. So we happen to find in the US,

more of those companies that behave that way. So you take a company that we don't know, for example, Costco. To me, the thing that sets Costco apart is exactly that, is the fact that they've been time and time again willing to leave money on the table now to the benefit of their consumer and to the benefit of the long-term health of their business. That kind of behavior is so unique. It's so

so hard to find. And it's the ultimate filter. At the end of the day, you'll find a lot of businesses that are phenomenal. The question is, can they be phenomenal for 20 years? And are the people who are running those businesses thinking in that framework?

I was just rereading your 2024 letter just prior to hopping on the call here. And you made a point that ties in well with the point you made of very few companies can generate these excess returns for very long periods of time. So you highlighted that you're not only looking for these great companies that can do well during the good times, but those that can also take advantage of the tough times to position themselves even better during those good times. And it's that second point that's really the key to long-term compounding. And

A lot of investors, or maybe all of us have potentially got caught in a business where we thought it was well-positioned to be resilient during those tougher times. And say after a great five-year run during the drawdown, investors just sort of get burned. And I think you even highlighted that that's the main risk you want to avoid as investors. So perhaps you could expand more on that.

That comes back to sort of my origin story in Brazil, where we're always worried about what was going to happen if everything went to hell in a handbasket. Every time we invested in a company or we were looking at a company, the first thing that we would think about is what if everything goes wrong? And we have to make sure that that business was able to survive that and more than survive that they would be in a position to take advantage of that.

That goes back to sort of the start, the very early days in Brazil, because that's really what mattered. We're more about, I don't want to drown more than anything. And that's where sort of the market power and the founder's mindset are so important. The market power for obvious reasons, because when you are in a dominant position, which you're not abusing, there are levers that you can pull forward.

that will allow you to take advantage of tough times to redeploy capital in ways that others won't be able to do. In the founder's mindset, there's another aspect to it, which is what we're lucky for also is this sort of very unique combination of a culture in a business. And I emphasize a culture because it's never just one person. You have on one hand, a very clear sense of urgency,

of getting stuff done when things are not working, but at the same time, you have this obsessive focus on the long term. You will find amongst US, particularly US-based CEOs, a very strong sense of urgency. And you will find in certain family-owned businesses through this very long-term orientation, but that can sometimes turn into complacency.

So finding those two things is really, really rare. And it becomes particularly relevant when times are bad. The mistake that I see more people making that we try not to make is sort of confounding short-term momentum with longevity.

Everybody is very momentum driven. Everybody wants to be in the thing that is going to work really, really well in the next three years. And usually those things that is reflected in the valuations. And sometimes that kind of people get blindsided by the fact that you could do really, really well in three years. That does not necessarily mean that in five years or in 10 years, your business is going to be as good.

And we are always obsessed about when things go wrong, when things go bad, if the world is not working the way it should work, how are we faring? That's why I like to say that to me, sort of active management, which if you want to be very precise about it, is what we do. It's much more about risk management than it is about sort of enhancing returns in comparison to a benchmark. So I'm obsessed about risk.

making sure that I can survive the tough times so that I can compound my capital over very long periods of time.

Robert Leonard Yeah. If we dive in deeper on the point you just made there, you said that what you do at Zeno Equity Partners is more about risk management than enhancing returns above some, say, arbitrary benchmark. So in your letter, you talked about how the benchmark, although it could be said it's a passive strategy, it's a number of companies that are selected by some group of people, for one. Number two is a

A passive strategy is owning a number of companies that you likely don't know much about and companies that aren't going to fare well during the inevitable market downturn. So in an active strategy, you're avoiding owning those losers, let's call them, losers in a portfolio or whatnot, but you also get the benefit of being well diversified and likely own a number of winners that hopefully carry a lot of the weight. How about you just talk more about that point you just made where it's more about risk management than the enhancement of returns?

There's one very important principle, which is, to me, risk management has to do with the underlying business that we're buying. We're buying pieces of companies. So what I care about is the underlying risk of that business. You don't measure that based on market-driven metrics such as volatility and volatility

value at risk, stuff that is representative of how the market is pricing that asset. So if you think about risk management as volatility management, then you probably are better off owning a very broad portfolio of companies. Honestly, I couldn't care less about that. I want to own businesses where the underlying risk is low.

relative to the return that it can offer me. When I think about risk management, that's what's in my mind is the underlying risk of that business that I'm buying. If that means that the portfolio will be more concentrated because there are very few businesses that offer me a low underlying risk, that's fine because I'm not trying to think about these things with a 24-month window in mind.

Most sort of active managers, their main focus is just, I have to beat this index, and I have to beat this index over the next, I don't know what, 24 months, 18 months, 36 months. The behavior that you're incentivizing with that is a behavior of measuring yourself against this broad portfolio of companies and just trying to overweight some of them and underweight others

so that you can then figure out how the market is going to behave with those specific names. I have no clue how to do that. Maybe if I did, we would manage $50 billion, but I have no idea how to do it. So what I worry about is avoiding permanent capital loss. And avoiding permanent capital loss is about not investing in businesses that run the risk of losing a lot of value over time. So that's sort of when I talk about risk management, the way that we

Select a portfolio. It has a lot to do with mitigating the underlying business risks of the companies that we own.

If we dive in further on the founder's mindset, I think that assessing the management team of a company can sound easy, but I think can be a bit more difficult in practice because there are a number of managers that will likely say what you want them to say because they know what you want them to say, essentially. So how about you talk about some of the biggest mistakes you've made with regards to properly assessing a management team?

I think the mistakes that we made more recurrently is putting too much emphasis on the financial aspects of the alignment of interest. Taking that as a proxy for how well aligned people really, really are. What we found over time is that

You want the right kinds of incentive that will foster the right kind of risk-taking. And that doesn't necessarily mean loading up on options that will vest in a short period of time and diluting your investors and having very, very aggressive financial targets in the short term.

So I think the mistake that we made in the past, and I think we've learned and we're making that mistake less and less, is where you put too much emphasis on the financial incentives and you don't really spend time looking at the behavior. Because at the end of the day, you're absolutely right. CEOs these days, management teams are so well-rehearsed and they're so good at telling the story, right?

You're not with very rare exceptions. And there are exceptions of people who are truly honest, transparent, and unrehearsed when we speak to them. And I like to think that all the companies that we own are like that.

Because they're so rehearsed, what really matters is looking at the behavior. And you can look at the behavior. You can go back to periods where things were not going well. And what was the management team saying? How were they behaving? When the stock, for any given reason, went down a lot, did they buy shares? Are they in the habit of selling shares as soon as they vest?

How are people promoted from within? One thing that we do here is we probably speak to, on average, 15, maybe 20 former employees of businesses. And I think a lot of people do that. You talk to people who've worked for all the media, for example. You can see the difference and what their culture is. And that translates to the results of the business over the long term.

So yeah, I think paying too much attention to financial incentives is probably a recurring mistake. And then the other thing I think is that I think a lot of people, we live in a world where there is no informational advantage. Everybody knows everything. Everybody has access to the same data. Everybody's able to build the spreadsheets. Everybody has everything. The only thing that makes a difference is behavior.

And in our case, we maybe could be different is that we focus a lot of time on very few things and we're thinking with a very long-term mindset. Doesn't mean that we're going to have better access to anything. Everybody knows everything, but it's what you do with the information that you have and how you meet even different moments that really matter.

And given your experience investing in Brazil, you've seen a number of businesses that have just been put to the test during these difficult market environments. I was curious if there's any types of business models that you see today that you just largely avoid, maybe others can get attracted to it due to things like high return on capital, high insider ownership, management that thinks long-term and whatnot. Is there anything that sticks out in that?

where there's this experience you have that simply many other investors don't have that's changed the way you sort of view some business models that are out there in the US or other countries? It's a good question. It's very hard to generalize.

Because even when we were investing in Brazil, it's not like we could find a common thread of business model across all the different businesses that we invested in. Or even if you look at our portfolio today, we have a VMH, we have a software company, we have an industrial gases company, we have an airline. Who could have thought that we would invest in an airline? I never thought in my life that I would invest in an airline until I met Ryanair.

But I think that the problem that we find is not so much that there are business models that people think are great that actually aren't. It's what happens after you establish that it is a good business model.

how do you operate that business then to make sure that it continues to be a great business model for a very, very long time? So I'll give you an example. The only of the sort of mega large cap companies that we own in the US is Amazon. Why is it that we own Amazon and we don't own the others? Because in Amazon,

It was the only company that we, and we've looked at all of them, almost all of them. It was the only one where we could see the recurrence of the kind of behavior that we believed would sustain the moats and would sustain the reinvestment opportunity for a very, very, very long time. That doesn't mean that Google or Microsoft aren't amazing businesses. They are fantastic businesses.

But I don't know, I literally don't know, I don't have a view, if they have the right culture that will allow them to sustain that reinvestment opportunity for a very, very long time.

Let's talk about a couple of names in your portfolio. The first one I wanted to touch on was Lindy PLC, ticker LIN, a best-in-class industrial gas and engineering company. And I discussed with you whether there was any names you wanted to touch on. And you said this one wasn't discussed by anyone, which is sort of what you want to find with a lot of names, something that tends to get overlooked. And I think one of the reasons it can be overlooked is when I look at the past five years, they're seeing...

mid-single-digit top-line growth, yet the stock has continued to just trounce the S&P 500. Talk about how a company like Linde can deliver such good returns to shareholders without necessarily delivering the top-line growth that you see in the LVMHs, the Amazons of the world.

First and foremost, the company has double DPS in five years. So that's the reason why it's done so well at the end of the day, right? When you look at the top line growth, you have to be mindful of some accountancy counting peculiarities. They use natural gas as their main raw material. And the contract that they sign with their clients is that they pass through the natural gas at cost.

So whenever natural gas prices are going up or down, they'll have an accounting impact on their revenues that doesn't really matter for the profits. Linde has blown organic revenues, X acquisitions, X currency, et cetera, by about 6% a year over the course of the last five years with volume growing about 1% and price growing about 5% to 6%. Now, looking at this company from the framework of market power,

We invest in opportunity and the founders mindset. Market power. The industrial gases market is 90% of the businesses in the hands of three companies in the world. 90%, this is a global business that exists everywhere in the world from Brazil to China, to the US, to Germany, to India. And there are three companies that have 90% of the market share.

It is the closest thing I've ever come across to an unregulated utility.

You sign a long-term 20-year take-or-pay contract with all the kinds of inflation protection that you would want. And once you establish your air separation unit next to that big client that you're going to supply on a take-or-pay basis, you then can supply everything else in a catchment area of up to 300 miles where you're basically a monopoly. And the reason why you're a monopoly is because you're basically transporting molecules of air

and very heavy tanks and cylinders, and those don't move very well, right? So once you establish the catchment area, that's it. You own that catchment area. So the market power is clearly there. Linda probably has one of the top three management teams that I've ever interacted with in my life.

And they have demonstrated again and again that they behave exactly the way that I would like a company that I invest in to behave. They have been extremely disciplined in their capital deployment. They are extremely transparent with investors. They have a lot of skin on the game. And we've spoken to dozens and dozens of people that work at Lynda, and everybody is cut from the same cloth.

And Juan, their investor relation, he could be the CFO of any company around. Matt White is a phenomenal CFO. The chairman, Steve Angel, who was a former CEO, was a phenomenal operator and steward. And the current CEO behaves exactly the same way. So they have all the attributes from a behavioral point of view that we like. And it's interesting because the three companies that own 90% of the market, they're all listed. It's Linde, Erlich, Kiedler, and Air Products.

And they do exactly the same thing. And they're the same business. And then you stack their returns against the other guys, the fundamental business returns. And it's like they're operating in a different level.

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Outside the founder's mindset, what do you think is some of the primary drivers of their competitive advantage versus the other two players?

I don't think there's another. I think that's it. I think that's literally the founders' mindset is how they built this company over time. It's interesting because Lynda is a spinoff from Union Carbide. And somehow that culture worked in a way that they over time built positions in certain markets that are extremely valuable that other companies that were competing with them didn't really pursue. And Lynda used to be called Proxair.

And the three companies that I alluded to used to be four. And what happened is that Proxair bought Lynda, which was the biggest one. And through that acquisition, they became the largest one in the industry and basically crushed it since then. The interesting question here is your reinvestment opportunity, right? So what are the drivers, given that industrial gases is something that would grow in line with industrial production, what are the drivers that are going to allow them to redeploy capital at high rates of return?

The high rates of return are there. The question is, is there demand? And what we're seeing now in the world is that this push towards the decarbonization of supply chains is very good for them because one of the things that they sell is hydrogen. Hydrogen is a very unfriendly product for the environment unless you're able to capture the carbon that comes out from breaking the natural gas.

And there is a lot of demand from companies, particularly in the US, to decarbonize their hydrogen supply chain. And they have a backlog of about 7 billion new orders that they will deploy over the course of the next few years. And a big chunk of that is related to decarbonization. And then this effort that we see across the world of reshoring supply chains,

is also very much in their interest. So they have these two sort of long-term drivers that, again, you're going to have one year or another year where the growth is not going to be amazing. This year is probably going to be a pretty mediocre year for growth. But at the same time, the opportunity is there and they will redeploy capital accordingly.

You mentioned the company had doubled EPS in the past five years and made a note here that the return on capital had gone from 14% in 2020 to 24% in 2023. Maybe you could speak more to why their profitability over the past few years has increased substantially.

It's a couple of things. One is sort of the benefits from the merger between Proxair and Lynda, which happened in 2017, if I'm not mistaken. And then it took a while for them to get approved, et cetera. And then they started really ripping the benefits. And the second is inflation is a lovely thing for this business because they're extremely in control of their costs, but they have an almost... That's why I say it's like an unregulated utility.

they have an almost automatic pass-through of inflation to their numbers. So that's another thing that we like about it is it will, if we live as I think, as we believe that we will continue to live in an environment where inflation is not going to go away, that's a great asset to own.

Wonderful. Well, thank you for walking through all three bullets. So you also own Appfolio, which we recently just did an episode on here recently, and you were kind enough to help me a bit with the due diligence of that one and your colleague, Lucas. So thank you very much for that. In a presentation your team gave on Appfolio, at the very end, you included a quote from Charlie Munger, the big money is not in buying or selling, but in the waiting. So before we talk about Appfolio,

I just want to mention, I love that quote and very much resonated with it. So perhaps you can make a comment or two regarding that quote. Munger is probably the biggest influence in my life as an investor. And also because I love a sense of humor. To me, that is such an obvious sort of conclusion. And maybe it's because of my lack of skill of trying to understand market structure and the behavior of people. When you're trying to make money in the short term,

you're trying to understand human behavior. Markets in the short term are not driven by fundamentals. Markets in the short term are driven by behavior. And if you're trying to buy or sell very frequently, you're always putting yourself in a position where you're trying to guess the way that people are going to behave. And I don't know how to do that.

And because if I had to do that, then I would have to worry about things like volatility, like the kind of stuff that people that invest in markets really have to worry about.

So, to me, it's just find a great business or find a collection of great businesses managed by people that are very high trust. And that's the thing that I think I learned in Brazil and I learned from Munger and Buffett as well, is that you've got to invest with people that you trust. You're going to make mistakes. You're going to place your trust on the wrong people every now and then. And the good thing about public markets is that you can change your mind.

limit yourself to only invest in environments where you think it is a high trust environment. And then you can wait. And then, you know, you can just focus your efforts and your brainpower on other things than, you know, is this the right time to buy? Is this the right time to sell? That's why I love that quote so much.

I'm reminded of just when I speak with people generally about investing, I'll get various questions from people, most of which are simply annoying questions. People want to know what's going to happen to the economy or the market in the next 12 months. Is it going to go up or down? Is this stock going to double in the next year? Is Nvidia going to continue to see their stock price soar? It's like all these questions I could care less about. I just want to highlight the key lesson that Munger is sharing here. It ties into the lesson that

that the real secret of long-term compounding is letting great businesses compound your wealth over long periods of time. When you run the numbers on a moderate rate of compounding over 10 plus years, that's why you see these great fortunes made in the stock market. It's never predicting what's going to happen this year with the S&P 500. It's not going to be what's going to happen with interest rates, inflation, the economy. It's all about understanding that

very critical concept. You're absolutely right. But the truth is, it is so against human nature to behave that way, both intellectually, because our minds are just, many people have said before me, our minds are not built to understand the impact of compounding, but also because we were bred to react. It's in our nature to feel like we have to be doing something all the time.

So, you know, it's very much a struggle against your natural urges to behave that way. If you're able to do it and you're able to figure out what works in terms of the businesses that you're going to own, then you can end up, you know, and you live long enough like Charlie and Warren did or do still, then, you know, you're going to benefit.

So if we tie this into AppFolio, I shared in that episode that this stock has compounded at over 35% a year since the IPO in 2015. Yet if you took this sort of short-term approach, there were a number of years where you would have lost money owning this stock. So I'm sure many people would have got shaken out during the drawdowns, but the long-term investors ended up prevailing at least thus far. And I think at first glance, many people would assume that software companies are

eventually just simply going to be disrupted by AI. And that's sort of the big question for me is like, what does this business look like 10, 15, 20 years from now? And I know you've certainly thought about that a great bit. So perhaps you could talk about what gave you the confidence in this company's durability in the property management space and how you came to develop the level of conviction you have.

And just to be clear, AI is something that is much more recent in the history of the business than our investment in the company. So there's no doubt that the emergence of AI in the way that we've seen it in the last couple of years, it has widened. The way we like to think about it is widened the dispersion of outcomes for this business. No doubt about it. So there is a new thing that we have to think about. Now,

A lot of people faced with that would immediately react and feel like they have to do something. I better sell a photo because then software is dead and that's it. And we like to be a little bit more deliberate in how we think about these things and go a bit deeper. So I think there's no doubt that AI is going to have a very significant impact on a lot of software businesses. Sure. The way we're thinking about this right now is number one, basically, since it really took off,

Upfolio embraced it from day one, both in terms of their tech stack and in terms of their product development. Everything in the company is touched by AI more and more. Which I think also ties into the culture. It's not just a company that just talks about AI. They're actually doing something about it.

Yes, that's exactly right. And there is a sense of urgency, like I was talking about before, that led them to immediately sort of embrace it and take advantage of it. And you see that. And for the companies that are able to do that, AI could be an incredible boost to their profitability and their business.

The second thing is when we think about the specific market in which Upvoto operates. I think AI is a particular threat to software business, whether they're VMSs or horizontal, where there is a very repetitive workflow, where the interactions are very predictable.

and where there is an algorithmic advantage of the business. When you think about property management, which is where this company is inserted, it's anything but that. When you think about the scope of everything that Upfolio does and how not recurrent are the different tasks that the software has to deal with,

It shows that this is one where AI by itself would be very hard to replicate. Yeah, I'd like to tap in more on that. So let's say you have a tenant who's putting in a maintenance request and this gets automated. There's email sent, the contractor gets an email of what the maintenance request is. So that's something that is a highly automated process. Perhaps you could touch on these other parts that aren't so simple and aren't so easy to automate.

Even that is not that simple. These things are not that straightforward because there's a human on the other side that makes it more complicated. But like, for example, screening. Every time somebody else moves in, you got to screen that person. You got to go through, you got to get documents from them. They have to upload the documents. There's a bunch of stuff. Accounting. You have to get the accounting done. You have to send the accounting to the property owner.

The property owner will come back with a question. All these things are a lot more complicated. And then you have the data component. A folio is a system of record as well. So what we kind of like, where the conclusion that we're arriving at at this point is that the closer you are to being the core operating system of an activity that is very diversified,

the more protected you are from an agent, just somebody at a property manager coming up with a little agent that will automate a specific thing. There are a number of things happening at the same time, right? So that's our view right now. Now, like I said, we're obsessed about the underlying risks of the businesses that we manage. And we're scrutinizing this thing on a daily basis. And I'm happy to change my mind if the facts change.

I have no problem with that. Right now, the evidence is that this is working in favor of the company. Also because when you think about the competitive landscape, above Epifoto, there are two very large, very old legacy property management software companies.

We'll have a much tougher time embracing AI than they will. And I think right now it's playing to their favor. But like I said, the dispersion of outcomes has increased. So we have to be mindful of that when we're looking at the business. And we know that the good thing is that we know there's a group of people running this business that are even more worried than we are about these things and seizing the opportunities and will act accordingly.

Yeah. I mean, despite all the hype and talk around AI, it is going to be fascinating to see how this plays out in all these different industries. And VMS is something that just is so fascinating to me, given the quality of many of these businesses out there. One of the great things about VMS is how difficult it is for the product to be ripped out of the customer's hands. But Appfolio has been an example where they've continued to manage to

rip the competitor's software out of the customer's hands and putting it into the hands of AppFolio. So perhaps you could talk more about that, despite the advantages of these entrenched players working with property managers for many years, they're still able to get customers to convert. So perhaps you could touch on that as well, because that was also one of the big questions for me is, how much longer are they going to be able to do this?

It's interesting because, I mean, they will tell you that it's becoming harder and harder as they move up the chain and they move towards larger property managers. The sales cycle is getting longer and longer. So there's no doubt that they're facing much higher switching costs of their target new clients than they were when they were acquiring like small clients and smaller property managers. That is unequivocal. But it goes back a little bit to...

the behavior of the incumbents when they get to that point where they escape capitalism. Has RealPage really invested in their product that much? RealPage is an amalgamation of a bunch of different tiny companies that they bought over time. Then they got bought out by a private equity fund, which probably levered the heck out of it and is probably much more focused right now on generating cash flow than anything else.

The fact that a photo has been as successful as it has been, even though it's been slower than what they would like, they're still getting a lot of new customers at the higher end. Is this a function of the fact that the incumbents were not as disciplined in how they managed their business?

I want to be mindful of your time here, but I did have one more question before giving you the final handoff. So from age 19 to age 50, your life has been dedicated to the craft of investing. And I could only find one other interview you've done, which happened to be in Portuguese. And assuming the translation was correct, you mentioned that one of your favorite non-investment books was Mastery by Robert Greene. I was curious if you could just say

say a few words about this book and what you learned from it that helped you become a better investor? I came across that book very late in life. I wish I had read it when I was 19, because it would have framed my future in a much more interesting way than what it's kind of like fumbling around and trying to figure stuff out. But it gave me a great perspective on what it means to be a master in something and the journey to get there.

What does it mean? How do you start? What is it that you're looking for? Right? And how do you recognize mastery? And first of all, it was very sort of elucidating in terms of when I reflected on my own career and the phases that I went through in my life or that I'm still going through. And it gave me a very clear understanding of where I'm headed as a practitioner. What am I striving to in that journey to sort of master something?

And maybe I'll master this when I'm Buffett's age, but at least I know what to look for.

Yeah. I mean, I just did an interview with a gentleman from Barron's, his name's Tay Kim. He just wrote a book about NVIDIA. One of my favorite things about reading a book like that is just learning from someone who is dedicated to the craft of mastery, but just learning from someone like that of how they behave, where their focus is, having that founder's mindset of taking a 20, 30 plus year view in all the actions you're taking today.

It's such a fascinating topic. And I'll have to pick up that book and I'll be sure to link it in the show notes for those who are interested. That's great. I didn't know about this book. I'm going to take a look at it. But Christian, I really appreciate you joining me. This is one conversation I really enjoyed and was really looking forward to. So thrilled to have the listeners tune into this conversation. So before I let you go, please give a handoff to how the listeners can learn more about you if they'd like and Zeno Equity Partners.

Thank you so much, Clay, for taking the time to speak to us and learn a little bit about our story. Anybody who's interested, you can find me on LinkedIn or our website is xenoeb.com, where we have all our letters available. We write on a quarterly basis. The first three letters of the year, we're usually writing about one company that we're invested in. And the last letter of the year, we talk about more broader topics that are of interest to us and to our investors.

Well, thanks again for joining me and thank you for being so giving of your knowledge and expertise with our listeners. Thank you very much. It's been a pleasure.

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