💎Asset-light businesses are superior

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Asset-Light Businesses Models are Superior 👑

Lawrence Cunningham (The Author of Quality Investing & Quality Shareholders) once said: "Asset-light industries are attractive since they require less capital to be deployed in order to generate sales growth"

This means that asset-light businesses can grow without large investments. As an example, if you run a telecom business, you have to build out costly infrastructure to get access to customers and build cash flow. This requires a lot of capital upfront, and you might not see a return on that capital before 5-10 years.

An asset-light business lets you acquire more customers, and sell more to your existing customers without large capital investments. This is why SaaS (Software as a service) businesses are so attractive investments. The incremental cost of a new customer is very low. It does not require huge upfront investments. This also allows these businesses to use more capital to develop their products and utilize smart marketing strategies to attract more customers.

EY did a study comparing the total shareholder return of asset-light businesses to their asset-heavy counterparts in different sectors:

Source: https://www.ey.com/en_no/strategy-transactions/how-asset-light-strategies-and-models-can-boost-business-growth

As you can see, the asset-light business models did significantly better than the asset-heavy ones. The return comparison is total shareholder return (TSR).

Note: There are many examples where an asset-heavy business model can be superior. It creates a natural barrier to entry. If you need billions invested to even get into the game, way fewer competitors will be attracted to compete with you. This is why we must understand the business model and competitive advantage in-depth before making decisions.

Why do capital-light business models promote better returns?

The more of the total business you want to keep in-house, the more work it takes to maintain and develop the different systems and functions. By outsourcing elements of the business that is not part of the “core business”, companies are able to focus their time and attention on elements that are important for TSR:

• Market/Customer opportunities for increased sales

• Innovation through collaboration and increased go-to-market speed

• Less capital is tied up in the business, which increases margins and provides more cash that can be used to reinvest into promising projects

• Companies utilize asset leverage to get a better return on capital employed (ROCE)

Source: https://www.ey.com/en_no/strategy-transactions/how-asset-light-strategies-and-models-can-boost-business-growth

How to identify an asset-light business model

For our example, we will use two ratios to determine if a business is capital-light:

• Capital Expenditure/Sales should be lower than 10%

• Capital Expenditure/Operating Cash flow should be lower than 20%

Note: The lower these numbers, the better.

Capital Expenditure / Sales

Let’s use Fortinet as an example: First, we find Fortinet’s revenue for 2023 in the Income Statement (Yahoo Finance). Revenue for 2023 = $5.3 billion

Next, we need to find the capital expenditure figure, located in the Cash Flow Statement:

Capital Expenditure for 2023 = $204 million or $0,2 billion.

Now that we have both figures, we put them together:

Capex/Sales = 0.2 (CapEx) / 5.3 (Revenue) x 100 = 3.77%

Capex/Sales of 3.77% is well below 10% and within our range for a capital-light business.

Capital Expenditure / Operating Cash Flow

Now let’s look at the next ratio. Capex / Operating Cash Flow. Here you can find both in the Cash Flow Statement:

Fortinet’s 2023 operating cash flow = $1.935 billion. Now, let’s put it together:

Capex / OCF = 0.2 (CapEx) / 1.935 (OCF) x 100 = 10.33%

Fortinet is below our requirement for both sales (<10%) and operating cash flow (<20%, which means it is considered a capital-light business.

8 Examples of capital-light business models:

• Adobe

• Paycom

• Fortinet

• Admicom

• Mastercard

• Novo Nordisk

• Meta Platforms

• Constellation Software

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