What is a spawner?
According to legendary value investor Mohnish Pabrai (Trades, Portfolio), a “Spawner” is a company with the so-called "DNA" that reflects a deep conviction in the importance of “relentlessly adding and incubating new businesses” that have the potential to be massive compound growth engines. Pabrai claims these types of companies should “take failures in their stride, as they will have many." Ultimately, Pabrai says, this is the business mindset needed for true growth companies.
A great example of a Spawner company is Amazon (AMZN, Financial), which has a strong culture of “experimentation” and making “bets” but “not bet the company bets." In his 2017 letter to shareholders, Amazon CEO Jeff Bezos stated:
“Staying in Day 1 requires you to experiment patiently, accept failures, plant seeds, protect saplings, and double down when you see customer delight.”
Pabrai also said that “Microsoft (MSFT, Financial) would have been a shadow of itself without spawning," and "General Electric (GE, Financial) and IBM (IBM, Financial) would have died decades ago.”
Advantages of Spawners
Spawners reinvest their pre-tax earnings to grow. This gives them a major advantage over companies that are “profitable” by sacrificing growth opportunities. For example, Amazon was criticized for many years for not making any money. Aswath Damodaran, a Professor of Valuation at New York University, calls Amazon “the field of dreams story,” referring to Kevin Costner's classic movie and the famous line “Build it and they will come.” Amazon had a long-term plan all along to build a great service for customers and expand its user base before focusing on profitability. Without this approach, not only would the company have not been able to build out its scale so rapidly, but it also would have had to pay approximately 25% of its earnings as taxes.
According to Pabrai, “Capitalism is brutal… Virtually all Businesses and Business models mature and die. Spawning keeps the mothership young and healthy.”
Most businesses follow a corporate lifecycle which goes from disruptive startup to high-growth business, a mature stage and then decline. Many businesses start to decline because they fail to continually innovate, as innovation takes a lot of bets to succeed. Spawning helps them to continually create new business lines. Not all bets will be successful (just think of the Amazon Fire phone), but one major success makes up for a whole lot of failures. For example, Amazon's Amazon Web Services is now the market leader in Cloud and makes up the majority of the company's profits.
In his presentation on Spawners, Pabrai talks about a Spawner stock called Kotak (BOM:500247, Financial) that he was "smart enough to buy in 1995" but "dumb enough to sell in 2000" at zero gain. This Indian broker would have been a 200-bagger if he had kept holding it.
The five types of Spawners
Pabrai identifies Spawners as falling into the five categories described below:
- Adjacent Spawners. These companies expand into related business lines. An example is Starbucks (SBUX, Financial), which started with coffee and added frappuccino bottles, Verismo coffee machines, Starbucks Reserve and even Starbucks alcohol.
- Non-Adjacent Spawns. This group creates or buys businesses in unrelated areas. For example, the Chinese company BYD Co (SZSE:002594, Financial) went from electric vehicles to add Electronics, New Energy, Rail Transit and even face mask manufacturing.
- Embryonic Spawners. These types of companies acquire smaller businesses and then grow them into huge businesses. For example, Meta Platforms (FB, Financial) acquired Instagram, Whatsapp and Oculus VR, which will become a key part in the Metaverse. Imagine if Meta didn’t acquire Oculus VR - they would find it very difficult to change direction as they are now doing.
- Cloner Spawners. These companies are not very innovative and instead operate with what I like to call the “fast follow." Microsoft is a great example,with Microsoft Office, Explorer, Azure and Teams. You may even argue Microsoft “copied” the GUI (Graphical Interface) of the original Mac - Apple (AAPL, Financial) even sued them in 1988 over it.
- Apex Spawners. These are the greatest Spawners which apply all of the methods above. The majority of 10 or 100 baggers are in this category. Examples include Amazon, Alibaba (BABA, Financial), Alphabet (GOOG, Financial)(GOOGL, Financial), Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) and Baidu (BIDU, Financial).
How to find Spawners
Pabrai starts searching for Spawners by looking at the history of the company and asking the following questions:
- Does it have strong spawning DNA?
- Does it have a great capital allocator at the helm? Ex. Jeff Bezos, Warren Buffett (Trades, Portfolio), Pony Ma.
- Does the company have below a “$50 billion” market cap?
Pabrai has what he calls the “$50 billion” rule. There were greater than 3,700 IPOs in the past 20 years, but just nine of these grew to exceed a $100 billion market cap. Thus, working backwards, he reasons, if you want to find a 10-bagger, then it's best to look below a $5 billion market cap. For 100 bagger stocks, look below a $500 million market cap. For example, Amazon is a fantastic company, but it would be pretty much impossible to become a 10 bagger by this point, as the $1.5 trillion market cap would need to grow to $150 trillion to be a 100 bagger. To put things in perspective, the GDP of the entire world is $84 trillion!
Long-term compounders
Pabrai has praised the practice of investing in “long-term compounders” with a “set it and forget” method. He quotes the legendary investor Nick Sleep, whose Nomad Investment Partners averaged 20.8% returns for 12 years with over 40% of the fund value in just Amazon stock at one point. As Sleep once said, “The truly brilliant investors weren’t investors, they were entrepreneurs that didn’t sell."
Non-Spawners
The majority of companies aren’t Spawners, even though they may have great businesses. These types of companies tend to focus on the core business lines and view other businesses as distractions.
For example, McDonald's (MCD, Financial), which has an incredible core business, spotted Chipotle (CMG, Financial) very early on and even took a 20% stake. However, the company felt the other business (even though related) was a distraction and sold its stake in 2006. Chipotle stock has since then went up by 3,200%, as they had such a long growth runway ahead. Even Ford (F, Financial) sold Jaguar Land Rover to focus on its core brands!
Non-Spawners are usually characterized by using excess cash to buy back shares or pay dividends. These companies tend to have strong earnings, but will be taxed on them.
