Looking For Billion Dollar Opportunities? Get Ready For The Rise Of Asset-Heavy Business Models.
Summary: Over the past decade, conventional wisdom has told investors to focus on asset-light business models. Financially intensive opportunities have struggled to excite investors because they cannot scale with ease. But with low interest rates, cheap debt, and the ability to finance capital expenditures, asset-heavy business models will grow over the next ten years, and they will present numerous billion-dollar business opportunities. 10x Value Partners is excited by this shift, and we have built an ecosystem that can support the rise of asset-heavy business models.
Asset-heavy business models have always been approached with caution, as they simply do not have the agility or flexibility that can lead to rapid growth. But the new economic conditions of low interest rates and cheap debt has given fixed costs businesses a new foothold. Asset-light businesses will always offer positive venture opportunities, but with easy financing options now available, the overall mentality of investors has and will tilt more towards asset-heavy models. A unique opportunity awaits those ready to capitalize.
Believers of asset-light businesses will laugh at the idea of fixed-asset models. Much of that has to do with the rapid returns digital innovation has fuelled. For example, Airbnb (an online marketplace of accommodation bookings) managed to build a catalogue that can rival established hoteliers such as Marriott and Hilton with comparably little funding. Airbnb’s asset-light structure gave it success, and if it had made property asset and real estate purchases, its growth would have slowed considerably.
So what is the deal with asset-heavy businesses? Should they be preferred? We will discuss the four key advantages of asset-heavy business models and how they will take up a larger market share moving forward: (1) Full Value Capture, (2) Vertical Customer Integration, (3) Low Interest Rates, and (4) Flywheel Cycles. With the following information, you can identify billion-dollar opportunities that match the new economic reality.
Asset-Heavy Advantage #1: Full Value Capture
While asset-light businesses enjoy economic flexibility and low overhead costs, they suffer from a lack of full value capture of a product or service. In fact, asset-light models improve the value of the underlying asset, but are unable to access that revenue or monetary appreciation themselves.
Our Airbnb example can help demonstrate this value capture loss. Through Airbnb, properties can generate more rental income, which leads to an increase in property value (often in the range of $100k up to $1m). Airbnb creates real estate value that it cannot access because it does not own the property. With 6.2 million real estate properties listed on Airbnb, you could argue that roughly 100$ billion dollars in value was created outside of the platform. That value is likely similar to the entire market capitalization of Airbnb itself.
While asset-heavy models do not have the rapid growth of asset-light models, once the company has established, the full value of each product or service is kept within the business. Revenue increases can boost profit margins, but they also increase the value of each owned asset. Asset-heavy companies build profit but also capture the value their business adds to the underlying business.
Asset-Heavy Advantage #2: Vertical Customer Integration
In a typical scenario, asset-light business models rely on third parties or individual entrepreneurs to provide inventory supply. While this lowers costs and reduces work expenses, it limits the platform’s ability to manage high-level quality control and to develop an enhanced user experience.
If you own and operate the entire supply chain (as asset-heavy businesses do), you have complete control over user experience. You can provide a uniform product to your customers, and in the long run, that kind of detail and attention to your clientele will result in a larger market share. Customers will shift to the business that offers the best solution. Asset-light platforms cannot compete against the customer satisfaction and brand trust that an asset-heavy model can build.
Asset-Heavy Advantage #3: Growth Fueled by Low Interest Rates
Central banks have lowered interest rates from the mid-single digits down to almost or even below zero. With the prevalence of Covid-19 and the slow economic recovery from lockdowns, it looks like interest rates will stay low. An aggressive uptick in the benchmark rate would trigger the collapse of countries that currently face high debt/GDP ratios. Hedge-fund legend Ray Dalio mentioned that credit is now free for anyone creditworthy, and it will likely stay that way.
Low interest rates are a boon to asset-heavy models. When debt came at a high price, any business asset limited the potential growth of slow-moving companies. Now that debt is virtually free, a business can take on assets with almost no reduction to business expansion speed. You can capture the value of an asset without any upfront cost. A previous barrier to success is now removed for asset-heavy business models, and that will help them compete against other agile businesses. Case in point: Amazon Web Service is the most profitable business segment of Amazon. AWS offers cloud-based computing, renting data centres and computing power to worldwide customers. It owns that tangible asset with almost no debt cost.
Asset-Heavy Advantage #4: Fly-Wheel Cycles
Once an asset-heavy business reaches a certain level of scale, it has a large pool of assets that generate income. The asset pool leads to the benefits of diversification. If one particular asset stops producing value due to a breakdown or any other reason, the overall collection of assets can absorb this short-term distortion. Financial institutions find a diversified business far less risky, which can lead to more attractive interest rates. Access to additional credit and debt at better rates gives asset-heavy business models a growth advantage since the company costs decrease. Lower company costs can result in lower pricing, that in turn leads to consumer demand. A positive flywheel leads to an increase in profit and scale compared to competition.
We can already see other asset-light companies switching as they take on more fixed costs to take advantage of the flywheel scenario. As mentioned before, AWS has now expanded into logistics infrastructure additionally to its data centres. Netflix has moved from digital streaming and now commands a robust content production facility. The move into asset-heavy business models has begun, and the company that can build flywheel cycles off of stable assets has a head start.
Success Drivers Of Asset-Heavy Business Models
By now, you probably understand the importance of asset-heavy business models over the next decade. But not all industries are suited to the introduction of fixed-costs or intensive asset allocation. Financial institutions still do extensive assessments of a company before they lend money to asset-heavy borrowers, and that can limit growth. There are three elements to consider: (1) High predictability and low volatility of cash flows, (2) Relative stability and/or predictable value of the underlying asset and (3) a Liquid resale market.
These three factors determine a businesses chances of a loan default, and banks rely on that information before handing out low interest rates, the primary driver of investments into asset-heavy models. High predictability and low cash flow volatility are required to pay interest and amortisation on time. A stable underlying asset helps mitigate the risk of the lent money. The ability to turn the asset into liquid capital offers the lender a higher chance of recovering their loan in the worst-case scenario of borrower default. Consider each of these three elements when looking into a heavy-asset opportunity, as they will determine each company’s ability to obtain its debt (the critical requirement for success).
Industries Disrupted By Asset Heavy Business Models
Looking at the criteria above, it is not surprising to see most activity in the real estate sector. However, over time, and with the growing understanding of financial institutions, we predict that many sectors of the economy will be affected. Akin to previous innovation cycles, initial innovation will be in the B2C segment. Later, there may also be opportunities within B2B. We put together a list of the recent industry shifts from asset-light to asset-heavy paradigms.
Low interest rates, full value capture, and vertical integrations have all contributed to a rise in asset-heavy business models. The overall macro shift in our economy has affected many industries, and it will offer billion-dollar opportunities to investors aware of the hidden value. At 10x Value Partners we are excited about this shift, and we are building an environment that will locate and support asset-heavy business models returns.