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Redbubble: Long Growth Runway and Exceptional Management

March 30, 2018 in Asia, GARP, Ideas, Letters, Small Cap

This article by John Lewis is excerpted from a letter of Osmium Partners.

Redbubble Limited (RBL.AX) operates as an online marketplace that connects independent artists with customers and a network of third party fulfillers utilizing print-on-demand technology to fulfill customer orders. It offers apparel for men, women, and kids; cases and skins, such as phone cases and wallets, as well as laptop sleeves and skins; various stickers; home decor products, including throw Pillows, duvet covers, travel mugs, and mugs; bags, such as tote bags, pouchstudio pouches, drawstring bags, and laptop- sleeves; stationary products comprising greeting cards, postcards, calendars, spiral notebooks, and journals; wall art products, including posters, canvas prints, framed prints, photo prints, framed prints, and art prints; and gift certificates. The company was founded in 2006 and is headquartered in Melbourne, Australia. Redbubble’s current market capitalization is approximately $374 million.1 (RBL.AX is a holding across all funds.)

Last week, we spent time separately with the Chairman of the Board as well as the CEO, COO, and CFO of Redbubble. The management team is exceptional.

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Certain factual and statistical (both historical and projected) industry and market data and other information contained herein was obtained by Osmium Partners from independent, third-party sources that it deems to be reliable. However, Osmium Partners has not independently verified any of such data or other information, or the reasonableness of the assumptions upon which such data and other information was based, and there can be no assurance as to the accuracy of such data and other information. Further, many of the statements and assertions contained herein reflect the belief of Osmium Partners, which belief may be based in whole or in part on such data and other information. The analyses provided may include certain statements, assumptions, estimates and projections prepared with respect to, among other things, the historical and anticipated operating performance of the companies. Such statements, assumptions, estimates, and projections reflect various assumptions by Osmium Partners concerning anticipated results that are inherently subject to significant economic, competitive, and other uncertainties and contingencies and have included solely for illustrative purposes. No representations, express or implied, are made as to the accuracy or completeness of such statements, assumptions, estimates or projections or with respect to any materials herein. Actual results may vary materially from the estimates and projected results contained herein. Past Osmium performance is not indicative of future results. Osmium Partners disclaims any obligation to update this letter. A portion of the Partnership’s assets may from time to time be invested in securities that have limited liquidity. The Partnership’s investment strategy is to make concentrated investments in what it views as its best ideas. The Offering Memorandum and Limited Partnership Agreement offers a comprehensive overview of the risk factors involved in investing with Osmium Partners. The information contained herein is provided for informational purposes only. This is not an offer to sell, or a solicitation to buy, limited partnership interests in Osmium. An investment in Osmium is not suitable for all investors. Stocks mentioned in the newsletter do not constitute a recommendation to buy or sell the individual securities.

A Case Study of R1 RCM

March 30, 2018 in Case Studies, Ideas, Letters

This article by Ryan O’Connor is excerpted from a letter of Crossroads Capital. The following case study was written prior to the Intermedix acquisition announcement, which Ryan estimates may increase intrinsic value by $15+ per share.

Given our mandate and focused approach, we can aggressively pursue compelling investment opportunities whenever and wherever they arrive. It’s with this in mind that we’d like to introduce you to R1 RCM, or just “R1” for short – a resilient, non-cyclical, high-quality business that’s been undergoing a value-unlocking transformation since we initiated our position in the low $2’s in late 2016.

R1 is a leading provider of revenue cycle management services to hospital networks. That means it handles their front- and back-office needs, aiming to streamline operations, cut out unnecessary costs, and reduce billing errors, all in a bid to maximize revenues and profits. With hospitals facing tight 1-to-2 percent margins, R1 can make a big contribution, often doubling or even tripling their profitability over time.

To deliver those extra profits, R1 plugs directly into its clients’ operations, tying its own differentiated IT and systems into hospital networks and working hand-in-hand with employees to eliminate margin-sapping inefficiency. With R1 on the scene, hospitals label patient visits more accurately, find more insurance options, and make sure everything gets properly billed. Moreover, by rationalizing vendors, moving hospitals to an offshore shared service platform (to benefit from labor arbitrage), and taking other cost-cutting measures, R1 is in a prime position to enhance its partners’ – and its own – bottom line.

While it’s a solid business today, R1 has a complicated history. In fact, R1 wasn’t even always called R1 – it was originally known as Accretive Health, a spinoff of Ascension Health, the second-largest hospital system in the US. As Accretive, its troubles included:

— being charged with abusive billing practices by the state of Minnesota,

— being charged with failing to protect consumers’ personal information by the FTC, and

— a full-blown SEC investigation into aggressive revenue recognition from 2011 through 2013.

To make matters worse, in 2014 Accretive was delisted from the NYSE and banished to the OTC netherworld after missing a deadline to restate 2011-2013 results. Of course, problems like these did pretty much what one would expect for the share price: From above $30 in 2011, it crashed to below $10 in 2012, slumped below $5 in 2015, and even dipped below $2 for part of 2016. Then Ascension, the company’s largest customer, smelled blood in the water – ultimately making a lowball bid to reacquire Accretive at roughly 50% below market value, threatening to pull its business if Accretive didn’t fall in line.

Yet while the stock was tanking, the company itself was healing. First, in 2012, Accretive settled with the state of Minnesota while admitting no wrongdoing. Then, in 2013, it settled with the FTC and leadership changes were enacted, including the CEO and Chairman. Next, at the end of 2014, it filed restated earnings for the 2011-2013 period. Finally, in early 2016, it concluded a new agreement with Ascension that killed the take-under bid. Instead, Ascension bought $200 million worth of 8% convertible preferred shares in Accretive and got warrants for another 60 million in common shares. In exchange, it gave Accretive a new 10-year exclusive service contract and an enormous amount of new business. It was this new symbiotic arrangement that sparked our initial interest in a name that, at the time, was nothing short of despised. We pulled the trigger.

Fast forward to the start of 2017, and the company took further steps to dissociate itself from its difficult past, changing its name to R1 RCM and up-listing to the Nasdaq. Of course, we invested well ahead of these value-unlocking events in order to profit as R1’s respectability rose phoenix-like from its own ashes. And that respectability recently reached new heights as management nailed down another highly accretive deal with another highly reputable client: Intermountain Healthcare.

R1’s deal with Intermountain resembled the one with Ascension: Intermountain bought $20 million worth of R1 shares north of $4, with warrants for 1.5 million additional shares at $6 thrown in. In exchange, R1 got a 10-year exclusive service renewal and contract extension, plus rights to serve hospitals Intermountain might acquire later on. And by this point, the Ascension deal had been modified to grant R1 similar rights to serve hospitals Ascension might itself acquire down the road.

So where does all this leave R1 today?

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Disclaimer: The specific securities identified and discussed in this commentary pertain to the beneficial owner of this account and should not be considered a recommendation to purchase or sell any particular security. Rather, this commentary is presented solely for the purpose of illustrating Crossroads Capital’s investment philosophy and analytical approach. These commentaries contain our views and opinions at the time they were written, they do not represent a formal research report and are subject to change thereafter. These commentaries may include “forward looking statements” which may or may not be accurate in the long-term. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable. Past performance is not indicative of future results. All investments involve risk and may decrease in value. Additional Disclaimer: This reprint is furnished for general information purposes in order to provide some of the thought process and analysis used by Crossroads Capital, LLC. It is provided for illustrative purposes only. This material is not intended to be a formal research report and should not, under any circumstance, be construed as an offer or recommendation to buy or sell any security, nor should information contained herein be relied upon as investment advice. Opinions and information provided are as of the date indicated and are subject to change without notice to the reader. There is no assurance that the specific securities identified and described in this reprint are currently held in advisory client portfolios or will be purchased in the future. The reader should not assume that investments in the securities identified and discussed were or will be profitable. The specific securities identified and described do not represent all of the securities purchased, sold, or recommended for advisory clients. Any performance shown for relevant time periods is based upon a composite of actual trading in accounts managed by Crossroads Capital under a similar strategy. Except where otherwise noted, performance is shown net of billed management and incentive fees (where applicable), and all trading costs charged by the custodian. Composite performance calculations have been verified by our third-party administrator. Performance of client portfolios may differ materially due to differences in fee structures, the timing related to additional client deposits or withdrawals and the actual deployment and investment of a client portfolio, the length of time various positions are held, the client’s objectives and restrictions, and fees and expenses incurred by any specific individual portfolio. PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. These materials may not be disseminated without the prior written consent of Crossroads Capital, LLC

Don’t Get Your Teeth Kicked In

March 30, 2018 in Letters

This article is excerpted from a letter of PenderFund Capital Management. The author, Felix Narhi, serves as Chief Investment Officer of Pender.

“Since 1871, the market has spent 40% of all years either rising or falling more than 20%. Roaring booms and crushing busts are perfectly normal.” –Morgan Housel

Last year was a banner year in the US markets. Following the election of Trump, the S&P500 bolted out of the gates on initial optimism for deregulation across many sectors and ended the year with investors cheering huge US corporate tax cuts. In what has become a familiar refrain, a handful of mega cap internet and technology stocks continued their momentum.

The party on Wall Street didn’t end on New Year’s Eve. The gala continued right into 2018 as January’s total return marked the best start to a year since 1997. Indeed, since Trump was elected President, the US markets have largely shrugged off the political sideshow and chaos of the White House as the S&P500 put together an uninterrupted 15-month rally with no losing months on a total return basis. That period was the longest streak in the history of S&P500, beating the previous record of 10 months, set back in 1995, by a comfortable margin.

The recent mini-streak ended in early February 2018. The CBOE Volatility Index (VIX), or “the fear index”, which is considered by many to be the world’s premier barometer of investor sentiment and market volatility skyrocketed by 116% on February 5th. That was the largest one-day increase ever. On the same day the S&P 500 fell by 4.1%. Investors were provided with a quick lesson on the dangers of short-term speculation and trend extrapolation as leveraged bets on low volatility imploded.

During the S&P500’s hot streak, the price index jumped 33% over 15 months. The index outperformed the underlying corporate fundamentals which pushed the S&P500 index even deeper into overvalued territory. By the end of the month, investors had something new to worry about – heightened risk that the Federal Reserve might hike interest rates faster than expected following growing signs of inflation.

Don’t get your teeth kicked in

“The most dangerous people in the world are very smart traders who have never gotten their teeth kicked in.” –F. Helmut Weymar

At Pender, we sometimes say that there are only two kinds of companies: Companies that are having problems and those that are going to have problems. The same is also true for the broader indices – it’s just a question of when a major correction will occur as extended periods of tranquility are often followed by not-so-tranquil times.

The S&P 500 is currently in the midst of the second greatest bull market in length and magnitude in history. It is less than a year away from becoming the longest bull run ever. It has been so long since there has been a major correction that the institutionalized memory of the gut-wrenching selloffs that occur periodically in the markets is in danger of fading.

Increasingly, the investors and fund managers who are making important investment decisions have never had their proverbial teeth kicked in. A survey of more than 4,800 fund managers in London, New York and Paris conducted last year showed that half of respondents had nine years of experience or less. That means there are thousands of fund managers who didn’t experience the 2008 collapse and its run up, let alone the dot com bubble that burst in the early 2000’s, the 1997-1998 Asian financial crisis, or the more distant 1987 and 1973-74 market crashes. Unfortunately, what we learn from history is that we don’t learn from history.

In any case, we keep in mind Buffett’s simple guideline, “The less the prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own.”

Secret Rule #2 and Patiently Onward

“In a rising market, enough of your bad ideas will pay off so that you’ll never learn that you should have fewer ideas.” –Daniel Kahneman

Warren Buffett’s # 1 rule of investing is “never lose money”, followed quickly by his second rule — “never forget #1”. While we remain admirers of the Oracle of Omaha, there is a clear flaw with Rule #2. Taken literally, one could put money in a GIC or a t-bill and meet both rules. But after taking into consideration inflation and taxes, investors would be going backwards, never mind have any realistic chance of growing their wealth over time. Rather, we believe Rule #2 should reflect what Buffett actually did to accumulate his capital.

The real secret Rule #2 is to be patient and to appreciate that investing is an endeavour where magnitude is more important than frequency. In other words, how big your wins are matters more than how often you win. Like many aspects of life, it turns out that capitalism is also beholden to the “80/20 rule”. A minority of individual stocks account for most of the stock market’s total returns over time, because only a handful of companies create real long-term wealth.

The key, in our opinion, is to be patient with such compounders so one can benefit from magnitude in capitalism. This also explains in large part why portfolio turnover and returns tend to be inversely correlated. It’s hard to keep up when you sell the Starbucks, Amazons and Berkshire Hathaways of the world early-to-midway through in their respective lifecycles.

We believe it is important to see the world as it really is in order to stack the odds in one’s favour. It turns out that successful long-term investment strategies are also behold to the “80/20” rule. The greatest flaw in short-term investing is the belief that great business performance is always linear. Time tends to push out the weakly convicted and creates opportunities for those with a long-term perspective.

An idiosyncratic and patient approach to portfolio management is not practiced by many, but it tends to work over the long haul because it is aligned with how the world really works. Don’t just take our word for it. Recent research*concludes that among high Active Share portfolios – whose holdings differ substantially from their benchmark – only those with patient investment strategies on average outperform. This successful group represents a very small percentage of all active investors.

In large part, incentives driven by short-term relative performance and benchmarking prevents most managers from implementing the secret Rule #2 in their investment strategies. Yet these real-world findings have clear implications for today’s active vs passive debate.

Read more on how long-term considerations impact our investment strategies as they relate to interest rates, disruptive business models and cycles (including comments on individual holdings) in this Investment Insight.

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Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the simplified prospectus before investing. The indicated rates of return are the historical annual compounded total returns including changes in net asset value and assume reinvestment of all distributions and are net of all management and administrative fees, but do not take into account sales, redemption or optional charges or income taxes payable by any security holder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. This communication is intended for information purposes only and does not constitute an offer to buy or sell our products or services nor is it intended as investment and/or financial advice on any subject matter and is provided for your information only. Every effort has been made to ensure the accuracy of its contents. Certain of the statements made may contain forward-looking statements, which involve known and unknown risk, uncertainties and other factors which may cause the actual results, performance or achievements of the Company, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. © Copyright PenderFund Capital Management Ltd. All rights reserved. March 2018.

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March 29, 2018 in Twitter

A Snail’s View on Investing

March 27, 2018 in Asia, Asian Investing Summit, Featured, Letters

This article is authored by MOI Global instructor Jiro Yasu, representative director of Varecs Partners. Jiro is an instructor at Asian Investing Summit 2018, the fully online conference featuring more than thirty expert instructors from the MOI Global membership community.

In 1986, my grandfather, Koichiro Yasu (安 弘一郎) wrote a book about the origins of my family and Jyujiya Securities Co. Ltd. (十字屋証券), our family brokerage firm, which was originally started by my great grandfather, Tsunesaburo Yasu (安 常三郎), in 1924. Late in life, Koichiro was diagnosed with liver cancer and knew his remaining life was not long. Instead of going after his bucket list, he wrote a book to share his experiences with other family members and people in the brokerage industry. We privately published the book and distributed it at his funeral (so you won’t find it on Amazon).

The title of the book is “Memoir of a Snail”. The book started with the following Haiku by Seibo Kitamura (北村西望, 1884-1987), a Japanese sculptor.

Tayumazaru　(たゆまざる)　
Ayumi osoroshi (あゆみ恐ろし)　
Katatsumuri (かたつむり)

Tirelessly onward
Remarkable progress
The Dao of a snail

Mr. Kitamura created the Peace Statue at the Nagasaki Peace Park. When he was making the statue, he found a snail on the ground which looked like it was not moving. The next morning, he found the same snail on top of the statue. He recognized that untiring small efforts will make a huge difference over time. His success did not come easily. So, I guess he saw himself in the snail.

My grandfather also thought his half century experience in the brokerage industry was like the methodical walk of the snail. He was the kind of person who preferred humility and stability. He never over-expanded the business nor took undo-investment risk. He indirectly learned from his father, who was his polar opposite. Tsunesaburo was a big speculator and always reached for what he could not afford. I respect him since his drive and luck became the basis of our family business. But I also respect my grandfather since he was the guy who kept us in business.

The book introduced a couple of investment successes from both my grandfather’s and great grandfather’s days. Tsunesaburo was a journalist covering the markets before getting into the brokerage business. I guess he took advantage of his special relationship with journalist friends and made a fortune by shorting popular speculative stocks before the Asahi newspaper put up an article that the government was considering delisting some of them. The article proved to be correct, and years later he made enough money to become a member of the Tokyo Stock Exchange.

Koichiro’s trade of his life was an arbitrage trade. A few years after World War II, the government decided to issue a new yen and freeze deposits to cope with high inflation. To convert old yen to new yen, people needed to deposit cash to their bank accounts within about one month after the announcement. At that time, a common way of saving money was storing bills under mattresses or in drawers. Also, people were only allowed to withdraw 300 new yen per month from their bank account, which was barely enough to support daily needs (the average monthly salary of a public worker was about 500 yen). Therefore, most of people’s savings were stuck in bank accounts and losing purchasing power due to the high rate of inflation. Prices were rising as high as 1000% in 3 months.

Koichiro and a few other brokers found a loophole: buy a stock in the old yen, and then turn and sell it for the new yen. Although the Tokyo Stock Exchange was occupied by the GHQ and officially closed, brokers set up aisles in front of the exchange building and actively traded securities. My family’s firm made 20% every time they did this trade for clients. New clients who learned of the loophole from word of mouth kept coming to Jyujiya with their old yen bills.

When the stock exchange officially reopened, the Ministry of Finance put a very high capital hurdle requirement to be a member of it. Jyujiya had enough capital to maintain its membership because of the new yen/old yen trades.

Koichiro preferred such arbitrage transactions throughout his career. The book also introduced profitable trades related to dismantling the Zaibatsu. For example, if you bought shares of one of Mitsubishi’s chemical companies, you could convert it into shares of three new spun-out entities. Since these spin-outs traded at a premium, there were large spreads to be captured. In many cases, shares of Zaibatsu companies were sold through auctions by a government body to licensed brokers. Also, there was no Bloomberg terminal then, so a broker’s location provided great advantage for arbitrage transactions. Koichiro actively participated in such auctions.

At the end of the book, my grandfather wrote a message to successors of the family business: as Japanese equity markets face increased globalization and deregulation, boutique firms like Jyujiya will have to find a new raison d’être. My family decided to exit the brokerage business right before the financial crisis. Around the same time, we started VARECS as a boutique investment firm. We thought the investment management business was more suitable for boutique firms to be differentiated and succeed.

Value investing and compounding capital is a lot like the crawl of a snail, I believe. We try to invest in high quality companies at a price that has some margin of safety. I think the returns of our portfolio will not be a homerun in any particular year. We instead try to achieve decent returns while preserving capital over the years. I still have 30 more years to reach the age my grandfather was when he wrote his book. We wish to compound capital at attractive rates for 30 years — like the snail which reached the top of the statue.

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The Impact of Technological Change on the Firm Boundary

March 26, 2018 in Asia, Asian Investing Summit, Commentary, Information Technology, Letters

This article is authored by MOI Global instructor Rajeev Mantri, director of private investment firm GPSK Investment Group and executive director of Navam Capital, an India-focused venture capital firm. Rajeev is an instructor at Asian Investing Summit 2018, the fully online conference featuring more than thirty expert instructors from the MOI Global membership community.

In a landmark paper titled The Nature of the Firm published in 1937, then-26 year old economist Ronald Coase addressed the question of why firms exist. “Outside the firm, price movements direct production, which is coordinated through a series of exchange transactions on the market. Within a firm, these markets transactions are eliminated and in place of the complicated market structure with exchange transactions is substituted the entrepreneur-coordinator, who directs production. It is clear that these are alternative methods of coordinating production. Yet, having regard to the fact that if production is regulated by price movements, production could be carried on without any organization at all, well might we ask, why is there any organization?”

Coase, who went on to win the Nobel Prize for economics in 1991 for his work as the pioneer of the theory of the firm, posited that the transaction costs of doing business in a market economy necessitated that individuals should organize themselves under the rubric of a firm. The world has changed unrecognizably since Coase developed the theory for why a centrally-planned institution like a firm exists in any market economy. The principal forces affecting the size and structure of the firm are government policy and technology. The Coasian lens of transaction costs helps explain why conglomerate firm structures are commonly found in emerging and frontier markets – wherever government policy-making is a powerful exogenous force and the rule of law is weak, it makes sense for firms to integrate vertically or expand corporate scope by entering new industries.

Over the last 25 years, technology too has had dramatic effects on the nature of the firm. Technological changes strike at the heart of possibly the most important strategic decision made by the capital allocator, christened the “entrepreneur-coordinator” by Coase. This is the decision of what to buy and what to build. Stated differently, technology has always been a critical determinant of setting and resetting the boundary of the firm, and momentous changes over the last three decades have hastened the speed at which this boundary shifts.

Shifts in the firm boundary inevitably lead to shifts in the value captured by the different actors in an industry. The rise of e-commerce undercuts both offline retailers and legacy brands. “Direct-to-consumer” means that even small, niche brands are able to gain global distribution without having an offline footprint. Retailers, product marketers and manufacturers who were operating in an equilibrium deemed to be settled by the dominance of organized retail are being disrupted by the emergence of new marketing and distribution channels enabled by the mobile internet that have made certain segments far less profitable or even irrelevant.

The media business has felt the impact of shifting firm boundaries even more dramatically than retail. In the old television entertainment business model, studios created content that broadcasters would licence, offsetting content acquisition costs with advertising. Now, technology has shifted the firm boundary to fuse content production and distribution, where consumers are willing to pay for an advertising-free viewing experience. In print media, content production and distribution that were both controlled by media houses have been disaggregated, as consumers read individual articles rather than bundles curated by professional editors that are distributed and discovered through channels the content producers have almost no control over.

Applying Coase’s insight, the transaction cost that caused the emergence of a firm in the industry value chain can be reduced or eliminated by technology. When this happens, the “entrepreneur-coordinator” or capital allocator of the firm must act to re-position the firm in the new context. Viewing technology as a force that reduces transaction costs and shifts the firm boundary is a powerful way to anticipate how an industry might change in response to innovation. Armed with this understanding, an investor can make better judgments about which businesses will accrue market power and which segments stand to lose.

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The Underappreciated Value of a Long-Term Orientation

March 23, 2018 in Commentary

This article is authored by Felix Narhi, Chief Investment Officer and Portfolio Manager of PenderFund Capital Management. Read additional insights.

“I ask everybody not to think in two to three-year time frames, but to think in five to seven-year time frames.” –Jeff Bezos

Amazon is a remarkable enterprise that was built in part on an unwavering long-term orientation. Founder Jeff Bezos doesn’t care about quarterly earnings because he knows the near-term earnings simply reflect the actions and initiatives Amazon took years ago. He is always thinking about the direction of Amazon five to seven years out, rather than what is happening today. Such a perspective is highly unusual in the corporate world, but far more likely in founder-run firms.

It is also important in the investment world. Thinking long term impacts how you plan and where you allot energy, time, money and resources. While we try to navigate the near-term twists and turns of the market, we keep three long-term considerations front of mind.

1. The great 35-year interest rate cycle probably bottomed in 2016

Interest rates are likely headed up, possibly trending higher for a long time. As we speculated in our fiscal year-end commentary last year, this big news didn’t make any front-page headlines, but could have profound long-term implications on asset values and investment strategies. When great cycles turn, there are usually multi-year, if not multi-decade, consequences for investors.

Just ask Bill Gross, the former superstar bond manager of PIMCO, how much fun it can be to get the big cycle right and ride a secular wave for decades. Of note, Gross’ and PIMCO’s success coincided within an epoch of credit expansion – a period where those who reached for carry, that sold volatility, that tilted towards yield and more credit risk succeeded. What if zero -bound interest rates, that define the end of a total return epoch that began in the 1970’s, accelerated in 1981 and came to a mathematical dead end for bonds in 2016 and commonsensically for other adjoined asset classes as well?

We suspect many strategies that worked well over the last few decades may not work as well going forward, no matter how compelling the rear view mirror looks (we are looking at you, “bond proxies”, as noted in our July 2016 note Utilities – Reward-free risk?). In any case, fasten your seat belts – we are about to find out.

2. Disruptive periods like today change the opportunity sets

Many, if not most, industries are in the process of being reshaped by the disruptive forces of technological change. We believe one of the great lessons in microeconomics is to discriminate between when technology is going to help you and when it’s going to hurt you. We’re seeing this broadly as legacy companies struggle to match the agility and scalability of born-digital competitors like the FANGs (Facebook, Amazon, Netflix and Google), while keeping their cost structures competitive. Perhaps the most instructive case study is Sears vs Amazon with important lessons for other industries that are impacted by disruptive business models and technologies that are changing consumer behaviour.

A major disruptor purchased across multiple Fund mandates in early 2017 was Baidu, frequently referred to as “the Google of China”. We generally do not delve deep into our individual holdings externally, but Baidu was a rare exception written up last year here, which we believe was hiding in plain sight as a misunderstood and unloved megacap.

Another name in this category that we added in 2017 is TripAdvisor, the world’s largest travel site. We bought the stock initially last July and we doubled down following a sell-off in November. TripAdvisors’ solid reputation among travellers for reliable advice on hotels, restaurants and attractions had made it one of the largest and fastest growing online properties in the world. Yet, it remains very under monetized. In a nutshell, we believe either management will fix this issue, or it will be sold off to a strategic buyer at a premium relative to our entry price. As long as TripAdvisor’s many properties continue to grow unique monthly users, which feed its powerful network effects, internal value should continue to build at a healthy pace.

Ultimately, we believe this represents latent monetization and foreshadows significant potential upside as a standalone company, or a bigger premium as a takeout. Just consider Facebook after its IPO almost six years ago when management successfully pivoted from their desktop-centric model to a mobile-first strategy. The potential rewards for monetizing a massive and growing engaged user-base can be truly breathtaking. The stock has been a ten bagger since bottoming in August 2012.

Read more on the disruptive forces of technological change in this blog post, including comments on Syntel (SYNT) and Discovery (DISCK).

3. Just about everything is cyclical

As the saying goes, stocks aren’t usually cheap and popular at the same time. We often begin our search for opportunities in companies and industries we understand that are having problems. The stocks of such companies are more likely to be mispriced. We attempt to discern the source of consensus pessimism in such situations, and occasionally take the other side of the trade when we either have a variant view to the market, or we believe other important attributes are being overlooked by investors. These situations often take time to work out, but we prefer to remain patient as long as the firm is building internal value and improving their competitive position, even if the stock action is unfavourable in the interim.

Sometimes we make a mistake and our patience is misplaced. Either the facts change or our investing thesis is just plain wrong. In such cases, it’s best to sell and move on (Altisource Portfolio Solutions, sold in 2017, was a recent example). But often we find our mistakes are related to timing, particularly when the idea is a Compounder. Ultimately such businesses will grow in value and eventually bail out investors who timed their purchase poorly.

Bruce Flatt, the CEO of Brookfield Asset Management, recently penned another terrific letter that included some lessons learned by the management team. As it relates to this topic, Flatt wrote, “the single greatest way to dig ourselves out of mistakes is to be patient with investments and, in most cases, double down. This is the best way to recover losses, although it requires conviction as well as availability of the necessary capital. This is particularly important when we have acquired a good business, but our timing was poor. Doubling down in this case is virtually always the answer. However, one has to be careful because if the business is just a bad business, it only serves to compound the pain. But, generally we have found that in the absence of technological change in the extreme, doubling down and being patient is the most proven way to turn around an investment.”

Likewise, we endeavor to remain patient (or double down) with good businesses during periods of adversity when they are having problems – we have found that cyclical headwinds usually become a tailwind again. Some examples of top Pender holdings purchased during periods of adversity that went from “dogs” to “stars” and sold in the past year include Panera Bread, Wynn Resorts, KKR and Whole Foods. They were all founder-run firms which delivered exceptional returns to unitholders over our holding period.

“The time to buy is when there’s blood in the streets.” –Baron Rothschild

As such, we bought South Korean-based steel maker Posco in late 2014 as a deeply cyclical close-the-discount opportunity. Statistically speaking, we originally bought the stock at a very attractive valuation. The only prior period that Posco traded at lower levels since it started trading in the U.S. in 1994 was a small window during the 1997-1998 Asian financial crisis. The stock’s subsequent rebound was dramatic — a four bagger in less than two years. However, as we quickly (re)learned, every situation is different.

The year following our original purchase, the steel industry went through one of its most challenging cycles in history, crashing Posco to record-setting low valuation levels. The stock went from trading near the trough valuations relative to its past 20-year record, to setting new precedents for all-time lows that future generations will no doubt use as “worst case” historical examples (similar to how we referenced the Asian financial crisis as a “worst case” scenario). This excruciating period required us to draw upon our deepest reserves of patience and fortitude in late 2015.

As long we believe there is no fundamental impairment to the underlying business, we try to keep in mind, the time to buy is when there’s blood in the streets. We added to our position during this downdraft because of our conviction that Posco, as the world’s most efficient steel maker, would be a survivor. If the world’s manufacturing and construction industries required steel in the future, Posco would still be around to pick up the pieces after less efficient peers went belly up. Since then, operating conditions materially improved, non-core assets were either sold or restructured and debt was paid down meaningfully. Not surprisingly, the stock has been repriced and became one of Pender’s top performers in both 2016 and 2017 (we have been trimming our position during the run up).

In hindsight, our initial timing on Posco was less than ideal. However, because we added to our holdings during the downturn, we were able to generate a reasonable return for investors over our holding period. Importantly, the return on the incremental capital invested has been extraordinary. The moral of the story here is that as long as the facts remain at your side, one should always consider buying when there’s blood in the streets – even when it is your own blood.

Read more on taking advantage of cycles in this blog post, including comments on Liberty Global (LBTYA), Liberty Latin America (LILA), Platform Specialty (PAH) and Colfax (CFX).

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Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the simplified prospectus before investing. The indicated rates of return are the historical annual compounded total returns including changes in net asset value and assume reinvestment of all distributions and are net of all management and administrative fees, but do not take into account sales, redemption or optional charges or income taxes payable by any security holder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. This communication is intended for information purposes only and does not constitute an offer to buy or sell our products or services nor is it intended as investment and/or financial advice on any subject matter and is provided for your information only. Every effort has been made to ensure the accuracy of its contents. Certain of the statements made may contain forward-looking statements, which involve known and unknown risk, uncertainties and other factors which may cause the actual results, performance or achievements of the Company, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. © Copyright PenderFund Capital Management Ltd. All rights reserved. March 2018.

Selected In-Depth Investment Ideas

March 22, 2018 in Uncategorized

Last month I had the pleasure of hosting a group of MOI Global members in St. Moritz, Switzerland for the inaugural edition of Ideaweek, an opportunity to share and learn in an inspiring Swiss mountain setting. Here is how Ghana-based member Abdallah Toutoungi summed up his experience:

There’s something to be said about the caliber of influencers present in St. Moritz. The organic conversations allow for deep reflection on ideas and intimate discussions about business, life, and wisdom. Essentially, as John put it emulating Munger, “We try to operate in a seamless web of deserved trust and be careful whom we trust.” Although that might be the ultimate goal, MOI Global has been able to ‘carve the mountains’ to create an environment fertile for exceptional people to have candid conversations where you can understand the significance of the Chinese proverb, “A single conversation with a wise person is worth a month’s study of books.”

Time disappears behind the mountains and the conversation takes its place, breakfasts merge with lunches, and lunches with afternoon talks, and afternoon talks with dinners. Awaiting the morning, the night becomes too long and the morning can’t come fast enough to continue the conversations. These conversations span subjects broad and deep, from specific investments to best practices to operating a business to personal anecdotes and challenges.

Ideaweek was a resounding success, and we are already planning the 2019 edition. Invitations to selected members of MOI Global will go out in the near future. I hope you will consider joining us—there really is no better way to learn and form new friendships than in a relaxed, informal atmosphere, while engaged in winter activities and surrounded by like-minded people with a desire to grow as investors.

I am pleased to include impressions from Ideaweek 2018 in this issue of The Manual of Ideas.

In January we hosted Best Ideas 2018, the sixth annual edition of this fully online conference. The latest edition featured more than one hundred instructors from the MOI Global community, providing plenty “food for thought” and ideas for further research.

In this issue, we feature transcripts of some of the most enlightening sessions. We do not claim comprehensiveness, as many sessions that are not included in this issue also contain terrific insights and ideas. Explore Best Ideas 2018 in detail at https://moiglobal.com/i/

The sixth annual edition of Asian Investing Summit is upon us, and you are cordially invited as an MOI Global member! This fully online conference, to be held on Thursday and Friday, April 5-6, will feature the best ideas of more than thirty instructors from the MOI Global community, all of whom share a value-oriented investment philosophy and possess deep expertise in investing in Asia.

In the past, Asian Investing Summit and the other online conferences hosted by MOI Global were available to anyone purchasing a conference pass. Since last year, only members of MOI Global have access to these online summits. Access is not only exclusive to members but also fully complimentary.

Tune into the sessions at Asian Investing Summit 2018. You’ll enjoy LIVE access on April 5-6, followed by unlimited replay access.

I am excited to announce that we are accelerating efforts to create engagement and knowledge-sharing opportunities for members. On September 20, we will host the inaugural Latticework London gathering of intelligent investors, while on November 1, we will host The Frankfurt Conversation, a forum for learning and idea exchange. Member invitations will go out soon — I hope you’ll consider joining us!

Warm regards,

JOHN MIHALJEVIC, CFA
Chairman, MOI Global

Members, log in below to access the restricted content.

Not a member?

Thank you for your interest.  Please note that MOI Global is closed to new members at this time. If you would like to join the waiting list, complete the following form:

Selected In-Depth Investment Ideas

March 22, 2018 in The Manual of Ideas

Last month I had the pleasure of hosting a group of MOI Global members in St. Moritz, Switzerland for the inaugural edition of Ideaweek, an opportunity to share and learn in an inspiring Swiss mountain setting. Here is how Ghana-based member Abdallah Toutoungi summed up his experience:

There’s something to be said about the caliber of influencers present in St. Moritz. The organic conversations allow for deep reflection on ideas and intimate discussions about business, life, and wisdom. Essentially, as John put it emulating Munger, “We try to operate in a seamless web of deserved trust and be careful whom we trust.” Although that might be the ultimate goal, MOI Global has been able to ‘carve the mountains’ to create an environment fertile for exceptional people to have candid conversations where you can understand the significance of the Chinese proverb, “A single conversation with a wise person is worth a month’s study of books.”

Time disappears behind the mountains and the conversation takes its place, breakfasts merge with lunches, and lunches with afternoon talks, and afternoon talks with dinners. Awaiting the morning, the night becomes too long and the morning can’t come fast enough to continue the conversations. These conversations span subjects broad and deep, from specific investments to best practices to operating a business to personal anecdotes and challenges.

Ideaweek was a resounding success, and we are already planning the 2019 edition. Invitations to selected members of MOI Global will go out in the near future. I hope you will consider joining us—there really is no better way to learn and form new friendships than in a relaxed, informal atmosphere, while engaged in winter activities and surrounded by like-minded people with a desire to grow as investors.

I am pleased to include impressions from Ideaweek 2018 in this issue of The Manual of Ideas.

In January we hosted Best Ideas 2018, the sixth annual edition of this fully online conference. The latest edition featured more than one hundred instructors from the MOI Global community, providing plenty “food for thought” and ideas for further research.

In this issue, we feature transcripts of some of the most enlightening sessions. We do not claim comprehensiveness, as many sessions that are not included in this issue also contain terrific insights and ideas. Explore Best Ideas 2018 in detail at https://moiglobal.com/i/

The sixth annual edition of Asian Investing Summit is upon us, and you are cordially invited as an MOI Global member! This fully online conference, to be held on Thursday and Friday, April 5-6, will feature the best ideas of more than thirty instructors from the MOI Global community, all of whom share a value-oriented investment philosophy and possess deep expertise in investing in Asia.

In the past, Asian Investing Summit and the other online conferences hosted by MOI Global were available to anyone purchasing a conference pass. Since last year, only members of MOI Global have access to these online summits. Access is not only exclusive to members but also fully complimentary.

Tune into the sessions at Asian Investing Summit 2018. You’ll enjoy LIVE access on April 5-6, followed by unlimited replay access.

I am excited to announce that we are accelerating efforts to create engagement and knowledge-sharing opportunities for members. On September 20, we will host the inaugural Latticework London gathering of intelligent investors, while on November 1, we will host The Frankfurt Conversation, a forum for learning and idea exchange. Member invitations will go out soon — I hope you’ll consider joining us!

Warm regards,

JOHN MIHALJEVIC, CFA
Chairman, MOI Global

Members, log in below to access the restricted content.

Not a member?

Thank you for your interest.  Please note that MOI Global is closed to new members at this time. If you would like to join the waiting list, complete the following form:

MOI Global