I wrote about a month ago about my take on the Corona virus from a Asia perspective, basically my worst case scenario has come true and then some. The virus is more or less out of control in Europe and large parts of the developed world is staring into two scenarios: Either they do a shut-down like China and suffer the economic consequences of that, or they keep things running as per usual and the spread will just continue. Two horrible options to choose from. And on top of that we have a highly political situation between Saudi, Russia and USA, which knocked oil completely. My timing of buying my first oil holding ever into the portfolio Tethys Oil, could not have been less well timed, but such is investing life. I have managed to time things horribly before and I will do it again.
First my overall portfolio strategy right now, is to stay defensive and I think I have many such holdings (Swedish Match, Philip Morris, Diageo, Greatview Aseptic, etc..), the second thing is more short term tactical. We have seen a multi-year out-performance of Developed Market stocks vs Emerging Markets, just like the growth/value spread I have been wondering, when is it time for EM to shine again? Given the Corona spread in developed markets, I think this will exaggerate a mean reversion of returns (which was bound to happen anyway) in favor of EM. So I’m happy that my portfolio already has a strong tilt to Emerging Markets and I intend to keep it that way. Thirdly currently I’m mostly worried that this virus will kick-start a (also overdue) cyclical downturn with rising un-employment. So although EM might on relative basis fall less than developed, it might all come down more from here. Finally, a market like this creates opportunities to build positions in things you would not normally consider, so I will use this opportunity to make some portfolio changes.
This was a speculative holding with a lot of potential upside, unfortunately the company has not been able to deliver what the promised. I have full respect for that things take longer than planned, but you also need to decide at some point that you waited enough. That time has come and I choose to sell my full holding. Unfortunate and I realize a loss of 50% on this holding, but I knew the risks when I invested.
Buying TGS Nopec and Veoneer and Adding to Dairy Farm
I don’t have very much cash right now in my virtual fund, which is a bit ironic going into this downturn, given that I held larger cash levels for quite a while before. With the Irisity sell I have about 6.2% of my NAV in cash. So these 6.2% needs to be spread into these three holdings:
TGS Nopec – 2.5%
My favorite blog buddy valueandopportunity has for a long term held TGS and he recently added to it in this downturn. It is a oil exploration services company, please check his blog for more info on the company. The stock is down some -60% is a short time. I think this is exaggerated, the company is very well managed, asset light operations and is debt free with some cash in the bank. Previously when oil price hit $30 the company had one single quarter with losses. I’m happy adding TGS as a new long term at these levels. I realize just like my fellow blogger said I might be early here and I’m catching a falling knife, but I don’t really care. If oil doesn’t stay at these levels for years TGS will recover. On the downside oil might stay low for years given an significant economic downturn is in the cards but then most of my other holdings will also be down more from these levels. The risk reward looks very good at these levels in my view.
Veoneer – 1.5%
This is speculative case, again looking like catching a falling knife. This company is the spin-off from Autoliv which produces the next generation safety equipment for cars. More or less everything has been going against the company lately. Car sales declining, then corona, then some delayed contracts and lost contracts to a competitor. Due to all this, its easy to forget that this is a big tech company, with a lot of skillful engineers and a lot of patents. The company recently raised 420 million USD at 17.5 USD per share, its now trading below 9 USD. So the short term capital raising risk is gone, although down the line another one might be needed in a about 2 years time. This company is now deducting cash from market cap trading at Enterprise Value of 500 million USD, for a company with a good pipeline of products, 700 staff, which to a large extent are engineers and having revenue of some 1.9bn USD this is cheap. My belief is that someone like Geely will just come and snatch this up very soon.
Dairy Farm – 2.2%
I thought long and hard about this holding, I know it very well by now. I considered to throw it out for a while as well when I feared that the company would be loss making for the coming years, due to the situation in Hong Kong (protests not Corona). The report for second half of 2019 was released and the company is not in as bad shape. I was quite positively surprised and they are executing fairly well on their turn-around in other markets. After all, this is a very defensive company, running 7-elevens and supermarkets in the Asian region. Longer term it has many things going for it. The general population growth in Asia and a larger middle-class being the main investment case. Right now with the HK situation and Corona shareholders have just decided that this is almost un-investable, which I fully understand, short term. But now the stock is so cheap, I decide to take a long term perspective again, although it might fall more before it recovers. I only hold a 1.8% after selling this down recently (at 5.71 USD per share), now I get to buy that back at 4.33 USD per share. Going back to some conclusions I made around my investment skills, this is another example where I have to say I traded this stock very well:
So I’m as of today’s close fully invested, for the first time in a long while. But I do have something which I see as an alternative to cash at that is BBI Life Science, which is the buy-out event I invested in some months ago. The stock is flat lining here waiting for the offer to go through, I could sell out to a small profit and use that cash for other investments. BBI Life Science is a bit over 6% of my current portfolio.
+ SaaS company with strong track-record of growth in number of customers, revenue and cash flow.
+ Providing services in a niche with strong tailwinds, companies need to find way to communicate with their customers online effectively.
+ Founder led with large shareholding from the founding team.
+ Operating out of Polish University city, young entrepreneurial city, with low staff costs.
+ Has invested in developing value adding services like ChatBot and Helpdesk, these are also sold as separate services.
+ Potential upside (if approved) in Polish preferential taxation of income generated by intellectual property rights.
+ / – Somewhat questionable that cash flow is shifted out as dividends instead of reinvested in such a nicely growing business. Current dividend yield is ~6%, which of course is attractive and it also significantly reduces risk that there is anything fraudulent going on in the company. It is after trading in Poland, a market I’m not so familiar with.
– Growth in number of customers have been on a downward trend.
– Competition increasing, both from freemium services and larger player with a wider offering.
– Reporting comes first in Polish which later is translated into English and some info only released in Polish (I thank google translate).
Background and Overview
The company has one prime product and three “add-on” services which also can be bought separately. As can be seen in the timeline above, the three add on services are fairly new products.
LiveChat which is the main product of the company is a software used by businesses to communicate with customers browsing their website. They see the product as a simple chat window placed on the website. The business owner and his agents, on the other hand, have access to the sophisticated application designed for communication and quick customers service. The company operates its products through a SaaS (Software as a Service) model. Examples of the product’s use are very varied. LiveChat solution can facilitate sales processes in e-commerce, serve as a recruitment supporting tool in education and HR and as a contact channel in industries which require personalized communications, such as real estate.
Knowledge Base platform lets companies create their own knowledge bases, which can be accessed by both their employees and clients
ChatBot is a product which allows the creation of conversational chatbots to handle various business scenarios. Their main goal is to automate corporate communications and to improve the effectiveness of customer service teams by addressing repeatable customer inquiries. The solution, introduced to the market, fits into the Company’s strategy to develop the offering of products for text-based customer communications. At the same time it responds to the now popular trend towards automation of communications using AI-based mechanisms
HelpDesk solution enables customers to leave a message for a company by using dedicated email addresses. It’s also possible for team members to create a ticket if a customer’s query came from other communication channels, such as LiveChat, Facebook Messenger, WhatsApp or a phone call.
The supervisory board seems to be a mix of company founders who are no longer active in the company and board professionals . The two founders who are still active are:
CEO – Mariusz Cieply has been with LiveChat since its founding in 2002 – first as software developer, later as project manager and now as its CEO. Mariusz is one of the main shareholders of LiveChat.
CFO – Urszula Jarzębowska has been working in LiveChat Software from 2002. She has 12 years of financial experience with both public and venture-backed companies.
The ownership proportions within the consortium which holds 47.1% is the following:
Marius Cieply (CEO) 15.57%, Maciej Jarzębowski 11.69% (who is a founder and (I guess) married to the companies current CFO), Jakub Sitarz 11.69% (Founder/programmer no longer active in the daily business of the company). The remaining ~8% of the consortium is not disclosed, but the CFO has a portion of that.
Business & Outlook
The company has a very impressive list of customers
The growth in number of paying customers can be shown in many ways, this is LiveChat’s own presentation:
Another way to describe this would be the following:
I think this gives a clearer picture of how customer growth has been on a steady downward trend for some time now. But it’s also quite clear in the MoM graph that it seems to have bottomed out, at least temporarily. Another aspect to this is the churn of customers, which LiveChat is not as generous with data on. But they do disclose that the churn has been stable around 3%. They also note that the leave ratio is much lower for larger customers (companies using the more expensive subscription plans and buying more licences).
We will come to competition soon, but obviously the customer growth is affected by strong competition which has entered the space. Livechat has previously been spoiled to with very little effort gain large traction, today they have to work harder. One channel they use are affiliate partners who get a kick-back for redirecting paying customers to LiveChat. I think you understand what kind of affiliates that is, you google for “best customer chat service” and you land on different homepages ranking providers, all with links to the providers. Overall LiveChat does not invest huge amounts of money trying to win customers, but is rather trying to use clever cheap ways. Like providing a very good blog/homepage of their services. This is if I grasped the competition correctly is more in line with how the freemium services/companies are acquiring customers. So judging from figures there seem to be a potential turn-around or at least flattening of a previous “nasty” trend, the stock market seems to think so too.
A big positive is the fantastic margins that LiveChat has historically held, which enabled the large dividend payments. It’s just a staggering generating such cash flows at the same time as the company has had yearly growth in the 20-40% range.
I think Poland instead of Silicon Valley is a big reason for this, wage levels are probably 20% of the Valley, but the quality of staff is definitely not 20%. In many ways it could be better, given this being one of few very attractive employers in the city. Historically many great companies were built in slightly off locations with staff that wanted to live there.
It’s undisputed by now, how businesses and consumers are moving online, the clothing industry being one of the ones most affected by this. Another example could be retail banking, which used to be a very personalized face to face experience. Today most people want to avoid visiting a bank branch. Overall all companies today have a challenge in communicating with their customers. This has obviously spurred growth in multiple new channels where companies tries to find new ways to connect with their customers. LiveChat has been riding on that wave and I think it’s a wave that still has a lot of runway left, giving this investment idea a nice tailwind. On the other hand the LiveChat growth figures are telling a story of slowing growth, that I account more to competition than that the actual market itself has entered a lower growth stage. According to the available market data and the company’s own estimates, the current value of the market for live chat type solutions may exceed USD 700m, with LiveChat having some USD 35m of that.
Zendesk has a nice graph showing how new ways of interacting with companies comes naturally for younger generations:
The market got a scare a few years ago, believing Facebook and Apple wanting to step into this space in a bigger way. Facebook would make it possible for customers to chat with companies on their homepage through Facebook messenger. Given that Facebook messenger is a well established channel it would not be strange that more and more companies moved more of their customer communication to that channel. LiveChat’s comment on this is: The company is developing a business ecosystem around its products, LiveChat and Chatbot, in order to be able to better address users’ needs. Thanks to these developments, they will be able to communicate with their clients via multiple platforms, not just using their website, but also via text message, Apple products, mobile devices, Facebook Messenger, social media communicators and platforms. For the interested reader a longer comment from around that time: LiveChat comments on Facebook chat.
Group’s growth strategy
This is taken from the company presentation:
The company’s development strategy is based on making continuous, balanced investments into further development of the LiveChat product, including in particular: a) functional development of the app; b) new communications channels;
• development of the ticket system
• mobile systems;
• social media;
• an integrated communications tool c) data-driven tools for larger corporations
Much of the above is based on the new services like Helpdesk, which recently launched. Overall LiveChat is mimicking much of what the market leader Zendesk is doing, which leads us into the Competition. I also learned from reading around on their blog that they have deployed clever tactics in the past to improve their LiveChat product. The company used a stand alone service called chat.io to play around and test new functionality without disturbing existing user-base. When a lot of new ideas had developed within the chat.io product, they merged them into the new LiveChat 3.0 version and started to roll it out to existing customers (Blog reference)
In interviews the CEO states that they are not afraid to charge properly for their product. It’s a premium product and they do not go for free versions (except a short free trial), since their experience is that it’s hard to convert a non-paying customer into a paying one. So they are confident they have a product which stand out in the competition. What does the landscape then look like in such a niche as chat-related services on company homepages?
I will focus on the two companies larger than LiveChat (tawk.to & Zendesk), which are at two extremes in their strategy of offering this product.
Visiting their homepage the first message is: “You never have to pay for live chat software again”. This is the largest freemium service of chat. Given it’s free it’s not surprising they have a huge number of customers, 2.2 million. As we know today, free always comes at a cost, like usage of customer data. There are also some other costs, like a monthly fee if you want to remove the tawk.to logo from the chat. Also they sell services of agents that talk in your chat for US$1 an hour. This obviously attracts a big set of smaller companies without the budget shelving out every month for a chat system and perhaps do not even have the staff to man such a chat. It is on one hand worrisome that such an attractive product is offered as a freemium/fully free service. On the other hand, as long as LiveChat can offer something significantly better, these companies might be door-openers to new customers. Tawk.to is not the only provider of such a freemium service, some of the smaller players in the above picture follow the same strategy. At the other end of the spectrum we have:
Zendesk is a US listed company with 10bn USD in Market Cap. They come from a different background, having customer support as their main product and later adding on chat. Another difference is that the company did not organically grow these new product offerings, but bought several companies. For example the Chat functionality was bought from Singapore based Zopim. Later they also acquired BIME Analytics which became their data analytics (BI-tool) platform. Zendesk currently have some 145 000 paying customers for all their products and some 45 000 chat paying customers. The company has expected revenues of some 181m USD the previous quarter, so they clearly charge their customers. Just focusing on the chat side of Zendesk, the pricing levels are very similar to LiveChat.
When you start to look into Zendesk and seeing the changes LiveChat done over the past few years, one realizes that they are playing catch-up on services Zendesk has already launched. In LiveChat’s investor presentation they mention that Helpdesk is to challenge Zendesk and other competitors with an attractive alternative. This product was just launched in May 2019, so it’s to early to tell how it has been received. Also in their presentation they compare number of paying chat customers for Zendesk vs themselves. Zendesk has over the last year lost customers each quarter, whereas LiveChat is (as you have seen) still adds customers.
Here it’s worthwhile to stop for a second, just how much is a Zendesk customer paying? (181million*4)/145000 = 4993 USD per year, per paying customer. Given that a lot of that revenue is not chat related, it still shows the income potential per customer with a wider offering (which LiveChat is building up currently).
Here I have plotted the trend in how much an average LiveChat customer is paying:
Although the slope of the trend is not extremely strong, I’m still happy to see that this is a positive trend. It tells quite a lot, that while the market has been flooded with good freemium options that LiveChat has increased income per customer. This is such an important point and one of the main reasons I see LiveChat as investable. Some observations around this:
LiveChat is now building up their product offering, with cross selling there is potential to reach closer to Zendesk earnings per customer.
LiveChat has been able to historically, at least slightly, up-sell their products to each customer (meaning more agents per customer, or adding chatbot services etc).
LiveChat is still adding paying customers, when Zendesk (with their strong overall offering is losing paying customers).
The company paid out almost 100% of profits during 2018 and during previous years paid out a large portion of profits as dividends. Over the last six years the company has paid out some 200 million PLN or 55m USD to shareholders (current market cap ~220m USD). My guess is that this was partly done because the founders wants to “cash out” without selling their shares and losing the company. So since the company was growing so nicely without massively reinvesting profits, they reasoned that they could shift out profits through dividends. In my view this has been a mistake, looking at how Zendesk has reinvested all of its cash-flow (and then some) they have grown much stronger over these years. If they can reinvest the capital at a higher rate of return than what investors can find elsewhere that should be preferred. At the same time Zendesk runs a totally different model of acquiring companies for growth. Whereas LiveChat grows organically with a strong local Polish team, which is a model I prefer. They have increased number of staff from some 84 to 145 in 1.5 year, so it’s not LiveChat is not investing at all. Many of these people are deployed to work on the chatbot if I have understood things correctly from my communication with the company. They also bought the domains chatbot.com and helpdesk.com last summer. So clearly they are stepping up things and deploying some of that nice cash flow back into growing the business.
But it’s still a fact that the company is paying out a very high dividend, currently at a 6% yield. So here I am complaining that you get a 6% dividend yield owning the company. Well, repeating myself, I think the ROI had been even better if they managed to deploy that capital for further growth. So given that LiveChat do continue to shift out capital to it’s investors and probably will not see the same high growth numbers as Zendesk, is the company worth buying?
Maybe we should deal with this question directly. Zendesk seems to be the market leader, why don’t I just buy that company if I like this niche? Short answer, because it generates losses and is at nosebleed valuation levels. I do think Zendesk is an impressive company, but for an investor like me, who cares about valuation, it’s a no go. A quick comparison table:
So with that out of the way, let’s move over to trying to value LiveChat.
Equity Risk Premium: Being a company listed in Poland I would normally warrant a higher risk premium, but given that all revenue is generated in USD from customers worldwide and the high dividend yield basically putting the accounting fraud risk at zero I’m going to go with my standard rate of 10% discount rate.
Growth: As we have seen, customer acquisition growth has stopped around 10% lately, whereas revenue growth has been somewhat stronger than that. My assumption here is that customer growth rate probably over time will drop to low single digits, but the growth will rather come from up-selling to existing customers.
Revenue Growth Bull: 20% first 5 years, dropping to 10% over the coming 5 years
Revenue Growth Base: 10% for the coming 10 years.
Revenue Growth Bear: Dropping to 5% over the first 5 years and then 0% growth.
Margins: Track-record is fantastic and I see no major reason that this should deteriorate significantly.
Margin Bull: 65% EBITDA margin, increasing to 68% over the next 5 years.
Margin Base: 65% EBITDA margin constant over time.
Margin Bear: 65% EBITDA margin, decreasing to 60% over the next 5 years.
Taxation: Here I have left the tax rate in all scenarios at the current corporate tax rate. But there is a kicker in all scenarios that the tax rate would drop under a new legislation interpretation where intellectual property revenues could be taxed at a much lower rate (IP Box tax)
Valuation Bull: 74 PLN per share – Probability 20%
Valuation Base: 48 PLN per share – Probability 50%
Valuation Bear: 30 PLN per share – Probability 30%
Which gives me a weighted target price of: 47.8 PLN per share, in line with my base case valuation. With the share currently trading at 33 PLN, I see enough upside (45%) with limited downside to enter a position at these levels. I will start with a position which is 4% of my portfolio and see how this develops.
Key Metrics to follow
This will be something I want to introduce for all of my holdings, some very brief key metrics that I will keep up to date, to follow the company over time.
LiveChat Key metrics:
Month over Month Added customers.
Quarterly Revenue per Customer.
Changes in capital allocation strategy.
Excess Cash Adding to Swedish Match and Irisity
The excess cash I have left after buying into LiveChat I distribute equally to my positions in Swedish Match and Irisity. Both companies in my view have a very nice risk/reward profile from here. Swedish Match Zyn product seem to be doing great and I don’t understand why the share is trading so weak when the Swedish Krona is losing even more to the USD lately. Irisity is reporting Q2 results soon and it will be interesting to see how the roll-out of their products to security companies have been going.
When investing in a company I do my best to understand the products the company is selling. I want to understand the environment the company is operating in, competitors, brand value, together putting the company into a context. I try to understand the management of the company and where they want to take the business. I then try to look long-term if the industry has headwinds or tailwinds and how much sales is affected by the general market cycle. All this and more goes into my valuation of the company. But even when I try to cover all bases, the stock market keeps throwing curve balls left and right, I had my fair share and there will certainly be more in the future. The other day it felt like I was dealt another curve ball.
The management of Edgewell Personal care, went out bought a shaving company start-up called Harry’s for 1.37bn USD. Edgewell with an Operating Income of some 300m USD, net debt of 1.1bn USD and Market Cap (pre announcement) of some 2bn USD, thought it is in a good position buying a start-up for 1.37bn USD. Worse than that, they pay 1.085bn USD in cash and very little in stock. This brings debt levels to seriously tough territory, at a time when I at least believe we are close to the peak of the cycle. I thought I bought a low risk defensive company, it suddenly transformed into a equity position sitting on a huge debt rocket.
Harry’s is one of the competitors (Dollar Shave Club being the other) that I mentioned i my analysis of Edgewell when I invested. They are taking market-share from Edgewell, Gilette and BIC over the last years, particularly in USA. Harry’s top-line revenue is expected to be about 325m USD in 2019 (growing at 30% historically).
They do own their factories and it has been an impressive growth case, so of course it isn’t a worthless investment, it’s just a combination of overpaying and overstretching Edgewell’s balance sheet. I’m so disappointing in Edgewell throwing in the towel to create this themselves organically. By acquiring Harry’s it’s like admitting to not being able to compete with these guys. That speaks volumes to me about the management of Edgewell. At today’s close, I sell my full holding in Edgewell. Obviously I wish I never invested in the first place, given that I now take a -16% loss on the holding, but I never saw this coming. Investments really can surprise you in so many ways..
Other thoughts about my holdings and the market
Markets have come off a few percent from their highs and my portfolio has under-performed quite a lot the last few weeks. Some of that poor performance obviously is related to Edgewell, but there have been other holdings performing poorly too. Trade war is a big worry, especially for my portfolio that feels fairly exposed to this. I’m not very positive on us seeing a deal anytime soon, there is too much pride in China for that. At the same time I changed my mind about the so often cited coming China crash. I still think it will come, just not this year. My bets are on a pretty ugly 2020 in China, with serious deterioration in their economy in the later part of next year. These things are impossible to predict, but from everything I read and hear, it seems like we have already passed the peak. It will just take a while for slow moving things like the property market to start to wobble and finally fall.
My more defensive companies like Philip Morris, BATS, Swedish Match, Diageo, Dairy Farm, Gilead, Inditex and Essity has not really done that much lately. They have more or less performed in line with the market or slightly better. Below I instead focus on the more high risk holdings:
One of my largest holdings, the quite illiquid company Tonly Electronics has traded down. This is quite warranted given the Trade War that to some extend will affect the company. I’m still hopeful that the company will be able to improve margins during this year, which really is the key thing to be watching in the next report for the first half year. The fairly good dividend yield, which was paid out yesterday, at about 5% yield is also reassuring. Tonly was an opportunistic investment where I see a very deep value case, but not necessarily something I want to hold for another 5 years, as long as some of that value is unlocked at some point.
A holding that has been a long term holding, but where I numerous times discussed if it really should be. Nagacorp came through with how they plan to finance the third stage of their expansion in Cambodia. After reviewing the terms, I actually think they are quite fair this time. So I decided to increase my position size here and for now throw away my doubts and really firmly put this in my long term holding bucket. I increase my position size to a 7% holding, nearly doubling the position size, more or less back to where it was before I started to reducing my holding. Somewhat ironically the average selling price of my shares is exactly where the shares are trading at now, 8.96 HKD per share. But the situation was different then, I very much doubted that the majority owner would come through with a decent deal for everyone. Now that he did, it changes a lot for me. I many times stated I would be happy to have a very large holding here if I just could trust management. The trust gauge is not really at 100% yet, but it’s much higher than before and this money printing machine feels like a stable holding at 7% weight.
One of my original holdings since I started the blog. As explored the Electric Vehicle theme back 2015-2016 most signs pointed to that the real S-curve effect would start around 2020. I remember telling colleagues back in 2015, isn’t it cool that in just 5 years all big car companies most likely will be launching full EV line-ups. That more or less have come true, maybe with a 1 year delay until we really see them in every car dealership. Even if I got the EV theme correct, the company Coslight has not turned out as I planned when I invested more than 3 years ago. Now when EV sales numbers really are starting to climb, I don’t think its the right time to sell this company. I’m down significantly, on not really any news. The company still also has its game software development which is a profitable cash generating business. There is a lot debt here as well, which has been my main oversight when investing. So I might get wiped out from the debt, but somewhat stubbornly perhaps, I want to see this through.
Finally my speculative holding Irisity has lately been on a bit of a roller coaster ride. But fundamentally on the company, I’m even more bullish than before. First quarter sales on Monthly Recurring Revenue was fairly solid showing continued strong growth (from low levels). The latest news about HikVision also being banned, just like Huawei, plays perfectly in the hands of companies like Irisity. The largest competitors in this space for sure are the Chinese, with companies like Sensetime having huge software development teams on video-surveillance. If western companies avoid or even are banned from using Chinese tech in this area, a lot of the competition in the market is removed. I’m considering to increase my holding further, but will stay put for now and hope I can increase and a better entry level.
That is all for now. I’m trying to find time to publish a real deep analysis of some new ideas I have had for some time now. But you will have to wait a little bit longer for that. Comments as always are appreciated!
This is a follow up post of my recent portfolio changes. Below is my current portfolio, now fully invested, no cash. As always you find this picture on my portfolio tab. Another small push of about 0.5% is needed for the portfolio to take a new all time high.
Below follow my thinking on the portfolio changes I made:
Before I start this post, I just have to comment on the last months terrible portfolio performance. After being comfortably ahead of the MSCI World benchmark, I’m now behind by almost 5% on the year. The portfolio is down nearly -8% in 1.5 month. Some of it, is company specific stuff, like the gaming halt in China (NetEase). Some of it is just general Emerging Markets and China sell-off, versus how strong USA (which I’m heavily underweight) is in comparison. A picture says more than a 1000 words:
Now over to something more fun than my under-performance, which I’m not too worried about, its bound to happen, especially when you have such large regional tilts.
In a recent post I laid out my new and hopefully improved portfolio construction/allocation. I summarize my new portfolio construction in the following three buckets:
The idea is to keep the main focus on the long-term portfolio. This bucket contains about 15 stocks and carries the majority weight (65-90%) of my total portfolio . Given a 5+ year holding period, this implies that I should not change more than 3 holdings in a year. I did not put that as a strict requirement, because sometimes more action is needed. But the Target Holding Period defined above is really there to imply that this should be a low turn-over portfolio of great long term holdings.
I have been following stocks and the market so long now, that I see stocks that are miss-priced for one or another reason. When I see the risk/reward as favorable, I now have the flexibility to take part on a more short term basis. The analysis on my side here could be anything from very deep to more shallow.
I’m not sure if this the gambling genes in me that likes this so much, but I just love speculative stocks. I added this investment bucket for two reasons:
1. I spend quite a lot of time researching and reading about these kind of stocks. I think I sometimes actually have an information advantage (that is yet to be proven).
2. Because its fun. Investing is mostly serious business, but it should also be fun and exciting.
Portfolio Changes – Selling 3 holdings
It will take some time to have a portfolio that is fully in line with the above buckets. I think for example the Opportunistic cases I present today are not the strongest ideas ever. Nevertheless I think they are good enough to enter my new and shiny three bucket investing strategy. Below I will go through what has to leave the portfolio. At a later stage there still might be 1-2 long term holdings that needs to be evaluated if I’m really comfortable holding long-term.
Kopparbergs – Sell Full Holding – 5% investment return
Since I bought into Kopparbergs I spent quite a lot of time, Peter Lynch style, looking at cider products in stores around the world. Walking around daily life, like in a supermarket is just full of investment opportunities don’t you think? In fact this is in general something I draw quite a lot of inspiration from. The more important step in that process is both figuring out what you think of the product compare to its competition and more importantly, how other people feel about it. In the case of Kopparbergs, I think that competition has stepped up significantly and consumers are now having choices similar to Kopparbergs. Kopparbergs more or less created a new cider segment, with very sweet cider. From what I see in stores, although less sweet, for example Carlsbergs Sommersby cider is extremely popular. My case was that Kopparbergs cider had a good chance of being a hit in the US, I now changed my mind about that and see it as less likely. Kopparbergs product offering is not strong enough to really stand out in this competition. Another important factor is that selling these products is as much about distribution and network as in having an awesome product. For all the above reasons I decided that the likelihood of Kopparberg continuing a strong growth journey in cider sales, is low.
A behemoth in property services, mainly related to cleaning with almost ½ million staff is an impressive entity. My investment thesis was a turn-around in free cash flow after paying down debt and after that a significant dividend increase. That didn’t really play out as planned and the stock market has also been as disappointed as I. Selling this holding is for totally different reasons though and that for me is too low growth opportunities. This is a steady (potentially) high dividend paying company. Although high dividend stocks have many nice characteristics, it’s not really what I look for in a long-term investments. There has to be both growth and dividends. Mature businesses which are just fighting with operational efficiencies is not what I believe will generate alpha long term. It might do so in a bear market, given the stability and quality of the company, but I’m not going to hold ISS as a timing play on a bear market.
I will have to expand what I look for later, in my Part 2 of the “Art of Screening”
Radisson Hotel Group – Sell Full Holding – 39% investment return
I’m usually pretty tough on myself and my investments failures. That’s because I’m not here to brag, but to become a better investor. But now I will do a bit of bragging. Damn it feels good when you are spot on in an investment idea. I painted out a investment scenario whereby HNA would be forced to sell it’s position in Rezidor (now renamed to Radisson). On top of that I had listened to a 3.5 hour investor presentation on how the hotel group was going to structure it’s turn-around. So it was a double whammy turn-around + bid case. As it happened the market started to believe the turn-around, especially when it already started to show in the latest results. Then came the bid by a Chinese hotel company: HNA sells Radisson Holdings to Jin Jiang-led consortium.
Unfortunately this bid did not give as much of a stock price bump as I had hoped. There is still some un-clarity around how much Jin Jiang will need to offer the minority holders, but they might low ball investors and keep the stock listed. There still might be more upside here, but my investment case has played out and I’m happy stepping off here, overall a great investment which returned 39% in less than 6 months.
I will at end of trading today add 5 new holdings to the portfolio, and after selling the 3 above holdings, this is what my new 3 bucket portfolio will look like:
Short comments on new holdings
Obviously this will need to be expanded over multiple posts, but here is the quick and dirty on these 5 new holdings:
Amer Sports – Opportunistic – 4% position
Since my previous investment in Xtep, I have both researched and followed the Chinese sportswear and sport shoe producers in China. I invested in the one (Xtep) that was trading cheap on all kinds of metrics. If I had taken a more long-term approach, perhaps I should have considered the local champion Anta instead. Anta which is a 13bn USD MCAP company recently showed a tentative interest in bidding for Amer Sports, a Finnish holding company for a long list of attractive brands/assets. The tentative offer was at 40 EUR per share and the stock quickly after repriced from 29 EUR to 36 EUR, but has after that come down to 34 EUR. If one wants to play mathematics on that, one can say the market is pricing about a 50% probability of this bid actually going through.
My investment case is two fold:
I liked Amer Sports already before this bid and had already done a quick due diligence on the stock. Even if the bid falls through, I’m not in panic mode holding this stock, it could convert to the long-term time bucket if I did a deeper due diligence and like what I see even more than I already do. There has already been other speculations that Amer might spin-off parts of its business to unlock value.
The market is way too skeptical on the bidder in this case. I take this as typical “China fear”. This investment, so makes sense for Anta. If and when it goes through I will be very compelled to add Anta to my long-term holding bucket, I think they would do great things with Amers portfolio of companies. We have Winter Olympics coming up in Beijing 2022 and Amer holds several “winter” assets. Anta has the network in China to actually being able to grow these brands in this tricky market, in the past Anta has bought the China rights to the at the time quite poor brand Fila in 2009. They have totally re-positioned the brand in China over these years, growing it into a real success, from 200 to over 1000 stores in the country. I put the probability of Anta being serious with this bid at 90-95% and I take the probability of a successful takeover somewhat lower (85%), since there is some overhang with for example USA wanting to meddle in this, given that many of the brands under Amer are tightly related to USA.
My own expectation is that this should be priced at 85%*40 + 15%*29 = 38.35 EUR, giving about 12.5% upside on current market price of 34.1 EUR.
JD.com – Opportunistic – 4% position
In this pretty brutal China sell-off I have been scratching my head if and when I should poke my hand in trying to catch any of these “falling knives”. I somewhat randomly felt that now would be a good time to catch one of the stocks I have been looking at for quite some time. JD.com is the case of a quickly growing e-commerce company with tremendous revenue growth. The company plows all of the cash back into investments in its own business and other businesses. For example it’s a co-investor in Yonghui Superstores, which my largest holding Dairy Farm owns 19.99% of. For a primer on JD.com I kindly refer to Travis Wiedower who presents the case in his investor letter: JD.com in Letter, EGREGIOUSLY CHEAP blog.
A pretty disastrous allegation having hanging over you, I will refrain from speculating in the probabilities of this being true. The main point here is that at this stage the company is bigger than Richard. Yes, Richard built this company and yes this will have a negative effect on JD’s perception among the Chinese. What did Richard do in the US when he got arrested? He was actually studying at Carlson School of Management to complete the American residency of a US-China business administration doctorate programme. Having time for these types of studies shows that other people are running the company by now. There is some issues with the governance structure if Richard would be imprisoned, but we very far from that right now, he is not even charged yet. Richard has built a fantastic business in China, in many ways better than Alibaba’s model. My best guess is that these allegations will die out and JD.com will on a 1-2 year time horizon trade significantly higher. When/if this allegation overhang is removed, this might move into my long term time bucket.
Irisity – Speculative – 2% position
The company listed in 2013 under the name Mindmancer. The idea was to provide smart camera surveillance systems to construction sites, schools and such. The whole package of software imagine recognition, cameras and installation was provided by Mindmancer. They had some success and have installed this in numerous places over these last ~5 years. The problem was that the business model didn’t scale and it was hard to keep the company profitable. There was also management issues, where one of the founders, a very young an enthusiastic guy was the CEO. He probably had the heart in the right place, but was to inexperienced to run and grow this company. The largest shareholders which is connected to the University in Sweden where the company started, decided to appoint a new CEO, change the name of the company to Irisity and do a rights issue (24 MSEK at 7.8 SEK per share) to strengthen the balance sheet. After that the new CEOs strategy has been to go for scalable sales model, just selling the software they develop. The software is proven in all the live conditions where it has been installed already. They are going for so called Software as a Service (SaaS) model. Somewhat surprisingly this quite quickly has got a lot of interest from market participants, both G4S and several of the worlds largest camera producers.
“Irisity AB (publ) signs license agreement with Hangzhou Hikvision Digital Technology Co. Ltd.
Hikvision is the world’s largest supplier of innovative video surveillance products and solutions. With 20,000 employees, including nearly 10,000 in R & D, the development of intelligent cameras leads. Hikvision is listed on the Shenzhen Stock Exchange with a valuation of USD 46 billion. The company shows a strong YoY 32% growth, with sales of USD 6.6 billion (2017). In collaboration with Hikvision, Irisity now evaluates embedded integration of IRIS ™ AI software in Hikvision’s camera platform.
– Hikvision is a wish party to Irisity, we already have our AI with several of their IP cameras, but are also looking forward to creating a Linux embedded solution right in the camera. This is the future, since very few cameras will be delivered without built-in AI! Comments Victor Hagelbäck, CTO on Irisity.”
What is not mentioned in the press release is that Hikvision produces almost 100 million cameras per year, so the potential is gigantic if these companies really like the Irisity software.
So to summarize, the company has a proven product in the Nordic markets. They are currently trying to convince huge players, that its software algorithms are good enough. In a best case they would want to pay Irisity to embedd them in their products. Right now this license agreement is not worth any money, its just shows that Irisity has got to actually showcase their products and on some level for example Hikvision (several other big companies are doing the same) is evaluating their product. I find Irisity (valued at about 35m USD) at a very attractive risk reward right now, even if the probability is very low to see large orders. This is truly speculative, one of these lottery tickets, but with much better odds than playing the lottery.
Scorpio Tankers – Speculative – 2% position
This is a fairly simple case, market analysts seems to think that Day Rates should normalize. They have not done so, so far. Equity markets have given up and stock is tanking (ha ha). Taking the long term view on day rates, its seems plausible that they would increase from these levels. I’m a firm believer in mean reversion. Scorpio has a attractive fleet of new vessels, as long as day rates recovers somewhat, they are highly cash generative. Let’s see if that happens or not.
UR-Energy – Speculative – 2% Position
Canadian listed Uranium miner, that I actually owned already back in 2006-2007. At the time, it was the only junior Uranium prospecting company, that actually came out on the other side of the bull and following bear Uranium market. They are now a small scale Uranium producer, with a large portion of their production hedged at higher levels. I will have to write another time about Uranium, but its a very special market and a strong case can be made for long term increases of as its called yellow cake. I’m choosing UR-Energy as my Uranium proxy, because they have excellent management, a very crucial detail in the mining industry, which is full of crooks and cheaters.
Please comment what you think of my new holdings and I will try to follow up with more details in later posts!