February Investor Update

Dear investors and well-wishers,

The fund returned 12.1% in January, taking us to +110% net for the last 12 months and 86% net for the financial year-to-date.

This was broad-based and we now have over 50 positions. Since inception we have now done ~6x the market return net of fees.

We are still seeing new opportunities, and many of our best performers of late have been positions made in recent weeks and months.

I’ve given some examples below, but please don’t rush out and buy the stocks, we bought at significantly lower prices!

Dermtech

We’ve written about blood diagnostics for cancer before (Guardant is up about 130% since).

Melanoma diagnostics poses several challenges. GPs are the first point-of-contact, and generally refer suspicious moles or lesions to specialists who will make an assessment and take a biopsy. Here the risk is that a melanoma is misdiagnosed as something harmless. It’s estimated up to 17% of early melanomas are missed.

Furthermore having part of a mole knifed out is not particularly appealing to anyone, bringing in patient friction and delaying diagnosis.

Dermtech focuses on melanoma in an ingenious way. The diagnostic process is genetic, but instead of a blood draw, a kind of sticky tape is put on the suspicious lesion in question, capturing cells across the melanoma.

This is an easy, fast and scalable test that can be deployed in almost any clinical setting (GP clinic, dermatologist’s office, etc) to determine whether a given lesion requires a surgical biopsy. It can be used by any physician, in contrast to current biopsies which ideally should be performed by a specialist, a real issue in vast parts of the world with no local dermatologists.

Dermtech has patents over the concept of using an adhesive to obtain and analyze RNA in humans or animals for any purpose, and have further patents on both their specific adhesive patch design and gene classification models.

As usual, we focus on the decision makers, which in this case are key opinion leaders in melanoma who guide standard-of-care. They are supportive. The company is also winning over insurers, with coverage extended to 6 million Texans last week.

Company presentations in biotech can give the impression that the two most important things are regulatory approval and market size.

But that is not enough. Two other questions must be answered:

  1. Will end payers pay, and
  2. Will clinicians actually adopt the new technology?

As seems to happen so often to our companies, Dermtech became a short seller favourite right before it exploded in price:

Short interest is currently sitting at ~29% of the float.

It’s always a challenge to estimate market sizes, but the revenue opportunity here is likely well over US$1 billion, which is substantially more than the entire market cap of the company (when we purchased, anyway).

Shockwave

Many of our best performers lately have been in the life sciences.
Shockwave has now more than tripled since purchase. The company uses sonic pressure waves (sound) to break up calcium in arteries. The basic idea has been in use for 30 years in the treatment of kidney stones.

Sadly this was a company in which we only took a small position, though we did plenty of work. With forecast growth of 92% and a clear pathway to broaden the scope of their treatment, this is one to hold as they roll out their method across related conditions.

Eargo

Eargo has a fresh take on the stale hearing aid industry, which has frustrated customers with ugly and inconvenient solutions.
Eargo offers a decent out-of-the-box hearing aid at a fair price with a very high level of convenience. The devices are FDA-approved and regulated (not over-the-counter) but the firm has worked hard to improve the entire purchase experience.

The devices are rechargeable and look like modern consumer electronics compared to the rather obtrusive models of the past:

Skillz

Skillz was another recent position. Skillz enables developers to create paid competitions in mobile apps and esports, taking a 14% cut. Users are highly engaged. This data in particular caught our eye, as we are always looking for evidence of customer love and engagement.

Metrics are solid – for every dollar spent on user acquisition, the company currently estimates they receive $4.7 of gross profit in the first three years, with a payback period of only four months.
Monetizing a game via paid competitions can work better than using annoying ads or in-app purchases, as it instantly creates a community and a viral way to attract new players through word-of-mouth – and is clearly a little addictive.

Returns in January (and February to-date) have largely come from new positions. One way in which we are dealing with such strong markets is to continue searching for new positions before they hit the front pages.
We ran some rough analysis on our portfolio to see how much overlap we have with other tech funds. This is what we came up with:

With time, we think these overlaps are likely to decrease, as we are directing new capital to novel, fast-growing companies doing something new. A benefit of the exuberance surging through markets is that plenty of new businesses in tech and the life sciences are being funded and making it to listed markets, albeit increasingly through SPACs.

Outlook

There’s a strong level of optimism in financial markets. This is somewhat justified as $1.9 trillion of US Government spending is about to wash through markets and central bankers seem determined to keep interest rates at lower bounds. Those caught under-invested mid last year have had to buy in at higher levels or miss out completely.

This dynamic is why we keep our overall exposure as constant as possible – a lesson we learned the hard way several times. If you move to cash based on (whatever) macro fear, you usually have only the briefest of periods to enter at lower prices before the crisis passes. Good deals don’t stay around forever.
On the other hand if you’re wrong and markets rally leaving you on the sidelines, you are stuck: you have to buy back in at higher prices and risk losing twice, or stay out of the market forever. The situation is worse if you are short and actively losing money on the way up.

We are doing what we did at the lows: staying invested.

We hold over 50 decent sized companies growing revenues organically at over 90%, invariably taking wallet share from less nimble firms. Sometimes we wonder if it’s riskiernot to own these companies.

Best wishes

Michael

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