May Investment Update

Dear investors and well-wishers,

The fund returned -3% in April, and is up ~5% so far in May, leaving us ~22% for the calendar year-to-date.

We’ve been moving up/sideways for the better part of a year now. The Nasdaq has bounced ~25% since 1 January, but small caps as measured by the Russell 2000 are up ~1%, software stocks as measured by cloud computing ETFs are up ~15%, and the biotech index is up ~3%. The strength has been very focused.

But even as indices languish, we are seeing company after company post record revenues, record margins, and record profits. Over the most recent reporting period, the organic growth rate across our portfolio stands at ~59%. This has been quite an extended period of multiple compression.

Meanwhile, the productivity boom from advances in AI is yet to show in the numbers, other than in the forward forecasts of companies like NVDA and AMD (semiconductors constitute about 18% of our portfolio).

We trimmed NVDA sadly, though I have noted that in the past that the best performing stocks are those that sell everything they can make, be they Apple, Tesla, or now NVDA. Our larger position is AMD at ~6%.

Real time measures of inflation have dropped below 3%. The next three months should see large falls in US CPI as the inflation months from last year roll out of the series. And with that, a peak in rates, and perhaps an end to multiple compression and a return to world where companies appreciate in line with the growth of their fundamentals.

Record revenues, record profits

MercadoLibre announced gross profits grew by 43%, GAAP net income tripled, but the stock continues to trade at a multi-decade valuation low.

MercadoLibre’s income statement

Other than 2022, MercadoLibre has not traded cheaper than this in a decade

Nubank reported record revenues and a ~124% increase in gross profits, all while improving margins. Nubank swung from a quarterly GAAP loss of $45 million last year to a quarterly profit of $142 million. Nubank was down nearly 50% over the very same period, and at one point over 70%.

I, for one, am looking forward to when companies posting record revenues and profits trade are making new highs rather than lows, as NU did in Q1 2023

We added to Crowdstrike, a company which is generating almost $1 billion of operating cash flow, which we expect to reach over $2 billion per annum in the next few years. As things stand the company is going to build an enormous cash pile. With clients across industries, security has largely escaped the slowdown in SAAS companies that primarily serve other technology businesses.

Closer to home, we had small success with positions in Life360 and Xero. Both firms reported record revenues, price increases and substantial improvements in margins. Impressively Life360 recorded 63% growth in subscription revenue, with substantial price increases having minimal impact on churn.

It’s likely that we see more price rises from these kinds of companies – the bulk of which flows straight through to the bottom line.

Reporting Season

As another reporting season winds up there is an increasing diversion between companies that are taking a commercial approach to profitability and those who are not. Needless to say we are focused on the former.

AppLovin and Unity offer an interesting contrast between two companies in the same industry with adopting these two wildly diverging strategies. Both were hit hard by the slowdown in gaming, though there are early signs the industry is returning to modest growth. Both fell over 85%.

In their latest results, AppLovin improved annualized GAAP net income by +$400 million, and is now generating well over $1 billion of operating cash flow, with only ~28% accounted for by stock-based comp. This company was trading for less than $5 billion at the beginning of this year.

Unity, on the other hand, increased its GAAP annualized loss to over $1 billion, and even after adjusting for ~$650 million of stock-based compensation, is losing money at the operating cash flow level. It’s hard to know how to describe a company losing a billion a year, but it’s certainly not an enterprise run for shareholders. While racking up these losses the company has reportedly minted three billionaires – the two founders and the non-founding CEO.

Companies on this path will continue to melt away.

I noted in a letter earlier this year how out-of-touch Twilio’s CEO came across when lecturing in San Francisco. This was perhaps not surprising when you look at the payments to some of his direct reports who are earning over US$25 million each.

Twilio executive pay

The four above stand to make around $100 million each over the next few years. I wonder who will actually buy all that stock?

Ofcourse, strategies can change, and one by one companies are making moves in the right direction, refocusing on shareholders – though Twilio is a case study in how ‘long term’ thinking favouring insiders over shareholders was actually short-sighted and has materially weakened the company.

Shopify, which a few months ago seemed in the same camp as Twilio, surprised the market (and us) by announcing both a substantial workforce reduction and the sale of their challenged fulfilment business. Delivering US-wide fulfilment never made much sense to us or others in the market, it seems. Far better for Shopify to let someone else take the risk in the ultra-competitive, capital-intensive part of the value chain.

One thing we noticed over the last two years was that revenue growth exceeded expectations across the softwared space, but EPS collapsed last year. That is now decisively reversing across the tech space, with EPS upgrades coming through in both big tech and now finally the beaten down growth stocks.

To give one more example of a portfolio company posting record revenues and margins, announced a 55% increase in gross profits with sharply improved GAAP margins, reduced stock-based compensation on an absolute as well as percentage basis, and a swing from a $13 million quarterly cash draw last year to $42 million in positive cash flow this quarter.

There will be a time when companies growing at over 50% while posting record revenues and margins are up 60% rather than down 60%. We have a portfolio full of companies that fit this description, from Crowdstrike to Life360 to MercadoLibre, and now, judging by the +40% quarter-on-quarter guide, NVDA too.

Best regards



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