Portfolio update, a fee rebate, and fish oil

Hello everyone,

The fund returned 0.9% in July.

There were a couple of interesting developments since month end.

Stanmore Coal received an unsolicited bid, conditional on finance, into which we sold our shares. Arbitrageurs will have to bet that a deteriorating coal price doesn’t scupper the deal. The coal ETF we shorted has collapsed in value, so this was a win on both sides. No fund manager on the planet will want to be caught with a bag of ESG-unfriendly coal stocks in a global slowdown.


Carvana has also performed well since month end, reporting year-on-year revenue growth of over 100%. As a reminder, we invested earlier this year at a market capitalization of around US$5 billion, against short interest of over 70%, with a number of lengthy hack pieces doing the rounds.

It’s hard to describe how exceptional these results were – the firm’s 107% revenue growth was on a base of nearly US$2 billion, and profit per car improved from $2,173 to $3,175 (average purchase price is about $18-19,000). If you know a company of this scale that can grow this fast while improving margins, we really want to know about it.

Since the end of the quarter July web traffic has come in 11% higher – so growth has actually accelerated.

We’re generally sceptical of TAM analysis, as it encourages loose thinking and investment losses. However, on a revenue run rate of ~$4 billion, growing at over 100%, Carvana still has only about 0.4% of the US secondhand auto market.

Given their superior user experience and an economic model that allows them to underprice the market, we think a 10x increase to 4% market share is not only possible, but likely. And there would be no reason for them to stop there.

This is now a meaningful position for the fund, and we’re not going to sell a single share. Again, the short side played out too, as the retail ETF we discussed previously has sold off considerably this month.

In another interesting note – Pinduoduo is now estimated to be taking some 28% of all the e-commerce growth in China.

This is the first successfully scaled business model that combines social media, gamification and e-commerce. As an example of the whimsical nature of Pinduoduo, self-described as a cross between Costco and Disneyland, the firm rewards buyers with in-app digital fruit trees that grow with each purchase. At a certain level, Pinduoduo sends an actual box of fruit to the user.

This is the fourth successful venture of Colin Huang, PDD’s ex-Google CEO. We originally thought he was targeting a profitable niche in online retail, but it’s becoming increasingly clear that’s not Colin’s plan. He’s going for Alibaba.

On an enterprise value of $25 billion ($20 billion a few weeks ago where we were buying), this is firmly within the 5-10x return category. And if the red and orange lines above cross, that could be an understatement.

I’ve written about these three investments as we bought the first shares, so happy to report that the fundamentals are all on track. As a reminder, these results occurred after the July month end.

Fee rebate

Markets have been quite volatile over the past year, but in the interests of managing expectations, I thought I’d share the returns from a long only investment account we run:

This was a profitable outcome, and helpfully ensured our fund management company is capitalised for the foreseeable future, but it’s worth noting:

1. There were multiple periods where the portfolio was down for over a year,

2. The strategy moved sideways for over two years from mid 2016 to mid 2018,

3. There were plenty of down periods and sharply volatile months.

And this in the context of a good outcome!

Someone who bought when we were up and sold when we were down could have quickly lost a lot of money in a strategy that generated solid profits.

The difference between a frustrating, premature ending, and 2.5x multiple on capital in a relatively short period, was persistence, and as simple as staying the course. This is as it should be, in business as in life. So a very warm thank you to those who invested on 1 January this year. That’s precisely the kind of courage markets reward. Be assured we’re entirely focused on generating returns and pushing the fund to new highs.

Long-term thinking should work in two directions, so in that spirit, we’ve decided to rebate all the fees incurred last year. It has always bugged us that asset managers earn fees when their funds are down. We can’t guarantee we’ll always be able to do this, but can now, so will do so.

Most of the time our fund strategy outperformed the long only account, but the last year or so is one of those exceptions. We had similar stocks in both, but the main difference was that in the first portfolio, we held them longer. Lesson learned.

>6 year gross return chart. You’ll have to forgive me for using gross returns as the period covers different vehicles with different terms.

For what it’s worth, I think this is the most exciting portfolio we’ve ever had, and a few years ago our core positions included Appen, Afterpay and Xero, which shortly after became an investing acronym.

Fish oil – there’s something to it after all

It’s common knowledge that fish-eating populations have fewer heart attacks and live longer. This is correlation and not causation, and no doubt linked to other common factors, like lifestyle, or perhaps poverty.

However, every time someone tries to pin down this effect in a rigorous study, it vanishes.

This hasn’t stopped fish oil supplements from growing into an enormous industry, but it’s been something of a surprise to review the following evidence from Amarin, a US pharmaceutical company.

In a >8000 person study over five years, a single derivative of fish oil (close-to-pure EPA, called Vascepa) reduced the risk of serious stroke and heart attack by 25%. For every 1000 people on the supplement, there were 159 fewer heart attacks over five years. This mirrored a much earlier study in Japan with over 16,000 people, which found a 19% risk reduction, but led to no major change in medical practice.

These are quite large numbers. Statins reduced risk by a similar magnitude, and developed into a >$20 billion annual market. Lipitor alone, a statin owned by Pfizer, generated over $125 billion, and almost all of that was gross profit.

Amarin management is widely seen as having gotten lucky, and chanced on a blockbuster hiding in plain sight, though that gives far too little credit to a team that spent a small fortune (and it takes one) pinning down a widely believed but unproven belief.

The story is somewhat de-risked as Vascepa is already approved for those with high triglycerides and is generating revenue at a rapidly growing >$400 million run rate. Safety isn’t really a problem either, given the seafood provenance. The relevance of the latest study was that it showed a striking benefit of Vascepa for a wider audience, perhaps even all of us.*

There’s a caveat here, which caused a recent sell-off and shows how treacherous these kinds of studies can be. Instead of water or a vegetable oil, Amarin used paraffin oil as a placebo. This may have skewed results by increasing the rate of heart disease in the placebo arm, which is a reasonable if the mineral oil, say, interfered with statin absorption.

In favour, the placebo arm had the same incidence of major cardiovascular events as one might expect, which combined with evidence from the prior Japanese study, gives considerable comfort that there’s a real effect here.

Source: Amarin

Using conservative assumptions, Vascepa could generate Amarin’s current market cap with about a million annual subscribers. Every additional million users could generate another ~100% of after tax value.

To consider the scale of the opportunity, in the United States there are over 35 million people on statins… all of whom see a doctor… and many of whom will soon be seeing advertisements for Vascepa.

Amarin is a single drug company, so (in our humble opinion) their optimal strategy is to sell to a major pharmaceutical company, who could pump Vascepa through existing distribution channels and ramp up volume faster, on substantially higher margin. There is only about ten years of patent life, so timing is quite critical.

The wildcard risk is that management takes it upon themselves to buy a pipeline of development-stage biotech assets, which frankly, nobody wants to see.

However, irrespective of the investment outcome here, I thought I might bring it to your attention that there’s now convincing evidence, from two large-scale multi-year trials, that pure EPA / Vascepa is something we should probably all be taking.

All the very best Michael

*Amarin’s IP covers protects EPA mixes over 90%, and this was tested in court against generics manufacturer TEVA, who settled. A number of competitors have come out with mixtures containing another Omega-3, DHA, but increasingly it looks like the optimal ratio of EPA to DHA is 100% EPA. Another stroke of luck for Amarin!

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Frazis Capital Partners Pty Ltd is a corporate authorised representative (CAR No. 1263393) of Lanterne Strategic Investors Pty Ltd (AFSL No. 238198). The Frazis Fund is open to wholesale investors only, as defined in the Corporations Act 2001 (Cth). The Company is not authorised to provide financial product advice to retail clients and information provided does not constitute financial product advice to retail clients.

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