Dear investors and well-wishers,
The fund returned -2.6% in August.
I recorded several podcasts recently in a new format with covering companies like Farfetch, Adobe, NVIDIA and Twilio, available on iTunes and Spotify.
Core holdings like Cloudflare, bluebird bio, Alnylam, Elastic and Farfetch announced serious progress, though in many cases the initial positive bounce reversed with the broader market..
Broadly we see three opportunities
- Beaten down internet platforms with significant cash balances
- Fast growing companies on single digit PE ratios buying back shares in bulk
- Tech companies that have maintained ultra high growth in a very tough environment.
- Life sciences companies with clear value creating catalysts.
I suspect companies with significant buyback programs will be the first to recover from this sell-off, while beaten down tech platforms that maintain exceptional organic growth rates will offer the highest long term returns, albeit with a bumpier road.
Life sciences is challenging as many of the most exciting companies are trading richly, while those that are not flavour of the day are still trading at generationally cheap levels. Our largest two positions are Alnylam and bluebird bio. This week bluebird won their second FDA approval for their treatment for cerebral adrenoleukodystrophy in young children, priced at $3m paid up front. It has been an exceptionally long journey for bluebird to get their first commercial revenues, and the company expects to treat their first patients this year.
Bluebird has spent a fortune and many years developing gene therapies – and will finally bring one to market this year.
Farfetch is a good example of a company making substantial progress while enduring a substantial sell-off from its highs.
Farfetch is down significantly from its 2021 peak, at one point well over 90%.
Farfetch is the leading luxury fashion platform online, and this month reported a major new partnership with Richemont and Net-a-Porter/Yoox.
The key features of the deal are:
- Richemont brands will go on Farfetch. This will double Farfetch’s GMV, meaning about 3% of global luxury spend will run through their platform, so there’s a long way to go.
- Farfetch will own 47.5% of YNAP (Yoox & Net-a-Porter), with the option to buy the rest, capped at ~15% of Farfetch’s current stock. Richemont will become a major shareholder of Farfetch.
- Along with Farfetch’s option to buy the remainder of YNAP, Richemont has an option to sell the remainder to Farfetch after three years, provided three out of the prior four quarters are profitable.
This demonstrates the power of Farfetch’s platform, with Richemont, Yoox and Net-a-Porter choosing to outsource to Farfetch.
Yoox and Net-a-Porter suffered from a serious technical debt, and had previously engaged IBM in a failed effort to rebuild their tech stack. Farfetch’s technology investment, which is being marked down so severely right now, is clearly paying off.
For Farfetch this is transformational.
Firstly, it adds Richemont to their platform which joins recent brand wins of Salvatore Ferragamo, Reebok, Harrods in London and Neiman Marcus.
Secondly Net-a-Porter and Mr Porter are key competitors and are now allies.
But most importantly, this establishes Farfetch as the likely dominant online luxury fashion platform.
Luxury firms are reluctant to sell on multiple platforms (in fact, were reluctant to sell online at all) as this could lead to competitive discounting and a brand-damaging loss of control over the customer experience. There is a reason that Shopify has been unable to make headway in this market. Better for them all to focus on the one which aggregates the most customers and has the best technology behind it, which is the happy position Farfetch now finds itself in.
Even a firm with the scale and heft of Richemont can be confident of generating incremental sales.
There are other interesting aspects of the deal which are net positive. Yoox offers a different, lower-end market to Farfetch, giving them access to a different part of the market without diluting their main platform. Most of Farfetch’s revenue is undiscounted (~75%), and doing so on Farfetch would be problematic. Best for that to happen on another platform.
Farfetch plans to use Yoox as an avenue for brands to discount unsold out-of-season stock, and will develop the site as their cyclical fashion outlet, where second-hand and off-season products can be sold.
This deal also offers the chance to move into previously under-represented categories.
Watches and jewellery represent 20% of luxury sales, but are significantly under-represented online, comprising only 3% of Farfetch’s revenue and 1% of their unit sales. The opportunity is significant – on a call Farfetch’s founder pointed out a recent sale of a $2.4 million watch.
Farfetch is one of the positions that has challenged us this year. After peaking at $70, we first bought around $16 earlier in the year, which (sadly along with other purchases we made at the time) proved premature, with the stock correcting over 50% from March to the lows of June.
But despite the performance of the stock, the company is continuing to make progress. In their most recent results they recorded >20% constant currency revenue growth in one of the toughest consumer environments of recent decades, with 6% of prior revenues lost from Russia, and an even larger chunk under pressure in China.
At the lows the company traded for <1x revenue. The company is investing for growth now while targeting long term operating margins of 20-30%, which in a few years time would likely result in a sizeable multiple uplift on substantially higher revenues. An advantage of playing in the luxury space is that gross margins are high at 46% in their latest result.
Farfetch is targeting long term growth of 25-30%, which is not unreasonable given its low penetration and the fact it was growing at twice that rate pre COVID. Even this year, with a weak consumer and serious geopolitical issues in key markets, the firm grew over 20% on a constant currency basis on tough COVID comparables.
Farfetch couldn’t be less out of fashion in the investment community right now. They are consumer focused and on luxury no less. This is a largely online business and the firm investing heavily in their platform. But this is clearly paying off with major new brand wins like Richemont, and we firmly believe is the correct strategy for today: to keep investing, grow through this tough consumer environment, and emerge in a vastly superior position.
It is their investment in technology – a dirty phrase indeed right now – that has made them now the dominant online luxury platform both in terms of technology and demand aggregation. You can’t get a best-in-class tech stack for free. The rewards for this certainly did not come this year, but will in years ahead.
Unlike the first part of the year, there is increasing divergence between companies that have maintained growth and have improving KPIs, and those where growth rates have collapsed.
Valuations across software and internet platforms in particular, as well as small and mid caps generally are particularly attractive right now.
There’s also an increasing divergence between companies buying back shares and those that are issuing them, and we are developing that part of the portfolio (I wrote about our recent purchase of Crocs, for one example).
Recent inflation data has proven stickier than expected, even as the original drivers like gasoline prices have fallen dramatically.
US gasoline (white) tracked US yields closely (blue), but there has been a nearly 100 basis point increase since mid August while gasoline has collapsed, and inflation concerns have shifted to other components like housing
German electricity prices (white) are off their historic highs, but CPI prints have remained exceptionally high
The outlook is unclear as ever. Key initial drivers of inflation have declined, but other components have since increased. I suspect the decline in energy continues, as crude prices have fallen even while OPEC has delivered production cuts, and the price of end demand products has fallen even further (see gasoline above). But watching the debate around the stickiness of housing inflation amongst experts on both sides is a reminder that of how little can be really be forecast about these things in advance, save to say that those who expected the worst have been proven right (this time, and so far).
One thing we do have is a clear line of site on fundamentals, which for our companies continue to improve. And despite the challenges in markets today, that our sectors have rarely traded cheaper.
There has been a significant divergence between small and mid caps, where there are growing companies on 15-20% free cash flow yields, and the broader market, which remains more expensive (albeit cheaper than it was). In our universe the companies that have performed best have been those that maintained explosive growth or have extensive buyback programs. In the life sciences there will likely be an opportunity in blue chip devices, tools and robotic equipment, as these acyclical companies have sold off significantly while end demand remains consistent as always.
And even the laggard companies have started to adapt aggressively. Twilio announced a reduction of 11% of their workforce, and Paypal, with a $105 billion market cap, announced a $15 billion buyback program. The benefit of all these measures will be seen over the coming 6-12 months, and I suspect the companies that reduce share count over this period, buying back stock in a severe downturn, will outperform those that dilute heavily at the lows.
The 10 year yield has pushed to new highs, but it’s notable that many technology stocks remain above their May and June nadirs, even as megacaps in the space like Microsoft and Google are close to their lows of the year.
We’ll remain focused on the opportunities above.
On a growth-adjusted basis, there has rarely been a better time to invest in software
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