June 20, 2022
Survivor & Thriver Fund, LP
As of April, our fund was down 40% year to date. In April alone, we were down 21% which is the steepest decline we have experienced for a single month in our 10+ year history.
Given the unusual macro circumstances and our recent underperformance, I wanted to provide some perspective on how I am thinking about our portfolio and address some questions that I would appreciate clarity around if I were in your shoes.
For the exception of a family home, nearly all of my family’s net worth is invested alongside yours in the fund. This alignment of interest is by design, and I would not manage outside money any other way.
Shaky market sentiment that started with taper tantrum fears in November last year have snowballed into panic about potential stagflation and a potential future recession. Prices of many stocks we follow now trade at or below their March 2020 peak-COVID-fear lows. This is remarkable because most businesses, across sectors, have moved forward materially since those very dark days.
I have tremendous confidence that when the end-of-world sentiment eventually shifts and the forced selling ends, the rebound will be equally monstrous.
Drawdowns are expected and a necessary part of long-term investing. The single most important virtue to achieving All-Star investment returns is preserving the stamina to remain invested in your best ideas as long as they are compounding intrinsic value ahead of a reasonable valuation.
The emotional rollercoaster created by stocks bouncing between hated-and-loved can be gut-wrenching. No matter how confident I might be in any business, it is never easy to watch a stock we own decline, day after day, even when the reason is simply sentiment driven.
Investing for multi-bagger returns
Our fund is unique because the investor base is comprised of families with multi-general capital and the flexibility to think like private business investors. This structure allows us to focus on a handful of ideas where we can develop an outsized advantage in underwriting a range of long-tail business outcomes that we think are mispriced.
We tend to gravitate towards business transitions where the stock can be purchased on a value basis and requires thinking outside the traditional financial investor mindset to build conviction. As a result, our workflow and decision making are centered around developments specific to the businesses and sectors where we are invested.
Our investment filter has been influenced by studying great entrepreneurs and the extraordinary returns their businesses have created for shareholders since going public. My personal heroes include Phil Knight – Nike, Howard Schultz – Starbucks, Reed Hastings – Netflix, Daniel Ek – Spotify, Ray Kroc – McDonalds, Jeff Bezos – Amazon, Bill Gates – Microsoft, Elon Musk – Tesla, Jean-Louis Dumas – Hermès, and Sam Walton – Walmart.
Rhymes with early 2020
The last time I wrote a letter addressing an unusual drawdown in our portfolio was on March 22, 2020: “Now Is The Time To Think Like A Business Owners, Not A Trader“. The early COVID period was particularly difficult because of the extreme uncertainty around humankind health and survival; business was an afterthought.
Looking back, my mistakes in the early COVID days were selling long-time core positions with substantial unrealized gains, and other smaller holdings, out of fear that the most extreme economic scenarios might be suddenly around the corner.
In the early days of the pandemic no one had a clue where interest rates or valuations would go. Based on the magnitude of the selloff at the time, we found the confidence to circle the wagons around the remaining stocks in the portfolio that seemed to meet our Survivor & Thriver company criteria under a stress tested scenario.
We doubled down on the businesses with flexible cost structures, high returns on capital, years of secular tailwind runway, and exceptional management aligned with minority shareholders. The only new core position we added in that March-April 2020 period was Roku, which had declined 55% from its 2019 high, roughly where it trades today.
In the end, simply not betting on the end of world and remaining fully invested in great businesses produced returns in 2020 that few managers could match. Our fund ended 2020 up 132% gross after being down more than 40% through March.
Was some of that performance COVID pull forward and low rate driven? Yes, of course. But stocks had become excessively oversold and each incremental investment we made at that time had been down 40% to 75%. Several of those businesses have grown in size between 200% and 300% over the 2019 reported financials.
Today we are facing a very different set of macro uncertainties compared to the drawdowns of the COVID period. What rhymes with 2020 is the extreme behavior of investors who have crowded into a consensus trade that all but guarantees interest rates, inflation, and the war in Ukraine, will result in a bottomless spiral of capital destruction for most.
Although a correction was warranted after an excessive 2020, the degree of the sector agnostic selloff that began in November 2021 has gone far beyond fundamentals in our view – especially for any business reinvesting for growth.
We see a much more resilient outlook for American businesses than the market does. This is especially true for the tip-of-the-spear winners who are leading transitions that reduce cost and barrier frictions, improve quality of life, and are unlocking economic structures for businesses to be built on top of.
Similar to what we faced in early 2020, it is impossible to know the “what, why and when” that will give markets the confidence to differentiate between business quality and discount a future that might not be so bleak.
What we do know is that the more coiled the spring, the higher it bounces.
Instead of trying to time markets, we think the best path forward is to remain focused on our holdings and ensure what we own is on track. If an investment thesis is intact and the stock declines, it only makes sense to add to that position with incoming capital.
Questions I might ask if I was in your shoes:
1. What is the magnitude of the return potential created by this selloff and what is your current conviction level in the core positions compared to other stocks on our watchlist that have fallen more?
- My guess is that the weighted average upside of the portfolio is between 100% and 200% only to reflect where the businesses are today. The longer-term upside potential is multiples greater – if it wasn’t we would find other things to do.
- The current portfolio is comprised of 11 positions, of which one is private and held at less than a 50% discount to its last financing round (ring fenced from the liquid portfolio). Of the core positions, Spotify and Roku are the most dislocated in our view and trade for deep discounts to any reasonable ongoing business assumptions.
- Over time we think both SPOT and ROKU have 8x to 10x upside as they transition from subscriber growth-mode to closing the hourly monetization gap with advertising rates more in line with peer walled garden platforms. Both businesses are exceeding our expectations in execution including market share gains and widening advantage over peers.
- Our initial Spotify investment was made between late 2018 and early 2019 for about $115 per share, about where it trades today. Within the last two years we added to the position at around $225 per share as the company delivered on major operational and strategic milestones that few thought were possible.
- Lastly, the fund has two smaller more speculative positions in construction technology and proteomics that are on a path to producing future pre-tax earnings that exceeds their current market cap.
Indivior PLC (London: INDV.L) is one our largest positions and sells the leading treatment for heroin and opioid addiction. We made the investment in 2019 for about 53 pence when the company was being sued by the DOJ and traded for less than the cash on the balance sheet. Today, the stock trades for 310 pence with a $2.7 billion market cap, $1 billion in cash, strong secular growth tailwinds, ~$250 million in EBITDA, and a newly extended share buyback program. Although we recently sold 1/3 of our initial position to allocate to more opportunistic parts of the portfolio, we think there is a comfortable 50% upside before reaching fair value.
2. What is the narrative driving the drawdown in our largest positions and how does that enhance or limit a future rebound?
- The biggest contributors to our drawdown this year have been Spotify and Roku. Both companies announced aggressive growth spending plans for 2022 that are historically high for them. The market just hates to see outsized growth spending right now because of rising interest rates. But we think both management teams are shrewd capital allocators and are working within company-generated cash flow.
- Both businesses have reached a scale and advantage over competitors where it makes sense to double down on growth initiates because the incremental returns are extremely attractive. In our view, Roku and Spotify’s announced spending capex announcements make total sense.
- It is an advantage to be one of the few remaining companies who are able to reinvest aggressively when your stock is down so much, when large competitors are rapidly pulling back spending, and funding for potential start-up competitors has dried up. This is the kind thinking and courage that we expect from our management teams when we can understand the plans and triangulate an expected return.
3. How do you differentiate between a drawdown and a mistake?
- As an investor in business outcomes, we consider mistakes to be when the investment thesis changes enough to upset the risk profile and future earnings outlook. Mistakes are not always correlated with losing money. We have made mistakes where we got paid for being wrong and have made mistakes where we lost money for being wrong. The stock price alone never tells the whole story.
- A stock’s daily price movement is more reflective of general market sentiment than an efficient discounting of future earnings. Expanding on the Nike reference earlier, Nike’s stock declined more than 30% in 1984 partly related to fears around the record sponsorship Michael Jordan deal and how that investment fit into the bigger picture of building a new mainstream market for athletic apparel. Would it ever pay off?
- We are not married to our positions and are willing to sell quickly if an investment no longer meets our criteria and return objectives.
- Examples of mistakes we have made in the past and talked about in past letters:a. About-face changes in the capital allocation direction of a business that undermines long-term earning power,b. Predatory controlling shareholder group not aligned with minority owners forces a buyout far below liquidation value,c. Management not 100% focused on being more relevant in tomorrow’s economy,d. Overdependence on a famous founder and capital allocation strategy to drive value in an otherwise mediocre business,e. Misjudgment of moat, quality, and margin of safety due to a “cheap” stock price,f. Balance sheet leverage becomes a bigger problem than expected,g. Large, overvalued acquisition leads to permanent impairment and internal chaos
Please stay in touch
As always, feel free to call me with any questions. I do not have a view on how long the current environment will last, or how low valuations can go. But I would be happy to discuss any of our investments and why we are so excited to be fully invested today.
Thank you for your support.