March 22, 2020
COVID-19 Partnership update
Dear JDP Partners,
I wanted to write a note to thank our investors who reached out to Seth and I over the past couple of weeks. My partner Lili and I are healthy and working from home. Seth is healthy and with family in Arizona. Mark Chapman is healthy and working at home in BVI. Our back office is also healthy and not skipping a beat (audit is wrapping up this month). We appreciate the COVID-19 research many of you have shared from within your professional ecosystems around the world. We also appreciate your interest in trying to understand the impact that the recession might have on our portfolio companies, and the subsequent willingness to add capital during such uncertain times.
What we know for sure
The impact of the virus on society is unknown and rapidly evolving. When it comes to business, this is what we know for sure: (1) Weak, leveraged companies with high fixed-operating costs can go bust without help from third-party capital such as private equity funds or the government, (2) Most of 6,000+ US public companies will survive but growth could be stunted temporarily, (3) Some companies will Survive and Thrive because they benefit from demand transitions for their technology that will be accelerated in a recession at the expense of competition. Today stocks are largely trading together, as if the market was one big company. During times of crisis our capacity as humans to see past this moment is limited. Our natural instinct is to buckle down, take action to feel safe, and preserve resources. Crisis also triggers plenty of irrationality—like fist fights over toilet paper and panic-selling any stock at any price. Most public companies will be fine, and we will look back on this time as the opportunity of a decade. The second quarter and third quarters of this year will be horrific for corporate earnings including ours. But the market will look past the virus dip at some point and discount the future because that is how markets work.
Positioned for the rebound
In February we took a hard look at our portfolio companies, their balance sheets and risk of permanent impairment to revenue that a recession could cause. This resulted in us selling two large holdings out of an abundance of caution. The two companies had appreciated around 90% in the last 18 months and 15% in 2020 on a blended basis. The stocks we decided to keep are positioned to benefit from a recession because of major transitions they are leading in productivity, how business is done, and how life is lived. Most importantly, our companies have a predictable cash flow stream adequate to fund growth, and a low-risk balance sheet. Survivor & Thriver company traits and the 2007 – 2019 Peak to Peak performance study was a focus of our 2019 Annual Partnership Letter. Quality over price In the coming weeks we believe the market will be able to better differentiate between companies that will emerge stronger vs. companies that will emerge weaker. In the negative-growth, zero-interest rate world that we are entering, companies that are able to grow (thrive) without the need for outside capital will become even more valuable than before the recession. Recessions act as a catalyst to bring new economy transitions forward faster. Companies on the right side of this can emerge much stronger and compound value faster than the market over long periods of time because they are able to take market share from weaker competition. A simple example: Radio advertising and direct mail were already dying but will die much faster in a recession. Post-virus marketing budgets once spent with the local radio stations will transition to platforms like Spotify and Cardlytics which use hyper-local user movements, daily spending patterns, habits and interests to measure and maximize return on ad spend even for the smallest business. As a result, JDP’s cash + incoming capital is being used as follows: (1) Slowly adding to our existing Survivor and Thriver holdings at prices that are now grossly underestimating earning power (2) Slowly building two new positions from our “dream” list on the big down days
Why we don’t sell our highest conviction ideas now and try to buy them back later
You can catch early, but you can’t catch late. Market bottoms are never obvious and come at strange and seemingly irrational times. A prominent investor friend recently pointed out to me that the WWII-era bear market bottomed in 1942, nearly two years before D-day. The Coronavirus is not WWII. Selling a high-conviction idea at a hugely discounted price today because you might get a better price in a month introduces enormous risk of permanent loss. Why would we do that? Trading for the sake of market timing might be fine for individuals looking for one-off outlier situations, but it amputates a total portfolios ability to keep up with the S&P 500 when things turn. We want to buy more when prices decline far below the present value of future cash flow, not sell. Can you imagine if any one of the most successful business owners in the world like just panic-sold their life’s work in March because they thought valuations would temporarily decline? Of course not; they are surely investing more into their businesses when things fall, taking advantage of the forced sellers and weak competition.
Special Situation Basket
We chose to keep this basket (7% of AUM) because the crisis has created additional optionality that is not worth giving up. For example, the largest stock in the basket is directly benefiting from the crisis and is up 25% YTD which has helped offset declines elsewhere.
Now is the time to think like a business owner, not a trader
Capital can be contributed to the Fund at the end of each month. Existing investors can add capital in $25K increments (unless otherwise agreed) by signing a one-page form here. The minimum for new investors is $250,000 (US fund) and $500,000 for the Offshore feeder (Credit Suisse nominee platform approved). Stay healthy.