2021 Q3 Quarterly Update Partnership Investing
Updating our readers on recent developments and announcement on future content!
Welcome to our second quarterly update of Partnership Investing (PI). A lot has happened since our last update in the world of investing. Fears of COVID and the Delta variant have given place to fears of inflation and the Omicron variant. We consider ourselves long-term investors in businesses that can compound value for years to come. We do not attempt to forecast macroeconomic developments like interest rates or inflation. Despite that we do not explicitly try to forecast macro developments, there are a few important thoughts we would like to share. These thoughts should not surprise readers familiar with our philosophy, but we think it is good to communicate these thoughts as the Partnership Investing reader community is growing. We will also announce something relating to our future content. You can find this announcement below the individual company updates.
To be clear, even though we do not try to forecast these things, we are aware that macro events can have an impact on the performances of businesses, our stocks, and consequently the performance of our portfolio. Our thought process is that buying businesses with their destiny in their own hands. This implies that the performance of the business is not significantly impacted by changes in commodity prices or financing costs. We also try to buy companies at levels where a modest rise in interest rates does not significantly impact the long-term appreciation of our investments. You might have seen us discount cash flows at discount rates of 8% or higher and our IRR hurdle for a company to join the Partnership Portfolio is at least 12%. All this to say that we have built these “protections” in our investment process to avoid having to worry about things we and our portfolio companies have little control over. If a company’s long-term success is dependent on factors outside of its control, we are simply not interested.
Now, let’s move on to the portfolio updates. Since we have begun PI we have posted about five companies: Naked Wines, Pushpay Holdings, Intellicheck, Vitec Software and, Surgical Science Sweden.
Naked Wines reported its first-half results in November. The highlights of the report are that revenue growth was less important than expected and contribution margins contracted. Supply-chain issues and higher freight costs have negatively impacted WINE’s contribution margins. This is no surprise after hearing many other companies suffering from the same issues.
The less-than-expected top-line growth was, according to management, attributable to Apple’s change in privacy policies (IDFA) on iOS devices. This made targeting across channels and platforms harder for advertisers like WINE. Due to signs of low LTV customers, WINE has decided to slow down marketing spending until the desired LTV/CAC ratio can be achieved. While the revenue growth is somewhat disappointing, we are reassured that management has decided to stay disciplined with shareholder money instead of spending to achieve an arbitrary revenue growth number.
Customer behavior has more or less reverted back to pre-COVID levels. Customer retention was decent and shows that, even in a post-COVID world, customers recognize the value WINE delivers.
Here again, the share price has taken a hit. We do not worry about this as we find the communication from management transparent, candid, and understandable. We still think the WINE shares are valued attractively on a long-term basis. We do not see the need to drastically revise our expectations 5 years out. We believe over this period, WINE is still poised to deliver value-creating growth and that the shares are attractively valued..
Pushpay (ticker: PPH)
Pushpay also reported its first-half results last month. We already mentioned our conviction eroding due to our doubts about management’s ability. This has culminated in a decision to sell the stock.
Pushpay announced an acquisition before its first-half result, the acquisition of Resi Media, a streaming software. Unfortunately, we do not see the strategic rationale behind this acquisition. Resi Media would be an interesting feature at best, spending the amount of shareholder money they did to add a feature seems like poor judgment to us.
First-half results did nothing to reassure us. The revenue growth has materially decelerated (to about 12% a year). Pushpay does not seem to have added many customers since the last period and they even lowered their profitability expectations for the full year (EBITDAFI, an even more adjusted metric than when we wrote it up). It certainly looks like they bought Resi Media to acquire customers in the Catholic market. This makes us question if they have the ability to acquire these customers on their own after giving the mid- to small church market to upstarts like Tithe.ly.
Not everything is to blame on Pushpay, but on ourselves. Our growth expectations were simply too high. We could have seen this material deceleration come earlier or at least have planned for such a scenario. We will take this as a lesson for future investment cases.
Additionally, we knew in advance about the management situation. We gave the new CEO the benefit of the doubt after a turbulent 2 years at the C-suite and Board levels. This unpleasant experience has led us to not invest in any companies where the management situation is any less than rock-solid with a solid track record. Even a stellar company like Keywords Studios has stayed on our watchlist due to, amongst other things, their management transition. Consider this a lesson learned the hard way.
IDN came up with its third-quarter results a couple of weeks ago. The stock collapsed from 9.15 USD to around 5 USD the week thereafter. We do not care about such short-term price bumps if the sustainable competitive advantages remain unchanged. An unreasonable price decline could even be an excellent opportunity to expand our position in a company we believe in.
SaaS revenue growth was flat in comparison to Q2. The company is among others been held back by measures due to COVID. Again, the gross margins on total revenue were lower than in the last few years due to the sale of scanning equipment. Looking at the stock price movement, the market seems to be disappointed about the slowdown in new client signings. Management states that implementations are delayed, so growth can come in at a later stadium. Of course, we would like the company to implement new customers sooner than later. However, we do not see signs that the competitive advantages of the company and its products are declining.
In the meanwhile, the company is further expanding its marketing activities and therefore its opex increased. IDN is working on multi-channels to sell its products. They are signing up customers in many different industries. For instance, they signed up universities for age identification products. Also, they came to an agreement with a company to expand their validation operations internationally. The company is starting to utilize its superior product for many different use cases.
We must note that the tone in the past few quarterly calls is not what Wall Street likes. The CEO seems to stay very vague when asked questions on the reason for slower-than-expected implementations and the visibility of future revenue. The company has only recently hired salespeople to grow the business and it is understandable that they need some time to ramp up. The comments on new use cases and client types is encouraging but we expect to see material growth over the next few quarters to deem the investment thesis intact.
Sure, the company is still not structurally in the black. We still believe that the company is investing its money properly and we are confident that the payback of the investments will be worth the wait. Taking all of the above into account, we are definitely long IDN and we even made use of the price drop to buy some more shares.
Vitec Software (ticker: VIT-B)
Vitec Software has kept on acquiring different companies since our last update. Vitec has issued 900m SEK worth of equity to spend on acquisitions. Considering Vitec’s track record, this should be seen as a positive. The shares were issued at a valuation that we would consider high and thus good for existing shareholders. Since then, the shares have kept going higher, with a recent pullback. The quarterly results were steady and more or less as expected, with decent revenue growth and modest margin expansion. Vitec has acquired two companies since our last update, one of which is outside of the Nordics.
We still hold Vitec shares despite the rapid increase in share price. The issuance of equity at an above-average valuation, if spent wisely, could lead to good value creation for patient shareholders. We are confident in Vitec’s ability to do so and we happily stay on as shareholders.
Surgical Science Sweden (ticker: SUS)
Surgical Science reported its first quarterly report as a combined entity with Simbionix. The revenue growth was good as the company recovered from a turbulent 2020 where robotic surgery sales were down due to COVID. There is nothing particular to note about the results. We are excited to see how the company fares in a world where COVID is not such an acute issue for hospitals and elective surgeries recover.
We are convinced that robotic surgery is a long-term winning category and we think SUS is a good way to invest in the industry. The company will post its financial goals before its next quarterly report in February 2022. We look forward to this release as this might reset expectations for the entire market. We personally think that, at maturity (2030 or so), the margins will be much higher than today as the incremental margins in this business are very high (80%+).
We hope to be able to buy a slightly larger position at a lower valuation in the short term, but we will have to see how the share price behaves until the new financial goals are set.
Partnership Investing content update
Readers of our newsletter are used to us writing companies up in which we are invested or have recently invested. This creates an interesting alignment between us writers and the readers as we try to stay as transparent as possible about what led us to invest in the company and our future expectations for our investments. We put our money where our mouth is.
We have now grown to more than 400 subscribers and are seeing an increased interest in more regular and frequent write-ups on companies of all sorts. To address this, we have decided to write more often on companies we are following, but not yet invested in. We will, of course, keep posting about companies that are added to the Partnership Investing portfolio.
This will solve multiple problems at once:
We simply cannot generate 12 great investment ideas a year. This problem is two-fold. Firstly, it is very difficult to find this amount of good or great investments every year when applying a high bar on the quality of the company we are writing about. Secondly, the best investment ideas do not come at regular monthly or bi-weekly intervals. There are a number of companies that we follow and deem investable. Unfortunately, they are not always at the right price and, in fact, often come down to attractive levels at the same time during broad market downturns.
This broadens the number of companies we can talk about. We now have more freedom in what companies we want to write up. The company we write up might be extremely interesting to us and readers, yet not be investable for the Partnership Investing portfolio for one reason or another.
This solves the problem of timing a write-up with an attractive valuation. This is probably the biggest issue we have faced and thought about. Like we mentioned earlier, there is not an attractive investment to be found every month, let alone a NEW one. Holding ourselves to a regular schedule in this format is bound to cause problems at some point. Broadening the scope of our newsletter to companies of interest and not only new investments solves this perfectly as we are constantly doing research and following companies.
This increases the frequency at which we can put out content. Until now we were limited by research bandwidth, valuations, and the time needed to write a proper piece of content. Most of our research does not end up on a post due to various factors. This broader scope makes us better able to write about companies we have followed for a while and are particularly interested in, without the pressure of making it an investment case. We think this puts us in a position to post more often and to choose our portfolio additions even more wisely.
Although none of our posts are meant as sharing our research and not investment recommendations, this removes some of the alignment that we previously mentioned. To solve this, we will make it very clear to readers what write-up is about a company we added to the portfolio and what write-up isn’t. We will keep sharing our future expectations for additions to the PI portfolio, will keep updating readers on a quarterly basis and there will be a clear difference in format between the two. We will keep experimenting with the format for the write-ups that are not additions to the portfolio until we have found “The One” for us and our readers.
To conclude this quarterly update, we want to thank our readers and followers for being with us. The quarter was eventful with our first sell and we are reflecting on this experience with a shaky management situation. Whether we were willfully blind, naive, or let our biases get in the way, we will use this experience to set a higher bar for management in our future write-ups and investments.
Feel free to contact us on Twitter @PartnershipInv or partnershipinvestingblog@gmail.com, we are always happy to engage with thoughtful people!
Disclaimer: Always do your own research. This is not investment advice and for informational purposes only. Partnership Investing is not a registered investment adviser and may or may not hold securities discussed on this blog.