Q2 2021 Quarterly Update Partnership Investing Portfolio
Read our latest thoughts about our portfolio companies and our research process.
Welcome to our first quarterly update of Partnership Investing (PI). In these quarterly reports, we address the companies we already pitched to you in former posts. Our goals are keeping readers up-to-date about the developments of these portfolio companies and checking whether the developments would change our investment cases. Besides the portfolio updates, we use these updates to learn from mistakes, and by journaling, our investment activities improve our decision-making. This quarter, we will be sharing our learnings on the advantages of shortening our decision-cycle as investors.
Since we have begun PI we have posted about four companies: Naked Wines, Pushpay Holdings, Intellicheck, and Vitec Software.
Naked Wines (ticker: WINE)
We are very pleased with the developments at Naked Wines. The period FY2021 was a transformative year for Naked Wines. As consumers looked for other ways to buy wine, Naked Wines’ offering has attracted many new customers. The revenue growth for the period was consistent with our expectations (about 68% YoY) and both repeat contribution and Standstill EBIT was in the expected range. Retention and engagement metrics were abnormally high, which has provided Naked Wines with more cash to invest in customer acquisition. We expect these metrics to return towards historical levels as the pandemic ends. What gets us most excited about Naked Wines are the scale efficiencies that starting to become visible. These efficiencies of scale will improve unit economics, allow Naked Wines to experiment with other marketing channels to acquire new customers and provide better value for customers.
We were also pleased by Naked Wines attracting Darryl Rawlings as Chairman of the Board. Darryl Rawlings is the founder and CEO of Trupanion and has been the leader behind extraordinary shareholder returns. Darryl has a great track record as a business builder and his understanding of the unit economics that drive a consumer-oriented business is a great addition to the Board. To have a glimpse into Darryl Rawlings’ thoughts on these subjects, we would recommend you to read his shareholder letters. We think Darryl’s expertise will be of great help to Nick Devlin and he has already shown his commitment by buying Naked Wines shares after these shares were listed on the US OTC.
We expect Naked Wines to grow slower coming year due to FY2021 being extraordinarily good, but we have more conviction in the long-term prospects for the company than ever before.
Pushpay (ticker: PPH)
Pushpay’s last fiscal year has two sides that are contrasting. On the one hand, Pushpay had record revenues and profits as more church-goers donated to their church digitally. This drastic increase in transaction volumes and thus revenues provided a tremendous amount of operating leverage. Software-as-a-Service revenue also grew healthily as Pushpay bundles and cross-sells its payments and SaaS offerings. The last results were also in line with our expectations. This has to be nuanced, our expectations were established shortly before Pushpay published their results and they had provided a very narrow range in their guidance. Pushpay has reiterated its focus on winning the Catholic churches segment and has committed to invest significant funds to attract these potential customers.
On the other hand, Pushpay’s management and ownership have gone through a tremendous amount of change and disturbances during the last 12 months. As we mentioned in our write-up, Pushpay’s largest shareholders sold their stake to Sixth Street (which we found encouraging), Bruce Gordon stepped down as CEO and now as Chairman, Molly Matthews was internally promoted to the CEO role (which was not well-received by the market) and the CFO Shane Sampson recently resigned to join a smaller, New Zealand based company. This turbulence has not worked in the favour of share price performance, as Pushpay has yet to get back to its all-time high. Although we do not really look at short-term price moves, it is fair to say this signals that the markets are not convinced about Pushpay’s future prospects.
Pushpay will be looking for a US-based CFO to replace Shane Sampson, which fits well in our narrative of “Americanizing” the company. This is a step towards a US listing that would significantly improve Pushpay’s profile and exposure to US investors.
Despite the hiccups and uncertainty, we still think Pushpay’s business has a bright future and that the company is undervalued. However, we are not blind to these developments and have reduced our position to reflect the increased uncertainty around management.
Intellicheck (ticker: IDN)
We posted our thesis on IDN on the first of June. The stock increased approximately 7% since the post. IDN reported its second-quarter financial results on the third of August. IDN increased its revenue by 68% in comparison with the first quarter of 2021, despite COVID-19 measures limiting the use of IDN’s products at retail clients. These stunning results were partly caused by sales of scanning hardware. The sale of hardware is part of the implementation of IDN’s services to customers. We did not take into account hardware sales specifically in our investment case since customers are able to use IDNs services with regular retail scanning equipment. However, the sale of the scanning equipment is a sign of trust from customers because the scanning equipment cannot be utilized to operate products of competitors and essentially starts the relationship with IDN.
Operational expenses grew along the revenue causing a net operating loss. As we explained in our original investment case, IDN is growing its sales team in order to improve the visibility of the company and its products in the marketplace. The efforts in sales growth are visible in the number of implementations of clients. The company says that it is hiring slowly in order to hire the right people and to train them. Since we are long-term investors we do like the long-term mentality of management. Furthermore, the company reported new sales opportunities via resellers and high margin sales opportunities of age identification accounts. The resellers could boost the exposure and sales of the company in later years.
On the top line, the results are in line with our expectations plus some windfalls. In the meantime, analysts from Craig Hallum and D.A. Davidson have begun covering IDN, a signal that IDN is getting more attention. We are now waiting until IDN’s exceptional products catch more attention from the market and the operational leverage kicks in.
Vitec Software (ticker: VIT-B)
There is little news except for the financials for the first 6 months of 2021. Vitec Software has continued acquiring Nordic VMS companies at their usual pace. They have acquired 3 companies year-to-date with an aggregate 140m SEK in revenue. We hope to see more accretive acquisitions in the next months.
Organic growth for the first half of 2021 was 8%, above our expectations. We still think 4% organic growth is a reasonable long-term benchmark we can hold Vitec accountable to. Revenues grew 22% in total and EBITA (a decent proxy for FCF) grew even faster thanks to some margin expansion. EBITA margins were 28%, compared to 26% last year. All-in-all, Vitec keeps performing well and we see little reason to doubt or reevaluate our thesis at the present moment.
Shortening your decision cycle
As investors, we have been confronted a few times with instances where our decision cycle proved to be too slow. Researching a company for an extended period of time during which the stock had gone up so much the opportunity at hand was gone, or holding a company longer than we should after our investment thesis was broken. These experiences, and reading about the experiences of other investors made us think about how to optimize our processes to shorten this decision cycle without compromising on decision quality.
But why shorten the decision cycle? Well, this came about when reading the book about Colonel John Boyd. John Boyd was an ex-Air Force fighter pilot that has done groundbreaking work on military strategy. He developed a concept to quantify a fighter plane's performance and compare different fighter planes. This framework became known as Energy-Maneuverability theory, or E-M Theory for short. After completing this theory, he zoomed out from air-to-air combat and developed theories on military strategy and conflicts in general. This theory, Patterns of Conflict, was used in the First Gulf War and was the inspiration for the Operation Desert Storm strategy.
John Boyd developed a framework known as the OODA Loop, this is probably where most people would recognize the Boyd name from. The idea was that the decision cycle goes through 4 stages, Observation - Orientation - Decision - Action. In a military or combat context, he explains that by shortening your own decision cycle, while lengthening your enemy's decision cycle, you can gain an advantage that will lead you to victory. While we do not directly compete against anyone like in business or war, and winning is very subjective, we still think there are ways to apply Colonel Boyd's work to our investing process.
The OODA Loop (simplified):
Observation: This is the information-gathering process. We analyze the environment, look for both quantitative and qualitative information that we find important to make a sound decision.
Orientation: Our observations are then used to orient ourselves, determine our place in the environment we observed and recognize patterns. This is also the stage where you start thinking about what actions could be taken based on your analysis.
Decision: Once we have gathered the relevant information, analyzed it, and determined what actions can be taken, we make a decision.
Action: Now it is time to act on our decision. The cycle starts over again when we start to monitor the environment and keep gathering information.
By simplifying the OODA Loop, we can analyze the stages of the decision-making process and try to optimize it to react faster to the environment around us. The main purpose is to be nimble and take faster decisions under changing environmental circumstances.
The processes that will be described below are not meant as a programmatic way to make decisions, but to help you analyze your own decision-making process and see how shortening the cycle can benefit your investment process. Investors are likely to go through multiple decision cycles at the same time, all differing in length and levels of focus. An investor might, for example, be looking at the market at a higher level to determine whether his opportunity-set in a certain geography is better than in another and decide where to put his limited resources to work. At the same moment, he might be researching a company as a potential investment and going through the decision cycle on a single investment opportunity. The focus of this post will be on the decision cycle for stock selection, but we hope you can take away some ideas for other types of decisions.
Observation: The information-gathering process
A first step to compress your decision cycle would be to invert the subject of this post and ask yourself: How can I avoid lengthening the time and effort needed to make a decision?
The answers to this question will depend on the subject, but avoiding subjects that are outside of your circle of competence is an obvious and easy way to increase your decision-making speed. Doing this even before the observation phase will spare you a lot of wasted brainpower and time.
Fortunately, investors can choose whether or not to engage in certain situations. Knowing yourself, what your expertise is, and what your limitations are is key to avoid embarking on a path that leads you into an overly complex situation. Instead of explicitly trying to compress your decision cycle, choosing your battles is an efficient way of not lengthening your decision cycle. Avoiding overly complex subjects will let you focus on things you can understand and will over time improve your decision-making speed and quality.
Next, start with clear criteria and parameters. These should not be too constraining nor too wide. The goal is to know what you are looking for and where you will look. Depending on your expertise, experience, and mandate, these parameters can change over time as long as it does not impair the speed and quality of your decision-making.
Try to have an idea of how much and what information you will need to make a decision. We operate with both limited information and in the Age of Information where the Internet has an abundance of information.
The outcomes in stocks are probabilistic in nature. We cannot know anything with certainty. It is therefore important to gather enough quality information and to weigh them appropriately to feel comfortable underwriting a certain range of outcomes.
Distinguishing valuable information from noise and determining how much information you need to feel comfortable to make an educated decision is a helpful tool to compress the decision cycle. The amount of information you need to be comfortable with will likely change slightly during the process, but it is important not to go overboard on information gathering as this will expand the decision cycle and can introduce noise into your analysis later on. This is a difficult balance to find, too much information and your decision cycle is likely to be stretched and the more chance you have of listening to noise. Too little information and you might miss the key pieces to the puzzle and large mistakes will be inevitable.
The parameters and criteria you set always need to be top of mind as you gather information. If you spot factual information that makes a company uninvestable by your criteria, it is best to quickly filter out this company and stop wasting time and resources.
You have now observed the environment, gathered quantitative and qualitative data on the subject of interest. It is now time to move on and to try to make sense of your observations.
Orientation: Analysis
During the orientation process, you want to start asking questions and answering them for yourself as you go through the information. The parameters and criteria you have set for new investment opportunities have mostly been met, or you would have already moved on. The questions and the answers to these questions slowly start to form a story about the company and you start to connect the dots. Your previous experiences might help you do this faster as your pattern recognition skills develop over time.
The best way to improve those skills and help you build (or debunk) the story faster is to look at as many case studies or read articles, books, etc. as possible with the explicit aim of building your pattern recognition skills. Note-taking apps are a great way to write down your thoughts, organize the key takeaways, and make connections.
John Boyd himself used a variety of concepts from different disciplines in his work. Charlie Munger also pointed to the benefits of being familiar with different disciplines and how it can help you find the answer to difficult questions. David Epstein, in his book Range, lists many examples of breakthroughs that only happened because someone looked at the problem from a different perspective. Building pattern recognition skills, using mental models to solve different kinds of problems, and being open-minded about learning from other disciplines are extremely valuable ways you can come to better decisions faster.
Most investment theses rely on a few key drivers. If those few drivers are what drives the business and the thesis, this is where you should spend the majority of your brainpower. Try to interpret the information and think about what it implies about the drivers of the thesis. By focusing on the key drivers of the business, or simply the main drivers of the subject at hand, you can drastically reduce the time needed to analyze the subject without compromising on quality.
When it comes to existing positions, this stage is somewhat different. You already have a hypothesis for the investment, but new information has come to light. Now you need to distinguish if this new information is a signal or simply noise in the observation phase. In the orientation phase, you start asking new questions like:
Does the new information still fit in your original story for the business?
Does it contradict your thesis?
Does it reinforce your original thesis?
The answers to these questions will inform your decision.
When your analysis of the available information is done and you understand the environment, context, and potential implications for the future, you can start thinking about what courses of action you can take.
Decision
You have now a few options at your disposal. You could choose to directly act on your analysis by buying or selling the stock, but you could also decide that you need more information or time to better understand the subject or situation. This would stretch your decision cycle, which is not ideal but could save you from a mistake. To avoid having to go back multiple times, setting up an efficient way to gather information and exclude information in the observation phase is of crucial importance.
Unfortunately, news, developments, and changes in the environment do not happen on our schedule, so it is entirely conceivable that you would have to wait until more information comes to light in some instances.
Something you could do to make decisions faster in this stage is to attach certain conditions to the viability of the hypothesis. By introducing feedback into this cycle, we can make a decision with a smaller impact and wait until we get this feedback to adjust later on. For example, we could decide to buy a smaller position and write down reasons we would sell or buy more. These conditions should be clear and fact-based. Writing down these conditions will keep you honest. The human tendency to rationalize new information that goes against the original reasoning is dangerous and we want to avoid such pitfalls and biases. By doing this, we are actually restarting the loop by going back to the observation phase (we are observing the feedback that comes in after we made a decision and acted on it).
When you have made a decision, also try to write down why you have chosen this course of action. This will help you make faster decisions down the line as new information comes to light and thus stay flexible to changes in the environment.
Action
This is quite self-explanatory. With your observations, analysis, and your decision, it is now time to act. Once you have taken action, you can start the observation phase again to see if the environment has changed or if new information has become available.
Closing the loop
By thinking through your current decision-making process, you have hopefully found a few ways to optimize certain phases. Although we do not operate under the same pressure as military decision-makers do, finding ways to reduce the time needed to act decisively can help you react faster to the environment around you. This can help you correct (and sometimes even avoid) mistakes and be able to seize opportunities faster, which, in the long run, will undoubtedly improve your performance.
Over time, the analyses, decisions, and observations will form a sort of database you can use to inform later decisions. By constantly refining your process, documenting it, and optimizing it, the benefits will compound over time and allow you to make bigger and better decisions in a shorter and shorter time span. This is a key reason why we started this blog. Although the benefits of writing our ideas down will not materialize in the next months, we are convinced it will make us better investors in a few years if we keep at it.
Finally, our own process constantly changes as we are trying to optimize our decision-making. The OODA Loop and the way we described it is meant as a way to reflect on how we are doing things and how we could improve them. Whether you use some concepts in this post to change how you decide to spend your time researching a company, allocate resources or hire talent, being decisive and move fast is recognized by many as a way to gain an advantage in a competitive environment.
Recommended readings:
Boyd: The Fighter Pilot Who Changed the Art of War, by Robert Coram
Certain to Win: The Strategy of John Boyd, Applied to Business, by Chet Richards
Range: Why Generalists Triumph in a Specialized World, by David Epstein
Poor Charlie's Almanack: The Wit and Wisdom of Charles T. Munger, by Peter Kaufmann and Charlie Munger
Farnam Street: https://fs.blog/2021/03/ooda-loop/
Decision journal: https://fs.blog/2014/02/decision-journal/
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.