Revealing the Partnership Investing Watchlist

Here are five stocks we are watching closely.

The Partnership Investing Watchlist

We have mentioned earlier in our post that we wish to share more about our investment and research process. By solely posting our additions to the Partnership Investing portfolio, readers only get to see the end product of extended periods of research, thinking, and evaluation. While this may be the most interesting part for most of the public, we think there is value in disclosing and sharing parts of our research process. Feedback can help us refine our process where it is lacking, some readers might learn a thing or two along the way and it also gives more context to the additions to our portfolio.

We have shared our thoughts on decision-making in our Q2 update and our framework for analyzing Unit Economics in a separate post. This month, we will share our watchlist. This list consists of five stocks we have been following and have gotten mostly comfortable about their ability to create shareholder value in the long term. The reasons for them not being in our portfolio differ, but we expect to do more work on these names until the opportunity to add them to our portfolio presents itself.

Before we get into it, don’t forget to subscribe to receive our posts and updates on global growth companies:

How does a stock end up on our watchlist?

To give you some additional context on how our research pipeline looks like, you can distinguish a few different stages of research:

• Research list: This is a list of names we have gotten recommended or briefly read about that might be of interest to us. This list is getting longer faster than we can get through, but it serves as a starting point to find new investment ideas.

• Work in Progress: These are names we are currently actively investigating. This is the stage where the bulk of the research occurs. We try to reject quickly in this stage as we want to spend most of our time looking at businesses that are investable for us.

• Rejected: This is self-explanatory. We write down the reasons for rejecting the company. These reasons can range from the company being too complicated or not having enough growth in front of it. We will occasionally revisit names that were rejected for fixable reasons.

• Watchlist: These are companies we think are or can be investable. Something is holding us back from actually investing. This can be valuation or preferring for some uncertainty to clear up. We are usually convinced these companies have the ingredients to create shareholder value at a high rate but prefer to stay on the sidelines until the right moment. This stage brings the most FOMO and mistakes of omission.

• Portfolio: This is again self-explanatory. We see a path to value creation for the companies and feel this is a good place to put our money to grow. The research does not stop here, we constantly look around for news items and clues that we might be wrong. We will steal an Ian Cassel quote: "What you don't own can't hurt you". Here, we actually own the stocks and need to stay vigilant about the validity of our investment thesis.
  
  

Our watchlist

Now that we have given you context on how our pipeline actually looks like, it is time to share the names we are currently watching. These are names that are likely to be written up whenever we finally decide to add them to our portfolio.

AB Dynamics (ABPD-LN)

AB Dynamics (ABDP) is a manufacturer and developer of car testing equipment, especially for Advanced Driver Assistance Systems (ADAS) such as cruise control and auto emergency braking (AEB). They develop and produce simulators, driving robots, software, and other testing-related equipment.  It is one of the only companies that have equipment for every car testing phase, from simulation testing to track testing.

ABDP aims to reduce customers' development time and costs with their products. The simulation products give customers the opportunity to test products in the lab before it would be done physically. With Guided Soft Targets and launchpads can customers physically simulate traffic scenarios without full impact collisions with their cars. Their products are used by carmakers who test new cars. Due to new regulations and new trends in automotive, cars have more and more ADAS. ABDP enjoys this trend since these systems need to be thoroughly checked. 

A lot of testing needs to be done before these cars are allowed on public roads. The most difficult part is testing autonomous cars in complex traffic situations. The scenarios will become more complex when cars have more ADAS. The more complex the scenarios, the more testing equipment is needed. ABDP has developed software that synchronizes its products and allows customers to repeatably imitate real-life traffic situations.

ABDP is a highly regarded player in the active car-testing market. EuroNcap and the American NHTSA qualify safety of cars before they are publicly sold. ABD is a key supplier of ADAS testing equipment. The industry needs high-quality and reliable equipment. ABDP has several patents for its steering robot products. These products account for approximately 50% of total revenue. ABD has deep technical expertise after years of experience in the industry. ABD has more than ten years of experience in performing complex real-life tests. In all these years they got a strong relationship with lots of car manufacturers; ABD works with the top 20 auto manufacturers. The relationships give them the opportunity to identify trends early. They also do their R&D in collaboration with these customers. Besides, ABD is opening up regional offices to give customers service after the sale. It will obtain information on clients' needs that new entrants might not have. Due to the combination with the fact that ABDP delivers all products and services needed to test a car, we think that the switching costs are significant. Clients will not switch easily to other players due to the ability to perform complex tests with products of ABD.

Anthony Best has founded ABDP. Although he stepped back as Chairman this year, he will still be involved with the company in an advisor role. Best and his wife are the biggest shareholders with in total over 25% ownership.

Even though we like the competitive advantages of the company, we still have our concerns regarding the business model. A lot of products of ABDP are bought ones and will not be replaced for many years. The recurring revenues represent only 30% of total revenue. We are afraid that growth could slow down due to its business model. If recurring revenues increase steadily, we will take another look at the company.

Keywords Studios (KWS-LN)

Keywords Studios is a UK-listed provider of outsourced solutions to the gaming sector. Keywords Studios is the largest outsourced partner of the biggest names in gaming like Electronic Arts, Activision Blizzard, and, Square Enix amongst others. The company’s growth strategy is centered on consolidating a fragmented industry of outsourced suppliers to provide a one-stop shop to game creators.

The gaming industry has grown quickly in the past decades and has become the largest entertainment industry. With the growth of mobile gaming, the total gaming industry is estimated at $300B in total and 200B through direct revenue by Accenture. The industry is expected to double again with the next 5 years or so, providing an attractive tailwind to Keywords.
While gaming companies used to insource most of the development process a few years ago, the trend has been towards outsourcing more parts of the process to providers like Keywords. There are many studios that provide outsourced solutions worldwide. Most of these studios are small and focus on a few parts of the game development process like Localization (translating text and voice-over in local language), art, or customer service. Keywords, on the other hand, has leveraged its global scale and relationships to become a key partner to gaming companies.
The gaming industry, especially on the publisher side, is known to be hit-driven, much like Hollywood and the music industry. Companies like ATVI, EA, and TTWO have to spend a large amount of development and marketing costs upfront and success is far from guaranteed. Keywords have, unlike aforementioned companies, a more predictable stream of revenues and get paid for the work they delivered instead of the commercial success of the game. This significantly de-risks their business and their relationships with gaming companies provide them a more predictable and diversified revenue base.

Keywords” growth strategy is centered on acquiring studios all over the world that offer different services. Unlike the serial acquirer that we own, Vitec Software, Keywords leverages the different studios’ relationships and services to cross-sell and bundle outsourcing services to their clients. The studios still operate with autonomy and are not integrated, but Keywords does try to create revenue synergies between the different studios. Due to the growing industry and leveraging of the relationships between studios, Keywords has had good organic growth of more than 10% over the past 5 years  In addition to organic growth, most acquisitions have been very successful. Keywords has delivered a 40% revenue CAGR and 39% CAGR in adjusted profit before tax over the last 5 years. This is an outstanding record that has created much shareholder value; the share price has gone from 110 pence in January 2014 to 2900 pence today. a >50% CAGR over almost eight years.

At this point, we are quite confident Keywords Studios fits the bill in what we are looking for at Partnership Investing. However, we have not decided to add it to the portfolio yet. The share price has done very well in the last year or two. In the meantime, the CEO and strategic leader of the company, Andrew Day, has resigned as CEO. After our less than ideal experience with Pushpay’s management turnover, we choose to be a bit more careful this time. We still need to do some more research to have a better view of the performance of acquisitions and have more confidence in our valuation of the business before adding it to the Partnership Investing portfolio. We will be watching the company closely and this might not be the last time you hear of Keywords Studios from us.

Cellavision (CEVI-ST)

Cellavision is a Swedish company listed in Stockholm. The company provides digital morphology solutions. The company’s products and software help laboratory personnel to digitalize and automate the blood analysis process. Usually done by manually handling a microscope, the analysis process is more automated and efficient.by using imaging and software tools offered by Cellavision.

Cellavision sells their products to laboratories that analyze blood samples and other bodily fluids. Cellavision has focused on the mid to large laboratories that handle a large amount of samples volume. The market is split up in laboratories that use manual microscopy (80% of the market) and digital microscopy (20% of the market). Cellavision has the largest market share in digital microscopy (>90% of digital microscopy). The total market size on an annual basis for Cellavision is about SEK 1.4B for large laboratories alone, with mid to smaller laboratories being more or less the same, for a total of approximately SEK 2.8B. Cellavision’s products were somewhat costs prohibitive for smaller laboratories with less volume. Mid- to large laboratories do see significant productivity and costs benefit from Cellavision’s product through faster turnaround times and increased capacity. This is the reason the trend within the industry is towards digital microscopy and larger laboratories have much larger penetration.
The next 10 years, Cellavision sees this trend towards digital microscopy continue and has launched a new product designed for mid to small laboratories and veterinarians to capture the part of the market for whom Cellavision’s products were too expensive.

Cellavision has grown from SEK 265M revenue in 2016 to SEK 471M in 2020 with EBITDA margins hovering around 30% during the period. COVID caused growth to slow to 2% in 2020, but 2021 revenues are on track to deliver growth again. The company has a large market share in a niche with attractive tailwinds and economics. They are able to grow without much capital and have a relatively predictable revenue base through the sale of consumable instruments and software. The business model has proved itself very scalable and the release of new products should put the company in a position to grow profitably for years to come. After speaking with smart investors and users of the products, we feel confident the company has a strong business that is conducive to long-term value creation. The Cellavision shares have compounded at a 38% CAGR in the last five years, starting at SEK 80 in 2016 to 400 SEK today.

Despite all the attractive characteristics we have found in this company, we are not yet confident in our view as to how long and how fast the company will be able to grow cash flows. The release of the products for smaller laboratories has had some hiccups due to COVID, which makes it difficult to really gauge the commercial success and potential.
In addition to this, the CEO recently left for another company and Cellavision now has a new CEO. Just like Keywords Studios, this causes us to pause and evaluate the situation more carefully after our recent experiences.
Finally, the shares are richly valued. Although we are not unwilling to pay up for businesses that fit our quality criteria and have room to grow profitably for many years, the aforementioned circumstances in combination with a more-than-premium valuation keep us away from adding it to the Partnership Investing portfolio.
For now, Cellavision will stay on our watchlist until we feel the risk/reward fits our investment framework.

Mips (MIPS-ST)

Mips is a Swedish company listed in Stockholm that focuses on helmet-safety technology Mips’ technology, in the form of an ingredient that is put into the helmet, provides increased head and brain safety to shocks The company has expanded their market by including their technology into helmets for different activities like sports, moto, and, safety.

Each of the activities mentioned knows different brands that are focused on that end-market. Mips licenses their technology to these different brands in exchange for a royalty fee per helmet. The helmet market is competitive, with many different brands fighting for volume and customers. Some brands are able to differentiate themselves by having increased brand awareness or better distribution. Mips has chosen to collaborate with all these brands as an IP company instead of entering the competition. By licensing their technology, the brands essentially are responsible for distribution and marketing. The safety category, the last market entered by Mips, is by far the largest. This category includes helmets used in manufacturing, construction, and industrial sites. The potential growth from this market is enormous for a company of Mips’ size and Mips hopes to make significant inroads into this category within the next few years. Mips estimates its market opportunity to be about 130M helmets while they have sold about 7.2M units in 2020.

The business model is insanely capital-light and consists mainly of fixed costs. Mips outsources their manufacturing and the brands are responsible for most marketing activities and distribution. They take little to no inventory risk and just collect the checks from their partners. Mips focuses on R&D to improve their IP portfolio and has recently increased investments in brand marketing to make the yellow Mips sticker on the helmets a recognized signal of safety among the customer base. This business model delivers impressive EBITDA margins and cash conversion all while growing at high rates. Mips has expanded its EBITDA margins from 40% or so a few years ago to 56% in the latest twelve months. The share price has done very well since its IPO in 2017, growing from SEK 52 per share to SEK 1100. A twenty-bagger 4.5 years!!

The company has been able to reach more and more brand partners in different categories. This has led to incredible growth in both revenues and profits. The COVID pandemic has slowed down growth in 2020 but has caused pent-up demand for 2021, revenues for the first 9 months were up ~90% year-over-year. The company possesses many attractive characteristics and the runway for growth seems long. We are keen on learning more about the company and its future prospects. 

We have stayed on the sidelines mostly due to our lack of imagination. We could not have imagined the company having such a strong 2021 and we have vastly underestimated the amount of operating leverage this company is capable of. The valuation seems very high, even when taking our 3-5 years estimates into account. We have thought this way for a while now. Since then, the company has kept surprising us to the upside and the shares have done extremely well, so we are probably missing something. At this point in time, it is somewhat difficult to stay on the sidelines of a business we like this much. However, we have to keep price discipline to achieve the returns we aim for and we would need a much better understanding of the company and its prospects to underwrite the current valuation with a reasonable degree of confidence. We hope to be able to add these shares to the Partnership Investing portfolio at a price we feel good about sooner rather than later and this might need a mindset change on our part.

Semrush (SEMR-US)

Semrush (SEMR) is a company providing multiple online visibility services such as Search Engine Optimization (SEO), Social Media Marketing (SMM), Competitive Intelligence (CI) etc. SEMR went public in 2021. SEMR began as a data provider for marketers. The company is still led by its founders Oleg Shchegolev, the CEO, and Dmitry Melnikov, the COO. Shchegolev and Melnikov own 67 USD million and 11 USD million worth of shares, respectively. Furthermore, the investment fund of Pat Dorsey, a widely known investor, and writer, has a stake in the company as well. Pat Dorsey is partly famous because of his writings about economic moats and his work while at Morningstar.

Online visibility becomes more and more important with more companies depending on online sales. SEMR gives multiple case studies in which customers’ online traffic significantly increases when using SEMR’s products. SEMR estimates its total addressable market at 13 billion USD annually. It is estimated by multiplying the number of targeted customers with the average current revenue per customer. This figure is high, perhaps even unrealistic, because this would assume they attain a 100% market share.

SEMR has mostly SMBs as clients. SEMR does not concentrate on a specific industry, but digital marketing agencies represent 20-25% of their customers. There are lots of providers delivering visibility services. These providers have often specialized, expensive products offering only a part of the services that SEMR offers. The products are most often more in-depth and qualitatively better than some of SEMR’s products. SEMR is cheaper and has a wide range of (superficial) tools. SMB’s don’t need sophisticated tools so they will choose the cheapest product.

Ahrefs is another relatively cheap online visibility provider. Customers often use Ahrefs and SEMR simultaneously. Ahrefs is more specialized in SEO and is higher regarded in backlinking. Both SEMR and Ahrefs subscription models start at around 100 USD per month, whereas specialized players ask multiples of this price or the same price for a product with fewer capabilities. Similarweb is another player in the competitive intelligence market. With their solutions, a customer can compare website traffic of several companies and their pricing starts at 249 USD per month. Customers of SEMR can sign up for the freemium product. With the product, customers have limited online visibility solutions. SEMR wants its customers to get to know the products when they are new to online visibility. When customers see the advantages and get acquainted with the tool, then they are converting into paid customers. We see this, among other things, back in the retention rate. The retention rate was around 120% in the trailing 12-month revenue. The retention rate is high because customers see the advantages of the solutions, add solutions on top of their current subscription plan and SEMR is continually adding new solutions to their platform.

SEMR saw its revenue grow since 2016 by 54% annually. This year it is going to reach between 175 and 177 USD million revenue. The growth is staggering but due to its heavy spending in growth through sales and marketing, it still makes a loss on an aggregate basis.

We like the Semrush story. Their founders still run the business and they have a long-term vision. They want the business to be the biggest in the online visibility market, a platform that no one can ignore. However, other players are adding new capabilities to their platform as well and Semrush is still making a loss. We are really curious how competitive advantages will evolve and how much of the market SEMR can capture. We are going to keep an eye on Semrush and we will write more about it when we think that the company deserves a place in our portfolio.

Closing words

We will keep researching as many companies as we can. We have recently requested names from our Twitter followers and have added a significant amount of interesting companies to our research pipeline as a result of it. The Q3 portfolio update will be published soon enough and we hope to find good investment opportunities in the near future to write about. In addition to writing about the Partnership Investing portfolio additions, we will look at ways to post interesting content more often, whether directly relating to the portfolio, research, or our investment process.

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.