Jencay Australia Investment Fund

AFS Licence Number 402024 Quarterly report – 31 Mar ch 2 019 ACN 148810413

Performance Unit Price

Returns are net of fees, exclude buy/sell spreads and assume Since inception Latest Latest Latest reinvestment of distributions/income (annualised) 5 years 12 months Quarter NAV per unit AUD 2.9083 Fund total return 19.3% 19.7% 18.3% 21.3% Application price (0.5% spread added) AUD 2.9229 ASX Small Ordinaries Accumulation Index 3.7% 8.0% 5.8% 12.6% Redemption price (0.5% spread deducted) AUD 2.8938 Performance hurdle (RBA cash rate + 2.5%) 4.9% 4.4% 4.1% 1.0%

Performance Chart Fund Composition

480 Fund Fund return index (incl. reinvested distributions net of fees) Cash Performance hurdle index (RBA cash rate + 2.5%) 2 ASX Small Ordinaries Accumulation index Industrials Healthcare & other 240 32 23

120

100

Information 60 Technology

44

25/07/2011 30/09/2012 30/11/2012 31/01/2013 31/03/2014 31/05/2014 31/07/2014 30/09/2015 30/11/2015 31/01/2017 31/03/2017 31/05/2017 31/07/2018 30/09/2018 30/11/2018 30/09/2011 30/11/2011 31/01/2012 30/03/2012 31/05/2012 31/07/2012 31/03/2013 31/05/2013 31/07/2013 30/09/2013 30/11/2013 31/01/2014 30/09/2014 30/11/2014 31/01/2015 31/03/2015 31/05/2015 31/07/2015 31/01/2016 31/03/2016 31/05/2016 31/07/2016 30/09/2016 30/11/2016 31/07/2017 30/09/2017 30/11/2017 31/01/2018 31/03/2018 31/05/2018 31/01/2019 31/03/2019

The chart tracks the movement in value of AUD100 invested in the Fund at inception, relative to the Reserve Bank of Australia cash rate plus 2.5% Fund size: AUD 88m (performance hurdle) and relative to the ASX Small Ordinaries Accumulation index. Returns are net of fees, exclude buy/sell spreads and assume reinvestment of distributions/income. The chart utilises a log scale on the vertical axis to reflect relative returns more clearly. Top 10 stock positions as % of overall portfolio: 57%

Equity markets rebounded strongly in the March quarter, following a tough December quarter, with the ASX Small Ordinaries Index up 13% and the broader ASX All Ordinaries Index up 11%. The Fund enjoyed an exceptionally strong 21% gain. Many of the technology exposures that were weak in the December quarter reversed course this quarter. Nearmap and Jumbo Interactive were standout performers in the half, accounting for much of the Fund’s outperformance. Takeover offers were made for two of the fund’s positions, Spicers and Netcomm Wireless, which we will discuss further in the commentary below. Although the Fund’s cash position looks low at 2%, Spicers and Netcomm should convert to cash by July – the Fund’s cash weighting would be 11% including these proceeds. Universal Biosensors and 3P Learning were pushed out of the Top 10 by GBST and Netcomm Wireless due to relative share price movement.

Top 10 Stock Positions Weight % Name Summary Investment Case (recent updates in italics) 12 nearmap Captures high resolution orthogonal, oblique and 3D images of cities from light aircraft and renders them seamlessly on a subscription- based browser within 2 days of capture. Their Australian business is profitable, cash generative and still growing, while the less mature US business is gaining momentum. The share price almost doubled over the quarter with the market finally appreciating the quality and potential of the business. Although meaningful upside remains, we have trimmed a portion of our holding. 6 Jumbo Leading online reseller of official Australian Lottery tickets via the www.ozlotteries.com website. Jumbo was one of the first online Interactive lottery resellers in Australia and has about a 1/3rd share of online lottery sales. Following a very strong first half performance, the share price jumped during the quarter and although still undervalued, we sold a portion of our holding. 6 Medical The company has been supplying Penthrox, an extremely effective inhaled analgesic pain medication, in emergency medical settings in Developments Australia for 30 years but only recently entered foreign markets where sales are starting to grow strongly off a small base. Their asthma spacer is also growing internationally. A solid first half result seems to have given support to the share price. 5 GBST Wealth platform and financial markets software. GBST has endured a challenging period driven by a conversion of their platform source code from a legacy language to Java as well as operating in the Brexit impacted UK market. They are about halfway through their base code conversion which management report as going to plan. The share price bounced in the quarter probably reflecting its previously oversold position and emerging signs that the worst may be behind them with revenues growing in the 1st half. 5 Netcomm An opportunistic bid was made for the company at a price that we consider to be significantly below fair value, albeit a premium to recent Wireless subdued trading prices. Surprisingly, the Directors are supporting the offer, but we are hopeful that a better offer emerges. The position should convert to cash within the next few months unless shareholders vote against the offer. 5 Nanosonics Manufactures and distributes a unique device (the Trophon) that disinfects ultrasound probes using a proprietary hydrogen peroxide nano-mist process. Trophon is gaining rapid acceptance as standard practice in the industry. Dependable, high margin related consumable sales are an attractive feature of the business and growing strongly. A pipeline of new products in the infection prevention space could add value in the future. A solid 1st half was reported, and the share price jumped during the quarter. 5 Integrated Global leader in performance monitoring and diagnostics software for business-critical IT infrastructure, including Unified Research Communications and Payments. The share price recovered from its previous oversold levels, following a satisfactory 1st half result. A new CEO is yet to be appointed. 5 Redbubble www.redbubble.com is a world leading global marketplace, connecting independent artists with 3rd party fulfillers for on-demand production and distribution of unique products to end customers. Despite previously reported challenges with its unpaid search performance due to a change in Google’s algorithm, their 1st half result was reasonable, and the share price has partially recovered from last quarter’s hammering. 4 Spicers An attractive offer for the company emerged and this position should revert to cash by July. 4 Clinuvel Australian Biotechnology company whose key product, the orphan drug Scenesse, is enjoying strong revenue and profit growth. Scenesse is a unique hormone replacement implant used to treat patients with erythropoietic protoporphyria (EPP), a rare skin disease that causes intolerance to light. With pending approval for Scenesse from the FDA and other countries, plus probable application in other skin disorders such as Vitiligo, Clinuvel has the potential for significant growth ahead of it. A target date of 8 July has been set by the FDA for review of Clinuvel’s New Drug Application. Greater awareness of the company in the investment community is emerging, which has driven the share price higher and we have lightened our investment into this strength.

Jencay Australia Investment Fund Quarterly Report March 2019

The WAAAX’s – Australia’s version of the FAANGs

In our March 2018 quarterly report, we contrasted the FAANGs (Facebook, Appen Amazon, Apple, Netflix, Google) to Jencay’s technology stocks. Since then Appen provides language technology data and services for Content Relevance “WAAAX” has emerged as a new acronym for a group of five of the ASX’s and Speech and Data Collection. Essentially, they have a global crowd-sourced homegrown technology successes: Wisetech Global, Altium, Appen, Afterpay contractor workforce that help improve search accuracy and language and Xero. Jencay still holds a small position in Altium, the only one of the five, translation for their large clients. Their growth since IPO in 2015 has been but we continue to have a very large exposure to technology companies, some incredible (share price up more than thirty-fold), driven by the explosion in of which have shot up in price recently i.e. Nearmap and Jumbo Interactive. The search, big data and artificial intelligence. We have kicked ourselves a number ASX 300 Information Technology Index has risen 27% over the last year, of times for not buying Appen but aspects of the business do concern us, significantly outperforming the overall market. including their concentrated client base comprising a handful of the world’s The coining of an acronym for any investment theme makes us sit up and take biggest technology companies, contracts that are relatively short, a very labour note, as it often coincides with overconfidence, exuberance and inflated intensive business with margins that do not scale, and a recent appetite for valuations, pointing to a need for caution. A snapshot of valuation and share acquisitions which raise questions about their confidence in producing organic price performance for the five WAAAX’s is shown below: growth going forward. Afterpay Wisetech Altium Appen Afterpay Xero Although included in the technology index, Afterpay is actually a consumer Market Cap AUD millions 7,272 4,279 2,742 5,566 7,091 finance business, that has supercharged its growth using technology and by Revenue latest 12 months AUDm 285 205 364 158 437 targeting the millennial demographic. Finance is provided to their customers EBIT latest 12 months AUDm 77 67 61 (52) (10) over a very short duration and is interest free to the buyer, with the retailer Enterprise Value/Sales Ratio 25 20 7 35 16 accepting a discount and in effect absorbing the finance cost. We have been Enterprise Value/EBIT Ratio 93 63 45 (106) (737) deterred from Afterpay due to a valuation that has always looked inflated and Price/Earnings Ratio 142 69 59 (169) (216) a business that can be incredibly cyclical – although there is currently unlimited 12 month price change % 149 66 168 267 52 Source: Factset appetite for credit exposure from numerous sources, consumer finance businesses often become unstuck when the credit cycle turns, and funders turn We note the following: off the taps. In such a scenario, Afterpay’s short duration book would run off - All trade on very high multiples of Revenue and Profits. extremely quickly, with revenues evaporating. - All five have experienced exceptional share price gains over the last 12 months, with Altium and Xero’s gains less spectacular than the other three. Xero Leading cloud-based accounting software platform for small businesses. Xero’s - Afterpay and Xero are still lossmaking and Wisetech is barely profitable. organic growth has been phenomenal and although it appears to be a very good

- Altium and Appen’s valuations appear more reasonable than the others based business, valuing Xero is challenging because it has not been profitable and is on earnings multiples, but do not appear to be bargains. still burning cash. Although Xero continues to invest to grow their reach, the For each of the five companies, we have varying degrees of concern about long- scalability of the business does not seem as clearly apparent as it does for some term growth or valuation (or both), as described below: of the stocks in our portfolio such as Jumbo Interactive and Altium, who have managed to grow costs significantly more slowly than revenues relative to Xero. Wisetech We feel there is more upside in other stocks.

A provider of software solutions to the logistics industry globally. Wisetech has been an aggressive acquirer of similar software providers around the world and In summary has recently accelerated its acquisition strategy, funded by share issuance, perhaps a recognition that its currency (share price) is significantly overvalued We believe that the emergence of the WAAAX’s coincides with excessive and acquisitions are needed to keep the game going. We have typically steered enthusiasm for tech stocks, and indeed most stocks that have exhibited strong clear of roll-up scenarios, because many of these types of companies eventually positive earnings and share price momentum. Valuation, fundamentals and become unstuck for a variety of reasons including difficulty integrating acquired downside risk has become less of a focus for many market participants. companies (We think integration of software companies can be particularly Although we have benefitted from this wave due to our large holding of similar challenging); share price declines that make future acquisitions difficult leading types of stocks, we have been actively trimming our winners and reallocating to lower earnings growth; or merely running out of acquisition targets. proceeds into those stocks that have underperformed. Altium We have been selling our winners more slowly than we have in the past because Global provider of software for electronics engineers enabling the design of experience has taught us that quality stocks tend to continue to outperform in printed circuit boards. Although Altium’s valuation does look high, if they can terms of both earnings growth and share price gains especially if their market achieve their own growth targets, upside remains. Altium has one of the most price is below fair value, as determined by long term free cash flow forecasts. visionary management teams on the ASX and a sensible strategy that to date Sale proceeds have been shifted into those stocks that are still has been executed remarkably. Incumbent competitors, in contrast, have underappreciated by the market because they are too illiquid for most investors struggled to adjust to the world of packaged software and transactional sales. or because they have previously disappointed, but these are more likely to be Upfront license fees are a large part of Altium’s revenues and if sales velocity the WAAAX’s of the future than the current WAAAX’s. The WAAAX’s may yet slows, this is probably their main vulnerability. wane.

Fund Key Features Custodian JP Morgan Chase Bank N.A. Administrator Link Fund Solutions (formerly White Outsourcing) Fund auditor Pitcher Partners Investment strategy The Fund seeks to generate attractive risk-adjusted returns over the long term and protect capital by buying securities trading significantly below fair value (bargains) and holding cash on deposit when bargains are not available in the market. The Fund has a small cap bias in accordance with the Manager’s opinion that most bargains are found amongst small caps. Investment universe All securities listed on the Australian Securities Exchange (ASX) and cash to be held on deposit Fund size cap The fund is now closed to new investors (subject to Trustee discretion) but will remain open for additional investment by existing unitholders Investment restrictions ▪ Maximum of 40 individual securities ▪ No short positions ▪ Maximum exposure of 15% to a single security ▪ No leverage Base management fee 1% p.a. excluding GST. Management Expense Ratio 1.025% p.a. inclusive of non-recoverable GST. Performance fee 20% of returns above the Hurdle rate subject to a high-water mark. The Hurdle rate is the Reserve Bank of Australia Cash Rate Target plus 2.5%. Entry fee None Buy spread 0.5% Sell spread (0.5%) Redemption notice 6 months’ redemption notice required otherwise 5% early exit penalty to be applied

Contact Details Web www.jencay.com.au Tel +61 415 233 512 Trustee and Investment

Manager Email [email protected] Administrator Tel +61 2 9547 4311 Link Fund Solutions Email [email protected] Level 12, 680 George Street, Sydney, NSW 2000

Disclaimer Jencay Capital Pty Ltd (Jencay) has prepared this Quarterly Report for the Jencay Australia Investment Fund. All reasonable care has been taken in preparing this document however Jencay and its associates make no representation or warranty as to the accuracy, reliability or completeness of this Quarterly Report. The information contained within this document is for use only by wholesale clients as that term is defined in the Corporations Act. The contents of this document are confidential and must not be reproduced or provided or disclosed to others, except with written permission from Jencay. The information contained in this document does not constitute advice or a recommendation from Jencay or any of its affiliates, associates or officers. Past performance is not a reliable predictor of future performance.

Jencay Australia Investment Fund Quarterly Report March 2019