July ,
Dear Friends,
For the second quarter of , Andvari was up .% while the S&P was up .%. For the first six months of , Andvari is up .% while the S&P is up .%. Below, the table shows Andvari’s composite performance figures against three benchmarks while the chart shows the cumulative gains of a hypothetical $ investment.
Annualized Since Inception Year to Date at // Andvari Total, net 1 57.6% 4.8% -4.4% 13.5% 18.9% 10.8% 17.1% S&P 32.4% 13.7% 1.4% 12.0% 21.8% 2.7% 14.8% Russell (IWM) 38.7% 5.0% -4.5% 8.8% 14.6% 7.7% 14.3% Vanguard Balanced (VBIAX) 18.1% 10.0% 0.4% 2.7% 13.9% 1.4% 9.4%
$250 Andvari Total, net S&P 500 $225 Russell 2000 Vanguard Balanced $200
$175
$150
$125
$100
He second quarter was quite a rebound from the negative first quarter performance for two reasons. First, the share prices of two of our larger and long-held investments, Mesa Labs and Sientra, increased significantly. Second, I redeployed capital into a handful of new holdings, some of which also increased significantly shortly thereafter.
1 “Andvari Total” represents all of Douglas Ott’s investment accounts and all the discretionary accounts Andvari manages where it takes an active role in picking individual stocks and receives a fee. From // to // results included only Ott’s personal and retirement accounts—the first Andvari clients transferred their accounts on //. Andvari believes including Ott’s performance figures for the first months of is fair as he managed those assets similarly relative to later clients. Results are net of management fees (% per annum), time-weighted, and includes all cash and other securities. He indexes and funds are listed as benchmarks and are total return figures and assumes dividends are reinvested and net of their respective underlying fees.
Bertland Ave. # P / ..
Durham, NC www.andvariassociates.com
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He table below shows our most notable activity during the second quarter.
Sold All Shares Sold Some Shares Bought Some Shares New Holdings Luxoft Mesa Labs GCI Liberty Tencent Lagercrantz Sientra Roper He Trade Desk Markel Quorum Information Appian MarketAxess Alphabet
Starting from the left, I liquidated our stakes in Luxoft and Lagercrantz. I sold Luxoft for three reasons. First, the problems faced by Luxoft’s European bank clients had gotten more serious and would be a drag on Luxoft for longer than I first thought. Second, I’ve learned the hard way that Luxoft’s management is not the best: they’ve overpaid for several recent acquisitions and have failed to communicate effectively with their investors. Finally, Luxoft has roots in Eastern Europe and Russia. It is likely the geopolitical climate will be a perpetual negative attribute and impediment to the company’s share price ever reaching fair value.
Regarding Lagercrantz, a Swedish company found in some of the non-retirement accounts Andvari manages, although it’s an excellent company trading at a reasonable valuation, I simply saw better investment opportunities.
DETRACTORS FROM PERFORMANCE Charter Communications (via Liberty Broadband and GCI Liberty) is one of Andvari’s largest holdings at over % of assets under management. Charter being down .% during the quarter was a drag on performance. He market seems to be focused on Charter’s short-term results rather than whether the company is doing the right things to increase shareholder value over the next five years.
Charter continues to plant seeds for a later harvest. Hey are spending in areas where the benefits will take time to show up in their financial statements. For example, Charter has been upgrading its entire network to handle internet speeds up to - gigabit per second and to be all-digital. Furthermore, the company has been hiring and training its own customer service and field service employees. His is more expensive in the short-term than outsourcing these functions, but over the long-term it will lead to a better customer experience, which will lead to lower customer churn and lower expenses from having fewer problems to fix.
Rising interest rates have also detracted from performance because income- producing securities make up nearly % of Andvari assets under management. As a reminder, bond prices go down when rates go up. A note from JP Morgan to their clients in May described how the magnitude of the current bond sell-off has been something of a rarity in the last years. Heir chart to the right shows the rolling -day returns of investment grade corporate bonds.
Bertland Ave. # P / ..
Durham, NC www.andvariassociates.com
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CONTRIBUTORS TO PERFORMANCE Andvari had six holdings that were up at least % in the second quarter and up for the first half of the year.
Performance Performance YoY Sales Name Industry nd Qtr. ‘ st Half ‘ Growth 2 Constellation Software Software 17% 34% 29% Upland Software Software 19% 59% 52% He Trade Desk Software 88% 3 n/a 61% Appian Software 33% 3 n/a 35% Sientra Medical devices 102% 39% 96% Mesa Labs Life sciences 42% 70% 11%
Interestingly, they all happen to share a variety of characteristics. One, they require little capital expenditures to grow. Two, all are growing faster (some much faster) than the S&P ’s current sales growth rate of .%. Hree, many also appear to be very expensive or plainly unprofitable based on generally accepted accounting principles (GAAP).
One shouldn’t be too concerned with this third trait as GAAP accounting masks the true future earnings power of these companies in two ways. First, nearly all the companies are investing heavily to maximize long-term results—this naturally depresses operating results in the short-term. Second, three of the six are highly acquisitive, which means acquisition-related expenses (including the ongoing amortization of the intangible assets of acquired companies) are also depressing reported operating results. All these companies have very bright futures and are attractive investments given their high rates of growth.
NEW HOLDINGS As you know, there was a high amount of activity this quarter: Andvari sold two and added five new investments. Allow me to introduce the five additions to the Andvari stable.
The Trade Desk He Trade Desk provides software to global ad agencies that helps them to purchase and manage data-driven digital advertising campaigns. He company has invested heavily to please its current customers and attract new ones. He Trade Desk has had % customer retention rate over the last years while growing revenues from $. million in to $ million in . And unlike almost every other high-growth software company that has gone public in the last three years, He Trade Desk has had positive operating margins.
He company also has an exceptional leader in its founder and CEO Jeff Green. First, he is an entrepreneur who is extremely passionate about the business and the digital advertising industry. Jeff has spent the past years of his life trying to build an independent digital advertising exchange modeled after stock exchanges in the financial markets. He first iteration was AdECN, which he founded in . Microsoft bought AdECN in for $ million, but never embraced Green’s vision for the business. Hus, Green left Microsoft in to start He Trade Desk.
2 His is the year-over-year sales growth for the respective company’s most recent quarterly results. 3 Performance for TTD and APPN is as of the date of initial purchase, which occurred in April and May respectively.
Bertland Ave. # P / ..
Durham, NC www.andvariassociates.com
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Secondly, Green is the largest shareholder with over . million shares (about % of total shares and he controls over % of voting shares) worth about $ million. Green’s interests are aligned with shareholders given his large ownership. Control of the company is also important as it indicates Green is on a mission to build an extraordinary advertising technology company that will be the best in providing the most value to its customers. He does not want to be in a position of having to sell his company only to see it later neglected and shut down as Microsoft did with AdECN.
Appian Appian has created a “low-code” software platform that enables companies to create custom business applications in rapid fashion. Low-code means that little or no coding is required to create a piece of software. With Appian’s platform, users can create a business application – times faster than the route of traditional software coding. Appian users save a lot of time and money, which is why the company has nearly doubled revenues in just the last years from $ million in to $ million in .
In addition to having a great product that lots of businesses need and want, the company has an exceptional leader in its founder and CEO, Matt Calkins. First, Calkins started Appian in at the age of . Even more impressive is the growth the company has achieved while only taking $ million from outside investors. Second, Calkins has retained significant ownership and control after the company’s IPO in : he owns over million class B shares and controls .% of all voting shares. With his Appian shares worth nearly $ billion, chances are good Matt will do what is best for all shareholders.
Finally, I do not believe it’s all about the money for Calkins. He has the traits of a person who wants to be the best at whatever he chooses to do. How do I know this? Because Matt is a serious board-gamer, so serious that he has created and published three games of his own. So, what is so great about a board-gaming CEO? As a board-gamer myself, I know he relishes complex challenges. A serious board-gamer must also have a deep appreciation for strategy and a willingness to continually re-evaluate strategies as circumstances change. As a CEO of a public software company, the object of the game is to grow shareholder value at the highest rate possible over the life of the business. Knowing that Appian’s CEO is a fan of complex, non-traditional board games, I am confident he has an above average grasp on how to win this game, or to at least be one of the very top performers.
Tencent Holdings Tencent is a Chinese technology conglomerate involved in video games, subscription media businesses of all kinds, online payment systems, digital advertising, and e-commerce. All Tencent’s offerings are tied together with their WeChat app, which has over billion monthly active users, % of whom spend two or more hours every day using it. He app is used to communicate with friends, make payments, play games, and many other things. It is easy to understate the ubiquity of WeChat and how it is nearly impossible to have a normal life without using it.
Tencent has tripled revenues over the last three years, from about $. billion to $. billion,4 and there is no sign of slowing down. China is still a market that is () huge and () untapped. For example, according to a report by Goldman Sachs, half of China’s working population have an average annual income of between $, and $, U.S. dollars. As incomes grow, consumers in China will spend more on entertainment, goods, and other services, from which Tencent will benefit directly and indirectly.
4 I use an exchange rate of RMB = . USD.
Bertland Ave. # P / ..
Durham, NC www.andvariassociates.com
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MarketAxess MarketAxess operates the most popular electronic bond trading platform in the world. He company has over % market share in the electronic market, but just % market share for the entire bond trading market. Most bond trading is still conducted over the phone between financial institutions. Electronic trading will steadily take share and MarketAxess will be the clear winner.
Alphabet Alphabet is the holding company for Google and a multitude of “other bets” like Waymo (autonomous vehicles) and Nest (smart-home tech products). Google remains the dominant provider of search and other online services. YouTube is still an under-monetized asset. And despite Google being a distant third place in cloud computing after Microsoft and Amazon, Google’s Cloud Platform business recently became a billion-dollar-per-quarter business.
Adding all this up, Alphabet has over $ billion in annual revenues, produces over $ billion in free cash flows, and it is still growing revenues at over % per year. Adjusting for the $ billion of cash on the company’s balance sheet and the investments the company is making that depresses reported financials, Alphabet is trading at a %–% earnings yield and growing intrinsic value per share at a mid- to high-teens rate. His is a very attractive investment proposition.
SUMMARY I am very pleased with performance during the second quarter, especially Top Equity Holdings % of Net since it more than made up for the negative performance in the first quarter. As of June , Assets Although it’s always satisfying for the market to finally recognize the true Mesa Laboratories 17.7% business value of a company in which you’ve invested, I also remain humbly Liberty Broadband 8.2% appreciative of the near equal weightings that luck and skill have in the Upland Software 8.0% investment business. It has taken years of continuous study to appreciate the GCI Liberty 7.8% trajectories and business models of our investments before committing capital to them and we’ve been very lucky to have benefited so quickly from Sientra 7.2% some of them. Roper Technologies 7.2% Micro Focus 5.7% As a reminder, Andvari’s investment philosophy is a “careful and Visa 5.2% concentrated” one. Our top equity holdings represent over % of net Tencent 4.7% assets under management. Although the ride can be bumpy in the short term, over the long term it is more likely that clients outperform their SBA Communications 3.7% benchmarks and Andvari can justify its management fee. To have a shot at differentiated results, one must do something that is different.
I am extremely thankful to all Andvari clients for the trust and confidence they have placed in me.
Sincerely,
Douglas E. Ott, II
Bertland Ave. # P / ..
Durham, NC www.andvariassociates.com
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Legal Information and Disclosures
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Bertland Ave. # P / ..
Durham, NC www.andvariassociates.com