Ophir Asset Management Level 26, Governor Phillip Tower One Farrer Place SYDNEY NSW 2000

Dear Fellow Investors, Welcome to the May 2018 Strategy Notes – thank you for investing alongside us for the long term. Due to a fairly intensive travel schedule through the back end of April, we took the decision to delay our monthly ‘Strategy Notes’ to a little later this the month. We hope you enjoy the updates. Strategy Notes – From Auckland to Omaha With an investment mandate that allows both Ophir Fund’s to invest in Australian and -listed equities, it is not surprising that New Zealand is one of the more frequently visited international destinations for the investment team. Prior to heading to the US for an extensive trip later in the month, we took the opportunity in April to also touch base with a number of existing NZ-based portfolio holdings in addition to a handful of exciting emerging companies that the nation is now beginning to produce with some degree of regularity. In many ways, the NZ-listed company space has proven to be a happy hunting ground for the Ophir Fund’s for some time and we certainly enjoy the innovative and motivated entrepreneurialism that seems embedded in many management teams in businesses across the Tasman. The ‘tyranny of distance’ facing emerging Kiwi companies quite often works in their favour as founders and management teams are required to think about product scalability and global expansion opportunities far earlier in their company lifecycle than in perhaps other regions. With fairly limited opportunities in the domestic market (the entire population of New Zealand is ~300k less than that of Sydney’s), any budding entrepreneur with a desire to grow a meaningfully- sized business will almost automatically be crafting that idea with global growth goals in mind. We like this natural inclination and desire to expand offshore as it almost immediately sets the success bar higher for businesses and encourages management teams to take intelligent risks early on in their growth journey. Of course, this doesn’t mean there is a dearth of very large companies in NZ that have built significant businesses servicing the domestic populous – indeed the top ten largest companies (as measured by total profit) are dominated by a collection of businesses that generate the bulk of their revenues onshore. In a similar vein to the Australian large cap experience, the majority of these businesses also represent fairly ‘older world’ businesses models entrenched in the more mature stages of the company lifecycle. Of the top ten (, , , , Kaingaroa Timberlands, , Transpower New Zealand, , and Mercury NZ), four essentially operate as majority state-owned enterprises, one is a listed dairy farming co-op, another an unlisted timber plantation and another a national chain of petrol stations. While certainly not a ‘high-growth’ collection of businesses, it is interesting to note that a good number of domestic-facing NZ businesses actually achieve higher EBITDA margins and better overall returns on capital than their listed Australian counterparts. This is primarily a reflection of the broadly smaller market size and the fact that the region tends to sit fairly low on the priority list for foreign companies looking to aggressively disrupt existing offshore markets. In our view, this geographical moat will not last forever, however, and a number of businesses in the larger end of the NZ market that have effectively been ‘over-earning’ versus global peers in recent years will likely experience some competitive pressures in the years ahead. Like , however, scratching below the surface of the larger listed company names has uncovered some wonderful examples of entrepreneurial drive and global innovation – with many small NZ companies in recent years rapidly expanding to become far more substantial in size. While we are limited in our own investment universe to those businesses that are publicly-listed on the NZX, we can only be impressed with the speed in which New Zealand’s start-up community has rapidly developed into a globally relevant destination for local and international venture capital. According to a recent report from the NZ Ministry of Business, Innovation and Employment, more than NZ$875m in capital was raised in 2017 by New Zealand-based businesses across the private equity and venture capital space. Early stage capital commitments tend to favour higher-growth opportunities and it has been the burgeoning Kiwi tech sector that has proven to be the key attraction for foreign capital in recent years. From barely rating a mention only a decade ago, technology now sits as the country’s third largest export (behind tourism and the dairy industry) with the NZ tech industry contributing over NZ$10bn in combined revenue in 2017 and employing more than 40,000 people. 3-Year Revenue CAGR (%) - Selection of High-Growth NZ Companies

Source: NZ Ministry 0f Business, Innovation & Employment No event could perhaps be more symbolic of the heights to which the emerging and start-up environment in New Zealand has reached than the pending first commercial rocket launch from NZ-based start-up Rocket Labs – expected sometime toward the end of June this year. Started in 2006 by New Zealander Peter Beck as a company focused on developing smaller, lower-cost satellites for the telco, mapping and space research industries. The business has developed a pilot rocket (in their manufacturing site in Auckland) entirely powered by engines that are constructed by 3D printers that are expected to provide customers with the opportunity to deliver smaller commercial payloads into orbit. With the business already commanding a private valuation in excess of US$1bn prior to achieving first revenues, the potential for the business to meaningfully grow from here is enormous. Keeping true to their New Zealand heritage, the launch of the company’s 17- metre tall ‘Electron’ rocket won’t occur at the more familiar launch pads of Cape Canaveral or Kennedy Space Centre, but from a private launch site in the Hawke’s Bay on New Zealand’s North Island. Across the listed space, we have been fortunate enough ourselves to have shared in the success of a small number of NZ-headquartered businesses and currently retain four holdings in NZX-listed companies across the Ophir portfolios today. While no longer NZX-listed, cloud accounting software developer (XRO), for example, is a business we have written fairly extensively about in previous Letters (you can access it here) that has continued to experience a terrific rate of growth as their global sales strategy begins gains momentum. From humble beginnings in founder Rod Drury’s Wellington apartment in 2006 (the business didn’t operate from a formal office premises until 2007), the company now commands a NZ$6bn market capitalisation with over 2000 staff worldwide and 1.4m subscribers across 180+ countries. In its breakout year in 2008, the firm was thrilled to announce to shareholders annual total revenues of $134,000 – ten years later and the business now generates over $100,000,000 a quarter. While the business is no longer a ‘small cap gem’ lying undiscovered across the Tasman, the considerable market capitalisation of the business isn’t symbolic of a business that has reached peak growth, in fact far from it. While the initial core markets of Australia and New Zealand are certainly maturing (i.e. they are still experiencing overall growth however the rate of that growth year-on- year will slow from here), the business at a group level will still record overall subscription growth for FY18 in the order of ~30%, with a similar amount of growth expected for the 2019 financial year. Expansion into global territories will be the primary driver of growth from here, given the business remains in the early stages of market penetration in the much larger US and UK markets. The UK experience, in particular, has been highly encouraging to date with subscriptions to Xero’s product growing +47% on the prior year. We expect to see a continued acceleration in net subscription additions (i.e. growth increasing at an increasing rate) as market share increases and overall brand awareness expands. Xero Net Subscriber Additions by Geography (‘000’s)

Source: Evans & Partners

Pleasingly, the business looks set to benefit from some regulatory tailwinds in the UK in FY19 that will require all businesses with revenue >£85,000 to lodge tax returns electronically. While the overall impact at this stage is hard to quantify, we are reminded of the incredible surge in license sales experienced by Australian accounting software provider MYOB through the 1999-2000 period following the announced introduction of the GST in July 2000. Winning the UK, in our view, will be critical for the business on a five-year view as it essentially provides a sound capital base to then attack and grow into more international market opportunities – potentially Canada, Singapore, South Africa and Malaysia. Perhaps more importantly, the business has now reached the crucial stage of moving from loss making to first profitability, effectively enabling future organic growth to be funded by its own free cash flows. While the journey has taken ten years to reach cash flow breakeven, the subsequent uplift in equity value of the business over the period again provides a wonderful example of the incredible competitive advantage that businesses with a supportive shareholder base enjoy. Sacrificing near term profit or dividends for longer term growth optionality hasn’t historically been an easy sell for Australian or NZ-listed management teams and it is encouraging to see shareholder patience being acutely awarded. Fellow listed Kiwi tech player Pushpay Holdings (PPH) has provided us with another fantastic example of entrepreneurial grit and innovation from the Land of the Long White Cloud. The mobile payment technology business (focused primarily on the church-giving and charity sectors) announcing this month a more than doubling of revenues to US$70.2m over the year while average revenue per customer increased +36%. This is a terrific achievement for a business that had its genesis only in July of 2011, where co- founders Chris Heaslip and Eliot Crowther shifted their own paid work commitments to work nights in order to focus on the development of their mobile payment application idea during the daylight hours. Fast forward seven years and the business stands as a dual-listed public company with market capitalisation in excess of $1bn processing more than US$3bn in annualised payments across the platform they created. Faith-based giving (i.e. donations from individuals to their respective churches and/or charities) across primarily Pentecostal congregations in the United States has provided the bulk of the growth to date, with the Pushpay platform now being utilised across 54 of the top 100 largest churches in the US. Religion is an enormous business in the US, with the faith sector processing well in excess of US$120bn in donations across 340,000+ churches each year - a thematic we expanded on some time ago when we first highlighted the business to investors in these Letters (this can also be accessed here). In a similar vein to Xero, the business is shortly approaching its own ‘second act’ of the growth story, with the company expected to reach monthly cash flow breakeven by the end of calendar year 2018. While dual-listed currently on both the New Zealand and Australian stock exchanges, the business has also flagged the likelihood of listing on a North American stock exchange by the end of the calendar year in order to further broaden the capital and shareholder base. With 97% of customers located in North America (in addition to 258 staff), the move seems a logical next step for the business and we look forward to the next stage of growth from Chris and the team. Finally, it would be remiss of us to highlight a collection of NZ success stories without mentioning the most obvious recent growth story, the A2 Milk Company (A2M). While not a creation of the NZ tech ecosystem, the milk and infant milk formula manufacturer has proven to be an incredible creator of value in recent years, including briefly holding the mantle of New Zealand’s largest listed business by market cap in May of this year. Similar to both Xero and Pushpay, the business was initially founded from humble beginnings, though it is a terrible shame that neither of the original founders– research scientist Dr Corran McLachlan and New Zealand businessman Howard Paterson – would ever experience the ultimate success and global expansion of the business. Both tragically died within a month of each other in 2003, at a point when the duo were still embroiled in proving up the science behind the benefits of the A2-only milk product. The business would eventually list on the New Zealand stock exchange in March 2013 and, now three years into its dual-listing on the ASX, is slowly joining the ranks of Phar Lap, Crowded House and pavlova as NZ-originated products that (domestically and internationally) are ultimately – and incorrectly - claimed as Australian-made icons. While the growth trajectory of A2 in recent years has been nothing short of stellar, it has never been in a straight line – a factor that was all too obvious this month with the business seeing a fairly dramatic sell-off following a company update that fell short of elevated market expectations. In a later cycle market, high growth businesses on elevated earnings multiples that miss expectations are particularly vulnerable to even the slightest slowing in earnings momentum. From entering the month at $11.27 a share, the business will likely finish the month in the vicinity of ~$9.60 – a fall in value of some -15%. The cause of the most recent decline is less to do with any structural operational concerns and more a result of the company becoming somewhat of a victim of its own success. The incredible growth experienced by the business in penetrating the infant milk formula market in China has ultimately resulted in the company delivering a number of successive earnings ‘beats’ in recent years. Forward consensus estimates (i.e. the investment bank research analysts providing earnings forecasts to their clients), as a result, had grown somewhat accustom to the expectation that the company would continue in its ability to beat earnings forecasts into the future. Prior to the company’s strong half- yearly update in February of this year, the average analyst forecast for revenue for the 2018 financial year sat at ~NZ$875m, rapidly increasing to an expected ~NZ$920m following the half-year numbers. Optimism, as it does, quickly took hold and over the next three months sell-side expectations continued to edge higher, taking average revenue forecasts across the consensus toward ~NZ$960m as at the beginning of May. Whilst certainly pleasing to see such broad-based enthusiasm for the business and the growth opportunities ahead of it, such elevated expectations ultimately sets the bar very high – in this case too high, with the business formally guiding expected revenues for FY18 to instead likely to be closer to the vicinity of NZ$910m. While some destocking of product in China ahead of the release of a new packaging design this month has created some short-term headwinds, the bulk of the share price fall reflected primarily a rebasing of expectations rather than anything more sinister. As we have written to investors previously, earnings momentum continues to be one of the key near term drivers for share price performance in the current market, with the share price revision experienced by A2 this month providing a sound example. A2 Milk Company Group Revenue (NZ$m)

While it’s never pleasant to experience capital loss, we view the outcome as a short term adjustment and continue to remain excited about the prospects ahead for the business. For some perspective, it should be noted the NZ$910m in revenues represents growth of 67% from the year prior – this is all the more impressive given Group revenue was already sitting at a healthy NZ$550m in FY17 (and remembering the business generated just NZ$62m only six years ago). No doubt the experience will provide some interesting insights around managing consensus expectations for incoming CEO Jayne Hrdlicka (ex CEO Jetstar), who takes the reins from current MD & CEO Geoff Babidge following his retirement at the end of this financial year. Looking forward and we continue to feel the business remains well placed to extend its market share runway into China’s infant milk formula market, with the A2 Milk product currently accounting for just ~5.4% of a US$15bn market (with a number of competitors currently speaking for well over 10%). A unique and market-leading product proposition that continues to resonate strongly with Chinese mothers (verified last month via global player Nestle launching its own A2-only product) combined with a surety of supply and extensive distribution network continues to place the business on a solid runway toward further market share gains. US Visit – Oracles and Oreo’s And so to Omaha for a visit to the Berkshire Hathaway Annual General Meeting – an event that has long sat on the bucket list for us to attend but scheduling never really made possible. We were incredibly fortunate enough this year to be offered an invitation to attend and, given we had planned to be visiting the States for a series of meetings with a number of listed and unlisted businesses at the same time, we were thrilled to be able to attend. As a result, we soon found ourselves (alongside fellow Ophir portfolio manager Tim Masters) collectively bunked into a twin share three-star motel room in Omaha ahead of joining ~40,000 others in the enigmatic chaos that is the ‘Warren and Charlie’ show. While we probably wouldn’t categorise ourselves into the camp of complete Buffet devotees, it is very difficult for one to not be naturally in awe of the incredible track record that Warren and business partner Charlie Munger have generated through their investment partnership of the last 53 years. Since inception in 1965, the Berkshire partnership has delivered compounding growth in book value per share of +19.1% per annum, turning one $19 share in an ailing textiles business into $211,750 today – a return of over 11,000x (for some context, the S&P 500 over the same period returned +9.9% per annum, or a 149x return). While the enviable investment returns (and the possibility of obtaining some insightful investment tidbit or market observation from Buffet and others) obviously creates some motivation for the thousands of attendees, it is arguably not the main reason for attendance. Given the AGM itself is now broadcast live to the world via Yahoo webcast (https://finance.yahoo.com/brklivestream/), it is just as easy for individuals to access these insights from the comfort of their own homes rather than making the pilgrimage into middle America. What became immediately apparent to us upon visiting Omaha was instead the sheer sense of community shared amongst the attendees - a collective group of passionate investors from a variety of backgrounds, all united in a collective desire to continually learn and exchange ideas with other like-minded individuals. This knowledge exchange was comfortably the highlight for us and we were thrilled to meet new connections across a variety of industries, geographies and backgrounds through our two days in Omaha – many of which we look forward to meeting with again as valuable providers of industry insights for businesses in which we are currently invested. The takeaways from the meeting itself have been widely reported in the financial press and any further summation from us would likely do the 8-hour long meeting an injustice. In terms of investment ideas for ourselves, however, there were two key themes that provided us with some pause for further reflection:

1) USA All the Way… Admittedly, the United States and the majority of its citizens have for a long time been a nation of unbridled optimism - while a collection of predominantly US investors at the so-called ‘Woodstock of Capitalism’ certainly doesn’t provide anything near a suitably unbiased sample size, the overall positivity and general investment sentiment toward the domestic US economic recovery was palpable. Multiple discussions with both US-focused investors and corporate leadership teams both inevitably turned to the prospects of the sustaining economic recovery, with overall sentiment and general investor mood certainly buoyant. While surging equity markets arguably already reflect a great deal of this economic recovery, our expectation would be that US market leadership will likely begin to shift away from the mega-cap end of the market (that are predominantly global facing in terms of revenue generation) and back towards some of the more traditional US-facing businesses that have lagged the recent rally. Despite forward-looking economic data cooling somewhat, the recently announced corporate tax cuts look to be the key impetus to add further fuel to the fire and we would expect to see a renewed uptick in business investment across mid and smaller sized businesses across America. Unsurprisingly, Warren himself remains unwaveringly positive on the US economy – pronouncing that if he had just $1bn to invest, he would still deploy the comfortable majority of the capital into the US market, given he felt there remained multiple areas to deploy and compound returns within the US economy. This thematic already looks to be playing out somewhat, with US small caps (arguably the sector most heavily represented by businesses that are US-domestic focused) beginning to substantially outperform their larger counterparts over the last three months: S&P 500 vs Russell 2000 Small Caps vs USD Index – 3 Month Rolling (%)

2) US Healthcare – A Phoenix Rising? Buffet has not been shy in his criticism of the current US healthcare system, with the sector possibly set to face its largest shake-up in decades. US healthcare spend has grown from ~5% of total US GDP in 1960 to now upwards of ~18% - an incredible thought to think that 18c in the dollar is being diverted toward an industry that, on a whole, continues to provide a fairly sub-standard level of care. Americans, on average, currently spend $714 a year (or 1.6% of their after-tax earnings) on out-of-pocket healthcare expenses, a +13.5% increase since 2013. For the US Government, the burden has increased dramatically – in 1970, federal expenditure on healthcare was approximately $170 per person, today that figure sits north of US$10,000 per person, per year. Berkshire’s announced partnership with Amazon and JP Morgan looks like an early attempt to provide a mechanism to reduce this spend (albeit at their own profit) for, at least in the early stages, the ~1.1m employees currently employed by the three multinationals. While exact details have remained relatively tight lipped to date, the development has certainly already sent shockwaves through the incumbent businesses currently enjoying benefits of the current bloated and archaic system. Following the joint venture announcement in late January of this year, equity market investors immediately removed some ~US$30bn in market capitalisation from the top ten largest listed US health insurance and pharmacy stocks in just the opening two hours of trading. There will be a raft of genuine opportunities to profit from this seismic shift over time and if there was one thematic where we see multiple potential opportunities for emerging businesses to take share rapidly, this would be it. This won’t be an easy path (the partnership, for example, is still yet to appoint a CEO for the new health initiative) and one must remember the US healthcare industry currently shares in US$3.3 trillion in revenues – there will be many that are highly incentivised to maintain the status quo. We were fortunate enough to make a number of contacts in the space on the trip and will continue to watch the space carefully as it unfolds. 3) The Perils of Size Without ever wanting to place a dampener on the achievements of Warren and team, the obvious takeaway from recent performance of the Berkshire portfolio has been the impact of size on overall portfolio returns. While underperformance is inevitable for any investor at a singular point in time, one would expect the enormity of the Berkshire portfolio will have provided some of the headwinds to Berkshire’s +7.7% per annum return over the last ten years (versus the S&P 500 +8.5% per annum over the same period). With a minority stock portfolio currently valued at over $190bn (i.e. outside of their majority holdings in 100+ company-owned businesses including GEICO, BNSF Railway Co, Berkshire Hathaway Reinsurance, See’s Candy etc etc), Berkshire is far from a nimble beast. At the peak of Buffet’s outperformance vs the S&P 500 around 1980, Berkshire’s total market cap was in the vicinity of $420m – a veritable drop in the ocean to the $480 billion market cap it commands today. For some perspective, an investment return that would have doubled the company’s value in 1980 would now add just 8 basis points (0.08%) to the BRK book value today. Fund capacity and the impact of size on portfolio returns is a consideration that we, as investors in a far smaller pool of capital than Buffett, have looked to address early in our own product design for the Ophir Funds (driving the decision to hard close the Opportunities Fund in 2015 to additional capital and soft close the High Conviction Fund in March of this year). One can only imagine the compounded per annum returns that Warren and Charlie may have generated if the fund had maintained a capacity limit of $1bn - the mind boggles.

Favourite Quote of the Event: “If you’re going to live a long time, you have to keep learning. What you formally knew is never enough. If you don’t learn to constantly revise your earlier conclusions and get better ones, well, you’re like a one-legged man in an ass-kicking contest.” Charlie Munger.

As always, thank you for entrusting your capital with us.

Kindest regards,

Andrew Mitchell & Steven Ng Co-Founders & Portfolio Managers Ophir Asset Management

This document is issued by Ophir Asset Management (AFSL 420 082) in relation to the Ophir Opportunities Fund & the Ophir High Conviction Fund (the Funds) and is intended for wholesale investors only. The information provided in this document is general information only and does not constitute investment or other advice. The content of this document does not constitute an offer or solicitation to subscribe for units in the Funds. Ophir Asset Management accepts no liability for any inaccurate, incomplete or omitted information of any kind or any losses caused by using this information. Any investment decision in connection with the Funds should only be made based on the information contained in the Information Memorandum and/or Product Disclosure Statements.