STOCK | 9/28/20 FRESH LOOK

TENCENT HOLDINGS LTD (Ticker: TCEHY) LBIR RecommRecommendationendation

Stock Price: $65.31 (9/28/20) Company Size: 604.3B Author: Janice Quek

Industry: Internet Company Rank: 199 Sector: Technology Software/Services

Tencent Holdings is one of the largest Chinese internet technology and investment holding companies in the country.

IN THIS FRESH LOOK WE’LL COVER: u Summary of the Business Tencent is a top Chinese internet technology company that provides platforms for Grab-and-Goä messenging, digital payments, media, games THESIS and e-commerce. It also offers cloud and advertising services to businesses. An investment in TCEHY is a play u Recent Developments on Chinese consumption of internet- Tencent’s business benefitted from the based services. Tencent is a pandemic as users spent more time using its diversified internet services company platforms and services. We see lasting shifts in that provides platforms for internet use that would drive growth ahead. messenging, digital payments, media, games and e-commerce. To maintain u Competitive Environment strong growth and its leadership, it Tencent has market leadership in many of its will need to keep a high pace of business segments. We think the market innovation to strengthen user environment is favorable to its growth. engagement and platform u Conclusions/Recommendations monetization. We believe the company will continue to maintain its strong competitive position, and sustain robust topline growth through its

investments. We rate TCEHY a Green Light.

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Data as of 9/28/20 unless specified

Revenue Fwd $69.3B Enterprise Value: 604.3B Market Cap: 625.6B (TTM): ($60.4B)

YTD Return: 35.1% Fwd (TTM) 9.01x RSI: 46.9 Price/Sales: (10.42x ) Gross Margin 45.6% Revenue Growth 30.2% ROIC (TTM): 15.5% (TTM): (Fwd, YoY): 52-Week High: 72.77 52-Week Low 40.33 200-day Moving 56.7 Avg. EBITDA 18.31B CFO 27.43B FCF 27,43B

Insider Transactions (2020): NA

technology companies are generating significant SUMMARY OF BUSINESS û revenue streams engaging and encouraging their Tencent Holdings is a Chinese internet users to spend more time and money on their technology and investment holding company platforms. that offers multiple services, such as social media platforms, online and mobile video games, financial technology and payments, cloud, online Broad portfolio of services for consumers and advertising and media and entertainment, among businesses others. It generates revenues from service fees, Tencent Holdings is a key beneficiary of this transactions or through subscriptions. Tencent internet technology boom. The company has also invests in a large portfolio of almost 700 businesses in almost every major segment of the companies that it believes are in high return, high internet. Starting with its social communication growth areas, or likely to have strategic value platforms, Weixin, WeChat (for overseas users) with its existing businesses. and QQ, which has more than 1.2 billion monthly active users, the company has expanded into a broad range of other online services, leveraging Large consumer market, plenty of monetization its wide user base from its communication opportunities platforms. It now offers mobile payment services, has more than 900 million internet users wealth management products, news, social today. Its mobile internet penetration rate is media, music, and literature platforms, and a almost 100%, and the penetration rate of online large app store for various consumer services. payments reached 85% as of March 2020. As of Tencent is also the top PC and mobile games the third quarter of 2019, the average number of platform in China by number of users, owing to hours a Chinese spends online was about 5 hours its acquisitions and large investments in top game and 50 minutes, browing internet websites, using publishers like (League of Legends), social media, playing online games or listening to (Fortnite), Bluehole (PUBB), Ubisoft, music streaming services. The internet has (). It also become a key part of a Chinese’s life, and creates its own games e.g. Peacekeeper Elite,

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Honour of Kings, which have performed very Stores (facilitate businesses building a digital well. Not only do these consumer-facing presence, and selling consumer goods on the platforms and services generate solid revenue Weixin ecosystem), financial products, and streams through service subscriptions, sale of enterprise software (WeChat Work – virtual items in games and social media, and collaboration and communication software). commission-based transactions from consumers, Tencent also owns Tencent Cloud, a public cloud they provide a large captive audience for the service that offers computing, storage, database company to sell its enterprise-level services to and security software for businesses operating in businesses. Some of these services comprise the cloud. platform advertising, Mini Programs and Mini

Tencent’s various business segments (Source: Investor Presentation)

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Financial and Operational metrics Tencent has expanded rapidly in the last four LB•LOGIC Tencent’s businesses years, driven by its growing portfolio of are primarily in internet media and entertainment, and is at risk technology companies, addition of innovative of increasing censorship platforms and services, and increasing options to measures imposed by the Chinese monetize its services. Between FY2015 and government. The company’s revenue growth suffered in 2018 FY2019, revenue grew at a 4-yr CAGR of 38.3%. and 2019 when the government Its services have gained strong traction, and the delayed new video game number of users continue to grow. launches, and popular TV shows Weixin/WeChat has more than 1.2 billion experienced delays in their release, slowing advertising monthly active users, has 106 momentum. Fortunately, its million subscribers, its payments platform has enterprise cloud and e-commerce about 50 million monthly active merchants, and it operations mitigate some of this risk. has more than 1 million paying customers using its cloud services. While some areas of its businesses are starting to slow its pace of growth as they mature e.g. subscriber growth on Weixin, û RECENT DEVELOPMENTS the company still has many emerging growth opportunities, such as in live video streaming where it gained control of top video streaming Tencent generally benefitted from quarantine platform, Huya earlier in 2020, with Weishi, its measures imposed from the pandemic as more short video app, and with Mini Programs and people stayed home and spent more time online, Mini Stores where merchants can market and sell particularly in Q1. The number of active users their products. In terms of online advertising, the across its platforms rose, and users spent more industry is only at a penetration rate of 14%, and time playing games, consuming media, and most ads are offline. Mobile payments services, preferred to purchase their essentials over the although widely used among consumers, is still internet. This increased monetization not readily offered by many offline merchants, opportunities for the company. Tencent particularly those in the lower-tier cities of China. outperformed in social advertising, reporting Similarly, many companies in China are still at rapid ad impressions growth, and video ad the early stages of their enterprise cloud revenue contributions increasing from a single- migration, and will likely increase consumption digit percentage last year to over 40% in Q2. of the cloud in the years ahead. However, media advertising demand declined year-on-year due to delayed releases of some shows, which resulted in a drop in traffic. Its Tencent’s rapid revenue growth and high margin Fintech and Business services segment improved business segments have enabled it to achieve in Q2 when more people returned to work, and profitability quickly. The company is net income resumed their pace of consumption. Merchant positive, and delivers a 5-yr average operating demand for Tencent’s payment solutions ramped margin of 29%. It is also free flow positive since the start of the pandemic, especially in the and has a 5-yr margin of 37.2%. retail and restaurant categories.

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In another ongoing development with Tencent, Financial and Operating Results the company’s WeChat app has been caught in the fray of increasing U.S.-China tensions. President Trump has sought to ban the app in Tencent announced good results in Q2 as its saw U.S. app stores, citing it as a threat to national demand for its services from the pandemic. The security as the personal data of Americans are company reported total revenue of RMB 114,883 stored on Chinese servers. While Tencent has million (USD 16,228 million), a growth of 29% tried to propose a workaround by creating a U.S. YoY from Q2 of FY19. Revenue performance was version of the app, deploy certain security strongly driven by its Value-Added Services measures, and use a U.S. based entity for storage (VAS) segment, representing 57% of its total and data management, it appears these proposals revenue, which grew 35% YoY due to greater have not satisfactorily address concerns. Tencent demand for video and music subscriptions stands to lose 19 million of its current users in the during the quarter. Online games revenue, also United States with this ban. Management had part of its VAS segment, grew 40% YoY, driven mentioned in the last earnings call that only about by its smartphone games, which saw revenue 2% of its total revenues come from the U.S., of increased 60% YoY during the quarter, offset by a which less than 1% is advertising. In this regard, 7% decline in PC games. Online advertising grew impact to Tencent’s performance if the ban goes modestly at 13% YoY due to weakness in media through will be minimal. advertising mentioned earlier. Its Fintech and business segment, representing 26% of its total revenue, however reported robust growth, up LB•LOGIC The pandemic 30% YoY. During the pandemic, Tencent made accelerated interest in digitization use of the opportunity to promote its business and internet services consumption. We believe some of services, particular in cloud and healthcare. It saw this interest has led to more huge success with its Tencent Meeting software, enduring changes in a work communication and collaboration tool. consumption, use of remote working technologies, and Tencent Meeting had more than 10 million daily purchasing behavior, which will active users, and the company deepened drive strong demand for integration between Weixin and Wechat Work to Tencent’s services ahead. improve customer management and sales conversion for its retailers. Tencent Health was also used widely (>300 million users) to access

important real-time pandemic data, and to seek medical advice online. Tencent Health Code was developed, and became the most used ePass to verifying health and travel history during the

outbreak.

Tencent also reported a strong set of profitability metrics in Q2. Across most of its segments, the company saw percentage points improvements in gross margins. Overall non-IFRS operating

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profit was RMB 38 billion (USD 5.3 billion) an game content and added higher quality increase of 38% YoY, and translating to a margin interactive elements. It also released a new game of 33%, up from 31% in the same quarter last year. – Supercell’s Brawl Stars which was very well Non-IFRS net profit was RMB 30.2 billion, up 28% received. Finally, in its advertising segment, the YoY. Tencent announced free cash flow of company launched a new integrated ad platform RMB28.5 billion in Q2, up 127% YoY, reflecting so advertisers can more efficiently access solid cash flow generation from its operations. inventories across all its channels and bid for them.

LB•LOGIC Tencent’s majority ownership of live streaming Outlook and Estimates platform Huya has reduced overall gross margin of the company. The live-streaming business has high cost of revenues Management did not provide specific guidance due to talent acquisition and other for the rest of year, but suggested that the revenue sharing fees. However, it is a hypergrowth industry, business environment is likely to improve, albeit expected to drive large at an uneven pace for different sectors. We monetization opportunities and believe that the internet technology sector is less consequently new revenue streams for Tencent. affected by Covid-19 and Tencent’s business is actually benefitting from lasting shifts in internet use. We are optimistic that Tencent can continue to achieve growth either through its current operations, or through its portfolio of acquired Product Innovation and Company Expansion high-growth companies.

Tencent launched a number of innovations to help users cope with the pandemic. For example, to alleviate the impact of the pandemic on their businesses, the company released a free and user friendly toolkit for these merchants to quickly shift their businesses online and build and operate Mini Stores, a program on Weixin for retailers to sell their products online. This toolkit include functionalities such as order management tools, after-sales service capabilities and live broadcast. To foster social connections,

Tencent enhanced features on its communication platform QQ, which included being able to organize online parties, play social games in video chat mode etc. In online games, it upgraded

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launched WeBank, China’s first online-only COMPANY MANAGEMENT û bank. It gained partnerships with NBA to stream Pony Huateng is the co-founder and current basketball games in China, and invested in a CEO of Tencent Holdings. He has been involved wide variety of companies ranging from games in the strategic development and management of to cars. Tencent continues to invest in emerging Tencent since its founding. Prior to Tencent, Pony industries and companies. The company has was head of research and development for the more than 71,000 employees today and is internet paging system at China Motion Telecom headquartered in , China. Development Ltd. Pony has a B.S. specializing in Computer and Applied Engineering from û COMPETITIVE ENVIRONMENT . He is currently China’s Tencent competes with a large number of wealthiest person, surpassing Alibaba’s companies due to its diversified portfolio of in 2020. Pony Ma discusses key principles by businesses, ranging from enterprise software and which he leads Tencent in an article here. cloud services to social media and consumer service platforms. It has key operating segments Tencent was founded by Pony Ma, Yi Dan Chen, in social communication platforms – Weixin, Chen Ye Xu, Li Qing Zeng and Zhi Dong Zhang WeChat and QQ, digital payments, cloud in November 1998. It released its first messenger services, online games and video and music product OICQ in February 1999, which was subscriptions. rebranded to become QQ. The company remained unprofitable for the first three years. By 2004, it was ready to become public, and Tencent has achieved market leadership in many listed on the Stock Exchange on 16 of these segments. Its Weixin/WeChat app is the June 2004. The company originally derived most popular messenging app in China, income solely from advertising and premium particularly since alternatives like Facebook are users of QQ, who paid monthly fees to receive banned in the country. The app has expanded extra services. Gradually, it moved into new over time in the number of features offered to ventures, and started to license games in 2007. become a “super-app”, and Weixin has become Between 2011-2014, Tencent stepped up its an indispensable tool in the daily lives of almost investments in the gaming business, acquiring 1.2 billion Chinese citizens. With the app, users Riot Games, developer of League of Legends, can do almost everything from communicating and a minority stake in Epic Games (developer with people, to paying for things e.g. street of games like Gears of War, Infinity Blade). The vendors, taxis, transfer money, play games, company also invested in other areas such as hailing a ride, and booking flights. While other Chinese search engine .com, in a logistics apps also offer multiple services, Weixin is used and warehouse firm, e-commerce website the most because of its messaging feature, and JD.com (where they handed over their e- being able to access other services without commerce businesses Paipai, QQ Wanggou and leaving the app makes it convenient and a stake in Yixun to JD.com to build a stronger desirable. Tencent competes with other digital competitor to ), a lottery payments services, and is one of the leading apps technology firm and a restaurant ratings used in China, competing with Alibaba’s Alipay website. Between 2015 and 2017, Tencent for market share.

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LB•LOGIC Unlike in most developed economies where In the video games segment, Tencent is the top games there are more alternative forms company by revenue globally, supported by its of payments, China still has many massive gamer base, and its large portfolio of popular adults that do not own bank accounts (~224million in 2017), game titles. Although the company has produced a which limits their access to few popular games of its own, much of its success is credit/debit cards, bank transfers, due to its investments and acquistions of top video checks etc. As such, many game publishers worldwide e.g. Riot Games with Chinese started using digital payments with apps, and we do League of Legends. It competes with other game not see this behavior changing in companies such as Sony, , Nintendo and the future, even when more Apple for gamers. qualify to own bank accounts.

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Source: Canalys In the public cloud segment, Alibaba and Tencent market share of 8.8% in third place. Globally, Cloud are the leading public cloud providers in Amazon’s AWS remains the public cloud leader, China. According to data from market research well ahead of Microsoft’s Azure. Alibaba, while firm Canalys, the top three cloud providers the largest in China, only has a 9.1% global accounted for 73% of cloud infrastructure market share, while Tencent has a 2.8% market services spend in the last quarter of 2017. Alibaba share. had a 46.4% market share, while Tencent Cloud came in second at 18%. AI Cloud had a LB•LOGIC Tencent also has a history of investing in many high LB•LOGIC Despite Alibaba and growth companies and emerging Tencent’s leadership in China, opportunities, some of which their single-digit global market have blossomed to become strong share do suggests that cloud revenue generators and market infrastructure spending in the share leaders in their field. These world’s second largest economy include top video streaming is still in its early stages. We can platforms Huya and Douyu, and expect that as cloud adoption food delivery app Meituan becomes more saturated in the Dianping. Huya has since been U.S. and Europe that Alibaba and consolidated in Tencent’s Tencent’s market share would financials and there is discussion grow as the Chinese economy of merging Huya and Douyu. continues to mature.

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Source: Statista

û TREND ANALYSIS: VALUATION The valuation of many Chinese public companies has fallen in the last few years as frosty U.S.- China relations and President Trump’s aggressive protectionist stance have worried investors. His latest proposal to ban WeChat in LB•LOGIC President Trump’s relection the U.S. and push for a law to delist Chinese would likely continue to put price risk on the stock given his anti-China position, companies on American exchanges have and especially if the Senate bill to delist impacted the stock negatively. At a forward P/S Chinese companies becomes law. We do ratio of 9x, we think that Tencent’s multiple is not see the market adjusting valuation to a fairer value until this is no longer a risk undervalued considering its growth forecast, its factor. diversified revenue streams in many high- growth positions and its strong competitive position.

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Fwd. Revenue Revenue Forecast Gross Margin Forward P/E Forward P/S Growth (%) (Millions USD) (%)

Tencent Holdings (TCEHY) 30.20% 69,278 46.2 36.08 9.01

Baidu Inc (BIDU) 1.20% 15,554 45.3 19.49 2.74

Sina Corp (SINA) -3.67% 2,074 - 18.52 1.15

Alibaba Corp (BABA) 38.20% 98,685 45.0 28.63 7.43

JD.com (JD) 29.02% 106,978 15.1 46.96 1.01

services and digital payments in the country - CONCLUSION / û industries that are highly lucrative and growing RECOMMENDATION rapidly. Tencent also maintains a strong cadence of innovation, often releasing new Tencent is a global juggernaut in internet functionalities to sustain user engagement and technology and services. Its messenging app finding new monetization opportunities. It is Weixin/WeChat has clear dominance in China, also an avid investor, raising many emerging, and it is a market leader in online games, cloud

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hypergrowth companies along the way that particularly if Trump is not reelected. We rate eventually becomes integrated with its core Tencent a “GREEN LIGHT”. businesses. Using this strategy, it has built a diversified portfolio of robust revenue streams, and we believe that this will continue to drive strong topline growth in the future. Tencent’s valuation is also undervalued, and we think that there is room for multiple expansion, n Stock Chart for Tencent Holdings (TCEHY)

n Performance Data 2014 2015 2016 2017 2018 2019 RETURN ON INVESTED CAPITAL (%) 26.1% 20.8% 19.1% 22.3% 19.2% 17.1% GROSS MARGIN (%) 59.5% 57.9% 54.5% 49.2% 44.7% 43.9% EARNINGS (MILLIONS USD) 3,859 4,583 6,186 10,581 11,896 13,504 YoY Earnings Growth (%) 53.0% 18.8% 35.0% 71.1% 12.4% 13.5% REVENUE (MILLIONS USD) 12,792 16,366 22,870 35,181 47,256 54,602 YoY Revenue Growth (%) 30.1 27.9% 39.7% 53.8% 34.3% 15.5%

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EQUITY 0.94 STOCK: TCEHY | 9/28/20 FRESH LOOK n Valuation Data 2014 2015 2016 2017 2018 2019 SHARE PRICE (USD) 14.41 19.13 24.35 53.77 38.87 49.20 SHARES OUTSTANDING (MILLIONS) 9,370.7 9,345.5 9,395.0 9,428.4 9,457.0 9,552.6 MARKET CAP (MILLIONS USD) 135,940 183,892 229,877 489,672 379,284 460,484 PRICE/SALES RATIO 10.6 11.3 10.2 14.1 8.1 8.5

A word about our Fresh Looks: These reports are meant to be produced quickly, giving our Portfolio Manager the information he needs to make an investment decision in a short timeframe, as markets often move quickly after earnings announcements. You will notice the “Traffic Light” at the top. This is a scale indicating the likelihood that we follow a name in future quarters, with the intention of producing a rating of Buy/Hold/Sell after we study the company further. “Green Light” is roughly equivalent to “Buy” after we study a company more than once. “Yellow Light” approximately means “Hold” and “Red Light” would indicate a sell and an end to our continuing coverage of a company. By making these reports public, we intend to give the broader investing community a window into the Left Brain investment process. Since many of the names we cover lack Wall Street research, sometimes these Quick Looks will be some of the only publicly available analysis on a particular stock/bond. We believe that even our rapid-fire reports on certain names will provide great value for the reader. Given the time-sensitive nature of Fresh Looks, they are raw, unfiltered documents. You may see a typo here or there, or perhaps a note from an analyst written directly to our PM, Noland Langford. That is just part of the process. The methodology here is the analyst reads the most recent earnings call, along with the Management Discussion & Analysis section of the most recent Quarterly Report, along with compiling the key quantitative metrics that we value most at Left Brain. The result is a short report that gives us just enough information to take a position in securities where time is of the essence: sometimes the market doesn’t give us enough time to consider every angle before we take action. We hope you find these previously “internal use only” documents useful in your understanding of the investment markets.

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DISCLAIMER: This Report is provided for informational purposes only and is prepared without regard to the investment objectives, financial situation, or needs of any investor. The Report is not intended, and should not be relied upon, as a source of any investment recommendation, makes no implied or express recommendation to hold, sell, purchase or take any other action with regard to a security, and is not an offer or solicitation for the purchase or sale of the security that is the subject of the Report. Investors must exercise their own independent judgment as to the suitability of a security. Past performance is not indicative of future performance. The price of securities can and will fluctuate, and any individual security may become worthless. A high or favorable rating, rating outlook, gauge, or similar opinion is not indicative of future performance, and no user should rely on any such rating, rating outlook, gauge, or similar opinion to predict performance or potential for return. Future performance may not equal projected or forecasted performance or potential for return. All ratings and related analysis, as well as data, statistics, analysis and opinions contained herein are solely statements of opinion and are not statements of fact or recommendations to purchase, hold, or sell any security or make any other investment decisions. This report may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will materialize. Reliance upon information herein is at the sole discretion of the reader. THE REPORT IS PROVIDED ON AN "AS IS" AND "AS AVAILABLE" BASIS WITHOUT REPRESENTATION OR WARRANTY OF ANY KIND. Left Brain Investment Research LLC DISCLAIMS ALL EXPRESS AND IMPLIED WARRANTIES WITH RESPECT TO THE REPORT, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE. The Report is current only as of the date set forth herein. Left Brain Investment Research LLC (LBIR) has no obligation to update the Report or any material or content set forth herein. For LBWM readers of this report: Please consult with your LBWM financial advisor to ensure that any contemplated transaction in any securities mentioned in this letter align with your overall investment goals, objectives and tolerance for risk. In addition, please note that Left Brain Investment Research LLC, through its wealth management affiliate, Left Brain Wealth Management, including its principals, employees, agents, affiliates and advisory clients, may have positions in one or more of the securities discussed in this communication. Please note that LBIR, LBWM, including its principals, employees, agents, affiliates and advisory clients may take positions or effect transactions contrary to the views expressed in this communication based upon individual or firm circumstances. Any decision to effect transactions in the securities discussed within this communication should be balanced against the potential conflict of interest that LBIR, LBWM, its principals, employees, agents, affiliates and advisory clients has by virtue of its investment in one or more of these securities. LBIR is an affiliate of Left Brain Wealth Management LLC, an investment advisor registered with the Securities and Exchange Commission. LBIR is an affiliate of Left Brain Capital Appreciation Fund, L.P., Left Brain Capital Appreciation Offshore Ltd, and Left Brain Capital Appreciation Master Fund, Ltd., all of which are hedge funds managed by Left Brain Capital Management, LLC. The general partner of these hedge funds, Left Brain Capital Management, LLC, is an affiliate of LBIR. © 2020, Left Brain Investment Research LLC. All rights reserved. Reproduction in any form is prohibit

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