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Dear GreenWood Investor:
“Opportunities multiply as they are seized.” —Sun Tzu
We are pleased to report a year of good progress for our investors, as our collaborative and constructive engagements added considerable value to our performance. Even still, we are not satisfied. We remain hungry and curious. We’re looking for more businesses to bring our active approach to. In terms of 2023 returns, our separate accounts, which remain open to any investor, returned 28.0%. For fund returns, please see our Results page to check on that performance, which was modestly better than this result.
Importantly, this was achieved without any of the exposure to over-valued large technology companies which generated more than half of our equity benchmark’s returns this past year. Furthermore, much of our portfolio is outside of the US, and even in investor-despised Europe, which has just hit an unprecedented valuation discount relative to the US, where investors remain enamored with the most recent fad in Silicon Valley.
Exhibit 1: Valuation Divergence (Relative Forward PE) Between US & EU At Historical Peak
While it was a good year for our returns, in all cases except one, the business fundamentals have outpaced the share price performance. This is the opposite story to broader benchmarks, where valuations have borrowed from the future with valuation expansion.
In contrast, our margin of safety has improved, as FCF growth in the portfolio outstripped our performance. Our ability to sustain this momentum is underpinned by excellent managers guiding under-appreciated companies through transformational moments in their history. These managers behave like owners. They are not managing for the quarter, or even for the year — they are managing for long-term business prosperity. Even still, our top 6 positions, accounting for 74% of our accounts & funds’ net exposure, grew FCF per share by 39.7% in 2023 using consensus estimates.
Exhibit 2: FCF Yields – Top 6 Positions
*Uses annual uranium price & assumes mine at full operational capacity; **Proportional method used on NAV
If we were an alternative asset management firm, given multiples have expanded in each of the industries our top investments are in, we would have reported blistering mark-to-model returns. Despite widespread agreement that private assets remain significantly mis-marked, we find it strange that this mark-to-myth model has not yet lost investors’ confidence. Instead, many continue to underwrite new capital commitments based on the latest fad that Silicon Valley has captured imaginations with, or interest rates that existed over two years ago.
While public equity investors live with the last emotional stock price-tick to measure performance, no matter how much this is divorced from the underlying fundamental momentum, we maintain more benefits than mark-to-myth investors. We take less risk. We don’t have to risk significant portfolio and asset leverage. We have better margins of safety through lower valuations. We have less failure risk, and we have daily liquidity. Beyond these benefits, we also have the responsibility of living up to the high expectations of the market’s “what have you done for me lately” attitude. While it’s grueling, it demands top level performance continuously. We welcome these demands.
The downside of having only a long-term value creation focus is that it often removes the sense of urgency for us to ensure the near-term outlook is as attractive as the long-term view. This is very hard. Simultaneously optimizing for two opposite time horizons requires balancing divergent priorities. Yet it ensures value creation isn’t a long-shot intangible dream in the distant future. When pressed on why he wouldn’t want his luxury group to be privately held, Bernard Arnault pushed back in his 2001 interviews for the book La Passion Créative by highlighting the merits of remaining public.
“What I believe is that being listed brings a lot of positive things to a business for its development. So you have more of responsibility to a market and even vis-a-vis your management. You are constantly obliged to question yourself for satisfaction of the market, and therefore your countless shareholders. You always have to justify your choices, your investments. In a private group, decisions are much less transparent to shareholders, even if they are numerous, and vis-à-vis staff.” -La Passion Créative, Bernard Arnault (translated from French via Google Translate)
A high sense of urgency accompanies most activist efforts. In fact, most of our last letter was dedicated to highlighting the Builders in our portfolio that have a high sense of urgency. However, what’s very different from our style of activism is that we’re not just focused on the short-term. Rather, we are focused on the long-term prosperity of our companies while also ensuring the near-term is as exciting as the long-term. This also differentiated Bernard Arnault, who used private-equity raider tactics to take control his marquee luxury brands. However, after winning control of these assets, rather than dress them up for a quick sale, he positioned them for long-term compounding. He articulated this balance he made between prudence and risk-taking that made his style look more like Silicon Valley founder-led businesses than any French business at the time (2001).
“[Being an owner manager] teaches you to modulate two constraints: risk-taking, of course, but also prudence. …Risk-taking is, for an entrepreneur, like breathing, necessary to life and sometimes to survival. It is, moreover, an opportunity for adventures to be shared in the four corners of the world with teams, who vibrate all the more as the stakes and risks increase. In addition, when you are a manager-owner, you are really associated with all the shareholders who buy your shares on the stock market; your vision is strongly influenced by this association; there are operations, mergers, costly acquisitions, which a pure manager will make, being convinced, of course, that it is in the interest of his company, but which you will consider from another angle as a ‘majority shareholder. Will I make this move the same way a pure manager does when playing with my own money? Probably not always. Basically, I think it must be reassuring for the shareholders of a group like LVMH to have an owner at the helm. Even if we must constantly overcome this opposition between prudence and risk-taking. But it is from the management of this type of contradiction that progress is born.” -La Passion Créative, Bernard Arnault (translated from French via Google Translate)
This duality between prudence and risk-taking mirrors a lot of the other dualities we’ve seen in other major value-creators. Sergio Marchionne balanced short with long-term, finance and engineering, and luxury vs. mass market. David Cote wrote extensively about prioritizing both short and long-term goals in the interview we had with him a few years ago. Sir Martin Sorrell also discussed how he balances capital with culture in our first chat we had with him and our investors. Over the past year, Sir Martin has gone through one his most challenging years in his entire storied career, but we remain committed to his capital and culture effort to re-imagine the ad agency model. While he’s spent the last year on culture, we suspect the emphasis is now shifting to capital, as he has recently started S4 Capital’s first share repurchase program.
Balancing culture and capital, prudence and risk-taking, short and long-term, and innumerable other dualities is what owner-managed businesses do best. Yet investment ideas do not always perfectly align with an owner operator culture. Despite a total investable universe of multiple thousand-companies (with market capitalizations over $1 billion), the owner operator universe is still quite small relative to the investable universe.
For certain special situations outside of the owner operator universe, we believe we can help bring a critical ownership mentality to the daily governance of those companies where only agents are in control. In doing so, we believe we are expanding the investable universe to areas where owners unfortunately no longer manage many businesses.
We are grateful to be playing a role in three of these transformations that are building fundamental momentum, and doing so by balancing these competing dualities. Just as we mentioned we were “tripling down” on our constructive activist efforts in December of 2022, we have been fortunate enough to have placed four directors at Leonardo (LDO IM) and are one of the owners that went on the board at MEI Pharma (MEIP).
Good governance is a daily action for those with skin in the game. Working on behalf of the company’s customers, employees, shareholders and other stakeholders is a team effort and a constant effort. We love being a part of it. It’s reinforced by the small moments that speak volumes about the validity of our approach. I’d like to share a few moments from the past year that particularly stuck out to me, and are very telling. We’ll start with our three largest positions, where we sit on the boards, which also coincidentally drove the lion’s share of our returns for the year, with Leonardo contributing 17.7%, CTT contributing 5.5%, and MEI Pharma contributing 3.8%.
Expanding Ownership Cultures
“Three ingredients make up the essence of the owner’s mindset and establish it as a source of competitive advantage. The first is a strong cost focus—treating both expenses and investments as though they are your own money. The second advantage is what we call a bias to action. Adi Godrej, who runs Godrej Group, a leading Indian consumer-goods company, exhibits this bias in how he runs its operations. “It is our superior speed to make big decisions and take actions on them,” he told us, “that lets us constantly outmaneuver larger global consumer-goods companies that come into our markets.” The third advantage is an aversion to bureaucracy—an aversion, that is, to the layers of organization, headquarters departments, and hordes of corporate staff that can accumulate, capture power, and create complex decision processes that clog the arteries of a business and slow it down.” — The Founder’s Mentality
When I first met the new CEO of Leonardo, Roberto Cingolani, he told me that he would spend the company’s capital like it was his own family’s. Every month that has gone by, the company has faced a substantial number of cost and capital allocation decisions, as the European Aerospace & Defense is having its moment, being very active.
Roberto has needed very little advice in these capital allocation decisions because he’s already thinking like an owner. It’s embedded into his mindset. While he doesn’t have a controlling equity position in the company, he behaves even more rationally than others we’ve seen that do.
He has a bias against cost and bureaucracy, and is transforming Leonardo with a great sense of urgency. This upcoming March, investors will get to see the results of his first nine months on the job. A year ago, the company’s reputation with investors was the worst-rated in the industry, as measured by Brendan Wood International. We believe as more investors learn of the owner mentality and the sense of urgency that Roberto and his team have, that the company has a fighting chance of becoming one of the most respected companies in the industry. Its products and capabilities already have a top notch reputation with customers, and we believe the company’s capital stakeholders will soon feel a great sense of alignment with the ownership mentality that is trickling through the company now.
The opportunity remains substantial. It still has the cheapest valuation of its European peers. In fact, the valuation discount to peers remains wider than pre-Covid levels. Despite the performance achieved thus far, Leonardo’s best days undeniably lie ahead.
We could say the same for CTT, which is entering its 504th year as an organization. Operating profit is set to hit a company record in about a year’s time, given the capital markets day guidance of €100-120 million in EBIT in 2025. Besides this figure being a new company record, what’s more compelling is that the majority of it will be made up by profit drivers that didn’t exist when we entered the board room in 2019.
A highlight of the year for me was in December, when a union called a strike during the busiest moment of the year. Zero employees showed up for the strike, outside of the 6 union leaders that called for it. This strike was called just as a new customer-satisfaction bonus scheme was in the early phases of being trialed. The company has been working on preparing data and processes for years to get to this point. It already has the leading position in on-time delivery in the entire market, but the company is pushing the bar even higher. While most employees feel a sense of ownership over the company and its brand, this incentive scheme will bring that commitment to a new level by continuing to prioritize the customer experience.
This also is starkly contrasted to competitors that are owned by venture, government or short-term oriented investors. A great example of this was in 2021-2022, when VC-funded Paack, government-funded Correos, and Royal Mail-owned GLS were attacking the Iberian market with price points that carried with them deeply negative gross margins. All three were fighting to “dress up” short-term results through unsustainable price points.
As Royal Mail pulled the GLS IPO, Correos posted a negative result for its sole profitable segment of Express & Parcels, and Paack’s venture-funding has evaporated, so has the sustainability of these competitors. As CTT held price, and reinvested in quality of service throughout the heat of the moment, it has re-accelerated its market share conquest on the Iberian peninsula. E-commerce ordering frequency in Iberia is still fractions of where it has hit in other developed markets, meaning the profit drivers from this core division are sustainable and secular in nature.
Thus, the accelerated revenue growth rate demonstrated in recent results has sustainable profit drivers under-pinning it. Furthermore, according to consensus estimates, EBITDA from 2023 will hit a new company record when its reports full year financials. The stock remains 65% below its levels when it last reported a smaller number in 2016. The story is far from being over, and our suspicion is that the new record will not be the peak, as the company’s medium-term guidance promises more by 2025.
The EBIT guidance of €100-120 million would support a market capitalization of €1.0-1.2 billion at peer valuations. These peers are not growing nearly as fast as CTT, so this is even conservative. The only question remains is how many shares the company can retire between now and then, from the current 138.9 million left outstanding. Every day that goes by with it trading for less than half of fair value means the share count will likely be considerably less.
Hitting Their Stride
Rounding out the top five positions in the portfolio, which account for 69% of our net exposure, we are excited that Bolloré (BOL FP, exposure largely through Compagnie de l’Odet) and NexGen Energy (NXE) are finally hitting their stride after a multi-year period leading up to a pivotal 2024. While these are not new positions for us, and perhaps at times we may have sounded like a broken record discussing these investments while the stocks remained flat-lined, 2024 will be a transformational year for both companies.
In our view, the company’s leading Arrow deposit has the potential to be for uranium mining what Saudi Arabia is for oil considering its economics. As Uranium prices have now surpassed $100 per pound, using today’s spot rate would mean that once Arrow is fully operational, the free-cash-flow of the company will be north of $1.6 billion. With the fully diluted market cap today at a mere $4.6 billion, we would prefer to remain invested as co-founder and CEO Leigh Curyer builds his mine. Just as he discussed with us in his first zoom with our investors a couple years ago, his priority had been first and foremost, the company’s people. Only after, was it process-oriented, and then again, only after he got these two right, did he focus on the project — or the outcome.
While we believe NexGen Energy will likely receive a takeover offer once the government of Canada fully approves its world-class uranium mine, we would prefer to not benefit from a quick take-out.
Exhibit 3: Uranium Price & Industry Mining Cost Curve
Leigh’s style is exactly the mindset other founder-managed companies have taken that have allowed them to outperform the market so materially. During the back half of the year, I discovered a relatively unknown book during a zoom I had with Daniel Ek and the defense firm he founded, Helsing. Sitting prominently on the desk behind him was The Founder’s Mentality.
Mirroring a lot of the same themes that we have included in our white paper on Owner Operators, I immediately devoured the work. The styles between founder and owner-managed businesses are nearly identical, yet for public markets, owner-managed businesses actually outperform founder-led businesses. Considerably.
Exhibit 4: Founder-Led Company Performance- Indexed Total Shareholder Return
Source: The Founder’s Mentality
While we view Spotify to be a very high quality founder-led company with terrific growth prospects, its own valuation can’t compete with Universal Music Group (UMG), which maintains more of a competitive advantage than any other player in the music industry.
Bolloré & UMG
As we recently wrote in our latest research note to investors, we believe the market is materially under-estimating the growth trajectory of UMG as streaming companies implement a more “artist-centric” economic model. Given UMG dominates 70-80% of the top 10 charts, and well over half the top 50 streams — which generate half the music label’s revenue — we believe UMG and its world-class talent will have the most to gain as this new economic model takes hold.
With UMG already set to beat the consensus estimates over this year and the coming years, we believe more streaming services adopting the “artist-centric” model will bring UMG’s revenue growth rate back to north of 20% over the coming years. That would allow operating income to more than double over the coming years — making it a high-quality, high-growth and high-margin investment that has zero exposure to the economic cycle.
Of course, a better way to own UMG is through Bolloré, whose stock price is backed 118% by the fair market value of its UMG ownership. Each 10% move in UMG implies a 12% impact to the fair value of Bolloré’s stock price. Given that all of the cyclical businesses have been sold over the past two years, the company has a war-chest of cash, or €5.67 per net share, with 92% of the company’s equity backed by a net cash position. With Bolloré trading at a 63% discount to its net asset value (NAV), comprised largely of publicly-listed securities and cash, the biggest risk in Bolloré is that the family decides to take the company private at a healthy premium to today’s stock price.
We’d prefer to remain invested alongside Vincent Bolloré, who continues to buyback stock at less than half of NAV on a daily basis. Anchored by a highly attractive investment in UMG, we believe Bolloré is set to outperform the company with the strongest forward-looking growth profile in the entire music industry.
Of course, for years, Bolloré and NexGen failed to keep up with market indices — which are increasingly being driven by a handful of highly valued technology giants. Owning them has required patience, but given both are managed by founders, we know that sooner or later, the founder will strike back and take advantage of this relative under-performance.
Marked to Emotion
“Most managers have very little incentive to make the intelligent-but-with-some-chance-of-looking-like-an-idiot decision. Their personal gain/loss ratio is all too obvious: if an unconventional decision works out well, they get a pat on the back and, if it works out poorly, they get a pink slip. (Failing conventionally is the route to go; as a group, lemmings may have a rotten image, but no individual lemming has ever received bad press.)” Warren Buffett’s 1984 BRK Shareholder Letter
Ironically for a market that’s dominated by machines, we see most assets being marked to emotion on a daily basis. The few humans that are left participating in daily trading appear to us to be more volatile than in past decades. Furthermore, knee jerk reactions are being magnified by the machines that are doing most of the trading today.
This has created even lumpier performance for most active managers than in the past. Higher volatility is, in turn, driving more investors to alternative asset classes that don’t experience reported volatility like public market investors. Private equity investors, like Brookfield, have created major fortunes by taking advantage of the unwillingness of most investors to grin and bear volatile reactions.
This herd-like mentality opened up two extremely high-quality investment opportunities for us in the back half of 2023. Using insights gleaned from our close proximity to e-commerce at CTT, we undertook a multi-month effort to underwrite PDD Holdings. This US-listed Irish holding company owns China’s leading disruptive marketplace called PinDuoDuo. During the summer, as it became unbearable for most investors to remain publicly invested in Chinese equities, we took a position in PDD.
During our diligence phase, a local Hong Kong investor that was invested in the company noted that Western investors should just stay away as they won’t appreciate PDD’s operating culture. He highlighted how the company gives no guidance, talks to no investors, and does not optimize its business for the short term. This means that quarterly earnings often have very large deviations from consensus, driving >20%+ moves in the stock. Paired with an extremely bearish market sentiment on Chinese equities, this combination became “uninvestable for those in western markets.”
Adding to the narrative during the summer for PDD was that its international business, Temu, was burning cash and carried with it a negative valuation consolidated into PDD’s holding company structure. Yet, as we were able to validate the major competitive advantage its direct-selling model has, from Chinese factory direct to the global consumer, we understood the losses to be highly temporary as the company leaned into digital marketing — becoming by far the largest digital advertiser on all leading platforms.
Temu has moved extremely rapidly to over-take Shein in global consumer wallet share, surpassing this highly-valued, yet private, startup in shipment volumes in many markets we track. While investors that own Shein continue to mark their investment to a mythical level, Temu is rapidly curtailing the market opportunity that Shein had in front of it. Yet, because of quarterly earnings volatility, we were able to take a position in this promising startup at a negative valuation.
A dramatic 30% share price fall in reaction to a profit warning at Rentokil triggered Chris’s efforts to underwrite the pest control opportunity. In the merger integration with Terminix, one of the leading brands in the US pest control market, Rentokil had a marketing hiccup as teams transitioned. This caused the company to report lower US organic growth than its highly-valued “compounder” peer Rollins (which owns the Orkin brand).
Terminix has suffered from 5 CEOs in the last decade, as its private-equity dominated board constantly changed strategies to chase short-term profit bumps. This meant underinvesting in employee training in order to eek out higher near-term profit margins. Unfortunately, under this private-equity leadership, this led to the company’s net promoter score and employee morale hitting embarrassingly low levels — with the NPS registering as low as -65.
This is all music to the ears of Rentokil’s owner-oriented CEO, Andy Ransom, who has publicly stated that “The single thing that keeps me awake at night is colleague retention.” Ransom joined Rentokil in 2008, later taking the reigns in 2013, and immediately set about implementing his “RIGHT WAY” culture initiative. This strategy directly targets to improve employee and customer retention by investing behind employee training (the average first year pest control technician receives 260 hours of training) and fostering a positive people-first culture.
At its core, Rentokil’s “RIGHT WAY” is actually about creating a culture that enables employees to take ownership and accountability all while placing the customer first, which is crucial in a service business. This has led to Rentokil earning numerous “Best Workplace” awards in the UK along with an industry leading NPS of +48.
Ransom admits he had been stalking Terminix as an acquisition target for nearly a decade, but not until Terminix’s most recent CEO, Brett Ponton, implemented an employee-focused strategy termed “The Terminix Way” (which we understand was largely based on Rentokil’s “The Right Way”), was Ransom ready to act. While the integration of the two organizations is still in the early innings, Terminix employee retention is up over 500 basis points since the closing of the merger.
We believe Rentokil’s culture will help to bring additional progress towards further improving Terminix’s culture and operational processes. By continuously improving Terminix’s culture, it should increase employee retention, which in turn will improve customer retention, and thus significantly improve organic revenue and profitability. And this is all in addition to the “at least” $200 million of net cost synergies benefit outlined from the merger.
Due to the quarterly profit volatility making the company “uninvestable” for the compounder crowd, the business trades for 18x 2023 earnings, and that is before significant synergies ripple through the income statement— which should push group margins to best-in-class levels globally. That compares to Rollins’ 49x earnings multiple, where the compounder crowd continues to herd.
In short, we are pleased with the fundamental momentum our portfolio generated in 2023. While our returns outperformed our benchmark, they lag the near 40% growth in free-cash-flow per share. Accordingly, our margin of safety has improved. The average FCF yield for our top five positions, representing nearly 70% of our net exposure, is a highly attractive 17.1%.
While our portfolio’s mark-to-emotion returns have outpaced broader indexes, we have not borrowed from the future like the indices have. We believe this bodes well for our forward-looking performance. Just like an owner manager managing for both short and long-term, we believe both outlooks are compelling. Furthermore, we have spent considerable time in the board rooms ensuring the outlook keeps improving.
As consensus expects CTT to hit a record level of EBITDA in 2023, given the early innings we see in Iberian e-commerce and the company owning the fastest growing bank in the country mean that the growth drivers behind this expected 50% improvement in 2023 FCF per share are secular and sustainable.
Europe’s defense industry will likely experience a decade of tailwinds as the continent responds to its 9/11 moment that occurred in 2022. Leonardo is only just starting to hit its stride, and the improvement that can come as the company rebuilds trust with capital markets is still substantial.
MEI Pharma is developing two compelling assets that could help large bio-pharma companies to refill their clinical pipelines. After years of under-investing in these pipelines, large pharmaceutical and biotech companies are getting very assertive in their M&A activity. The fact that shares trade for half of the cash on the balance sheet, gives us even more capital allocation opportunities than those companies with richer valuations. It also focuses the company’s capital spending to only the most value-added efforts. The bar is very high for any capital commitments when our stock is so attractively-priced.
I’d like to take this opportunity to publicly welcome Josh Pesses to the GreenWood team. We are so honored that Josh will contribute his over 20 years of investing and capital markets experience to both our firm and to our efforts to constructively engage with a second busted healthcare target. Josh is fastidiously finishing his diligence and working on our approach, and we are excited that his decades of healthcare experience will make its way into our portfolio in the near future. Welcome Josh, it’s an honor to have you with us.
So ignore your mark to myth portfolio. It doesn’t reflect today’s environment. A market clearing portfolio is available today. And it has never been so attractive in the ponds where we fish.
We could hardly be more excited for the year ahead. We look forward to growing your capital along side ours.
Committed to deliver,
This article has been distributed for informational purposes only. Neither the information nor any opinions expressed constitute a recommendation to buy or sell the securities or assets mentioned, or to invest in any investment product or strategy related to such securities or assets. It is not intended to provide personal investment advice, and it does not take into account the specific investment objectives, financial situation or particular needs of any person or entity that may receive this article. Persons reading this article should seek professional financial advice regarding the appropriateness of investing in any securities or assets discussed in this article. The author’s opinions are subject to change without notice. Forecasts, estimates, and certain information contained herein are based upon proprietary research, and the information used in such process was obtained from publicly available sources. Information contained herein has been obtained from sources believed to be reliable, but such reliability is not guaranteed. Investment accounts managed by GreenWood Investors LLC and its affiliates may have a position in the securities or assets discussed in this article. GreenWood Investors LLC may re-evaluate its holdings in such positions and sell or cover certain positions without notice. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of GreenWood Investors LLC.
Past performance is no guarantee of future results.