Reading Time: 21 Minutes. Click here to read this letter as a PDF. The Use…
Estimated Reading Time: 10 minutes. Click here to read this article as a PDF.
“Bad companies are destroyed by crisis, good companies survive them, great companies are improved by them.” -Andy Grove
This letter will be briefer than usual, as we have been focused on executing our collaborative co-investment playbook as well as researching new companies that best complement the portfolio to withstand this turbulent market environment. We shared many of our views on the portfolio this past week when GreenWood Investors and friends met in Portugal for ours and CTT’s Investor Days. We have posted the recordings from the various sessions on an investor-only section on our website.
Our first quarter performance was in-line with global market indices. The Global Micro Fund returned -5.3% and the euro-denominated Luxembourg Global Fund -5.7%. These returns compare to the MSCI ACWI benchmark returns of -5.5% in the quarter. The co-investment I fund, was -3.8% in the quarter net of all fees and expenses. The co-investment II fund performance was positive during the quarter, but it will remain confidential until we publicly unveil the fund’s target.
As it relates to first quarter performance, co-investment II was the largest positive contributor adding 7.8% followed by NexGen Energy with 1.3%. Both of these companies were perceived beneficiaries of the very unfortunate war in Ukraine. The fund’s losses during the quarter had three primary drivers- Vertiv (-1.5%), S4 Capital (-3.5%), and MEI Pharma (-4.8%). I’d like to review these three detractors below as we’ve taken different actions in each case.
Vertiv (“VRT”) cost the fund 1.5% during the first quarter due to a material earnings downgrade that was reported with its full year results. Vertiv is a teaching moment for me, as I believed the company had all the hallmark features of being a safe “compounder.” We had an experienced owner-operator at the helm, a secular tailwind at our backs, and many years of improving margins and deployment of excess Free Cash Flow ahead.
Unfortunately, the company far underestimated inflationary headwinds to certain critical components, specifically fans, which remain in short supply. Due to its ongoing ERP implementation in its North America region, the company did not identify there was an ongoing mismatch of contract pricing and inflationary cost pressures until it was far too late. Following the earnings miss, we concluded that even with already announced price hikes leading to future margin benefits, the execution risk remained very high. Without an improving supply chain, which is out of Vertiv’s control, there was further risk to the outlook. We thus made the decision to move to the sidelines. While Vertiv could be considered an “OK” investment as our entry point was below our final sale, and we sold the majority of our position in 2021 in the high-$20s, this was certainly not the outcome we anticipated.
S4 Capital (“SFOR LN”) detracted 3.5% from the fund during the quarter, and its drawdown might be considered an “own goal” as the company twice delayed its annual results. The second time was on March 30th, which drove the stock down -40% as the company didn’t provide additional color as to the reasoning. And naturally market participants initially believed the worst- fearing auditors found a problem with the accounts. Thankfully, through additional conversations with former employees, we were able to gain comfort that this was not the case, and that the S4 strategy and growth thesis was not derailed.
This view was validated a few weeks later in April when the company reported strong net revenue growth of 35% year-over-year, which is in excess of its 25% target rate. While the stock remains in the “penalty box” due to overall concerns on advertising spending levels, we believe Sir Martin and the S4 team will doggedly continue to win new business and a greater budget share from its existing clients. We have chosen to stay invested, and have recently added to the position on share price weakness. If you missed last week’s animated chat with Sir Martin at our Investor Day, we encourage you to catch the replay.
MEI Pharma (“MEIP”) detracted 4.8% from first quarter performance. It is no secret that the biotech sector is undergoing a very painful downtrend, emphasized by the fact that in May over 20% of the Nasdaq biotech index was trading below cash- by far the highest level in over 20 years. And MEIP is no different, with the the company currently trading at over a 60% discount to the net cash on its balance sheet, still with a multi-year cash burn runway. In late March, MEIP was informed by the FDA that the agency was reversing its prior guidance of allowing accelerated approval for its PI3K inhibitor drug based on a Phase 2 trial. Instead, the company would need to conduct a randomized trial, thus spending additional capital and delaying first revenue to beyond the cash runway.
What the market doesn’t know is that the FDA has publicly stated a willingness to look at early randomized data, meaning its ongoing Phase 3 trial, already a year into enrollment, could generate an interim data read out as early as next year. This would significantly shorten the timeline to approval, and largely allay the market’s concerns. We have purchased more shares and are also actively engaged with the company to offer our perspectives on how to best optimize and position the company, as we continue to broaden and deepen our engagement with our investments- particularly those stuck in a turnaround.
No doubt there is much to be concerned about in this current market environment. The confluence of trends, whether it be a clogged supply chain, inflation, war, food and energy shortages, and central banks reversing almost two decades of loose monetary policy, proves there are well-telegraphed risks abound. We think there are many market participants who are unlearning the biases of “never sell” mental models that inadvertently relied on 15+ years of quantitative easing. We are now in a tightening environment, the likes of which many managers, including ourselves, have never experienced. But we are very much aware of the changing tides, and to us that means we need to have even further emphasis on owning companies that are run by managers with skin-in-the-game, have a catalyst roadmap, and generate cash.
While there are no shortage of things in the world to worry about, we believe that having capital invested with owner-operators in this uncertain market environment is absolutely key. A friend of ours recently noted to us when reflecting on the comparisons of today’s economic environment to the 1970s, that the companies which performed best had a CEO who was a boxer. Managers need to be “street” fighting every day, and on high alert for all possible ways things could go wrong. He also observed that actively engaged investors significantly helped underlying company performance. We agree with both observations. And with the vast majority of the fund’s long exposure invested in owner-operators, we have confidence this period will only make our companies stronger.
While we did not add any new long positions during the first quarter, we leaned into existing positions and re-entered a former GreenWood portfolio company, Capricorn Energy (“CNE LN”) to gain energy exposure at the onset of the Ukraine war. Further, our current opportunity set is rich, and we are researching many best-in-class consumer and technology companies, essentially all of which are down over 50% from the 2021 highs. We believe we are nearing the time when we will be taking the countervailing view to the narrative that “the world is ending.” And while there are certain signposts that some market participants are throwing in the towel, many are still clinging to a world where EV / Sales ratios ruled the day. And thus we remain patient and net neutral “disruptive technology” exposure.
We have increased short exposure, mostly to over-earning hidden covid beneficiaries with all-time high margins, and investors can read about those updates on our website. Even yet, we remain balanced, and are not chasing the beaten-down profitless tech names. We are particularly mindful that bear market rallies can be vicious for shorts. We are taking a more nimble approach by being countercyclical in our buy and sell decisions.
We conclude this quarter’s letter by reiterating what we told many of you in person last week in Portugal. We are ready for whatever comes, and are committed to being able to perform regardless of how this uncertain environment evolves. We shared a lot of updates with you last week, so please feel free to reach out if there is anything you’d like to discuss.
Thank you for your continued trust and support.
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.