RV Capital commentary for the first half ended June 30, 2016.

Dear Co-Investor,

The NAV of Business Owner was EUR 408.64 as of 30 June 2016. The NAV fell 7.0% since the start of the year and rose 308.6% since inception on 30 September 2008. The Dax was down 9.9% and up 66.0% respectively.

RV Capital

RV Capital – How did our companies get on in 2015?

The main purpose of my half yearly letter is to reflect on the operational performance of our companies in the previous year. This is based on the belief that in the long run the value of our fund is driven by the operational development of our companies as opposed to the gyrations of the stock market.

Given the near 50% increase in the price of the fund in 2015, you are probably thinking some pretty special things happened at our companies last year. You are right.

Grenke continues to expand both at home and overseas

Grenkeleasing grew its net income by 24% in 2015. This was well ahead of its growth in interest income (a proxy for revenue) of 13%. In particular, it benefitted from a decline in interest expenses (despite an increased loan book) as well as a decline in loan losses.

Grenke continues to invest in opening subsidiaries in new countries and further branches within existing countries. It began offering leasing in Singapore as a first bridgehead into Southeast Asia as well as starting a factoring business in Ireland. Furthermore, it opened 5 new branches in existing markets.

Grenke is really just getting started. None of its other countries are even close to the penetration of Germany (its first and largest market), which itself grew new business at 18% in 2015. On top of this, it has promising new businesses such as factoring and startup financing. It is a privilege to accompany it on its journey as a co-owner.

Google gets a new name

The big news at Google in 2015 was its reorganization. It renamed itself Alphabet and separated itself into two segments, the largest of which by far is Google. The Google segment comprises many of its legacy businesses such as Search, YouTube and Cloud computing. The remaining businesses are collectively known as “Other Bets” and comprise Alphabet’s moon shot projects, such as self-driving cars.

As part of its reorganization, Alphabet provided segment reporting for Google and “Other Bets”. In total, “Other Bets” reported operating losses of US$ 3’567 m. As I expect “Other Bets” to be (hugely) profitable in aggregate, it does not make sense in my view to penalize Alphabet for their losses. Excluding them, the Company’s earnings power increased by 23% from US$23’425 m from US$19’011 m. This is an incredible rate for a large, liquid, fairly non-cyclical business and sets a huge hurdle rate for a new idea to make it into Business Owner.

It is not just in the “Other Bets segment” that Alphabet undertakes moon shot like R&D. The Google segment also undertakes considerable R&D in particular in the field of artificial intelligence. As such, even the US$23’425 m mentioned above probably understates the businesses underlying earnings power.

Overall, I am incredibly positive about Alphabet’s new structure and think it will be very value creative in the long-term. The idea behind it is to allow the company to continue to scale as it moves increasingly into fields that are far removed from Search. It is modelled on the structure at another one of our holdings, Berkshire Hathaway. It has worked spectacularly for Berkshire. Expect more of the same at Alphabet.

Novo Nordisk celebrates a string of successes with its pipeline

Novo Nordisk had a typically solid year in 2015. Revenue grew by 8% and operating profit by 21%, both in local currencies. Net income even grew by 32%, driven by a DKK 2’376 m tax-free gain from the IPO of NNIT, its IT subsidiary. On a recurring basis, net income grew 22%.

The big news at Novo over the last year or so is the tremendous progress it made with its pipeline of innovative new drugs.

  • Most importantly, Novo finally received approval for Tresiba, its new long-acting insulin, and launched in the US in January 2016. This gives Novo the gold standard in the most important insulin category.
  • It filed for approval for Xultophy in the US. Xultophy is a combination product of Tresiba (a long-acting insulin) and Victoza (a GLP1) for type 2 diabetes. In my view, it has the potential to revolutionise the treatment of diabetes as it lowers blood sugar with a significantly lower risk of hypos.
  • Novo filed for regulatory approval of faster-acting insulin aspart in both the EU and the US for the management of blood glucose around meals for both type 1 and 2 diabetes patients.
  • Most significantly in the longer run, a once-daily oral formulation of semaglutide (a GLP1) showed very encouraging results in a proof-of-concept phase 2 trial, and has since entered phase 3 development.

It is an incredible series of successes, and I only picked out the highlights. Despite this, 2016 will not be without challenges. In particular, it will be interesting to see what impact Lilly’s forthcoming launch of a generic long-acting insulin will have on the market.

However, as Novo has, or will shortly have, the gold standard for many diabetes treatments, I remain confident in the future.

Credit Acceptance accelerates growth in new loans

Credit Acceptance grew its net income by 8% in 2015 to US$300m. Adjusted for various accounting effects, growth was 14%. As it bought back a substantial number of shares in 2014 and to a lesser extent in 2015, adjusted EPS outpaced net income growth at 21%.

Credit Acceptance experienced a substantial increase in new business volumes in 2015 with the number of loans up 33%. It is difficult to pinpoint precisely where this growth came from as competitive intensity remains high for auto loans. CAC did however greatly expand its sales force a few years back. After overcoming some initial teething problems, it now seems to be firing on all cylinders. Importantly, the growth did not come from a loosening of credit standards. Credit Acceptance has not changed its pricing since 2012. I remain very positive on the long term future for CAC. If it can replicate the market share it has in its strongest regions elsewhere in the US, the business can become many times bigger than it is today.

In the shorter term, there are signs of an overheating in the auto loans market. Some thoughtful investors draw parallels between auto loans today and residential mortgages in the financial crisis. It is important to remember though that the root cause of the financial crisis was not lending to people with lower credit ratings per se, but, amongst other things, a deterioration in lending standards and a misalignment of interests between those sourcing the loans and those underwriting them.

I cannot comment on the market as a whole, but CAC is unlikely to fall into either of these traps. It remains disciplined in its underwriting as evidenced by the continuity in pricing. Furthermore, there is alignment throughout the value chain. The borrower, the dealer, and CAC all have a financial interest in the loan being repaid. In my view, CAC will be

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