RV Capital Semi-Annual Letter: Business Owner TGV Vs. The DAX

RV Capital Semi-Annual Letter: Business Owner TGV Vs. The DAX

RV Capital letter to investors titled, “Business Owner TGV Vs. The DAX,” for the first half ended June 30, 2015.

Dear Co-Investor,

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The NAV of Business Owner was EUR 374.75 as of 30 June 2015. The increase in NAV was 25.1% since the start of the year and 274.8% since inception on 30 September 2008. The Dax was up 11.6% and 87.7% respectively.

RV Capital – Development of the fund’s participations

The following table shows the net income development of the fund’s holdings at year-end 2014 in order of importance.

RV Capital

When I buy part of a company, my investment hypothesis is always the same – it is a great business with wonderful managers at an attractive price – though of course not always correct. Having taken the plunge and bought a stake, I then track the development of the company versus this hypothesis. Has the company expanded its market and/or products and services? Are costs under control? Has management allocated the company’s capital sensibly?

Where the rubber hits the road is the companies’ earnings. A discussion of these is the main theme of this letter.

If the hypothesis is playing out, then earnings should be going up. This need not be the case every year. In particular cyclical companies such as BMW will occasionally have down years as people put off major purchases, such as a car, in a recession, but over longer periods the direction should be up.

Note that I have no interest in the development of share prices. This is why I don’t waste your time with a discussion of the fund’s or individual company’s price development. If a company regularly increases its earnings power, the share price will track this over time. A robust investment process correctly identifies companies which increase their earnings power. A rising share price is the outcome. My sights are firmly trained on process. Confusion between process and outcome is the single biggest source of error in the stock market. After all why not keep buying that hot biotech company with no hope of making money if the share price keeps going up? What’s not to like? A complete loss of capital when the party stops is what’s not to like.

RV Capital – Grenkeleasing

Grenkeleasing had a fantastic year. It grew net income at a whopping 38%. This was underpinned by strong revenue growth of 20% and a slower increase in costs. Grenke has been investing heavily in new markets and services in recent years as a result of which its return on equity (“ROE”) troughed at 11% in 2013 vs. an internal target of 16%. ROE was 13% in 2014 indicating that it continues to invest whilst at the same time earnings have room to grow faster than revenue until the ROE normalises. In fact, I suspect the underlying profitability is in excess of 16%.

The increasing margins reflect lower one-time costs associated with the launch in new continents (South America in 2013 and Asia in 2014) and the greater revenue base to spread investments over. It does not reflect a letting up of investment. Grenke entered two new countries in 2014 in Chile and Croatia, opened three new locations in France, and one each in Amsterdam, Saarbrucken and Bern. 70% of its business is now transacted outside of Germany.

Product-wise, Grenke also continues to invest. The most promising area is factoring for SMEs, where it benefits from its ability to process small tickets cost effectively and underwrite risk accurately. Today, Grenke is present in Germany and Switzerland with its own subsidiaries, and the UK and Hungary through franchisees. In the long run, I expect the expansion in factoring to follow in the footsteps of leasing. In addition to factoring, it continues to develop banking products through Grenke Bank including time deposits and start-up financing.

RV Capital – Novo Nordisk

Novo continues to power ahead for the sad reason that the global diabetes epidemic shows no signs of abating. In 2014, its revenues increased by 8% and operating profit by 13%, both in local currencies. As Novo reports in Danish crowns but generates the majority of its business elsewhere in particular in the US, the local currency perspective is most apt.

Net income growth lagged operating profit growth at 5% due to FX losses on unhedged balances in the Russian rouble and Argentinian peso. EPS growth amounted to 8%, helped by share buybacks. By historical standards, 2014 was a tough year for Novo. In particular, it had to deal with the partial loss of reimbursement for its two most important drugs at Express Scripts, the largest pharma benefit manager in the US. All things considered, it was a decent year.

On the pharmaceutical front the news was much better. The launch of Tresiba, its new long-acting insulin, continued in a further 14 countries. Most significantly, it was able to resubmit an application for approval of Tresiba in the US in early 2015. If all goes to plan, launch will take place in late 2015. Other launches included Xultophy, a premix of Tresiba and Victoza, in the EU; NovoEight, a haemophilia product in Europe and Japan; and Saxenda, a novel obesity treatment, in the US.

Both the near term and longer term pipelines of new products look very strong. Phase 3a data for its new fast-acting insulin came in positive earlier this year and it anticipates receiving approval in 2016.

Phase 3 trials for a once-weekly GLP-1 will continue throughout 2015 with filing planned in late 2016. If all goes well it should be approved in 2017. GLP-1 is a hormone found in the gut which stimulates insulin production only when glucose levels in the blood are high. As such, it has lower hypo risk than insulin and is the preferred treatment for early stage diabetics. Novo is already market leader for daily GLP-1 with Victoza.

If all goes to plan, by the end of next year Novo will have best-in-class fast-acting and long-acting insulins and by the end of 2017 best-in-class daily and once-weekly GLP-1s. Looking further down the road, Novo will make a decision later this year on whether to proceed with phase 3 trials for an oral GLP-1 having completed phase 2 trials this year. It is also working on insulin which can be taken orally. GLP-1 and insulin in tablet form would be genuine game changers.

RV Capital – Baidu

Baidu enjoyed the strongest revenue growth amongst our holdings, as you would expect given the earlier stage of the Chinese Internet market and the global trend towards online advertising. Its revenues grew by 54% to roughly US$8 bn. The growth was mostly organic, driven by an increase in the number of advertising customers from 753K to 813K and above all an increase in average spend from RMB42’200 to RMB59’400. The company continues to negotiate the transition from PC to mobile with 37% of sales coming from mobile.

Net income increased below the rate of sales at 25%. It continues to invest heavily, in particular in marketing and promotion (+133%), content (+125%), and r&d (+70%). The main focus of the marketing spend was the pre-installation of its key apps on smartphones. For content, it was the acquisition of attractive films and TV shows for iQiyi, its video site. Whilst spending on app pre-installation should have plateaued in 2014, content costs are likely to increase further as there are a handful of companies in China in a content arms race to become the leading video site. It is instructive that Google has neither of these costs as it invested very early in Android and YouTube effectively gaining dominance of the smartphone and video before the value in these activities was widely recognized.

Going forward, the focus of Baidu’s investment will be “O2O,” standing for online-too-ffline, and referring to the many offline activities such as ordering food or cinema tickets which are at an early stage of going online. Baidu aims to establish its key gateways – search, maps, and Nuomi (group buy) – in the nascent O2O market. As such, there will be no let-up in the pace of investments. There are mixed feelings about this amongst investors as in certain areas such as wallet or group buy there are already strong players in AliPay or Meituan. I share these concerns to a certain extent, but on balance prefer to see our companies investing too much rather than too little and have confidence that if they do not work out, Robin Li will scale them back.

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