Argosy Investors commentary for the first quarter ended March 31, 2022.
Dear Investors,
2022 first quarter performance was -15.1% in select accounts. The S&P 500 by comparison returned -4.4%. We ended the quarter with 43% of the portfolio in cash and equivalents, which means that these results would have been worse without the allocation to cash. Looking into why our performance lagged the market so significantly, some of our worst performers were our largest positions. I am optimistic we will not see that pattern repeat, particularly with businesses that have generated strong business results during our ownership. Those positions are:
Q1 2022 hedge fund letters, conferences and more
| Rank in Portfolio by Position Size | Company Name | First Quarter 2022 Position Performance | Contribution to Argosy Investors’ First Quarter 2022 Performance |
| 8 | Grid Dynamics Holdings Inc (NASDAQ:GDYN) | -62.6% | -2.7% |
| 2 | Trisura Group Ltd (TSE:TSU) | -27.5% | -2.5% |
| 3 | Meta Platforms Inc (NASDAQ:FB) | -32.3% | -1.8% |
| 17 | Vizio Holding Corp (NYSE:VZIO) | -53.4% | -1.2% |
| 4 | FirstService Corp (NASDAQ:FSV) | -26.5% | -1.0% |
| Top 5 | -9.2% |
While I’m not at all happy with this quarter, there are some things that give me some comfort. For instance, Grid Dynamics has a significant employee count in Ukraine and Russia, a fact that not many would have considered relevant until recently. The silver lining with GDYN is that I had sold down this position by 75%+ in the quarters leading up to this one, but I still believe GDYN is a good company with the ability to adapt to changing geopolitics (they announced a joint venture in India shortly after the war in Ukraine broke out), and it may be attractively priced for further investment now.
Trisura has been one of my all-time great investments, and their 2021 ended very strong with a bright outlook for 2022. Some folks may not know that Trisura has increased EPS from $0.32 in 2018 to $1.49 in 2021. Their success as a fronting insurer is impressive to say the least, and while I am disappointed in their performance this quarter, at 15x 2022 earnings, Trisura offers as good a value as I’ve seen since I first purchased shares over 5 years ago.
Meta Platforms, formerly known as Facebook, declined significantly after announcing their 4Q 2021 results and sharing that changes Apple had made to their privacy controls will negatively impact them going forward. At the same time, they announced they were making significant investments in the metaverse, a somewhat ambiguous effort to develop a new way that people will interact with each other through technology. I can’t pretend to know everything about the metaverse and the potential it holds, but ultimately the investment in the metaverse, if unsuccessful, can be stopped and will still allow FB to generate significant free cash flow. FB currently trades for a mid-teens multiple of free cash flow, so absent a complete deterioration in the business, I would expect attractive returns from FB here.
Reviewing Vizio, we purchased it quite recently and it has declined precipitously in our brief period of ownership. They have an explicit strategy to sacrifice gross margins from their TVs to further develop the audience for their smart TV offering, a competitor to Roku. I purchased the shares expecting the thesis to play out over a number of years, so I intend to monitor the company and its results as we move forward. Their first quarter results reflected strength in their Platform (Smart TV) segment, which will be their primary source of profit going forward. Further, the news that Netflix and other streaming companies are considering subscriptions that include advertising is positive news. In some ways, what is old is new again, as this development is somewhat of a return to the dual-revenue-stream model cable TV channels use. The shift towards more streaming programming including advertisements is a positive for Vizio, since they may be able to monetize the ads directly or indirectly. I’ll keep you posted on their progress.
Existing Portfolio Activity
Sold: GDYN, XPO, FND, DAVA, CIGI
Bought: FB, FSV, STNE
This quarter included some continued sales from prior quarters, most notably GDYN and DAVA, two IT outsourcers that have been very successful over my period of ownership but that had gotten quite expensive relative to their strong prospects. This risk management has served the portfolio well, as our trimming of both positions allowed us to avoid significant losses that occurred later in Q1 as a result of the Ukraine War, where both companies have some level of exposure. GDYN in particular is now priced at a level far more attractive than it had been in quite some time.
FND, XPO, and CIGI were “cyclical” risk sales in the sense that all three stocks have benefitted from some pandemic-related boosts in sales and/or they are more exposed to economic downturns. Floor & Décor is a terrific business that we would love to own more of at a better price. Given the significant amount of home renovations that have occurred during the pandemic, we thought better of our continued ownership in this stock until we were at a more favorable point in the economic cycle.
XPO experienced once-in-a-generation demand for its LTL and brokerage services during an extremely tight freight market, and we are already beginning to see weakness in the freight market. We sold in advance of what we expect to be some weakness in the LTL market.
CIGI is a commercial real estate broker, and CRE brokers have typically seen commissions evaporate during economic downturns, as sales plummet. With rising interest rates, we expect owners of assets will be less likely to unload their holdings, while there could be some pressure on real estate valuations over time if interest rates remain higher than the historic lows they reached during the recession. All of this may pressure transaction volumes in the short-term and transaction values (and thus commissions) in the next few years. CIGI is transitioning away from the commission-driven CRE model towards a higher recurring revenue focus, but they are still not yet far enough beyond that foundation to avoid a significant hit to their earnings.
Meta Platforms
I added to Meta Platforms, formerly known as Facebook, a bit above $200 during the quarter due to weakness after its year-end results. I believe we purchased FB at 15x 2023 earnings during the quarter, and despite all the negative press about Facebook, I continue to believe it is one of the best business models out there. Purchasing a great business capable of growing double digits, even 20%+, with a present earnings yield of 6.6%, implies that we can earn 15%+ returns from these levels, which is why we added to our position.
FirstService
FirstService is the largest manager of homeowners’ associations in the US and only has 6% share of the market. Currently 30% of homes are members in HOAs, while 50% of newly built homes are being built into HOAs. FSV also owns a group of businesses that provide services to the residential and commercial construction industries. I estimate that they earn a 20% on their net tangible capital and added this company to a handful of accounts that did not previously hold FSV. Given that the valuation has gotten more favorable since our purchase, I would not be surprised if more FSV makes its way into the portfolio at some point.
StoneCo
StoneCo has, like Vizio, seen a dramatic decline in value since adding to the investment during the first quarter. I added to the position early in the year after STNE had dropped significantly due to challenges in their credit portfolio, which they have changed, as well as increasing interest rates in Brazil, which the company was slow to incorporate into their pricing. Despite these changes which should benefit STNE later in the year, the market in general has obviously continued to struggle and emerging markets stocks have been hit even harder in many cases. Expectations are very low for the company now, and there is a good case to be made that the business could be worth much more than current prices a couple of years from now.
New Portfolio Activity
IronSource
I purchased IronSource early in the quarter and have seen IS decline in value nearly 32% through the end of the quarter, and further after the quarter. IronSource is a platform that helps game publishers maximize the financial success of their games and earns a cut of the revenues generated using its technology. They have grown extremely quickly in recent years, as gaming has become an increasingly popular outlet for free time. They grew 46% last quarter to over $150 million in quarterly revenue, at an operating margin of 18%. They expect to generate $800 million in revenue this year, and likely $0.15 per share of free cash flow in 2022, with the potential for $0.25 a few years from now. I believe that IS has a very profitable business model with the potential for a long runway of growth. At the same time, I could have chosen a better purchase price to make the investment, and that has become clear quite quickly. At current prices below $4 per share, returns from here can be attractive over the course of a few years.
Conclusion
2022 started off rocky and only got more so, with the rapid rise of energy prices, war in Ukraine, and longer-term concerns about a trend away from globalization, among many others. The portfolio has not emerged unscathed from this period. The current period has proven to be a challenging one to invest in because almost the last 24 months of financial data from most companies is a bit of a mirage. Many companies believed to be long-term beneficiaries of the pandemic have returned to pre-pandemic levels, but there are many more companies that didn’t make headlines with extraordinary sales and/or margins that may not hold over time. In that way, analyzing many businesses can be challenging, and could require a greater degree of conservatism in assessing likely sales and/or margin potential. I remain focused on the long-term potential of the portfolio and recent developments have started to expand the number of companies that offer potentially attractive returns. I am optimistic about the long-term opportunity with the portfolio, and with the list of strong companies on my watchlist that in some cases are getting more attractive.
Until July,
Argosy Investors
