Hedge funds doubling down into Carvana and why I won't invest into Constellation Software.
Funds are still buying tech en-masse, Kaspi, Zigexn
Hello,
I will write more shorter articles on this Substack, to clarify my thoughts.
So hedge funds are still overweight Tech, according to DataRoma - a great site which shows the latest 13F filings from several funds in a clear way - shows that Facebook, Microsoft, Google and Amazon were the most bought companies. Given the recent consumer data and the performance of energy (as well as some funds like Third Point buying oil/mining companies), we'll see if those will still be the top ones in Q2.
While overweight tech is to be expected, given the last decade - many of the funds doubled down on Carvana. Robert Vinall, Oakcliff Capital, Tiger Global (which added ! $1b of Carvana) and even Maverik Capital. I have recently written about Carvana. Given the resources that those funds have what is the appeal of Carvana compared to other companies?
John Hampton has a great article from 2017 on when to double down on companies. The gist is: Generally don't double down on companies, especially not when they have levered business models - and respect your framework if you do buy more.
But enough harping about hedge funds, here are two great write-ups from two companies in my portfolio:
The first one is Kaspi. A Kazakhan company that combines most of the current tech trends. I had a small position in it and recently increased my position to around 4% when the stock plummeted. Here is the writeup you should check out.
The second one is ZigeXn. An HR/business platform company that trades cheaply in Japan.
Why I won't invest in CSU
Constellation Software is a great business and fintwit favourite and that for a good reason. Their CEO is a remarkable capital allocator and he has created enormous shareholder value.
Here are some great write-ups and resources for Constellation Software: Definitely read them to make up your mind about constellation.
https://www.the10thmanbb.com/investment-ideas/csutsx
So Constellation Software is a great capital allocator, in an industry that I understand and they have a market cap under 50b? It seems like a dream stock, so what am I on about.
Valuation
No matter how you look at it, the quality of Constellation Software comes with a hefty price. Even with their 20% growth (through acquisitions and organic growth), 33 Price/FCF is expensive. Given that inflation and the change in interest rates, will compress valuations in the future - it suddenly matters what you pay for a company. Valuations and margin compression is one of the biggest risks. While CSU has been incredible resilient even in market wide sell-offs, it is not a given that it will do so in the future.
What moves the needle and competition?
While a lot of private equity is still focused on the fastest growing software companies, some have made the leap to buy profitable companies with low growth at cheap prices. I have no doubt that Mark Leonard, can still deliver superior returns, but it does limit the opportunities especially if you don't want to overpay.
What is more worrying tho, is that as Constellation Software grows it needs to either acquire more companies - thus reducing the due diligence into each acquisition or it needs to buy bigger ones. This is difficult. Usually bigger companies are older and have a set culture and mindset that will be more difficult to change. Additionally tech-debt will be much higher, and optimisations take longer. Whereas 10 years ago a $100m acquisition was significant, it now isn't. The bigger the take-overs become, the more risky they inherently get. This risk should create a price discount, not a price premium. There is a reason why many conglomerates trade at a discount and this risk is why.
Unproven track record in other sectors
With competition rising and smaller acquisitions not mattering anymore other neglected sectors become more enticing. Mark Leonard said that they looked at a $1b oil investment. (thanks for the transcription Sleepwell)
Q: For non-VMS potential investments, there's a lot a lot of competition out there, can you give an update on how far you've gotten? Have you taken a close look on anything? Been outbid?
Mark Leonard: Took a hard look at a thermal oil situation, looking close to a 1 billion investment and it was tax advantaged, at a time the sector could not get financing and unfortunately the price of oil ran away on me. I was trying to be opportunistic on a sector that was incredibly beaten up.
Q: Does it fit any sort of template of business characteristics you would be looking for outside of VMS software?
Mark Leonard: Very large tax assets because we pay an awful lot of cash tax and it's going up because of new regulation in the states. Would have the return through dividends from a public company and would have flown through us in a tax deferred way, so from a tax perspective incredibly attractive. One of the characteristics there, was complexity. Where there's a troubled situation with a peculiar circumstance and there's lots of complexity I think we can compete better than the average investor, particularly where people are willing to take capital forever.
Q: If large VMS investments prove attractive and fruitful would you still pursue other markets outside VMS?
Mark Leonard: Of course not.
While Mark Leonard rivals Buffett in terms of capital allocation prowess in Software, his abilities outside of that are not really known. I am comfortable that he won't take a decision that will harm shareholders, but will he take ones that create similar returns to the last decade?
When will I buy CSU then?
Easy. When it's 30% cheaper. Might take a few years tho.
So did you buy CSU now the ratio is at 22,5x?
This post deserves love just for the links to other Constellation articles!