Dear Partners,
I’m very pleased to be writing to you. This is the first letter to the partners of Simaan Investment Management. I do not consider you merely clients; our method of investing makes us partners in the same businesses as we invest together.
The timing of this letter is somewhat fortunate. Our investments are starting to turn back in our favor after an initial period of difficulty. Investing requires both patience and decisiveness, but we’ve needed more patience so far. Thankfully, our initial thoughts and conclusions about our investments are bearing out. I would anticipate that most of the companies in our portfolio will continue to generate improving earnings, and, if conditions remain favorable, market prices will reflect that.
Conditions are good right now. Federal Reserve interest rate adjustments have created an environment where there is a lot of money looking for a home. So far, the sheer number of dollars flooding into capital markets has been able to keep prices up against some headwinds that might otherwise have caused a bear market, if not a recession. In fact, the money has been flowing so fast, investors haven’t asked questions before putting their money to work. This effect, where investor cash goes to “index funds” - investment vehicles that invest across large swaths of the market, typically piling money into the biggest companies - has been a big contributor to our slow start this year. These investment vehicles distribute that money regardless of the prices of the companies they’re buying. This is partly why we tend to look for companies that are smaller – better prices.
It looks like the prospect of even more money in financial markets is starting to influence some of the less well-known companies’ prices, too. Meanwhile, finding new investments will become incrementally harder. Still, I’m very happy to see our portfolio companies performing like I believed they would.
We are continually pursuing a portfolio that will deliver above-market returns while minimizing the amount of risk we take to achieve those returns. Here are some things you may want to know about what it will look and how it might change over time:
1) The portfolio will be diversified in terms of its holdings, but critical to its long-term success is its concentration. This style of investing has been named “focus investing,” and it means that rather than adding investment holdings for the sake of diversification, we invest money in a few companies that we know well and that we think have excellent long-term prospects. Occasionally, we will add investments that are more short-term in nature, but only if there is an obvious and large mispricing of the security.
2) “Focus” investing means that the portfolio will probably never contain more than 40 or so individual holdings, and probably no fewer than seven at its optimal levels. Studies show that 93% of company-specific risk is diversified away once your portfolio gets to 16 distinct securities. By the time you get to 32 securities, 96% of company-specific risk is taken care of. To get to 99%, the portfolio must have 500 securities. What you give up for that 3% of risk is almost all your familiarity with the companies themselves, and the ability to benefit from that deeper knowledge by way of enhanced returns.
3) As we add or remove securities, there may be some differences between our “master portfolio” and your personal accounts. These differences are mostly due to timing considerations. Suppose we recognize a good investment opportunity and add it to the portfolio, and it suddenly takes off. If you became a partner after the purchase of this stock, the price may not allow us to add the stock to your portfolio without additional risk and potentially lower returns. The opposite might also be true. We might purchase a stock, only for it to continue to drop in price. While the decline in price would be advantageous for you, we might choose to hold off on purchasing it for your account if there is evidence that we might be able to get an even better price.
4) Our emphasis on long-term performance allows for returns to compound over time. The key to this style of investing is that good companies get bigger over time and returns build up on top of each other. We’re looking to find those companies and concentrate our investments in them.
5) We won’t venture beyond the businesses and industries we can understand thoroughly. Until we feel confident that we can know the strengths and weaknesses of a company’s business model, its operating prowess, and the dynamics that shape the industry, we won’t be willing to risk your hard-earned money.
I have spent most of the past six months building the portfolio I’m referring to. The process of constructing a complete portfolio and properly managing it will be ongoing in perpetuity. Currently, we are seeking to add new businesses to the portfolio that have sustainable competitive advantages. The businesses we have already invested in all show good long-term prospects.
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StoneCo Ltd.
Our largest position is in StoneCo Ltd., which is a fledgling payments processor to small and medium-sized businesses in Brazil. Right now, the company operates only in Brazil. StoneCo is among the first companies looking to digitize payments in Brazil, has the most beneficial complementary services and products for its customers in the market, and provides the best customer service solutions. They have invested in local hubs - physical office spaces from which their staff of “Green Angels” ride out on green motorcycles to provide hands-on support anytime a customer is having difficulty with any of their platforms. These local hubs are also local sales headquarters, providing a local touchpoint for their customers. StoneCo uses the transaction data it amasses to provide financing to those customers – a feature that has been very successful. In an economy that is transitioning to more and more electronic payments and transfers, this company is an undeniable leader.
Even with all the great things StoneCo has going for it, there have been two obstacles that have contributed to its not performing as well as we’d hoped in the short term. The first was one we anticipated – existing payments processors tried to cut prices and get increasingly aggressive in competing to shut out StoneCo. The problem was enough for StoneCo’s CEO, Thiago Piau, to write a letter highlighting StoneCo’s commitment to its strategy despite the competition. (A quick Google search will turn up this letter and some of his others.) I still believe StoneCo’s customer service capabilities and its ability to meet all its customers’ needs seamlessly and cost-effectively give it a long-term advantage in the market, and so far, its revenue and earnings growth in such a challenging environment has verified that belief.
The second obstacle was one that was not highlighted in StoneCo’s initial paperwork. Some of its early-round investors, who bought stakes before the company went public, were able to sell their positions in StoneCo through a secondary issue of shares. This didn’t change ownership stakes for shareholders, but the price fell with the announcement, and speculators were scared off. I’m still confident the price will continue its rebound. The company’s prospects are excellent, and not limited to Brazil. This is likely to be a cornerstone holding for our portfolio.
Pacific West Bancorp
Pacific West Bancorp, our second largest position, has declined slightly from our initial entry point but remains close to that price. This bank is a regional player primarily in California. Its revenues have grown despite management making a concerted effort to improve the credit quality of the bank’s loan portfolio, meaning both the bank’s risk and its interest revenue from those loans might decrease. PacWest does some specialty lending, including providing funding for venture capital firms, that differentiates it from some of its competitors. We anticipate that the improved quality of PacWest’s loan portfolio and its product offering give it the ability to weather any economic environment while the bank continues to crank out strong operating results.
Hilton Grand Vacations
The newest addition to our portfolio is Hilton Grand Vacations, a timeshare company that carries the Hilton name and, until recently, was part of the larger Hilton company. HGV manages resorts, buying completed projects and selling off the timeshare inventory, then managing the properties. The large network of resorts under HGV management makes it more enticing for vacationers who might want to travel to different locales from one vacation to the next, thanks to HGV providing a means of exchanging timeshare spots between vacationers. For vacationers who want to finance their timeshare purchase, HGV has a very lucrative financing arm that creates significant value for the company. Often, HGV will buy timeshares back from their vacationers looking to sell their timeshares, allowing the timeshares to retain their value. We tend to lean away from businesses that require a great deal of ongoing capital investment, but this business uses less than we anticipated. With the Hilton brand name, great resorts in its network and good prospects for growth over the next 5-10 years, this was one we were happy to add to our book.
Boston Omaha
Some have called Boston Omaha a “mini-Berkshire Hathaway.” In fact, one of the co-CEOs of the company, Alexander Buffett Rozek, is Warren Buffett’s grandnephew. Along with his fellow co-CEO Adam Peterson, Mr. Rozek has founded a diversified company that is primarily engaged in the billboard advertising business. Their reasoning is that billboard advertising probably can’t be disrupted with mobile internet technology. So far, that has proven correct. They hired an experienced manager for their billboard business and continue to make operating improvements and further investments in good properties. Additionally, the company has several other lines of business under its umbrella, including most prominently a bonding insurance issuer. I would be thrilled if Boston Omaha became a mini-Berkshire or even a micro-Berkshire, and I’m bullish about its prospects to pull it off.
The Liberty Media Braves Group
Liberty Media, a global media conglomerate, happens to own Major League Baseball’s Atlanta Braves. Liberty has issued tracking shares in the Braves. Tracking shares are shares that mirror the performance of an internally controlled business while not relinquishing control of that business. For the Atlanta Braves, there are two classes of these tracking shares that are available in public markets. The Class A shares (BATRA) have a very small level of voting power, and Class C shares (BATRK), have none. We own the Class C shares.
With more and more American billionaires, sports franchises, of which there are few, are coveted by a growing group of able buyers. American team sports, especially baseball, have the benefit of local media rights deals that can add an avalanche of reliable cash to a franchise’s operations. The Braves recently opened a new stadium. They have a young and exciting team with a relatively low payroll and sharp management. Operating results have been sturdy, and there is a government-protected monopoly on the sport. This may not be the quickest gainer, but it has a very high probability of success over a longer period.
Opera Limited
The last company in our portfolio has also been the most successful investment we’ve made thus far – Opera Limited. Opera is based in Norway but operates globally, offering a web browser (like Google Chrome, Firefox and Apple’s Safari) that essentially receives a sales commission on advertising sales made by search engines and other ad placements based on Opera’s users. Opera has a very small piece of the global market share for web browsers, primarily because of the corporate titans it competes with for that business. However, it has something going for it that its competitors don’t. The browser creates a virtual private network, or VPN, for its users – a secured, private network that is hard to hack and doesn’t track user movements. This technology is not particularly advanced. The reason it isn’t offered by other browsers is that most browsers want to track user data for advertising purposes. The only other major browser that doesn’t track user movements is Safari, which is almost exclusively used through Apple products. This has created a special niche market in developing countries, and especially in Africa, among users who value privacy but won’t pay for Apple products. Opera has taken advantage of that niche. Thanks to that user loyalty, Opera is expanding its business in new directions, including the money transfer business, mobile gaming and gambling, and other such projects that leverage that trust.
We came to Opera after several of those new ventures had been planned and announced but before most of them had been launched and before any of them had begun to impact its revenues. It has been a transitional time for the company, but we see value in what the company is doing. Our investment in this company may increase or decrease based on how these new lines of business are able to execute on delivering new value to the user base. As of now, we are happy the price of the stock has increased so quickly but would also love the opportunity to buy more shares at better prices.
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As we enter the second half of 2019, I look forward to continuing to identify companies that suit this investment portfolio and can deliver the returns we hope for. Sticking to our principles is critically important. As economic growth continues, the temptation to jump in and ride the markets upward gets stronger. Growth can’t continue forever, though. Since we can’t know when the ride will stop going up and start going down, we will invest cautiously. We aim to make this portfolio one that holds up in all conditions and will continue to look for companies that fit.
Sam Simaan, CFA
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