Tarpon U.S. Equities – First Annual Management Letter
Updated: Jan 8, 2021
First, I want to sincerely thank the investors in this project. I can promise you dedication
and passion, and I hope we can not only generate healthy returns on your investment, but also make those of you providing seed - money and early financial support partners in a profitable and value - generating investment firm down the road. As a side note, I am personally satisfied with the investors and partners I have, knowing I will somehow contribute to some of the worthwhile causes you put your money behind.
To bring everyone to the same page, I have been working with U.S. Equities for more than eight years now, with the greater part of my schedule dedicated to it over the last four years. Over this period I had been letting Zeca aware of this work, even if distantly, until when, early in 2019, sparkled by a great feedback he gave me, we began to talk about launching this project so that Tarpon could not only benefit from a proprietary way to allocate capital in the U.S., but also gather useful knowledge to its other endeavors, and I could not only focus solely on U.S. Equities, my passion and life project, but also launch a business, addressing my entrepreneurial wishes. The timing was propitious for both sides, and here we are, already writing our first management letter.
We began to make investments to our portfolio on October 09, 2019. As agreed beforehand, our work started with me bringing individual cases to discuss with Zeca, as well as the whole equity team at Tarpon whenever someone wants to join or there are synergies with topics they are looking at in Brazil. Those cases are from the U.S. portfolio I had in place, as well as from my “wish list”. As Zeca understands my thought process and provides feedback on individual cases and portfolio composition, our intent, from day one,
has been to put together an initial portfolio ready to receive more capital and outside investors.
The work has been great so far. We have accomplished a lot and the personal chemistry
is better than I expected. I could not be gladder for the time and energy that Zeca, as well as all the Equity team to a lower extent, has brought to our project. Zeca’s inputs, feedbacks and business acumen are, not surprisingly, proving invaluable to our portfolio, which has already taken a good shape. Before moving on to the portfolio and a few short paragraphs on the key investments on the next section, I want to use the opportunity in this first letter to establish some guiding principles for our fund and partnership. These principles will hold us true to our firm’s mission:
“To be a conventions - free capital allocator focused on selected, deeply rational and long-term oriented equity investments that generate superior returns to our clients and partners, while contributing to the development of the capitalism ecosystem around us.”
Guiding principles: 1 - This is a life-long project for me, and I hope at least a decades-long one for my partners. From that follows most of the below. 2 - Survivorship mindset. We won’t risk our existence on shortsighted investment decisions, bad fundraising, or whatever kind of misguided/short-term oriented actions. 3 - We will have an unblemished reputation, upholding to the highest moral standards in our dealings with clients, companies, and partners. 4 - We aim to be a source of joy and fulfillment to every life we touch on our daily activities. 5 - Patience. This is paramount to so many things, including our success in being able to say no to most investment ideas that the market/news throws at us, so that we can select a few long-term compounders. 6 - We will always bear in mind one of the greatest quotes I have ever seen, by Daniel Kahneman: “Nothing is as important as it seems when you are thinking about it.” A stress-free, rational existence follows. Doing things right the first time and putting yourself in a good position to face varied scenarios help a lot in this regard. 7 - We will be open and candid with partners and clients. Our fee structure is mostly performance based. Most of my money, and that of any future team-members on the investment side, will be in the same portfolio as partners and clients’ money. 8 - We will gladly forego unnecessary bureaucracies. We will be lean and each one in our team will have work to do that is relevant to our mission, rather than to our egos or to outsiders’ eyes. 9 - For an investment to be relevant in our portfolio, we won’t relent on key features, such as that the business model is strong (competitive-wise), that the company is “going
somewhere", and that we feel good about the managers and influential shareholders we are tying ourselves to. By “going somewhere” I mean companies evolving operationally; it could be a firm developing a new market, taking market share, or simply doing things better, beating competitors and improving its economics meanwhile. If we can find a couple of reasonably priced ideas that really fit this mold each three years, we are sure to do very well, as, from experience, the compounded return on such cases tend to extrapolate initial expectations - as our partner Pedro Faria told me, “the human mind has trouble thinking exponentially”. 10 - We will rely on a businesslike mindset to invest. We will approach buying and selling stocks with the same thoughtfulness as businessmen must have when dealing in the “real world”, without the crazy liquidity of capital markets. If we are as exigent as Warren Buffett must be when he decides to buy a company for Berkshire to hold forever, we will commit few mistakes, and the winners will carry us through. From that, follows a proprietary studying process little disturbed by “noise”, but attuned to signals, much less trading decisions than a typical fund, and a concentrated portfolio - the most successful entrepreneurs out there just don’t spread themselves too thin. 11 - We shall never relent on maintaining a learners - mindset. Regardless of results, we must always be challenging ourselves and our beliefs. As the business- world evolves we must advance, preparing ourselves to invest in new business models, but in a disciplined way. 12 - We aim to build value not only through the fund’s returns, but also through knowledge and experience that proves accretive to our partners and invested companies over the years. Longer term we intend to see our capital and knowledge taking roles that help good companies thrive.
Main investments and comments:
GoDaddy and WIX
GoDaddy and WIX enable small businesses to build a presence and market themselves
online cheaply and effectively.
GoDaddy is an older, first generation company in this market. It began as a seller of
domain names in 1997, dominated that market with attention-grabbing TV ads and has managed to evolve to a second-generation model (the only one amid its peers). WIX is t
he typical second-generation player; instead of selling a domain and letting the client figure out how to build a site, second generation players provide an easy do - it - yourself website building experience - domains and hosting become just part of the package. WIX also came up with a powerful freemium model for customer acquisition (which GoDaddy has copied for its website builder).
With annual revenues surpassing $800M and $3B respectively, WIX and GoDaddy have
crushed competitors. Peers like Web.com and Endurance are shrinking. Just one competitor at scale remains, Squarespace, which is still private, with revenues about half of WIX’s. Even big guys like Google have left the space. And outside of the U.S. a consolidation process led by our pair and mostly organic is also gaining pace. All of this shows that scale leads to an array of competitive advantages that compound over time: higher gross profits, more R&D investments, better product, more clients, more marketing dollars, lower CAC, more partners to the ecosystem, etc.
Organic recognition online is a key driver for low CAC; WIX and GoDaddy have
clearly beaten competitors in that regard, being leaders when we analyze Google searches for all the peers (on Google Trends), besides dominating both SEO on the relevant topics, and the discussion in blogs. This is a huge moat, as we are talking about a market whose target customers are in the tens (if not hundreds) of millions and scattered across the world; in other words, you cannot send a salesperson after them, they must be aware, recognize your brand as trustworthy and come to your site.
The market potential is large not only from more small businesses coming online and
adopting more services, but also from bringing professional website designers and marketing agencies in as clients. It is not a clear line separation, but our pair approaches this opportunity from different angles.
Being founder-led to this day, and having its VC backer, Mangrove Capital, as a major
and influential shareholder, WIX’s corporate culture is still squarely focused on being at the
technological forefront, constantly launching new features and aiming to make its underlying software solutions for website design so good that professional designers, who currently make the majority of the sites in the world relying on open-source software, start to adopt it. If the company can realize even a small part of this opportunity, the payout can be relevant for its results; and that is apart from the core, do-it- yourself business still growing at 20%+ rates. Not unexpectedly, WIX’s valuation is not simple, although, just as GoDaddy, it is a great subscription business model that provides a good floor on the downside.
GoDaddy had its IPO in 2015, after being co-owned by its founder and a consortium of PE firms (KKR as the leader) since 2010. Today both have completely sold-out, but KKR’s successful strategy remains: take advantage of GoDaddy’s amazing brand recognition and scale (its clients hold about 1/3 of the world’s domains) to not only grow customers at a low CAC, but also grow along with its customers, by providing them with additional services, such as e-mail, Office 365 package, websites, etc. The company also invests heavily in R&D and new features though, and we cannot forget that this market is huge, with groups of clients who have different needs; for instance, not every client wants to build a site herself, and many small business owners do want assistance by phone on how to get or improve their operations online - GoDaddy has a well-regarded, domestically based, call center operation, providing superior customer service, as well as bringing in additional revenue. To close, GoDaddy’s valuation is quite simpler, as it already generates healthy free cash flows, despite still growing revenues at double digits rates; and its strong balance sheet allows for potentially accretive acquisitions to gain weight in either specific geographies or new products, something the company has already shown it knows how to do.
Charter, through the holding company Liberty Broadband:
Charter is a residential broadband giant, whose fiber-rich cable systems pass through
more than 50M homes in the U.S. and serve over half them. An investment of mine since 2014, the stock has had an impressive run that was not unaccompanied by the performance of the business.
Back in 2014 Charter was a collection of cable assets scattered across the country and historically under-managed due to a turbulent financial history that began with Paul Allen, Microsoft’s co-founder, paying absurd prices to buy cable systems in the late 90s and just finished with a Chapter 11 that left the company in the hands of bondholders after the 2009 financial crisis. But when I first invested the company had already been controlled by John Malone, the wisest man in the industry in my opinion, for almost two years. The leadership team he had brought in was delivering exceptional results by investing to improve network quality and customer service, reduce churn, grow customers, lower unit expenses, grow earnings, re-leverage the balance sheet, buyback shares, and repeat. I saw a long runway for that process to continue, not to mention the possibility that Charter would be a winner in what smelled like a big round of consolidation about to happen in the industry.
Both expectations have proved even modest. Operational performance has been excellent, and we acquired the much larger Time Warner Cable at a great valuation.
Obviously, a lot has already happened in this case, so that despite the stock trading at
similar valuation multiples to when I first invested, it is not nearly as attractive as it was back
then. Still, given the competitive landscape (incumbent telcos with copper assets to a great extent) and the fact that some cable peers enjoy higher free-cash-flows per home passed (due to them having already explored pricing to a larger degree), there is still a good deal of growth for Charter over the coming years. As a plus, we get not only a very resilient business, whose financial model richly rewards shareholders, but also to sit beside John Malone and Greg Maffei, Liberty’s CEO whose deal - making shrewdness we also admire, for any further M&A rounds (at a 10% + discount at the holding level).We bear in mind, nonetheless, the risks of a more mature business model at this point.
4Imprint is an online distributor of promotional products, such as pens, bags and shirts
with your logo on it, with over 30,000 SKUs. It targets employees responsible for making such purchases within mid-sized companies, by offering them an easy way to solve their "sporadic problem", with guaranteed quality and quick delivery (usually in a few days, but as soon as 24h).
Through an asset light business model, 4Imprint "creates" demand and coordinates it
with its supply chain. This may seem an “easy” operation for outsiders, but the reality is far from that. The company has been steadily digging its moat on both the demand and supply sides of the equation for decades.
4Imprint was founded in 1985 as a catalog/mail-order business, which has since
evolved into the internet era. It was acquired by an U.K. asset heavy printing company in 19 95. Over the years, 4Imprint’s management team based in the U.S. and led by CEO Kevin Lyons-Tarr and CFO David Seekings, grew their business tremendously, while those old assets in the U.K. dwindled, so that today, despite being listed in London, the company is an U.S. business with just a minor, also asset light, presence in the U.K. Most importantly, the board of directors was shrewd enough to put the men who built 4Imprint in chargeat the holding level as well, and they certainly deserve it, having organically grown revenues from $112M in 2006 to ~$820M in 2019, for a compounded annual growth rate of 17% that continues unabated (16% growth in 2019) despite operating margins consistently between 6% to 7%, which may seem thin but is quite good for a distribution business with no working capital needs.
The company operates in a $25B space, more than half of which fits it niche. Amazingly
online orders represent just 25% of the market, half of which is still in the hands of
ridiculously small, field-sales - force kind of distributors. 4Imprint’s largest competitor
likely has less than $250M in annual sales, and figures fall quickly down the rank. With its sheer size in this niche market, 4Imprint undercuts competitors, operates at lower gross margins and continually takes share, while benefiting from the secular macro trend of
people opting to buy things online, without having to deal with that “ typical ”
On the demand side, 4Imprint has an unparalleled trove of data that enables it to bypass
the usual trap for anyone trying to sell anything online, Google or Amazon, to a much
greater extent than its competitors can. By sending out catalogs, as well as 2.5M “
Blue Boxes” of gifts annually (compared to the roughly 1.5M sales orders it rakes in), the company has an unique edge on customer acquisition cost, which is perhaps going to increase materially as it ramps up a TV - ad campaign that began in late 2018 and is showing great results so far - another marketing avenue no competitor can match, due to scale.
On the supply side, 4Imprint is deeply ingrained within its main suppliers’ operations,
not only accounting for a large part of their businesses, but also providing them with visibility so that they can run their operations efficiently and pass back savings to 4Imprint, something competitors with a fraction of 4Imprint’s scale and lacking its data analytics capabilities cannot replicate
Apart from the above, I canassert that David and Kevin are remarkably high in my regard. Reviewing their track record and visiting them last August, I found in the pair the most impressive combination of low-key personalities and widely successful managers I have ever seen. Their headquarters in the small Oshkosh, WI is indicative of the company’s mindset: low cost but filled with satisfied employeesproviding great customer service and value. Moreover, the way they approach balance sheet management, with no debt, paying out free cash flows as dividends, as well as their square focus on organic growth, avoiding the easier acquisition-led strategy many end up pursuing ,is commendable, especially these days when more firms seem to drive “shareholder value” through financial maneuvers than from old- fashioned sound operating practices. I look forward to years of partnership with Kevin, David, and the whole team at 4Imprint.
I appreciate your confidence and look forward to the coming years for enjoyable
interactions, engaging studies, our evolution, and rewarding investments.
Tarpon U.S. Equities
January 11, 2020