Welcome to the 20th edition of the Rational Cloning Newsletter (Weekly Ideas Series).
Helping you discover the best ideas of others.
Happy cloning.
Weekly Investment Ideas
(1) Greenhaven 2021 Q4 Letter
a. Digital Turbine (APPS)
In 2021, digital advertising company Digital Turbine completed 3 acquisitions that allow them to control the mobile advertising process from end to end. The company enjoys technology advantages by being preinstalled on devices, as well as first-party data advantages from their carrier partnerships. At their most recent analyst day, Digital Turbine laid out a path to quadrupling revenues and growing EBITDA by 10X in the next three to five years. Given today’s starting multiple of less than 8X this year’s expected gross profits, anything approximating achieving their “plan” should yield very attractive returns over time.
Digital Turbine also has a massive opportunity with their SingleTap technology, which dramatically improves the likelihood that an app is installed when a user clicks on its SingleTap-enabled ad. SingleTap has grown to a $100M+ business with just 15 customers. At their analyst day, Digital Turbine’s Chief Revenue Officer charted the path to “…really accelerate this into a $1 billion-plus business over the next few years.” In his words, “[t]he way we see this is a very relatively moderate growth from 15 advertisers to 150, which, by the way, represents only a subset of our total advertiser customers today at Digital Turbine.” The current run rate revenues for the entire company are $1.2B per year, so growing SingleTap to $1B in revenue itself would nearly double company revenue overall. This doubling only requires blocking and tackling on an existing product with a very high value proposition to a subset of customers; it does not require a moonshot invention. The SingleTap technology could also be licensed to other platforms such as Snap and Meta (Facebook). At an investor conference in December, management tried to highlight their announcement that Facebook was live-testing SingleTap, which could be a very big deal since Facebook is the second largest distributor of Android apps (Digital Turbine’s priority). The market yawned, and the shares ended down.
b. PAR Technology (PAR)
In previous letters, I have written about the importance of the people at PAR, and this investment being a “jockey bet.” Fortunately, it is becoming a jockeys bet as CEO Savneet Singh has continued to attract talent, including a head of M&A from 3G, a CTO that used to run Salesforce’s marketing cloud software, and long-time Panera CEO Ron Shaich, who has made a sizable personal investment in PAR. The combination of talent and secular tailwinds set the company up well for success. I believe that the company should be able to grow software revenues substantially even if they do not sign up another large chain (I suspect they will sign up several). There is significant embedded growth to be realized from revenue contracted but not yet live for their loyalty division (Punchh), cross-selling, and penetrating franchise locations that have not yet adopted the Brink POS system.
PAR has substantial cross-selling opportunities. As with Digital Turbine, there is a very long runway for growth that does not require acquisitions or significant capital expenditures. The company has three primary products for enterprise restaurants – a POS system, a back-office management system, and a loyalty system – which should work best when used in combination rather than individually. The Brink POS system sells for roughly $2,000 per year, back office for $1,500 per year, and loyalty for $1,000 per year. Because these divisions were brought together through acquisitions, there is limited overlap in their customer bases so far. As existing products are sold to additional existing customers, growth will ensue. The company is in the process of launching a fourth product, payments, that will add another $2,000 per year of very high margin revenue per location that adopts it. In aggregate, if a customer uses all of the modules (POS, back office, loyalty, and payments), the revenue per location will exceed $6,500, more than 3X what was possible three years ago.
PAR has a current valuation of approximately $1B. If you back out the profitable hardware business and the profitable defense business, which will be sold, the shares trade for 6X my estimate of 2022 year-ending recurring revenue, which should grow in excess of 30%. Again, over time, the multiple should finish compressing and the health of the company will be rewarded.
c. KKR (KKR)
The path forward for KKR is well-defined. As a class, alternative assets will likely continue to grow at a double-digit rate as investors are attracted to the relative returns in a low interest rate world. The largest players should continue to attract a disproportionate share of AUM as they have the best fundraising platforms and carry the lowest career risk. Nobody gets fired for hiring KKR.
In the case of KKR, growth will likely be augmented by an expanding base of retail investors for whom KKR products have not been available historically. To seize this opportunity, the firm had quadrupled the headcount by focused on retail investors. As co-CEO Scott Nuttall noted, “We raised about $2 billion in the first 9 months of [2021] as these products have been launched. Candidly, we’re ahead of our expectations because there’s been a significant amount of interest, and we have been growing these relationships. And a lot of the team that we’ve hired is just showing up in the last 6 months, and there’s going to be many more here next year.”
KKR will also benefit from growth in products developed for insurance companies, in part aided by the closing of their recent acquisition of Global Atlantic. Co-CEO Nutall recently suggested that the “asset-based finance opportunity” will easily exceed $100B and should get closer to $200B. Given that fee-paying AUM is currently $350B, retail and insurance related products should move the needle even with lower fees.
Will the returns for private equity investors decline over time with the growth in AUM and fund sizes? Most likely. However, we are not investing in KKR XII, which recently closed with $18.5B in commitments. Instead, we are investing in the investment manager of this mammoth fund (and others) that will earn management fees on the capital and has the opportunity for gargantuan incentive fees. We can argue about how fast AUM and earnings will grow, but until interest rates are multiples higher than today, they are selling water to allocators in a returns desert. The potential for KKR is impressive and no capital needs to be raised to seize the opportunity.
d. Elastic (ESTC)
Elastic is the market leader in search and has a strong product line-up in security. Very few companies are able to consistently generate 30% more revenue from their existing customers than they did the year before. Elastic is one of them. Their Net Revenue Retention (NRR) has been hovering around 130% or higher for as long as it has been disclosed. The company has the benefit of operating in growing industries (data and security) and continues to both add new products and transition free (open source) users into paid users, particularly for their cloud-hosted business, which grew over 80% last quarter. Elastic recently announced that their CEO would be transitioning back to CTO, which spooked investors, but they also announced that they had exceeded guidance and will generate cash from operations this year. This is a company that has grown to $1B in sales in less than a decade and still has all of the capital that it raised on its balance sheet. Shares currently trade for less than 9X this year’s revenues, which should grow over 30% as the company becomes operating cash flow positive.
d. Teledoc Health (TDOC)
The share price of Teledoc Health (TDOC) is down >75% and instead of selling for 20X revenues, they are trading for less than 5X revenues.
For starters, unlike many other “Covid beneficiaries,” Teledoc still expects to grow 25-30% per year for the next three years, regardless of progress to a more normalized environment… Over the past ten years, Teledoc has evolved from being a Zoom solution for doctors to a much broader swath of comprehensive service offerings, including the delivery of mental healthcare, the monitoring of chronic conditions, lab testing, and specialist referrals.
If Teledoc can achieve their stated growth ambitions, it will be a result of cross-selling, which has been successful for them historically. For example, more than 40% of telehealth users today have accessed multiple products, compared to just 10% in 2017. If every Teledoc patient used every product, revenue would grow more than 25X without adding a single new customer. Of course, every product is not right for every person, so that is not realistic, but a path of incrementally cross-selling offerings that have broad applicability (e.g. mental health services) is a non-herculean path to sustained growth.
e. Cellebrite (CLBT)
Recent SPAC/carve-out from a Japanese company, Sun Corporation. The sponsor of the SPAC is Adam Clammer, who spent 18 years in growth investing at KKR. The company is in the Digital Intelligence “DI” space, and their customers are primarily government agencies and law enforcement (state and local) who use their products to extract and manage data from cell phones. From a quantitative perspective, Cellebrite checks a lot of boxes. They have a broad base of customers with an installed base of over 5,000 public safety and 1,700 enterprise customers. The company is growing revenue at 25%, but that is understated as users shift from licenses to SAAS. Net revenue retention is over 140% and recurring revenue is growing over 30% per year. As both the frequency and amount of data collection rises, the company benefits from secular tailwinds and their solutions have a large ROI for end customers as they allow technical personnel, which are the constrained resource, to be more efficient. Cellebrite has 80% gross margins and is seizing on the opportunity to sell more seats and more modules to existing customers, estimating that they are 20% penetrated on their current base. Shares are currently trading for less than 5X 2022 revenues, which is a >50% discount to peers in the DI space. I like our chances for continued growth and even multiple expansion over time.
(2) Alta Fox 2021 Q4 Letter
a. IDT
We believe the recent sell-off in IDT is a good example of the market violently selling off misunderstood assets without much validity. At the time of this writing, IDT’s share price has declined from a peak of more than $65.00 in November to approximately $35.00. This sell-off strikes us as an irrational move based on panic selling and illiquidity rather than changing fundamentals. As a conglomerate with many distinct businesses, IDT is neither easy to understand nor easy to value. The lack of any sell-side coverage does not help, nor does some SAAS-valuation exposure in some of their business segments. Large insider ownership reduces the freely traded float. However, instead of rehashing the full IDT thesis, one can simply look at their most valuable business: NRS.
In the most recent quarter, NRS grew revenue 105% over the prior year. This was triple-digit growth on top of triple-digit growth in the prior year (2-year comp was 321%). That is incredible organic top-line growth. Unlike many other SAAS businesses, NRS is already EBITDA breakeven (achieved in the most recent reported quarter). Therefore, we are dealing with a “Rule of 40” in excess of 100. NRS is a 90%+ gross margin business dominating a niche with no meaningful competition, growing triple digits, and already scaling profitability. Moreover, IDT at the parent-company level has a strong balance sheet with more than $100M in cash, is generating significant EBITDA across its other business segments, and is managed by an A+ management team with a proven track record of value creation.
We continue to believe that shares of IDT are likely to more than double over the next few years and that NRS itself could be worth $30 per IDT share in a few years’ time.
(3) Maran Capital Management 2021 Q4 Letter
a. Countryside Partnerships (CSP.LN)
Countryside is in the midst of an activist-driven turnaround and strategic shift. The business has two pieces: a homebuilder and what the company refers to as its “partnerships business.” The partnerships business redevelops housing projects owned by local housing authorities, eliminating the need for CSP to buy land on its own. This business has better growth prospects, better visibility, lower capital intensity, and higher returns on capital employed than the traditional homebuilding business. It is deserving of a much higher valuation in the market.
Countryside is in the process of exiting and monetizing its traditional low-return home-building business to focus exclusively on the capital-light and high-return partnerships business. The company has been undergoing a significant amount of change:
New board chair appointed (who was previously CEO of Ferguson plc);
new business model (monetize home building to focus exclusively on partnerships);
dividend eliminated (leading to forced selling by income funds); • massive share repurchases announced (one third of the current market cap);
activist shareholder appointed to the board (from 10%+ owner, Browning West); and
CEO ousted (with a replacement to be named by the new board).
All of this change, as well as a weak quarter (the business is volatile, and Q4 2021 results were poor), has caused a significant fall in the price of the stock.
At recent prices, the company’s market cap is approximately £1.5 billion. The company has line of sight to over £400 million of asset sales from its legacy home building segment, and a share buyback authorization for that entire amount. The effective enterprise value is therefore £1.1 billion. Against this enterprise value, the company recently reduced its net income guidance to £225 million in 2024. Therefore, the company is trading at less than five times its 2024 earnings guidance.
Three activist investors together own over 20% of the company and have been aggressively buying more shares at recent prices. Of note, Browning West recently increased its position to just under 12.5% of shares outstanding, and both Jeff Ubben’s Inclusive Capital and Adam Patinkin’s David Capital recently crossed the 5% threshold.
So, you have three large holders in control of almost 25% of the shares (worth just under £400 million at recent prices), all of whom have been adding. The company has a £400 million share buyback authorization – another 25% of the shares at recent prices – and I believe many of the legacy income funds holding the stock have completed their exits.
2024 earnings per share should be north of £0.50. If the stock traded at 20x EPS, reflective of its high returns on capital and growth outlook, it would be a triple. Regardless, I think this is very conservatively a “three-year double,” and if the stock continues to languish, the buyback will be even more value accretive.