Sold all Soho China @ HKD2.21. I sold all the shares because I was clearly wrong about the deal and that I would not have bought the shares at the current price even if I don’t have a position to start with.
The cost basis of this position is around HKD 4.3 which means a painful 50% loss!
A couple of lessons learnt:
This is my first unsuccessful special situation investment in the last 5 years. Despite the high probability of success, each failure carries a huge loss in the event of failure. As such, despite my four other merger arb successes this year, this one loss is enough to negate all those profits. This is a good reminder that merger arbs are fundamentally not the best investment opportunities since they have small upside and huge downside. So it is a game of not making mistakes and keeping the success rate high. It is another reminder that I should keep the average special situation position small to let diversification do its magic and achieve a reasonable average return
Clearly, I made a mistake by not paying as much attention to the “political” risk of the founder and instead focus too much on the business logic of the deal. In hindsight, if I had done more work on the founder, then I would have concluded that the situation was not analysable and hence belongs in the too-hard pile
Going forward, I will be much more careful when dealing with private enterprises in China
I will continue to invest in merger arbs if I am capable of assessing the odds and the return satisfactory.
The portfolio delivered a net return of 0.5% for the first half of 2021 while FTSE Global All Cap index’s return is 12.7% during the same period. Our portfolio’s cumulative return since 2016 is 101% while the above-mentioned index’s cumulative return is 105%. Cash is 18% of the portfolio.
1H 2021 Portfolio Performance
In the past six months, I exited 51jobs and Avanza. The privatisation deal for 51jobs was finalised in June 2021 and we netted 12% profit over 9 months. We have 2 other workout situations within the portfolio comprising 9.5% weight. Works-out is a way to earn better-than-cash returns with a short duration and less affected by the general market price fluctuations. I will always prefer owning great businesses at a reasonable valuation over work-outs but in times where I cannot find sufficient such investment ideas, then work-out is often the next best option.
Unfortunately, we are no longer partners in Avanza’s growth journey because Avanza’s valuation was so expensive that the prospective return on a 5-year horizon is very likely to be negative. Operationally, Avanza is firing on all cylinders and I am very confident that they will continue to do well. If valuation becomes reasonable again, I would definitely like to own Avanza again.
We became a partner to a very high-quality business in China – Tencent. Tencent is a company that defies categorisation. It is so many things all at once – gaming, social network, fintech, media and cloud. Despite being one of the largest companies globally, it still has a very long growth runway ahead and is likely to offer an excellent risk-adjusted return. Tencent owns WeChat which is in my mind a modern utility in the digital life of Chinese people. On one hand, the dominance of WeChat provides Tencent with predictable long term earnings growth but on the other hand, this same dominance also raises the spectre of anti-monopoly regulations. Tencent has leverage WeChat to weaken competitors by denying Bytedance and Alibaba access to China’s largest social network. In the not too distant future, Tencent is very likely to open up WeChat ecosystem to its competitors at the request of regulators and hopefully, this should be enough to satisfy the regulators. However, there is always a risk that Tencent would be forced to spin-off WeChat due to its position as a natural monopoly to truly ensure equal access to all stakeholders. At this moment, this risk seems small but significant. I take comfort in the fact that historically Tencent has been a responsible corporate citizen that cares deeply about its users and the wider society. For example, Tencent has been very restrained in terms of monetisation on WeChat while investing heavily into the digitalisation of industrial companies through cloud computing, enterprise software solutions and building customer relationship management systems on WeChat for corporates and SMEs. Going forward, Tencent is under increasing pressure to prove that it can create more value for society than it extracts from society. And Tencent’s track record suggests that they have a very good chance of creating value for society through constant innovations.
 Assuming a fee structure of 1) no management fee, and 2) a 20% performance fee above 5% threshold
Games Workshop (GW) continues to be my largest investment at a 20% portfolio weight. For the 12 months ending May 2021, Games Workshop revenue and net profit reached GBP 353.2m and GBP 122m. This represented year-on-year growth of 31.6% and 71.1% respectively. When I first invested in Games Workshop in 2018, the net profit was GBP 59.6m. The company compounded earnings at a rate of 22% for the last 4 years. And I believe that the company can continue to grow earnings by around 15% per year for the next 5 years due to 1) continued geographic expansion 2) bringing Warhammer IP to a larger audience via animations, video games, novels, comics, and live actions series.
“Despite paying a hefty multiple of 24x 2020 earnings, I believe we are getting a fantastic bargain because this is a very high-quality franchise with strong growth prospects, under-appreciated IP monetisation potential and strong corporate culture that reinforces its moat with time.”
And GW continues to look like a fantastic bargain today especially as the prospect of Warhammer IP becoming a world-class media franchise is looking promising.
Consider the three categories of Warhammer fan base – Collectors, Gamers, and IP fans. Collectors and Gamers are monetized via miniature sales. The IP fans might purchase Warhammer novels published by Black Library (Games Workshop’s publishing arm) but the revenue generated is not material. Traditionally, the rich characters and narratives of Warhammer are more about creating long-term stickiness and loyalty of the existing fan base rather than recruiting new fans. I believe this is changing in a big way with Games Workshop’s two-pronged IP strategy. In a recent interview, Jon Gillard explained this two-pronged IP strategy:
“Firstly, there is already a lot of great fan content out there. Some of that is being brought in-house to sit alongside other internally generated animation projects. All this content will be aimed squarely at “Warhammer” fans and will provide levels of depth and nuance for this highly “Warhammer” savvy group. Secondly, in licensing, we will develop big content projects in partnership with companies worldwide that we expect to appeal to that broader audience that is less knowledgeable and will need more accessible offerings.”
GW’s recently announced subscription program called Warhammer Plus, which bundles the above-mentioned Warhammer animation, miniatures, and other ancillary contents, is clearly targeting the core Warhammer fans. Warhammer Plus is about increasing the core fan base’s average revenue per user and probably also helps with long-term retention.
GW is collaborating with Big Light Production to turn the Eisenhorn novel into a live-action series that is going to be released on Netflix. This is meant to be accessible and bring Warhammer IP to a large audience. In the same way that the recent adaptation of Witcher into a Netflix series helped to introduce many audiences to the video game of Witcher 3, some of the audience will be eventually converted into miniature-purchasing fans which is where the real money is made.
The two-pronged IP strategy will increase average revenue per existing fan while also introducing Warhammer to a larger audience which can help to lower acquisition cost per fan. GW still has a very long growth runway ahead and can grow earnings at 15% per year with a high degree of certainty. GW is my largest investment because it has the lowest probability of permanent impairment despite the rich headline valuation.
Secular growth of hobby games
It seems increasingly clear that Games Workshop is a beneficiary of the secular growth of the hobby games sector. Hobby Games, which includes board games, trading card games, role-playing games, and miniature games, typically require the players to meet in a physical space and involve physical objects such as cards, miniatures, and boards. This is clearly the opposite of video games where gamers interact in a virtual world. For a long time, many believed that video games are permanently taking time and money away from hobby games. As such, the revival of hobby games in recent years has taken many industry insiders by surprise. The growth of hobby games remains robust despite the impact of COVID-19. Trading card games, such as Magic and Pokemon, are seeing very impressive revenue growth rates in excess of 20% in 2020. According to ICV2 (a hobby game trade magazine), the US hobby game sector generated USD 2bn of revenue in 2020 which was up 21% versus 2019 and up almost 100% versus 2015. In China, live-action role-playing games are becoming a huge hit with Chinese youth.
The pandemic has revealed the extent of the fans’ emotional connection with Warhammer because Games Workshop sold more miniatures even as most fans cannot meet to play the tabletop game. It seems to suggest that the collecting and painting aspects of the hobby are much more dominant than I previously expected. The pandemic also revealed the bottlenecks in Games Workshop’s manufacturing and supply chain capabilities. For most of part of the first half of 2021, Games Workshop could not meet the customer demand due to manufacturing and supply chain limitations. However, the company is putting plans to steadily expand manufacturing capacity at the Nottingham site and building warehouses. I expect the manufacturing and supply chain bottleneck to be resolved by 2022.
Games Workshop has three sales channels – third-party trade channels, self-operated retail stores, and online sales. Sales from self-operated retail stores reduced significantly due to COVID-19 restrictions, and only accounted for 20% of total sales in FY 2021 which was down from 34% in FY 2019. The reduction in retail store sales was more than compensated by an increase in online sales as online sales accounted for 25% of total sales in FY 2021 compared with 18.4% in FY 2019. Physical stores are a very important recruitment channel and provide physical spaces for Warhammer fans to play tabletop games. Hence, I expect retail store sales to steadily recover as COVID-10 restrictions ease. While online sales might slightly decline as a percentage of total sales, it would remain important for fans who do not have easy access to offline stores.
Investment Action: Added 0.5% to Soho China @ HKD4.2 as the spread to offer price has widened to almost 20% since my first purchase a few weeks back.
There seems to be some delay in the deal due to the need to get approval from SAMR which is the Chinese regulator for market competition. Buying a few office buildings should not trigger any concerns but nonetheless, it is critical to get their seal of approval. Seems like a good opportunity to add.
Bought a 3% position in Soho China at HKD 4.45. This is a simple merger arb and I see it as a better-than-cash investment opportunity.
Blackstone is making an all-cash offer for Soho China at HKD 5 per share which translates into an 11% upside from current share price of HKD 4.5.
Time to closure: I expect the deal to complete within 8 months which gives a pretty decent 15+% IRR. There is some risk that this deal could take longer
Probability of Success: 90%.
Blackstone is a reputable real estate PE firm and the founders of Soho China are very well-known figures within the Chinese business community. I think it is very unlikely for the deal to fall apart.
The price seems to be fair for both parties. Blackstone can see some upside from this transaction as there should be quite some room to improve rental income by improving occupancy rate and general recovery from COVID-19. And maybe there is a little upside from rerating from cap rate. The current cost of debt is ~5% and Blackstone could probably lower it once they gain control. Finally there should be some 2-3% of the like-for-like rental price growth annually
For Mr and Mrs Pan, this is a reasonable valuation for them to exit the business. Building office space seems to be a very structurally challenging business in China due to intense competition and the rise of shared working space. Soho China’s premium office space positioning has helped to insulate them from the most intense price competition.
Given that it seems like a fair deal, then both sides should be motivated to close this transaction.
I don’t see material regulatory issues as Soho China’s market share is low and office space is not a sensitive sector
There is a general risk of unanticipated events happening and I am not too intimate with the parties involved
While the probability of failure is low at 10%, the downside from the deal not going through is very high at over 50% using the pre-announcement share price of HKD 2-3.
All things considered, I am only committing 3% capital as I would not consider Soho China a favorable long-term investment in the case of deal failure.
Bought a 3% position in Kuaishou at an average price of HKD 193 per share.
I believe that short video platform is a structurally good business with an excellent LTV / CAC ratio. Kuaishou is the second-largest short video platform in China behind Douyin (TikTok). Unlike long video platforms like Netflix, short video platforms have very little content cost due to a high degree of UGC and PUGC content. On the monetization side, short video platforms can make money by 1) ads, 2) live-streaming, and 3) eCommerce. In the future, I believe short video platforms can explore even more monetization opportunities through gaming and local services.
Short video platform’s favourable LTV / CAC ratio stems from 1) user behaviour, 2) product format and 3) AI-first product
Even though Kuaishou is behind Douyin in China, I believe Kuaishou’s China business is more like a community of KoL and users whereas Douyin treats KoL as commodity content suppliers. User experience on Kuaishou is more akin to going to a music festival where the music fans go there to see their favourite band whereas the Douyin user experience is similar to listening to a very smart radio programme that only plays music that you like.
I think both Kuaishou and Douyin would do well and continue to take time share in China.
That said, an investment in Kuaishou is very risky and many things can go wrong – competition, execution, new verticals didnt work out, international growth sizzle out. But the upside more than compensates for the downside at the current valuation.
I think Kuaishou could make a net profit of RMB 50-100bn in 2025 in base case and probably still have a respectable growth of 20+%. Hence the valuation feels reasonable to me.
I might write a full post on Kuaishou at some point in the future.
When I initiated the position in 51Jobs (see previous post here), I expect the deal would likely close within 3-6 months. And now 8 months have passed by and the deal is still work-in-progress. So much for my forecasting skill!
But I did get something right when I wrote that:
My guess is that mgmt team will join them in the privatisation deal at some point and hence they only have to buy 50% of the shares outstanding.
That finally happened on 4th May 2021. 51Job announced that the CEO, who owns 17.6% of the shares outstanding, would join the buyer consortium together with another PE fund – Ocean Link. Let just say that Ocean Link as a PE fund is not new to this privatization game.
Currently, there is still a 9% spread available based on the current share price. I think the risk-reward is extremely good from here since the management participation in the deal increased the probability of success significantly.
If I have to make a guess here, the buyer group needs to convince Recruit Holding to either join the buyer consortium or sell out. Once the buyer consortium can reach some kind of agreement with Recruit, then the deal is a done deal. See this Nikkei Asia article here.
While these privatization deals generate small profits in the bigger scheme of things, I enjoy the analytical process of guessing the probability of success.
Nintendo reported, in my view, excellent results for the Fiscal Year (FY) 2021 and it is a real pleasure to be a business owner (and customer) in this fantastic business.
My core investment thesis for Nintendo remains the same: Nintendo Switch is a sustainable gaming platform because it is anchored by Nintendo’s world-class games and supported by a mix of long life-cycle games and new games by both Nintendo and third-party game developers. Nintendo Switch is in a positive feedback loop now where its large install base is attracting more third-party game developers which in turn attract more Switch buyers. If my assumption that the Switch gaming platform would defy the previous console lifecycle of peaking in year 5 and ending in year 7, then I assess Nintendo’s intrinsic value with the following factors: 1) Switch install base, 2) software revenue per install base, and 3) gamer engagement with Switch platform. Continue reading
Investment action: add ~1.3% to Tandy Leather and make it a 3% position. Bought at an average price of USD 4.2
I first purchased Tandy Leather Factory shares in Dec 2019 and it has been a bumpy ride since then. They are still mired in the accounting restatement crisis while being hit by COVID-19. This resulted in delisting and now still trading on the OTC market.
They finally announced a final bit of positive news on 21 Apr 2021. See link here
Tandy Leather announced that its sales for 1Q 2021 is USD 21.3m & have a net cash position of USD 10m. This is a very favourable quarterly revenue trend coming out from covid-19. Generally speaking, Tandy managed the COVID situation well and grew its eCommerce operation significantly.
Strong revenue recovery implies a few things:
Healthy demand for leathercraft
Strength of online channel and specialty retail category such as leathercraft is very well suited to eCommerce
What I don’t know is how much revenue is driven by retail vs wholesale activity
There is a scenario that Tandy use online as an efficient sales channel to expand the reach and only use stores for customer service. In this scenario, we could see higher organic growth even post-pandemic.
But the risks are still clearly there. 1) financial restatement still not done yet & 2) two CFO resignations within one year
However, given that Tandy was able to execute a USD 1m share buyback in Jan 2021 and still maintain a sizable cash balance. Plus they actually survived COVID. The risk of fraud is reduced.
Based on q1 numbers, it seems like Tandy could be doing 80-85m annual revenue in 2021. assuming 7.5% net margin (historical margin is 5-10%), then Tandy could be making 6-8m of net profit this year. The current market cap is USD 36m with 10m of net cash, the implied earning multiple is 6x. Hopefully, once restatement is done, we could see substantially higher share buyback activity
Investment Action: Sold all Avanza shares @ SEK 304 which is roughly a 3% position now
Despite a set of very strong Q1 2021 results, I am going to sell Avanza shares and very unfortunately no longer be part of Avanza’s growth journey from here. I sold a large chunk of the Avanza investment in Oct 2020 at around SEK 185 and clearly my ability to time the market is terrible because Avanza shares trade around SEK 300.
The main reason for selling is the same as before: Avanza’s earning is cyclically high due to higher than usual trading activity from its customers (mostly retail customers). Continue reading
CD Projekt released a strategy update on its website on 30th Mar 2021.
In this strategy update, CD Projekt confirmed that its flywheel strategy to build game franchises – anchored in rich single-player AAA games and then create incremental game content and expansion into broader entertainment format. Continue reading
What a year! Despite being stuck at home for most of 2020, it has been a very eventful year.
The portfolio delivered a net return of 15.6% in 2020 while FTSE Global All Cap index’s return is 16.8% during the same period. Our portfolio’s cumulative return since 2016 is 100% while the above-mentioned index’s cumulative return is 81.9%. Cash is 32% of the portfolio.
I prefer to show the investment return net of imaginary fees because any aspiring investment manager should be able to generate excess return net of fees.
 Assuming a fee structure of 1) no management fee, and 2) a 20% performance fee above 5% threshold i.e. 18.3% – (18.3%-5%)*(20%) = 15.6%
Live Portfolio’s 2020 Investment Return
Live Portfolio Investment Positions as of 31 Dec 2020
The 5-year milestone
During Warren Buffett’s early years operating his investment partnerships, he encouraged his partners to evaluate his investment performance on a 5-year basis and “preferably with tests of relative results in both strong and weak markets”. And so at this 5-year mark, it is time to take stock and reflect.
I am very pleased to generate an annualised return 15.6% over the last five years which has a respectable 2.2% advantage relative to our performance yardstick, FTSE Global All Cap Index, with an annualised return of 12.7%.
Our high cash level, fluctuating around 20-40%, has been a significant drag on investment performance for the last 5 years. Due to a combination of high market valuation and the relatively limited scope of my circle of competence, I have not being able to find enough attractively priced new ideas. While there is nothing I can do about the high market valuation, I am steadily expanding my circle of competence which should ultimately translate into more investment ideas and lower cash level.
This investment return is generated against the backdrop of a generally rising stock market over the last five years. The portfolio did experience a violent but short bear market in March 2020 where we fared better against the general market’s 30% decline with 15+% decline. By and large, I do not believe that I have experienced a full market cycle of bull and bear market to pass Warren Buffett’s test of “relative results in both strong and weak markets”.
Our investment journey has, so far, been very pleasant as we have not suffered a loss in any year so far. But I would like to make a prediction – this investment operation is almost guaranteed to suffer a loss in at least one of out the next 10 years but I just don’t know when the losses would occur. As Charlies Munger said:
“If you’re not willing to react with equanimity to a market price decline of 50% two or three times a century, you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get.”
While I would rather avoid any losses, especially the 50% decline ones, it is better to be mentally prepared for it. Unfortunately, I am confident that my prediction would come true. Better to accept it as a fact of life.
While we are on the topic of making predictions, I believe you are entitled to know my expectations for future investment return even if it is largely based on my simple estimates. You should note that my expectations are in fact more like aspirational goals and risk of disappointment is quite high.
Over the last 100 years, the annual return for US equities averages around ~7.5% while the Chinese equity market generated ~9% average annualised return for the last 20 years. So in the long run, we should expect equity returns to be in the range of 6-9%. For our chosen benchmark of FTSE Global All Cap, it generated 7.5% annualised return since its inception in 2002 which falls exactly in the range of 6-9%. Since the goal of this investment operation is to generate above average return, it is reasonable to expect 6-9% return as the lower end of our future return expectation.
While beating 6-9% might not seem like a very ambitious goal, vast majority (90+%) of fund managers are not able to beat the market consistently after accounting for management fees. This is true globally including US and China. Said in another way, only truly exceptional investors can generate better than average return in the long run. If you do not find an exceptional investor, you are better off with index investing.
But there are a few exceptional investors who has been able to outperform the market very consistently for a very long period of time. So it would be illuminating to evaluate their investment track record and use their track record to form the upper limit of our future investment returns.
Below are my best estimates of some of the world’s greatest investors returns based on publicly available information and I tried to use after-fees net return as much as possible.
World-class investors’ track record
These world-class investors generate long-term annualised return in the range of 15-30% and averaging around 20%. These are truly impressive performance as every one percentage point of outperformance when compounded over long period of time can lead to massive difference in cumulative return. For example, the difference in cumulative return between 10% and 9% annualised return over 10 years is 22.6%. Only world-class investors can sustain the advantage of 10-20 points above the long run equity returns of 6-9% for a long period of time.
In general, I believe it is fair to conclude that any investor who can compound at a rate of 20% net of fee for more than 10 years should be considered a highly competent one. Said in another way, any investor’s achievement of 80% return in any single year is clearly not representative of that investor’s long term performance. While 20% return may not sound like a lot, the power of compounding guarantees a very wonderful result over the long term. Just look at Warren Buffett, 99% of his wealth came only after his 50th birthday!
While I have every ambition to become the best investor that I can be, it is hubris to compare myself against the greatest of investors of all time. So I would consider myself doing a great job if I can achieve 15% annualised return net of all fees for the next 10 years. This is going to be no mean feat considering the current valuation is at alarmingly high levels.