In the off-cycle February letter, Bronte Capital mentioned that travel obligations had prevented a comprehensive quarterly update. This month, they are catching up.
Since late October, the markets have been on an upswing, with junk stocks rallying significantly in months like December 2023 and March 2024. This posed challenges for Bronte Capital. However, the market tone shifted dramatically in April. Their short positions started to pay off, and only minor issues emerged on the long side.
Despite the notable market changes, there isn’t much to report. Their results have been satisfactory, not exceptional. Considering the scale of the squeeze event since October, they view their performance as commendable. They have avoided any major portfolio missteps over the past few months.
This letter focuses on long positions that generated profits, even if their initial analysis wasn’t entirely accurate.
Hibbett
Hibbett Inc (NASDAQ:HIBB) is a rare consumer-facing stock for Bronte Capital, as they typically avoid consumer stocks. Recently, they discussed it extensively. According to Form 13G, they own just over five percent of the company, marking the only instance Bronte Capital has filed such a substantial shareholder notice.
Hibbett received and accepted an acquisition offer from JD Sports Fashion PLC (LON:JD), a Manchester-based global sneaker retailing giant. While it might be tempting to celebrate this outcome and move on, Bronte Capital prefers a post-mortem analysis to maintain honesty.
The deal and its price raise questions about their thesis for Hibbett. They genuinely believed Hibbett’s profits would significantly increase over the next five years. Their argument was straightforward: Nike Inc (NYSE:NKE) had a strategy of favoring distributors that enhanced its brand and sidelining those that didn’t. Bronte Capital believed Hibbett was among the favored retailers and anticipated Nike would diminish competition, potentially including Foot Locker.
Although Nike has made slight conciliatory moves towards Foot Locker Inc (NYSE:FL), nothing substantial has changed. Foot Locker’s results suggest a slow decline, supporting Bronte Capital’s thesis.
Therefore, it is puzzling why Hibbett’s management, whom they consider honest and competent, agreed to a deal at ten times current year earnings. The most plausible explanation is that Bronte Capital misjudged the situation, and Hibbett’s management, having better insight into the business, saw the offer as fair. However, they remain open to alternative interpretations and encourage contact with John for different views.
Additionally, Bronte Capital has outlined their doubts about their analysis of the sneaker retailing sector in an appendix and seeks comments on the matter.
Google/Alphabet
Bronte Capital's largest holding remains Alphabet Inc (NASDAQ:GOOG) (NASDAQ:GOOGL), the parent company of Google, which constitutes approximately 12 percent of their managed funds. This substantial investment has been a mainstay in their portfolio for over a decade. They initiated a significant position in Google back in October 2010, right before the stock experienced an 11 percent dip.
Despite the immediate drop, the investment proved to be remarkably astute. If Bronte Capital had maintained their entire position from October 2010 until now, they would have realized a gain of roughly 1300 percent. However, they have frequently trimmed their holdings over the years—a decision they now regret with each reduction.
In April, Alphabet reported outstanding results. Google Search, now a $280 billion business, is growing at over 10 percent annually and shows signs of accelerating growth. This far surpasses Bronte Capital’s initial projections of Google’s potential.
Initially, Bronte Capital had a defined perspective on Google's growth prospects, detailed in their 2015 client letter. They estimated global GDP at $77 trillion, with the highest advertising spend, as a percentage of GDP, in the U.S. at 1.3 percent. They generously projected global advertising spending to reach 1 percent of GDP, equating to $770 billion. Assuming Google and Facebook captured 30 percent of this market—three times their current revenue—the pre-tax earnings would be $92 billion, translating to a post-tax valuation of $970 billion.
At the time, the combined market cap of Google and Facebook was about $780 billion, leading Bronte Capital to consider these stocks fully valued. Despite this, they retained their Google shares due to a lack of equally high-quality investment alternatives.
Today, the combined market cap of Alphabet and Meta Platforms Inc (NASDAQ:META) (formerly Facebook) is nearly $3.4 trillion, 3.5 times what Bronte Capital once estimated as the maximum terminal value for these companies. Their initial projections fell short for several reasons:
- Global GDP is now closer to $110 trillion.
- Advertising spend continues to rise, surpassing 1 percent of global GDP, largely driven by online advertising, especially Google. Online advertising's measurability and effectiveness have boosted demand, and the shift from physical to online businesses has further increased advertising needs.
- Facebook and Google now account for over 30 percent of global advertising, with Google's ad revenue alone comprising about a quarter of a percent of global GDP and outpacing GDP growth.
- They underestimated the long-term margins, with Meta achieving about 40 percent and Google in the low 30s, even after accounting for growth expenditures like AI development.
- Tax rates are lower than anticipated, and
- The end multiple on earnings is higher, particularly given these businesses' inflation-resistant nature.
Despite these miscalculations, Bronte Capital continued to hold Google stock, recognizing its superior quality and consistent growth. They struggled to find other investments of comparable merit.
Currently, Bronte Capital still holds a significant position in Alphabet, but they acknowledge that their primary reason for doing so was the absence of better alternatives, not a prescient understanding of Google’s future. They admit their projections were comically low in hindsight.
Even with current multiples and growth, Alphabet's valuation does not seem overly expensive. Yet, Bronte Capital finds it challenging to justify holding 12 percent of their portfolio in a stock whose performance and valuation they find inexplicable. Consequently, they plan to trim their position irregularly and may do so sharply if a more attractive investment opportunity arises.
Debt Shorts Analysis
In February, Bronte Capital issued an off-cycle letter detailing their exploration of shorting corporate debt. They targeted companies on the brink of bankruptcy that, surprisingly, had issued billions in debt unlikely to be repaid. Admittedly, this was a new venture for Bronte Capital, and they acknowledged potential risks they might not yet understand.
The letter sparked significant responses, with several individuals sharing their own cautionary tales. Bronte Capital values such insights, preferring to learn from others' mistakes rather than their own—a more cost-effective approach. Notably, their largest client facilitated introductions to other funds experienced in this domain, offering valuable lessons from their past errors.
Bronte Capital maintains a policy of openness to criticism. They encourage feedback, especially when there is a perception of missteps, as they prioritize understanding potential pitfalls. Presently, debt shorts constitute a single-digit percentage of their fund. They have hedged against duration risk but aim to increase this proportion, balancing it against liquidity and risk constraints.
Advancements in System Building
Bronte Capital has invested considerable effort in refining their short book systems over recent years. Managing 700 short positions demands robust identification and monitoring capabilities. While their long book performed well pre-COVID, its post-COVID performance has been merely adequate. They recognize the need for system enhancements in this area, though they anticipate this will be a gradual process.
Their long book serves dual purposes: it must be a sound investment and provide effective collateral and a hedge for their short positions. This dual mandate can often lead to conflicting requirements. For instance, an analysis once identified Cathie Wood’s ARK Innovation ETF (NYSEARCA:ARKK) as the best hedge for their short book among 1700 indices. Despite its correlation, the ETF did not represent an ideal investment.
Bronte Capital plans to make incremental, deliberate modifications to their long strategy. These may involve improvements in screening processes and risk measurement, while maintaining their overall style. They continuously seek opportunities for enhancement, driven by a commitment to excellence.
Closing Remarks
Bronte Capital expresses gratitude for the trust placed in them and remains dedicated to pursuing strategic improvements to maximize returns and manage risks effectively.