GreenWood Investors commentary for the second quarter ended June 30, 2024.
Dear GreenWood Investor:
Our accounts and funds generated satisfactory performance in the first half, modestly outperforming our benchmark. Our separate accounts, which have no hedge exposure, returned 11.0% in the first half vs. 10.2% for the MSCI ACWI. The >5% alpha advantage we had throughout the first six months was eroded rapidly during the end of June, when electoral fears in France ricocheted throughout European markets.
The portfolio outperformance has rebounded subsequent to quarter end, but frankly, this has not been a year where we feel like reaching for excess performance, given the euphoric market conditions experienced up until the last few days. As avid personal users of AI tools, we have our own strong opinions about the AI-hype cycle. Yet, our thoughts on this topic are worthless to you, as there is far more for us to do outside of the most crowded topic in capital markets. Suffice it to say, we have been actively working to eliminate any direct or correlated risk to these factors, which is proving to have added value during these last few days of market turmoil.
We are determined to protect our portfolios from the pockets of over-optimism, and we remain committed to our transformational stories that continue to remain out of favor, nearly across the board.
Coinvestment Updates
“Opportunities multiply as they are seized.” —Sun Tzu
All of the performance generated thus far this year has been generated by our coinvestments, where we intend to add value via our roles in each target’s governance and capital allocation. We are pleased with how each has developed so far this year.
Leonardo SpA (BIT:LDO)
Once again, the largest contributor to performance was Leonardo SpA (LDO IM, contributing 12.7% to our performance). CEO Roberto Cingolani hosted a capital markets day in early March, where the company broke a few records. It was the first time the company has articulated a capital allocation strategy. It committed to going from industry laggard to a leader in its order book, top-line, and operating profit performance.
While for some traders the Ukraine war is old news, important government customers are just adjusting to the “new normal,” which we believe will last at least a decade. The Italian government is mulling near-term orders that would eclipse its total annual defense expenditures. Importantly, these jumbo orders, of which Italy is just a small minority, are largely not included in the 5-year plan that Roberto unveiled in early March. While we are now over one year into our board representation, as I recently reflected on twitter, we are more excited today than when we started the journey.
As the company alluded to in its capital allocation strategy, it anticipates adding share repurchases to its portfolio of capital allocation levers, which gives us comfort we will ultimately be rewarded the longer shares remain the cheapest in the industry.
Source: LDO CMD Deck
MEI Pharma Inc (NASDAQ:MEIP)
Shares of MEI Pharma were weak most of the first half of the year, and removed 3.4% from our performance through June, with some of this under-performance reversing subsequent to the end of the first half. We purchased shares at the earliest possible moment when we could, and I personally joined our activity, as we were able to add to our position at roughly the same levels where we did over a year before.
While biotechnology drug discovery inherently is unpredictable, at times share prices fall below worst-case scenarios for the balance sheet. This often provides contrarian investors with a win-win proposition: a win if the drugs work, and a win if they lose. That has characterized all nine of our biotechnology investments we’ve made since inception.
Subsequent to the first half, MEI took the sobering, but necessary step, of reducing its workforce as it began to evaluate strategic alternatives to maximize the value of these assets. With owners of over 30% of the shares sitting on the board, we are well-aligned with shareholders to ensure we can deliver the highest possible value. We look forward to concluding this brief chapter on a high note in the coming quarters.
Next Coinvestment
We started the year excited to engage with our fourth coinvestment target, where the management welcomed our help in their newly formed mission to turn around an incredibly cheap opportunity. Unfortunately, the opportunity ran away from us during our initial launch period, as the shares have bounced over 50%. While we remain very close to the situation, we have reduced our accounts and funds’ position, having generated >1.5% of performance from this name. Josh’s work with the company has managed to add value even if we are waiting for a better entry point. If it emerges, we will be back in touch, as the company has welcomed Josh’s efforts at a governance level. In the mean time, we remain very busy on alternative opportunities.
Waiting on… CTT
“The big money is not in the buying and selling, but in the waiting.” Charlie Munger
Last but not least from our coinvestments, CTT has added 4.4% to our performance in the first half of this year. We are very cognizant that our journey here began five years ago in May of 2019, when we took a board seat and partnered with a new CEO to transform the company. For both of us, the sense of urgency is high to finish the job that started back then.
Back then, we had the idea that separating the bank from the logistics company would not only simplify the equity stories of each side of the house, but it would also simplify regulatory considerations — all while unlocking a “sum of parts” story. Unfortunately, interest rates converged to zero during 2019, and then went negative in 2020. Bank valuations in Iberia fell from 1.0x book, when we started buying shares, to well less than half of book value by 2020. While the concept had merit, market conditions wouldn’t allow for this dream to become a reality.
Exhibit 1: Iberian Bank Valuations
Data Source: CapIQ. Iberian bank comps include UNI SM, SAN SM, BKIA SM, CABK SM, SAB SM, SAB SM, BCP PT
Since then, the company has rebuilt its profit stream outside of mail with the transformational growth drivers that excite us most — namely being an e-commerce leader in Iberia, and disrupting the incumbent financial services industry. While investors seem to be myopically focused on CTT’s treasury certificates distribution lately, the executives have kept their head down, and continued to execute in the areas under their control, which will grow profitability at least 40% this year.
The CEO recently admitted that the company is considering “all possibilities” on the bank’s future, and it is doing so in a very different environment from 2019 & 2020. Of course, the company recently re-confirmed its 2025 profit targets of €100-120 million, which we believe will just be one step of a journey that has continued to compound for us.
Exhibit 2: Industry Profit & Share Price CAGRs
Data Source: CapIQ for TSR & EBIT Estimates
While the market has been concerned with themes and fashions other than profitability, eventually a company’s profit returns to focus. When the focus returns, CTT will have fewer and fewer shares to divide those earnings by. The company recently began its fourth share repurchase program, with plans to shrink the share count at least another 4%, and is now accessing volume on a wider array of trading venues. This should provide an avenue to conclude this program more quickly than the prior programs. The compounding effect from shrinking the share count, for us, is helping make the wait worth it.
We maintain our high sense of urgency nonetheless.
When The Waiting Is Worth It
“Those who understand compound interest are paid by it, those who don’t, pay for it.” -Albert Einstein
I recently took a trip down memory lane by reading Tommaso Ebhardt’s biography of Sergio Marchionne. The main thing that struck me was how easy hindsight feels on Sergio. I remember purchasing in Fiat, a collection of assets with a market cap just north of €4 billion in 2011, knowing that Ferrari would be worth easily that, once it was separated from the group — a promise that Sergio long made to the truly faithful. At the time, it was a deeply controversial name to own, with a prominent British investor telling conference attendees to short the stock as it was a “crappy company.”
I vividly remember waiting many years for the value of Ferrari to be realized. There were many ups and downs to getting to the IPO, but the whole time, Sergio was busy preparing a business plan for the prancing pony that would truly excite capital markets investors. Had he sold it in 2011 or 2012, he wouldn’t have even cleared the $4-5 billion valuation he was long convinced of, much less the $10 billion IPO valuation in 2015. Even worse, he would have robbed patient investors of the current fair value of $75 billion.
In early 2016, I remember the brutal sell-off around the five year anniversary of our first purchase of Fiat, and how frustrating it felt to own a stock that had failed to keep pace with global indices despite all of the progress Sergio had made. The IPO and spin-off of Ferrari was finally achieved, yet all the while, shares of both Fiat and Ferrari continued to de-rate. Our moment supposedly had come — the sum of parts were getting realized, but in early 2016, those parts were in free fall. Five years into the journey, the trying correction was relatively short-lived, though it underscored how a terrific investment didn’t deliver consistently.
In fact, in hindsight, it seems like an overwhelming majority of the time, the mark-to-market judgement of the Fiat journey told us we (and Sergio) were wrong. Most of the time we looked dumb to continue to believe in the transformation. We looked even dumber in July of 2019, when we sold our Ferrari at what we thought was a very rich 22x forward EBITDA. Of course, shares continued to revalue to higher levels, and we left a lot of value on the table at Ferrari — a painful mistake.
We are reminded of Munger’s wise words above, that the magic of compounding often lies in doing nothing. But that’s only half the story of compounding.
The Other Secret To Compounding
“You have to make a bloody difference! If you have this goal in mind, whatever your job, the satisfaction, even economic, will come during your career.” -Sergio Marchionne
The secret of compounding is not just in the waiting, but applying consistent pressure on a daily, habitual basis. In past letters, I’ve often talked about the importance of management teams having a sense of urgency. Of course, in the case of Fiat, waiting through the significant volatility was worth it for the investor, because Marchionne and his team never stopped working to improve the outcome.
It rarely showed up in the valuation, and sometimes it would not even show up in the financial results, but over time, it showed up in both. The sense of purpose that he and his team had fueled a work ethic that defied normal conventions, which in turn, generated outlier returns for a banal industry.
A sense of purpose has always underpinned the executives transforming both CTT and Leonardo. They have routinely said “no thank you” to job offers that provided far more in compensation and in some cases, much more prestige. Having a great sense of purpose is more powerful than any compensation scheme. It motivates daily behavior to reach for better outcomes, and to have an impact. In interviews, Sergio would consider a manager’s desire to have a fundamental impact on outcomes to be the sole characteristic he needed to work with someone.
This sense of purpose is key to driving consistent, daily effort that make these companies hard to compete against. This daily execution, applied at a near constant level of effort, is key to harnessing the power of compound interest — “the most powerful force in the universe,” according to Albert Einstein.
For investors to have the patience of waiting for compound interest to work its magic, they must have tangible evidence that they are investing in cultures and managers that are applying this consistent effort — and are building companies that are harder and harder to compete against. It’s the reason why BancoCTT is the fastest growing bank in Iberia and CTT Express is “the fastest-growing parcel company in Iberia, indeed in Europe,” as the CEO noted on the most recent earnings call.
The effort is compounding while the denominator, or the share count, continues to shrink.
The Common Denominator
“The secret to success is constancy of purpose.” Benjamin Disraeli
If there is a common denominator to our portfolio — whether or not it’s a situation where we’re actively involved in the governance, or not — is they are companies who are difficult to compete against. They are purpose-built cultures led by owners and founders that come into work every day hungry to make a difference. They all have very undemanding valuations, as they look and feel a lot different from any of their competitors. They are not a mainstream “peer,” and are often penalized by acting differently from the “sleeping giants,” as Sergio would call them.
During our diligence of PDD last summer, the more we learned about culture, the more we thought how unfortunate it would be to compete against these managers. Yet, because it is so relentless in everything it does — especially in not talking to investors — it is heavily penalized by the market, and often called a “fraud.” Since we’ve purchased shares, operating cash-flow has increased around 2.5x, yet shares have lagged this performance considerably. While its international arm Temu will start to lap incredibly difficult comparable quarters, the consistent daily pressure that its high-efficiency business model and ultra-low prices brings to the marketplace will continue to work in our favor.
During the first half, we added to our positions in Rentokil (RTO LN) and Compagnie de L’Odet (ODET FP) as electoral worries over-shadowed the fundamental transformations both have been undergoing. Around the same time we purchased more, we also posted our most recent research on both names on our public research page. We believe the short-term volatility offers us an opportunity here.
Since acquiring Terminix, the best-known pest control brand in the United States, investors have placed Rentokil in the penalty box as Terminix has consistently lagged the performance of its best-in-class competitor Orkin (owned by Rollins, or ROL). Yet far from being “broken,” Terminix has been subject to a financially-oriented board flipping through executives faster than employees could keep up. Terminix is not yet difficult to compete against, but Rentokil’s owner-oriented management team and culture have been fixing the underlying issues of technician retention, which also drives customer retention. As the integration continues to progress, organic growth at Terminix will follow — with customers churning less. Consistent, daily pressure to transform this asset, will be working in our favor as shares remain out of favor. As it succeeds, competitors may find out that the “compounder moat” lies more in consistent daily execution rather than a business model birth-right.
The Uncommon Approach
While we continue to find investments run by owners or founders that we believe represent outstanding opportunities at outstanding valuations, far more of our diligence efforts are spent looking at situations where we can bring our sense of urgency into the governance framework to improve the underlying investment outlook.
We are working on four possible candidates where we believe we can add value. Of course, for us to form a coinvestment initiative around one of these — the stars will have to align. We are not interested in a hostile campaign, and instead would prefer to partner with managers to reach for the discontinuity that we’ve articulated in this letter, and that we see showing up in ambitious industrial plans. Of course, entry points matter, and valuations still matter — even in 2024. So in a way, multiple things need to align for us to reach out with another coinvestment opportunity.
As a prominent local Italian banker told me during the second quarter, as a result of our campaign last year, many companies in Italy are waking up to the value-add potential of a committed, constructively active shareholder on their board. Working in a collaborative fashion, we believe we can partner with purpose-driven managers to achieve outcomes that are worth investing in.
Our brand of governance commits to our companies. We put our skin in the game, and we put our soul in the game. We bring the same 24-7 thought process that characterizes many successful investment firms to the board room. As I wrote in an article on independent boards during the second quarter, the answer isn’t always “yes.” We are not there to be a “yes man.” But the creative and constructive will to overcome challenges, applied on a daily basis, doesn’t stop. Just like compound interest, it can be a powerful ally. But just like compound interest, while half of the genius lies in waiting, the other half lies in a consistent, unyielding effort to build.
Much of our effort remains focused on our core investments surprising and delighting its shareholders in the days ahead. We aspire to be like the managers we study at great length — seeking to apply consistent, daily effort to learn more, achieve more, and generate better performance as a result of it. Yet, we are not confusing mere activity with progress. While our portfolio has changed little throughout the course of this year, a significant amount of effort is going into ensuring we will deliver outcomes worth the journey. We appreciate the opportunity to invest and compound your capital alongside ours.
Committed to deliver,
Steven Wood