RV Capital Q4 2024 Commentary

RV Capital's commentary for the fourth quarter ended December 31, 2024.

Dear Co-Investors,

The NAV of the Business Owner Fund was €1'200.05 as of 30 December 2024. It increased by 57.9% since the start of the year and by 1'109.5% since inception on 30 September 2008. The compound annual growth rate since inception is 16.6%.

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The €1’000 Bogey

Passing the €1’000 mark was a meaningful milestone for me. This was not because the fund passed the bogey for the first time—that happened in 2021 and meant nothing. It is significant because the fund passed it for the second time. After finishing 2021 at €1’003.77, the fund declined almost 50%, ultimately bottoming out in December 2022 at €526.35. I feel a deep sense of relief that the fund has not only surpassed its prior high but has pushed on since.

A Painful Experience

That drawdown was the most painful experience of my investing career. Fund managers are encouraged to invest in their own funds - to eat their own cooking - on the basis that it aligns their interests with their investors. The idea has merit, but losing my co-investors’ money felt far worse than losing my own. It was a small consolation that inflows into the fund had slowed to a trickle in the run-up to 2022 as the fund was soft-closed. Nevertheless, some investors did invest in this period, including a doctor friend who helped me greatly during a medical emergency in 2022. And in any case, a 50% drawdown is only slightly less painful for investors with a lower cost base. For both constituencies, I felt terrible.

A Medical Emergency

When it rains, it pours. Mid-way through 2022, I had a medical emergency, which was unconnected to the drawdown. I wrote about it in my 2022 letter. I am frequently asked whether one crisis compounded the other. I can emphatically answer “no”. It helped. Confronting my own mortality whilst surrounded by family and dear friends helped put the disappointing performance of the fund in perspective. Delivering great returns is important, but other things are more important. I would have preferred not to have been sick, but to the extent it had to happen, the timing was not so bad.

Getting Back to Par

After the drawdown, I was determined to recover the losses. Rather than fight their way back, some fund managers simply close their fund and launch a new one to start with a clean slate. That was never an option for me. RV Capital is a one-fund operation. Equally importantly, I wanted to recover the losses without taking irresponsible risks. My rough math was that if the fund compounded at 15% p.a., it would take five years to recover. That was fine by me. That it only took two years is a bonus. Importantly, it was achieved through aggressive but not reckless investment decisions. I doubled down on those stocks that I thought had been unfairly marked down in 2022 – mainly Meta and Carvana – whilst selling those where I had lost conviction.

About Drawdowns

Drawdowns are not supposed to be painful. A core concept of value investing is “Mr. Market”, described by Ben Graham in “The Intelligent Investor” as follows:

Mr Market is a manic depressive who goes through periods of euphoria and periods of depression. The intelligent investor, by contrast, should be sanguine about stock market booms and busts and where possible take advantage of Mr. Market’s mood swings.

True value investors are supposed to delight in market crashes. During the stock market crash of 1973/74, Warren Buffett is famously described as a kid in a candy store.

A kid in a candy store was not how I would describe my frame of mind in 2022, more like the footballer who missed the deciding penalty in the World Cup Final.

Why Was I Not More Sanguine?

The most obvious reason is that we were fully invested, and, more pertinently, all our holdings fell in unison. Holdings such as Meta, Prosus and Credit Acceptance fell as seemingly unrelated risks such as Apple’s ATT initiative, the China tech crackdown and used car inflation all struck simultaneously. It is difficult to get excited about things getting “cheap” when the things you hold are getting even cheaper. It is easier to enjoy a downturn if you have capital to deploy or can sell “winners” to buy the “losers”.

A subtler reason is that I felt more viscerally responsible for this drawdown than those in the past. Past drawdowns tended to coincide with broader market drawdowns, such as the Great Financial Crisis in 2008/09 and the pandemic in 2020. However, whilst 2022 was not a great stock market year, it was not a terrible one either. The drawdown was caused, at least in part, by some poor investment decisions in the run-up to 2022, as I discussed in my 2022 letter. I set a high standard for my investment decisions, and not all lived up to it.

Two Lessons Drawn

I draw two lessons from experiencing the drawdown. First, a big downturn may, in fact, probably will coincide with poor investment decisions. I was mentally prepared for a drawdown - I had experienced them several times in the past - just not one in a bad but not terrible market. I should have been. By 2022, I had managed the fund for almost 15 years and largely avoided active investment mistakes resulting in a permanent loss of capital. Was my expectation that this would go on forever? That was unrealistic.

Second, the investments in the portfolio should be as uncorrelated as possible. Within the constraint of a ten-stock portfolio, I tried to maximise diversification - the investments in the portfolio differed by sector, geography, and size - but I could have gone further. This was part of the rationale behind our recent investments in the energy sector. During a geopolitical crisis, oil is one of the few assets that appreciate in price, and I hope our investments there offset losses elsewhere in the portfolio in future crises.

Two Lessons Not Drawn

I would not hold more cash, appealing though the prospect is of having mountains of cash to deploy in a crisis. As I wrote in my 2014 letter, cash is a drag on performance for the long-term investor under most scenarios. Market crashes simply do not happen often enough to offset the miracle of compound interest

I would also not own less tech. What is considered “tech” spans the entire breadth of the economy, ranging from retailers (Amazon) to media companies (Netflix) and even car manufacturers (Tesla). If “tech” is shorthand for a modern company, I am all in. True tech companies depend on transitory technological advantages. By that definition, we had zero “tech” exposure.

Lessons for Capital Allocators

There are enough lessons to draw from the experience to warrant a longer memo. For now, the most important one is that every investment manager should expect to experience a large drawdown in their career. During the crisis, I received some “helpful” suggestions to invest in less volatile stocks. The problem is that volatility is only known after the event. Nestle, a company long celebrated as a “bond proxy”, illustrates this point well. Its share price has fallen 30% over the last five years. There is no avoiding downturns. Investors who do not have the stomach for them are likely in the wrong business.

Correlated to this, it is important to build an investor base that has the stomach for a big drawdown. During the financial crisis of 2008-09, many funds failed not due to poor investment choices but because investors withdrew at the bottom. The lesson I drew was clear – build an investor base that can withstand the inevitable ups and downs of the stock market or, more pertinently, discourage those investors who cannot. This is especially tough in the early years when funds struggle to make ends meet, but it pays off in the longer term.

A final lesson is that every setback is also an opportunity. I know from my conversations with emerging fund managers that they are terrified of launching their funds shortly before a market crash. They need not be. Crashes are infrequent, so normally, the fear is unfounded. But if it does happen, it presents a great opportunity to show the world what you are made of. As the boxer and philosopher Mike Tyson says:

Everyone has a plan till they get punched in the face.

From a quantitative perspective, the Business Owner Fund looks less attractive today than three years ago - the annualised return is lower, and the volatility is higher. However, I believe it is more attractive from a qualitative perspective. The investors know their manager will not leave them in the lurch when there is a setback.

Loyal Investors

On the topic of investor base, a source of satisfaction is that most of my investors stayed the course throughout the downturn. After all, it would have been a pyrrhic victory if the fund had recovered, but everyone had bailed out at the bottom. In this respect, we did well. In 2022, the fund had €14 m of redemptions and €8 m of inflows, giving a net outflow of €5 m. These account for 4%, 2%, and 2% of the fund's average net assets in the year, respectively. To the majority who stayed, I send thanks for your loyalty. To those who left, I send apologies for disappointing you. And to those who invested, I send congratulations. I will be deferring to you on market timing decisions going forward.

What Should Investors Expect?

Whilst I hope that years like 2022 do not happen too often, I would be remiss not to point out that 2022 was not an aberration. Health-permitting, I hope to manage the fund for many decades to come, and if so, we will likely experience comparable or perhaps even worse drawdowns than 2022. This is not - I hope - because the fund is unusually risky. It is because there is a small probability of extreme events in capital markets in any given year. The longer you are active, the higher the chance one hits you. Given that the fund had more or less gone up in a straight line from inception until the end of 2021, I frequently had to explain to investors that the fund could have a large drawdown. Mesmerised by the price chart, they concluded that besides being a genius, I was unusually humble. I am neither. However, today, it feels like the pendulum has swung too far to the opposite extreme with memories of 2022 still fresh.

My expectation is the same today as before 2022. A handful of concentrated bets in businesses run by passionate and engaged owners provide the opportunity for satisfactory returns but the certainty of setbacks. The fund's price chart until 2022 was more pristine, but I prefer today’s. It better reflects reality.

Six Chinese Investments

In 2024, I added four Chinese companies to the portfolio: NetEase, H World, Yum China, and Didi. Including Prosus and PDD, this brings the number of Chinese companies in the portfolio to six and the allocation to China to around 30%.

I summarise all six companies' businesses, history, my investment rationale and any controversies surrounding them. I include Prosus and PDD despite writing about them in my H1 2020 and 2023 letters, as the six together give a sense of the breadth of the opportunity in China today. My aim is to provide my co-investors with an overview of our China investments. These summaries should not be mistaken for exhaustive analyses, though. They do not discuss risks, market dynamics, competitors, etc.

Rich Opportunities

All six companies have different businesses, notwithstanding some overlap between Tencent and NetEase in online gaming. Yet, they all share low valuations and sought-after business characteristics such as wide moats, high returns on capital, and long growth runways. In five out of six cases, they are run or overseen by their founders. They are also returning capital prodigiously, with the one exception of PDD. Yum China leads the way with a 9% annualised capital return. It is not long ago that sceptics argued that Chinese companies would never return capital to shareholders. How times change.

A Basket Approach

The approach I have taken to investing in China is a basket approach. Valuations strike me as cheap across the board, and I do not want to miss out on a recovery by picking the wrong investment. That said, concentration is still high if the six China investments are viewed as a sub portfolio. Some basket approaches skip analysis of the underlying investments, relying instead on statistical cheapness as a source of margin of safety. There is nothing wrong with this, and it worked spectacularly for Warren Buffett for his South Korean investments. It is not the approach I took though. I studied and visited the companies in which we have invested.

Specialists vs. Generalists

Despite my best efforts, I am conscious that local investors retain a significant information advantage over a Swiss-based, non-Chinese speaker like me. I hope this is not disconcerting for my investors. There are both advantages and disadvantages to being a specialist or a generalist. Whilst the specialist likely has better and more timely information, the generalist can see the companies in a broader international context and compare them to international peers regarding business quality, outlook and valuation. Whilst the specialist by definition can only invest in their field, the generalist has the freedom to roam where opportunity seems richest. By investing today, at the depths of a five-year bear market, I hope to maximise this advantage.

China Misgivings

I am conscious that many people have misgivings about investing in China. I attempted to address those in my first-half letter and will not rehash them here. As more Chinese companies burst onto the world stage —most recently Deepseek— my optimism about Chinese entrepreneurship looks prescient, even if it has yet to manifest in share prices.

A Weak Economic Backdrop

The Chinese economy is currently weak. The talk is about consumption downgrades, overcapacity, and trade wars. This is reflected in the most recent trends in the companies’ earnings to varying extents. Weak trends tend to illicit pessimism amongst investors. I take a different view. Companies do their best work when they have their backs to the wall. They sharpen their focus on the customer and double down on efficiency. These actions pave the way for greater earnings power in the long run. It is a bonus that the dour backdrop depresses share prices. In recent years, we saw how this can play out at Meta and Carvana.

Prosus

Prosus, a global consumer internet investment holding company, is the longest-held Chinese investment in the fund, bought in early 2020. Although it is Netherlands-listed, I classify it as Chinese as its largest holding is Tencent, the Chinese tech mega-cap. Prosus' stake in Tencent accounts for 125%(!) of its market value.

About Tencent

The rationale for owning Prosus is Tencent. Tencent is one of China’s oldest Internet companies, founded in 1998 by Pony Ma, who remains the CEO and large shareholder. It initially gained traction with QQ, one of China's first instant messaging clients. Like most early Internet businesses, it had more eyeballs than profits. In response, it integrated other services, most notably gaming, into QQ. This led to Tencent becoming a large game publisher and, more importantly, anchored integration and experimentation in its DNA.

The heart of Tencent’s business today is Weixin, a mobile-first instant messaging app launched in 2011 with 1.4 billion mainly Chinese users. Weixin is deeply integrated into daily life in China, where it is also used for payments, entertainment, accessing services through mini-programs, and many other purposes. It is described as a “super app”, a “Swiss army knife”, or an “operating system”, reflecting its versatility and ubiquity. Tencent does not monetise Weixin directly. Tencent’s primary sources of revenue are online gaming, payments, and advertising. However, Weixin is their connective tissue.

Why Own Tencent?

Tencent has manifold competitive advantages, most notably the network and ecosystem effects that Weixin enjoys. Tencent’s moat is so wide that regulation is likely a bigger threat than competitors, similar to the dominant tech companies in the West.

It is growing revenue at a high single-digit rate despite the weak Chinese economy and leveraging operating expenses to grow earnings faster.

It has a passionate owner-operator in Pony Ma, an engineer at heart, who has shown himself adept at navigating political and regulatory challenges in China.

Tencent’s Valuation

Tencent returns approximately 4% of its market capitalisation annually through dividends and share buybacks. In addition, it has regularly distributed one-off dividends in the form of stakes in its private equity portfolio, most recently Meituan. Earnings should grow in the low to mid-teens, implying an owner return at or above 15% p.a. The P/E, at 15x 2026 earnings, is inexpensive. An overlooked store of value is its extensive venture capital portfolio, which is worth at least US$160 billion or 25% of its market capitalisation.

Why Prefer Prosus?

I prefer Prosus to Tencent because of the wide discount of Prosus’ market value to its NAV and even its stake in Tencent. Prosus trades at 60% of its reported NAV and 80% of its stake in Tencent. A share repurchase program launched in 2022 accretes the NAV per share by around 5% p.a. and supercharges whatever returns Tencent and the remainder of the portfolio bring. I am not optimistic that the discount will close soon, but if it does, it provides an additional source of upside.

Yum China

Yum China is the largest restaurant company in China, operating over 15,000 restaurants in over 2,100 cities and towns spanning every province. Its main brands are KFC and Pizza Hut, but it also operates Taco Bell, two local concepts called Little Sheep and Huang Ji Huang, and partners with Lavazza to develop Lavazza coffee shops in China. KFC and Pizza Hut have 510 million members in their loyalty programs, and 65% of sales come from members.

Yum China became an independently listed company in 2016 when it was spun off from Yum! Brands and listed on the New York Stock Exchange. In 2020, it completed a secondary listing on the Hong Kong Stock Exchange. Yum China operates independently from Yum! Brands under a Master License Agreement. The key terms are a 50-year licence term with automatic 50-year renewals and a licence fee equal to 3% of net system sales.

KFC is Yum China’s stand-out business. It opened its first restaurant in China in 1987 and is now the largest quick service restaurant (“QSR”) brand in China with over 11,000 KFC restaurants. McDonald’s, by comparison, opened its first restaurant three years later, in 1990, and today has around 6,000 restaurants. KFC accounts for 75% of Yum China’s revenue and most of its profits.

No Major Controversy

There was no particular controversy around Yum China when we bought our stake. Pessimism was high around the consumer in general and same store sales in particular. As a result, the yield including share buybacks at our time of purchase was around 13%. Excluding its net cash, it was even 18%!

Why Own Yum China?

Yum China’s competitive advantage lies in its strong brands, particularly KFC. KFC was one of the first brands in China after its economy re-opened. It is well-known and has an enormous membership program. Its brand strength is reflected in exceptional unit economics - new stores boast a payback of around two years.

Yum China has excellent long-term growth prospects. It grew the store count by 1,751 units in 2024 and is on track to reach 20,000 stores by 2026, implying an 11% CAGR. Same-store sales have contracted recently due to weak consumption trends but could turn positive if efforts to rebalance the economy from investment to consumption are successful.

Its CEO, Joey Wat, has run the business since 2018. In contrast to our other investments, she is a professional manager. However, she thinks like an owner—the company plans to return $4.5 billion to shareholders in the three years to 2026. I met her once, and she seemed warm but driven.

Yum China’s Valuation

Yum China’s massive capital return program equates to an annualised return of 9%. Earnings should grow around 10%, assuming mid-single digit % revenue growth and some operating leverage, giving an overall owner return above 15%. At a mid-teens P/E, the valuation is inexpensive, especially given that nearly one-fifth of its market value is held in cash. Comparable businesses such as McDonald's, Chipotle, or indeed Yum! Brands tend to trade on higher multiples in the West, given the favourable characteristics of the QSR business model.

NetEase

NetEase is one of China’s largest consumer Internet businesses. It was founded by William Ding in 1997, who remains the CEO and largest shareholder with a 40% stake. It went public on the NASDAQ in 2000 and obtained a secondary listing on the HKEX in 2020.

NetEase is a global leader in online gaming, developing and publishing numerous successful games across mobile, PC, and console platforms. Together with Tencent, it dominates online gaming in China. NetEase’s strength lies in community-based games, whereas Tencent’s is in session-based games like Honour of Kings.

NetEase’s most successful game is Fantasy Westward Journey (“FWJ”), one of China’s longest-running and most successful “MMORPGs” (Massively Multiplayer Online Role-Playing Games). FWJ was launched in 2001 and has grown nearly every year, illustrating the longevity and durability of leading gaming franchises in their genre. More recently, NetEase landed a big hit with Eggy Party, a Roblox-like game launched in 2023. NetEase also publishes Blizzard’s games in China, the most important of which is World of Warcraft.

NetEase’s other businesses include music streaming (Netease Cloud Music), private label e-commerce (Yanxuan), and online education (Youdao). Their contribution to earnings is not meaningful. In contrast to Tencent, NetEase’s attempts to expand beyond gaming have enjoyed only modest success.

The Gaming Crackdown that Wasn’t

Chinese gaming stocks came under considerable pressure at the end of 2023 when the National Press and Publication Administration floated new regulations to curb excessive in-game spending. With memories of the tech crackdown still raw, investors panicked. NetEase saw a record-breaking fall of 24.6%, losing $14.7 billion in market cap. Tencent fared slightly better with a 12.4% drawdown, its largest since 2008. With the Chinese government keen to restore confidence in the stock market, it was quickly clear that the draft regulations would not be implemented and were not the prelude to a broader crackdown. Despite this, NetEase’s share price did not immediately recover as sentiment weighed heavier than facts, as is often the case in panics. Under this backdrop, we bought our initial position. Since then, the government has made numerous supportive comments about the industry, and the summer’s break-out hit “Black Myth Wuhong” was a source of national pride. In hindsight, it was a storm in a teacup.

Why Own NetEase?

For a long time, I was sceptical about the durability of gaming companies’ moat. As a non-gamer, I thought games were short-lived and hit-driven. I’ve learnt that the opposite is the case. Games that dominate their genre have very high lock-in as players invest time acquiring skills, spend money on virtual items, and form friendships with fellow gamers. All this is lost if a player switches to a different game. Analyst Matthew Ball describes in “The State of Gaming in 2025” the phenomenon of “black hole” games - franchises with such a hold on players that it is virtually impossible for a new game to pull them away.

NetEase has good growth prospects. Growth was subdued in 2024 due to a lack of new launches and challenges at two of its biggest hits, Eggy Party and Fantasy Westward Journey. 2025 should mark a return to high single-digit revenue growth driven by the launch of several promising games at the end of 2024, including Marvel Rival, further launches over the year, and Blizzard games' return to China. International gaming, in which NetEase has invested for many years, should increasingly drive growth.

It has an owner-operator in William Ding. Like his peer Pony Ma, William Ding is well-known for being a passionate engineer dedicated to his company. Given his high ownership stake, he is well-aligned with other shareholders.

NetEase’s Valuation

NetEase returns around 60% of its net income to shareholders through dividends and share buybacks. In 2024, the capital return was around $3 billion or 5% of its $60 billion market value. Additionally, NetEase has net cash of $18 billion, which provides further firepower to return capital. Including some operating leverage, earnings growth should be around 10% giving an overall owner return of 15%. The P/E is in the mid to low teens, which is an attractive price for such a high-quality asset. Excluding cash, the P/E is even lower.

H World

H World is China's second-largest hotel operator in China, operating around 11’000 hotels with over one million rooms across 18 countries. H World has eighteen brands, but the most important are HanTing and Ji Hotel in the economy and midscale segments. In 2019, it bought the Steigenberger brand and expanded internationally.

H World was founded in 2005 by Ji Qi. Ji Qi is a serial entrepreneur known as the “godfather of entrepreneurship” in China. He founded and successfully listed three companies within ten years—Trip.com (the online travel agent, then known as Ctrip) in 1999, Home Inns (the Hotel Group) in 2002, and H World (then known as HanTing Hotel) in 2005. Since 2021, he has been Executive Chairman, having retired as CEO. He owns 30% of the company.

H World operates most of its hotels under so-called manachise agreements, which combine elements of franchise and management contracts. H World appoints the hotel manager and collects fees from the franchisees (typically around 12% of revenue), whilst the hotel owner bears most operational costs and risks. In return, they can use H World's brands and booking system. The manachise model has allowed H World to expand rapidly without tying up capital in real estate whilst maintaining brand standards across the network and leveraging the expertise of local hotel owners.

H World owns the world's largest hotel membership program, H Rewards, with 228 million members. It was an early proponent of technology, with many of the processes at its hotels, including check-in, digitised. Its app has over 180 million registered users.

Why Own H World?

Chinese hotel owners enter a franchise agreement with H World to achieve a better return on capital. This means achieving higher occupancy, better room rates and greater operating efficiency for a lower investment. H World is competitively advantaged to help them achieve these goals. Its brands and membership program are important sources of traffic. Typically, 70% of room nights are booked by members, and 60% are direct bookings. Processes are standardised, allowing franchisees to achieve higher operational efficiency. For example, the staff-to-room ratio at HanTing, at 0.16, is the lowest in the industry. And it achieves economies of scale in procurement and hotel design, which it shares with franchisees. In Shanghai, I saw the latest Ji Hotel design – Ji Hotel 5.0. It is beautifully designed, pragmatic and high-tech.

In Ji Qi, H World has one of China’s most successful entrepreneurs. Although he no longer runs the business, he has skin in the game as the largest shareholder. As Executive Chairman, he oversees all major strategic decisions.

H World has strong growth prospects. It typically opens around 1’200 new hotels p.a. Its mid-term target is to get to 15’000 – 20’000, which implies a near doubling at the high end. The market tends to fret over trends in “RevPAR” (revenue per available room), which have been negative recently due to the weak Chinese economy. However, I view hotel growth as a better indicator of H World’s long-term earnings power. One benefit of the weak economy has been increased hotel supply, enabling it to accelerate openings.

H World’s Valuation

With a P/E in the high-teens, H World is attractively valued, especially considering earnings are likely in a cyclical trough. The owner return should be comfortably at or above 15%. In July, it announced a three-year shareholder return plan of up to US$ 2 billion or 20% of its market value. Whilst it is committed to paying out 60% of earnings as a cash dividend (equivalent to a 4% yield), the share buyback is contingent upon the share price. A return of 5-7% p.a. seems plausible. The weak economy tempers the short-term growth outlook but should track hotel growth in the medium term.

Didi Global

Didi is one of the world’s largest mobility services platforms. In Q3 2024, it facilitated 3.6 billion rides with a gross transaction volume (“GTV”) of $15.6 billion. By comparison, Uber facilitated 2.9 billion rides with a higher GTV of $41 billion, thanks to food delivery. Didi’s main market is China, where it offers rideshare, taxi hailing, bike sharing, and chauffeur services. Internationally, it is active in 14 markets, the most important being Brazil and Mexico. It holds stakes in early-stage companies active in intra-city freight and self-driving cars. It also owns 3% of Chinese auto OEM XPeng and 5% of Grab.

Didi was founded in 2012 by Cheng Wei, who remains CEO and a large shareholder with a 6.5% stake and 39% voting rights. Like most industries in China, ride share’s early years were characterised by overcapacity and subsidy wars. In the halcyon days of a regulatory free-for-all, Didi consolidated the market, buying Kuadi in 2015 and Uber China in 2016. Uber retains an 11.9% stake in Didi from that transaction. Today, Didi is the dominant player in China, with a 70% market share.

Busted IPO

In June 2021, Didi raised $4.3 billion through a listing on the NYSE in an ill-fated IPO. Immediately after the IPO, Didi found itself in the crosshairs of the Cyberspace Administration of China (“CAC”) and China’s State Administration for Market Regulation (“SAMR”). The CAC ordered the removal of Didi’s app from app stores in China, preventing Didi from signing up new users and causing a precipitous decline in Didi’s share price. In June 2022, it was de-listed from the NYSE and since then only trades on pink sheets. Didi’s IPO and Ant Financial’s failed IPO are likely the two signature events that triggered the bear market in Chinese equities, which arguably persists until today.

Is Didi Investable?

Didi is likely viewed as uninvestable by many people given its run-in with regulators and de-listing. I view this as mistaken. Didi rehabilitated itself with regulators through rectification measures and a $1.2 billion fine, and since January 2023, its app has been restored to app stores. Regulators have three priorities – good driver relations to promote social harmony, a stable platform to support consumption, and good shareholder relations to bolster the stock market. The regulators’ priorities align well with Didi’s, so I do not expect any regulatory hiccups, let alone a repeat of 2021. A primary listing, likely in Hong Kong in 2026, should end its stay on the pink sheets and draw a line under the affair.

Why own Didi?

Didi is a wide-moat business. Rideshare platforms operate as two-sided marketplaces, where the value for one side (riders) increases as the other (drivers) grows and vice versa. Riders benefit from shorter wait times and better coverage, and drivers benefit from greater earnings from more frequent rides. The network effect is so strong that Didi maintained its dominant position throughout the crisis.

Didi has good growth potential. While rideshare is highly penetrated in tier-one cities, traditional ride-hailing services still make up 50% of the Chinese market. Lower-tier cities are expected to grow their penetration to the level of tier-one cities over time. To promote the transition, Didi initially allows ride-hailing services to use its platform free of charge in lower-tier cities. Furthermore, Didi anticipates gradually growing its take rate from today’s level of 20%. It has room to grow with the regulatory cap set at 29%.

Didi’s Valuation

The valuation is cheap, likely because of Didi’s checkered history. Like many companies that IPO shortly before a crisis, its balance sheet carries a lot of excess cash. Given a current market cap of $24 billion, $6 billion of net cash, and $1.5 billion of non-core holdings, its enterprise value is $16.5 billion. It targets $2 billion of EBITA in its core China segment in 2026, implying an EV/EBITA of 8x. Its owner return should be comfortably above 15%. A $1 billion share buyback should reduce the share count by around 4% p.a. Earnings growth should be double-digit, assuming high single-digit revenue growth and some operating leverage.

PDD Holdings

PDD is one of the world’s largest e-commerce platforms operating as Pinduoduo in China and Temu internationally. It sells general merchandise, and in China, it also sells agricultural produce.

PDD was started in Shanghai in 2015 by Colin Huang. Despite facing two entrenched competitors in Alibaba and JD, today, it is the second largest e-commerce player in China. PDD’s key innovation was pioneering social commerce through a TikTok-like product feed in its app. The advantage of an algorithmic feed is that it can capture user demand higher up the purchase funnel. It also allows for cost to be taken out of the value chain. For example, a manufacturer can make one SKU in bulk based on demand rather than produce endless variants of the same SKU to optimise search results. Colin calls this “mass customisation at scale”. PDD brought other innovations to market, including gamifying the user experience, connecting customers directly with factories (“C2M”), and subsidising prices to acquire new customers.

In late 2022, launched Temu, the international version of its app incorporating many of the elements that made it successful in China. Two years later, Temu is the world's second most visited e-commerce marketplace per Similarweb. Amazon implicitly acknowledged Temu’s price advantage when launching a competing service, Haul, as:

a place to discover even more affordable fashion, home, lifestyle, electronics, and other products with ultra-low prices and typical delivery times of one to two weeks.

(My emphasis)

Controversies around Temu

Today, Temu’s model appears under threat. Western governments aim to eliminate the de minimis threshold, under which Temu can send low-value packages without paying duty, and many countries have imposed or intend to impose tariffs on imports from China. I doubt these measures will have much effect in the long-term as there is more to Temu than a simple tax arbitrage. Temu eliminates much of the cost embedded in Chinese goods sold by local merchants in the West, including markups by middlemen, expensive online ads, inventory obsolescence, and multiple other inefficiencies. They are more likely to make Temu stronger. For example, Temu wants manufacturers to adopt the semi-managed model (where they position goods in local warehouses) instead of the fully-managed model they adopt today (where Temu ships directly from China). The threat of tariffs and the removal of the de minimis threshold should provide new impetus to this push.

Why Own PDD?

PDD is a wide-moat business. It operates a two-sided marketplace where the value for one side (consumers) increases as the other (manufacturers) grows and vice versa. Manufacturers gain customers (a particularly acute need in China given weak domestic demand), and customers benefit from lower prices and more variety. It also benefits from a data network effect as the more user data it collects, the better the algorithm matches products to customers. It also has cost advantages thanks to its frugal – some argue too frugal - culture.

PDD has enormous growth potential. Its more mature China business is growing at 20% p.a., thanks to the appeal of its ultra-low prices to cash-strapped Chinese consumers. Temu is growing much faster, albeit from a low base, as it only recently launched in many countries.

In Colin Huang, PDD, has one of China’s most successful entrepreneurs as its largest shareholder. He no longer holds an official role at the Company but remains engaged.

PDD’s Valuation

The valuation is very low, likely due to the negative news flow on Temu. PDD’s P/E is likely in the high single digits. It is even lower, excluding its monster cash pile of nearly $40 billion. I do not share the pessimism around Temu, but in any case, Temu is a small part of PDD’s business. The owner return is comfortably above 15% as earnings should grow far more than this, however, the company does not return capital to shareholders today despite having a huge cash balance and a highly cash-generative business model. The intrinsic value of any investment is the sum of future cash flows to shareholders. Should PDD never return capital, its value is effectively zero. However, I expect it to return capital over time.

A New Investment in Aker BP

Last year, we were not only active in China. We also made a second investment in the energy sector in Aker BP.

Aker BP is a Norwegian oil and gas company engaged in exploration, development and production on the Norwegian Continental Shelf. It is one of Europe's largest independent E&P companies, producing 439 mboepd (almost 0.5% of the global output) in 2024. Of the volumes sold in 2023, 86% was oil and liquids, while 14% was natural gas. The production primarily comes from six major hubs: Alvheim, Edvard Grieg/Ivar Aasen, Johan Sverdrup, Skarv, Ula, and Valhall, whereby Sverdrup is by far the largest.

Aker BP was formed in 2016 when Det norske oljeselskap, a Norwegian oil company, merged with BP’s Norwegian assets. Det Norske’s largest shareholder was Aker ASA, an industrial holding company controlled by colourful Norwegian entrepreneur Kjell Inge Rokke. Rokke launched his business career by purchasing a 69-foot trawler in the US in 1982 and came to dominate fisheries on the US West Coast. After the merger, the company was renamed Aker BP. In 2022, Aker BP bought Lundin Energy’s oil and gas business. Today, Aker Capital is the largest shareholder at 21%, followed by BP at 16% and the Lundin family at 14%.

Aker BP and the International Petroleum Connection

I came across Aker BP through the International Petroleum ("IPCO") connection. IPCO's CEO Will Lundin kindly introduced me to Ashley Heppenstall, the chairman of IPCO and a board member of Aker BP. Ash is an industry insider who has seen it all (he was CEO and President of Lundin Petroleum from 2002 to 2015) and tells it as it is. The technical term for people like Ash is “old school.” He mentioned I may want to look at Aker BP.

Under a backdrop of rising share prices for energy companies, Aker BP’s stock had been beaten up on two fears – first, that Johan Sverdrup, its giant oil field, was entering decline, and second, that mega-project Yggdrasil was in jeopardy due to procedural errors in the licensing process. Ash thought the fears were overblown. He pointed out the industry truism:

The big fields get bigger.

He also opined that Yggdrasil was too important for the Norwegian economy to be stalled for long. He was right on both counts.

Intrigued, I dived deeper into Aker BP and found a lot to like. The two things to focus on at oil companies are their cost position and reserve development. Aker BP is best-in-class in both respects.

Saudi-like Production Costs

Aker BP has ultra-low production cost of $6.3/boe. Sverdrup is even lower at $2/boe. These are at the bottom of the cost curve. Aker BP has done a great job of increasing reserves. From 2015 to 2023, 2P reserves increased from 498 to 1’716 mmboe. Projects under execution should add 770 mmboe in volumes by 2027. The backstory of these projects is intriguing. During the covid pandemic, the Norwegian government launched time-limited tax incentives to encourage investment. When most investors were focused solely on free cash flow, Aker BP went all-in and sanctioned every viable project in its pipeline. I love to see this type of countercyclical behaviour.

Aker BP has other appealing characteristics. It has one of the lowest emission intensities amongst its peers and aims to be net zero by 2030. Norway is politically stable, and its tax regime is supportive.

A Culture of Excellence

What I particularly liked is Aker BP's entrepreneurial culture. CEO Karl Johnny Hersvik told me about how he was hired. He had a chance encounter with Kjell Rokke in a coffee shop. They discussed what was wrong with most oil companies and what he would do differently. Rokke made him CEO of Det norske in 2014 with a mandate to go and do it. Hersvik may not be the founder, but he effectively is one.

Performance-First, not Safety-First

The key to the culture is what one former employee described to me as “focus on the asset”. Hersvik transformed the company from an exploration company to a development and production company. He emphasises that the culture is performance-first, not safety-first. The point is not that safety is less important, but that mediocrity will pervade all areas, including safety if there is no culture of excellence. Aker BP developed the alliance model for larger projects, whereby suppliers share risk and reward, creating alignment and common incentives. It sounds deceptively simple, but most companies are culturally not set up to do this, as executives are loathe to hand the reins to suppliers.

Capital allocation is also first-class. Thanks to a series of smart transactions, the company is what it is today. In his tenure, Hersvik has acquired and successfully integrated over 25 acquisitions. More recently, Aker BP has pivoted to organic growth. At 25%, the IRRs on its own projects are far higher than on M&A.

12% Dividend Yield

Companies with advantaged cost positions, strong cultures, outstanding track records of deploying capital, and supportive shareholders tend to command premium valuations. In the oil sector, different rules apply. Aker BP has a dividend yield of around 12% p.a. The dividend can likely be maintained in most oil price scenarios given Aker BP’s strong balance sheet (leverage is just 0.2x). The dividend alone would make Aker BP a decent investment. However, it aims to grow as well. It targets raising production from 440 mboepd to 525 mboepd by 2028. Its ambition is to raise the dividend by 5% p.a. This would comfortably give us a 15% owner return.

Business and the Moral High Ground

A few weeks ago, I listened to a talk by a woman about the business she had built. She was articulate, likeable, and clearly understood her domain well. She is also a board member of one of the two largest supermarket groups in Switzerland. The retail business is outside her domain of expertise, but it is not unusual for board members to be industry outsiders. An external perspective on key strategic issues is welcome. Coop and Migros, the Swiss incumbents, are struggling due to competition from discounters Aldi and Lidl, who are taking market share and putting pressure on prices. I was keen to hear her take.

What came next surprised me. She claimed the discounters’ success was due to under-investing in apprentices, squeezing suppliers, and neglecting environmental standards. The Swiss incumbents were struggling due to their higher ethical standards. “Shouldn’t farmers also be allowed to earn a living?” she asked rhetorically.

As it happens, I know a bit about the German discounters. Some fifteen years ago, Andreas recommended a book about Aldi’s business model called “Konsequent Einfach,” which translates as “Consistently Simple.” I was so taken by the book that I wrote to Charlie Munger suggesting Aldi might be a risk to his Costco investment (luckily, he ignored my advice!). The book shaped my thinking about retail and business more broadly.

Consistently Simple

As the book title suggests, Aldi’s success is not due to harming Switzerland’s youth, farmers or environment but keeping things simple. Author Dieter Brandes argues Aldi’s secret sauce is limiting the number of products it sells or “SKUs” to around 750 (it has gone up since). A limited selection creates numerous efficiencies: stores can be smaller (saving on lease expenses), and Aldi can build more (shortening customers' travel times). Furthermore, each SKU has a higher turnover; for example, rather than having five brands of washing powder in three different sizes, it has one that turns much more quickly. This creates supply chain efficiencies, scale economies, and fresher produce and lower waste in the case of perishables. Thanks to its business model innovation, Aldi takes cost out of the system and passes some of the savings on to consumers.

The board member’s analysis of the Swiss supermarkets’ travails was wrong in two respects. From a business perspective, the root cause of the incumbents’ problems was a loss of competitiveness, not their higher ethical standards. From an ethical perspective, the discounters are more virtuous as they drive improved living standards.

So why was she so misguided? It was not due to a failure of intellect or maliciousness—she was smart and likeable. She was wrong, likely because taking the moral high ground feels more comfortable than facing a loss of competitiveness. If the entire board thinks similarly, I am pessimistic about Coop and Migros, absent regulatory intervention.

The Temptation of the Moral High Ground

While the Swiss grocery market might seem like a niche topic, the underlying phenomenon resonated with me: incumbents frequently seek the moral high ground by accusing new entrants of harming consumers, society, or the environment. Occasionally, these accusations are fair, though more often, they are not. Most of the time, innovations have upsides and downsides. The former tend to outweigh the latter. However, incumbents generally focus on the downsides rather than acknowledge the inevitable trade-offs.

Our investments in Meta and PDD Holdings illustrate this phenomenon well. Both companies are constantly attacked by incumbents - by traditional media in the case of Meta and by physical and online retailers in the case of PDD. Both companies’ business models unquestionably have their downsides. Social media can be used to spread misinformation, and cross-border e-commerce has an environmental cost. However, I am convinced that both companies are a huge net benefit for society. We are better off in aggregate when information and goods flow more freely. Traditional media should not have the right to dictate what news people consume, and Western retailers should not have the right to add their markup to imports from China. Even if you disagree, the point is moot, as the clock cannot be turned back on the Internet or globalisation.

Implications for Investors

Amidst all the noise, such accusations could be a signal that the innovative competitor is on the right track. Disruptors typically succeed by introducing new technologies, business models, or cost structures that challenge the status quo. If incumbents feel compelled to discredit them, it indicates they are gaining traction in the market. Given their high growth potential, they may be good investments, especially if the accusations scare other investors away and cause them to trade at a discount to intrinsic value.

At the same time, these accusations could signal that incumbent companies are struggling to compete. More critically, they reveal that the incumbents prefer to retreat to the moral high ground rather than adapt strategically. This bodes ill for their future earnings growth. The combination of high legacy earnings and a depressed outlook may cause their stocks to trade on low P/E ratios, attracting bargain hunters' attention. In this situation, though, the incumbents are likely value traps.

The Role of Regulation

Which investment ultimately turns out best may be determined by regulators. If incumbents are successful in shaping public opinion against the new entrant or enlisting regulators to their cause, it may lead to new laws and regulations that blunt the new entrant’s competitive edge or block its business altogether. In this respect, incumbents have a significant advantage. They are likely better politically connected than the upstart. They have current employees, customers, and suppliers who can advocate for them, whereas the new entrant’s future stakeholders have no voice. And they are highly motivated to make their case, whereas the innovator’s customers may be less motivated because they take the innovation for granted. For example, the 40 million packages arriving in the EU daily suggest that Europeans quite like Temu and Shein. Yet, I do not see them taking to the streets to support the de minimis threshold that has allowed the Chinese e-commerce players’ businesses to flourish.

Ultimately, investors need to navigate these dynamics by answering the questions. Is the innovator’s business model scalable and sustainable? Is the incumbent capable of adapting and innovating in response? And what will the regulatory response be?

My focus is on the former two questions. As an optimist, I believe a company with a better mousetrap will succeed. Regulation may slow things down, but ultimately, it cannot stop progress. Regulation often strengthens the new entrant by forcing it to innovate faster, as Chinese tech company Deepseek recently demonstrated. In response to export restrictions on GPUs, it simply figured out how to use what it had more efficiently.

What are the Broader Implications?

There is an obvious parallel between grocery retail in Switzerland and what is happening in Europe more broadly. Europe’s pro-regulation stance often stifles innovation. It likely feels good to the bloc’s politicians to take the moral high ground and draw attention to the downsides of many innovations, which, to be clear, are real. It is also likely not coincidental that foreign companies bear the cost of this regulation as Europe has so few indigenous tech champions. However, what is expedient in the short term is likely to be a disaster for the continent in the medium to long term. A continent that blocks innovation is doomed to decline.

It is doubtful that the EU can continue to impose its regulations on the rest of the world for much longer. European companies (though not Europeans working at American ones) have contributed little to the AI revolution with the exception of ASML. Yet, the EU believes it can dictate regulations to the rest of the world. Neither the US nor China will tolerate this. The EU will have to choose between dialling back its regulatory ambitions or blocking Europeans’ access to cutting-edge AI applications. It seems to be leaning toward the latter (the AI functionality of my Meta Ray Bans does not work in the EU). The stance will only accelerate the continent’s demise.

Conclusion

From a societal perspective, I believe people greatly value innovative products and services despite their downsides but do not fully comprehend how dependent they are on supportive regulation to exist. The topic of regulation is not what mobilises millions of people to take to the streets and protest. It is too niche and too arcane. However, I believe it would if people better understood the direct line between innovation and prosperity, and the constant threat that innovation faces from regulators egged on by incumbents.

From an investing perspective, I believe innovators can represent excellent investment opportunities, especially if incumbents’ attempts to discredit them cast a shadow over their share prices. The next time you read that one of our investments is bad for consumers, society or the environment, I understand if your initial reaction is: “Rob seems to have lost his moral compass”. However, I hope your second reaction is: “It sounds like Rob might be on to something.”

The Annual Gathering in Engelberg

Andreas and I hosted RV Capital's 9th Annual Gathering in early January. It brought us both great pleasure to see so many old friends and make new ones. Thank you all for coming. If you missed the physical meeting, videos of all sessions are available on YouTube. We held a topical panel for the first time this year: on China. I can thoroughly recommend it. There is a range of viewpoints, and not all reflect my own thinking, but that is totally okay—the point of a panel is not to echo the host's opinion...gaddammit!

La Decima

Next year's event will be the 10th anniversary or as Real Madrid fans say: La Decima. It will take place on the weekend of 10-11 January 2026. I normally open registration quite close to the event as by then, I figure attendees have a better idea of their schedule in January. The downside is that many hotel rooms, including those at the Hotel Terrace, are already taken. For this reason, I will open registration earlier this year on the 23 May 2025. Precise details on how to register will follow nearer the time. I realise that between May and January, a lot can change. I would appreciate it if you cancel your ticket if you register and your plans change. Engelberg does not have a basketball stadium, and we try to optimise numbers so that the ballroom at the Terrace is full, but not too full.

In the meantime, all the best for 2025, and happy investing!

Rob