Paper Portfolio – February 2020 Update

The paper portfolio is off to a strong start in 2020. During the month of January, the paper portfolio returned 4.18% vs -0.04% for the S&P500. January was the strongest relative month since the inception of this portfolio.

While the index was also off to a strong start in the first two weeks of the year, the S&P500 quickly gave back all of the year-to-date performance as fears around a new strain of coronavirus in China infected the minds of global investors despite the virus’ limited footprint outside of China at the moment. Luckily, the paper portfolio was able to hang on to most of the gains even as the S&P500 turned down.

Last month, the stocks-only portion of the paper portfolio finally started to outperform the S&P500 on a cumulative basis since inception. Due to the continued strong performance of the portfolio, the gap has continued to widen. The stocks-only portion of the portfolio has returned 15.6% since inception vs 9.3% for the S&P500. This month, the paper portfolio as a whole inclusive of cash drag was also able to do so. Since inception, the paper portfolio has now returned 12.2% vs 9.3% for the S&P500.

As discussed in the past, over the long term the paper portfolio should continue to outperform the S&P500 given the superior level of value creation. While valuations are indeed higher for the paper portfolio, as long as we are right about the businesses and business models and their ability to create value, this portfolio should outperform even while experiencing moderate contractions in multiples over time. My belief in the strength of this portfolio has never been firmer.

There were a number of very strong winners during the month including SE, SHOP, SQ, UBER, Adyen, MELI, and PINS.

SE, SHOP, Adyen, SQ, and MELI continue to benefit from overall strengthening of optimism around their core businesses as they continue to execute on their long-term visions.

UBER was the single strongest performer in the portfolio during the month. Not only has insider-selling pressure abated, the company seems to be on a credible path towards profitability as Uber Eats losses get rationalized. The company has already announced a sale of the Uber Eats India business, and the media is suggesting that US rationalization is coming soon as well. The stock should recover towards its IPO price as they make progress towards profitability. However, as discussed over the last few months, I think Uber has very interesting long-term potential. I anticipate a richer stock price in the future.

PINS also performed very well. I did not expect the stock to start working so quickly. PINS was helped by 3rd party app download data that reminded investors that PINS is still one of the most relevant apps even if it does not get as much attention as other social peers like Facebook, Google, Snapchat, Bytedance/TikTok, etc.

On the losing side, ILMN, ALGN, ASML, LVMH, and WORK performed poorly. However, none of these stocks are performing poorly as a result of real long-term issues with the underlying businesses.

ALGN, ASML, and LVMH were all impacted by the coronavirus scare. ALGN’s 2nd largest market is China. Unfortunately, dental offices across the country are currently not operating. China is the key growth driver for luxury businesses like LVMH…unfortunately, the Chinese are likely limiting their time in crowded public spaces at the moment. As a semiconductor-related company, ASML is a higher beta stock, and the semiconductor industry is facing some uncertainties since Wuhan (epicenter of coronavirus outbreak) plays a role in the semiconductor supply chain.

ILMN was the weakest performer in the portfolio. The company’s guidance for 1Q20 was particularly weak. While full-year guidance was okay, it would require a fairly strong ramp throughout 2020 to achieve. I have no particular insights into how the near-term shapes up, but ILMN continues to look like a strong structural winner as precision medicine and genomics play a growing role in our lives.

WORK continues to face lingering pressure as a result of Microsoft’s incredible success across the board. Microsoft Teams is doing well, which creates some uncertainty for WORK. However, the long-term opportunities for WORK and Teams are likely different. The world is big enough for both of them to coexist.

Speaking of WORK…WORK is a great segue into two of the three new adds to the portfolio for this update: ServiceNow (NOW) and Atlassian (TEAM).

Similar to how WORK is transforming the workplace, NOW and TEAM are also transforming how companies operate in their own ways. NOW’s approach to transforming the workplace starts with IT. In most traditional businesses, IT is almost an afterthought and most business segments are run as silos. Perhaps that worked well decades ago, it is inappropriate for the modern workplace. Companies need to move quickly, and technology needs to be a core part of the equation rather than an afterthought. ServiceNow’s platform helps break down silos and threads IT through the entire enterprise. Although ServiceNow is already a very sizable business with $3.5 billion of revenues and ~$65 billion market cap, the addressable market is very, very large. NOW believes it has a direct shot to $10 billion of revenues (and I think likely more in the long-run). Assuming it can get to $10 billion of revs, the stock should likely double to triple.

Whereas NOW offers an incredibly powerful platform for all enterprises, TEAM provides SaaS software that is most relevant for developers and tech-driven enterprises. While this is a smaller subset of businesses, there is no doubt that all businesses will be tech-driven businesses in the future. TEAM offers a best-in-class platform for supporting “agile” work environments. While the company’s original focus was on developers, TEAM is now more broadly focused on enabling collaboration across company teams. The company is rolling out templates that help tailor the platform for functions / roles beyond core developers, which broadens the addressable market.

While both NOW and TEAM are at/near all-time highs, the strong recent performance largely brought both of them out of deep troughs. Given the incredible strengths of both of these platforms, I think it’s most appropriate to overlook the recent runs and manage risk instead through sizing.

The third addition is HUYA. HUYA is the Twitch of China and is the leader of game streaming, especially for mobile games. HUYA competes with DOYU in game streaming. On the platform, you can watch gamers stream their personal games as well as major esports competitions. HUYA provides interesting optionality and exposure to esports. Since esports is a very nascent industry, there are very few ways to gain exposure (currently we have exposure through ATVI, SE, and TCEHY). Although HUYA is higher risk since it does not own any of the underlying game IP (e.g. the IP holder can grant esport competition streaming rights to competing platforms), game streaming has a fairly straightforward route to monetization. HUYA sold off recently as an investment in ESL (a leading esports tournament organizer) failed to close. I think that gives us an interesting opportunity to own HUYA at a small weight.

Disclosures: I own shares in SE, BABA, ATVI, MTCH, SHOP, SQ, TCEHY, UBER, and TEAM. I have no intention to trade any of the shares mentioned in the next 48 hours.