Paper Portfolio – July 2020 Update

The Paper Portfolio did very well in June.

Initially, the Paper Portfolio lagged the index early in the month as investors furiously bought stocks related to economic reopening (including a number of very questionable bankrupt companies like Hertz)…the Paper Portfolio, unfortunately, has limited exposure to that theme. But, fortunately, our timely addition of Boeing allowed us to at least partially participate since Boeing is one of the few long-term secular businesses that is suffering at the moment. I know it is hard to imagine when we will go back to normal travel patterns, but there is no doubt in my mind that travel remains very much a long term secular growth industry.

Interestingly, by the end of June, most of the reopening plays have almost completely reversed course (because, of course, a number of these companies are bankrupt…), while the vast majority of secularly-driven businesses in the Paper Portfolio continued to drive higher. And even more fortunately, Boeing not only did not mean revert but actually lands in the top 5 performers in the Paper Portfolio for the month.

For June, the Paper Portfolio increased 11.45%. The stock-only portion of the Paper Portfolio increased 12.05%. This compares against the 1.78% increase delivered by the S&P500.

This brings year-to-date returns to 44.54% for the Paper Portfolio vs -3.18% for the S&P500.

SE and SQ (our two largest positions) were also our two best positions in June. SE returned 34.39%, while SQ returned 29.43%.

SE is not only a beneficiary of the current COVID-19 disruption, but the company also announced very promising statistics around their payments efforts during their latest earnings release. In less than a year, they have been able to drive incredible adoption of Shopee Pay because of COVID-19 as well as the linkage of Shopee Pay to their e-commerce platform, Shopee. Now SE truly has a trifecta of businesses (digital entertainment, e-commerce, and payments) that no other player in the world can match.

June was an unusual month for SQ. SQ technically is seeing a lot of pressure on their offline merchant base (many restaurants) due to COVID-19. However, the company’s recent commentary suggests offline pressure is not as bad as expected and should improve because of gradual reopenings. At the same time, SQ was able to recapture a lot of transactions online space. And, of course, as Capital Flywheels has flagged repeatedly, SQ’s Cash App is on a rocket ship at the moment. Everything points up.

Boeing came in 3rd at +25.68%. This ended up being a very lucky call last month. At one point it was up as much as 60% during the “reopening” craze. While it has done well in a very short period of time, Boeing remains attractive over a long horizon, and hence it makes sense to continue to sit on a decent sized position here.

A couple of other names that returned more than 20%: Shopify (25.26%), Cloudflare (23.67%), TAL (another very timely and lucky addition last month, 21.11%), Match (20.23%), and Huya (20.30%).

On the losing side, Uber and Slack are the two major disappointments. Uber declined 14.43% due to their failed bid for Grubhub. Grubhub ultimately sold to Just Eat (a UK player). This delays market consolidation in the US. On top of this, with virus cases rising, reopenings may be reversed, which would lengthen the impact on Uber’s ridehailing business. Overall very messy near term situation. As for Slack – the company reported strong earnings but did not meet expectations. The specter of competition with Microsoft Teams continues to overshadow Slack, in my opinion.

This summer is going to be the moment of truth. There is absolutely no question in my mind that the US has severely and incompetently handled the COVID-19 crisis from a medical perspective. Yes, the impact on the economy should be taken into consideration but we were neither here nor there. We partially shutdown, which devastated our economy but with only 50-60% compliance with lockdowns, we devastated our economy without actually putting out the virus fire. In comparison, Europe (with twice the population of the US) have achieved monumentally better results even though they were less prepared (virus hit Europe first). They have less cases and less deaths AND can now return to a more normally functioning economy. We, on the other hand, have more cases, more deaths, AND lower ability to return to normal soon. It is unbelievable to Capital Flywheels that so many people cannot understand that giving up our liberty for 2 months by wearing a mask in order to avoid 2 years of COVID-19 chaos is an EXCEPTIONALLY good trade-off. Now we are unlikely to be able to take that choice again because the virus has spread too widely to control. The economy was never meant to be shut down indefinitely so of course we are and will reopen. Some people will survive. Some people will die. Good luck to us all.

Almost 250 year ago, the people of Boston, Massachusetts dumped 342 chests of tea into the Atlantic in defiance of the British Empire, sparking the revolution that would create the wonderful country, the United States of America. The history books record this as a heroic event based on principles such as that of Liberty. The event is remembered as important and not silly because no history book records the event as people fighting over the asinine and frivolous boxes of tea that somehow caused a revolution. The actual 342 boxes of tea certainly meant nothing to the British Empire or the American colonists…50 years from now when the history books are written on COVID-19, maybe the historians will record the event as one of heroism and of how people fought for liberty (“Give me Liberty or give me COVID-19 death!”) by not wearing a mask…but Capital Flywheels strongly believes history will record this period as one of utter foolishness because the political system has somehow coopted something that is good for everyone into a question of liberty and choice. In our every day lives, our liberties are always in a constant struggle with the laws of the land. We do not generally complain about them (For example, why can’t people walk around naked in the name of liberty? Why should child sexual abuse be illegal if people’s liberties desire it?). The answer is that none of those things have been coopted to represent liberty. Yet somehow masks are.

Given the uncertain COVID-19 situation (and Capital Flywheels’ expectation that the US will continue to deal with a very stressful situation until at least mid-2021 (late 2021 seems more realistic timeframe for “returning to normal”), the Paper Portfolio will continue to prioritize secular stories that are levered to the digital world for the July rebalancing.

The Paper Portfolio will completely sell HUYA and WORK and add Wix (WIX) and Zoominfo (ZI).

While Capital Flywheels would like to hang on to HUYA and WORK, Capital Flywheels believes it makes sense to preserve decent cash cushion given the environment. In order to add WIX and ZI, we therefore have to sell in order to make room.

WIX is a leading website builder. Historically, it is not that exciting of a business but they are taking a page out of Shopify’s playbook and have / will release a number of products serving e-commerce businesses. This creates interesting optionality.

Zoominfo is a leading sales intelligence platform. Their database allows salespeople to figure out who to contact at target organizations in order to pitch products / services. This is incredibly valuable because salespeople can only sell if they know who to sell to. Zoominfo has a lock on most of that data.

We have now wrapped up half of 2020 (what a year so far!). While Capital Flywheels personally believes things in the US could be in much better shape if people’s minds were more open (e.g. maybe acknowledge that the fight for liberty does not NEED to happen over something as trivial as wearing a mask…I’d much rather fight over the question of liberty over something like free speech on internet platforms…), July 4th is just around the corner and is still the single most important holiday in Capital Flywheels’ opinion. Despite the US’ recent shortcomings, the events of 1776 continue to shape the present and echo far into the future in this country and around the world. And that deserves remembrance (in a safe manner).

Let’s see what July brings us.

Disclosures: I own shares in SE, SQ, UBER, SHOP, FB, MTCH, PINS, AYX, BABA, PLAN, and TEAM. I may transact in shares mentioned in the next 48 hours.