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Monthly Report: International Fund December 2020

31/12/2020

Forager International Shares Fund

Wow, what a ride. We have never seen anything like 2020.

The first quarter of the year saw one of the largest and fastest sell-offs in market history, with stock markets hammered by the pandemic and global economic lockdown. The recovery was almost as steep, underwritten by the world’s central bankers. The buffering effects of the Australian dollar helped mute the sharpness of both the downturn and the recovery for local investors. But volatility was extreme. Violent price moves left many paralysed. We’re not going to pretend some nights in March weren’t restless. But it’s the sort of investing environment where we can best hope to gain an edge over the crowd.

The Fund owned eight stocks (Celsius, Fathom, Open Lending, ThinkSmart, Farfetch, GAN, Spotify and Uber) that doubled over the full course of the year. Many more if you cherry pick from the 23 March low. In Celsius’s case, its share price ended the year almost 10 times higher than our first purchase in January 2020.

One should not expect a repeat near-term. Even if we managed to eliminate all mistakes next year, market conditions are unlikely to reward winners so rapidly. This has not been a normal market. However, it remains more bifurcated than usual, and that should prove good for us.

The portfolio is more diversified than it’s been in years. At 31 December 2020, the largest five investments represented just 20% of the portfolio, versus more than 30% a year earlier.

We do not know what 2021 will bring. But if the market continues to race higher, the portfolio will continue to get more defensive. In cricketing parlance, more blocks and singles, fewer boundaries.

Value and growth in some steady businesses

Companies such as APi Group (NYSE:APG) continue to trade at attractive valuations despite being exposed to growing end-market — in this case fire safety and security (see the September 2020 Monthly Report). APi should also benefit from the Democrats recently winning control of the U.S. Senate, particularly given renewed hopes for a rural broadband stimulus and an increased focus on energy efficient buildings.

With more than half of the company’s revenues of a recurring nature, APi Group provides a defensive growth opportunity in a market that has significant pockets of lofty valuations.

And there is Whole Earth Brands (NASDAQ:FREE), which is now the Fund’s largest single investment. Whole Earth is a branded consumer goods company focused on natural and artificial sweetener products, as well as being a leading global supplier of licorice extract and derivative products — a business that has been around for 150 years.

You may be familiar with some of the company’s portfolio of zero calorie, low calorie and natural and sweetener products, including the Whole Earth, Equal, Canderel and Pure Via brands. These products are generally the number one brand in Australia, Europe, South Africa and the United States (subsequent to their two recent acquisitions, discussed below).

It operates both of its businesses globally, distributing table top sweetener products into the retail, food service and e-commerce channels while supplying licorice products to some of the largest manufacturers in the world, including Haribo and Hershey’s. The business’s global platform distributes to more than 100 countries with six manufacturing facilities of its own and a broad network of distribution partners and co-manufacturers.

Whole Earth should benefit from consumer trends that continue to shift towards natural alternatives and “free-from” additive solutions. Moreover, the natural sweetener growth opportunity in emerging markets is significant and the company is currently expanding into the Indian and Chinese markets. Global sweetener penetration sits at only 3% in those markets, versus just over 12% in Europe and North America.

In today’s stock market, these types of reliable businesses with growth prospects are not cheap. But Whole Earth Brands is an exception.

A forced seller helps

It was listed on the Nasdaq stock exchange in mid 2020 through a reverse merger with a Special Purpose Acquisition Company. Prior to going public, the two businesses that comprise Whole Earth Brands — Merisant and Mafco — were owned by corporate raider Ron Perelman. This prior ownership is key to the opportunity.

Perelman has been an aggressive seller of his assets over recent years (including his impressive art collection) as he seeks to reduce high levels of debt. Historically, the majority of Whole Earth’s cash flow was used to service debt and pay out dividends to Perelman, so that he would not default elsewhere. The business was starved of capital for integration, cost-cutting, brand-building and, most importantly, growth.

Thanks to COVID, Perelman had to take a discount on the reverse merger deal and his continued selling after the listing further depressed the price, giving us our opportunity.

A sweet investment opportunity

We love the shareholder-friendly capital allocation policies of the business. Within months of becoming a public company management authorised a US$20m buyback (more than 5% of its market capitalisation).

And it now has the capacity to plug more adjacent businesses into the network. Whole Earth recently announced the acquisition of the Swerve and Wholesome brands, two natural sweetener products which expand the company’s product footprint and provide significant topline and cost synergies. The two acquisitions have almost doubled Whole Earth’s annual revenues since the business listed and increased its market share in North America, from 5.4% to 11.6%.

Trading at less than 10 times expected 2021 operating profits, we see significant tailwinds and a management team that is being set free from its high debt burden for the first time. It should all translate to higher profits and a much higher share price over the coming years.

Twitter: Overused and under-monetised

Twitter (NASDAQ: TWTR) is the preeminent tool for breaking news and knowledge in the western world. What’s in the newspaper tomorrow is largely a rehash of what’s on Twitter right now. Facebook might be the place to connect with your friends. But Twitter is the place to connect with your interests — be it professional or hobby — especially anything information-rich. It’s become the public forum where experts from myriad fields collaborate and joust, and anybody can join the discussion. The so-called network effects are strong and strengthening.

And yet we’ve watched the stock safely from the sideline for more than half a decade. Twitter the business has massively underperformed expectations. For too long it has failed to grow its revenue, unable to monetise its user base at a fraction of potential. It has also failed on costs, pouring money into research and development that hasn’t had much impact on product quality or revenue generation. We’ve seen some improvement in those metrics over the past few years, but it was more abrupt changes in 2020 that really caught our eye.

In the first quarter of the year, active fund managers Silver Lake and Elliott Management both acquired stakes in the company and took a board seat each. They’re playing good cop, bad cop roles. Silver Lake has a long history of success with underperforming tech companies. Elliott Management butts heads and breaks noses. Both will come in handy in pushing Twitter closer to its potential.

That’s largely the bull case for the stock. Despite question marks around management and monetisation, Twitter user growth has been accelerating since 2018, even more rapidly since the onset of COVID-19. Revenue is now following suit. The company’s backend technology, which had been hampering the company needlessly, is being redesigned from the ground up and will better serve the needs of advertisers. And now the new board will offer the right oversight to ensure management either delivers or disappears.

The Fund bought its stake midway through the year, with the stock up nearly 50% since our initial purchase. It’s getting closer to our base case valuation. But the upside remains immense if the company can get a few important things right. We’re watching closely.

Brexit, finally

Finally, the end of 2020 culminated with a Brexit agreement being signed, after negotiations went down to the wire. Although the UK is now facing a lot of similar restrictions without the benefits of being an inside member of the EU, the disastrous “no deal” scenario that investors were worried about is finally off the table. With a significant portion of global investors underweight the country and equity valuations at attractive levels relative to other developed markets, we continue to hold a number of investments that give us exposure to the region and a potential domestic recovery.

Fund statistics

Interim Distribution

The Forager International Shares Fund paid an interim distribution to unitholders at 31 December 2020. The $0.10 per unit distribution is a conservative portion of the income already realised this financial year. While much can change between now and 30 June, given the unrealised and realised gains made to date, investors in the Fund should plan for an increased amount of taxable income for the full-year.

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