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Monthly Report International Fund December 2021

31/12/2021

December brought to a close a tough end to the year for the Forager International Shares Fund. Over the past six months, the Fund’s unit price declined 12% while the MSCI ACWI IMI (in Australian Dollars) returned 8%. Over the December quarter, the numbers were -5% and 1% respectively.

The return for the year was still positive at 15%, thanks to a stellar first-half performance. With a few notable exceptions, it was largely the same small-cap stocks contributing to both sides of the ledger. Small-stock outperformance was a significant tailwind to the Fund’s returns in the 2021 financial year and you should note that there is little crossover between the Fund’s holdings and any index. We provide those references so you can see which way the wind is blowing. 

It has been blowing against us. The S&P 500, the bellwether gauge of US large-cap stock performance, is up 10% in US Dollars since 1 July. The Russell 2000, a broad index of much smaller stocks, is down 4%. 

The Fund’s focus is long-term returns from the businesses we invest in and we are mostly happy with our progress. However, share prices clearly got a long way ahead of reality. We were taking profits along the way for most of these stocks and completely sold out of some positions, such as Celsius Holdings (NASDAQ:CELH). Some of our bigger, safer plays have performed very well – including Keysight Technologies (NYSE:KEYS) and Zebra Technologies (NASDAQ:ZBRA), up 34% and 12% respectively since 30 June. A focus on finding larger, more defensive businesses like Tesco (LSE:TSCO), which is up 13% on our second-half purchase price, has paid some early dividends. That’s why the Fund’s return for the year was still healthy. We stepped in the right direction, but clearly not far or fast enough.

Boohoo (AIM:BOO), though, is a poorly performing investment that can’t be attributed to wider market conditions. 

The online fashion retailer disappointed us again in December with an unscheduled trading update on its third-quarter results. After lower-than-expected growth in the first half of the year, the anticipated rebound in demand did not materialise. At least, not universally. While sales in its home market of the United Kingdom grew an impressive 32% above the previous year, other geographies suffered. Boohoo’s management team blamed the stunted demand on supply chain issues and delivery delays that are being seen across most industries, as well as higher-return rates than what’s considered normal. Sales weren’t the only issue, though. Margins are also expected to be impacted well into 2022. Combine lower sales growth with higher-return rates and inflated distribution costs and the results aren’t pretty. 

Our original thesis hinged on Boohoo overcoming its earlier ESG-related concerns to continue growing revenue above 20% per year, doing so as profitably as they had in the past. While the first point of the thesis looks to be on track, the second two are not. If the operational issues we’ve seen are short term in nature, then Mr Market is providing a wonderful opportunity to own a profitable, fast-growing business at a reasonable price. The stock price is now down 59% from our first purchase 15 months ago. We need to see more evidence of that or an even cheaper price. For now, we’ve decided to watch from the sidelines and have replaced it with another UK stock in which we have significantly more confidence.

Flutter Entertainment (LSE:FLTR) is a business we’ve long known well. It’s a global sports-betting and online-gaming company. Australians would be most familiar with its main local offering, Sportsbet. It has a similar positioning in the UK and Ireland throughPaddyPower and Betfair (which the Fund owned when it was listed). It also owns PokerStars, a market-leading online poker company, and recently announced the acquisition of Sisal, Italy’s leading online gambling company. More valuable than all of these, though, is its leading position in the more nascent US sports-betting market via FanDuel.  

Along with competitor DraftKings, FanDuel received an unbelievably valuable free kick versus other players in the industry, which stems from their history as the leading fantasy sports companies. When US states began legalising sports betting, other industry players had to build a customer database from scratch, meaning lots of expensive marketing. However, DraftKings and FanDuel already had a very long database of highly qualified sports nuts to whom, at almost no cost, they could market. But unlike DraftKings, FanDuel is part of an international juggernaut that brings immense knowhow in conventional marketing, upsell, technology and product development and this is reflected in market share differences.

We know from experience in Australia that this is an industry where the market leader wins an outsized share of the spoils. It can spend more absolute dollars on marketing, technology and product development than competitors, while spending a lower percentage of revenues.

Two years ago we did very well from owning backend system provider GAN Limited (NASDAQ:GAN), whose biggest customer was FanDuel. Back then, it was our theory that FanDuel could build a market-leading position. Today, that’s a fact. Since then, it’s achieved higher market share than we predicted in a market that’s growing faster than first anticipated.

In the US, FanDuel has a market-leading share in excess of 40% in each of the six biggest sports-betting states (excluding the historical gambling state of Nevada). That bodes well for the states still to legalise sports-betting and online gaming. Our variant perception revolves around the market underestimating the immense difference in profit potential between market leader and second place. We also think the American market can grow strongly for years longer than most analysts have in their models. If our expectations prove realistic, market-leading positions outside North America may give us some good downside protection from today’s share price, heavily discounted over the past six months.

An attractive platform for 2022

Through share price falls and active rebalancing, the smaller, growthier part of the portfolio has shrunk versus other types of investments. We’ve been decreasing rather than increasing exposure and aren’t currently rushing out to buy more. There are mild echoes of the year 2000, when value outperformed growth for half a decade. That’s not a prediction, rather an observation that there’s no reason share price falls have to stop at fair value. We have the dry powder needed to participate if things become ridiculous.

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