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Saber Capital 1H17 Letter – Big, Inevitable Trends; Large Caps; Tencent; Apple

Saber Capital Management 2017 Mid-year Update, August 15, 2017

“The outside world can push you into Day 2 if you won’t or can’t embrace powerful trends quickly. If you fight them, you’re probably fighting the future. Embrace them and you have a tailwind.” – Jeff Bezos, 2016 Amazon Letter to Shareholders

  • Portfolio gained 14.6% gross vs. S&P 500 gain of 9.3% (including dividends)
  • Cash position continues to be elevated, fluctuating between 10-25%

Embrace Big, “Inevitable” Trends

  • According to Bezos, one of the keys to staying hungry is to embrace big, sweeping, fundamental trends
  • One of these big trends is the Chinese e-commerce market which has recently passed the US as the largest in the world and is still growing at around 20% annually
  • Other industries benefiting from the same general tailwind include mobile advertising, video consumption, mobile payments, cloud computing, and many other related industries are certain to grow significantly over time as tens of millions of people in China enter the middle class each year and allocate higher percentages of their growing purchasing power toward these areas
  • Unlike burgeoning industries such as automobiles or airlines that produced rapid growth in volumes but created little to no lasting value for owners, Chinese ecommerce and digital advertising market are dominated by a select few companies that are highly profitable, well-managed, and are well-positioned to create enormous value from these industry tailwinds
  • Productivity and consumer spending will continue to rise in China over time and some of the best companies in the world will come from business models that capitalize on extremely powerful fundamental trends

Tencent

  • Chinese internet holding company with one of the most powerful network effects in the world
  • Operates in numerous businesses that generate significant FCF, take very little capital to grow, and have huge runways for growth in China and around the world
    • These businesses and investments consist of video game publishing, music and video subscriptions, ecommerce, mobile payments, and online advertising among other assets
  • Company’s crown jewel is WeChat, which is a mobile app that is unlike any application that exists in the West. WeChat dominates China and its 963 million users spend more time on WeChat than US users spend on Facebook and Instagram combined
    • Far from just a messaging and social media application – used for just about everything in China including messaging, work communication, calls, social networking, online shopping, paying bills, transferring money, and much more
    • 1/3 of WeChat users spend more than 4 hours a day inside WeChat universe
    • Barely been monetized yet but is in prime position to capitalize on numerous fast-growing industries like mobile advertising, online shopping, and mobile payments
  • Despite a vast untapped potential in some of those markets referenced above, company is already highly profitable
    • Revenue is growing at close to 50% annually
    • Thanks to 30% net profit margins, turns a good chunk of that revenue into FCF to reinvest
    • Producing about 35% returns on incremental capital investments and is growing its already sizable $8bn of FCF at 40% per year
  • Growth obviously will slow down at some point but given its unique competitive position and the huge size of the markets it operates in, there is likely a very long runway ahead for the company
  • To summarize, 4 things I like about Tencent: huge network effect of WeChat; massive runway for growth; high returns on capital and significant FCF; company is run by its driven, long-term focused founder who remains one of the major shareholders
  • Stock has risen significantly YTD but I think over a long period of time, Tencent shares will likely compound at a rate that roughly mirrors the growth of the company’s intrinsic value – this rate of compounding will be quite high (15-20% annually) for a number of years to come

Large Caps

  • Insight that is much less commonly held is that large-cap, well-followed stocks can be excellent investments at times
  • Even with volatility being at all-time lows for much of the past year, mega-cap stocks – 10 of the largest, most well-followed companies on the planet – still saw an average of a 40% gap between their 52-week high and low prices
  • Despite the army of analysts poring over unlimited bits of information that supposedly increases market efficiency, Apple is currently valued at a whopping $300Bn more (or nearly 60%) than it was just one year ago
  • Apple remains our largest position, although it doesn’t offer the same value as it did a year and a half ago when we first started investing in it
    • Apple falls into what I refer to as “Category 2” investments – stocks of durable, mature companies that occasionally get mispriced by Mr. Market; these are stocks that might offer 30-50% or even 100% on rare occasions but typically will be sold as they approach a more reasonable value
    • Ideal investments are the “Category 1” investments, or the compounders – businesses that produce high returns on capital and have long runways for potential growth

Edge

  • Patience in investing means avoiding the mediocre ideas – there are lots of stocks of subpar businesses that look cheap but these companies rarely produce a good investment over time
  • Important for investors to know their limitations – simply being honest with yourself about limitations and weaknesses is extremely important in investing
    • Helps you to avoid certain biases that might cause you to invest into situations that are above your pay grade
  • Patience is the antidote for finite mental bandwidth
  • Ubiquitous-sounding bullet points about “long-term”, “patience” and a quote or two from Warren Buffett will not get the job done. Perhaps a passage from Proverbs 14 is more relevant: “All hard work brings profit, but mere talk leads only to poverty”

Image Source: Dr. Kati Suominen – Digital Disruption in 2016-2020

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