Hayden Capital 2Q18 Letter – Lessons from Asia; Amazon

Smart Money
  • Portfolio was up 5.7% compared to S&P 500 and MSCI World index of 3.4% and 0.3%, respectively, during 2Q18; annualized return since inception of 15.2% (net of fees)

Lessons from Asia

  • Business models that can scale globally and create astronomical wealth in the process are those that have been battle-tested thoroughly in their domestic markets first
  • Traditionally, this segment has been dominated by the US – where a culture of entrepreneurship + relatively large homogenous culture (#3 population) + richest economy / domestic market to sell to + willing venture investors to fund startups, have created a perfect environment to nurture future global businesses
  • This is starting to change. China is starting to develop a culture of entrepreneurship / risk-taking + has a large homogenous culture of 1.4 billion people + is the world’s second largest economy / domestic market + has growing ecosystem of venture capitalists
  • On the funding side, for the first time, Chinese VC investment has surpassed that of North America in Q2 2018 – taking 47% of global VC funding vs. 35% for the US
    • Even excluding latest Alipay / Ant Financial round, China still makes up a sizable 36% of global funding
  • There are often exclusivity agreements attached to investments – if Alibaba invests in a company, typically they will include a clause that the investee can’t raise money from any entities associated with Tencent (and vice versa)
    • This even applies to investment bankers, with major banks having to choose sides
    • In certain cases, it may even make sense to “defensively” invest some money on a firm, just to make sure your competitor can’t use that piece against you later on
  • JD customer described Amazon’s China website “as bland as plain water”; instead, he preferred JD’s bright colors, pop-ups, and flashing lights, which made him “feel festive and in the mood to shop”
    • What seems obnoxious to those in the US, is “festive” to others
  • Almost consistently, when asking Singapore or Hong Kong based investors what their portfolios look like, something like 90% of it will be in US companies
  • Consistent answer for why they choose to invest in US companies has been that most listed companies in Asia are sh*t
  • Investors need to be especially wary of this for investments in conglomerates with “sum of the parts” situations – typically where the holding company’s shares trading at a significant discount to the combined value of listed subsidiaries
    • It’s more likely for the subsidiary values to be artificially inflated, for alternative reasons other than “unlocking value”
  • These types of issues are symptomatic of an immature market, where there’s lack of an “investing culture”. Less than 7% of Chinese households own stocks, compared to over 55% for the US. Over 70% of trading volume is dominated by retail investors, which results in wild swings in stock prices
  • Eventually, this will change as the market matures, just as it did in the US post-1930’s

Amazon (AMZN)

  • It can’t possibly keep growing at 20%+ growth rates for much longer, right?
    • I disagree
  • In terms of APRU, AMZN is still far behind its archrival Walmart, at ~$800 annually per existing customer vs. Walmart at ~$1,800. The cause of this $1,000 gap is largely explained by the significant amount of groceries Walmart sells, and explains why this is the next “battleground” for AMZN
    • Average household spends $150/week on groceries, or ~$60/person
  • Last August, AMZN bought Whole Foods for $13.7Bn, and just 3 months later had already returned Whole Foods sales growth around to 4.4% y/y, vs. just 0.6% the quarter before
    • The real benefits of the acquisition lie online
  • Amazon is now the leader in online grocery market, with 18% market share vs. Walmart at just half that; as of Q2 2018, AMZN already generated $650M ($2.6Bn annualized) in online grocery sales
    • Nielsen predicts online groceries to account for 20% of total grocery sales by 2025, equal to $100bn in annual sales (~9x larger than today, or a 32% CAGR)
  • Cold-chain logistics was a completely different infrastructure than Amazon’s traditional non-perishable market, and more of a challenge than they expected. Items have a relatively low value-to-weight ratio, and even worse, deteriorate in quality/value rather quickly
    • The only solution was a highly dense network of refrigerated warehouses, which was expensive to build, and hard to justify given it had few synergies with Amazon’s core non-perishable business of selling electronics, laundry detergent, etc
  • Then came Whole Foods. By acquiring the company, AMZN gained access to a network of over 400 refrigerated warehouses overnight, located within 10 miles of 80% of US population
    • Many Prime members are also customers of Whole Foods and thus covers an even higher 95% of Prime households
    • By integrating Prime benefits with Whole Foods, AMZN is driving increased loyalty to the Prime & Amazon brands, while gaining a foothold in a rapidly growing market experiencing 30% growth y/y
  • If they’re successful, at a $100bn industry by 2025, AMZN would add an additional ~$18bn in revenues by simply maintaining a 20% market share
    • By integrating online & offline, margins can be multiples higher than the industry standard of 1-2%. This is because volumes placed online have very low incremental costs
  • Today, Amazon only has ~5% market share in overall US retail sales, but ~20-25% of incremental sales, implying there’s still a large opportunity to bridge that gap
    • Launching into the grocery vertical will help them do so, and help it fend off the “law of large numbers” to keep growth from plateauing

Hayden Capital 2Q18 Letter, August 8, 2018

Image Source: Kleiner Perkins