Dear Clients,

Here we go again – if only we were better at guessing when the market would fall 20% plus. We have yet to get it right in the last 20 years, but perhaps we will one day!

As wild as the last few weeks have been in the market, we have remained calm amongst the volatility and chaos.

We were fortunate to host the Rugby League CEO of the Penrith Panthers, Matt Cameron, last week for our All-Team meeting. For those that aren’t rugby league fans, Penrith over the last five years has done what no team has ever done before in the modern era – win four consecutive premierships (and incredibly been in five consecutive grand finals). In a game which has a salary cap to equalise the competition, this is a feat that perhaps won’t ever be replicated.

Matt was giving insight into the special sauce of the Panthers and unsurprisingly there were many common traits between the Panther’s winning culture and our beliefs on what makes special businesses. At the start of their turnaround in 2020 they committed to “falling in love with the process”. This is illustrated in many ways, but none more so than in the change room. If you walked into the Panthers change room at half time, you wouldn’t be able to tell if they were winning or losing by 30 points. No arms waving, no shouting, just calmly working through the process of what needs to be done in the remaining 40 minutes to win. Remaining calm and emotionally stable has been critical to their success.

I chuckled to myself upon hearing this, as it was being presented to us on one of the days where the world was imploding and public growth businesses had fallen 10 to 15% overnight. If you had been in our office that morning you would have had no idea that was the case. Everyone was just calmy working away at either making our existing businesses better or trying to find the next new investment opportunity. One of my favorite sayings to the team – a sentiment echoed by Matt last week – ‘focus on the process and we will get the outcome. If you focus on the outcome – you will never achieve it.’

We have been investing for over 25 years now, and I now have enough grey hairs to know that every three to seven years, something happens in the world whereas an investor we have no ability to predict what is going to happen in the short term. These events create so much uncertainty that there is no clear line of sight to predict what will happen with any conviction. Consider events that we have lived through – the dot com bust, the GFC, the European debt crisis, COVID and its aftermath, and now the Trump induced chaos. When clients call up and ask “so what do you think will happen?”, I always respond the same way – “I have no idea”. I know this drives some of you a little crazy. I am sure that at this point in the conversation some of you are thinking “but we pay you to have an idea”!

Rather than trying to guess what will happen in the broader market, we spend all our time thinking about the businesses that we own. This is our process that allows us to stay calm.

This process is simple and in shorthand our thinking is summarized like this:

• Do we have the right CEO and team? Are they nimble enough to change tack as required in the new environment?
• Does the business still have a big growth opportunity in front of it? Can the business grow strongly regardless of the economic environment?
• Does the business have the capital flexibility to control its own destiny and take advantage of any opportunities that may arise as the world struggles to deal with what is going on? And finally;
• What is the share price relative to what we value the business at? I.e. is there a significant margin of safety which ensures if we are wrong on any of the above, we will still make good money.

The best lessons are learned from your mistakes and, in our business of investing, these mistakes can sometimes take the form of not buying shares when you should have.

18 years ago, we were looking closely at investing in Booking.com, the online travel agency. It was in the middle of the GFC. I still remember the long drive out from NYC to meet with the CFO like it was yesterday. The shares were trading at around $50. In the years prior the business had been growing nicely in the order of 20% pa as it went about disrupting the way people booked travel. The share price, like many other businesses, was down approx. 70%. The world was entering the deepest recession since The Great Depression and everyone was questioning if the financial system as we know it would survive. The shares had fallen to a point of trading on a PE of 8-9x. This is extremely cheap for a capital light business that we believed would grow at 20% pa plus for a long time. While we were clear on the long term opportunity, as economic growth plummeted, the short term was scary with no line of sight as to what the near term growth would be.

We decided not to buy shares. What has happened since? Booking.com has been an ‘90 bagger’, with the shares now over $4,500! Revenue did slow significantly in the near term to single digits, the business re-accelerated and as they say…the rest is history.

As it turned out, you didn’t need to have a view on the short term. Every criteria I set out above was ticked. This was a painful lesson in not trying to ‘pick’ the short term and has shaped our thinking since.

Perhaps a current example in the portfolio will bring this to life a little more, and hopefully get you as excited as we are – Block.

In the last 10 years, Block has grown from a simple payment processor for very small consumer businesses to a diversified financial services provider. It has grown gross profit rapidly from approx. $200m in 2014 to over $10bn this year (42 % CAGR) and over $3.5bn in EBITDA. Today it has a market capitalisation of $32bn and net cash of $2bn. It is currently trading on a forecast enterprise value to free cash flow multiple of approx. 10x and a PE ratio of close to 9x.

The business has decelerated over the last 2 years from 30%+ gross profit growth to an expected 15% this year (this includes a re-acceleration to 20%+ in the back half of the year). It’s true that its market is more competitive than what it used be and Square, in particular, has suffered some execution missteps in recent times. And yes, it is exposed to consumer spending and it isn’t clear how this will play out in coming quarters. However, we think the management changes that have been made over this period are accelerating product velocity and the business still has significant growth opportunities ahead of it. At the same time, profitability has improved dramatically, and we forecast over the next six years the business will generate its entire market capitalisation in free cash flow. So while the share price may keep going down in the short term and growth may slow to single digits, the margin of safety in the current price is so large, we are very happy to own more shares.

So how do we deal with the volatility? We have been in the market every day actively deploying capital slowly and methodically into our best ideas. We don’t try and pick the best day. We don’t try and pick if the price is going up or down. This “chipping away” method as we call it (but yet to trademark) is a tool we use to maintain emotional stability and avoid wasting mental energy thinking about the outrageous daily moves up and down. We just look to own more of the businesses we love at these extraordinarily cheap prices.

In August this year, TDM will be 20 years old. I am proud to say, despite all the different world events that have hit us, our processes and methods have remained the same. It has evidently worked. As of today, we have produced 25% returns per annum on a five, ten, fifteen and twenty year horizon. Is the portfolio materially lower than where it was 8 weeks ago? Absolutely. But what we see right now is a wonderful portfolio that is trading at prices that are cheap by every measure. Whatever is thrown at us, we are sleeping well at night knowing the portfolio has very significant returns in front of us. While only time will tell if we are right, we are remaining calm and focusing on our process that has worked so well for us over the last 20 years.

As always, we are always happy to take your call and answer any questions you have … except the one you want to ask the most!

Tom Cowan on behalf of TDM