Henderson Capital: 8 Month Update

Selling Yext and Rubicon Project

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As macro uncertainty lingers and the market continues to distance itself from the economy, I’ve found it prudent that I deepen my understanding of the individual businesses I own.

Over the course of these last few months I’ve come to the brilliant realization that I know absolutely nothing about the economy. Quite frankly, I’m not sure anyone does. And that’s ok with me. Where I think I excel, is in my ability to clearly and honestly examine the present and position my portfolio in a way that’s apt to benefit from it.

As a reminder, Henderson Capital’s goal/mission is to buy great businesses at fair prices and hold them for a long time. Most often, these are digital businesses with a strong customer value proposition. I prefer my businesses to be operating in emerging industries or industries with tailwinds and diverse avenues for growth.

I attempt to invest only in businesses that I deeply understand. Sometimes that learning process can take weeks, sometimes months, or sometimes I simply can’t understand the business model at all. When I find a business I like, at what I believe to be a fair price, I try to build a sizable position.

If my goal is to beat the market, I can’t be the market. In other words, I try to avoid “diworsification”. As a 21 year old with high risk tolerance, I run a concentrated portfolio. I try to be highly selective when looking at potential companies to add to my portfolio. If I don’t think it can best the returns of my existing holdings, why should I add it?

Now with all that said, let’s get to my portfolio. Since October 18th, Henderson Capital is up 37.78% vs the S&P 500’s 4.58%. Here’s how it looks…

Buying:

Electronic Arts - I initiated only one new position this month, and it was in Electronic Arts (EA). EA is one of the global leaders in the interactive entertainment/video gaming space. In the above paragraphs, I stated that I look for great businesses at fair prices in promising industries. I can’t think of an industry with more tailwinds than gaming right now. If you need explanation as to why, I recommend reading Matthew Ball or Arron Bush’s work in the space.

For anyone unfamiliar with the business model fundamentals, users purchase one of EA’s games (often digitally now) for a set price, but most of Electronic Art’s revenue is generated over the lifetime of the users experience with the game. This part of the revenue line is called “services” revenue. This refers to in game purchases. For example, FIFA, EA’s popular soccer franchise costs ~$60 for the actual game download, but makes much more in revenue over the life of the game.

According to an article on sportsbible.com, net revenue for FY 2020 from Ultimate Team (an in game feature for the FIFA and Madden franchises) totaled ~$1.5 billion, while full game downloads across their entire library accounted for $800 million. In other words, the game purchase is practically a customer acquisition cost.

The franchise value of EA’s top games offers strong competitive advantages, and allows easy migration to external gaming tailwinds. For example, new industry innovations like Twitch and other forms of steaming and sharing, can automatically benefit brands like FIFA, Madden, and Apex Legends.

Eventually I’ll write a longer form piece on Electronic Arts, but if you’re currently interested, check out the links above to Aaron Bush or Matthew Ball’s writing on the gaming industry as a whole.

Roku - The coronavirus hasn’t been an agent for change, but merely an acceleration of the inevitable. Things that were expected to digitalize over the next decade have done so in weeks. Work, education, family gatherings, and obviously the advertising shift away from linear TV. That’s right, Roku has been no exception.

Headline numbers were somewhat misleading for Roku’s 1st quarter, as they saw higher than normal advertising cancellations due to decreased overall marketing budgets. However, this was partially offset by a faster than normal ad spend switch away from traditional tv to the Roku platform. In short, advertising will continue to shift towards connected TV and advertising budgets will come back over time.

Over recent days, Roku has seen some turbulence due to supply side issues. Their TV manufacturer (TCL) is also making cheap TV’s for Android’s new CTV platform. While this initially gives me pause, the thesis is still in tact. If I begin to see new accounts dramatically slow, I may consider changes to my position.

Semler - I’ve added to my position in Semler Scientific periodically over the last month as Semler continues to show signs of strong growth while trading at a more than favorable valuation.

Due to coronavirus, Semler has seen a decline in testing volume for the QuantaFlo. People are worried they’ll get sick visiting their care providers, so they’re postponing routine visits. This is going to result in slower variable software licensing revenues. However, 68% of Semler’s revenue is fixed through long-term licensing arrangements, so the bulk of their top line should remain unharmed.

Semler added during their conference call that even with a 4% reduction in fixed fee revenue and a 97% reduction in variable fee revenue, they’re still expecting to add cash over the quarter!

Semler Scientific continues to be well managed, and highly profitable on a net margin basis.

Selling:

Yext - I sold my entire Yext position this month. While I’m still fond of the Yext mission, and I do hope they succeed, I’ve found some glaring red flags. Number one, and by far the most important, is management’s capital allocation decisions. In the 4th quarter of 2019, Yext lost ~$31 million on ~$81 million in revenue. Management attributed most of this to increased employee related costs and new lease arrangements.

In an increasingly digital world in which remote work may very well be the future, Yext has spent up to acquire offices in New York, NY and Tokyo, Japan. I understand that it’s important to scale up, but these aren’t spending habits that I typically support.

On top of the capital allocation issues, I’ve struggled to picture a world where Yext truly has a moat. What are they doing now that Google can’t?

I may very well be wrong on Yext, but as an individual investor I get unlimited pitches and can swing at which ever ones I please. I’m letting Yext go by.

Rubicon Project - Rubicon Project is an independent supply side ad platform. This month I sold my entire position. After their merger with Telaria, growth slowed significantly and I began to have serious concerns about where the SSP sits in the advertising value chain.

Who do most of the OTT providers use to manage ad inventory? How come a dominant SSP doesn’t already exist? What’s to prevent OTT providers from managing their own ad space and going direct to the DSP’s? How come Roku, who owns the most dominant CTV platform, built out a DSP specifically, instead of anything on the supply side? There were simply too many questions I couldn’t find answers to, so I finally decided to exit the position due to lost conviction.

Announcement: Over the next few months I’ll be interning at the Motley Fool and I could not be more excited! Many of the investors that I’ve long admired have roots with TMF, and I’m looking forward to learning all that I can there. However, this does mean that I’ll be putting my writing on pause for the remainder of my time there.

So with that said, thanks for reading! Looking forward to writing to you all in a few months.