I have now fully recovered from Covid-19, assuming that is what I have had over the past week. The main symptoms were severe fatigue and shortness of breath. This was debilitating enough to excuse me from doing any work or household chores but almost imperceptible if I remained completely immobile, say reading Twitter or watching Netflix in bed. My lungs felt like they took a pounding but have recovered quickly. So all in all not the worst virus I’ve had the pleasure of hosting by any means. I’m thankful to be getting off relatively lightly.
Given the extraordinary times, I’ve updated again below with my latest thoughts on the economic outlook and what this means for my game plan. I’ve also updated on my purchases from last week.
The outlook for the economy looks increasingly bleak to me. The immediate impact of the lockdowns on economic activity and unemployment is of unprecedented magnitude. GDP across most of the world looks set to fall by double-digit percentages this year. The US is already recording five times more unemployment claims than the previous record in 1982. We are already in a severe recession.
The question is how quick the recovery is going to be. This is very difficult to predict- we are in uncharted territory. To start with we don’t know how long lockdowns will go on for or whether they will need to be reintroduced at a later point. I’m optimistic that they might be over before the end of April, but note that this is a lot earlier than the official lines at the moment. There is even more uncertainty about the long term economic consequences of these lockdowns on employment, investment, financial stability and corporate profits a few years down the line. It’s hard to be optimistic that the recovery would be sharp and ‘v-shaped’, even if lockdowns do just last a few more weeks. It isn’t totally out of the question, but it becomes less and less likely with each ‘irreversible’ business decision triggered by the shock (eg sacking staff, reneging on debt, shutting up shop). These decisions have knock-on effects as fear and caution spreads across the economy. The result is that consumers cut back spending, suppliers don’t get paid and investments are curtailed. Huge government bailouts will help but don’t look likely to be sufficient to mitigate this.
Following my last post, I followed through on my plan to raise some cash, but ended up raising a bit less than I was originally planning. I had second thoughts on sensing the general market buoyancy and on reappraising a couple of sale candidates that had updated very positively last week (Atoss and Esker) and deciding to keep hold of them. The net result was that I raised 22% cash rather than the 33% I originally intended. Having some cash at hand will allow me to take opportunities of any further falls and means I’m now more ambivalent about which way the market goes. This makes the volatility feel a lot more comfortable and should help stop me make any rash decisions.
Unfortunately, the immediate timing of my decision to raise cash proved to be pretty poor. The market bounced hard over much of this week, even shrugging off news of unprecedented US job losses. Could this be a sign that we already saw the bottom? Possibly, though it seems unlikely.
With volatility and emotions running high, it’s very easy to make mistakes. I think patience is the name of the game. If prices don’t immediately fall again from here, the risk is feeling the fear of missing out and redeploying into what turns out to be a ‘sucker’s rally’, before the downtrend resumes.
I think my best course of action is to sit on my hands and reassess in a couple of weeks. If the situation hasn’t changed dramatically, probably the safest approach would be to then reinvest my cash balance gradually over the next few months.
I am also in the fortunate position of having the option to inject a great deal more cash into my portfolio if warranted. This cash was reserved for a deposit for a house purchase and the transaction was on the verge of completion before Coronavirus hit. Completing a house purchase now is looking like an increasingly foolhardy idea, with dark clouds ahead for the housing market and the possibility of a golden buying opportunity for stocks. If I account for these funds I’d be just over 60% in cash.
After a hectic couple of weeks I now have several trades to update on. As I signalled in my post at the beginning of last week (which now feels like a lifetime ago!) I got rid of some holdings I thought could be particularly exposed to Coronavirus: JD Sports, Churchill China, Lululemon and most of my Games Workshop. I replaced them with businesses I thought would be less exposed but had been sold off to some extent nevertheless: Ideagen, Alpha FX and ServiceNow.
This week I followed that up by selling another six smaller holdings: the rest of Games Workshop, Liontrust, Fabasoft, Accenture and Salesforce. Again, most of these seemed like businesses that would be relatively more exposed to negative effects from the crisis. There were no replacements for these sales as the point was to raise some cash to take advantage of any buying opportunities coming up.
Ideagen is a small IT business that supplies specialised risk and compliance software to businesses operating in highly regulated industries, such as healthcare, transportation and defence. It is UK-listed but is very internationally diversified with customers all around the world. It actively pursues a ‘buy and build’ strategy, regularly making acquisitions to consolidate a very fragmented market of individual small businesses producing bespoke software products.
I’ve followed Ideagen with interest for some time, though have never bought the shares. It is one of few investments where I have actually met the management, a little while ago now. I didn’t find this especially illuminating but left with a positive impression of the Executive Chairman, David Hornsby (though he is quite a maverick character).
- Business economics: Ideagen should have the qualities I look for of being capital light with recurring revenues. However, it’s not evident in its accounts that this results in high profitability, as returns on capital and margins are both quite low. This appears to be partly because it is sacrificing short term profits to grow rapidly through acquisition and partly an artefact of accounting rules where profits are obscured by goodwill amortisation charges. There is some risk that profitability does not turn out as expected but I am prepared to give it the benefit of the doubt.
- Track record: Ideagen has not been around a very long time but has been very successful in very rapidly growing revenues and profits over the last ten years or so. It has demonstrated it is adept at buying and integrating large numbers of acquisitions. When performed well in the right kind of market, this strategy can add a lot shareholder value.
- Competitive advantage: the markets in which Ideagen operates appear to have attractive qualities. They are all quite niche and bespoke, suggesting there are few other competitors and limited incentive for rivals to enter. From the customer’s perspective risk and compliance software is relatively low cost but important and integrated into other processes, making customers less likely to want to switch. At the overall business level Ideagen is very well diversified. This should add up to a very solid competitive advantage.
- Growth prospects: Ideagen is still fairly small but operates internationally. It looks to have plenty of potential to continue to pursue its strategy of growth through acquisition. I think the nature of the products and the fact that many customers are in defensive sectors should mean that the demand for Ideagen’s services is defensive. About two thirds of revenues are recurring and this percentage is steadily increasing over time.
The share price has fallen along with everything else over the past few weeks. On a relative basis, momentum is strong as the price has fallen less far than some (about 25%) and the long term uptrend is still intact. The valuation seems decent given the growth potential. Ideagen is yet to update the market but I think it should be relatively resilient to any Coronavirus-related concerns.
Alpha FX is fairly small UK-listed corporate FX broker that has both listed and come to my attention fairly recently.
- Business economics: this is the classic type of people-oriented, capital-light business I like. The metrics look good with very high margins (40%) and decent returns on capital (20%), though the latter were higher in the past.
- Track record: Alpha FX was founded in 2010 and only listed on the stock market a couple of years ago. The founder and CEO, Morgan Tillbrook, is strikingly young at only 36 and has achieved very impressive progress in growing the business so far. The growth rate in recent years is phenomenal.
- Competitive advantage: this is where I have the greatest concerns. The market for FX broking seems likely to be highly competitive on price as the service seems fairly homogeneous. Nevertheless, there is scope for differentiation on quality of service and the ambitious, customer-oriented culture at Alpha seems impressive. I note that it is extremely highly rated by employees on glass door. I don’t normally pay too much heed to the management of a business but do get the sense in this case that Alpha FX is very well-run.
- Growth prospects: Alpha FX is still relatively small and growing very quickly so the prospects for continued growth seem good. Demand for FX services should be fairly defensive I would have thought.
The price has fallen over the last month along with everything else, though to a slightly lesser extent. The long term upwards trend is intact. The valuation seems cheap given the growth rate and the business does not seem particularly exposed to Coronavirus-related risks.
ServiceNow is a large US enterprise software business, with a market cap of around £40bn. It provides cloud-based IT service management via its Now platform. This platform allows various IT services and processes across a business to be coordinated to perform different functions (eg onboarding a new employee) in a flexible and seamless way.
I’ve been looking for an opportunity to invest in ServiceNow for some time and the current small dip seems as good a chance as any.
- Business economics: similar to other growing SaaS businesses, ServiceNow’s profitability does not look very impressive in its accounts. However, this belies a decent underlying business. It has a capital-light business model as you might expect, with large cashflows and relatively low capital expenditure. Its free cashflows are far above its reported profits, primarily because it earns a lot of deferred revenues, where customers have paid but not yet received the service. It is growing these cash flows at a rapid rate. This suggests that profitability is likely to improve dramatically over the coming years.
- Track record: ServiceNow has a very impressive track record of around than a decade of explosive growth, where it has grown revenues by about 50 times. The share price has followed a similarly impressive trajectory.
- Competitive advantage: ServiceNow is a clear market leader with a dominant position in IT service management. Its platform is acknowledged by most to be superior to rivals’ and ServiceNow has a market share of several times of its nearest competitor. Switching costs are likely to be very high as the platform is very heavily integrated into its customers’ businesses. ServiceNow also benefits from indirect network effects as partners innovate services that interoperate with the Now platform in a broader ecosystem. These network effects create a big scale advantage and make it harder for smaller players to compete.
- Growth prospects: despite being a large business ServiceNow is still growing fast. I can’t think of a market with such huge secular growth drivers and think ServiceNow still looks to have a long runway of growth ahead of it.
The share price has dipped though is still in a long term uptrend. The valuation looks pricey, though I think is warranted with such excellent long term prospects.