October trades

October was a decent month and my portfolio managed to claw back some of the fall from the end of September. The market as a whole seems to have recovered some of its mojo and US earnings season has started fairly positively, though I’m not sure how long this will last. The spectre of rising inflation and interest rates still looms in the background.

I’ve reinvested some of my cash balance but am trying to be patient in waiting for the best opportunities to allocate it. I plan to keep some of my portfolio in cash for a while (at least 10%). I am finding it a bit more difficult to decide how much to prioritise momentum when choosing investments at the moment. My instincts are drawing me to some of the cheaper opportunities that have sold off a lot recently but I am cautious about deviating far from my momentum strategy. Doing this has tended to cost me in the past.

I made a couple of trades in October. I sold SCS for a 15% loss near the beginning of the month after its results. They were OK but not as good as hoped and there were some references to concerns about supply chain disruption and cost inflation. SCS still looks like it’s attractively valued but it’s not a great business and my original buy thesis expected stronger immediate performance so I sold.

I replaced it with Intelligent Systems. Subsequently near the end of the month I filled in my last empty portfolio slot (from sale of Boohoo last month) with Beeks Financial. I’ve owned and written about Beeks before. I decided to buy back now after its last results were very good. This is an earlier stage and more risky investment than many of the others on my watchlist. However, I think the signs are looking promising that Beeks will develop into a high quality business and the rewards from investing in the earlier stages could be high.

Intelligent Systems

Intelligent Systems is a small (approximately £270m) US fintech business. Its main business is Corecard, a subsidiary which provides software and processing services for card payments. It operates primarily on the issuing side of the market, helping business and banks set up and administer the necessary infrastructure to offer credit or debit cards to consumers. This distinguishes it from many other payments businesses, which primarily offer services designed to facilitate payment processing by merchants. Intelligent Systems makes money initially from licensing its software and then subsequently from managing and updating it and from processing payments on its platform. In principle customers can choose to run the software in-house and process the payments themselves, though Intelligent Systems tries to do more of this itself as this part generates the recurring revenues.

Quality

  • Business economics: Intelligent Systems has a capital light business model and is already highly profitable for a small, growing business. Operating margins are almost 30% and look set to grow as do returns on capital (which are currently around 25%).
  • Track record: Intelligent Systems has been around since the 1980s as an investment vehicle for acquiring early stage tech businesses and helping them grow. It used to own a diversified portfolio of several businesses but since selling off Chemfree (an industrial washer business) it is now solely focused on Corecard. Corecard doesn’t exactly have much of a track record but it appears to have hit a point of inflection recently after successfully winning a major contract to provide services for the Apple card (partnering with Goldman Sachs as the issuing bank). This has substantially increased Corecard’s scale and boosted its reputation.
  • Competitive advantage: for a small fledgling business, Corecard does appear to have something of a competitive advantage in a specific niche. The quality and dependability of the software in this market is critical. Corecard’s USP is the quality and flexibility of its software which can be tailored quickly to bespoke requirements and allow card issuers to be quick to market. There appear to be high barriers to entry from the need for a reputation to win major clients and there appear to be high switching costs for the administration of existing cards. The importance of reputation is emphasised by the fact that Corecard essentially has no marketing activities, as there are limited options for prospective clients who will already be aware of Corecard. This seems pretty unusual for a software business. On the downside, Corecard faces risk from very high customer concentration so if something goes wrong it could be catastrophic.
  • Growth prospects: the growth prospects look excellent. Corecard claims to have plenty of prospective clients but is only constrained from supplying more by its existing development and processing capacity. The main bottleneck is to build up its operations in India with enough qualified staff. This is a particular issue at the moment following the aftermath of the pandemic but in the grand scheme of things I think it is a pretty nice problem to have. The prospects of Corecard onboarding some more major clients in the next few years look very promising and this could be fairly transformative for the scale of the business.

Price

After a massive run-up in 2019 when Corecard won the Apple/Goldman Sachs business, the share price has been oscillating. In the short term momentum is positive since the share price hit lows in July this year. The valuation seems very reasonable given the growth potential on offer.

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