Dear partners,

Thank you for your continued trust and support; you are the best partners I could ask for.

Before diving in, I want to warn you that this will be the year where taxes rear their ugly head. In the first three calendar years of the fund, the net tax burden has been extremely small since we often tax-loss-harvest and tend to hold companies for long periods. However, we have opportunistically trimmed some large winners as the valuations became expensive. Further, as Intellego has risen, we have trimmed to not let it take up too much of the portfolio. For these reasons, I would advise partners to put some cash aside for when K-1 season comes around. Unfortunately, I can’t estimate the exact tax burden but to be safe, I would have 5-10% of your current Infuse balance in cash/liquid investments if you’ve been a day-one LP. Of course, feel free to send over a partial redemption form (attached on your original sub form) if you need liquidity. Think of this like the accumulation of more than three years of pent-up gains so maybe call it a 1-2% annual tax drag. That’s obviously a bummer but we are still outperforming the index by more than 2200 bps net, annually, even when accounting for taxes.

For this letter, I wanted to do something counter-cyclical. Paranoia is inversely correlated to the direction of the market. The most important time to root out complacency is when things are going swimmingly and markets are at all-time highs and you see everyone posting YTD performance screenshots. In that spirit, let’s look at the real bear cases of our top three positions.

Intellego

There are many strange things about this wonderful, Swedish company. For one, days sales outstanding is about six months. If a product is truly mission critical, customers will pay on-time. Payment terms reveal a lot about negotiating leverage. Speaking of leverage, as Intellego’s large customers, Henkel and Likang, ramp up their orders, investors need to be aware of the concentration. Being dependent on two customers even before they have put in huge orders makes me wonder just how “in-control” of their destiny Intellego really is.

Further, there are very few regulations for UV technologies. In China, there are early signs but betting on healthcare mandates to change is a long, arduous process. The fact that this technology is somewhat new in hospitals also leads investors to wonder just how often these dosimeters are getting used.

And these two core arguments are besides some of the immature processes from the past. While Claes and the team continue to improve in all areas, there are still many question marks. The geographic revenue breakdowns jump all over the place. That suggests reliance on large wholesalers and big distribution partners like Henkel and Likang. As these orders fill the channel, a restocking fiasco is very likely down the line. Further, some of the numbers thrown out just don’t pass the smell test. Will Intellego really do $1 billion USD in sales at 70% EBIT margins? If the market is truly that big, won’t competitors be pushing day and night to work around any patent protections? One great thing about Intellego as a microcap was that it was profitable but niche enough not to attract high quality competition. As the company gets larger, the second act will be much more competitive than the first.

When we started buying at 5x earnings, the higher valuation now means that more hope is embedded into the price. We can’t bet as much on multiple expansion so returns will come from earnings growth which could be very lumpy.

Ok, now the “steelman” rebuttal – I won’t go in order but broadly, payment terms are improving. As a tiny company, Intellego overzealously used long terms to get in the door as they knew their product was high quality. The fact that Henkel and Likang are signing better payment terms than early wholesaling customers shows there is value in the dosimeters. Further, it’s better to think about the two large companies more as distributors rather than strictly customers. This is an important distinction because these relationships could continue to expand significantly. Henkel and Likang have huge distribution muscles and Intellego can ride on their coattails. If we do see these partners start to insource the product, dual-source radiometers, or find another dosimeter provider, that would be worrying.

The fact that regulations have been a slow uptake isn’t surprising. With standardization, Intellego would be a huge beneficiary. But without it, dosimeters are a small price to pay to lower the odds of a hospital infection. It’s simply a much bigger risk to not use UV protocols than be cheap and skip the disinfection. I like companies where the overall cost is a tiny piece of a customer’s budget but has a strong value proposition.

Lastly, to touch on some of the promotional messaging and abnormal accounting, I think Hanlon’s Razor is the best explanation. It’s better to assume incompetence than malice. That’s definitely not to say I think Intellego’s management is incompetent – after all, I wouldn’t have invested if I thought so – but rather, they had very limited resources in the early days. Utilizing the stock price was an asset and a lesson in reflexivity. For example, Elon Musk is the master of this – using the stock price to his advantage. There’s a big difference between a CEO trying to pump the stock and a CEO that believes so deeply in the company that they are buying stock themselves and persuading investors to understand the story. Time will tell the truth but I’m betting that Intellego is Claes Lindahl’s baby and he’s extremely bullish on the future of the company.

Pharmx

10x sales for a company growing 10%? What are you, crazy!? This company was founded 20 years ago but only has $5 million USD in revenue. Even though the long-term goals are exciting, that doesn’t ensure anything will actually happen. Further, pharmacies are becoming less relevant as the world moves online. And the CEO isn’t a founder and doesn’t have a long history of success.

So what gives? Why would we implicitly – through holding – buy a low-growth company at a very expensive price, considering profitability is around breakeven and there is no evidence that margins will improve anytime soon? Well, with Pharmx the numbers won’t show up for at least another year. And investors are paying up for that future potential. If it doesn’t materialize, this won’t just be a decent investment from here, it’ll be a poor one.

The reason investors are interested in this name is because it has a deep moat for its market cap. The largest point-of-sale company in the Australian pharmacy space, FredIT, has tried to compete with Pharmx to no avail. That’s always a great sign – when the competitor who is in the best position to win, can’t win. When you have clarity on the competitive advantage, the question of the market opportunity becomes very important. That’s why the potential of Pharmx’s e-commerce platform for Australian pharmacies is exciting. Currently, almost all of the company’s revenue is from its mature EDI (electronic data interchange) business. The ability to not just exchange information but to have a complete ordering and bidding system for suppliers and pharmacies can change the game. As Pharmx layers on services like advertising, data services, and ordering, it can capture more value and thereby grow its revenue by multiples. About $1 billion USD in non-drug products flow through the company’s systems. If a simple 5% blended take-rate can be achieved, that’s $50 million in high-margin revenue. Who knows how long that will take but management thinks they can reach half of that within 3-4 years. Even if the multiple compresses 50%, the stock could still double from here.

TransMedics

In TransMedics’ core market – DCD liver transplants – it already has over 60% penetration in the US. A lot of future growth is based on technologies that haven’t even started FDA trials, like kidneys. And for kidneys, the value prop is much weaker since they can be on-ice for 24 hours, compared to one hour for livers. Further, the company owns more than 20 private jets that depreciate at 10% per year and require constant maintenance. That’s not exactly ideal for high returns on invested capital!

Right now, most of the business is reliant on donor after cardiac death (DCD) liver transplants where there is increasing competition. The most formidable competitor, OrganOx, was growing over 100% and was bought by a large Japanese medtech company called Terumo. It seems likely that Terumo can accelerate the global distribution of OrganOx systems.

Lastly, a decent chunk of TransMedics’s growth plans are based on international expansion, of which there has been virtually no traction since inception. Different countries have different transplant waitlists and regulations. This makes the process much more difficult than the US – where there is one waitlist and the landmass is huge, so the core value prop of TransMedics is amplified.

To address some of these concerns, TransMedics has a deep, vertically integrated moat. Its technology has almost single-handedly grown the DCD transplant market. While buying planes is incredibly capital intensive, it solidified the competitive advantage. The process power that comes from doing thousands of transplants annually is underrated and the logistics infrastructure is getting more efficient every quarter. While there will always be competition, no other system enables the same flexibility and transplant successes. Even OrganOx has vastly inferior post-transplant results. And hospitals love TransMedics for many reasons. For one, surgeons don’t need to get paid overtime for transplants at 1 am. Two, multiple transplants can be scheduled for the same day, increasing revenue severalfold, compared to old methods. Three, TransMedics has their own staff to deliver the organs and even do the surgeries if requested. And fourth, post-op results are significantly better so hospitals get better ratings.

While it will likely be a slog internationally, TransMedics can use its future cash flow to slowly build out a global infrastructure. That won’t happen overnight but with kidney indications, and improved technology on current systems, the company could conceivably grow its revenues by a factor of 4-5x. That is the strongest bear-case – that the opportunity isn’t unconstrained – there are only so many people who die every year who opt in to transplants with healthy organs. But TransMedics will likely do an excellent job in executing on their mission to save lives and in the process, becoming very profitable.

Closing

While markets are at all-time highs, revenue-less SPACs are making a comeback, and Meta raised almost $30 billion in private debt that matures probably six years after the GPUs fully depreciate, we are actively trying to stay paranoid. Complacency kills so we’re keeping our head on a swivel but we’re also keenly aware we’re living through maybe the biggest technology revolution of all time. It’s an exciting time to be an investor – well, it almost always is – but pride goes before a fall so we’re humbling ourselves as much as possible.

I’m honored to have you as a partner. Thank you for your trust and support. It enables me to think long-term and will be our own competitive advantage.

The stock market, like life, will have its ups and downs. All we can do is focus on what we can control and work hard to continually raise our standards. Our strategy is simple – hitch a ride to the world’s best entrepreneurs that are running the fastest-growing, highest-quality companies at the most attractive valuations we can find. Here’s to many more years of focusing on the inputs and letting the outputs take care of themselves.

Sincerely,

Ryan Reeves

Disclosures

Infuse Asset Management LP (“Infuse”) is an investment management company to a fund that is in the business of buying and selling securities and other financial instruments. This information is provided for informational purposes only and does not constitute investment advice or an offer or solicitation to buy or sell an interest in a private fund or any other security. An offer or solicitation of an investment in a private fund will only be made to accredited investors pursuant to a private placement memorandum and associated documents.

Infuse may change its views about or its investment positions in any of the securities mentioned in this document at any time, for any reason or no reason. Infuse may buy, sell, or otherwise change the form or substance of any of its investments. Infuse disclaims any obligation to notify the market of any such changes.

The S&P 500 is a U.S. equity index. It is included for informational purposes only and may not be representative of the type of investments made by the fund. References made to this index are for comparative purposes only. Reference to an index does not imply that the funds will achieve returns, volatility, or other results similar to the index. The fund’s portfolios are less diversified than this index. Returns for the index are total returns which include dividends and do not reflect the deduction of any fees or expenses which would reduce returns.

An investment in the fund is speculative and involves a high degree of risk. The portfolio is under the sole trading authority of the general partner. An investor should not make an investment unless the investor is prepared to lose all or a substantial portion of its investment. The fees and expenses charged in connection with this investment may be higher than the fees and expenses of other investment alternatives and may offset profits.

The information in this material is only current as of the date indicated and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Any statements of opinion constitute only current opinions of Infuse which are subject to change and which Infuse does not undertake to update. Due to, among other things, the volatile nature of the markets, an investment in the fund/partnership may only be suitable for certain investors. Parties should independently investigate any investment strategy or manager, and should consult with qualified investment, legal and tax professionals before making any investment.

The fund is not registered under the Investment Company Act of 1940, as amended, in reliance on an exemption thereunder. Interests in the fund have not been registered under the securities act of 1933, as amended, or the securities laws of any state and are being offered and sold in reliance on exemptions from the registration requirements of said act and laws.

CORE VALUES

Our core values are an acronym that spells Infuse. That was intentional from the very beginning. We wanted our core values infused into the fund itself.

I - infinite

We are playing an infinite game. We firmly believe that business is one of the most powerful forces of good in society and because of that, investing can be a non-zero sum endeavor. We want partners with the same long-term mindset so we can support the brightest people who are creating the strongest companies.

​N - no

In today's world of plentiful opportunities, saying "no" is a superpower. Saying no to partners who don't have the same long-term vision as us. Saying no to great companies that just aren't top-tier. Or saying no to good opportunities that take us away from doing the most important work for partners. Saying "no" is much easier when you know what you need to focus on. Extreme focus is the driving force behind this core value.​

​F - fellowship

In the industry, principals are held to a fiduciary duty which means that they don't act in a way that harms clients. We think that is far too low of a bar. Instead, we think that we should treat you like a good friend or a family member. If we wouldn't offer our strategy to them, why should we offer it to you?

U - uffgeva

This is an Amish word that means "the renunciation of one's rights in service of others". We think that idea is core to good business. The businesses that truly serve customers will grow and thrive and we want to model that in our own business as well as the ones we invest in.

S - soli del gloria

This means "glory to God". My faith inspires me to work diligently for the One who gives me purpose.

E - excelsior

Another Latin word that means "ever higher". This is a testament to constantly striving to improve. Without a growth mindset, we will stagnate and be unable to deliver world-class returns for the next several decades. We don't congratulate ourselves when we are doing well. There is always room for improvement.

HIGH STANDARDS

We invest in the fastest-growing, highest-quality businesses in the world with the shortest payback periods. Fast growth usually indicates rampant customer demand and strong operating leverage signals effective execution. The combination of these two leads to high rates of intrinsic value growth. When valuation assumptions are reasonable, this leads to supernormal compounding. We compound your capital by relentlessly focusing on these three variables -- growth, quality and valuation. We don't want just one of them, we want all three. If you want much more detail about our process, please refer to this post.

EDGE

Our edge is that we ruthlessly focus on the best. We aren't just looking for companies that are doubling revenue every year, have the largest moat, or the lowest EV/FCF. We are looking for the handful of companies that rank in the top 1% along the growth, quality, and valuation continuums. We truly have long-term investors with an extremely flexible mandate which allows us to concentrate on owning only the best. We don't need to compromise on any of our criteria. Our vision is a beautiful, virtuous cycle where our portfolio companies grow stronger every year, giving us time to find even stronger companies.

Vision

My goal is that Infuse would be the best-performing public equity fund over the next 50 years. I realize that sounds crazy but that’s the goal – long-term, world-class returns, not absolute AUM. To give us the best odds of accomplishing that goal, there are a few things that might be helpful.

To invert the premise, we can’t have the best-performing fund over 50 years if it doesn’t survive 50 years. One of the main ways that funds dissolve is through excessive leverage. In service of returns, leverage ends up destroying them. To me, the risk simply outweighs the reward, especially since world-class returns are typically derived from situations where there is a lack of agreement about a company. In these cases, stock prices can be wildly volatile. Adding leverage to that cocktail is a recipe for, in the best case, stress, and in the worst case, failure.

However, just making the claim that you want to be the best isn’t worth a whole lot without a strategy to make it a reality. To this end, our plan is to hold a concentrated portfolio of the fastest-growing, highest-quality companies in the world at the best valuations we can find.

Stock prices are a function of two things – earnings and other investors’ perceptions of those earnings. So in an ideal world, we’d buy stocks where earnings increase dramatically while the perception is that the company won’t be able to continue its success. However, perception can be quite fickle. Betting on how other people will view the nature of a company’s earnings in 5 or 10 years is not an easy task. That’s why we primarily focus on the velocity and durability of the earnings growth and then make sure we’re not overpaying.

While our goal is world-class returns, that’s really an output of good decisions. Focusing too much on explicit performance goals can create unintended consequences. As Theodore Roosevelt liked to say, “comparison is the thief of joy.” There’s nothing wrong with wanting to be the best, – however, there is something wrong when it takes your focus off the inputs to the process. Being consumed with the highest returns can also lead to decisions that make the process more fragile – adding leverage being an excellent example.

Therefore, with the long-term goal of world-class returns in mind, we seek to focus on the inputs to the process. After all, that’s what we have control over. Namely, we have control over our specific standards of growth, quality, and valuation. And when we focus, every day, on trying to raise those standards, the outcome will take care of itself.

FULL SLIDE DECK for accredited investors. Thanks for the interest. If you have any questions, reach out at ryan@infuse-am.com

Dear partners,

Thank you for your continued trust and support; you are the best partners I could ask for.

At the end of the day, good investing is about understanding reality. If you deeply understand a situation, you will know what to do. However, the future is unpredictable so understanding, alone, doesn’t guarantee success but rather informs probabilities. Our primary job is to find situations where the probabilities are extremely in our favor. One probability-tilting characteristic is buying a stock at a low multiple of cash flow. Just blindly buying a low multiple stock is not good investing but it does tilt the odds in your favor. However, if you’re buying a business and expect to get paid back from cash flow, longevity and business quality matter immensely. After all, if you pay 10x cash flow on a stagnant business, it has to survive at least ten years for you to make money. This is a simple yet important insight. So a dominant competitive position and a moat definitely tilt the odds in your favor. Buying a truly scarce asset is a good way to not lose money because there will likely be a bid for that asset. But if an asset is easy to replicate, by definition, it won’t be as valuable. Another factor that improves odds is management alignment. As public market investors, we don’t have the whole story, no matter how good your scuttlebutt is. Trusting a management team with a track record of fleecing investors severely handicaps the odds of success. Further, strong financial footing helps quite a bit. If a company is profitable without debt, it’s awfully hard to go bankrupt. Sure, things will change over time but that’s where the irreplaceability and moat come into play. With a robust financial foundation, you seriously decrease the odds of a disastrous outcome. We could go on and on, but the goal is to see reality for what it really is and in doing so, improve your odds drastically. If you can find a company that is hard to replicate with an aligned manager, a strong financial picture, at a low multiple of cash flow, that is a great start to stacking the deck in your favor. But that’s also like saying ice cream is tasty. Of course it is! What actually matters is putting these concepts into practice. Those criteria are an example of our map but the map is not always the terrain. In reality, businesses are messy and we have to make probability-weighted decisions based on incomplete information. The ideal scenarios are when your research says the odds of success are much higher than the market is expecting. Variant perception is at the heart of good investing but it’s also incredibly difficult. If the herd is running one way, that is usually toward safety. Making a bet that the majority isn’t seeing reality clearly is daunting. It requires constant paranoia of trying to see blind spots. One great quote about this concept is from Henry Ford:

“Even the man who most feels himself ‘settled’ is not settled — he is probably sagging back. Everything is in flux, and was meant to be. Life flows. We may live at the same number of the street, but it is never the same man who lives there. It could almost be written down as a formula that when a man begins to think that he at last has found his method, he had better begin a most searching examination of himself to see whether some part of his brain has not gone to sleep.”

With all of that said, I want to talk a little bit about one of our top positions and how we thought the odds were tilted in our favor. We started buying Intellego at around a $60 million USD valuation. The CEO owned about 10% of the shares but there had been a string of questionable governance things like a board member being convicted of insider trading, a part-time CFO, and very promotional press releases. At the time, the company was doing about $8 million in EBIT, had about $6 million in inventory/fixed assets, $8 million in receivables net of payables, and a negligible amount of debt. I figured that even if they got a 50% haircut on the working capital, the true enterprise value was about $53 million on $8 million in EBIT. Receivables were still too high but they also signed some very lenient contracts in the early days just to get traction. The main thing I needed clarity on was how difficult it would be to replicate the dosimeter business. Well, it turned out that the patent on the photochromic ink had just been continued, a huge German client had been doing trials for well over a year, and there were rumblings of a billion dollar Chinese distributor interested in an exclusive deal. Still, it was not clear that dosimeters would be used every day in hospitals and manufacturing. After all, why were receivables so high if the products were being used constantly? Surely, hospitals were just trying the dosimeters and then not paying quickly because the product was not mission critical? These questions are what I spent hours on, trying to see reality as clearly as possible. Quite honestly, I couldn’t get complete satisfaction. Different users had different opinions, different hospitals had different protocols, and different countries had different disinfecting regulations. But even with incomplete information, on the downside, I thought the company had decent odds of lasting more than six years and in an upside scenario, had the potential to grow its earnings by at least an order of magnitude. These asymmetries don’t come along very often so when they do, betting big can make sense. At the same time, extreme paranoia is warranted because surely, I must’ve been missing something! I talked to every bear I could and tracked down as many answers as possible. I don’t say all of this to pat myself on the back but rather dive into a real-life example of seeing reality as clearly as we can and translating that into probabilities. At a very high level, I thought the odds of fraud were about 10%, there was a 10% chance the stock could go up 20x, a 30% chance it would get bought out at its current value, and another 50% chance it could triple in price. These were very rough estimates and they were and are still changing but the expected value was nearly 4x over a 5-year timeframe.

At the end of Q2, Intellego was at a ~$258 million USD market cap and its trailing EBIT is roughly $27 million, or a 9.5x EBIT multiple. That is just two turns (~7.5x initial EV/EBIT) higher than where we bought it, even though the stock has more than tripled from our average price. These situations, where we make money through earnings growth, are exactly what we are looking for. Some people are great at playing the perception game. But what is proven to move stock prices over the long run is earnings growth. Trying to tilt the odds in our favor by studying growth runways, business quality, and valuation is our formula for success. We have made many mistakes since the start of the fund but I’m happy to share how the Intellego thesis developed and how we grew your hard-earned capital through this experience. As the world continues to change, we will focus exclusively on how to tilt the odds in our favor.

Closing

I’m honored to have you as a partner. Thank you for your trust and support. It enables me to think long-term and will be our own competitive advantage.

The stock market, like life, will have its ups and downs. All we can do is focus on what we can control and work hard to continually raise our standards. Our strategy is simple – hitch a ride to the world’s best entrepreneurs who are running the fastest-growing, highest-quality companies at the most attractive valuations we can find. Here’s to many more years of focusing on the inputs and letting the outputs take care of themselves.

Sincerely,

Ryan Reeves

Disclosures

Infuse Asset Management LP (“Infuse”) is an investment management company to a fund that is in the business of buying and selling securities and other financial instruments. This information is provided for informational purposes only and does not constitute investment advice or an offer or solicitation to buy or sell an interest in a private fund or any other security. An offer or solicitation of an investment in a private fund will only be made to accredited investors pursuant to a private placement memorandum and associated documents.

Infuse may change its views about or its investment positions in any of the securities mentioned in this document at any time, for any reason or no reason. Infuse may buy, sell, or otherwise change the form or substance of any of its investments. Infuse disclaims any obligation to notify the market of any such changes.

The S&P 500 is a U.S. equity index. It is included for informational purposes only and may not be representative of the type of investments made by the fund. References made to this index are for comparative purposes only. Reference to an index does not imply that the funds will achieve returns, volatility, or other results similar to the index. The fund’s portfolios are less diversified than this index. Returns for the index are total returns which include dividends and do not reflect the deduction of any fees or expenses which would reduce returns.

An investment in the fund is speculative and involves a high degree of risk. The portfolio is under the sole trading authority of the general partner. An investor should not make an investment unless the investor is prepared to lose all or a substantial portion of its investment. The fees and expenses charged in connection with this investment may be higher than the fees and expenses of other investment alternatives and may offset profits.

The information in this material is only current as of the date indicated and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Any statements of opinion constitute only current opinions of Infuse which are subject to change and which Infuse does not undertake to update. Due to, among other things, the volatile nature of the markets, an investment in the fund/partnership may only be suitable for certain investors. Parties should independently investigate any investment strategy or manager, and should consult with qualified investment, legal and tax professionals before making any investment.

The fund is not registered under the Investment Company Act of 1940, as amended, in reliance on an exemption thereunder. Interests in the fund have not been registered under the securities act of 1933, as amended, or the securities laws of any state and are being offered and sold in reliance on exemptions from the registration requirements of said act and laws.

Thank you for your continued trust and support; you are the best partners I could ask for.

This quarter, I want to talk a little bit about selling. The biggest mistakes for most investors tend to be mistakes of omission, meaning big winners they missed out on (or sold too soon). Truly great businesses continually execute. That’s why Peter Lynch said to not cut the flowers and water the weeds. Globally, there really aren’t that many businesses that deserve to be held for very long periods. But when you do find one and it performs well, then it becomes difficult to not get attached. On the other hand, if something is egregiously overvalued, it makes sense to trim and be opportunistic.

It became much easier, psychologically, for me to sell losers once I framed it as securing tax losses. That is quite obvious but it helps me get out of the mindset where you hope the stock reaches your cost basis. The stock has no idea what price you bought it. You have no right to think it should get back to your purchase price. All that matters is the highest return, lowest risk bet for each dollar in your portfolio and how those bets work together. If you buy a stock and it’s down 5% the next day and you realize you made a mistake in your analysis, the question you have to ask is, if I had this amount in cash, where would I optimally allocate these dollars? The past is the past, even if you made the trade yesterday. If a company isn’t executing based on your thesis, then it’s an easy sell. This can take many forms. For instance, if the founder CEO leaves unexpectedly and they were a large part of your thesis, then maybe it’s a sell. The analysis can also change based on taxes. If the CEO resigns 11 months after your purchase, maybe it makes sense to hold for one more month to get long-term capital gains treatment? If you made a $100,000 investment and it was up 20%, then you’d have $20,000 in gains. The difference between 30% and 15% tax rates is $3,000. Essentially, if the stock goes down more than 2.5% (3/120), then your decision to hold off is a bad one. If you do this same calculation with a 100% gain, the number is 7.5%. Even at a 200% gain, the math says it’s better to sell if you expect the stock to go down by more than 10% in the next month. If you use 37% and 20% rates for high income earners, the calculation is just over 9% and 11% for the 100% and 200% gains respectively. Stocks can move wildly in one month, especially if they’ve just had a big move. So if the only reason you’re holding is to avoid taxes, you have to ask yourself if there’s a real chance the stock can go down by more than your breakeven point.

On the other hand, if you continually buy and sell, your pre-tax returns need to be high to compensate for the excess taxes. For example, if you were to take short-term gains (30%) on a stock every year, you’d need a 21.43% pre-tax CAGR to reach parity with someone who never sold a stock that was doing a 15% CAGR. At 37% tax rates, that number goes up to 23.81%. That is a giant difference. At 15% tax rates, the pre-tax return needs to be 17.65% if you were to sell every year and buy something new. These small differences add up immensely over decades. For instance, if you run this scenario over 30 years, let’s say your pre-tax return is 15% and you buy and sell a new stock every year, right after reaching long-term tax treatment, compared to someone who held a stock that compounded for 15% annually but then they sold after 30 years. Want to guess what the difference in returns are? 12.75% vs. 14.39%. Less than 2%. Doesn’t seem like that big of a deal, right? Wrong! It’s almost a $2 million difference. Starting with $100,000, after 30% years at 12.75%, you’re left with $3.66 million. But at 14.39%, you’d have $5.64 million. That’s over 50% more money! If you do the same calculations but use 30% short-term rates, the difference is over $3.6 million. So clearly it pays to not pay taxes every year and just let the companies compound. At the same time, if you think you can target significantly higher pre-tax returns, you just have to be aware that you need at least 643 bps of outperformance if we use a 15% CAGR as our reference point if you rack up short term gains every year.

So this is the tax paradox – and thereby the selling paradox if you’re serious about long-term after-tax returns – in isolation, holding for one more month in our example is likely a poor decision considering stock volatility but if you compound that decision over a long enough time horizon, it really adds up. What does this mean? Don’t be a slave to the idea of paying taxes but rather be keenly aware of their effects over the decades. I’m preaching to myself here because I struggle with this tension.

If you don’t think a stock is a good value going forward, there is a cushion you can give, meaning you can actually tolerate slightly lower forward returns because you have an implied tax advantage from holding. The math is slightly complicated but it basically indicates that, even with a huge winner, you shouldn’t compensate more than 3-5%. For example, if you have a 5-year time horizon, long-term capital gains rates, and a 300% gain, if your forward expected return is less than 3% annually compared to another opportunity, the math says sell. However, your estimate won’t be perfect so it’s likely a mistake to be overly precise in these decisions. The best investing decisions tend to be obvious. If you need to model everything out to a few decimal points, the opportunity is likely not good enough.

So the two primary times you should sell are when the company is executing poorly and you can quickly take a loss or when another opportunity is a no-brainer in comparison. This is overly simplistic but I think it gives a good foundation for being aware of taxes but not letting them rule you. The math is fairly straight-forward which is helpful in demystifying the stigma of paying taxes but it’s still very important to keep them in mind before hitting the sell button.

With that as the backdrop, we did make a sale early this quarter as Axon’s valuation had gotten ahead of itself. The stock’s IRR for our day one investors was over 80% annually. A good chunk of that was due to multiple expansion so the valuation piece of the Infuse formula has been severely handicapped. The forward expected returns simply aren’t good enough compared to some other opportunities so we trimmed significantly. That will show up on your tax bill next year but that’s also one reason why I extensively discussed this topic. Even still, we are beating the benchmark after fees and taxes which is incredibly important to me. You can easily buy the S&P 500 for a couple basis points in fees these days and get exposure to the strongest innovation machine in the world. If we’re not providing more value above and beyond that, we aren’t worth your time and your hard-earned money.

All that said, let’s talk stocks and give an overview of an undisclosed position (one of two) in the portfolio. I’m still not going to give the name since it’s so illiquid but it will be easy to know which company I’m discussing if you dig a little. I will, however, send a slide deck with more information on the company for those of you who reach out (only for partners).

The company is the leading EDI (electronic data interchange) provider for Australian pharmacies. Nearly every pharmacy in Australia and New Zealand uses this software to order items from suppliers. EDI companies convert data from different business systems so customers and suppliers can interact seamlessly. For instance, the invoicing format from your point-of-sale system might differ from the supply chain management software on the other end of the transaction. When you add in accounting and ERP systems, the whole thing gets messy. EDI software is like a translator of the different formats that enables everything to work together. This company’s business model is to charge the suppliers of the pharmacies about $200/year (after rebates for the point-of-sale vendors) for each different pharmacy they are connected to. For the EDI business, if we assume 70 suppliers could match with 5,000 pharmacies, the total addressable market would be $70 million. The company won’t penetrate its supplier base fully but at 50% free cash flow margins (yes, this is very profitable business) and even 50% penetration, that’s about 70% of the current enterprise value. But we aren’t even to the good part yet. In Australia, the government regulates prescription drug prices so pharmacies have had to attract foot traffic to offset this margin pressure. Our portfolio company has started a marketplace which allows suppliers to directly target pharmacies they want to sell into. Think of it like an Amazon-esque web portal for pharmacists. There is a take-rate here that varies depending on the product while the company also sells analytics that can be bundled into the pricing. Right now, about $13 billion flows through the company’s EDI software and I think there is a real chance that $1 billion could be transacted on the marketplace at some point. At a 4% take-rate, after including analytics, that would be a $40 million opportunity. At those same high margins, that would be 80% of the enterprise value. Putting these estimates together, that’s $37 million in potential annual cash flow. Even valued at 10x, we’d have more than a 10-bagger and the current market cap paid many times over in dividends. We’ve outlined a very bullish scenario but it is actually achievable. I look forward to sharing more information on this company as the progress of the marketplace starts showing up in the financial statements. This is another company that perfectly fits the Infuse formula.

Closing

I’m honored to have you as a partner. Thank you for your trust and support. It enables me to think long-term and will be our own competitive advantage.

The stock market, like life, will have its ups and downs. All we can do is focus on what we can control and work hard to continually raise our standards. Our strategy is simple – hitch a ride to the world’s best entrepreneurs that are running the fastest-growing, highest-quality companies at the most attractive valuations we can find. Here’s to many more years of focusing on the inputs and letting the outputs take care of themselves.

I’ll add one tiny paragraph to end as the events of the last few weeks have been interesting to say the least – I don’t know what the tariffs will bring but I do know that our companies are reporting strong numbers, they have good valuations, and improving moats. Note that the beginning of April has been even more volatile for the market than Q1 but I’m grateful that Intellego announced extremely robust preliminary results. Further, we had been trimming some overvalued positions so we are deploying some cash. We are currently open to new investors so if you know anyone who is looking to grow their capital, send them our way. Thanks again for the trust with your hard-earned savings. I’m eager to continue compounding your investment.

Sincerely,

Ryan Reeves

Performance Appendix

Disclosures

Infuse Asset Management LP (“Infuse”) is an investment management company to a fund that is in the business of buying and selling securities and other financial instruments. This information is provided for informational purposes only and does not constitute investment advice or an offer or solicitation to buy or sell an interest in a private fund or any other security. An offer or solicitation of an investment in a private fund will only be made to accredited investors pursuant to a private placement memorandum and associated documents.

Infuse may change its views about or its investment positions in any of the securities mentioned in this document at any time, for any reason or no reason. Infuse may buy, sell, or otherwise change the form or substance of any of its investments. Infuse disclaims any obligation to notify the market of any such changes.

The S&P 500 is a U.S. equity index. It is included for informational purposes only and may not be representative of the type of investments made by the fund. References made to this index are for comparative purposes only. Reference to an index does not imply that the funds will achieve returns, volatility, or other results similar to the index. The fund’s portfolios are less diversified than this index. Returns for the index are total returns which includes dividends and do not reflect the deduction of any fees or expenses which would reduce returns.

An investment in the fund is speculative and involves a high degree of risk. The portfolio is under the sole trading authority of the general partner. An investor should not make an investment unless the investor is prepared to lose all or a substantial portion of its investment. The fees and expenses charged in connection with this investment may be higher than the fees and expenses of other investment alternatives and may offset profits.

The information in this material is only current as of the date indicated and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Any statements of opinion constitute only current opinions of Infuse which are subject to change and which Infuse does not undertake to update. Due to, among other things, the volatile nature of the markets, and an investment in the fund/partnership may only be suitable for certain investors. Parties should independently investigate any investment strategy or manager, and should consult with qualified investment, legal and tax professionals before making any investment.

The fund is not registered under the investment company act of 1940, as amended, in reliance on an exemption thereunder. Interests in the fund have not been registered under the securities act of 1933, as amended, or the securities laws of any state and are being offered and sold in reliance on exemptions from the registration requirements of said act and laws.

Thank you for your continued trust and support; you are the best partners I could ask for. As we wrap up the year, I wanted to include a summarized section from our first quarterly letter:

My goal is that Infuse would be the best-performing public equity fund over the next 50 years. I realize that sounds crazy but that’s the goal – long-term, world-class returns, not absolute assets under management. However, just making the claim that you want to be the best isn’t worth a whole lot without a strategy to make it a reality. To this end, our plan is to hold a concentrated portfolio of the fastest-growing, highest-quality companies in the world at the best valuations we can find. With the long-term goal of world-class returns in mind, we seek to focus on the inputs to the process. After all, that’s what we have control over. Namely, we have control over our specific standards of growth, quality, and valuation. And when we focus, every day, on trying to raise those standards, the outcome will take care of itself.

Now, after just over two years in operation, it was a rather slow start on the journey of executing our audacious goal. But it has allowed us to really get back to our core principles and selectively add wonderful partners. With the fund now beating the S&P since inception and our process getting stronger by the day, we have laid a solid foundation for long-term compounding. But we couldn’t have done it without the steadfastness of you, our partners. We are just getting started and have so much work left to do. We are not letting one ounce of complacency creep in as the market tends to humble the proud. We are not satisfied and will continue to adapt so we can multiply your hard-earned savings. In keeping with the Q4 letter from last year, let’s take a look at the businesses you own a piece of, shall we?

Axon

Axon’s stock is never really cheap but they just continue to execute. New products like DraftOne are adding a ton of value to officers and Axon continues to innovate on its drone platform. While the company trades for a very high multiple, the contracted backlog of more than $9 billion shows that there is potential for at least several billion dollars of free cash flow in the future. However, I am looking to trim this one as I think the valuation has gotten ahead of itself. While selling a truly great company is almost always a bad choice, at some point, the math to justify forward returns becomes quite difficult. Axon’s IRR for the fund has been over 80% annually and I just don’t see nearly as much upside in the future. I do try to be slow to sell big winners as they tend to outperform even sky-high expectations. As we continually raise our standards, one thing I’ve realized is there really aren’t that many truly special companies out there so it pains me to sell a company I put in that category. Even still, sometimes the math just doesn’t quite pencil out and it’s time to trim. Next quarter, we’ll discuss our selling process but for now, we’re paring back a winner based solely on valuation.

Intellego

This is the Swedish microcap that we wrote up last quarter. Intellego makes dosimeters, which are small paper cards that change color when exposed to UV light (specifically UV-C). It seems like a very basic product but the company has strong patent protections and is the brand leader in the space. Since dosimeters are such a low-cost item (often under $5), Intellego has forward-vertically integrated into distributing UV machines to increase dosimeter sell-through. While it’s dilutive for margins and ROIC, it strengthens the competitive advantage significantly. We think it’s possible for the company to do $20 million in EBIT next year and maybe $15 million in FCF but the market cap is only a little more than $100 million. For 40%+ growth, we think this is a very good deal and I wouldn’t be surprised to see the stock double over the next year. Obviously, no guarantees since there are clear risks with a long history of questionable cash flow and board member shenanigans. However, this company fits the Infuse Formula to a tee.

Nu Holdings

Nu is executing on its own audacious vision of becoming one of the largest companies in the world. It surpassed 100 million customers at the beginning of Q2 and is marching towards the next 100 million. As it doubles down on gaining market share in Mexico, it continues to build out its super app in Brazil. High income clients can now book flights, shop, get a payroll loan, buy ETFs, exchange currency, get a business loan based on their personal loan limit, get a cellphone plan, and much more. Nu’s mission is to fight complexity – nothing in that mission statement revolves around banking. I don’t want to fully get caught up in the vision, but the management team has the skills to back up the story. Meanwhile, the top-line is still growing in excess of 30% and margins are encroaching on 30%, while the forward multiple is less than 20x. If we could find 10 companies of this caliber, I would be thrilled.

MercadoLibre

Staying in Latin America, MELI continues to spin its commerce/payments flywheel. While it started out as an e-commerce platform, its fintech business is now much larger. When management pulled back on giving out loans for fear of a worsening economy, overall revenue growth picked up with accelerating GMV in the core e-commerce business. Then, the finance business segment started to reaccelerate when the team realized nonperforming loan ratios were lowered than expected. But the segments aren’t fully independent. There is a beautiful synergy as on-platform payments lower the friction for the commerce business and faster delivery times lead to more orders and therefore more payments. Meanwhile, MELI also offers a plethora of tools for merchants in both commerce and finance. The company is still growing more than 30% and it has a leading brand in Latin America. Someday Nu and MercadoLibre will bump up against each other but I think we still have at least 5 years before they start competing head-on. For less than 30x forward earnings, the valuation is still reasonable for the company.

Shelly Group

Shelly Group continues to truck along. It now is offering chips to make smart appliances even smarter. Through a partnership with Samsung, your fridge can now connect to the Shelly platform. This significantly widens the TAM as there are millions of appliances and Shelly can produce these chips for an extremely low cost with high functionality. While the stock is up more than 2x since our purchase price, I haven’t even thought of selling a share. I think the company could reach $60 million in EBIT by the end of 2026, which implies a 10x multiple of today’s price. A 20x multiple would mean another double in two years, which I’d be very happy with. Broadly, that’s how I think of margin of safety – if the company can reasonably double in two years, then the risk/reward is probably pretty solid.

Tesla

I’ve been very patient with Tesla. Frankly, I’m a big believer in Elon but I also hate investing in companies where the narrative far outweighs any financial evidence. I do see a path to Tesla being one of the world’s largest companies but slight growth in a cyclical industry with very little pricing power is not a recipe for strong forward returns. Though the AI/robotics narrative is strong, I’m not adding at current prices since we haven’t seen much of the narrative translate into the earnings yet. This cognitive dissonance can be an uncomfortable tension but I’m trying to look at the big picture here. So while I fully admit that Tesla may be overvalued in the short run, the long-term destination of the company should not be underestimated.

HelloFresh

This company is the leader in meal kits, which is a historically tough business but they have a fast-growing segment of ready-to-eat meals that is now about a quarter of the business. The company actually has solid infrastructure for creating and distributing meals at scale and we started our position at under 5x my estimated earnings. For a company that could accelerate growth, is rationalizing spending in the core business, and led by a founder, this seems like a pretty reasonable price.

Nvidia

We do still own some Nvidia as the forward multiple isn’t egregious and it powers over 90% of AI workloads. This company is only becoming increasingly important though the hyperscalers are actively trying to save money through their own ASIC programs. The moat CUDA provides has been underestimated time and time again. While I don’t think Nvidia has quite the upside as some of the other companies in the portfolio, it has a product that the best companies in the world literally can’t get enough of.

Two Undisclosed Positions

Lastly, feel free to reach out if you’d like to discuss these companies but I’m not ready to talk about them publicly since they’re pretty illiquid. As the volume picks up, hopefully we can write them up in the future but for now, I’m not even going to give hints :)

Closing

Over the last two years, we have optimized taxes as much as possible. We do try to let our winners run but a few pieces of evidence caused us to lose trust in Alarum’s management. It’s humbling to say this now, just two quarters after writing it up, but we also made it clear that trust in management was the biggest question mark. We did end up selling at higher prices than the current stock price but it never makes me feel good to see a stock crash that we owned. That is a sign of poor business judgment. Even still, we saw the writing on the wall when growth slowed much more than expected and the founder cashed out almost all of his shares. Since we had to react quickly, that built up significant short term gains. Further, we also sold Celsius and Samsara this year due to valuation concerns. These three sales contributed significantly to this year’s tax bill. One of my biggest weaknesses as an investor is worrying too much about taxes to the point of riding winners back to where we bought them but I have been trying hard to overcome this bias so despite not being happy about giving LPs a large tax bill, I do think it’s progress. It’s all about after-tax, net returns so I make every decision with this in mind, but sometimes it’s better to move quickly and change your mind.

I’m quite happy with the blend of growth, quality, and valuation of the companies in the portfolio. But I’m even more pleased with the investor base. I’m honored to have you as a partner. Thank you for your trust and support. It enables me to think long-term and will be our own competitive advantage.

The stock market, like life, will have its ups and downs. All we can do is focus on what we can control and work hard to continually raise our standards. Our strategy is simple – hitch a ride to the world’s best entrepreneurs that are running the fastest-growing, highest-quality companies at the most attractive valuations we can find. Here’s to many more years of focusing on the inputs and letting the outputs take care of themselves.

Sincerely,

Ryan Reeves

Performance Appendix

Disclosures

Infuse Asset Management LP (“Infuse”) is an investment management company to a fund that is in the business of buying and selling securities and other financial instruments. This information is provided for informational purposes only and does not constitute investment advice or an offer or solicitation to buy or sell an interest in a private fund or any other security. An offer or solicitation of an investment in a private fund will only be made to accredited investors pursuant to a private placement memorandum and associated documents.

Infuse may change its views about or its investment positions in any of the securities mentioned in this document at any time, for any reason or no reason. Infuse may buy, sell, or otherwise change the form or substance of any of its investments. Infuse disclaims any obligation to notify the market of any such changes.

The S&P 500 is a U.S. equity index. It is included for informational purposes only and may not be representative of the type of investments made by the fund. References made to this index are for comparative purposes only. Reference to an index does not imply that the funds will achieve returns, volatility, or other results similar to the index. The fund’s portfolios are less diversified than this index. Returns for the index are total returns which includes dividends and do not reflect the deduction of any fees or expenses which would reduce returns.

An investment in the fund is speculative and involves a high degree of risk. The portfolio is under the sole trading authority of the general partner. An investor should not make an investment unless the investor is prepared to lose all or a substantial portion of its investment. The fees and expenses charged in connection with this investment may be higher than the fees and expenses of other investment alternatives and may offset profits.

The information in this material is only current as of the date indicated and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Any statements of opinion constitute only current opinions of Infuse which are subject to change and which Infuse does not undertake to update. Due to, among other things, the volatile nature of the markets, and an investment in the fund/partnership may only be suitable for certain investors. Parties should independently investigate any investment strategy or manager, and should consult with qualified investment, legal and tax professionals before making any investment.

The fund is not registered under the investment company act of 1940, as amended, in reliance on an exemption thereunder. Interests in the fund have not been registered under the securities act of 1933, as amended, or the securities laws of any state and are being offered and sold in reliance on exemptions from the registration requirements of said act and laws.

Thank you for your continued trust and support; you are the best partners I could ask for. 

After two years of running the fund, I’d like to reflect on how things have progressed. Frankly, 2022 was embarrassing and we got off to a rough start. Digging out of a 35% hole at one point was very daunting. However, the one variable that mattered was the rate of improvement of our research process. Focus on that and the results would follow. Our strategy, in my opinion, wasn’t the problem since the rate of change of earnings relative to the price paid is simple logic, so it was the execution of the strategy that needed refinement. That led to the creation of our quality checklist, which enabled us to build a library of over 1,100 companies that we could constantly compare against each other.

While the early versions of this database identified Nvidia as the top company, my personal lack of imagination still led us to miss the early gains. This is just one of many examples where our quality database has singled out incredible stocks. Over time, I have come to trust our criteria more and more, enabling us to have a wide backlog of potential investments. The simple exercise of comparing and contrasting every company against the same quality criteria allows us to truly identify the special companies over the long run. While revenue growth data changes quarterly, the characteristics of a great management team, barriers to entry, and consumer value surpluses change much less frequently. To hold a business for the long-term, the metrics you focus on have to align with that goal. You can’t hold a business for decades if you only focus on the stock price.

As our research process improved, so did our results. After two years, we are now neck and neck with the S&P 500 net of fees, but there is still much more work to be done. Even though we’re up 69.8% year-to-date, I’m not satisfied. Our goal is to not just eke out similar returns to the benchmark but to downright crush it. To reiterate the strategy, we concentrate in the fastest-growing, highest-quality businesses at the lowest multiples we can find; this is the Infuse formula: 

All else equal, a higher valuation will handicap returns. However, a low valuation with no growth and no quality, means no returns. It’s simple but not easy to identify great companies with low valuations. That’s because it’s a competitive marketplace. The best companies tend to have very high valuations since everyone knows they’re great. 

Further, the formula is additive in the numerator so if we find an extremely high quality company with very little growth at a rock-bottom price, that could still lead to strong returns. Likewise, if we find a company growing rapidly but with lower quality and a cheap valuation, this could also work out. The problem with these set-ups, as we’ve discussed, is that it’s hard to hold them for a long-time since time is the enemy of a low-quality business. That’s why we try our very best to find opportunities that are in the top decile along the three vectors of growth, quality, and valuation. Very often, in the Infuse Formula, there will be a trade-off. One of the three may not be top decile, or two of the three may be second decile, or all three scores may be high but none reaching the top decile. There are almost always trade-offs because investing is competitive. If an opportunity really is a no-brainer, the price will usually get bid up. However, if you can be correct about a change in a business’s trajectory before it really shows up in the financials, that is where big money can be made. But it often requires a deep understanding of an industry or company.

It’s simple but not easy to hold a very concentrated portfolio of these fast-growing, quality companies at low forward multiples. Every company has its risks and valuation multiples can get stretched but when we do find those rare opportunities that score very highly on the Infuse Formula, we have to take advantage. As always, we have to talk a little bit about companies as well! The one I want to highlight this quarter is a tiny Swedish company named Intellego.

Intellego is a Swedish company specializing in dosimeters for ultraviolet light. There are three types of UV – A, B, and C. UVA rays are long-wave (315-400 nanometers) that typically cause skin cancer. UVB rays are medium length (280-315 nm) which usually cause sunburn. And UVC rays are short-wave (100-280) that gets absorbed by the ozone layer so we don’t hear about it too often. However, it has germicidal properties which means it is good for disinfecting. 

Intellego’s dosimeters react to UV light and change color so that practitioners can measure the magnitude of UV for specific purposes. The original vision was from the founder/CEO, Claes Lindahl, when he bought the formulation in 2011 to see if he could help reduce sunburns. The idea was to provide a wristband that would change colors when you needed to reapply sunscreen. That product still exists but Lindahl found it to be too expensive to scale a consumer brand so the company pivoted to B2B sales in other applications.

With COVID, the one market that really took off was healthcare, which makes up roughly 70% of the current business. As mentioned, UVC light is germicidal which is great for disinfecting but it's also invisible so how do you know it’s working? That’s where dosimeters come into play. They are small paper cards that change color based on how much UV light they are exposed to.

Seems like a relatively simple business, right? Just sell paper cards to hospitals for less than $2 a pop and then sit back and relax. Well, it’s not quite that easy. Since the cost per card is so low, it doesn't make economic sense to have a salesforce going door-to-door among all of the different hospitals. So the company sells through distributors of UVC light into hospitals. The actual big light provider sells to the hospital and then the salesperson can add in dosimeters for validation. Unfortunately, the dosimeters weren’t selling through very quickly because it wasn’t high-value enough for the salesperson. 

So now Intellego is backward vertically integrating and has purchased a couple of equipment resellers. The first one was Daro Group, one of the leading water disinfecting providers in the UK, for $12 million USD. Daro is set to grow 15% and be profitable this year. Intellego also started another reseller named Yuvio which offers UVC lamps for hospital settings. One interesting piece about this is that Yuvio resells OhmniLabs UVC robots, among other brands, that zoom around a room with a lamp to disinfect it. The autonomous robot companies love dosimeters because they reveal just how well the robots work compared to a stationary lamp. The stationary lamp may work very well in one particular area but germs obviously aren’t isolated to specific areas. Further, UVC companies that have low quality machines don’t like dosimeters since they expose the lack of radiation and therefore the lack of disinfection. Dosimeters are about 95% gross margins so the capital equipment reselling is much more capital intensive and low margin (far lower ROIC). However, it feels like a necessary step right now as the company tries to build distribution muscle and its moat.

As of Q2 2024, the company has done just over $22 million in revenue over the past twelve months at roughly 80% gross margin and 50% EBIT margin. Daro accounted for about one-third of the business in Q1 and dosimeters made up the rest. If we remove Daro, we find that dosimeters clock in at nearly 70% EBIT margins. Dosimeters, alone, also grew over 100% on the back of several large deals. It’s clear a very good business to sell as many dosimeters as possible but the problem of the low price tag still remains so it doesn’t make economic sense to sell directly to hospitals. Further, European hospitals aren’t exactly the most well-funded institutions. That’s why the curing side of the business is pretty exciting. The company has been in a two-year-long process with a German multinational that does more than $20 billion in revenue to sell dosimeters that validate UV light in the manufacturing process. By the end of the year, we should have some positive news from this customer. Instead of selling a dosimeter for $1.50, they typically sell it for $5 in the curing vertical and this contract alone could be worth the majority of the entire market cap if it takes off like Lindahl thinks it can.

Intellego is not limited to Europe though. The company’s heads of sales for North America and Asia actually work remotely in Alabama and Atlanta respectively. In fact, the founder even works from home. That’s one reason why opex has been so low and the company is able to put up such strong operating margins. There are about 6,000 hospitals in the US, which combine to account for about 1 million beds. In Europe, there are more like 30,000 hospitals that contain 2.3 million beds. Depending on how many dosimeters a hospital would use per day, we can come up with a healthcare TAM. At $1.50 per dosimeter, at 5 dosimeters per day, we get nearly a $100 million market if we assume all of those hospitals. We can change the dosimeters per day which is the real variable that has an impact. That’s why real-time validation is so important. Most hospitals with stationary UVC lamps may use a dosimeter initially and then think there’s no reason to use another one if the lamp hasn’t moved. That may be the case but it’s not the case with autonomous UVC robots that are cleaning an entire area as we discussed.

But the healthcare market is likely much smaller than the curing market. Intellego also uses its dosimeters in greenhouses in its horticulture verticals but let’s not even attribute much TAM to that as it’s still early days. The curing market is mainly focused on manufacturing companies. An automaker might use UV lights to speed up the paint-drying process, saving time and thereby money. In order to measure the level of radiation a dosimeter would be used. Anything that needs to be dried and hardened may be a potential market for dosimeters. The CEO/founder measures this market in the billions but that might be aggressive. Even so, directionally, the curing market is larger than $100 million and the average selling price for a dosimeter is more than 3x what it is in hospitals.

I think the main question most investors would have is: how defensible is a paper card? The answer is: you’d be surprised. Claes has three patents on the intellectual property, including very interesting applications like a QR code that would direct a UV robot to increase or decrease UV intensity and then shut-off based on the color of the dosimeter card. There is also an app that users can scan the cards and keep a running log of the exact color of each card for liability purposes. Imagine if someone got an infection after leaving the hospital and wanted to sue the hospital. Well, the hospital lawyers could show how well the area where the patient was staying was sanitized using the color of the card. In fact, hospitals in China are already starting to standardize this protocol for similar reasons.

Further, if you Google “UV dosimeters” almost all of the ones you’ll find are Intellego’s brand, even if they don’t explicitly say so since Intellego does white-labeling as well. The fact that Intellego is such a well known name in the industry coupled with its low-cost operation, means there is very little room for competitors to undercut on price. These cards sell for $1.50! Is it worth saving 50 cents in the event that the new card doesn’t work as well and doesn’t have a digital record management system? It’s just not really worth it. Now, at some point, if you’re using 100 dosimeters per day, it adds up. But the average healthcare associated infection costs $36,000 so dosimeters really act like insurance. It’s about validation and liability related to UV. In curing, if the light isn’t perfectly placed where you need it, an extra 30-60 minutes of curing time could be very costly. It’s well worth just going with the established market leader.

Another risk to mention is radiometers. These are electronic readers of UV light. They are typically at least a few thousand US dollars, routinely reaching $5,000, but they don’t have to be replaced. So it’s a larger investment upfront but they can’t be easily positioned to optimally measure UV light. I’m eagerly on the lookout for flexible radiometers but none have come to market yet. At the moment, due to the low cost and ease of use, dosimeters solve customers’ problems much better than radiometers.

There are plenty of risks with this story. First, the cash flow and balance sheet aren’t nearly as strong here as the companies I usually invest in. Intellego put in a strong cash flow performance in Q1 but heavily invested in capex to buy autonomous UV robots through its Yuvio subsidiary in Q2.

Along these lines, the first thing investors flag when looking at Intellego is the huge accounts receivables balance. In Q4 2023, receivables were 92 million SEK on roughly 107 million dosimeters sales for the year. Very roughly that implies 12 month payment terms. Management has explained that this was necessary in order to prove their value and then payment terms will shorten as time goes on. They are now guiding for receivables to be between 25-35% of overall revenue, which, if you annualize Q1’s results, it’s about 36%. So they are certainly on the right track. However, if we continue to see long payment terms, and cash keeps getting consumed, I think this will be a thesis breaker since customers aren’t truly paying for the value they’re seeing. Further, the balance sheet isn’t necessarily strong enough to weather it for much longer. My thesis is fairly focused on cash flow as I believe this year will be important for shortening payment terms and see some larger curing customers who should have the coffers to pay for the dosimeters. The company has also been able to sell Yuvio systems immediately (not leasing) as customers are eagerly ordering the advanced technology.

Second, there is a long checkered history with the company’s board. Over the past year, 4 of them have stepped down. To many investors, this is a glaring red flag. However, I think it’s more a function of the founder’s lack of network/resources in the early days rather than any maleficent intentions. Henrik Börjesson, Anders Ardstål and Per-Ola Rosenqvist have all stepped down, creating some controversy. Mr. Rosenqvist was convicted of insider trading so obviously he would have to leave the board. But that was his personal decision, not Claes’. Mr. Börjesson didn’t think he was qualified enough to take the company to the next level and Mr. Ardstål had too much on his plate.

Third, the company’s last auditor wasn’t great, which certainly added some bite to the bear pitches. But at Intellego’s last annual meeting, they announced an engagement with Deloitte and I’m looking forward to the first full-year audit. There was an accounting issue with the Daro acquisition that was yet another example of Intellego’s need to professionalize.

Fourth, the company still doesn’t have a full-time CFO. Further, the company had to delay its Q2 earnings report because its temporary CFO was on vacation. That doesn’t happen in professional organizations and shows that the company still has a long way to go in maturing.

Intellego is Claes Lindahl’s baby (CEO). He founded the company in 2011 and is still running it 13 years later. There have been many ups and downs over the years, including several years to even get the technology working and now the struggle of scaling the company despite a few problems with the auditor and board. With all of the challenges, Lindahl has remained strong and hasn’t wavered. In fact, over the last 4 months, he has personally bought over $400k USD and nows owns more than 12% of the company.

I don’t think it’s unreasonable to believe that the company could do $20 million in EBIT over the next 18 months. With $6 million in cash build, that would be a little bit more than 3x ‘25 EV/EBIT. For a company that could continue growing over 30%, with no customer concentration, a founder at the helm, a huge runway, and repeat customer behavior, that is far too cheap.

Closing

I’m honored to have you as a partner. Thank you for your trust and support. It enables me to think long-term and will be our own competitive advantage. 

The stock market, like life, will have its ups and downs. All we can do is focus on what we can control and work hard to continually raise our standards. Our strategy is simple – hitch a ride to the world’s best entrepreneurs that are running the fastest-growing, highest-quality companies at the most attractive valuations we can find. Here’s to many more years of focusing on the inputs and letting the outputs take care of themselves. 

Sincerely, 

Ryan Reeves

Disclosures

Infuse Asset Management LP (“Infuse”) is an investment management company to a fund that is in the business of buying and selling securities and other financial instruments. This information is provided for informational purposes only and does not constitute investment advice or an offer or solicitation to buy or sell an interest in a private fund or any other security. An offer or solicitation of an investment in a private fund will only be made to accredited investors pursuant to a private placement memorandum and associated documents. 

Infuse may change its views about or its investment positions in any of the securities mentioned in this document at any time, for any reason or no reason. Infuse may buy, sell, or otherwise change the form or substance of any of its investments. Infuse disclaims any obligation to notify the market of any such changes. 

The S&P 500 is a U.S. equity index. It is included for informational purposes only and may not be representative of the type of investments made by the fund. References made to this index are for comparative purposes only. Reference to an index does not imply that the funds will achieve returns, volatility, or other results similar to the index. The fund’s portfolios are less diversified than this index. Returns for the index are total returns which includes dividends and do not reflect the deduction of any fees or expenses which would reduce returns. 

An investment in the fund is speculative and involves a high degree of risk. The portfolio is under the sole trading authority of the general partner. An investor should not make an investment unless the investor is prepared to lose all or a substantial portion of its investment. The fees and expenses charged in connection with this investment may be higher than the fees and expenses of other investment alternatives and may offset profits. 

The information in this material is only current as of the date indicated and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Any statements of opinion constitute only current opinions of Infuse which are subject to change and which Infuse does not undertake to update. Due to, among other things, the volatile nature of the markets, and an investment in the fund/partnership may only be suitable for certain investors. Parties should independently investigate any investment strategy or manager, and should consult with qualified investment, legal and tax professionals before making any investment. 

The fund is not registered under the investment company act of 1940, as amended, in reliance on an exemption thereunder. Interests in the fund have not been registered under the securities act of 1933, as amended, or the securities laws of any state and are being offered and sold in reliance on exemptions from the registration requirements of said act and laws.

Thank you for your continued trust and support; you are the best partners I could ask for. I didn’t receive a single worried call, text, or email despite a rough 2022 so I’m happy to share that we’ve clawed our way out of the hole. We are now neck and neck with the S&P 500 since inception, despite virtually zero attribution from large cap tech. But as I don’t like to dwell on the performance when we’re in a drawdown, I won’t get too excited about things turning around. You can do the math on our year-to-date numbers at the bottom of this letter but as always, the process determines the outcome so that’s what we’ll focus on. We still have a long way to go before I’m anywhere close to satisfied.

One interesting topic I’d like to discuss before highlighting a company is the trade-off between returns on capital and cash flow generation. Customer lifetime value is a great example with software companies. If a customer is worth 10x more to you in two years, it makes great economic sense to spend everything you can on acquiring more customers. So the returns on your outgoing dollars are really good but you’ll likely burn cash in the process. Further, these sorts of calculations are constantly changing and likely can’t capture the real time forces of incoming competition and a changing macro landscape. So maybe the lifetime value of customers is actually shorter than previously calculated and now it doesn’t make sense to burn cash. The tolerance to burn cash also tells you a great deal about the risk tolerance of a management team. Maybe it tells you they are willing to take a really long-term view and forego current profits for more cash later. Or that they’re overly aggressive and don’t actually care about becoming a sustainable enterprise. So what tends to be a less risky business decision is to at least get to free cash flow breakeven and then reinvest the excess dollars that are flowing back to the business if those dollars continue to produce impressive cash returns. If you look at all of the very successful winners (100x+), nearly all of them were at least operating cash flow positive. Yes, some capital light businesses invested through the income statement so they weren’t GAAP profitable but a very high proportion were solidly GAAP profitable.

So, yes, while in theory, returns on capital and free cash flow generation are at odds, because you would surely have negative free cash flow if you owned a money printer that took in one dollar and spit out two in a year; oftentimes, the very best businesses can’t reinvest at high enough rates because they are drowning in cash. It’s typically the uber-competitive industries where companies are undercutting each other on price that you find cash burners. After all, if you could demand a higher price, you would! 

I think there is an element of intentional under-maximization with the best companies. What I mean is that if the returns on capital are very high, a prudent management team realizes that things could change so it may not make sense to swing for the fences, only to realize that you have to raise money at a terrible valuation or take on debt. It can actually make more long-term economic sense to not invest absolutely every dollar but maintain a solid growth rate and let the foundation of the company and its culture grow at a more measured pace. With that said, sometimes there are very real advantages to gaining market share and creating a brand like we’ve seen with Uber. The company became such a household name that now it is firmly profitable and Lyft is struggling to compete. Now, I think every situation is unique, especially since Uber was always able to raise capital at fantastic terms so maybe it is the rational decision to burn as much cash as possible if you know that future returns on capital are quite good. That calculus should change if your cost of capital increases substantially.

I used to be far more willing to invest in a free cash flow negative company but after some lessons learned, one thing I’ve noticed is that the industries these companies are in tend to be very competitive and the management teams tend to be quite aggressive. These situations can work out, but finding companies that have firm control of their destinies decreases investment risk exponentially. And this is crucial for a concentrated portfolio.

With that as the intro, early last quarter, we bought a small position in a company called Alarum. Formerly known as Safe-T, this is an Israeli proxy network company that is inflecting on profitability after a decade of losses.

Things really started to turn around in 2019, when Alarum bought a company named NetNut for ~$10 million. At this point, NetNut was doing just over $2 million in sales and its founder, Moshe Kramer, wanted some liquidity. Over the past 4 years, revenue in that business has grown to $31 million. NetNut provides B2B proxy network software that allows customers to scrape data from websites at scale. Over the past year, there has been a tailwind from AI as LLMs need lots of structured data from across the internet. What’s interesting is that investors view proxy networks suspiciously but LLMs use them to scrape training data. It’s all about perception.

In the fall of 2021, Alarum bought Cyberkick, a consumer facing cybersecurity business but has already decided to shutter it. In Q2, the company recognized a $6 million goodwill impairment, which made the GAAP numbers screen very poorly.

NetNut provides a residential proxy network that allows businesses to scrape websites at scale. Whether it be an airline that wants to track competitor pricing or an advertiser that wants to verify email addresses, proxy networks enable this. A proxy network is essentially a software program that allows the scraper to constantly change its IP address to get around scraping protections. NetNut has more than 85 million residential IP addresses that it sources through a partner called DiviNetworks which works with 200 internet service providers. Generally, the more residential proxies a company can obtain, the better its scraping potential.

One thing that is important to note is that retention rates are fairly high in this business because customers need to constantly refresh most of the data they need scraped. The company’s net retention rate has been accelerating and reached 166% last quarter and that is before its new products have really ramped up. That means the large customers are getting an increasing amount of value from NetNut core offering.

Unsurprisingly, e-commerce sites are a large buyer of this type of product. Sophisticated e-commerce sites will scrape pricing data for competitors and change prices in real-time on thousands of different products. This requires fresh data and the ability to get around scraping limitations.

The numbers are pretty if you dig around. Q3 ‘23 was really the first GAAP profitable quarter because Q2 had the goodwill impairment. However, the company has been EBITDA breakeven since Q1 ‘23. What’s really key is that NetNut is far more profitable than the Cyberkick business, which is almost fully wound down.

In the Q1 ‘24 financials, free cash flow margins were nearly 38% and NetNut revenue grew 14% quarter-over-quarter which can be annualized to almost 70% growth. So here we have a company growing about 70% with 38% margins. You certainly don’t see that every day. The company also now has $15 million net cash and should remain profitable from here on out. 

The company’s top two competitors do more than $300 million in revenue collectively so it’s safe to say there is plenty of market opportunity left. Management pegs the overall opportunity in the billions as the proxy network provides footholds for other products. For instance, the company recently launched its Search Engine Results Page API that enables better SEO and its highly anticipated AI Data Collector should be launching at the end of Q3 this year.

Most recently, there are estimates that the largest competitor, Bright Data, is doing $190 million in revenue. Further, it’s important to note that customers often use multiple proxy networks to have redundancy. Some providers get blocked from specific sites while others may have success. It all depends on the quality and density of the IP addresses of the proxy networks. 

The company’s two main competitors are Bright Data and OxyLabs, both of which are private. And then there are several more including SOAX, IPRoyal, and a newcomer in the AI space called Nimbleway. Bright Data (formerly known as Luminati Networks) was purchased by private equity, EMK Capital, for $160 million in 2017 for about 6x sales. Until recently, Alarum was trading for less than that so I viewed that as a floor valuation-wise. Bright Data is the largest competitor, boasting enterprise clients like Shopee, Microsoft, and McDonalds. The company has also created turnkey datasets that customers can buy separately rather than needing to scrape the data themselves. This is a route that NetNut is trying to monetize as well.

The moat in this space is mainly a scale advantage. Bigger players tend to have access to more IP addresses which enables better scraping. A lot of smaller players will buy data center proxies because they are cheaper but they can also be blocked much more easily. The real value is in residential proxies that are either purchased from internet service providers or actually retrieved through providing a P2P VPN service. Right now, NetNut has 85 million IP addresses, Bright Data has 77 million, and OxyLabs has 102 million. NetNut was able to scale to this as its former CEO, Barak Avitbul, founded a software company that helped ISPs in 2004. His relationships in the industry helped NetNut acquire the strong proxy network to scale as they have done. Unfortunately, Avitbul is no longer with the company as he stepped away in December of 2021.

There is a slight switching cost for large projects if a customer has to set up all of the workflows again. And then brand is very important. One reason Luminati Networks changed their branding is because there have been many lawsuits against the company, both from competitors and customers. Relatedly, Bright Data won a $7.5 million judgment against OxyLabs for patent infringement and NetNut got a case dismissed in late 2021 that Bright Data brought against it. But the point stands that brand matters. OxyLabs and Bright Data are the two names that have the biggest presence but NetNut has a solid position and is viewed quite positively despite what, in my opinion, is a terrible name.

Though NetNut doesn’t necessarily have the widest moat, it has done a good job of delivering a solid product at a reasonable price and the fact that the industry has grown is lifting all boats but there are definitely risks involved with this investment.

First, the company has a long history of losses and they did a poor acquisition of Cyberkick. They bought it in July of 2021 for $12 million and started winding it down about 2 years later because they wanted to get profitable. Now that the company has profits, there are questions about capital allocation. There is clear evidence that NetNut is quite profitable as a standalone business but management may use profits to do another poor acquisition.

Second, and related, management said this in Q2 ‘23, “And this does not account for an additional $2.2 million in non-dilutive financing we have available to us. As such, we are in a great position to continue executing and see no near-term scenario requiring us to raise additional funds.” But then they proceeded to do a $4 million private placement just a couple of months later at a bad price – well, great for the Chairman, CEO and CFO that invested $1 million, collectively. If management says one thing and does another, they have to build back trust. And the fact that the CEO and founder, Shachar Daniel, has been there for 10 years means that he’s overseen everything, especially the history of losses and bad acquisitions. But now he has far more skin in the game so it’s probable that he won’t be as quick to dilute shareholders.

Third, there are potential existential risks about privacy and security. Website content delivery networks like Akamai and Cloudflare have rate limiter products that can curb scraping tools. But proxy networks constantly rotate IP addresses as a workaround. There are third-party IP address blocklists out there that can be used to fight this problem but it’s incredibly difficult to block rotating residential proxies because they are real IP addresses. Since they are real, it’s perfectly legal. But it’s something to keep in mind – it’s possible that rotating proxies can be curbed technologically in the future. Moreover, there are litigious risks concerning privacy. Meta and X recently sued Bright Data for not complying with their terms of service, accusing the company of illegally scraping data. The legality of some of this is somewhat hard to nail down but walled gardens will continue to try to make it harder for proxy companies based on stricter terms of service. However, the judgment from the Meta case was recently in favor of Bright Data, a strong precedent that alleviates much of this risk.

Fourth, since NetNut isn’t the largest company in the space, it doesn’t have the same scale advantages that Bright Data and OxyLabs have. For example, Bright Data has a 60 GB plan that costs $8/GB for residential proxies. Compare this to NetNut which has a 50 GB plan that costs a little over $10/GB. So Bright Data, being more than 5x larger, can price at ~20% less since it can spread the cost of acquiring proxies across a larger swath of customers. Even still, the market is quite large and Bright Data is still growing nicely at its size so there is plenty of room for multiple players. While the industry has seen quite a few price cuts at the lower end of the market, NetNut’s accelerating net retention rate flys in the face of competitive worries for the time being. We are keeping a close eye on these dynamics as the industry is rapidly changing. I do think there is limited pricing power in the industry but the need for data will grow much faster than pricing pressures. This is the broad thesis but it’s still important to watch how competition affects NetNut’s long-term earnings power.

The current CEO, Shachar Daniel, has been with the company since the beginning in 2013. He owns a 4% stake which would be much larger if there hadn’t been so many dilutive raises over the decade. The company has a strange history as it spent the better part of 4 years trying to beta test different cybersecurity products at the beginning. Nothing really stuck so they pivoted to buy a few companies and they struck gold with NetNut. Importantly, the founder of NetNut is still with Alarum as the VP of R&D.

Management doesn’t particularly strike me as incredible but I think the recent focus on profits and the willingness to ignore the sunk costs of Cyberkick so quickly after the acquisition are two strong pieces of evidence that things are turning around.

The share count is 7.8 million ADS’s fully diluted (the ADS ratio is 10:1). On a $41 stock price (our average cost is much lower), the market cap is $320 million. After $15 million in net cash, the enterprise value is around $305 million. 

So NetNut is less than 7x forward sales. When we first purchased the stock, it was less than 4x sales so even though the multiple has not quite doubled, the stock has quadrupled since our first purchase. But where things really start to get interesting is if the Q1 ‘24 numbers can be improved upon. The company did $3.2 million in cash from operations, which is very similar to FCF since it’s such a capital light business. And since most customers pay monthly, there isn’t a ton of deferred revenue. Annualizing that, we get about 23x FCF for a SaaS company with big tailwinds and a huge combination of growth and profit potential. 

The stock has had quite a run so I’m not expecting a similar trajectory but if we can get to $20 million in FCF next year, a 20x multiple still implies about 30% upside over the next 18 months. If the company can execute on its strategy of moving up the value chain into data insights and foster growth through its new products, 23x forward FCF may still look like a bargain. While there are clear risks with this name, we are holding our shares.

Closing

I’m honored to have you as a partner. Thank you for your trust and support. It enables me to think long-term and will be our own competitive advantage. 

The stock market, like life, will have its ups and downs. All we can do is focus on what we can control and work hard to continually raise our standards. Our strategy is simple – hitch a ride to the world’s best entrepreneurs that are running the fastest-growing, highest-quality companies at the most attractive valuations we can find. Here’s to many more years of focusing on the inputs and letting the outputs take care of themselves. 

Sincerely, 

Ryan Reeves

Performance Appendix

Disclosures

Infuse Asset Management LP (“Infuse”) is an investment management company to a fund that is in the business of buying and selling securities and other financial instruments. This information is provided for informational purposes only and does not constitute investment advice or an offer or solicitation to buy or sell an interest in a private fund or any other security. An offer or solicitation of an investment in a private fund will only be made to accredited investors pursuant to a private placement memorandum and associated documents. 

Infuse may change its views about or its investment positions in any of the securities mentioned in this document at any time, for any reason or no reason. Infuse may buy, sell, or otherwise change the form or substance of any of its investments. Infuse disclaims any obligation to notify the market of any such changes. 

The S&P 500 is a U.S. equity index. It is included for informational purposes only and may not be representative of the type of investments made by the fund. References made to this index are for comparative purposes only. Reference to an index does not imply that the funds will achieve returns, volatility, or other results similar to the index. The fund’s portfolios are less diversified than this index. Returns for the index are total returns which includes dividends and do not reflect the deduction of any fees or expenses which would reduce returns. 

An investment in the fund is speculative and involves a high degree of risk. The portfolio is under the sole trading authority of the general partner. An investor should not make an investment unless the investor is prepared to lose all or a substantial portion of its investment. The fees and expenses charged in connection with this investment may be higher than the fees and expenses of other investment alternatives and may offset profits. 

The information in this material is only current as of the date indicated and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Any statements of opinion constitute only current opinions of Infuse which are subject to change and which Infuse does not undertake to update. Due to, among other things, the volatile nature of the markets, and an investment in the fund/partnership may only be suitable for certain investors. Parties should independently investigate any investment strategy or manager, and should consult with qualified investment, legal and tax professionals before making any investment. 

The fund is not registered under the investment company act of 1940, as amended, in reliance on an exemption thereunder. Interests in the fund have not been registered under the securities act of 1933, as amended, or the securities laws of any state and are being offered and sold in reliance on exemptions from the registration requirements of said act and laws.

Thank you for your continued trust and support; you are the best partners I could ask for. 

So far, we’ve written five letters detailing our strategy and diving into portfolio companies that rank highly across the growth, quality and valuation continuums. At the end of the day, everything is ultimately about valuation – it’s just that valuation is an art and a science. Time is the friend of the great business but the enemy of the terrible business. Therefore, to increase the odds of making money, it makes sense to invest in great businesses at reasonable prices. Obviously, the ideal is to buy an amazing business at a cheap price, but those opportunities rarely happen because the market is a pari-mutuel system, meaning the odds are constantly changing. Sooner or later, the price becomes too good for other investors to pass up and the price goes back up.

What happens more often is finding some really good deals if you’re just willing to look a few years out. For instance, not buying Nvidia was the biggest mistake of last year by far. I saw the hype coming with ChatGPT but I just couldn’t fathom that the company’s profits would accelerate so dramatically. At the beginning of 2023, the company was worth $360 billion and doing $6 billion in quarterly revenue. Now, the free cash flow run-rate is $44 billion. That was ~8x forward free cash flow! For one of the most dominant businesses over the past couple of decades. I mean talk about a fat pitch. I simply didn’t think $6 billion in quarterly revenue could turn into $11 billion in free cash flow in just one year. Just amazing stuff. Instead, I had a high weighting in small caps for the beginning of 2023, primarily Sanara Medtech, IDT, and Inspire Medical – all good companies – but certainly not Nvidia-caliber. I just vastly underperformed with these trades compared to the opportunity cost of Nvidia, which was right in my wheelhouse. I think that’s why it’s such a big mistake – because Nvidia is a company I’ve studied extensively and I missed the big move.

Further, I think there is a tendency to say “well, we missed that big winner” and then tear your hair out as the stock grinds higher. But it’s all about the future. Quite frankly, I don’t think Nvidia’s valuation is necessarily in bubble territory. It is possible for the company to do $70 billion in EBIT next year which is roughly 30x forward earnings. It is harder to know what calendar 2025 will look like in terms of demand and I wouldn’t be surprised if there is an air pocket where demand drops off slightly as some of the AI hype dies slightly, before continuing its ascent. To speak out of the other side of my mouth, I think AI is changing the nature of some of these formerly cyclical semiconductor companies. Semis have historically been cyclical so buying them at low multiples was a recipe for underperformance but as the hyperscalers need these chips, I think the upgrade cycles could shift demand to be more secular rather than cyclical. Because of this, we did trim Tesla slightly to buy a small position in Nvidia. I think this is a good case study in terms of “missing” a winner and the process for following it and deciding whether you can still make money from it. These scenarios of opportunity cost can be trickier to deal with than a loser because the magnitude of the opportunity cost can mess with your psyche. I think you need a sound process for dealing with FOMO while still keeping a level head to focus solely on the future. Getting in early and riding the wave based on granular S-curve estimates is the ideal scenario but all that matters is the future. A stock that has doubled can easily double again if the future earnings potential is still underappreciated.

Speaking of which, I think it could make sense to revisit Nu Holdings, as the stock has more than tripled from our initial purchase price and we haven’t sold a share. In our first write-up, Nu was around a $16 billion valuation and now it’s around $54 billion. Even still, I think the future is bright. The company could do over $2 billion in earnings for 2024, leaving us at 27x forward earnings for plenty of future growth. That’s not necessarily a demanding valuation for 60% growth. 

The company is now the third largest financial institution in Brazil, with about 88 million Brazilian users. In Mexico, Nubank is already the 6th largest bank with about 8% market share. And the company recently was approved for its final banking license in Colombia. These are the three geographies that Nu is focused on right now but they likely aren’t the only ones over the next decade. Nu has a culture of moving very slowly because underwriting risk takes time to deeply understand customer behavior. This unique approach to underwriting means that the company focuses on only a few geographies and a few products, expanding over time. For nearly the first five years, the company only had a credit card product in Brazil. Now that’s patience! Only now is Nu really expanding into adjacent areas like payroll lending and investment products. Phase one of customer acquisition in Brazil is shifting into phase two of increasing the average revenue per customer. And the company will now replicate that strategy in Mexico and Colombia. It will take time but the low cost structure combined with deep risk management has enabled the company to grow fantastically.

In Q4 of 2022, when we started buying the stock, the company did $125 million in quarterly EBIT. When annualized, the valuation was about 32x forward earnings. Now, the company is doing $500 million in quarterly EBIT, implying a 27x forward multiple. This is the exact type of situation we look for! The stock has more than tripled but the multiple has decreased by almost 20%. That is amazing! And that’s what happens when we carefully stick to our mandate of buying the world’s fastest-growing, highest-quality businesses for low multiples. Here’s to many more decades of finding companies similar to Nu Holdings.

Closing

I’m honored to have you as a partner. Thank you for your trust and support. It enables me to think long-term and will be our own competitive advantage. 

The stock market, like life, will have its ups and downs. All we can do is focus on what we can control and work hard to continually raise our standards. Our strategy is simple – hitch a ride to the world’s best entrepreneurs that are running the fastest-growing, highest-quality companies at the most attractive valuations we can find. Here’s to many more years of focusing on the inputs and letting the outputs take care of themselves. 

Sincerely, 

Ryan Reeves

Disclosures

Infuse Asset Management LP (“Infuse”) is an investment management company to a fund that is in the business of buying and selling securities and other financial instruments. This information is provided for informational purposes only and does not constitute investment advice or an offer or solicitation to buy or sell an interest in a private fund or any other security. An offer or solicitation of an investment in a private fund will only be made to accredited investors pursuant to a private placement memorandum and associated documents. 

Infuse may change its views about or its investment positions in any of the securities mentioned in this document at any time, for any reason or no reason. Infuse may buy, sell, or otherwise change the form or substance of any of its investments. Infuse disclaims any obligation to notify the market of any such changes. 

The S&P 500 is a U.S. equity index. It is included for informational purposes only and may not be representative of the type of investments made by the fund. References made to this index are for comparative purposes only. Reference to an index does not imply that the funds will achieve returns, volatility, or other results similar to the index. The fund’s portfolios are less diversified than this index. Returns for the index are total returns which includes dividends and do not reflect the deduction of any fees or expenses which would reduce returns. 

An investment in the fund is speculative and involves a high degree of risk. The portfolio is under the sole trading authority of the general partner. An investor should not make an investment unless the investor is prepared to lose all or a substantial portion of its investment. The fees and expenses charged in connection with this investment may be higher than the fees and expenses of other investment alternatives and may offset profits. 

The information in this material is only current as of the date indicated and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Any statements of opinion constitute only current opinions of Infuse which are subject to change and which Infuse does not undertake to update. Due to, among other things, the volatile nature of the markets, and an investment in the fund/partnership may only be suitable for certain investors. Parties should independently investigate any investment strategy or manager, and should consult with qualified investment, legal and tax professionals before making any investment. 

The fund is not registered under the investment company act of 1940, as amended, in reliance on an exemption thereunder. Interests in the fund have not been registered under the securities act of 1933, as amended, or the securities laws of any state and are being offered and sold in reliance on exemptions from the registration requirements of said act and laws.

Performance Appendix

Thank you for your continued trust and support; you are the best partners I could ask for. 

As I reflect more on the past year, the more it becomes clear that the core tension in the art of investing is balancing humility and conviction. When a stock goes against you, do you double down, sit still, or cut it? How do you know you’re right? What if you’re wrong? But if you let the stock price do your thinking for you, that is a recipe for terrible results, especially if you think you’re a long-term investor. If you study traders, you’ll see that price is the only thing that matters. If the price is down, they’re out of the position. But if you think you’re a long-term investor and act like a trader, you will almost surely lose money. So it’s important to know what game you’re playing. To be crystal clear, we are playing the long-term game. However, sometimes I find myself using the amorphous “long-term” to absolve myself of responsibility. The key question here is: how do you know you’re wrong?

It can actually be quite tricky because it depends on your time horizon. The trader will know they’re wrong when the stock hits their stop loss and kicks them out. But the answer is foggier for investors because time horizons can be different. If we drill further, the next question becomes: how long is long-term? There’s not a single answer here but I know it’s longer than one year but if your stock pick is still down after ten years, you might be wrong. After a decade, even if you paid a premium multiple, earnings growth should bring the multiple down. So the answer to balance the tension between knowing whether you’re wrong and how long is considered long-term is likely between one and ten years. Wow, so much clarity, right? (*sarcastic*). For myself, it’s somewhere between 3-5 years. If, after 3 years, the stock still hasn’t gone anywhere, it’s quite likely that I paid too high of a price or I didn’t properly assess the economic characteristics of the business. For example, if you paid 40x earnings, three years of 20% earnings growth would bring that multiple down to 23x. However, if you paid 40x earnings and there was no growth after three years and the multiple contracted to 23x, that’s more than a 40% loss. It’s all about earnings growth and the earnings multiple.

The harsh reality is that there are very few opportunities that meet these two criteria of fast earnings growth and a low multiple. That’s why our portfolio is concentrated. We put all 839 companies in our research database through an 18-point checklist and only four companies scored a three or lower (lower is better). However, the lowest free cash flow multiple of the four is 45x so there is a tradeoff between expected earnings growth and starting multiple. Another 19 companies scored a four on the checklist system. So out of 839 companies, only 23 scored lower than five. This is the pool we vigorously track and wait for reasonable multiples. As I look over our past mistakes, almost every one is a compromise on business quality rather than buying at too high of a multiple. That’s why we try to keep our standards ridiculously high and then wait for prices that meet our hurdle rate. It’s simple but not very easy because when a company sells-off, there is typically a reason for it. And it’s our job to determine whether or not the perceived risk is as real as the market is making it out to be.

With that as a preface, I wanted to switch up the format a little bit. For the last four quarterly letters, the format has been a discussion on the philosophy of the fund and then a deep dive into a company. As the philosophy has crystallized, I thought it would be nice to provide a quick blurb on the companies in the portfolio to give you a better sense of where your dollars are parked. So let’s not waste another moment!

1. Axon

The company has a dominant position selling hardware and software to police officers. Its new Taser 10 and Axon Body 4 will provide a top-line boost as the company continues to grow its recurring revenue business. With a visionary founder at the helm and plenty of runway left, the stock has never been cheap. That said, I see this company having the potential to do $10 billion in revenue one day as the international piece of the business develops and the company’s optionality kicks in through further products such as Axon Records and Justice Premiere. At 30% steady-state margins, it’s quite possible the company could do $3 billion in free cash flow one day. At 25x, that’s a $75 billion company, over 4x from today’s prices. I believe that will happen in 10 years, which would be a 15% CAGR, without adding back any cash accumulation.

2. Nu Holdings

The company is the dominant mobile bank in Brazil. With over 90 million users, Nubank is a household name and is still growing quite fast. It’s the 4th largest financial institution by users in Brazil and they are taking lots of market share in the credit card business, while also becoming increasingly sticky through new products like payroll lending. The management team is top notch, led by highly incentivized founder, David Velez and the company is expanding into Mexico and Colombia, hoping to get to Brazil-levels of penetration one day. At 200 million users and $100 in revenue per user, I think the company could easily get to $20 billion in revenue one day. At 30% banking margins, that’s $6 billion in earnings. Using a 15x multiple, that leaves us with $90 billion in market value. I believe that is doable in 7 years, leaving us with a 17% CAGR.

3. MercadoLibre

We’re going to stay in South America, as we move to MercadoLibre. The company is most well known for its dominant position in Latin American e-commerce. As an aside, notice that for each of these companies I used the word “dominant”. We look for fast-growing, profitable, founder led companies with dominant market positions. And MercadoLibre fits the bill. While there are often competitive concerns about Amazon and Shopee, both companies are retrenching to focus on profitability and competing with MELI is likely not the wisest use of dollars. Meanwhile, MELI will continue to invest in logistics and payments infrastructure, strengthening its flywheel. The company trades for about 25x forward EBIT which I don’t think is that crazy considering the company has grown at a 50% CAGR over the past 7 years. 

4. Shelly Group

This is a Bulgarian home automation company. Random, I know! But the growth and profitability are certainly something that caught my attention. Shelly Group recently changed its name from Allterco to focus on the main business line, Shelly. These are electrical relays that connect to appliances, lights, fixtures, etc. to enable home automation. The ease of use and interoperability have led to the company’s growth. It’s a seamless, inexpensive way to do home automation. The company forecasts greater than 40% annual growth for the next three years, expanding its EBIT margins to 30%. At that point, I could easily see the company doing $60 million in EBIT. At 15x earnings, that’s a 26% CAGR in roughly three and a half years. Meanwhile, the two co-founders each own more than 25% of the business and the products just keep improving. The company has a DTC sales channel through Amazon, Walmart and other retailers but the rest of the business that is sold through installers will likely continue to be a huge tailwind. 

5. Celsius

This is the newest addition to the portfolio and it differs slightly from the typical company that we invest in because it’s not founder led nor is it a market share leader. However, CEO John Fieldly has overseen nearly all of Celsius’s success and the company is rapidly gaining share against incumbents. If you’re not familiar with Celsius, it’s a fast-growing energy drink that has a positioning advantage as the “healthy” option compared to Monster and Red Bull. The company has grown sales from $50 million to $1.3 billion in just five years. And more recently, Celsius’s exclusive distribution relationship with Pepsi has strengthened its competitive advantage. The quick thesis is that Celsius’s market is likely wider than the incumbents because it resonates with both men and women while Monster and Red Bull, collectively, do 9x more in sales in the US. However, Celsius is already ahead of Monster and Red Bull in sales on Amazon. If that’s a hint at the future, it’s possible that Celsius could rival incumbent sales in five or so years. Even at $5 billion in revenue at 30% margins, that gives us $1.5 billion in earnings. At 20x earnings, that’s about a 20% CAGR from today’s price. While it’s not a guarantee that Celsius becomes the leader, it definitely has a counter-positioning advantage and plenty of growth opportunities, as the company has barely scratched the international opportunity. At the same time, we must monitor this investment closely because the barriers to entry are fairly low and there is quite a bit of competition.

6. Tesla

While Tesla is a $750 billion company, I still think it has plenty of growth in the tank. The company’s long-term goal is 20 million cars, which could yield more than $800 billion in revenue (the next gen model will be important to reach this volume). Further, its energy business is hitting an inflection point on profitability and while we’re at sort of an in-between point as far as autonomy goes, it’s an extremely attractive call option. As Elon has mentioned, the upgrade to actual full self-driving would be the single biggest instant value creation of all time. While Mr. Musk is often given to hyperbole, I’m with him on this one. And looking out even further, which is far more uncertain, the other bets like Optimus and Dojo do seem to indicate the company has a lead in real-world AI. 

But even if we just take the car business without FSD, $800 billion in 2032 revenue could give us $120 billion in profits. Using a simple 20x earnings, we get a $2.4 trillion company. That’s still a 16% CAGR without including all of the other long-term bets that will likely provide some value creation, if the company’s past is any indication of the future. Call me crazy but I think there is a real path to Tesla becoming the most valuable company on the planet. There will be bumps as more competition continues to come into the market but Tesla really is playing a different game. The sheer amount of data that the company has already collected and the millions of incremental cars that will be added annually to that treasure trove is an advantage that should not be overlooked. True autonomous driving is still a bit away but I don’t think that’s completely necessary to the thesis. If it does materialize, this can be a $5 trillion company over the next decade. I’ll take those odds as the company continues to innovate, lower prices, and attract some of the world’s most ambitious engineers.  

Closing

I’d like to point out the obvious before wrapping up which is the delta in the performance of the portfolio versus the underlying companies. The main reason for this is that we started the year off more diversified so these big winners were smaller positions and the rest of the portfolio dramatically underperformed as we were heavily positioned with small-mid cap companies like IDT, Sanara Medtech, Inspire Medical, and Xpel. As we reflected on the underperformance, it led us to focus maniacally on our very best ideas. The result is the current portfolio of just six companies.

Each one of the six has strong management teams with huge and growing reinvestment opportunities. Each one is also free cash flow positive and GAAP profitable with great competitive positions in their respective industries. The slowest grower is Tesla and each business has a very strong balance sheet as none of them even have net debt. I’m happy to let time do its thing, allowing these companies to serve more customers and continually add more value. And one last note on the portfolio – we did actually sell Snowflake as the valuation ramped up. At $70 billion, the stock will have to trade at 14x sales by 2029 to get a 15% CAGR. Considering 25% free cash flow margins, that’s betting on more than a 50x earnings multiple 5 years out to double our money. It fits the criteria for growth and quality but the current valuation is a little rich for our blood.

Moving on to some housekeeping – for the indefinite future, we are stopping any focus on fundraising, but rather concentrating solely on research and the portfolio. If you know someone who would be interested in becoming an LP, they can reach out to get on the waitlist so we can notify them when we reopen.

I’m honored to have you as a partner. Thank you for your trust and support. It enables me to think long-term and will be our own competitive advantage. 

The stock market, like life, will have its ups and downs. All we can do is focus on what we can control and work hard to continually raise our standards. Our strategy is simple – hitch a ride to the world’s best entrepreneurs that are running the fastest-growing, highest-quality companies at the most attractive valuations we can find. Here’s to many more years of focusing on the inputs and letting the outputs take care of themselves. 

Sincerely, 

Ryan Reeves

Disclosures

Infuse Asset Management LP (“Infuse”) is an investment management company to a fund that is in the business of buying and selling securities and other financial instruments. This information is provided for informational purposes only and does not constitute investment advice or an offer or solicitation to buy or sell an interest in a private fund or any other security. An offer or solicitation of an investment in a private fund will only be made to accredited investors pursuant to a private placement memorandum and associated documents. 

Infuse may change its views about or its investment positions in any of the securities mentioned in this document at any time, for any reason or no reason. Infuse may buy, sell, or otherwise change the form or substance of any of its investments. Infuse disclaims any obligation to notify the market of any such changes. 

The S&P 500 is a U.S. equity index. It is included for informational purposes only and may not be representative of the type of investments made by the fund. References made to this index are for comparative purposes only. Reference to an index does not imply that the funds will achieve returns, volatility, or other results similar to the index. The fund’s portfolios are less diversified than this index. Returns for the index are total returns which includes dividends and do not reflect the deduction of any fees or expenses which would reduce returns. 

An investment in the fund is speculative and involves a high degree of risk. The portfolio is under the sole trading authority of the general partner. An investor should not make an investment unless the investor is prepared to lose all or a substantial portion of its investment. The fees and expenses charged in connection with this investment may be higher than the fees and expenses of other investment alternatives and may offset profits. 

The information in this material is only current as of the date indicated and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Any statements of opinion constitute only current opinions of Infuse which are subject to change and which Infuse does not undertake to update. Due to, among other things, the volatile nature of the markets, and an investment in the fund/partnership may only be suitable for certain investors. Parties should independently investigate any investment strategy or manager, and should consult with qualified investment, legal and tax professionals before making any investment. 

The fund is not registered under the investment company act of 1940, as amended, in reliance on an exemption thereunder. Interests in the fund have not been registered under the securities act of 1933, as amended, or the securities laws of any state and are being offered and sold in reliance on exemptions from the registration requirements of said act and laws.

Performance Appendix

Thank you for your continued trust and support. As I reflect on the past year, I’ve been studying our biggest losers and have noticed these have been unprofitable companies that tend to be the smallest allocations in the portfolio. These are companies with substantial upside if everything goes well, but also more downside. To that end, we’ve cut all stakes in businesses without profits and have concentrated into the companies where we have the highest conviction. To be brutally honest, I have dug ourselves into a hole and I’ve lost many nights of sleep over it but I sincerely believe that concentrating in our best, most resilient companies will be the best way forward. It’s unwise to try to gain it all back at once as that will likely exacerbate things. I don’t take this responsibility lightly and, at the moment, it feels like I’m failing. With that said, I am still, maybe surprisingly so, confident about the future and the quality of the companies we hold. I am eager to focus on the road ahead, using this past year as an immense learning opportunity, laying the foundation for decades of success. Thank you once again for your support; it truly means the world. I won’t forget it.

In our first year of quarterly letters, we’ve detailed our philosophy and some specifics around how we maintain high standards to create the portfolio. It’s simple but not easy to pay reasonable prices for companies that can exponentially grow their free cash flow over a long period. Everything else could be considered an abstraction compared to the ratio of the multiple you pay and the free cash flow growth that you receive. But what I’ve come to learn is that the abstractions do matter because they directly affect your conviction in the business. If I pull up a screener with the lowest EV/FCF multiples and the fastest 5-year FCF CAGRs, it’s mainly a list of biotechs that got a large milestone payment, shipping companies, and energy companies. I wouldn’t consider most of these high quality businesses. So it’s important to curate a list of the highest-quality businesses – those that are defensible and have the potential to maintain high growth for an extended timeframe – and then figure out the earnings growth/multiple ratio.

To that end, we have a database of about 700 companies that have been profiled and sorted by the qualitative and quantitative factors we look for. As we learn more about a company, the scores get tweaked, resulting in a robust ranking process. We don’t necessarily make all of our decisions based on this ranking system, but it’s a great way to determine how we spend our time. The lowest-ranked companies don’t deserve our time unless something significant has changed in the business. It’s also a great filter so we can easily discard a new idea. This database will only grow stronger as the years go by and it’s, by far, our most valuable piece of intellectual property. Nearly every high-quality company you can think of has been profiled and added to the database, even slower-growing companies like Fico, TransDigm, Cintas, LVMH, Rollins, Old Dominion, or Copart. While it’s true that lower-quality companies can outperform because anything can be a good investment at a cheap enough price, we prefer to focus on the best of the best for several reasons. One, time is on your side. With a low-quality business, you usually can’t have a long-time horizon since the business value isn’t compounding at a high rate. After you get the multiple mean reversion, it’s typically time to move on. Two, the more decisions we have to make, the more opportunity for error. I would far prefer to do nothing for a long time, until there is a tremendous opportunity. Activity for the sake of activity isn’t fruitful in the craft of investing. Three, the benefits that accrue to the leading companies are consistently underrated. The smartest people want to work at those companies which leads to better products, happier customer experiences, higher margins, and more reinvestment. Four, there is a reasonable amount of knowledge arbitrage when you have long holding periods. If you’re constantly adding and subtracting new companies, your level of knowledge likely isn’t that deep on a company. As a counterpoint, this can easily lead to the endowment effect, which can be blinding when you do need to move on. None of this is revolutionary investing knowledge, but it’s a reminder, mainly to myself, that time is on the side of the quality business.

To stick with the theme of the first four letters, let’s now put our lesson into practice as we dive into another portfolio holding.

Shelly Group

The Shelly Group is a Bulgarian company that started as a telecom but has since narrowed its focus to IoT devices, mainly in the home automation space. The company recently changed its name from Allterco as its product line, Shelly, now accounts for the vast majority of the business.

The company makes most of its money from selling small chips, called relays, that allow customers to automate certain functions in their homes. This involves physically integrating the chip into the electrical outlet wiring and then using Shelly’s app to tie everything together. Shelly also sells dimmers, lights, and dozens of other products related to home automation.

The Numbers

Over the past 12 months, the company has done just over $60 million in revenue and over the past 6 months, grew 53%. Gross margins are over 50%. In Germany, Austria, and Switzerland (DACH), the company is growing well over 100% and this makes up nearly half of revenue. A relay device sells for as low as $19 on Amazon but the US accounts for less than 10% of revenue.

The company predicts it can grow sales over 40% for the next three years, to over $220 million by the end of 2026 and bring in more than $55 million in EBIT by that time. That’s a bold prediction and there is no guarantee those numbers are achieved but that is the standard management is holding themselves to.

Free cash flow conversion oscillates because the company typically builds inventory in the back half of the year with the Black Friday/Holiday season. However, the company is firmly free cash flow positive with a rock solid balance sheet of about $20 million in cash with no debt. Dilution is basically non-existent and the company doesn’t need to tap capital markets as it is self-funding with no plans to do large, empire-building acquisitions. The company will occasionally do small tuck-ins like the recent GOAP acquisition for a little over $3.5 million.

Market Size/Optionality

The market is sizable. IoT devices can be applied to industrial and commercial settings, not just home automation. The company recently announced a large customer agreement with Vodafone. The telecom operator will use Shelly’s products to monitor their energy usage in Africa, with intentions to roll out across all of Vodafone’s geographies. And we’re not just talking about energy efficiency. The company’s products are already integrated into some large irrigation systems that have seen great success with Shelly’s automations.

Shelly estimates there are 39 million households in the EU that could use its products right now, growing to 93 million by 2027. As of now, the company is about 4-5% penetrated based on its 2 million household reach. These estimates only include the EU and don’t give much credence to the industrial and commercial markets either. Shelly could easily reach its 2026 goals and still be nowhere close to market saturation.

Moat/Competition

One reason for the company’s growth is the very high energy prices in Europe. Shelly products enable customers to save on their energy bills. You can basically automate everything you can think of in your house and it’s all compatible with current home automation systems. You can set up your sprinklers, your lights, your coffee maker, your fridge, anything that plugs into the wall. And then you can automate it through the app and here is a real differentiator versus competitors – through Javascript. There is a whole Shelly Academy that teaches users how to write scripts to do all sorts of unique automations. Further, Shelly integrates with Alexa, Google Home, Zigby, Z-Wave, Wifi, Matter, Bluetooth, and pretty much any other home automation technology. The low cost of the hardware and the flexibility of the software is really at the core of the competitive advantage.

Shelly has sold over 9 million devices across 2 million households. The average Shelly user has between 4 and 5 devices but the power users, the top 50k customers, have nearly 25 devices! These folks have wired their entire houses, from garage doors to blinds to appliances and everything in between. Once this system is set, however, there is no recurring revenue so Shelly recently started a freemium model in its app. For a couple bucks per month, this new app enables users to get more data on energy usage, with personalized recommendations on how to save even more energy. Management has made it clear that this likely won’t be a huge revenue line item but it could provide a profitability lift in the future.

The thing that investors have to get comfortable with is the competitive advantage. Other than the fact that the company is illiquid and based in Bulgaria, this is likely the real crux of why some investors may be wary of this name. As bears point out, the hardware is fairly commoditized but the orchestration layer through the company’s software is where I believe the advantage lies.

The closest competitor in Europe is probably Pledj, which is Swedish. The company is a little bit smaller but has a very different distribution model. It only sells through licensed electricians because it is actually illegal to do your own wiring in Sweden. The government deems it too dangerous and therefore all electrical installations are done professionally. This means that the average Plejd relay is at least 2x the price of Shelly products. Installers can pocket a little extra money and users are typically less price sensitive when a professional is doing the installation.

Last quarter, Plejd grew only 3% compared to Shelly’s 46% growth, despite Shelly doing about 20% more in quarterly revenue. One reason for the Plejd weakness is the slowdown in home starts in Sweden due to interest rates. Naturally, a large portion of Pledj’s business comes from electricians doing big automation jobs on new homes.

This leads into one small advantage that Shelly has – its online communities. Since there is some friction in getting the relays set up, there is a tight-knit community where people help each other. For example, there is a Facebook group that has about 75,000 members and the engagement in the group is quite impressive. And one thing I love is that the CEO/co-founder can regularly be found answering questions.

Further, the company is continually looking to deliver value. It is creating an improved chip, manufactured by Espresiff, that will lower costs and run on Shelly’s new operating system. This pairing of a new chip and a new software backbone should make it far easier to connect to multiple home automation systems, improving the customer experience. Once again, the combination of very low cost hardware and customizable software is the foundation of the competitive advantage.

Risks

Shelly is certainly not a bulletproof business. The hardware is fairly commoditized but the fact that the company is creating its own chip and operating system are a clear differentiator from the competition. The fact that gross margins are mid-50% with mid-20% EBIT margins are strong pieces of evidence that the company’s products are not commoditized.

Second, the product is also not super simple to set up. If you look at the Google Play reviews, there are dozens of 1 star reviews talking about how the app’s UI is terrible and how adding new devices was incredibly difficult. The overall score is 2.6 stars out of 5, which worries me a little bit. That’s why I’m very bullish on the professional installer market which is multiples of the size of the DIY market. Compared to Plejd, it will be an incremental market for the people who want automation but don’t want to fiddle with their electrical outlets. It’s easier to go from the consumer market – and already having the organic online tutorials – to the professional market, rather than the other way around.

Third, the company is fairly reliant on Chinese manufacturers, especially Espressif. This is a risk that is worth recognizing as global supply chains haven’t been nearly as robust as we’ve become accustomed to. Management is aware of this and is working towards building redundancy in other regions.

Management

Dimitar Dimitrov and Svetlin Todorov are the co-founders of the original business, Teracomm, a telecom business that was founded in 2003. Both of these guys still run Shelly and they each own 32% of shares outstanding. They have worked together in communications for 20 years and now they are fully focused on the IoT business.

There are really two phases of the co-founders’ careers. From 2003-2013, it was Teracomm. Then they started Allterco, the IoT business. Teracomm was later sold in 2018 and that’s when Shelly really started to take off.

In 2021, they brought in the current CEO of Shelly Europe, Wolfgang Kirsch. He’s a retail/consumer electronics guy and he’s done a pretty good job so far with stoking European growth. Dimitrov is the overall CEO but he is mainly focused on R&D. He is the main technical one of the three top executives. Todorov recently became the CEO of Shelly US, which is based in Las Vegas. It’s an interesting move that signals the company is more serious about the US market than the current numbers would suggest.

Valuation/Summary

If the company can hit its current goals, it will be doing more than $55 million in EBIT in three and a half years. On a $380 million enterprise value, let’s say they just beat the $55 million goal to get to $60 million. That would be less than 7x EBIT. But, of course, that’s three and a half years away. A lot could change. Actual performance could fall short. Competitors could come in. Management could drop the ball. But let’s run through a back-of-the-napkin 5-year model.

Let’s say the company hits the $220 million goal by the end of 2026 and then grows 15% for the next two years, a far cry from the 4 year 45% CAGR growth they would’ve put up. That’s about $290 million in revenue. At 30% EBIT margins (management expects these), that’s $87 million. Even at 10x EBIT, that’s a 18% CAGR from here.

At 15x FCF, it’s the same CAGR if we assume a 10% (20% FCF margins) haircut from EBIT through to FCF for taxes and working capital.

Shelly is creating a very strong home automation brand in Europe. The company’s growth and margin profile certainly suggest that the products aren’t commoditized. While there is a perception that it’s a simple hardware business, the combination of being a low cost producer, coupled with the most customizable, open software makes the company a formidable competitor. Management is continually improving the product and despite very little marketing efforts, the growth of the online communities and the resulting revenues have been impressive. Meanwhile, the current valuation leaves room for more upside as the company executes its plan.

Closing

I’m honored to have you as a partner. Thank you for your trust and support. It enables me to think long-term and will be our own competitive advantage.

The stock market, like life, will have its ups and downs. All we can do is focus on what we can control and work hard to continually raise our standards. Our strategy is simple – hitch a ride to the world’s best entrepreneurs that are running the fastest-growing, highest-quality companies at the most attractive valuations we can find. Here’s to many more years of focusing on the inputs and letting the outputs take care of themselves.

Sincerely,

Ryan Reeves

Disclosures

Infuse Asset Management LP (“Infuse”) is an investment management company to a fund that is in the business of buying and selling securities and other financial instruments. This information is provided for informational purposes only and does not constitute investment advice or an offer or solicitation to buy or sell an interest in a private fund or any other security. An offer or solicitation of an investment in a private fund will only be made to accredited investors pursuant to a private placement memorandum and associated documents.

Infuse may change its views about or its investment positions in any of the securities mentioned in this document at any time, for any reason or no reason. Infuse may buy, sell, or otherwise change the form or substance of any of its investments. Infuse disclaims any obligation to notify the market of any such changes.

The S&P 500 is a U.S. equity index. It is included for informational purposes only and may not be representative of the type of investments made by the fund. References made to this index are for comparative purposes only. Reference to an index does not imply that the funds will achieve returns, volatility, or other results similar to the index. The fund’s portfolios are less diversified than this index. Returns for the index are total returns which includes dividends and do not reflect the deduction of any fees or expenses which would reduce returns.

An investment in the fund is speculative and involves a high degree of risk. The portfolio is under the sole trading authority of the general partner. An investor should not make an investment unless the investor is prepared to lose all or a substantial portion of its investment. The fees and expenses charged in connection with this investment may be higher than the fees and expenses of other investment alternatives and may offset profits.

The information in this material is only current as of the date indicated and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Any statements of opinion constitute only current opinions of Infuse which are subject to change and which Infuse does not undertake to update. Due to, among other things, the volatile nature of the markets, and an investment in the fund/partnership may only be suitable for certain investors. Parties should independently investigate any investment strategy or manager, and should consult with qualified investment, legal and tax professionals before making any investment.

The fund is not registered under the investment company act of 1940, as amended, in reliance on an exemption thereunder. Interests in the fund have not been registered under the securities act of 1933, as amended, or the securities laws of any state and are being offered and sold in reliance on exemptions from the registration requirements of said act and laws.

Performance Appendix

Thank you for your continued trust and support. Despite the lackluster performance start, every one of you has been supportive and you have no idea how much that means. Our investment process is improving daily, and it's only a matter of time before we start seeing things turn around. But enough about the short term, let's dive in!

Last quarter, we discussed the qualitative checklist that we go through for every investment. This quarter, I thought it would be helpful to go through the quantitative side of our process.

As a fundamental investor, the quantitative side, from my experience, is sort of under-discussed because it’s table stakes. The numbers are out in the open so there’s no edge, right? On a quarter-by-quarter basis, I’d say there’s some truth to that. The market does a pretty decent job of incorporating the new information about forward guidance or quarterly losses. But, in my experience, it can miss the forest for the trees. Truly special companies are able to sustainably grow while expanding profitability. Sure, they may have an occasional blip and miss margin targets for a few quarters, but focusing on the numbers can allow us to zoom out and focus on top tier companies. After all, a company could have all of the perfect intangibles but if revenue is in decline and they’re losing money, then something is wrong! The numbers have to match the narrative. Sure, the numbers aren’t everything but they can allow you to see right through a beautifully crafted narrative.

With that said, let’s get into the quantitative checklist. But before jumping right in, note that some of these items will actually overlap with the qualitative list. For example, looking at the goodwill on the balance sheet is quantitative but it also speaks to management’s capital allocation philosophy. If they are throwing away money on large acquisitions, that isn’t what we’re looking for. Alternatively, a company like Constellation Software has created an entire business around acquisitions but they actually have a surprisingly low level of goodwill. So once, again, the numbers provide evidence of a qualitative dynamic. Ok, enough preface, let’s jump in.

1. Trailing 12 months revenue growth

2. Quarterly revenue growth

3. Gross margins

4. EBIT margins/operating leverage

5. FCF margins

6. Cash/Debt

7. Goodwill

8. Capital intensity/returns on capital

9. Share count/stock based comp

10. Implied rate of return

11. Payback period

These items are a little more self-explanatory than the qualitative checklist so let’s use a company from the portfolio to illustrate them in action.

MercadoLibre

MercadoLibre is a Latin-American e-commerce and payments company. Started right as the dot-com bubble was picking up steam, MercadoLibre was originally pitched as an eBay for Latin America. The founder, Marcos Galperin, grew up in Buenos Aires where his family ran one of the largest leather companies in the world. After studying at Wharton and working at his family’s company for a few years, Galperin went to get his MBA at Stanford. In fact, MercadoLibre was born out of a project at GSB. While Galperin was formulating his thoughts for his Latin American e-commerce company, he confided in a professor named Jack McDonald. One day, a guest speaker, a private equity partner named John Muse, came to give a lecture. What Galperin didn’t know was that McDonald had promised Muse that a student could drive him to the airport after class. That student was Marcos Galperin. As the story goes, Galperin pitched Muse his idea on the drive to the airport and boom, he had his first bit of funding. Just about a year later, eBay itself actually bought a 20% stake and in return, MercadoLibre became its exclusive Latin American partner.

MercadoLibre has adapted to the rapid changes in commerce over the years. It started out as an auction-based site just like eBay. After a while, it moved to more of a pure 3P, Alibaba model, taking a cut of each transaction. The company had 65% gross margins and 25% EBIT margins. Life was good. But Latin America is tricky. Runaway inflation, political instability, and an extremely underbanked demographic made sustainable growth difficult. That’s not to say MercadoLibre ever really struggled to grow. Rather, it had to make proactive decisions to lay the foundation for the type of leader it is today.

One such decision was to get into the payments industry. Called MercadoPago, the company created its own payment gateway around 5 years after its inception. This would allow merchants and consumers to transact online even without having a bank account. In Latin America, about 70% of consumers are unbanked or underbanked. For example, only about 115 million out of a 625 million population have a credit card. That’s just the way it is. But this difference allowed MercadoLibre to make important strides in the payments ecosystem. Today, gross payment volume exceeds gross merchandise volume by more than 3x.

You might be wondering how that’s possible if MercadoLibre is simply an online marketplace. How could payment volume be so much higher than GMV? Well, it’s because the company isn’t just a marketplace. Around 2014, the company launched a mobile point-of-sale system to give offline merchants a seamless checkout experience. Pago was also rolled out to other SMB websites, enabling them to take online payments. Think of this as a PayPal wallet rather than just a MercadoLibre dedicated gateway. Now, off-platform volume vastly exceeds on-platform volume.

But the revenue tells a different story because of the different take-rates. The company keeps about 3% for itself on payment transactions but the marketplace rate is between 3-4x higher because of a bundled fee structure. In 2013, MercadoEnvios launched, helping merchants with fulfillment and warehousing. Over the past few years, the company has taken deliberate steps to create its own delivery infrastructure. It’s certainly not as robust as Amazon but the company is making strong progress. These days about 87% of items sold go through Envios. What’s interesting is that Envios is only available in 6 out of the company’s 18 locations (Argentina, Brazil, Mexico, Uruguay, Colombia, and Chile). It goes to show you how concentrated MercadoLibre is in its top markets. In fact, just Brazil, Argentina, and Mexico account for 95% of revenue.

Surprisingly that’s not all MercadoLibre does. We haven’t even talked about its credit arm, MercadoCredito, its asset management business, MercadoFundo, its online store solution, Mercado Shops, or its online listing service, MercadoLibre Classifieds. While these businesses don’t make up a ton of overall sales yet, each one acts as a lever to increase customer retention in the company’s ecosystem.

Imagine you’re a small merchant that started on the marketplace years ago. You don’t have to worry about taking payments, shipping, demand generation (as you can buy ads on the marketplace) and now you start taking loans from MercadoLibre. You’re making a good living! But where to put that extra cash? How about transferring it right into a set of index funds, all through a digital wallet. If you’re doing all of that through MercadoLibre, your lifetime value is immense.

MercadoLibre has done a great job of using its e-commerce business as a wedge to popularize its payments wallet. The functionality has developed nicely and the flywheel increases stickiness. Further, the company has a loyalty program that is taken quite seriously, with the goal of becoming a Level 6 customer. Users can buy their way into the program, much like an Amazon Prime membership, where they get free deliveries and other bundled perks like Disney+.

That’s the narrative, do the numbers support it?

1. Trailing 12 months revenue growth

In 2022, MercadoLibre grew 50% in US dollars. And in the previous five years, the company grew at a CAGR of 54%, though that is somewhat skewed from COVID. I prefer companies that are growing faster than 30% and MercadoLibre passes this test.

2. Quarterly revenue growth

I also like looking at the quarterly cadence of growth, though you can sometimes miss the bigger picture by getting hung up on each quarter. The last five quarters of growth for the company have been (oldest to most recent): 63% -> 53% -> 45% -> 43% -> 35%

Growth has been slowing slightly but if you study the history of the company’s numbers, they jump around a bit, one reason being the currency changes in Latin America. For reference, the last five quarters of YoY growth in constant currency were 67% -> 57% -> 61% -> 56% -> 58%.

Definitely not falling off a cliff.

3. Gross margins

Last year, gross margins were 49%, down from 64% in 2016. So what happened? Well, before 2017, the company was a true, asset-light marketplace with a fledgling payments business. In 2016, total payment volume was just $7.7 billion and last year it reached $123.7 billion. Payments, of course, carry lower gross margins but they have very high returns on capital, especially since MercadoLibre already had a strong customer and merchant base. Further, as the company experimented with holding some of its own inventory, that was a slight drag on margins. It’s interesting that companies like MercadoLibre and Alibaba started as asset-light companies and have made large investments in logistics while Amazon started as more of a wholesaler and has shifted to a third-party marketplace. I think what these companies are finding is that there is a happy medium – too asset light and competitors can steal share because there is less of a focus on logistics but too asset heavy and the returns on capital aren’t great.

4. EBIT margins/operating leverage

Similar to the degradation in gross margins, EBIT margins have also dropped 11 percentage points since 2016. Notice that gross margins drop 15 percentage points since 2016 but EBIT margins dropped only 11 points. That shows that there isn’t an operational efficiency problem so much as the business model has evolved. Payments making up a larger part of the business is the main culprit here. With that said, MercadoLibre did make some very important investments in free shipping over the past five years. In 2016, sales and marketing made up 19% of revenue but by 2019, that was up to 36%. The company heavily invested in Envios, their shipping solution. Now, more than 80% of shipments are delivered in 2 days and more than 60% of packages are received on the same-day now. The free shipping initiative really started in the first half of 2017 when the company started offering it to customers in Mexico, Colombia and Chile that spent more than ~$20. This was rolled out in Brazil but at a higher dollar amount – $40, because logistics are a little more complicated in that region.

At the trough, EBIT margins went from 24% in 2015 to -7% in 2019. About 3/4th’s of this was from free shipping investments and the rest was the overall lower gross margins from payments. The important thing is that these were proactive investments in customer experience rather than a lack of ability to make money.

EBIT margins in the last four quarters have all been above 10% and I wouldn’t be surprised to see even more operating leverage over the next year.

5. FCF margins

The company actually holds a surprisingly small amount of inventory which certainly helps free cash flow. As of the end of 2022, inventory was $152 million, just 1.5% of revenue. Compare this to Amazon which carried $34 billion, or 7% of revenue. That is also probably a little skewed since AWS does $80 billion in revenue, so the truer value is closer to 8%. That means Amazon carries 5x more inventory per dollar of revenue than MercadoLibre does.

Further, the company only spends about 4% of revenue on capital expenditures. Compare this once again to Amazon’s 14% of revenue after including leases. It’s not a perfect example because we don’t know exactly how much of Amazon’s capex is for AWS but it’s likely a good chunk. Based on my estimates, it’s probably not more than half so maybe in the range of 5-7%. The point is that Amazon still spends quite a bit more on capital expenditures than MercadoLibre. As we briefly touched on, there are positives and negatives to this. For one, MercadoLibre has much higher returns on capital. However, you could argue that Amazon has a much stronger moat from all of its infrastructure investments. All of those investments pay off in customer satisfaction and higher utilization of the existing assets.

At the same time, MercadoLibre’s logistics providers already have decent infrastructure so the company doesn’t want to step on any toes whereas Amazon doubled the size of their fulfillment capabilities during COVID, which they are now optimizing. There are certainly trade-offs and I think there is a nice tension of continuing to invest in the customer experience while also ensuring those investments are hitting NPV hurdles.

It’s also important to note the company’s other working capital dynamics. As MercadoLibre’s credit business grows, it uses its own balance sheet so as credit receivables increase, free cash flow takes a hit. Alternatively, as the company flexes down its credit book, free cash flow gushes, like we’ve seen over the past 12 months; during this period, the company’s free cash flow margin was 32%. One of the main differences between net income and free cash flow is the provision for loan losses. Over the past year, the provision was about $1 billion that the company's auditors thought was reasonable to estimate. If losses are far less than this, then the company's GAAP profitability is currently being masked.

6. Cash/Debt

The company’s balance sheet has gotten a little bit more complicated over the years as MercadoPago has become a larger chunk of the business.

At the end of the fiscal year, the company had $4.5 billion in cash and total investments and $4.7 billion in net debt, which is understated by about $700 million after adding operating lease liabilities. So the company has $800 million in net debt and plenty of cash considering it doesn’t do big acquisitions and is solidly profitable.

7. Goodwill

The company does very few acquisitions and when they do make one, it’s usually so small that it’s for an undisclosed sum. The two most recent acquisitions were in 2021 when the company bought Kangu, a Brazilian logistics provider, and Redelcom, a Chilean point-of-sale system to strengthen MercadoPago in that region. Currently, MercadoLibre has $153 million in goodwill compared to $14 billion in assets and a $60 billion enterprise value. The company passes this quick test with flying colors.

8. Capital intensity/returns on capital

There are different ways to calculate returns on capital but I like to keep it simple. We can start off with 2022 EBIT and subtract taxes. That would be approximately $1 billion. Then PPE is about $1 billion. Net working capital has the most nuance here but at the end of fiscal 2022, current assets were nearly $11 billion and unrestricted cash and marketable securities were about $4.2 billion. I prefer taking out excess cash as a company shouldn’t be penalized because they’ve built up a lot of cash from being profitable. It’s another story if the company has just continually diluted itself to raise that money. As with everything, there is nuance. That’s why it can be helpful to calculate ROIC with the operating approach (fixed assets + net working capital) and the financing approach (debt + equity). That way, if a company has a large negative equity position, the company will be penalized. We can do the same thing on the operating side by subtracting the amount of money they’ve raised (additional paid-in capital) from the excess cash balances. So that means we have $9.1 billion in net current assets.

The company also has $8.6 billion in current liabilities though we have to take out the $2.1 billion loan because that will be paid back in less than a year. The goal of calculating ROIC is trying to find out the long-term capital that is going into the business and seeing how much profit returns back to shareholders. So subtracting $2.1 billion from $8.6 billion gets us $6.5 billion in net current liabilities. Now we get $2.6 billion in net working capital. Adding that to fixed assets, we get $3.6 billion in invested capital. And lastly, $1 billion in NOPAT compared to $3.6 billion is 28% returns on capital.

We try to find companies where there is a clear line of sight to more than 20% returns on invested capital as, if we hold the business long enough, our overall return will gravitate towards that number. It’s not always easy to calculate this as there can be a lot of nuance but it’s certainly a worthwhile part of the checklist.

9. Share count/stock based comp

The company’s share count has grown, on average, at just over 1% since 2013, with most of that coming from one equity raise in 2019. The company raised a total of $1.85 billion, $1 billion of which came from investors, $750 million from PayPal, and $100 million from Dragoneer. In Q4 of 2021, the company did its second equity raise of $1.55 billion but the share price had tripled from the 2019 price so the dilution wasn’t as high. Outside of these two equity raises, the company hasn’t really grown share count. Stock-based comp was $85 million on over $10 billion in revenue and $2.5 billion in free cash flow. So the vast majority of dilution has come through those two offerings. The 2019 raise was more focused on rebuilding the cash position after the large free shipping investments and the 2021 raise was to give the company more liquidity to grow its MercadoCredito business. Overall, with the balance sheet in the position it is now, dilution will be very minimal.

As an aside, I don’t talk much about buybacks and dividends as a part of capital allocation because the type of companies we’re looking for are typically reinvesting everything back into the business. A business that is in capital returns mode has likely saturated its market or can’t find high ROI projects within the business. There is absolutely nothing wrong with returning capital to shareholders, it’s simply in the best interests of shareholders, but we prefer to find companies that have plenty of runway and high ROI ideas. After all, we’re investing in the business so that its talented team can grow our investment!

10. Implied rate of return

Now here’s where we get into the valuation piece of the puzzle. I’ll just keep it high level but there are two parts to our process, an implied rate of return calculation and a payback period. The implied rate is basically a quick, 5-year earnings model to see what sort of assumptions are priced into the business.

MercadoLibre is trading for about a $60 billion enterprise value. I think it’s quite likely that the company can do 20% margins and trade at a 20x multiple, equating to 4x sales. At $12 billion run-rate sales, we can figure out how fast revenue needs to grow to hit our hurdle rate. For example, a hurdle rate of 20% means that MELI’s value would be $150 billion in 5 years. If we divided $150 billion by $48 billion ($12 billion at 4x sales), then sales would have to grow, on average at 26% (3.1^(⅕)-1). We can also just use our bottom-up revenue growth estimate and then figure out an implied return from there. This makes the valuation process much more concrete and we can ask specific questions based on the reasonableness of each assumption. If we think sales can grow 20% annually from here on out and 25% margins are more reasonable, then our expected return would be 18%.

11. Payback period

The second part of the valuation is understanding how many years it would take to get paid back out of the free cash flow in the business. This helps us think much more like business owners. A simple way to think of this is if you bought a laundromat for $100,000 and its annual profit was $10,000. Then, imagine if, in one year, you sold it for the same price as you bought it. Your return would be 10%. That’s exactly how a one-year bond works and that’s how valuing a business works as well – but it’s just much harder because there is competition and changing profit levels. You just have to think about the return you’d like and then pull the trigger if the investment hits your desired threshold. So if we held onto that laundromat for 10 years, assuming no growth, we’d get our initial investment back. So buying a no-growth business at a 10x multiple would give you a 10% return on your money. If profit levels decrease by 30% though, your payback increases by about 4 years (from 10 to 14).

In real life, you think about how quickly you can get your money back on any type of investment, even if it’s buying a coffee machine so you don’t have to go to Starbucks every morning. We don’t typically think in terms of discount rates and WACC. We can do the same thing for businesses. That way, when the price goes down, and the profit levels stay the same or increase, we’ll be getting paid back faster.

I’m not going to go through all of the numbers for MELI but I think we can get paid back from out of the free cash flow after about 10 years. If it takes significantly more than 10 years, I start to question the valuation a little bit.

That’s a wrap for highlighting MercadoLibre and going through our quantitative checklist. As we more deeply understand the companies in the portfolio, it allows us to have more conviction in the businesses. It’s crucially important to keep our qualitative and quantitative standards extremely high so that the portfolio is getting stronger every single year.

Closing

I’m honored to have you as a partner. Thank you for your trust and support. It enables me to think long-term and will be our own competitive advantage.

The stock market, like life, will have its ups and downs. All we can do is focus on what we can control and work hard to continually raise our standards. Our strategy is simple – hitch a ride to the world’s best entrepreneurs that are running the fastest-growing, highest-quality companies at the most attractive valuations we can find. Here’s to many more years of focusing on the inputs and letting the outputs take care of themselves.

Sincerely,

Ryan Reeves

Disclosures

Infuse Asset Management LP (“Infuse”) is an investment management company to a fund that is in the business of buying and selling securities and other financial instruments. This information is provided for informational purposes only and does not constitute investment advice or an offer or solicitation to buy or sell an interest in a private fund or any other security. An offer or solicitation of an investment in a private fund will only be made to accredited investors pursuant to a private placement memorandum and associated documents.

Infuse may change its views about or its investment positions in any of the securities mentioned in this document at any time, for any reason or no reason. Infuse may buy, sell, or otherwise change the form or substance of any of its investments. Infuse disclaims any obligation to notify the market of any such changes.

The S&P 500 is a U.S. equity index. It is included for informational purposes only and may not be representative of the type of investments made by the fund. References made to this index are for comparative purposes only. Reference to an index does not imply that the funds will achieve returns, volatility, or other results similar to the index. The fund’s portfolios are less diversified than this index. Returns for the index are total returns which includes dividends and do not reflect the deduction of any fees or expenses which would reduce returns.

An investment in the fund is speculative and involves a high degree of risk. The portfolio is under the sole trading authority of the general partner. An investor should not make an investment unless the investor is prepared to lose all or a substantial portion of its investment. The fees and expenses charged in connection with this investment may be higher than the fees and expenses of other investment alternatives and may offset profits.

The information in this material is only current as of the date indicated and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Any statements of opinion constitute only current opinions of Infuse which are subject to change and which Infuse does not undertake to update. Due to, among other things, the volatile nature of the markets, and an investment in the fund/partnership may only be suitable for certain investors. Parties should independently investigate any investment strategy or manager, and should consult with qualified investment, legal and tax professionals before making any investment.

The fund is not registered under the investment company act of 1940, as amended, in reliance on an exemption thereunder. Interests in the fund have not been registered under the securities act of 1933, as amended, or the securities laws of any state and are being offered and sold in reliance on exemptions from the registration requirements of said act and laws.

Performance Appendix

Interested in Infuse Asset Management? Let’s talk.

Thank you for your continued trust and support. I’m not happy with the fund’s performance over the first three quarters. Like we discussed last quarter, I’ve made too many mistakes. However, this quarter was truly a turning point in our investment process and I’ve never felt more excited for the future. I hesitate to dwell on short-term performance because we are truly focused on the long-term but I want you to know that it seriously weighs on me and I’m doing everything in my power to grow your investment.

The format of the last few letters has been a discussion of our philosophy and then an example of how we put it into practice. I’d like to continue that format for this letter. We’ve talked at great length about the three pillars of our strategy – investing in the fastest-growing, highest-quality companies at the best valuations we can find. I think it might be helpful to go through some of our criteria around quality and the checklist items we use. Refining this checklist and applying it to more than 600 companies in our database is one of the reasons I mentioned that this quarter was a turning point in our process.

Before jumping in, I’d like to point out that our checklists are directly related to our strategy pillars. We have one for the qualitative aspects of a company and one for the quantitative (growth/valuation). After all, the evidence needs to match the story! We create the portfolio by combining the two checklists and sorting the highest scorers. So let’s get right into it – here are the qualitative checklist items:

1. Founder/amazing management

2. Competitive advantage

3. CAP trajectory

4. Large and growing market

5. Recurring revenue

6. Limited competition

7. Financial strength

8. Diversified ecosystem

9. Organic growth

10. Mission critical or consumer surplus?

11. Is it easily understandable?

12. Would I be proud?

Let’s go through these one at a time:

1. Founder/amazing management

At the end of the day, businesses are just groups of people providing value in exchange for dollars. We love founders or family-owned businesses because they usually have a lot of skin in the game; this business is their life’s work. Professional managers can share these characteristics but it’s not typically as common. The ideal manager for us is a founder that still has a large stake as that shows us they’ve been able to be prudent with the funds they raised or maybe they even bootstrapped the business. This could imply a strong product market fit or top-tier efficiency.

2. Competitive advantage

A good question to ask is: if an incredibly well-funded, focused competitor came in, could they replicate the core value prop of this company? Frameworks like switching costs, economies of scale, brand, culture, network effects, process power, etc. can be helpful but the essence of competitive advantage is power. The value proposition has to be so compelling that the other constituents are forced to interact with the company. It’s also helpful when advantages stack on top of each other, reinforcing the power the business has. A company like Apple might be a good example of this. It certainly has a strong, beloved brand. There are network effects with the developer ecosystem. More users mean that it is more attractive for an app developer to create something. There are also scale economies wherein Apple can push its weight around and get tight integration and bulk discounts with suppliers like TSMC. The switching costs are also quite high for an iPhone user – learning a new system, getting the eye-roll from friends when your green bubble pops up in group chats, and transferring your data and making sure it's compatible.

3. CAP trajectory

A company may not have a super strong current moat, but maybe they are getting stronger and stronger. This is where the competitive advantage period (CAP) trajectory comes into play. Are there signs that costs are coming down with scale? Are there hints of lower customer acquisition costs as the brand grows? Are retention rates actually improving as customers adopt more products, increasing switching costs and potentially, network effects? This is also very important for more mature companies. The direction of the CAP is key. I think we’ve seen this with Facebook/Meta over the past 5-ish years. The big blue app has been dwindling for a while and TikTok has taken quite a bit of share. The fact that a competitor could storm the scene in 5 years made investors a little more wary of the terminal assumptions implied in Facebook’s previous multiple. Maybe investors overshot to the downside, time will tell, but this drives home the importance of CAP trajectory.

4. Large and growing addressable market

High returns on capital coupled with a big reinvestment runway and a deep moat is the key to compounding. There are certainly riches in niches but if the company saturates its market, it can’t really grow besides increasing prices. The equation for revenue is price * quantity. If the business saturates the market, the only variable left is price. That’s the reason pricing power is crucial for a company with a big moat in a niche. The best companies constantly expand their market size as they venture into other areas. Amazon is the best example of this as it started as a book reseller but from early on, Bezos knew they would expand into other categories. And then, of course, AWS was completely unexpected. However, a large market alone is not a good enough reason to make an investment. The classic “if we only get 0.1% of the market, we’ll be a great company” pitch isn’t really convincing. Big markets also mean more competition. So there are upsides and downsides. However, a big market with tailwinds offsets some of the effects of competition. That’s why this criterion is a large and growing market.

5. Recurring revenue

Companies with recurring revenue have multiple advantages. For one, they can more easily predict demand. This enables them to hire efficiently, preparing for growth rather than overhiring when demand peaks. Two, customer acquisition costs are typically much lower in these businesses. Retaining a customer is so much cheaper than getting a new one and that plays right into companies with recurring revenue. Now, this doesn’t have to mean a software/subscription business. I would say that Starbucks has a certain degree of recurring revenue and maybe even Chipotle. Or a company like Pool Corp distributes chemicals and pool equipment to maintain pools, of which 80% is recurring.

6. Leader/limited competition

This is similar to the moat but a little different. A company like Datadog can still have quite a bit of competition but it’s the leader in the space which attracts some of the best employees and lowers its cost of capital. In short, there are benefits to being the leader. We love it when a company is in a growing space but has limited competition. A company like Airbnb might fit this description. Sure, VRBO exists but Airbnb is the behemoth that leads to more unique supply which leads to greater demand. Ideally, the company is a leader by default because it has no competition but more often, there are always competitors. I see this dynamic more in medical devices where a company is the sole provider of a particular type of device through FDA approval. Inspire Medical Systems is a good example of that.

7. Net cash position and free cash flow positive

These next two are pretty straightforward. First, I like to see a positive net cash position. Quite honestly, I’m not really looking for management to optimize the balance sheet. That’s more appropriate for companies with a super deep moat and few reinvestment opportunities. Ample cash is like slack in a system. Sometimes it’s healthy because it provides a cushion when unexpected things happen. For example, I’d much rather a company hold a bunch of extra cash on the balance sheet and then buy a big slug of stock in a huge sell-off rather than just systematically offset dilution. Likewise, it’s awfully hard to go out of business if you’re making cash and you don’t have any debt. In fact, it’s astoundingly hard to do! If we can chop off the left tail just like that, I’m all for it.

8. Diversified customer base and supply chain

Some companies, especially smaller companies, have very concentrated customer bases. For example, there is a small skin cancer company where 75% of revenue comes from one customer. It’s not the end of the world to have a big customer but it certainly increases the risk. What if the customer leaves? That’s a huge short-term risk! The stock could be down 50-70% in one day. Some companies have a few big customers but they are very ingrained in their business. Something like Taiwan Semi might be a decent example because Apple makes up a decent chunk of revenue but it’s a little far-fetched that Apple would in-source the manufacturing or use anyone else. So there is a bit of nuance here but watching out for concentration on both the customer and supplier side is very important.

9. Acquisitions

Companies that make too many large acquisitions are riskier, in my opinion. Now, that isn’t always the case. Constellation Software or roll-up players like Transdigm have been some of the best-performing compounders of the last few decades. I do think there is a difference between a company that does big acquisitions and a company that is formed with the explicit intent to roll-up an industry through small acquisitions. I think the differentiator is decentralization. It’s tough to do a bunch of acquisitions and stay centralized. Salesforce might be a solid example of doing it well but there are many more companies that have fallen by the wayside because of empire-building (too many big acquisitions). If a company has done a lot of acquisitions, it makes me more nervous. Lightspeed or Teladoc could be examples of that. It’s not a hard and fast rule, but we pay attention to it in our risk score. One quick and dirty rule we look at is goodwill compared to the enterprise value. If it’s over 5%, we think we have the right to question management’s capital allocation a little bit. Just because management does a lot of acquisitions doesn’t mean they have wasted dollars. Constellation Software does hundreds of acquisitions per year but goodwill only makes up ~2% of its enterprise value.

10. Mission critical or consumer surplus

This is a very important dynamic but it’s an either/or question, though ideally the company has both characteristics. Both of these characteristics are pretty subjective but the idea is to think about them more deeply, not necessarily get the “perfect” scoring. Starting with mission critical, Salesforce would probably be a good example of getting deeply embedded into a company’s processes. Or an Oracle database would be an even better example. Migrating an entire database is not a simple task and it can be risky if things go wrong. Mission critical means that, once the product is being used, it’s not easily replaced since it serves such an important function. The next criteria is that the business provides a lot of consumer surplus. Costco is a perfect example here. They are intentionally not maximizing margins because they know that will maximize long-term profit dollars. The key phrase here is long-term. Management teams with short-term mindsets may try to maximize margins to juice earnings. But always providing more value than the alternatives increases customer loyalty and the odds that the business will perform well compared to competitors. Now, ideally, the company won’t have any competition but one sure way of keeping competitors at bay is providing so much value that customers can’t help but use the product or service.

As noted earlier, ideally the company can be both mission critical and provide consumer surplus. However, it’s something we look at together because it’s harder for consumer facing companies to be truly mission critical. A company like Uber is incredibly important but Lyft still exists (though it is currently being dominated) and taxis have improved quite a bit. There could be an argument that Uber is mission critical but I just use this example to say that it’s a little more difficult for consumer facing products because there tend to be lots of alternatives and low switching costs.

11. Is it understandable?

This has to do with both my own circle of competence and the business itself. Some businesses may very well be simple but I lack the sense to fully understand it. Others are just plain complicated. Either way, if I don’t deeply understand the crucial factors, I won’t know when I should change my mind.

Further, I’ve just noticed that if a company is making money in a very complicated way, there is typically some financial or lending component. For example, I just can’t quite figure out SunRun’s business. Maybe I’m not smart enough but I’d much rather focus on companies that are easily understandable. It helps me sleep at night and enables me to know when I should change my mind.

12. Would I be proud to be a shareholder?

Last but certainly not least, would I be proud to be a shareholder? I love this question because it gets at the heart of something very important – negative externalities. That’s just a fancy way of saying that something isn’t win-win. A company like Altria has plenty of negative externalities as smoking kills people. Plain and simple. Therefore, they face multiple headwinds. At the same time, Altria has been a great performer because it is highly addictive and they can just raise prices and buy back stock. However, I do think there are tailwinds to doing the right thing. Now, this is a very subjective question and some people invest using the inverse of this question. Companies like Warrior Met Coal and Altria are really cheap because people don’t want to own them and there is likely embedded alpha in those “unownable” companies. That’s fine but from a long-term perspective, I think we’re chopping off the right tail for things to go really right. Sure, these types of companies can continue to outperform, but we’re trying to zone-in on risk and I think negative externalities increase risk.

Quality

So those are the 12 main questions we reflect on to assess the quality of the business. This list certainly isn’t exhaustive but it helps us quickly sort companies so we can spend our time well.

There is quite a bit of nuance in these scores because the moat of Apple might be much deeper than the advantage that Crowdstrike has in endpoint security. So there is a magnitude in each of these questions – Bezos wouldn’t be put on the same level as an unproven founder (it’s not my place to name names!). Or Google’s financial strength is much different than a company that just put in its first quarter of free cash flow.

Lastly, very few companies can pass this checklist test with flying colors. Apple actually has one of the highest scores of any company I’ve looked at but even it doesn’t have a high degree of recurring revenue. Sure, you could make the argument that people upgrade their phones pretty often but that could also be delayed several years based on personal circumstances. The point is that there are always trade-offs with investing. This checklist is a start to understanding which trade-offs we’re going to make in the portfolio.

Now let’s look at a company in the portfolio that scores very well on the quality checklist.

Axon Enterprise

Axon is most famous for popularizing the Taser. In fact, the company’s old ticker symbol was TASR, until it started expanding into new product categories and updated the ticker to AXON.

The founding story is quite unique. Rick Smith was at Harvard when two of his friends from high school were shot dead. While grieving, he wondered if there was a non-lethal weapon that could solve the problem of gun violence. He kept thinking about the idea and eventually found the inventor of the Taser, Jack Cover, to team up with. Mr. Cover was a NASA engineer and had been working on his idea for nearly 20 years by the time Rick Smith reached out. But the story goes back even further. Some of Jack Cover’s inspiration was a 1911 children’s book called Tom Swift’s Electric Rifle (TSER – Mr. Cover later added an “A” to the name). Rick Smith and his brother, Tom, set out, with the help of Jack Cover, to improve the Taser in 1993. The original Taser actually used gunpowder so it was officially labeled a firearm which really depressed sales. So the Smiths decided to use compressed nitrogen and sales eventually took off. One early marketing stunt the company did was to pay cops to teach citizens how to use Tasers and thereby sell more devices. Now, Tasers account for just under 50% of the company’s $1.2 billion in revenue and the new Taser 10 should be released here pretty soon. As mentioned, for 24 years the company was named Taser International, but it rebranded in 2017 to Axon. Over the past decade, Axon has diversified its business and now the overarching mission is to protect life. In fact, Rick Smith set out a moonshot goal to decrease the number of police related deaths by 50% over the next decade.

One of the main products that Axon offers is body-worn cameras for law enforcement officers. These cameras are designed to record video and audio of interactions between officers and the public, which can be used for evidence in criminal cases and to improve officer training and accountability. A key feature of Axon's body-worn camera system is its cloud-based storage and management platform, Evidence.com. This platform allows agencies to securely store and manage their video and audio evidence, as well as other types of digital evidence such as documents and photos. Evidence.com also includes a range of tools and features for analyzing and organizing evidence, including redaction tools and automatic tagging of important events. Apparently, the library of footage in Evidence.com is 22x the size of Netflix’s entire catalog

In addition to body-worn cameras, Axon also offers a range of other products and services for public safety agencies, including in-car video systems, a portal for citizens to upload police-related videos, evidence management software, and training and consulting services.

Now that we have a sense of the business, let’s run Axon through the checklist:

1. Founder

Rick Smith has been at the helm since the beginning. I believe he is a fantastic leader and a real visionary. His brother is no longer involved with the company but actually started a somewhat competing company in the non-lethal weapon space, called Wrap. The idea was to use a silky substance to tangle intruders or criminals. So basically, Spiderman. Recently, Tom left Wrap and now works for a jet-sharing company called Set Jet.

2. Competitive advantage

Axon has several competitive advantages. One of these is its strong brand and reputation, which has been built up over the years through its commitment to providing high-quality products and services to public safety agencies. The company has a stronghold with police stations, as roughly 85% of all stations are active buyers of Axon products.

You can think of these stations like an installed base where Axon can continue to sell new models of Taser, more storage for Evidence.com and more sensors and cameras for officers. It’s not a perfect example, but Axon’s business model is similar to Apple’s with hardware upgrades and an incredibly captive audience because of sticky software.

3. CAP trajectory

The company continues to innovate and roll out new products. The Taser 10 is highly anticipated and to further the Apple analogy, a whole lot of customers will be reflexively upgrading because it’s an Axon product. But the company is certainly not resting on its laurels. It’s currently building VR training systems and drones for de-escalation, crime scene reconstruction, and search-and-rescue.

4. Large and growing market

The company pegs its own market at $50 billion, $10 billion of which is from evidence management. The thesis here is that Axon will just penetrate the wallet share of police stations even more deeply. This isn’t necessarily a land-and-expand type of business because Axon is already such a cognitive referent in the industry. However, as the company upgrades its products and stations need more and more storage for evidence back-ups, Axon has plenty of runway left.

5. Recurring revenue

About 45% of the company’s revenue is from Taser, which is non-recurring. But another 40% is recurring revenue made up from three sources: Evidence.com, Axon Records, and Axon Respond. Evidence.com is the cloud storage solution. Axon Records is a dynamic reporting system that enables officers to streamline their workflows for citations or managing evidence. And Axon Respond is a physical asset management software that shows police stations where all of their officers are for efficient routing. What’s amazing is that annual recurring revenue has grown at a 51% CAGR over the last 6 years and now makes up nearly $500 million in revenue.

6. Limited competition

Some of Axon's main competitors include Motorola Solutions, Digital Ally, and WatchGuard Video. These companies offer similar products and services to Axon, including body-worn cameras, in-car video systems, and evidence management software. But Axon is certainly the dominant player. In reality, it’s incredibly rare that a company has zero competition. But I love looking for singular companies, where they are so dominant that they might as well have no competition. I believe Axon fits this bill.

7. Financial strength

The company has $550 million in net cash and it did $180 million in free cash flow last year. While stock-based comp is pretty high at $100 million, a majority of that is from Rick Smith’s long-term equity incentive package.

8. Diversified ecosystem

The company doesn’t have any 10% customers for revenue or receivables. It also doesn’t rely too heavily on any specific supplier.

9. Organic growth

The company is extremely selective about its acquisitions. It only has $45 million in goodwill and will do small tuck-ins acquisitions for technology like buying a photo-sharing service called Familiar in 2013 to help build out Evidence.com.

10. Mission critical or consumer surplus

Police stations wouldn’t be in compliance with federal laws without their Axon products. The constant video streams and storage is a prime example. Sure, there are alternative products but they won’t work seamlessly with everything else. I keep coming back to the Apple example but I think the hardware/software integrations are very underappreciated.

11. Is it understandable?

The business is fairly straight-forward. About 40% is from physical Tasers and cartridges, 35% comes from Evidence.com, and the remainder is from sensors like Axon body and dashboard cams. Axon has a virtual salesforce to sell these products and also uses distributors that receive a small mark-up.

12. Would I be proud?

While there have been roughly 1,000 Taser related deaths since 2000, the company’s goal of cutting police related deaths in half is certainly worthy. In context, just last year, there were nearly 1,100 police related deaths. I believe Axon is headed in the right direction and even the mere presence of body cams creates more accountability.

Axon is a perfect example of a company with the qualitative characteristics that I look for . A dominant position in a large market, incredible economics, a founder at the helm, a good chunk of recurring revenue, a strong and growing competitive advantage, and a strong preference to internally innovate.

Now, this is just the qualitative checklist portion of our process. When combined with the quantitative measures, that’s how the portfolio is created. A company with all of the right intangibles could be a terrible investment if the price is far too high. Balancing the three pillars of our strategy – quality, growth and valuation – is tricky but I believe it lays the foundation for a very robust portfolio.

Closing

I’m honored to have you as a partner. Thank you for your trust and support. It enables me to think long-term and will be our own competitive advantage.

The stock market, like life, will have its ups and downs. All we can do is focus on what we can control and work hard to continually raise our standards. Our strategy is simple – hitch a ride to the world’s best entrepreneurs that are running the fastest-growing, highest-quality companies at the most attractive valuations we can find. Here’s to many more years of focusing on the inputs and letting the outputs take care of themselves.

Sincerely,

Ryan Reeves

Disclosures

Infuse Asset Management LP (“Infuse”) is an investment management company to a fund that is in the business of buying and selling securities and other financial instruments. This information is provided for informational purposes only and does not constitute investment advice or an offer or solicitation to buy or sell an interest in a private fund or any other security. An offer or solicitation of an investment in a private fund will only be made to accredited investors pursuant to a private placement memorandum and associated documents.

Infuse may change its views about or its investment positions in any of the securities mentioned in this document at any time, for any reason or no reason. Infuse may buy, sell, or otherwise change the form or substance of any of its investments. Infuse disclaims any obligation to notify the market of any such changes.

The S&P 500 is a U.S. equity index. It is included for informational purposes only and may not be representative of the type of investments made by the fund. References made to this index are for comparative purposes only. Reference to an index does not imply that the funds will achieve returns, volatility, or other results similar to the index. The fund’s portfolios are less diversified than this index. Returns for the index are total returns which includes dividends and do not reflect the deduction of any fees or expenses which would reduce returns.

An investment in the fund is speculative and involves a high degree of risk. The portfolio is under the sole trading authority of the general partner. An investor should not make an investment unless the investor is prepared to lose all or a substantial portion of its investment. The fees and expenses charged in connection with this investment may be higher than the fees and expenses of other investment alternatives and may offset profits.

The information in this material is only current as of the date indicated and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Any statements of opinion constitute only current opinions of Infuse which are subject to change and which Infuse does not undertake to update. Due to, among other things, the volatile nature of the markets, and an investment in the fund/partnership may only be suitable for certain investors. Parties should independently investigate any investment strategy or manager, and should consult with qualified investment, legal and tax professionals before making any investment.

The fund is not registered under the investment company act of 1940, as amended, in reliance on an exemption thereunder. Interests in the fund have not been registered under the securities act of 1933, as amended, or the securities laws of any state and are being offered and sold in reliance on exemptions from the registration requirements of said act and laws.

Performance Appendix

Thank you for your trust and support.

This is your hard-earned capital so I want to be frank with you – I’ve made a couple mistakes so far. First, I wasn’t as focused on current free cash flow as I should’ve been. For example, SentinelOne, was a detractor in the portfolio though I believe they are making progress on the bottom line. Even though it’s only been several months, I still believe it was a mistake to size it up in the portfolio initially. As rates have risen, companies burning cash have been hit disproportionately. I drastically underestimated the short term effect of this. I have rectified that mistake and have added several companies that are gushing free cash flow. No matter the market sentiment, companies that are growing, produce large quantities of cash, and have a net cash position are well-equipped to gain share and take advantage of whatever circumstances are thrown at them.

Second, I have been trading too much. I have been equating activity with fruitfulness and they may be correlated in normal lines of work, but they seem to have an inverse relationship regarding investments. I need to spend more time assessing the strength of the business rather than our short-term performance. It’s tempting to stare at the daily P/L but the illusion of control is unproductive. In a concentrated portfolio, being selective really matters. It’s fine to miss opportunities that are outside of my strike zone but it’s not acceptable to compromise on business quality and let that harm us. To fix this, I’ve strengthened our quality due diligence checklist, which I will review in the next quarterly letter.

The bad news is that I will make many more mistakes over the coming years. The good news is that I will improve from them. It feels terrible to make mistakes while stewarding someone else’s capital but dwelling on them won’t help us. Assessing them and seeing where I can learn, will. I will try to be transparent when I mess up but one strange thing about investing is it can be difficult to tell when a mistake is actually a mistake. For example, writing a decision off as a mistake based on one bad trading day likely doesn’t make sense. But that’s a topic for another day. Excelsior! (one of our core values – onward and upwards!)

[As a side note, the last few months have been quite astounding. An evenly split portfolio of just Amazon, Apple and Google would’ve been down 31% since August 8th, our inception date. And I certainly don’t believe buying those companies would’ve been a mistake; sizing them so large likely would be but again, a topic for another day.]

In the last letter, we discussed three unique ways we think about investing. To start off this letter, I’d like to share a quick overview of how we came to our philosophy. It will continue to evolve but the core tenet of paying less than something is worth, won’t.

Good investing is buying an asset that gives you a lot more cash than you paid for it. There are different ways to go about this though – on one end of the spectrum is getting a great deal and then flipping it to someone else, and on the other end, is getting paid out of the growth in cash flow from the business. Most investing takes place in the middle, where investors are trying to balance the price they pay with the cash they expect to receive over time. Now, the ideal situation is buying something for a low valuation that is growing its cash flow quite fast. If a business were doubling its earnings and you paid 2x earnings, you’d get paid back in one year, and then your yield-on-cost would be more than 100% after that. But it’s usually never that easy because a) other investors compete those returns away, b) if the deal was that good, management would just buy all the shares it could get its hands on, and c) the future is uncertain so it’s difficult to know with accuracy how much cash a business will produce over its lifetime.

That’s why the three legs of our strategy are growth, quality, and valuation. We’ll get paid back the most if the company is gushing cash flow and we pay a low price compared to that cash flow. But we also increase our odds of getting paid back in-full if the business is doing all of the right things. The financial statements are an output of a whole bunch of business decisions. And if those decisions are quality decisions, the numbers will take care of themselves.

The ideal investment in my mind would be a business that has no competitors, a deep moat and getting stronger, recurring revenue, a gigantic market with huge tailwinds, a founder led management team that is highly incentivized, employees with a strong sense of purpose, capital light, raving customers that provide viral word of mouth, 90% FCF margins, 1,000% revenue growth for the foreseeable future, very strong net cash position, that can all be purchased for 0.1x FCF.

Now, of course, that isn’t even remotely feasible (after 10 years $100 in revenue would turn into $1 trillion and the initial purchase price would be $10), but that’s the perfect scenario. If you can find a 10-year, 1,500% CAGR, please let me know.

The absurdity of the example is to make a point – no investment will ever resemble that opportunity but why not strive to find companies that look as close to that as we can?

Therefore, our strategy is simple but not easy – compound your dollars at high rates by investing in the fastest-growing, high-quality companies at the best valuations we can find. Another way to put this is that we buy into businesses with sustainable, fast-growing free cash flow per share, at low payback periods. At the end of the day, it all comes down to the cash produced versus the price paid. Simple, not easy.

Like we discussed Snowflake last quarter, we think another company that fits our criteria is Nu Holdings. To be clear, Nu is a newer position (pun intended) so it’s smaller than Snowflake but let’s run it through the criteria of growth, quality, and valuation.

Growth

Born in Colombia to an entrepreneurial family (all 17 of his aunts/uncles run businesses), David Velez saw firsthand some of the drawbacks of the Latin American banking system. This was especially relevant in 2008 when Velez was asked to open a regional office in Brazil for the private equity firm he worked at. To open a bank account, he had to go through a security screening, wait in line for hours, and even after that, it took four more months to finally get the account opened.

After that experience, while doing his MBA at Stanford, a friend introduced him to Doug Leone of Sequoia Capital. After graduating, Leone asked Velez to head up their search for Brazilian entrepreneurs as Sequoia thought that would be the next big innovation hub. However, after realizing that the entire country of Brazil graduated just 42 computer science majors, Sequoia shuttered its Brazil plans in October of 2012. Rather than accepting a job back at Sequoia, Velez decided to start his own business – a Brazilian neobank.

The Brazilian banking space was ripe for disruption. The top five Brazilian banks owned 90% of the market and at an average of 25% return on equity – these banks were among some of the most profitable in the world. A myriad of late fees and onerous interest rates were just part of the daily experience for a Brazilian. Velez raised some money from Leone and recruited two co-founders, Edward Wible as CTO, and Cristina Junqueira as the CEO of Brazil.

The team started out by offering a Mastercard credit card with no annual fee. Visa wasn’t willing to work with start-ups at that point and the Brazilian regulations were changing such that if Nubank wasn’t approved by April 2013, they’d be forced to obtain a banking license which would delay the launch date by three years. In fact, Velez once flew to the Netherlands to pick up a contract from a Mastercard office just because they couldn’t wait two days for FedEx shipping. Supposedly, Nubank’s initial product is the fastest that Mastercard has ever given approval.

In the early days, Nubank made money through the merchant discount rate. When customers would use the credit card, Nubank would get between 3-5% from the merchants for underwriting the customer. This is how most neobanks start out as they can institute low credit maximums and quickly stem losses. Further, neobanks typically don’t have large deposit bases from which they can do all sorts of lending.

Importantly, Nubank is very good at focusing before moving on to new products. After launching in 2013, it took them four years until their second core product, a bank account. Then it took another year to roll out debit cards and personal loans. I’ve heard from employees that you wouldn’t believe how focused the company can be and how important the customer experience is. I think the natural inclination for some fintechs is to grow as fast as possible but without a strong foundation, too much growth can become quite risky.

However, Nubank has quite a robust suite of products now. What started out with a simple credit card, has morphed into bank accounts, secured and unsecured personal loans, an investing platform, small business accounts, and money transfers. The company also partners for other types of loans like mortgages or auto.

The thesis here is pretty simple – Nubank has the best customer experience in a vastly underbanked population. The company’s growth has been nothing short of astounding. Since the beginning of 2017, total customers have grown from 1.6 million to over 70 million. That is a CAGR of 99%! Over 90% of those customers come from Brazil – the rest are from Mexico and Colombia. These ~65 million Brazilian customers make up 1/3rd of the population over 14 years old. It’s safe to say that the company has some pretty strong brand recognition by now. Further, NPS scores in Brazil are 90, which are some of the highest I’ve ever seen. Not to be outdone though, the most recent scores out of Mexico are 95. This means that 95% of customers would strongly recommend using the product.

The story these days isn’t so much about Brazilian customer acquisition – though it has grown over 40% YoY, adding about 5 million customers every quarter – it’s about providing more services to those same customers. The monthly average revenue per customer (ARPAC) is $8. This includes the interchange fees on purchase volume, credit card and personal loan interest, and then lending revenue from customer deposits. At the end of 2019, ARPAC was under $3, which is a 35% CAGR. While rising interest rates make up about half of that growth, the company is still doing a great job at becoming more embedded in customers’ lives.

In the latest quarter, the company announced that it’s already the largest credit card issuer in Colombia and Mexico. Mr. Velez even commented that he’s surprised the progress in these two countries has been better than the early days of Brazil. The fact we’re seeing evidence of a repeatable playbook is quite exciting for the future growth of the company. But growth isn’t everything, the company also has a strong and growing moat.

Quality

The moat here is that Nubank is the lowest-cost producer. By utilizing technology, the company has the lowest customer acquisition cost and the lowest cost to serve. Without the need for physical branches and large marketing campaigns, the company can focus its efforts on improving the customer experience rather than acquiring customers. While 2020 was certainly a unique year, the company spent $19 million in marketing and for 2021, brought in 20 million new customers. In the US, I’ve seen estimates that the average customer acquisition cost can hover around $200. The thing that originally caught my eye when looking at Nubank was that up to 90% of new customers come organically, without any paid acquisition. That’s simply because of how good the product is. Low fees, ease of use, and no waiting four months for approval!

Another piece of evidence for being the low-cost provider is that Nubank has one employee for every 12,000 customers whereas incumbents need 12x the number of employees. Extremely low-cost acquisition coupled with a low cost-to-serve means that the long-term economics are quite interesting. One data point here is that at the end of 2020, the monthly cost to serve a customer was about $1.2 and the average monthly revenue per active customer (ARPAC) was $3.3. So that’s about a 64% gross margin. Well, in the past two years, cost to serve has dropped to $0.80 and ARPAC has increased to $8.3, or more like a 90% gross margin. The main takeaway here is that costs don’t increase linearly with revenue. The platform that Nubank has built is incredibly scalable and customer satisfaction isn’t being deprioritized, judging by the NPS scores.

And bank accounts are notoriously sticky, especially the account that is tied to where customers receive their salaries. Payroll loans are quite popular in Latin American countries and Nubank has yet to really focus on that yet. The main takeaway here is that Nubank’s retention rates will only increase as customers use more of its products. In short, the switching costs will only get stronger.

Valuation

At our buy price, Nubank was trading for about ~$16 billion. The company did $4 billion in TTM sales and roughly broke even on the bottom line. Currently, the company trades for roughly 4x book value which is quite high for a bank. In contrast, Bank of America is around 1.2x and Chase is at 1.5x. But this also makes sense because these banks aren’t growing assets by over 70%. In fact, Chase’s assets will be about flat this year; it has taken Chase 9 years to grow 70%. Let’s put it this way – if Nubank’s book value per share can grow at 30% over the next five years, and the stock compounds at 15%, it will trade at 2x book, which I think would be a fair value. So you can sort of think of our expected return as the delta between the multiple shrinking to 2x and whatever the company ends up growing book value per share at. So if Nubank can grow at 40% over the next five years, then our return would be more like 25%.

That’s one way of thinking about the value but below is a slightly more nuanced way of looking at the scenarios.

Without including any more countries, the company has 130 million more Brazilian customers to go after, 90 million Mexican customers, and 40 million Colombian customers (these are the total populations over 15 years old subtracting current customers).

Even if Nubank acquires 50% of these customers, with current ARPAC rates, that gives the company $16 billion in eventual revenue. However, current Brazilian banks have monthly ARPAC’s more like $30-35. I don’t think Nubank will get close to that because it wants to keep fees low but I do think that it will continue bundling more and more products, deepening its customer relationships. I don’t think $15 of monthly ARPAC is out of the equation, undercutting competitors by 50%. With a 50% penetration rate (the current Brazilian penetration is 33%), assuming no more geographic expansion, and a little less than a doubling of revenue per customer, that gets us to $36 billion in revenue. The biggest bank in Brazil, Itau, does about $25 billion in revenue so this isn’t very far-fetched.

I don’t see why the company shouldn’t be able to trade at 2.5x sales, considering that 25% margins should be very doable. Right now, Itau’s margins are 25% and it has a much higher cost to serve, accounting for its 4,000 bank branches. If we assume that Itau can maintain higher margins because of extra fees but then cancel that out because of Nubank’s efficiency, maybe a reasonable assumption is a similar margin profile.

At a 10x PE, that’s 2.5x sales. On our $36 billion revenue estimate, that’s a $90 billion company. Now, the question is just how long will that take. Five years seems pretty quick as the revenue CAGR would be around 60%. In ten years, the revenue CAGR would be more like 26%, yielding a 19% overall stock return.

Now, of course, lots of things could change, especially in the geopolitical landscape in Latin America. However, Nubank has accomplished this growth despite its core market basically being in a recession the entire time. Since the company’s founding, GDP/capita in Brazil has fallen over 30% on an absolute basis. Any semblance of an economic tailwind over the next decade should be good news for the company.

Closing

I’m honored to have you as a partner. Thank you for your trust and support. It enables me to think long-term and will be our own competitive advantage.

The economy, like life, will have its ups and downs. All we can do is focus on what we can control and work hard to continually raise our standards. Our strategy is simple – hitch a ride to the world’s best entrepreneurs that are running the fastest-growing, highest-quality companies at the most attractive valuations we can find. Here’s to many more years of focusing on the inputs and letting the outputs take care of themselves.

Sincerely,

Ryan Reeves

Disclosures

Infuse Asset Management LP (“Infuse”) is an investment management company to a fund that is in the business of buying and selling securities and other financial instruments. This information is provided for informational purposes only and does not constitute investment advice or an offer or solicitation to buy or sell an interest in a private fund or any other security. An offer or solicitation of an investment in a private fund will only be made to accredited investors pursuant to a private placement memorandum and associated documents.

Infuse may change its views about or its investment positions in any of the securities mentioned in this document at any time, for any reason or no reason. Infuse may buy, sell, or otherwise change the form or substance of any of its investments. Infuse disclaims any obligation to notify the market of any such changes.

The S&P 500 is a U.S. equity index. It is included for informational purposes only and may not be representative of the type of investments made by the fund. References made to this index are for comparative purposes only. Reference to an index does not imply that the funds will achieve returns, volatility, or other results similar to the index. The fund’s portfolios are less diversified than this index. Returns for the index are total returns which includes dividends and do not reflect the deduction of any fees or expenses which would reduce returns.

An investment in the fund is speculative and involves a high degree of risk. The portfolio is under the sole trading authority of the general partner. An investor should not make an investment unless the investor is prepared to lose all or a substantial portion of its investment. The fees and expenses charged in connection with this investment may be higher than the fees and expenses of other investment alternatives and may offset profits.

The information in this material is only current as of the date indicated and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Any statements of opinion constitute only current opinions of Infuse which are subject to change and which Infuse does not undertake to update. Due to, among other things, the volatile nature of the markets, and an investment in the fund/partnership may only be suitable for certain investors. Parties should independently investigate any investment strategy or manager, and should consult with qualified investment, legal and tax professionals before making any investment.

The fund is not registered under the investment company act of 1940, as amended, in reliance on an exemption thereunder. Interests in the fund have not been registered under the securities act of 1933, as amended, or the securities laws of any state and are being offered and sold in reliance on exemptions from the registration requirements of said act and laws.

Performance Appendix

You should’ve received log-in credentials to your investor portal by now. If not, please let me know. Also note that you can find the quarterly performance at the end of this letter, in the performance appendix – though your actual returns may differ slightly depending on the timing of your subscription.

As this is the first quarterly letter, I want to provide the vision for the fund. I’ll also outline three aspects of our process and then end with an example of an investment that fits our criteria.

Vision

My goal is that Infuse would be the best-performing public equity fund over the next 50 years. I realize that sounds crazy but that’s the goal – long-term, world-class returns, not absolute AUM. To give us the best odds of accomplishing that goal, there are a few things that might be helpful.

To invert the premise, we can’t have the best-performing fund over 50 years if it doesn’t survive 50 years. One of the main ways that funds dissolve is through excessive leverage. In service of returns, leverage ends up destroying them. To me, the risk simply outweighs the reward, especially since world-class returns are typically derived from situations where there is a lack of agreement about a company. In these cases, stock prices can be wildly volatile. Adding leverage to that cocktail is a recipe for, in the best case, stress, and in the worst case, failure.

However, just making the claim that you want to be the best isn’t worth a whole lot without a strategy to make it a reality. To this end, our plan is to hold a concentrated portfolio of the fastest-growing, highest-quality companies in the world at the best valuations we can find.

Stock prices are a function of two things – earnings and other investors’ perceptions of those earnings. So in an ideal world, we’d buy stocks where earnings increase dramatically while the perception is that the company won’t be able to continue its success. However, perception can be quite fickle. Betting on how other people will view the nature of a company’s earnings in 5 or 10 years is not an easy task. That’s why we primarily focus on the velocity and durability of the earnings growth and then make sure we’re not overpaying.

While our goal is world-class returns, that’s really an output of good decisions. Focusing too much on explicit performance goals can create unintended consequences. As Theodore Roosevelt liked to say, “comparison is the thief of joy.” There’s nothing wrong with wanting to be the best, – however, there is something wrong when it takes your focus off the inputs to the process. Being consumed with the highest returns can also lead to decisions that make the process more fragile – adding leverage being an excellent example.

Therefore, with the long-term goal of world-class returns in mind, we seek to focus on the inputs to the process. After all, that’s what we have control over. Namely, we have control over our specific standards of growth, quality, and valuation. And when we focus, every day, on trying to raise those standards, the outcome will take care of itself.

Process Details

So that’s the vision. But, I also wanted to dive into a few more details on our process.

At the end of the day, we all just want high returns with a low probability of losing money. But there is tension. If you want to eliminate the potential of losing any money, then the upside will be quite low. Conversely, if you want the highest upside possible, there likely needs to be a non-zero chance of losing your entire investment. On one end of the spectrum is US treasuries. And on the other may be a seed investment in a biotech start-up. However, I do think there are some ways to increase the upside while decreasing the downside.

First off, we think concentration is important for growing your money. Extreme diversification can be good for wealth preservation but concentration is key for supernormal returns. You can look at nearly every example of the wealthiest people in the world – they pretty much had zero diversification, just owning a large stake in their business. Another way to look at it is if you were buying a collection of entire businesses – how many would you need to feel reasonably diversified? When you think of investing as buying actual businesses, I think the natural tendency is to concentrate. This seems likely because it takes quite a bit of time to deeply understand a single business, let alone 50 or 100.

We are bigger fans of what Stan Druckenmiller says about putting all of your eggs in one basket and watching it very closely. There is something very powerful about focus that sharpens decision-making. You can certainly be more intellectually lazy about a 1% position than a 20% position. Of course, humility is needed – I will be wrong. So there is certainly a middle ground – more than 4 or 5 but less than, in my opinion, 20.

Second, we as humans love putting things into categories. It helps our brain cope with complexities and makes our neocortex feel warm and fuzzy. As an example, labels like large cap and broad sector designations like tech are abstractions. What really matters is high upside and a low probability of losing money (high reward, low risk). So would you say a portfolio entirely consisting of software stocks is “risky”? At face value, it seems very risky. But why? Because sectors tend to trade similarly due to non-fundamental reasons like “fund flows” or technicals? Or because your portfolio’s Sharpe ratio will decrease from the added volatility? Or because it is accepted wisdom? It’s all an abstraction that misses the point – high reward, low risk. Now, of course, there are counter-arguments. In fact, there almost always are because reality is incredibly complex. Using the software example, there are real risks like the shortage of highly skilled programmers, missing a new paradigm, a worldwide cyber virus, low chip production which would affect overall cloud growth, or relatively low barriers to entry. Further, if your entire portfolio consisted of marketing software, that would be incredibly risky because competitors may compete on price, creating worse economics for the entire industry. And they may be competing for the same talent. But in general, labels like software and tech are typically lazy thinking. Just because the businesses have a code base doesn’t necessarily mean they should be lumped together.

Third, volatility is not the same as risk. We’ve defined risk as the probability of losing money. And volatility is the magnitude of price swings in a stock. If a stock crashes after a good earnings report, the volatility will have increased but the risk may be lower considering the shorter payback period. Instead of Wall Street’s love of a magic formula (risk = volatility), one legitimate reason investors equate the two is that high volatility usually means investors starkly disagree on the company’s future. If the business was highly predictable and barely grew, it would be much easier to value the company, and therefore, the stock price wouldn’t be as volatile. But a lack of agreement signals opportunity. So volatile stocks can actually be a ripe hunting ground because there is a greater probability of mispricing.

We’re talking a lot about the nature of risk because that’s at the core of investing. Put another way, upside is just good risk and downside is bad risk. Essentially, there is a wide spectrum of things that could happen, but gain is when good outcomes materialize and loss is when the bad ones do. Our goal is to tip the scales as much as is in our power to increase the probabilities of good and decrease the probabilities of bad. And once again, the outcomes will take care of themselves.

All in all, we tend to view these three aspects of investing – diversification, sectors, and volatility – a bit differently and we expect these views to contribute positively to our long-term returns.

Real Example

But enough theory, let’s put it all together and get to the good stuff – business analysis! One company that fits our criteria is Snowflake.

The company was founded in 2012 by two former Oracle database engineers – Benoit Dageville and Thierry Cruanes. The pair became friends shortly after Benoit interviewed Thierry. In fact, a colleague looped Benoit in because Thierry’s french accent was too thick to understand. The two hit it off since they had both done their PhDs at the same university in France. After years of working at Oracle (16 for Benoit and nearly 13 for Thierry), they became increasingly frustrated that Oracle was ignoring the cloud. So the pair jumped ship when Mike Spieser of Sutter Hill Ventures reached out to them about a new database idea.

Sutter Hill gave them $1 million to get started and the founders worked in stealth mode, with Spieser as interim CEO, for the first two years. In 2013, they hired Marcin Żukowski as a third co-founder since he created a way to make databases more efficient called vectorized query execution. All three technical co-founders had their PhDs and were the world’s leading database authorities. What’s more is that all three continue to work at Snowflake, rigorously improving the product (Benoit as President of Products, Thierry as CTO and Marcin as a VP of Engineering).

Once the company had its first product in 2014, Spieser stepped down and recruited a Microsoft executive named Bob Muglia, who ran the business until passing it off to current CEO, Frank Slootman. Slootman is arguably one of the most successful executives in enterprise software, having taken two companies public, Data Domain and ServiceNow (he grew Data Domain from barely any revenue to $600 million and helped ServiceNow go from $75 million to $1.5 billion in sales).

When Slootman joined, he brought in his long-time business partner and the CFO of ServiceNow, Mike Scarpelli. And to round off the core C-suite, Chief Revenue Officer, Chris Degnan, was employee #16 and the very first sales rep. So despite the fact that Slootman isn’t a founder, all three founders are still actively working on the product and Slootman definitely has a founder mentality.

Now let’s run the company through our three big criteria: growth, quality and valuation.

Growth

Snowflake, the product, is a consumption-based software that helps enterprises analyze their data. Customers typically buy credits for at least a year and then draw them down as they run various jobs. The big differentiator is that Snowflake was the first data warehouse born in the cloud (the name “Snowflake” even alludes to that fact). This allowed the founders to separate storage and compute, lowering costs dramatically. Traditionally, data warehouses like Teradata would charge customers for storage as well whereas Snowflake just stores data in the cloud and then only charges when computing resources are used. This wasn’t even possible before Snowflake.

Because of this innovation and solving a real customer pain point, the company has done over $1.6 billion in revenue over the past 12 months, growing nearly 90% year-over-year. By the end of this year, it will likely do well over $2 billion in sales which would represent a 4-year 114% CAGR. Over this period, the company’s average expansion rate was 175%, meaning that customers tended to spend 75% more on the product than in the previous year. Imagine for a moment, the power of a business where revenue grows 75% without adding a single new customer. That’s why the company has been singularly focused on scaling the business. Despite this rapid growth, the business still managed to throw off $300 million in free cash flow, though if you subtract stock-based comp, it is still negative. That doesn’t worry me though because the TTM incremental FCF margins after SBC (a mouthful to be sure!) are around 30%. I have no qualms about the underlying unit economics, especially when you recall the best-in-class expansion rate. It would actually be an irrational decision to not grow as fast when customers expand their usage that rapidly. It’s like refusing to pull a lever that spits out more money tomorrow.

Further, there is certainly no shortage of reinvestment opportunities. While management estimates the entire market opportunity at ~ $250 billion, up from $80 billion in the S-1, whatever the true numbers are, it’s clear the opportunity is huge. Data will become increasingly important for making business decisions and Snowflake is one of the primary engines powering this forward. And Snowflake isn’t just satisfied with analytics. The most recent product announcements from Snowflake Summit included Unistore which offers customers transactional capabilities.

In the world of databases, there are two main types – OLTP (online transactional processing) and OLAP (online analytical processing). Until recently, the company was solely used for OLAP workloads, like being the data source for powering a Tableau visualization. Now, the company is slowly moving into OLTP, where Oracle dominates. An OLTP database needs super low latency because it powers transactions – like a consumer buying on Amazon. Snowflake doesn’t need to be the fastest because the majority of transactions don’t need to happen in milliseconds but enabling customers to do analytics directly alongside their transactional data will provide quite a boost to efficiency. Moreover, to frame the market size, Oracle does more than $42 billion with 30% free cash flow margins. Snowflake doesn’t pretend like it’s directly competing with Oracle right now – because it’s not. But we are seeing the first green shoots of Snowflake’s grand vision.

As part of that vision, Snowflake’s next goal is to disrupt application development. This is still early but the company’s Native Application Framework will enable customers to develop applications right from Snowflake. Using the recent acquisition of Streamlit for Python development and Snowpark’s APIs, developers don’t need to keep a separate copy of customer data. Rather, they can just access data straight from the source through data sharing. This reduces costs and speeds up development. This is certainly something to keep an eye on and I suspect more and more applications to be built directly on top of Snowflake.

The company estimates it will bring in $10 billion in product revenue by fiscal year 2029 and will still be growing at least 30% at that point. I suspect they can actually reach the targets a little earlier but management’s estimates imply about a 37% revenue CAGR. If the company is still growing 30%, it’s possible that it would reach $18 billion in overall revenue in 8 years (assuming services still make up about 6% of revenue). Now, so much can change in 8 years and we’ll leave the assumptions for the valuation section, but it’s clear the growth opportunity is quite substantial.

Quality

The background of the company was important because the core group is absolutely top-notch. The three technical founders are still contributing mightily and Frank Slootman and team are maniacally focused on executing. It’s the perfect pairing of innovation and efficiency. Since the beginning, the founders wanted to stay out of the limelight because running a business wasn’t their strength and all they wanted to do was code. As evidence, Benoit has more than 100 patents to his name and Thierry has upwards of 50.

This team keeps pushing the boundaries. For example, the company launched a data-sharing marketplace in 2019 which has really strengthened the network effect. As customer data already lives in Snowflake, why not easily monetize it by sharing it with other Snowflake customers? Or beyond monetization, imagine how useful it would be to have a constantly updating dashboard of sales data from Walmart if you run marketing at Proctor and Gamble. Rather than sending gigantic CSV files and doing ETL (extract, transform, and load is a way of uploading data into a database that is often fairly cumbersome), you can access the data you need immediately. And in our example, Walmart can granularly control who has access so there are no data governance problems. As more customers use data sharing, the usefulness of the data marketplace increases which attracts more customers and the cycle reinforces – a classic network effect. And this also makes the entire ecosystem stickier. Data sharing is so important, in fact, that part of management’s comp plan is tied to stable edges. The company defines a stable edge as a customer that engages with the data sharing feature at least 20 times over a rolling 6 week period. And to give numbers around this, stable edges are growing more than 100% and about 20% of Snowflake’s customers maintain at least one. As more customers use Snowflake’s data sharing, the moat deepens, churn is reduced and expansion rates go up.

But if this doesn’t translate into the numbers, it’s not very useful – so here are the last three full, fiscal years of different bottom-line metrics.

GAAP operating income

2020: -135%

2021: -92%

2022: -59%

Non-GAAP operating income

2020: -106%

2021: -39%

2022: -3%

Free cash flow

2020: -73%

2021: -14%

2022: 8%

While the company is still aggressively reinvesting into the business, we are seeing clear signs of operating leverage. Over the same period, gross margins have also improved from 52% of revenue to 62% as larger scale improves the company’s negotiating power with the cloud providers, namely AWS.

You may notice the difference in GAAP and non-GAAP operating income and that is mostly a function of stock-based compensation. As part of recruiting Slootman and Scarpelli, along with options vesting for early employees, the company has had to work through quite a bit of dilution. The good news is that, according to management, dilution is running under 1% from here on out.

The company has also set targets for free cash flow, along with its $10 billion in product revenue estimate. Initially, the target was 15% but after a year, the goal posts were raised to 25%. Since Snowflake is already at 19%, 15% wasn’t very believable anymore. I imagine we could see some more improvement, especially as their negotiating power becomes stronger as they drive more volume to the cloud titans.

So there you have it, we have one of the most established teams in the history of enterprise software saying that they will grow at nearly a 40% CAGR for the next 7 years with 25% free cash flow margins, with an ever-growing network effect. That seems like quality to me.

Valuation

We’ve already done most of the work by looking at the growth opportunity and the quality of the company. Now we just have to put it all together.

If we use the $18 billion estimate and 25% free cash flow margins (FCF), that’s $4.5 billion in free cash flow. ServiceNow or Salesforce would probably be a good comparison at that scale. ServiceNow does $2 billion in TTM FCF and trades for 35x and Salesforce does $5.7 billion in FCF at 25x. If we use a simple midpoint, let’s assume Snowflake trades for ~30x FCF. If we tack on 1% dilution, that gets us a triple over 8 years, good for a 14% CAGR. Now, that’s not necessarily something to write home about but those are the assumptions that management has given. The fact that FCF margins were raised from 15% to 25% after one year indicates that there is room for moving up the estimates.

In a slightly more bullish scenario, I think the company could reach $11 billion in revenue in 5 years with 30% FCF margins and a 40x FCF multiple. That scenario, even after dilution, yields a 21% CAGR. I don’t think it’s particularly prudent to underwrite anything more aggressive than that, but I certainly don’t think it’s impossible, given Snowflake has a much larger TAM than ServiceNow and Slootman, himself, saw more potential. Frankly, I don’t see why this company can’t be valued in the hundreds of billions in the long run. But valuation is certainly important. A lower valuation speeds up our payback period and a higher one, lengthens it. There’s no way around that. At the same time, being too dogmatic with assumptions is a sure way to miss out on big winners. The very best companies tend to outperform high expectations. But high expectations require high levels of performance. In other words, if Snowflake doesn’t bust some base rates, our CAGR likely won’t be above 20%. On the other hand, based on the growth and quality assessments, Snowflake is not just a normal company.

When we truly think like business owners, prices going down only speeds up our payback period. For example, if Snowflake’s price dropped 20% from our buy price, the new expected CAGR from management’s targets would be 19%. So when you see prices go down, just remember that the forward-return expectations are now higher. You’d think the very same thing if you were interested in buying a local business. Let’s say you wanted to buy the laundromat down the street and finally put in debit card machines so people didn’t have to lug around quarters. If you saw that the owner kept lowering the price, you’d be more interested because you’d get paid back faster on your initial investment. Stocks are no different. In fact, they are usually an extreme example because the immediate liquidity can drive booms and busts. Ideally, we’d be able to take advantage of these extremes; however, by definition, extremes don’t happen very often so most of the time, we will just be out hunting for lower payback periods without compromising on our growth and quality standards. In times where we simply can’t make the payback scenarios work, we’re happy to continue to study companies but we may take a more conservative stance. To be clear, we don’t believe the current environment warrants conservatism. There are plenty of companies that fit our criteria with reasonable payback periods. We are actively deploying capital and we are quite excited by some of the prospective forward returns. At the same time, we think it is prudent to focus on companies with rock-solid balance sheets, huge customer value propositions, low employee attrition, and high profitability. But I might point out – it’s always a good time to focus on those characteristics.

Closing

I’m honored to have you as a partner. Thank you for your trust and support. It enables me to think long-term and will be our own competitive advantage.

The economy, like life, will have its ups and downs. All we can do is focus on what we can control and work hard to continually raise our standards. Our strategy is simple – hitch a ride to the world’s best entrepreneurs that are running the fastest-growing, highest-quality companies at the most attractive valuations we can find. Here’s to many more years of focusing on the inputs and letting the outputs take care of themselves.

Sincerely,

Ryan Reeves

Disclosures

Infuse Asset Management LP (“Infuse”) is an investment management company to a fund that is in the business of buying and selling securities and other financial instruments. This information is provided for informational purposes only and does not constitute investment advice or an offer or solicitation to buy or sell an interest in a private fund or any other security. An offer or solicitation of an investment in a private fund will only be made to accredited investors pursuant to a private placement memorandum and associated documents.

Infuse may change its views about or its investment positions in any of the securities mentioned in this document at any time, for any reason or no reason. Infuse may buy, sell, or otherwise change the form or substance of any of its investments. Infuse disclaims any obligation to notify the market of any such changes.

The S&P 500 is a U.S. equity index. It is included for informational purposes only and may not be representative of the type of investments made by the fund. References made to this index are for comparative purposes only. Reference to an index does not imply that the funds will achieve returns, volatility, or other results similar to the index. The fund’s portfolios are less diversified than this index. Returns for the index are total returns which includes dividends and do not reflect the deduction of any fees or expenses which would reduce returns.

An investment in the fund is speculative and involves a high degree of risk. The portfolio is under the sole trading authority of the general partner. An investor should not make an investment unless the investor is prepared to lose all or a substantial portion of its investment. The fees and expenses charged in connection with this investment may be higher than the fees and expenses of other investment alternatives and may offset profits.

The information in this material is only current as of the date indicated and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Any statements of opinion constitute only current opinions of Infuse which are subject to change and which Infuse does not undertake to update. Due to, among other things, the volatile nature of the markets, and an investment in the fund/partnership may only be suitable for certain investors. Parties should independently investigate any investment strategy or manager, and should consult with qualified investment, legal and tax professionals before making any investment.

The fund is not registered under the investment company act of 1940, as amended, in reliance on an exemption thereunder. Interests in the fund have not been registered under the securities act of 1933, as amended, or the securities laws of any state and are being offered and sold in reliance on exemptions from the registration requirements of said act and laws.

Performance Appendix

Note that Infuse Partners LP officially launched on August 8th, 2022 so Q3 was a partial quarter. The S&P 500 returns are calculated from August 8th to September 30th as well.

CORE VALUES

The name “Infuse” is an acronym for the core values of the fund:

These values aren’t just nice ideas – they informed every detail of how we structured the fund.

GOAL & PHILOSOPHY

The goal of the fund is to deliver world-class returns over the next several decades. And we intend to accomplish that goal by concentrating into the fastest-growing, highest-quality companies at reasonable valuations.

At the end of the day, fast earnings growth and multiple expansion are the key ingredients. Everything we do is in service of finding companies that are sustainably growing their earnings at faster rates with lower valuations than the current portfolio companies. We aren’t just growth, quality, or value investors. We’re all three.

An ideal investment for the fund would likely have these characteristics:

• A dominant leader in an industry with large tailwinds

• Founder led

• Loved by employees and customers

• Growing revenue over 50% and accelerating

• Cash generative with evidence of strong operating leverage

• Valuation allows us to get paid back in fewer than 10 years from free cash flow (we also have an internal hurdle rate that we look at over 5 years).

You can read much more about the overall process and philosophy here.

ALIGNMENT

Alignment is also very important for me.

Most of my family’s net worth will be invested in this fund and we thought deeply about the incentive structure. For early investors, it is 1% of AUM and 10% performance incentive over a 7% compounding hurdle. In fact, over a 12% annual return, this structure is more friendly than Buffett’s original partnership of 0%/25% over a 6% hurdle.

We have kept costs as low as possible so as to not penalize early investors. That is also why we are offering an early bird discount that is permanent for those LP dollars. We have also capped the expense ratio and will be amortizing it over a 3 year period. All in all, we are doing everything we can to be aligned with LPs while also charging enough to survive.

To force alignment, some funds use a lock-up period. We think that can work but we would rather have investors self-select into our strategy. In our view, it’s the investor's money – they should be able to do what they want with it! If they redeem, it’s most likely because:

1. the performance wasn’t good enough over a reasonable period

2. we didn’t do a good enough job of communicating our strategy and the risks involved

3. we didn’t screen the investor well enough to see if they were a good fit

As you can see, each one of these is our fault. If returns are world-class and we have the right, long-term LPs, then redemptions likely won’t be a problem. That’s why we don’t have a lock-up. And speaking of the “right” LPs – this fund probably isn’t right for you if…

WHY NOW?

So why is now a good time to start this fund?

In short, we are more excited about forward returns than we have been in a long time. But I also want to give the journey to how I got here.

Four years ago, I wanted to start a fund after finishing school but I felt that might not be fair to investors. First of all, who would allow a 21-year-old to manage their money? Second, I wanted to go through a gut-wrenching drawdown to test myself.

Over four years later, I feel much more confident. Investing City was my way to show, rather than tell, people that I have what it takes. We scaled that to a 6-figure business serving hundreds of clients. And despite this latest drawdown, I've kept my composure.

BUSINESS PLAN

That also brings us to Investing City. A few months ago, I sent a detailed email to subscribers and nothing has changed since then.

I want to provide as long a runway as possible for the fund so Investing City will continue to operate to pay my family’s living expenses. Nothing changes for Investing City subscribers except that I will provide clear disclosures about what is owned in the fund.

In terms of my time, I have automated a lot of the back-office tasks for Investing City and the synergies are huge as the core portfolios will be very similar. I have also cut back in areas like the podcast and making videos.

We have grand plans for Infuse but right now, we are laser-focused on surviving. After all, you can’t thrive if you don’t survive. And this is how we intend on surviving:

SUMMARY

In summary, the goal of Infuse Partners is to deliver world-class returns over the next several decades. We intend on doing that by investing in the fastest-growing, highest-quality companies at reasonable valuations. Finding and studying the next generation of winners gets us up in the morning and we plan on doing this for a lifetime. We are looking for LPs that have a similar, long-term mindset.

If you want more details, you can find the full slide deck here.

And lastly, if you have any questions or would like to be an LP (must be accredited), reach out at ryan@infuse-am.com.

We believe there are 3 legs to good investing — growth, quality and valuation. Most investors seek to focus on just one. We try to get all three. Valuation can be the trickiest because we’re dealing with exponential growth so that is the one we can compromise on the most out of the three. That’s because time is the friend of an amazing business and we seek to hold for as long as possible. That’s not to say we buy and hold forever. We constantly verify the strength of the holdings against one another and against the universe of companies that are growing their earnings very quickly. A prototypical company would be a leading company with a founder-led CEO in an industry with tailwinds that is growing revenue 50%+ with positive free cash flow (50% isn’t a precise number as it depends on the opportunity set).

On valuation, we prefer to get paid back from the company's estimated free cash flow over the next 10 years. We think that buying a stock should be assessed just as if we were to buy an entire business. To zoom in a little bit we also use a 5-year model with reasonable assumptions to see what is priced into the stock. If forward returns are too low, we may trim some if we hold it or not buy the stock if we’re looking at it. Our hurdle rate is 25% (but of course, it’s not a perfect science). We are not necessarily trying to find companies with super established moats like Moody’s or Visa but companies that are in the process of building their moats. This involves more execution risk but the rewards can also be much higher. That’s why we constantly verify because sometimes the competitive dynamics can shift. We typically keep a very concentrated portfolio of between 6-12 stocks for this reason. We seek to know each company better than even the employees in that company. It would be incredibly difficult to know even 15 companies that well.

The process (the input) that leads to the output of the portfolio first goes through the filters of underlying earnings growth. If the company’s growth is decelerating in a major way and margins are deteriorating, it’s an easy pass. After all, with thousands of choices, we need a way to filter so we can focus on the things in our circle of competence. However, there is always nuance. If a company’s revenue is accelerating, we give leeway to the margins because it is likely that the company is reinvesting huge sums back into the business. Despite this headwind, the uptick in revenue growth can still mean supernormal earnings growth. We also don’t mind if earnings are negative, although we certainly prefer profitability. When companies want to take advantage of a strong tailwind and the customer acquisition costs are far lower than the lifetime value of those customers, it actually makes sense to step on the gas. Sure, some companies view this as too risky but it actually makes economic sense. If you had access to a machine that spits out money, it might not be a bad idea to put nearly everything you had into that machine. You need to be pretty certain about the longevity of that machine, but your opportunity cost would simply be too high to not utilize that. One reality of business is that it costs a whole lot less to retain a customer than it does to acquire a new one. What we’re trying to get at is that there is nuance to the process. Negative doesn’t necessarily mean bad, as long as the incremental margins are strong.

Once we filter companies using these simple criteria, here’s where the fun kicks in. Our filter is pretty quantitative but then, using our qualitative process, we try the best we can to disqualify our potential candidates. It’s sort of like SEAL training. We’re trying to weed out the weak. The first test allows us to fish in a pond of likely winners but then, the successive tests only leave the strongest standing.

We mentioned it already, but the first test gets at the growth piece of the equation, and the next set of tests deals with quality. Quality is a tricky thing to define but it mainly has to do with durability, in an investing context. Sure, growth can be good now, but if it’s not sustainable, it’s not worth much. So what are the factors that contribute to sustainability?

There’s a whole lot but one thing we look for is win-win-win relationships. We love companies that are doing well by their employees, customers and shareholders. If one party is losing, then it’s a pretty easy pass. And quite honestly, shareholders are the least important in our opinion. Customers drive profits and employees create the products and services that customers use. So if these two parties aren’t incredibly happy, then there is a good chance that shareholders, in the long run, won’t be either.

To understand these dynamics, we study customer habits and how irreplaceable the product/service is. And we also make sure to get a sense of the company culture and what differentiates it. After all, companies are just collections of people and processes. Without the ability to attract great people, great products won’t exist.

Studying win-win-win relationships gives us a sense of the value created by the business. But studying the market gives us more detail about the value capture. And these two aspects, value creation and value capture, lead to long-term cash flow. If a company can create a ton of value, but is unable to capture any of it, it won’t gush cash in the long-run. Obviously, value creation and capture go hand-in-hand because it’s likely that you will capture more value if you create more, but it doesn’t always work that way. If your business operates in an incredibly competitive space and there are worthy alternatives, customers don’t need to rely on you. To study this, we use two simple mental models:

1. Opportunity = magnitude of moat * size of the market

2. Revenue = price * quantity

These models are saying very similar things. A business won’t be able to grow cash flow at extremely high rates without a big market. But in order to satisfy and retain customers, it needs some sort of advantage or else the magic of capitalism will do its thing. Another name for this is pricing power. If a business raised its prices and tons of customers churned, then the moat must not be super large. That doesn’t mean we like it when companies raise their prices. In fact, I’d rather the value that customers get from the product severely outpace any price increases. It goes back to the symbiotic nature of value creation and value capture. However, the degree of competition usually affects the latter. Ideally, we are looking for singular companies. Companies that don’t have “real” competition. The reality of business is that everyone has competition. But some companies have such a far lead, that it is very unlikely for competitors to catch up or make a dent in the business. Or maybe the competitors have just botched it. Or maybe the company got a lucky break in the early days and never looked back. Whatever it is, there is some reason why the company can capture more value than competitors. When this is the case, these companies can create even more value and the cycle repeats. It’s very difficult to catch a company in this virtuous cycle. So that’s why a rather large part of our process is studying competitors. If there are lots of worthy competitors, it’s likely that the company won’t move through our funnel.

But once again, companies are just collections of people and processes. Value isn’t created and captured on its own. So the management team and the ability to attract top talent is important to understand. Founders with skin-in-the-game is our preference but—if the moat is strong—not a necessary criteria. We do strongly prefer management teams where the business is their baby. An ownership mindset is a powerful force. Management is arguably the most important thing because they are the ones that set the tone for the value creation/capture which leads to long-term cash flow growth. However, if the business isn’t executing, management’s pedigree isn’t a thesis in itself.

To get practical, we read and listen to every interview by management, as what they say is important for the business. This gives us a sense of their character without being biased by meeting them in person. In fact, that is not a requirement of ours. Some managers will only buy a stock once they meet with management. Our view is that it can actually bias our process since CEOs are typically incredibly charismatic. There is usually quite enough public material to get a sense of who they are. In fact, our preference is getting reference checks from current and former employees. I know most businesses don’t even do reference checks for hiring but it is our belief that they are most helpful if done in a thorough way. People can always spin a good story about themselves but if everyone says they are lazy/incompetent, then they’re probably lazy/incompetent.

Lastly, we look at valuation. This is because we find it quite difficult to estimate the value of the company without a sense for its earnings growth and the durability of that growth. So that’s why the majority of our time is spent on the first two legs of the growth, quality, valuation trifecta. Some investors do a great job of buying a beaten down company, but that is generally not the pond we fish in. We are ideally looking to let the earnings growth do the work rather than the multiple.

Our actual valuation process doesn’t take too long as we’ve already done hard work to estimate the size and strength of the business. We estimate the cumulative free cash flow for the business and see if it would pay us back over the next 10 years. If it's not even close, we'll put it on a watchlist and be patient. In tandem with this, we also look out five years and get an estimate of earnings with a reasonable valuation multiple and get the implied CAGR. Our hurdle rate is 25% but we do actually lower it a little when we are holding a stock for tax efficiency reasons. Further, when we hold a stock, it’s one that we know well and we think it’s fair to let it get a little overvalued. Some of our biggest mistakes have been trimming based on valuation alone. Winners tend to keep winning.

That is our broad process – keeping incredibly high standards by finding companies with high growth, high quality and low valuations. It turns out that very few companies can satisfy each of these criteria. That is another reason why our portfolio tends to be concentrated. Even getting the first two legs of the trifecta narrows down the universe immensely. And finding reasonable valuations can be quite tricky. This can create some problems because we don’t like holding cash. Probabilistically, it is usually an error. However, when valuations are stretched, that is sometimes the only thing to do. We very rarely engage in short selling or buying options. In fact, our philosophy is basically the reverse – companies whose growth is rapidly decelerating and they are losing more money. Moreover, untrustworthy management teams who don’t prefer win-win relationships. However, the simple upside-downside math is such that we spend more than 95% of our time and attention on the long side.

We are business analysts through and through. We start with the filter of underlying earnings growth and then disqualify companies through the quality and valuation tests. The remaining few companies then enter the portfolio. Position sizing is a function of a few things – namely, upside and conviction. Upside generally means the valuation is lower and conviction refers to the quality. In the three-legged stool, there are ranges. Just because all the companies might be founder-led, some could be 10x better than the others. The same even goes for things like revenue growth – if customer habits are recurring, then the durability is likely higher and so the company might get a higher quality score. Position sizing is not a perfect science but you can think of it like a scoring system. We go through the growth, quality, and valuation frameworks and then the companies who score the highest, get the biggest positions. Every day the companies in the portfolio need to earn their spot and they are all vying for the top dog position. But there is extra responsibility as a top dog– more scrutiny! We try to line up the amount of time we spend based on the size of the position. But this has a downside as well. The more information we learn about a position, the harder it is to make blank-sheet decisions. What we mean by this is that every day is a blank slate. Ignoring taxes, would you buy your current portfolio, in all the same allocations, if you woke up with 100% cash in our account? If your ideal portfolio looks much different than your current portfolio, the good ole’ endowment effect is probably at work.

We also want to point out that the process is always adapting. We are always learning new things and putting more emphasis on certain dynamics. Business evolves and therefore, so should our process. At the end of the day, cash flow is king but how companies create and capture value evolves because of new innovations. People will want better lives and cheaper products, but the delivery mechanism will change over time. Our goal is to study the very best companies over the ensuing decades, building a library and knowledge base that is incredibly difficult to replicate. And we intend to do that one day/annual report at a time.

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The great thing about investing in the public markets is that the transaction costs are virtually zero. In financial terms, the only cost is any applicable capital gains taxes. And in non-financial terms, it’s a little bit of time to make the trades and update your spreadsheet. Since transaction costs are so low, the reversibility of a decision is quite high. I think it was Jeff Bezos who popularized this framework but the idea is that when you can easily reverse a decision, you shouldn’t actually take too much time making it. However, if you can’t reverse a decision, it makes sense to be more sure of the decision. Pretty obvious, right? He calls reversible decisions, two-way doors, and non-reversible ones, one-way doors.

Buying a stock is a two-way door. It’s quite easy to reverse the decision and make a new one. It’s not like a private business transaction where you can’t easily find a buyer, should you decide you want to sell. So by the framework, we shouldn’t actually take that much time to make our decisions.

That’s not to say that we shouldn’t have a checklist and do the table-stakes research. If you’re not doing that, you might as well buy an index and call it a day. Clearly, I believe in the power of research. But my point is that there are diminishing returns to research. There was an amazing study done that found beyond a certain amount of information, people’s decision-making abilities didn’t improve but their confidence did. That’s actually quite dangerous. That means you’re actively becoming more biased but tricking yourself into thinking it’s constructive.

This is a tricky topic because good investors can balance conviction and humility extremely well. One second they may be very excited about a stock but when they get a new piece of evidence that contradicts their hypothesis, they might sell immediately. That ability to update your view of something is absolutely crucial. And if you do an unnecessary amount of research, you may actually set yourself up to not being able to change your mind.

It’s all about confirmation bias – which along with anchoring, is one of the most dangerous investing biases. That’s why I’ve tried to shift from thesis-based investing to hypothesis-based investing. This may be a matter of semantics but a thesis is something you believe and a hypothesis is something you’re testing. A thesis sets you up to gather evidence. Just like a high-school English essay, you have your thesis and then your job is to find evidence to support that thesis. That process is the exact opposite in science. A hypothesis and a thesis are the same thing – something you think is true. However, the processes are the exact opposite. In science, you try falsifying your hypothesis. If you can’t falsify it, it becomes a theory or something that is temporarily true. I say temporarily because a scientific mindset leaves room for the fact that you could be wrong. So you’re trying to prove a thesis right and trying to prove a hypothesis wrong. The latter allows you to circumvent confirmation bias because you’re actively looking for disconfirming evidence.

So when you find something that falsifies your hypothesis, that’s great because now you’re one step closer to the truth. But it’s quite easy to dismiss a disconfirming piece of evidence in the face of a well-developed thesis. So maybe that’s the key? It’s not that we need less research, it’s that we need a different mindset as it relates to research. The point isn’t to gather evidence to support our ideas, it’s to constantly seek the truth.

Let’s use a concrete example. Imagine we are very excited about VR with all the talk about the metaverse lately. So our thesis is that VR will be the next big thing. We start gathering all this evidence that supports our proposition. Soon, we really believe VR will be the next big thing. And when we see data points that contradict our belief, it’s easy to make excuses like “those publications/people don’t know what they’re talking about.”

But a hypothesis needs to be a falsifiable statement like: “VR will be an industry that grows over 30% every year over the next 10 years.” If we start getting data that VR only grew 15% for the first year, we better have an awfully good reason why we think it should accelerate. But already, the hypothesis would be falsified. And now we would need to dig into the reasons why we thought it would be 30% and what happened that changed the actual facts. This is how better decision making happens.

This is why I like to invest in sectors where I know the numbers are actually booming. Investing by hope is much more risky. Going back to science, a scientific law is something that can be mathematically proven. Otherwise it’s not a law, it’s a theory. If we can blend our investment hypotheses into cold-hard numbers, it allows us to change our minds much more easily.

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For example, would you invest in Altria, the world’s biggest producer of cigarettes? Lots of people have made gobs of money investing in the company over the years, but would you?

There’s no doubt that smoking leads to lung cancer. So, is it an ethical problem to invest in the company? What about if you invested 70 years ago when people didn’t understand the health effects of smoking? Does ignorance play a part in the ethical nature of your decision?

These are tough questions and maybe there aren’t truly “right” answers because there is a lot of gray area.

Another example is the portfolio’s largest position, Upstart. When we first bought the stock, we got some valuable pushback from a few members about the morality of investing in the company. Was it right to charge upwards of 20% APRs in some cases? Should we invest if we would never personally use the product?

On the other hand, Upstart has great intentions. Their goal is to lower APRs for people who never would have had access to credit in the first place. So, although I may not use a short-term personal loan, is it my place to say that no one should? Is that a “mightier-than-you” attitude? The fact is that some people simply need a loan right now and they would be on the streets if they couldn’t get one; they may be in a tight situation and need a little money until they can get a job.

Or what about a company like Affirm, where you can convert a specific purchase into a short-term loan? You can pay for a vacation with monthly installments instead of upfront. Is that morally wrong since it’s likely not a financially responsible decision? Vacations are consumable products -- you can’t reuse them (just the memories!), so should people wait until they can afford to pay for them fully or should they go on them now and pay later? (hence the name, buy-now-pay-later!)

The examples are plentiful – what about investing in coal companies? Burning coal is bad for the environment, but should it be outlawed? What about the developing nations that don’t have clean energy? Is coal inherently a bad thing if it helps current people groups but may harm future groups? The questions go on and on.

The bottom line is that morality regarding investing is a bit tricky, maybe even trickier than business in general. Why? Well, this may be semantics but when you invest in a stock, you’re not explicitly giving the company your money. You’re buying those shares from other people across the world. You are putting your belief in the company though. On the other hand, I guess you can make the argument that your investment does help the company. If no one bought shares, the valuation would be super low which would make it more difficult to recruit top talent and do stock-based acquisitions. In that sense, you are “giving” the company your dollars. Moreover, some people like day-traders, don’t really even care about the business so does morality not matter for them? On top of this, as a public-market investor, you have so many options. In comparison, if you were start a business, it’s not very easy to back out of it and start a new one in a totally different field. But as an investor, you can easily pick and choose to invest in all sorts of businesses. So the scope of businesses you have to think about may be much wider which leads to more possibilities of gray moral areas.

And yet another complication is that people have different moral compasses. It’s easy to assume that helping people, not harming the environment, and “doing the right thing” is obvious but many people don’t operate from that worldview. So as much as I personally believe there is right and wrong, I can’t control anyone else and force them to see the world the way I do.

With that said, here is where I stand currently on these issues (you’re obviously free to disagree with me). I learned this framework from a wise man.

There are six stakeholder groups in any company:

1. Customers

2. Suppliers

3. Employees

4. Owners

5. Regulators

6. Communities

And each party wants a few things:

1. Customers want an amazing value prop

2. Suppliers want stability

3. Employees want autonomy and purpose

4. Owners want superior returns, low risk and long duration

5. Regulators want to look good

6. Communities want good neighbors

To get superior returns with low risk for a long time, each of these six parties must be satisfied. Sure, you can get high returns for a long time but if you screw your suppliers and your community, the risk increases. And the thing about the owner equation is that its multiplicative. If your risk increases too much, you won’t have any returns to speak of. If you multiply any number by 0, you get 0.

Therefore, treating people well is good business in the long run. In the short run, you may be making trade-offs like paying employees more and giving better deals to suppliers. However, your long-term risk is much lower. So even besides the fact that I want my portfolio to reflect my values, treating people the way you’d like to be treated is good business.

There is this whole ESG (environmental, social and governance) movement that has been going on over the past decade where companies are explicitly trying to do the right thing so that they can score high on ESG standards. It’s a bit of virtue signaling but I think it’s a step in the right direction. On the other hand, lots of people are skeptical of the ESG movement because it may not be grounded in reality. Like the coal thing – is it really fair of me to say that a developing nation shouldn’t be able to burn coal when they don’t have any clean alternatives yet? Does the fact that I can worry about things higher on Maslow’s Hierarchy of Needs (like self-actualization through having my portfolio reflect my values) outweigh the fact that a developing nation needs energy? That sounds awfully sanctimonious if you ask me!

So what’s the solution? How do we deal with all of this nuance?

Unfortunately, I don’t have a fancy framework. I think each situation requires a thoughtful approach. One thing I think about is “intent”. Coca-Cola’s drinks have an insane amount of sugar and sugar isn’t good for people. But does management have intent to create better alternatives than 40 grams of sugar in an 8 oz can? But obviously intent can be “gamed” and management can say one thing and do another. I like the Coke example because it takes things to the extreme. Sugar isn’t inherently bad but in large quantities, it is harmful. So should we never invest in anything that has the potential to do harm? Malfunctioning airplanes kill people, software glitches can be responsible for putting people in danger, cars are the single biggest murderers after disease. At some point, you must draw the line. You could find something wrong in ANY company you think of. Roku promotes laziness. Upstart’s APRs are too high. Cloudflare hosts dangerous websites. You name it! At some point, the virtue signaling goes too far and you need to decide where that line is for yourself.

I think intent does matter. If the company is trying to make the world a better place and is constantly working towards creating better products, that goes a long way. Sure, maybe Altria buying into Juul for vaping is slightly better. Or a pharma company lowering the drug price from $250k to $200k is great but that’s why I think it’s important to think through each situation individually. In these two examples, maybe the intent just isn’t good enough. So I’m speaking out of both sides of my mouth. Intent matters but some things just can’t quite be redeemed. I think a great question to ask is: if I was the target client, would I use this product? If the answer to that is a resounding “no”, it might require some more introspection. Going back to the Upstart example, if I desperately needed a loan and I was black-balled from all the local banks, I would likely use the product. But if I was addicted to nicotine, I would be trying as hard as possible to stop smoking. So in that case, I can’t personally make an argument for buying Altria.

One other thing I want to point out is that investing in companies that do no harm means you have fewer headwinds to deal with. Whether you like it or not, there is a stigma around a company like Coca-Cola or GM or Altria. And with that stigma comes a lower valuation multiple. Beyond this, there is a customer headwind where people will vote with their dollars and choose healthier options. The best employees will also want to work for the companies on the right side of change. It’s just much easier to invest in companies with fewer headwinds.

To wrap up all these rambling thoughts, I can’t tell you how to think and what to believe. But I think caring about people’s well-being is simply good business that reduces the risk of losing money in the long-term. And companies that make the world a better place have fewer headwinds which also decreases long-term risk. As long-term investors, while sort of implicitly, our dollars do impact the businesses we get behind. Therefore, it’s important to think about the types of businesses we want to be associated with. Morality can be a tricky subject because sometimes the high road really may not be all that high. And the low road might be higher than you think once you dig into the complexities. But if we’re thinking deeply about each situation and we’re updating our views as we get more data, I think that’s all we can ask for. We won’t be perfect, but I want my portfolio to reflect my values. And I have nothing against people who don’t see it the same way.

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To be more specific, just telling a close friend that they need to stop spending money and invest in the stock market, likely won’t result in the new desired behavior. If the advice is too general, there’s nothing for the new knowledge to latch onto. I view advice almost like a snowball rolling down a hill. The more context you have (the bigger the snowball), the easier you can integrate advice into your existing frameworks and the snowball gets bigger and bigger. But at the beginning, before the snowball has rolled at all, it doesn’t have enough momentum to absorb other fragments of snow.

Now, I’ll step off my philosopher soapbox.

One key example of this with investing is anchoring. It’s easy to tell someone: don’t anchor to stock prices. But, without a new tool for dealing with anchoring when it inevitably arises, it’s tough to follow the generic advice. (I haven’t defined anchoring yet but it’s when you attach to a price and let that inform your decision).

Picture this.

You find an interesting stock and you decide you’d like to buy it, you check the price and it’s up 10% on the day. What do you do? Well, you don’t want to anchor but it just feels wrong to buy the stock when it’s already up so much. How do you get over that feeling?

Well, one option is you can just trust the advice. You received advice from a trusted source or you have just observed over the years that anchoring is counterproductive, and therefore, you just need to get over the feeling.

In my experience, without knowing “the why” behind the advice, it’s very difficult to follow it. And I think this gets to the heart of it. Oftentimes advice is spouted but without the underlying reason for why the world works that way. When we find someone who can explain the underlying “whys” we are drawn to them. It’s like a cheat-code for life.

I think the reason why advice is rarely accompanied with the reasons for why something works is because we often don’t know or haven’t dug deep enough to understand. Reality is often deeply complex so it takes a lot of time and energy to figure out why things work the way they do. In fact, it wouldn’t be feasible for us to understand the “whys” of everything. It would take all of our time when, for most things, the fact that things are the way that they are is good enough.

Even a simple thing like why the sky is blue is pretty complex if you really get into it. But only a select number of people really care about that. Most of us are content with the fact that it’s blue and that’s all we need to know.

But when we really understand how something works, it’s so much easier to know how to react. So let’s get into it: why is anchoring not a good idea?

To understand, we must go to the underlying mechanics. Anchoring isn’t a good idea because of the reality of how the stock market works. When you buy a stock, you don’t get any participation in the past gains – only the future ones. Therefore, the key input is not what the stock has done, but what it will do in the future. Now you may argue that the past price movements hint about what the stock will do in the future. And yes, you might be right. The thing is that when you look at the data, on a short-term horizon (less than 1 year), stocks that are going up are more likely to continue going up and vice versa, stocks that are falling are more likely to continue doing so.

So if you were to anchor to a lower stock price and refuse to buy it at higher prices, then you would actually be making the statistically incorrect decision on a short-term basis.

But why is this the case? Well, there may be multiple reasons. Stocks with high relative strength (aka they are going up a lot) may signal that there is institutional demand or that momentum traders are piling into the stock. Or it may mean that the fundamentals are firing on all cylinders and that the previous stock price was much too cheap. Or that there is some macro event that people think will be helpful to the company. But oftentimes, stocks don’t just go up for no reason. In reality, stocks go up because there is more demand for the shares. People who are holding shares aren’t willing to part with them at lower prices and require higher prices to sell. It’s all supply and demand. Low supply means that fewer people are selling. And when fewer people are selling, buyers must offer higher prices to entice the holders of the shares to sell. These mechanics drive the actual price movements, just like in any market.

So why would someone hold onto an asset or offer a higher price than it’s currently worth? Because they think the price will be higher in the future. Different parties have different reasons for why they might think this – traders might just be speculating that things are going in the right direction and long-term investors may be doing their DCF models – but it remains, they think it’s going higher at some point.

I believe that, in the long run, prices go up because of fundamentals. Momentum traders are only piling in because the price is up. That usually doesn’t just happen for no reason (though I might have to make some caveats with things like GameStop and AMC). So when a company crushes its earnings report, the stock might explode higher because people now think the company will be more valuable than they previously thought. In between earnings reports, investors speculate based on credit card info, macro reports, trends for other companies’ earnings reports, etc. to guess what the variance will be – between the expectations and the reality of the results. When you add it all up, these short-term games drive prices in the long term. The funny thing is that there is just so much noise between earnings reports. A skilled investor will have a better idea about what matters and what doesn’t and she will be able to filter out the news that should go right in the trash can and the news that is important (as an aside, the news is rarely important).

But if you try to focus on short-term games, you can lose sight of the longer-term. If a company is trading at a $5 billion market cap, but you think it will do $10 billion in free cash flow in 5 years, you can be pretty sure that today represents a good price. But each earnings report can either point towards confirming or denying the original hypothesis. Some investors call this is a “thesis.” It’s really sort of like a crude form of science. You create a hypothesis and then the results can begin to provide evidence if that hypothesis is on track. Actual scientists may cringe at this comparison, but the general point remains – you have something in mind that you want to test and there are pieces of evidence that can confirm or deny the original hypothesis. Confirmation bias comes into play when we want to believe our hypothesis is true even when the body of evidence points to it not being true.

So you have this hypothesis in mind but sometimes, the evidence isn’t very clear. For instance, a company can just barely miss guidance. Should that require an immediate sell? Or was the variance low enough where the hypothesis is still intact? This is a tricky topic and depends on people’s time horizons and style (we can discuss this in another post).

All of this is really the art of valuation; having a hypothesis for the future of the business and then understanding what is priced into the stock. As the company reports its results, you have to make the decision as to whether the hypothesis is still on track. And then there are thousands of potential experiments you can run (different companies) and you need to decide which experiments will yield the highest returns.

Sometimes an experiment’s hypothesis looks like it’s right on track but then one piece of evidence seems to invalidate it altogether. When there are other experiments that seem like they will offer better returns, it makes sense to switch. But then there are also other considerations like how you don’t know the new experiment as well and there are costs (taxes) to switching. Like reality, it’s always complex but you need to know why you’re doing what you’re doing. Then, it’s easier to react.

And now we’ve come full-circle – back to the beginning. If a stock is up a lot, anchoring isn’t a good idea because it would likely be such a small piece of evidence in the whole scheme of the experiment’s hypothesis (this post isn’t about how to make those hypotheses but it’s the whole research process from analyzing management, the industry dynamics and tailwinds, advantages, company culture, etc. It’s all in service of strengthening or weakening the conviction in your hypothesis).

If you think a stock will 3x over 5 years, a 5% jump in the price lowers your expected return by a very small amount. Let’s do the math.

If your hypothesis is that a $1 billion company could become $3 billion in 5 years, the CAGR would be 24.6%. A 5% jump in price means $1 billion turns into $1.05 billion. So the CAGR goes from 24.6% to 23.4%.

So if a 1% decline in expected return invalidates everything, then a) you might have a lot of other high-return experiments or b) you might not have much conviction to begin with.

In this light, overcoming anchoring can be turned from an emotional thing to a rational one. Rather than just heeding the advice that anchoring is bad, you have a full framework for why anchoring is probably suboptimal for your returns.

But that’s the thing. Here we are almost 1,800 words later. Even a small thing is complex when you dig down a couple of layers. Here’s to thinking just a little better each and every day! The result will almost inevitably be better long-term returns.

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