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Technology: love it or loathe it?January 2019
Continued
Good old-fashioned ‘greed’ and some stellar top-line growth have made technology an interesting and fruitful place to invest over the last decade or so. How things change! If I had asked the above question in August, most people, I suspect, would have been very much in the former camp (and who cares about valuations?).
Then came September, and now they all seem doomed. What a difference a quarter can make, not helped by Apple’s profit warning. I’m not that surprised, but some of the commentary is exacerbating, which is euphemistic. How on earth are the woes at Apple being extrapolated across the broad-brush ‘technology’ sector? I witnessed a sell-off in Amadeus (global travel), Delivery Hero (EM food marketplace), Xing (B2C/B social network) and Zalando (online retail in Europe). What do these names have in common with Apple? Absolutely nothing. We all know growth is slowing globally, but extrapolating poor iPhone sales and Apple-specific issues in China to other, uncorrelated plays is irrational.
I wrote an article back in early 2018 titled ‘seeking quality tech’ where I was, as ever, bullish about the long-term prospects for the business models that I own. The article was in part about evolution and a behavioural shift in how we are consuming, the convenience we demand from our online portals and the power of platforms. Whilst these were flavour of the day, we, and the wider market, made some great returns through 2017 and most of 2018. These names have now fallen out of favour, so I thought it was only fair that I reflect on what I own, how they’ve performed and how I’ve positioned them across the portfolio.
These companies’ business models have all the characteristics I would look for, irrespective of sector or badge we ascribe – wide moats, high levels of recurring revenue (in several of the below cases), high market share, strong balance sheets and high returns on invested capital. There are some outliers that I see as future winners: Takeaway.com, Delivery Hero, Xing and Zalando, or a diversification tool such as Rocket Internet, which funds digital start-ups.
Phil WebsterDirector, European Equities
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These companies’ business models have all the characteristics I would look for, irrespective of sector or badge we ascribe.
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Whilst I had a tough year, which was in part due to weakness in the above names, only two of these appear in the top ten underperformers – Zalando, despite cutting the weight to under 2% before the profit warning, and Delivery Hero, due to a poorly timed entry. In totality they hurt, but as I’ll come on to explain I see this as an opportunity – if I was capitulating on some of these names then I would be asking some serious questions around my strategy. Was I chasing a theme or trend, did I understand what I owned, or more importantly, why am I selling now they are 30% cheaper?
Takeaway.com
I’ll make no apologies for starting with Takeaway.com, because it was one of my top performers in 2018. Food marketplaces like these are mostly winner-takes-all, or winner-takes-most, depending on the region. I tend to have the view it’s the former, which, post the sale of Germany in late December, has almost played out across Europe. The margins, returns and cash flow that are generated in these markets, once won, are significant. The Netherlands, for example, makes a 53% earnings before interest, taxes, depreciation and amortization (EBITDA) margin, and they still only have 27% market share.
However, in totality, Takeaway will only turn a profit at the EBITDA level for the first time in 2019, so this isn’t an investment for one year – it’s for the next 5–10. There has been a massive structural shift in eating habits, driven by time, convenience and the breadth of restaurants, which has grown with delivery.
Whilst this shift is happening, the graph might be helpful to illustrate how we managed the weight within the portfolio. I had the opportunity to build the weight up to over 4% in what was a misunderstood sector through 2017 and early 2018. After a brief pullback in early 2018, the share price soared to nearly €70 and the valuation became extended. As you can see, I reduced the position size before the sharp correction. Maybe you’re asking
why I didn’t sell it all? A fair question, but I believe in the long-term fundamentals; I’m not a trader, and we saw significant upside, especially in Germany. While the correction therefore might have been fair as the market got ahead of itself on the growth over the longer term, this is a business that I believe can double (conservatively).
In December, Takeaway announced an agreement to buy the German assets from Delivery Hero (the other food delivery business I own in the funds) and the share price rose 30% – this is a very accretive deal in terms of short-term cash burn and longer-term margin potential, highlighting the value still on offer.
Takeaway is up about 100% since I initiated the position, including the recent sell-off. I don’t, therefore, look at the business and see a shift in the fundamentals – this is all about the short-term view of the market, whatever that is.
Continued
Tech: the qualities we look for in all businesses
Name What do we do? 2018 EBITDA margins (%) Balance sheet ND/EBITDA ROIC
Amadeus Software for the travel industry 42% 1.3x 36%
Xing B2C/B2B social network for business professionals 33% Net cash 29%
SAP Global ERP Software 33% 0.3x 26%
Takeaway.com Food marketplace (Europe) -5% Net cash (pre-deal) N/A
Netherlands 53%
Zalando Pan-European online clothing retailer 5% Net cash 20%
Rocket Internet Investor in digital start-ups N/A 45% of market cap cash N/A
ASML Market leader in Lithography 32% 0.25x 28%
CTS Eventim DACH event ticketing platform 19% Net cash 25%
Delivery Hero Food marketplace (MENA, Europe, Asia, Americas) -5 to -8% Net cash N/A
Source: BMO Global Asset Management as at 31 December 2018.
Sep 16 Dec 16 Mar 17 Jun 17 Sep 17 Mar 18 Jun 18 Sep 18 Dec 18Dec 17
Initiated at E30
0
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Added at E36
Added at E45.8
Reduced at E51
Reduced at E52
Reduced at E59
Added at E42
Source: BMO Global Asset Management as at 31 December 2018.
Takeaway.com share price
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Delivery Hero
Delivery Hero’s underperformance was a function of poor timing on my part. I like these business models and after several meetings with them since their initial public offering (IPO), I became more comfortable with the strategy and profit path.
Having made the initial purchase at €45, I’m nursing a bit of a bloody nose, but post the sale of Germany (a smart, strategic move), I see this as a great opportunity at an attractive valuation. They have a significant net cash balance sheet and are investing heavily through 2019 to enhance their market dominance, which is already reaping rewards in new customers. They are the market leader in 33 of their 41 markets, where it is exceptionally challenging to displace the incumbent given customer loyalty to the market-leading platform. Whilst timing was not clever, I see great value today and have been building my position of late given the long-term returns I see on offer.
Zalando
The other poor performer this year is Zalando, which has been hit by several one-off factors, including a weaker backdrop, longer summer (deferred sales), heavy discounting by peers and some stock-specific issues around returns and fulfilment costs. ASOS, another online peer, also had issues and from reading the rhetoric, the market has completely lost faith in the longer-term margin potential of these businesses. The analysts are extrapolating a drag from the increased investment in distribution and their partner programme far into the future, with no operational leverage from the benefits these will bring. Maybe they are right, but Zalando isn’t far off its IPO price of €21.50 set back in 2014, which I see as anomalous, given what they have delivered:
Approximately 80% of Delivery Hero’s gross market value comes from countries where they are the market leader.
Delivery Hero SE as at 21 December 2018
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Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any products that may be mentioned.
Key risks
The value of investments and any income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested.
Past performance should not be seen as an indication of future performance.
Classification: only to be shown if not publicOpportunity remains huge
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2009 2011 2013 2015 2017(e) 2019
GMV in bn €
“… while we remain to work towards our long-term ambition: 5% market share of fashion in Europe.”
Source: Zalando as at H1 2018 interim results. This does not constitute a recommendation to buy or sell any particular security. GMV = Gross merchant value. 2018-2019 are estimates. For illustrative purposes only.
5%MARKET SHARE
Source: BMO Global Asset Management as at 31 December 2018.
Outlook
I don’t do forecasts, so I won’t suggest what the short term will bring. But I do know you don’t make money by following the herd. I’m not advocating jumping headlong into these names and I’m certainly not calling a floor. I’m saying that I see good long-term value in businesses with a competitive advantage. I’ve therefore been incrementally adding to these names where I see a disconnect with the fundamentals – only time will tell if the market sees what we do.
