VGI Partners Global Investments : Investor Letter from VGI Partners Limited

For personal use only

VGI Partners

Global Investments Limited

ABN 91 619 660 721

39 Phillip Street

Sydney NSW 2000 Australia T. [phone] www.vgipartners.com/lics/vg1

28 January 2022

ASX Market Announcements Office

ASX Limited

Exchange Centre

20 Bridge Street

Sydney NSW 2000

BY ELECTRONIC LODGEMENT

Investor Letter from VGI Partners Limited

VGI Partners Global Investments Limited (ASX:VG1) is pleased to make available the enclosed Investor Letter prepared by VGI Partners Limited. The letter provides details on the performance of VG1 for the twelve months ended 31 December 2021 and commentary on current positioning.

Authorised for release by:
Ian Cameron, Company Secretary
Investor contact information:	Media contact information:
Ingrid Groer, CFA	Max Hewett
Head of Investor Relations	GRACosway
VGI Partners Global Investments Limited	Phone:	[phone]
Phone:	1800 571 917 (inside Australia)	Email:	[e-mail]
	[phone] (outside Australia)
Email:	[e-mail]

onlyInvestor Letter

27 January 2022

"It is the search for companies with the characteristics that might enable extreme and usecompounding success that is central to investing. But distraction through seeking minor opportunities in banal companies over short periods is the perennial temptation. It must be resisted. This requires conviction. The share price drawdowns will be regular and severe. 40% is common. The stock charts that look like remorseless bottom left to top right graphs are never as smooth and easy as they subsequently

appear."

personalJAMES ANDERSON

Dear Fellow Investors,

F r the twelve months ended 31 December 2021 (CY21), VGI Partners Global Investments Limited (ASX: VG1) generated a net return of -2.5%. VG1's post-tax Net Tangible Assets (NTA) per share stood as at $2.34 as at 31 December 20211. This is a very disappointing result and has been driven by select core long-term investments performing poorly over the second half of calendar 2021. Nonetheless, we have taken advantage of depressed prices in key portfolio positions to add to our existing holdings and build n w positions in businesses we believe will deliver attractive returns to the portfolio in the years ahead.

We continue to focus on owning great businesses exposed to a long runway of secular growth that are attractively priced, based on our assessment of fair value. At writing, on our estimates, our Top 10 holdings are trading at 70-75 cents on the dollar with some holdings trading below 50 cents, and we believe our valuations are conservative. Our Top 10 Holdings represent approximately 74% of total

Forpo tfolio capital.

Our long portfolio is predominately made up of high-quality compounders that operate within favourable industry structures. Alongside these are a series of businesses that are earlier on in their evolution, but where we see great potential in the years ahead. We believe these businesses have a unique opportunity to grow, enhance their moats and thus evolve into high-quality growth compounders. This was the case with Amazon when we first purchased it in 2014 - it was not viewed as a high-quality compounder with its ongoing heavy investments (and associated prima facie accounting losses), yet looking a few years out we could see a profitable trajectory for its core e-commerce business while many market participants only saw losses. Interestingly, today we see several situations in the digital business landscape where high- quality businesses are very attractively priced based on our estimates of future earnings growth. We touch more on this later in the letter.

1 Post-tax NTA is calculated after tax on realised gains/losses, deferred tax assets and deferred tax liabilities, but before allowing for deferred tax liabilities/deferred tax assets on unrealised gains/losses.

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January 2022 Investor Letter

We observed some striking market dynamics during 2021, which included an incredible dispersion of stock returns. Certain parts of the market, such as COVID winners and "unprofitable" technology2, experienced significant valuation pressure. Market indices ended the year at their highs (before selling

off in January at writing) but looking underneath the surface paints a different picture - for example, key onlyUS indices (namely the S&P 500 and Nasdaq) have largely been held up by mega cap technology and a

handful of other businesses which have witnessed substantial multiple expansion coupled with strong

earnings growth. The top five winners in the Nasdaq-100 (Microsoft, Apple, Alphabet, Nvidia and Tesla)

contributed two-thirds of the overall Nasdaq 2021 return of +27% and excluding these five the Nasdaq

would have instead generated a +9% return in 2021. Furthermore, over a third of the ~3,600 companies

in the Nasdaq Composite are down by well over 50% from their 52-week highs. It is here where we see a number of opportunities rising to the surface.

"Unprofitable" technology had a particularly poor period of performance over the second half of 2021 and this has flowed into 2022. Pockets of exuberance that we witnessed earlier last year have washed out with the prospect of rising inflation and higher interest rates. This has led to a significant de-rating of growth stocks especially those securities that lack earnings or free cash flow. For example, we saw this having an outsized impact on new IPOs. The chart below encapsulates this dynamic, showing the

divergent performances between large tech (the Nasdaq-100) and "unprofitable" technology. This has
usecreated some attractive opportunities but has also caused some of our key holdings, like Pinterest and
Qualtrics, to perform poorly; in addition our longer tail of smaller positions was also caught up in this sell-
off, which we discuss in more detail later in the letter.
personal
Non-Profitable Tech Stock Index in 2021 vs the Nasdaq-100
30%
20%
10%
0%
-10%
-20%
Nasdaq-100 Index		Non-Profitable Tech Index
-30%
Dec-20Jan-21Feb-21Mar-21Apr-21May-21Jun-21	Jul-21	Aug-21Sep-21Oct-21Nov-21Dec-21

ForS urce: Bloomberg, Goldman Sachs.

N te: The Non-Profitable Tech Index is a market value weighted index based on a Goldman Sachs basket of 60 non-profitableUS-listed tech companies.

Related to this dynamic has been the increasing market concentration amongst large tech companies. ANGMAN (Facebook, Apple, Nvidia, Google, Microsoft, Amazon, Netflix) now account for 25% of the S&P500, up from just 15% three years ago. Most large tech companies had stellar years, with Alphabet (Google) +65%, Microsoft +52% and Apple +35% (the only company to disappoint was Amazon, which frustratingly is also the only one we own). Some of these FANGMAN performances have been underpinned by material multiple expansion, which seems unlikely to sustain itself. In fact, during January 2022, we have already seen some sharp declines in FANGMAN constituents. It is possible we are seeing a "Nifty

2 Unprofitable tech can be broken down into businesses that are unprofitable due to mature profitability being many years

away versus businesses that are unprofitable by choice due to reinvestment (such as Amazon for many years).

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January 2022 Investor Letter

Fifty" scenario emerge as per the 1960s (where the Top 50 US stocks entirely drove market returns) with the current case being rather different given the narrow skew to mega tech and assortment of other household name mega caps.

onlyWe observe we are in a market that is willing to pay stark premiums for stocks that have strong historical visibility and perceived predictability of earnings while companies deemed to have lower predictability are being heavily penalised. Beyond mega cap tech, we are seeing other pockets of "blue chip" securities where valuations are head-scratching. For instance, in the consumer goods space, companies such as Nestle and PepsiCo are trading at all-time high multiples. These are solid businesses, but they have limited ability to reinvest capital at high rates of return and are entering a period of having to rely on price increases to offset inflationary cost pressures in order to maintain their margins. Despite this, these securities are trading at free cash flow yields comparable to other digital businesses that have durable growth and the ability to reinvest large amounts of capital into their business. More broadly, after the

user cent investor "rotation" out of growth securities, we believe many ordinary, analog businesses look outright expensive whereas many advantaged tech-enabled businesses and many of tomorrow's future winners look highly attractive.

Amazon's share price performance has suffered because it has less predictability of earnings in the short term and continues to reinvest heavily. We like the fact that Amazon is continuing to invest aggressively and remains focused on deepening and widening its moat, and therefore we remain highly optimistic about the trajectory for the business. On top of this, there are concerns that Amazon is facing headwinds personalin the near term due to the pull-forward in e-commerce during COVID. We are less concerned about this given our focus on the longer-term trajectory of the business and the inevitable secular growth in e- commerce and cloud penetration. Nonetheless, the fact that Amazon's share price was flat during 2021 was a key drag to our portfolio returns (Mastercard, one of our other key holdings at 9%, was also flat). While disappointing, particularly when many other securities performed so strongly, we accept that this is the nature of running a concentrated portfolio - we simply cannot pick the precise timing nor magnitude f individual stock returns over a discrete time period. Nonetheless, we do expect both Amazon and Mastercard to contribute strongly to portfolio returns over the years ahead and we believe the probability of this has increased after recent price action, especially given the continued strong underlying business

performance and secular growth drivers.

Our approach is bottom-up and focused on identifying high-quality businesses with a long growth runway and ability to reinvest capital into their business at attractive rates of return.

ForAs we have discussed in previous letters, our investment approach is bottom-up and focused on identifying high-quality businesses with a long growth runway coupled with the ability to reinvest capital into their business at attractive rates of return. This philosophy leads us to businesses that tend to have pricing power (such as Richemont in super luxury jewellery and watches and SAP in enterprise solutions) or have pricing models based on a take-rate or ad valorem model (such as Mastercard in payments and Amazon in e-commerce/advertising), meaning that the businesses we own are generally shielded from inflationary pressures. We also have a large position in the CME Group (~8% weighting), which we have owned in VGI Partners' global strategy since 2008. We believe CME will be a major beneficiary in an inflationary environment due to its monopoly position on trading US interest rates futures (CME volumes should grow substantially in an environment with higher interest rate volatility) and key commodities.

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January 2022 Investor Letter

Nonetheless, thinking about inflation and the outlook for its trajectory is very important for all investors as it is a key determinant in valuing a future stream of business cash flows. The question today is, are we currently seeing a transitory, supply-induced inflation spike that will normalise beyond COVID before deflationary forces such as technology and automation resume putting downward pressure on inflation, onlyor are we in an environment with more persistent inflation driven by shortages in labour, materials and housing? While we do not presume to have an answer, this question has important ramifications for discount rates and multiples, which in turn impact the valuations of our holdings and prices we are willing to pay for new holdings. Our approach involves stress testing valuations so that we are comfortable

owning a business even if there is a 100bps to 200bps change in discount rates.

As per our previous letters, we have been shifting the portfolio away from capped upside in lower growth, analog world businesses. We are thus gradually moving away from businesses with lower, albeit more predictable, growth where in many cases valuations are relatively high (especially in terms of price for usegrowth), and allocating more of our portfolio towards structural growth (that is in some or perhaps most

cases, under-appreciated or even camouflaged) and where the price for growth is highly attractive.

Albeit not a pure digital world example, the large outperformance of Richemont over other luxury stocks over the last 12 months is a good example - Richemont had hidden value through its loss-making online b siness and under-appreciated growth within jewellery compared to say LVMH, which was viewed as the consensus quality player in the luxury sector. Over time, we believe that the companies that possess less obvious growth (and are therefore underappreciated by the market) but have inherently high-quality

personalbusiness models and industry structures, will outperform today's consensus quality/growth stocks.

We are excited by the current opportunity set in global listed markets especially digital businesses in the sub US$50 billion market capitalisation region - a zone which, as discussed above, has come under considerable valuation pressure over the past 3 to 6 months. This suggests that M&A activity is likely to gain momentum given the war chests that many corporates and private equity funds are holding (at writing, the bid by Microsoft for Activision reiterates this view).

Today, we see many companies we greatly admire that are deemed "loss-making" and being sharply marked down. Many of these companies choose to be loss-making in the short to medium term purely because these companies are not optimising their r venue algorithm (they are biding their time as they build their business flywheel) and they are simultaneously aggressively over-investing in their business via

o erating costs, namely research & development and sales & marketing.

ForThe ongoing sell-off in digital/technology companies, especially "loss-making" companies, is creating substantial opportunities for those who are genuinely long-term investors and are able to withstand short- term price volatility or, as some say, a capacity for investing pain (that is, being able to withstand a stock halving over a 12-month period and not get bluffed out, due to the conviction in your analysis). A capacity for investing pain is required to then experience the satisfaction of seeing, often when there is conviction in the analysis, the same security recover rapidly and move to new highs.

As far back as 2014, when we first bought Amazon, we have been asked: why do you invest in loss-making companies? Amazon was a "loss-making" company for many years. The reality was that it did not make losses due to a flawed business model - rather its management simply chose the long game and thus constantly reinvested in the customer experience and the business itself. This investment came through

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