gorodenkoff
The Partners Fund returned approximately -6.5% net in the third quarter, bringing year-to-date results to approximately -39.0% net.[1] Please refer to your statements as individual returns will vary based by share class.
As a group, our underlying managers have concentrated holdings in smaller companies where deep research can provide an informational advantage. On average, I believe they know significantly more about the companies in their portfolios than most market participants, and they often form what hedge fund investor Michael Steinhardt referred to as a variant perception, a strong viewpoint that is substantially different from the prevailing market assessment. Over time, contrarian and right can generate very attractive returns.
Unfortunately, this year has been a period of widespread multiple compression and high correlations. Macro views on interest rates and oil have generally overwhelmed company-specific insights or variant perceptions. Small and misunderstood has been a difficult corner of the market. In addition, broad investor flight away from risk has led to a historically large divergence between small cap and large cap companies, as highlighted in the chart below. While we don’t know for certain how long these headwinds will persist, fundamentals and being right about companies will matter again over time.
This quarter, we made a new investment in Skycatcher, managed by Sia Kamalie. I have known Sia for several years and worked with him to look closely at a South Korean gaming company that was trading below cash. Sia worked at The University of Texas endowment and ran a frontier market focused fund before launching Skycatcher 6 years ago “with a mission to invest in the next stage of the internet: virtual worlds.”
At first blush, what essentially boils down to a gaming strategy seemed too niche to merit dedicated exposure. However, there are more gamers than Facebook (META) users globally, and consumers spend more money on gaming than they do on movies, music, and video streaming combined. The industry also proved far more resilient than most sectors of the economy in the last recession as consumers turned to gaming, which has the benefit of being more immersive and less expensive than most other entertainment alternatives.
Sia is an example of a manager who does deep work and forms a variant perception. There are over 300 publicly listed gaming companies across markets including Japan, Korea, the Nordics, and the U.S. Skycatcher gains an informational advantage by investing heavily in capturing proprietary data on over 100 of these companies and also gains an inside view of industry trends through the portion of their fund engaged in venture investing.
As you can see in their presentation, Skycatcher believes that the market is underappreciating the quality of certain gaming companies. Video game companies historically have commanded low valuations because they are viewed as being “hit driven” and lacking in sustainable revenue streams, but Sia’s variant perception comes from looking deeper.
Over 50 franchises are actually better described as immersive virtual worlds, complete with marketplaces for buying goods, that exhibit extraordinary longevity as a result of becoming deeply integrated into the lives of their members. Sia believes that, over time, certain gaming companies will receive higher valuation multiples as the resilience of the revenue streams becomes better understood. In the meantime, Skycatcher is buying companies with SaaS revenues at non-SaaS multiples.
Skycatcher’s largest position is a Japanese listed company, Square Enix (OTCPK:SQNXF), whose crown jewel is the extremely popular, long-lived immersive game Final Fantasy. Skycatcher estimates that 40% of Final Fantasy’s 1.5M subscribers (paying $15 per month) spend 20+ hours per week playing the game, which is over 30 years old.
Historically, Square Enix has not broken out the economics for Final Fantasy and still does not present their financial information or operating metrics in a manner that allows its parts to be valued efficiently. Sia has been working with the company to improve the disclosures and also actively publishing Skycatcher’s views on investor forums (e.g., SumZero) to encourage other market participants to consider the variant perception, which he hopes should lead to closing of the valuation gap.
I don’t know if Skycatcher will ultimately be successful with their Square Enix investment, but I do believe that the combination of (A) deep domain expertise and (B) proprietary data being applied in a (C) concentrated manner to a (D) growing sector of the market that is likely (E) systemically undervalued has the potential for very attractive long-term returns. These returns are likely to appear when the world shifts from a macro-dominated landscape to one where fundamentals matter.
As I have said at the end of every letter, our fund of funds is going to be different. It will be smaller, the underlying holdings will be more esoteric, and I hope the managers will continue to collaborate more over time. I believe that it will be “good different,” but only time will tell.
Thank you for joining me on this journey. I will work hard to grow your family capital alongside mine.
Sincerely,
Scott Miller
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Disclaimer: This document, which is being provided on a confidential basis, shall not constitute an offer to sell or the solicitation of any offer to buy which may only be made at the time a qualified offeree receives a confidential private placement memorandum (“PPM”), which contains important information (including investment objective, policies, risk factors, fees, tax implications and relevant qualifications), and only in those jurisdictions where permitted by law. In the case of any inconsistency between the descriptions or terms in this document and the PPM, the PPM shall control. These securities shall not be offered or sold in any jurisdiction in which such offer, solicitation or sale would be unlawful until the requirements of the laws of such jurisdiction have been satisfied. This document is not intended for public use or distribution. While all the information prepared in this document is believed to be accurate, Greenhaven Road Capital Partners Fund GP, LLC makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors, appearing in the document. An investment in the fund/partnership is speculative and involves a high degree of risk. Opportunities for withdrawal/redemption and transferability of interests are restricted, so investors may not have access to capital when it is needed. There is no secondary market for the interests, and none is expected to develop. The portfolio is under the sole investment authority of the general partner/investment manager. A portion of the underlying trades executed may take place on non-U.S. exchanges. Leverage may be employed in the portfolio, which can make investment performance volatile. An investor should not make an investment unless it 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. There is no guarantee that the investment objective will be achieved. Moreover, the past performance of the investment team should not be construed as an indicator of future performance. Any projections, market outlooks or estimates in this document are forward looking statements and are based upon certain assumptions. Other unanticipated events may occur and may significantly affect the returns or performance of the fund/partnership. Any projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur. The enclosed material is confidential and not to be reproduced or redistributed in whole or in part without the prior written consent of Greenhaven Road Capital Partners Fund GP, LLC. 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 Greenhaven Road Capital Partners Fund GP, LLC and are subject to change, and Greenhaven Road Capital Partners Fund GP, LLC does not undertake to update them. 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/partnership is not registered under the investment company act of 1940, as amended, in reliance on an exemption thereunder. Interests in the fund/partnership 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. |
Footnotes[1] Performance: ((i)) is representative of a “Day 1” investor in the Partnership, ((ii)) represents returns earned by Class B investors assuming a 0.75% annual management fee and no incentive allocation, and ((iii)) is stated net of expenses, including commissions, legal, audit, administration, and other. Year-to-date performance for an individual investor may vary from the performance stated herein as a result of, among other things, the timing of their investment and the timing of any additional subscription and withdrawals. |
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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