July 2024 Investment Update

Dear investors and well-wishers,

The fund advanced 15% in June to bring our FY24 return to 81%.

I recorded an interview with Equity Mates where I discussed the last few years, available on Youtube here.

Crowdstrike

Crowdstrike has written itself into security history by sending out an update which Blue-Screen-Of-Death-ed computers all around the world.

A steep fall in the stock immediately made this top of mind for investors in software.

The first analyst estimates suggest this will only cause a ~3% hit to revenues (which will still post strong growth this year). We have so far passed for a few reasons.

Most obviously, this will gum up their sales process. Buyers will demand more technical due diligence, and pricing conversations will be tougher. This is an error that should not have happened. Someone at Crowdstrike did not perform quality assurance and is not testing their products properly.

But the real issue is that Microsoft has its own effective security product suite, and understanding this particular competitive tension was always the hardest part of the investment case.

Other competitors may benefit, like Sentinel One. But judging by its negative -45% GAAP margin, Sentinel One significantly underprices its offering relative to its cost. The firm may be winning customers, but at a heavy price.

And I suspect this will increase sales friction for everyone, ultimately to the benefit of the incumbent. Another win for Microsoft.

Valuation context is also highly relevant. Crowdstrike was one of the most expensive software stocks in the market, so it was primed for collapse if anything went wrong. It still trades at 14x forward sales.

Droneshield

Droneshield had a volatile month. As with Nvidia, our systematic approach came in handy, and somewhat to our surprise we hit our 2.5x profit target years in weeks rather than the expected years, so reduced our position significantly over $2.

The company reported earnings last week. First half revenues of $24 million missed forecasts of $30 million, but were still 110% higher than the same period a year ago.

After appreciating 5x in a very short period of time, the stock is now a cult favourite amongst lovers and haters alike.

This has happened to us multiple times before. It’s certainly not the first time we’ve bought a stock that rapidly appreciated, then become a battleground between retail investors, short-sellers, and weary/wary professionals.

One thing we’ve learned (and now systematized) is to crystallize profits when we’re sitting on large and unexpected gains.

We are still shareholders (Droneshield is 3% of the fund as I write) and firm believers that the market for both drone and anti-drone technology will be vastly larger in the future.

The company’s >100% revenue growth and doubling of its pipeline supports this.

The would-be assassin of Donald Trump apparently flew a drone over the site before his attack, illustrating two key aspects of the thesis:

Firstly, the importance of jamming commercial drones, and secondly, that most targets are undefended.

Clarity

Clarity announced a supply deal for Actinium-225, which will be investigated as the radioactive payload for a new bisPSMA therapy.

There are high hopes in the industry for alpha emitters like Actinium, with a shorter but more destructive path length. Theoretically, this could be more selective and more destructive to targeted cells, but so far it has proven difficult to strike the balance.

Clarity’s double-pronged ligand has resulted responses at lower doses of radiation than competitors in early trials. The hope is a similar approach here will help harness the power of alpha particles with greater control over the risks.

Stepping back, this was a very welcome update, showing Clarity’s intention to strengthen its early stage pipeline and repeat its early success in new indications.

You can watch our extended interview with the Chairperson Alan Taylor here.

Clarity is our largest position, and so will have an outsize impact on our fund’s month-to-month performance.

Semiconductors

There was a recent report that OpenAI is losing $5 billion a year, so we can only imagine how tough it is for the second and third tier large language models.

These must still make large investments, but have little prospect of significant revenues in the near term.

Scale, specifically massive purchases of GPUs and related infrastructure, is proving key to technical success. The clear winners today are OpenAI&Microsoft, Google, and Meta’s Llama, with Chinese competitors like Alibaba competing fiercely, and a notable mention for Mistral in Europe.

Which leaves VC-funded competitors in a tight spot.

At some point, possibly quite soon, these lower tier companies will pull back on capital spending and dump their excess capacity on the market. We have already seen the start of this with Inflection AI folding into Microsoft.

The key driver of GPU demand comes from the hyperscalers, Chinese tech giants, and companies like Tesla. But pricing takes place at the margin, and it’s an open question what the return on that $100b annual hyperscaler capex will actually be, and whether those capex numbers will be higher or lower than expected in 1-2 years out.

The bear case for Nvidia is a moderation in demand from the leaders, the dumping of capacity by failing competitors, and falling second hand values, a situation which has happened multiple times in recent history.

For now, Nvidia estimates are continuing to trend up and waiting times are long, but the stock is still close to the top of it's recent trading range.

Something to watch, especially now semiconductors have swung from overbought to oversold in just the last few weeks.

Summary

Interest rates are highly topical again, though we seem to be in one of those periods where markets don’t pay much attention to economic data.

It’s a curious moment where interest rates are forecast to rise in Australia, but fall in the United States. You would expect that would push down the Australian dollar but something else must be at play.

This has boosted small caps significantly relative to big tech, though that may simply be mean reversion. Not so long ago, based on the entire history of US stock prices, academics noted small caps had a long term return premium over less risky, more liquid large caps. This has not occurred over the last decade, as a handful of tech companies captured margin from almost every other company and consumer, so it will be interesting to see if this marks a change of regime.

So far the fund is up in July, despite pullbacks in many of the stocks that gave us market leading performance over the last twelve months.

We’re working on two new high growth positions in the medical technology space, and I’m personally focused on keeping the portfolio fresh and centered on opportunities that don’t depend on GPU capex.

And of course, focusing on making sure we capture and systematically monetize dramatic rallies in companies like Droneshield and Nvidia when we get lucky.

Best regards

Michael