As investors, the future actually becomes clearer when we shift our focus to the long term.
Many Web sites, including The New York Times, have created interactive models of the coronavirus pandemic in which you can move sliders of infection rates and fatality rates, and get a grim picture of the impact on the U.S. population. This week, in particular, many of us have been fearing the worst as the surge in COVID-19 cases enters our hospitals, taxing the health care system. With normal routines radically disrupted, and with many nations and U.S. states shut down or implementing stay-at-home policies, it is safe to say that our collective perspective is currently looking out a small number of weeks at most. Time, it seems, has contracted.
Despite government stimulus packages, global equity markets are down 24% from the highs of Feb. 12 to today. Our clients—institutional investors, financial advisers and private clients alike—are asking us two questions: “What is going to happen to the markets?” and “What is going to happen to Brown Capital’s portfolios?” To the first question, our answer is simply that we do not know; we invest in companies, we do not predict stock prices. (I wish we could.) As for the prognosis for our portfolios, our reply is, “What is your timeframe?”
On March 3—which seems like a lifetime ago now—I published an article titled “Coronavirus: Isolating Truth from Fear,” in which I listed some of the questions that we at Brown Capital are asking about the pandemic’s effects on the companies in which we invest. In the article, I landed on the advantage we think we possess given our “long-termism,” or 3- to 5-year evaluation horizon. Now, when our collective attention is on the immediate, I would like to unpack what we mean by long-termism—what happens when, as investors, we move the time-frame slider to the right.
The lens of time
An investor trying to meet an upcoming liability in six months views the world very differently than a permanent endowment. Similarly, asset managers bring different evaluation horizons to their portfolios. Many active portfolio managers claim to be long-term investors, but in reality turn their portfolios over 100% year after year. Other, usually steady managers may suddenly take radical action during market disruptions. For them, it may be easy to think long-term during normal times, when the future seems likely to resemble the past, but when the world seems upside down, their time horizon shrinks.
At Brown Capital, we look at the world through a 3- to 5-year initial evaluation horizon. No matter the market environment, the questions we ask are, “What will the companies we invest in look like in 3 to 5 years?”, “What growth profiles do they have?” and “Do they still meet our criteria of Exceptional Growth Companies?”
The counter-intuitive point is this: During times of extreme disruption, the long-term prospects of companies is actually easier to grasp than predicting stock price movements over the next month or six months. This may seem paradoxical; you would think that shorter-term events are easier to see than long-term developments. To make this point, I asked Brown Capital’s U.S. and international investment teams to give some examples of companies where the unanticipated short-term impact of the coronavirus may obscure the long-term prospects of Exceptional Growth Companies.
Company by company
Ambu, which is in our International Small Company strategy, is a Danish medical-products company that directly sells name-brand products for use in anesthesia, emergency care and patient monitoring. You are probably familiar with the company’s first product, the “Ambu bag,” the mask with an attached bag that doctors and nurses attach to a patient’s face to force air into the lungs when squeezed. However, central to our long-term growth thesis for Ambu is the success of the company’s disposable endoscopes, cameras that are inserted into the body. The aScope is a bronchoscope that helps doctors see the airways and lungs of patients for diagnostic and therapeutic purposes. The aScope is single-use and replaces other, reusable scopes that could carry a risk of cross-contamination even after cleaning and sterilization. A disposable endoscope that examines lungs is especially useful during the current pandemic that attacks the respiratory system.
Ambu’s stock price is up more than 40% since the coronavirus first appeared at the end of 2019, as investors focused on the sudden demand for the aScope. However, the share price has fluctuated wildly along the way as news for Ambu has developed. For example, on March 16, the government of Malaysia, the country where Ambu manufactures its endoscopes, announced a two-week shutdown of factories; the stock tanked. Then, on March 18, the firm announced that it fell under the Malaysian government’s list of exempted manufacturers, sending the stock soaring.
Investors trying to forecast the near-term stock price of Ambu must have been left shaking their heads—that is, unless they had a good grasp of what the Malaysian government might do in response to a global pandemic. By contrast, our investment thesis for Ambu predates the coronavirus and rests on the continued adoption of all kinds of its disposable endoscopes. Driven by customers’ needs for lower total cost and lower risk of cross-contamination, disposable endoscopes can potentially address 100 million procedures annually, yet less than 1 million were used in 2019. Looking out 3-5 years, we are confident that Ambu’s management team will figure out its manufacturing logistics—and that disposable endoscopes will gain further traction in ears/nose/throat, urology and duodenoscopy applications. COVID-19 may accelerate these trends, but our thesis for Ambu as an Exceptional Growth Company has much more to do with long-term disposable endoscopy adoption than a short-term bump in aScope sales.
Travel restrictions imposed around the world have hit the airline industry hard. The same goes for shares of PROS Holdings (U.S. Small Company strategy), a key provider of price-optimization software to the global airline and other industries, which have fallen 38% since Feb. 12. While the travel industry clearly has a bumpy runway ahead of it, it is crucial to understand the nuances of PROS to gauge how specifically it may be impacted in the long run. Since its founding three decades ago, PROS has diversified its customers from just the airline industry into other verticals including technology, food and healthcare. Today, travel represents less than half of PROS’s revenue. Also, the company’s contracts with its airline customers are 2 to 5 years in length, with pricing that is not tied directly to the number of tickets sold. Longer-term, we view PROS’s pricing-optimization software as being mission-critical to allow its airline customers to maintain profitability; the payback period for implementing PROS software can be as short as six months. We expect PROS to grow its wallet share among its travel customers. Importantly, the company also has a large market opportunity outside of travel, enabling businesses in a wide range of industries to price and sell their products online. Our long-term perspective of PROS as an Exceptional Growth Company has not been altered by the short-term disruption to the airline industry, in contrast to the deep under-performance of its share price.
The economic slowdown from a quarter of the world’s population living under lockdown has also hammered the prices of bank stocks—and the companies that provide services to them. Shares of Temenos (International Equity strategy), a Switzerland-headquartered provider of banking software to larger institutions, are down 24% since the market peak in February. The company has trailing 12-month revenue of $922 million and a market capitalization of approximately $8.4 billion (USD equivalent). Pre-crisis, the banking industry was spending almost $50 billion a year on operating software for functions such as core banking, front office, compliance and fund administration. Only 20% of that spend goes to third-party software providers. Long term, we believe margin pressures and the need to continue innovating will drive further third-party software adoption by the banking industry. Temenos’s customers enjoy a three percentage point increase in profitability from outsourcing their IT functions. Despite being an industry leader, Temenos has a footprint in only 30% of the global Tier-1 and Tier-2 banks, and less than 5% of the share of wallet of its existing customers. We like the company’s 15% estimated long-term growth rate and its 24%-26% operating margin, and we are comforted that 80% of its revenue is recurring from contracts with current clients. Unless there are systemic bank failures, we think Temenos’s outlook over the next 3-5 years remains bright.
Shopify (Mid Company strategy) is a leading provider of cloud-based commerce solutions that help businesses showcase their brand across all sales channels such as the Web, tablets, mobile storefronts, social media storefronts, as well as brick-and-mortar and pop-up shops. We think Shopify is an Exceptional Growth Company for three primary reasons. First, for merchants and product makers eager to sidestep Amazon’s fees and how it presents their brand, Shopify is a leading alternative platform for selling and interacting with customers. Second, our channel checks indicate that the company’s software is frequently described as the easiest to deploy. Lastly, several customers have told us that Shopify delivers most of the competition’s functionality at a price 75% below the competition.
In 2019, Shopify grew its sales 47% as consumers further embraced e-commerce and omnichannel commerce. Since the market peak on Feb. 12, Shopify’s stock price tumbled 35% on fears of decreasing consumer spending, before recovering. No doubt, social distancing efforts will cool the global economy, but we also think that these near-term efforts are forcing people to go online to get their needs met, and many merchants that have closed their storefronts are quickly adopting Shopify to get back in front of consumers. Although the stock market has focused on near-term economic headwinds, we think it has missed that this period of turmoil is spurring greater consumer and merchant adoption of Shopify’s products and services.
Hopefully these examples give you additional insight into how we view our companies through the lens of long-termism. Even better, perhaps during this time of maximum worry this exercise gives you a few minutes to consider what happens when we move the time-frame slider to the right. As investors, we think the future looks clearer, and brighter, when we do so.
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