Dear Partners,
The past two quarters have been difficult for all growth investors and certainly for Rowan Street partners. COVID reopening, inflation, threat of rapid increase in interest rates as well as the war going on in Europe all contributed to a very rapid market rotation out of growth stocks, which were the darlings of the 2020-21 time period. These types of rotations and corrections are normal and to be expected from time to time. Its worth reviewing what we wrote in our 2020 year-end letter after the fund posted +28.3% and +65.4% gross returns in 2019 and 2020 respectively:
What can we expect from the Rowan portfolio over the long run?
By no means should you be expecting the fund to generate anywhere near the kind of returns that we had enjoyed over the past two years. These kinds of returns are unsustainable, and without a doubt we will experience a market decline (perhaps a significant one) at some point in the future. Some of our portfolio holdings may experience drawdowns of 50% or more from peak to trough, just like we did in March of 2020. This is normal and part of the game of long-term compounding. Remember, we are not in the game of minimizing volatility. We are not traders, hedgers, market timers or “renters of stock.” We are strictly business owners and compounders of capital! And just like Jeff Bezos, Reed Hastings, Mark Zuckerberg or Elon Musk have never sold when the stock of Amazon, Netflix, Facebook or Tesla had declined by 25% or 50%+, and have always focused exclusively on the long term fundamentals of their respective businesses, you should expect us to do the same with our portfolio companies.
The last significant drawdown happened exactly 2 years ago, in the first quarter of 2020, when the stock market suffered the worst declines since the financial crisis of 2008. The S&P 500 index declined by 20% and the Dow plunged by 24% (worst first quarter for the Dow in its 135-year history). We encourage you to review our Q1 2020 Letter to see how we approached volatility at the time, which proved to be a unique opportunity to add to your investment in the fund.
As of March 31, our fund is down 27.8% from the beginning of the year. Nevertheless, by almost any measure, Rowan Street is in a stronger position now than it's ever been since our inception 7 years ago, and we strongly believe that this is the best time to invest in Rowan Street since we started the fund in March of 2015.
Our portfolio now consists of 10 highest quality businesses with ‘best-of-breed’ owner-operators at the helm, who are some of the most talented and passionate entrepreneurs in the world, in our opinion. We expect them all to grow 20%+ per annum over the next 5 years and to dominate their respective industries.
Revenues for our portfolio companies (on a weighted average basis) grew an astounding 44% in 2021 as compared to 16% growth for the S&P 500.
In 2022, our portfolio companies’ revenues are estimated to grow 20% as compared to estimated 7% growth for the S&P 500. As you can see, the underlying value of a business doesn’t fluctuate that much on an annual basis as their stocks do. And in the game of investing it’s important to keep your focus on the playing field and not on the scoreboard (over time the scoreboard takes care of itself).
Price/Sales valuation multiple (on a weighted average basis) for our portfolio companies jumped 66% for our portfolio companies in the 2020 pandemic year.
Towards the end of 2021, Price/Sales multiple for our portfolio contracted 15% and then another 47% in 2022 — an indicator of how rapidly the market sentiment for growth stocks has shifted (from extreme greed to extreme feat).
Whereas, our portfolio weighted average P/S multiple was 15.4x in 2021, it's now only at 6.9x! We think the current valuations for our portfolio companies are very undemanding, to say the least and, in our view, do not make much sense in relation to their future growth opportunities, their dominant positions and growing operating leverage of their business models. This sets us up for attractive long-term returns if our businesses continue to execute.
We used this rapid market downturn to acquire, in our opinion, highest quality companies that we expect to compound at superior rates of return over the next 3-7 years. We wanted to buy the kind of companies that we don’t have to sell in the future, and all 3 qualify (please refer to charts below for more detail).
So, if our fund is much better positioned today than it was a year ago, why is it down so much in comparison to March 2021? As the famed investor Benjamin Graham said:
‘‘In the short term, the stock market is a voting machine; in the long term, it’s a weighing machine.’’
Clearly there was a lot of voting going on over the past two years since the pandemic began — and much less weighing. We’re a fund that wants to be weighed, and over time, we will be — over the long term, all funds and companies are. In the meantime, during this downturn we had our heads down working to build the kind of portfolio that will have good odds of achieving multibagger long-term returns that we are after.
Let’s run through our top holdings in order to visualize what happened to their stocks in relation to the fundamentals of their underlying businesses:
(1) We have owned Spotify (SPOT) stock since its IPO year in 2018, and this company continued to be one of our highest long-term convictions despite the recent drawdown in the stock. We had outlined our investment thesis for SPOT in our H1 2021 Letter and in Q2 2020 Letter (we encourage you to review those). We believe there is great future for this company beyond what you can see and hear today!
(2) We have owned Meta Platforms (FB) in the portfolio since 2018, and are just as optimistic and confident in the long term prospects of the company despite the recent drop in stock price.
(3) We were fortunate to acquire Trade Desk (TTD) for the Rowan portfolio during pandemic lows in April of 2020. TTD has been our best performing idea over the past couple of years and we intend to hold on to every share we own.
New Positions
The beauty of the public markets is that if you can be patient, there is a good chance the volatility of the marketplace will give you the chance to own companies on your watch list. The stock prices of our 3 new positions (please refer to charts below) have fluctuated from 100-350% over the past 12 months (when comparing 52-week high by 52-week low). Certainly, the underlying value of a business doesn’t fluctuate that much on an annual basis, so the public markets are a fantastic arena to buy businesses if you can sit still without growing tired of sitting still.
(1) We have been following Docusign (DOCU) since its IPO in 2018. It’s stratospheric valuations over the past few years have kept us admiring this company from the sidelines. We took advantage of the recent drastic drop in stock price to build a core position for the fund.
Below, we tried to depict the psychology of the wild swings in market sentiment for Docusign stock as the “pendulum” swung from extreme greed to extreme fear:
(2) Shopify is the company we have been following for a long time, but never had a chance to buy due to its persistent stratospheric valuations (the best companies are never without a huge fan club). The recent sell-off in the stock finally gave us an opportunity to build a core position for our fund.
Below, is another depiction of a wild swing in the market sentiment for Shopify stock:
(3) Netflix is the 3rd position that we have recently added to the portfolio, taking advantage of the drastic decline in its stock in 2022.
Positions we sold over the past 12 months
Chinese positions: Alibaba (BABA) and Tencent (TCEHY). We existed both in Q2 2021 and layed out our rationale for the sale in our Q3 2021 letter (please click to review). Both stocks have declined substantially since our sales.
Zillow (ZG): we have owned this stock since 2019 and decided to sell our entire position in November 2021 after a material change in its business model and vision for the company was announced in their Q3 ‘21 earnings report. Even though this company has a very talented management team with a strong track record of success, our original investment thesis in the company broke down. All-in-all, we ended up breaking even on this investment.
Lyft (LYFT): we sold Lyft in Q1 ’22 to fund the acquisitions of our 3 new positions as we’ve outlined above. We had owned Lyft for a little less than 3 years and realized approximately 50% gain on the stock. The new companies we bought with the proceeds from the sale are significantly better businesses, in our view.
Eating our own cooking
Our investors (partners) should derive some comfort that your managing partners have majority of our net worths invested in Rowan Street. Our compensation comes solely from performance. Thus, we make money only when we make our partners money. If there is a drawdown in the portfolio, not only our personal net worth gets cut coincidently with everyone’s investment in the fund, but we also do not get paid until we make up all the lost ground.
We structured the fund like that from day one in order to focus on the long term compounding of capital and to tune out the distractions and the noise of short-term volatility in the marketplace (please review our note from 2019 on Volatility and How to Think About It). Every decision we make has only one purpose — to maximize the long-term wealth of every partner in the fund. Our goal is not solely to gather assets and charge you management fees. By design, we are true partners in the business and our goals and interests are perfectly aligned.
Conclusion
We do not say this very often, but we strongly encourage you to take advantage of the highly attractive prices created by the current market turmoil if you are able to do so. There is a very high probability that in 3-5 years we will look at current downturn in growth stocks as an incredible buying opportunity for our fund. As they say, “All past declines look like opportunities and all future declines look like risks. Its one of the great ironies in investing.” All the companies we currently own in the portfolio are estimated to grow at 20+% over the next 3-5 years, which is 3x the expected growth rate of the overall market, and the current valuations for a number of our positions will likely prove to be “silly” over time.
It takes great courage to invest at the maximum point of pessimism, but it’s precisely these times that bring about the strongest long-term results. As a reminder, the fund is open at the end of each month for new investments.
We would be happy to jump on the phone to catch up and discuss anything that is on your mind. In times of extreme volatility we feel frequent communication is necessary in order for you to understand our thought process and how we are steering our ship. We believe this builds trust and confidence in our investment approach and puts us on the same page as far as achieving long term success for Rowan Street Capital.
Best regards,
Alex and Joe
DISCLOSURES
The information contained in this letter is provided for informational purposes only, is not complete, and does not contain certain material information about our Fund, including important disclosures relating to the risks, fees, expenses, liquidity restrictions and other terms of investing, and is subject to change without notice. The information contained herein does not take into account the particular investment objective or financial or other circumstances of any individual investor. An investment in our fund is suitable only for qualified investors that fully understand the risks of such an investment. An investor should review thoroughly with his or her adviser the funds definitive private placement memorandum before making an investment determination. Rowan Street is not acting as an investment adviser or otherwise making any recommendation as to an investor’s decision to invest in our funds. This document does not constitute an offer of investment advisory services by Rowan Street, nor an offering of limited partnership interests our fund; any such offering will be made solely pursuant to the fund’s private placement memorandum. An investment in our fund will be subject to a variety of risks (which are described in the fund’s definitive private placement memorandum), and there can be no assurance that the fund’s investment objective will be met or that the fund will achieve results comparable to those described in this letter, or that the fund will make any profit or will be able to avoid incurring losses. As with any investment vehicle, past performance cannot assure any level of future results. If applicable, fund performance information gives effect to any investments made by the fund in certain public offerings, participation in which may be restricted with respect to certain investors. As a result, performance for the specified periods with respect to any such restricted investors may differ materially from the performance of the fund. All performance information for the fund is stated net of all fees and expenses, reinvestment of interest and dividends and include allocation for incentive interest and have not been audited (except for certain year end numbers). S&P 500 performance information is included as relative market performance for the periods indicated and not as a standard of comparison, as it depicts a basket of securities and is an unmanaged, broadly based index which differs in numerous respects from the portfolio composition of the fund. It is not a performance benchmark but is being used to illustrate the concept of “absolute” performance during periods of weakness in the equity markets. Index performance numbers reflected in this letter reflect reinvestment of dividends and interest (as applicable). Index information was compiled from sources that we believe to be reliable; however, we make no representations or guarantees with respect to the accuracy or completeness of such data.