“Read the last year’s market predictions and you will never again take this year’s predictions seriously” — Morgan Housel
Dear Partners,
2023 was a good year for our fund! Rowan Street gained +102.6% (net). Please see disclosures for the historical performance data. The biggest contributors to our outperformance in 2023 were Meta Platforms (+194%), Spotify (+138%), Trade Desk (+60%) and Shopify (+124%).
Below we listed some historical annual returns for our Top 5 largest portfolio holdings. As you can see, in any given calendar year stock returns can be very erratic, depending on the mood that Mr. Market is in (and the mood swings have been pretty intense over the past 4 years). However, the fundamentals of companies usually do not fluctuate even nearly as much from year to year, and over time, stock prices tend to accurately reflect the underlying business results.
If you remember at about the same time last year, “the herd” was indiscriminately selling and going to cash, treasuries and flocking to “safe securities” — the Coca-Colas, Procter & Gambles, Johnson & Johnsons and Exxon Mobiles of the world. Investors were shriveled up in fear as they saw no end to Fed's rate hikes and everyone was expecting a recession in 2023.
Lets review what we wrote in our 2022 year-end letter:
“The way we see it, the current consensus too will prove to be ill-fated and ill-timed. You cannot drive looking at the rearview mirror, you have to focus on what's ahead in your front windshield. So let's take a look at what's ahead. Currently, 10-year treasuries pay about 4%. By buying these today, investors are essentially buying an equivalent of an almost “riskless” stock that is selling for 25x earnings and offers zero growth.”
“After a huge correction in the market, there are a number of great growth businesses with excellent management teams and solid reinvestment track records that are currently trading at the kind of valuations we have not seen in many many years — way below the 25x earnings multiple of Treasuries and with substantial future growth opportunities. Yes, these are not risk-free, but for these businesses the odds of compounding value at high rates of return over the next 3-5+ years are finally stacked in our favor. We believe this is the time to actually put that cash to work (selectively of course), not to sell and go to cash! Could these valuations become even more attractive? Absolutely! But we believe it is a huge mistake to not invest in a great company selling at attractive valuations because of stock market and macroeconomic worries. How many investors looked back at stock prices from the depth of the Global Financial Crisis of 2008/09 and asked themselves years later: why didn’t I buy at those levels?”
And what actually happened in 2023? The “higher for longer” interest rate concerns gave way to optimism that the Federal Reserve is done raising interest rates and that the economy was more likely to achieve the dream scenario of a “soft landing.” Combine that with the Federal Reserve’s signaling of potential interest rate decreases in the later half of 2024, and it made for a happy holiday season. The market was up +26% in 2023 while the 10-year treasuries had a negative return over the past 12 months and the so-called “safe stocks” returned virtually nothing (PG +0.6%, KO +1.3%, XOM +2.6%, JNJ +2.8%).
So what did we do right in 2023?
We simply stayed invested in our companies. If you remember, Spotify and Meta Platforms (formerly Facebook), were the biggest detractors from our performance in 2022. And we expected both of them to be significant contributors to our performance over the next several years. We did not trade on the macroeconomic and interest rate fears and kept our portfolio turnover to a minimum. We only had one new idea in 2023, which we will go through in detail at the end of this letter.
Investing is a reductionist art!
Our experience has taught us that there are very few things we should actually be adding, and most of the time we should be subtracting. In this business, there are countless investment ideas, and an abundance of people constantly whispering and often yelling those ideas in your ear all day, every day. It’s about staying on your path and never forgetting what you are trying to do in the first place. It’s about keeping your peace and focus, always knowing what your game is. It’s about eliminating anything that can interfere with that game (bad ideas, emotions, distractions, people, boredom, feeling that you have to constantly act or do something). It’s very simple, but not easy! It takes a long time to find your style in the game, and it takes even longer to develop confidence in yourself and in the style that truly fits you. Confidence in its highest form is knowing your YES and being able to say NO to almost everything without doubt and hesitation.
Ian Cassel recently wrote a great article on Active Patience, where I believe he perfectly captured the essence of a successful investing journey. This is something that I have arrived at through my own investing journey over the past 20 years, but Ian had articulated it much better than I could. It’s only an 8 minute read — well worth your time!
New Position: Adyen (ADYEY)
Netherlands-based Adyen is arguably the best-run payments company in the world! Adyen is a financial technology platform which offers end-to-end payment services to big enterprises and also to SMBs through partnerships. They have one unique solution. They build everything themselves. They have 27 offices all over the world. They are publicly-listed in Amsterdam. Below is an example of their impressive list of clients:
We have been watching and admiring Adyen as a company from the sidelines for the past couple of years. Its stock price has skyrocketed +300% from its COVID lows of March 2020 until its peak of 2021, followed by a -75% collapse in the stock that bottomed out in the summer of 2023 (see chart below):
High quality, well-managed businesses tend to trade at a premium, but Adyen was in a league of its own. At the peak of 2021, it reached close to a 100 billion euro valuation on operating earnings of 595 million euros and free cash flow of 567 million euros (176x free cash). Patiently waiting for an opportunity to buy the stock, we were able to acquire shares for our fund at a 22 billion euro valuation this summer. Even after a 75+% collapse in the stock price, fueled by concerns of slowing growth, macroeconomic headwinds, increasingly competitive payments landscape and a general market sentiment souring towards growth stocks, Adyen wasn’t particularly cheap (statistically speaking). But we thought it was a fair price to pay for what we believe to be a high quality business overseen by a world-class management team.
Our average cost basis for Adyen stock is $7.43. Immediately following Adyen’s Investor Day that took place in November 2023, the sentiment for the stock started shifting as several factors came together to create momentum that propelled the stock price +73% from our cost basis. These were a combination of internal progress, improved financial performance, favorable market conditions, and recognition of their unique long-term advantages within the payments industry.
Adyen is a Surinamese word for “start over again.” It’s an apt name for the company. Adyen’s founders, Pieter van der Does and Arnout Schuijff, were founders of and senior executives in an international payment service provider named Bibit that was sold to the Royal Bank of Scotland in 2004. In 2006, Adyen was created with the aim of facilitating digital payments by building a modern – and better – payments infrastructure that connects directly with card networks and local payment methods.
How does Adyen make money?
For providing its payments services, Adyen has a variety of revenue sources that include:
Settlement fees: These are paid by merchants for Adyen’s acquiring services and are usually based on a percentage of the transaction’s value. Within settlement fees are interchange fees and payment network fees (sometimes called scheme fees) that Adyen collects from merchants and passes on to issuers and the card networks, respectively. The settlement fees also include markups that Adyen charges to merchants for providing acquiring services.
Processing fees: These are fixed fees on a per transaction basis that merchants pay Adyen for using the company’s platform.
Sales of goods: These are revenues from Adyen selling POS terminals and their related accessories to merchants.
Other services: These comprise foreign exchange service fees, third party commissions, and issuing services fees.
Using an example of a €100 transaction that involves Adyen as the acquirer, risk manager, and processor, the total settlement fee will be 1.7%, or €1.70. Of the €1.70 in settlement fee, €1.00 goes to the issuer in the form of the interchange fee, €0.50 goes to the card networks (the Visas or the Mastercards of the world) as the scheme fee, and €0.20 belongs to Adyen as the acquiring markup. The total processing fee is €0.06 and this accrues fully to Adyen. What the merchant ends up collecting is €98.24, or 98.24% of the total value of the transaction.
The Numbers
At the time of Adyen IPO in 2018, its processed payment volume was 159 billion euros. They are estimated to process 910 billion euros in payment volume in 2023 (42% CAGR for the past 5 years). Likewise, in 2018 Adyen earned 349 million euros in revenues and they are estimated to end 2023 with 1.7 billion in revenues (a 37% CAGR). Despite these staggering growth rates, Adyen is one of the most profitable companies we’ve ever come across. Prior to 2022, they were able to consistently generate 65+% EBITDA margins. In 2022, they posted a still very impressive 55% EBITDA margin, which disappointed Wall Street. The decline in their EBITDA margin was primarily due to management’s decision to strategically accelerate their hiring pace, which we will talk about a bit later in the letter. We applaud this decision and view this decline in profitability as temporary. Management is still guiding for 65% long-term EBITDA margins and we believe this is achievable given their track record. We expect Adyen to grow their processes volume and their revenues at 20%+ CAGR over the next 5 years, while growing their EBITDA and cash flows at slightly higher rates.
Competitive Advantages
Adyen processes digital payments for merchants. There is nothing special about what the company does, it's how they do it that’s special. Being the only company in the industry offering its services through a single unified platform gives the company a major competitive advantage, as Adyen doesn't have to rely on the tech infrastructure of legacy partners (i.e., Chase Merchant Solutions, Worldpay, First Data, and Ingenico) and on white label agreements with banks in order to support card payments, substantially simplifying the life of merchants by only having to partner with one company.
Due to its single unified platform and its global footprint, Adyen attracted enterprise customers, which currently make up a large chunk of the company’s volume and continue to be the fastest growing segment. Enterprise customers like Adyen because: (1) they get high authorization rates, (2) they can open up new geographies fast without additional partnerships, (3) they can drive actionable insights because they see all the data in the same place, (4) they can see data across all channels in the same platform (unified commerce).
While the Network effects (merchants are attracted to Adyen because of its wide range of features and global reach, while consumers are attracted to Adyen because it is accepted by a large number of merchants), switching costs and data they collect play a huge role in forming Adyen’s moat, its Adyen’s unique cultural attributes that attracted us to invest in the company.
Adyen was founded in 2006 with 4 engineers and 3 founders, who started with their own money and bootstrapped the business until 2011, when they did the series A. They were actually profitable that year, but raised capital more for introductions and networking rather than the capital itself. A lot of the largest VC firms in Silicon Valley didn’t want to invest in Adyen at the time because of the peculiar terms. Specifically, they didn’t want investors to be on the board of Adyen, they only issued common stock and no shares would have preferential terms. They could have raised a lot of money, but in typical Adyen fashion, they didn’t care about valuation and they didn’t really need the money. They raised only around $300 million, which pales in comparison to Stripe and Checkout that raised $4 billion collectively. Even during the Adyen IPO they didn’t really sell more shares — it was just an opportunity for early investors to get some liquidity.
Until this day, Adyen’s board (6 members) still sees every hire, which is unheard of for a company their size. They set the bar very high and make every attempt to create a productive place for talented people (more on their hiring process later). This is not a company focused on the next quarter, but on the next decade (something that we at Rowan love to see). That means there will be periods in which we will have to trust management and be patient while waiting for their investments to pay off. By starting with the most complex cases and building everything in-house, Adyen builds slower, but the result is much more scalable and flexible and sets it up for success over the next decades. Most others start fast, stitch together several solutions from other payment platforms and then find themselves constrained by the limits of their system a few years later.
Their hiring approach is perhaps most telling of the culture that founders have created, given that human capital is their biggest expense. As an example, let's contrast Adyen’s approach to hiring vs Stripe’s (their main competitor). Stripe’s headcount ballooned to 8,000 employees in the fall of 2022 as they aggressively scaled up its workforce during the pandemic boom, anticipating continued rapid growth in e-commerce. Sripe’s CEO Patrick Collison later acknowledged they were "too optimistic and over-hired for the world we're in”. In November 2022, Stripe laid off around 14% of its workforce (approximately 1,120 employees) due to slower growth and macroeconomic challenges. Collison cited operational inefficiencies and the need to adjust to a "leaner time."
Unlike Stripe, Adyen adopted a more conservative approach to hiring. They focused on strategic talent acquisition and prioritized cultural fit and long-term planning rather than rapid headcount growth. Adyen, by comparison, had only 2,575 employees at the end of the first half of 2022. Not only were they able to avoid layoffs, they actually went on the offensive in 2022, taking advantage of a favorable talent pool and continuing to opportunistically hire in key areas, boosting their full-time employees by +53% to 3,332.
Here is an excerpt from Pieter van der Does’ note to Adyen’s employees from November 2022:
“By now, I’m sure all of you have read the news about the wider tech industry engaging in headcount reductions. I’m writing to you today to explain why we are consciously choosing not to engage in such exercises. With an ever-evolving payments landscape and our financial product suite only in its infancy, we have a long runway ahead. We are in investment mode, and growing our team with a similar number of new colleagues in 2023 as we did this year is essential to realizing our long-term ambitions.
It’s business as usual to keep our eyes on the horizon – on where we want to be years from today. For our recruitment strategy, this means that we are not led by short-term trends such as the pandemic-related e-commerce or in-store volume fluctuations, and hire specifically to meet our long-term technical and commercial needs. Throughout all stages of Adyen, we have been efficient and disciplined regarding how many people are required to solve problems and grow our business. To scale our culture of speed and autonomy as we grow, we keep our talent standards high and only hire exceptional people that quickly gain traction.
This has resulted in times where we grew the team at a slower pace than we would have liked. In today’s talent market, we are seizing the opportunity to build the team to the size required to capitalize on our opportunities. For some teams, that means adding colleagues to scale existing capabilities. For others, it’s about building from scratch as we are training new muscles. By 2024, our ongoing investment into the team will have brought us to our next maturity level. At that time we will cool our hiring pace and allow the high operating leverage inherent to our business model to further expand.”
Their unique culture drives every decision every day, which is the difference between extraordinary and ordinary, and Adyen has an obsessive focus to maintain that culture. Adyen is very careful with every “chess move” along the way. They seem to always stick to their principles of simplicity. They are in fact long term and very patient — many say it but few actually practice it. Adyen is one of the few high growth companies that hasn’t even changed its guidance from their IPO perspective almost 5 years ago. As their CEO Pieter van der Does said: “When you have a business and you want to actually keep that business (not just exit it), your decisions start to drastically change.”
PORTFOLIO UPDATE:
Meta Platforms (META)
Meta Platforms has become our largest position in the fund, up +268% in just 14 months, aging very well from our November 2022 note. We gave a re-cap of this extraordinary move in our last letter in November and we encourage you to review. Our investment in Meta makes a great case to study. We first invested in the stock in 2018 and we just recently doubled our money on this investment in 2023. It took exactly 5 years and provided a very decent return of 15% per annum, however it hasn’t exactly been a smooth ride. Please take a look at the chart below:
As you can see, we first started buying the stock in April of 2018 at $150 and then added in December of 2018 when the price dropped to $135, adding further to our position when the stock eventually rose to mid-200s. In the first two years there was zero return from our investment. Covid took the stock to new highs of $372, and subsequently, in 2022, the stock dropped to new lows of $89 — a price not seen since 2015. When we wrote our note on Meta last year, we were sitting on a negative return for a 4 year time period. This can be pretty demoralizing and discouraging to investors. However, it is very crucial to be able to adopt the mentality of a business owner and to focus solely on the fundamentals of the business itself rather than the narrative around the stock. It’s interesting (and it happens very often in the world of investing) that you can have 3-4 years of zero to negative returns and then the stock can quickly skyrocket in just 6-12 months, paying handsomely for the wait. Staying invested when the stock experiences this kind of volatility can be emotionally difficult and there could be a lot of pressure to sell throughout the journey. However, if our investment thesis has not changed, management is executing well and the business continues to grow and make more money over time, we can afford to wait.
Spotify (SPOT)
In our year-end 2022 letter we wrote: “Spotify (SPOT) is currently selling for about $15 billion. Does this make any sense?” We argued that Spotify stock was extremely mis-priced by the market. That aged pretty well as the current market cap for Spotify is ~$40 billion. Spotify’s stock skyrocketed +138% in 2023, strongly contributing to our outperformance. Spotify surpassed analyst expectations by adding 26% more monthly active users (MAUs) year-over-year in Q3 2023, reaching a total of 489 million (estimated to close the year with 600 million MAUs). This impressive growth solidified Spotify's position as the world's leading music streaming platform. Investors also applauded Spotify’s bid to improve profitability by suspending its podcasting spending spree and implementing cost-cutting measures, including layoffs, which reduced operating expenses.
Shopify (SHOP)
Shopify is an all-in-one e-commerce platform that empowers businesses of all sizes to build, manage, and grow their online stores. Founded in 2006, Shopify now holds a commanding >10% market share in US e-commerce.
The value of Shopify lies in its simplicity for merchants to easily start and scale their business, so much so that merchants fall in love with their solutions and never want to leave, no matter how big they get. They understand that as they grow and confront new challenges, Shopify will solve their problems so they can take their business to the next level. That is the power of Shopify's flywheel.
We have owned Shopify’s stock since 2022. Our average cost basis is $60. Following our purchase, the stock hit a low of $26 in October 2022. Just 15 months following those lows, Shopify stock is now trading at $80 (a 200% rebound) as investors celebrated the decision to sell its capital intensive logistics business, which was largely expected to cost billions of dollars to build out — a move that enables Shopify to retain its original, asset-light business model. Additionally, while many tech companies struggled in the face of macroeconomic challenges, Shopify defied expectations by maintaining robust revenue growth in 2023. Revenue increased by 25% year-over-year in the most recent quarter, with gross profit growing by a healthy 36%. We are now sitting on a +35% unrealized gain on our position after owning the stock for almost 2 years. Not a bad return, but what a wild ride it has been. Just another example that volatility is the price of admission in this business.
theTradeDesk (TTD)
TheTradeDesk is a leading Ad-tech platform that empowers advertisers to reach targeted audiences across the open internet with real-time, data-driven ad buying technology. TheTradeDesk has had a very strong and healthy growth every quarter for the last couple of years and has significantly outpaced the industry and gained market share. During the same time, some of their largest competitors are coming off of low-to-negative growth from a year ago, theTradeDesk is coming off of 20+% growth and then posting an average of 23% growth over the past 4 quarters. Despite their rapid growth, they continue to be one of the few high-growth tech companies that consistently generate strong adjusted EBITDA (averaged 39% over past 12 months) and free cash flow that has steadily increased over the years. We bought TTD stock a little less than 4 years ago at an average cost of $17.40 (split-adjusted). Our position has soared +275% thus far since our purchase, translating to a 42% annualized return.
Topicus (CVE: TOI)
Topicus was spun off from Mark Leonard’s Constellation Software back in 2021. They are a serial acquirer of vertical market software (“VMS”) businesses, primarily located in Europe. Generally, these businesses provide mission critical software solutions that address the specific needs of their customers in particular vertical markets. Their focus on acquiring businesses with growth potential, managing them well and then building them up, has allowed them to generate significant cash flows and revenue growth during the past several years. Following CSU's spin-off of Topicus stock, our purchase has generated a +50% unrealized gain for the fund, translating to a roughly 14% annualized return.
As always, we appreciate your trust and confidence that you place in our investment discipline. We hope you have enjoyed the holidays and we are always around if you would like to chat.
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). The methodology used to determine the Top 5 holdings is the largest portfolio positions by weight. The top 5 do not reflect all fund positions. The Top 5 can and will vary at any given point and there is no guarantee The top 5 will continue to perform and, more generally, there is no guarantee the fund will meet any specific level of performance .