We evaluate the fund’s performance using two key parameters: the return achieved on capital invested in equities and the proportion of capital invested in equities relative to total assets (equities & cash). Our targeted return for equity investments has always been and remains 15%, a milestone we consistently met over the past 12 years since the fund’s inception. How much cash the fund holds is a function of the number of investment opportunities we find. Over time, we have improved our ability to identify and pursue these attractive investments, as evidenced by the steady increase in the allocation of capital to equities. The fund’s average investment rate exceeded 80% over the past two years, a number we expect to increase going forward.

Some of our investments faced headwinds in 2023, but the majority of our portfolio companies delivered good operating performances and/or benefitted from favourable market sentiment. Notably, Epsilon Net warrants a special mention as we reduced our holding by 40% in August when the share price approached our intrinsic value estimate. Subsequently, we spent a day with the CEO and his team in Thessaloniki before deliberating on our remaining holding. After our partial divestment and before our meeting, the stock price suffered a substantial decline due to the revelation of an accounting error. During our discussion with management, it became evident that the impact of the accounting error on intrinsic value was minimal, and corrective measures taken by management had been promptly implemented to prevent such errors in the future. The meeting also shed light on recent developments, such as the collaboration with the largest commercial bank in Greece (NBG) to develop payment services integrated into Epsilon Net’s business software. While we have not yet assigned any value to this new service, its potential upside is substantial. Epsilon Net remains a 6% position as the current share price still trades at a discount to our fair value estimate. In the second half of 2023, the fund also made a new investment in Alight Inc, which is written up in long form below.

‍

Alight Inc

Alight is a major provider of healthcare, retirement and payroll administrative services, primarily catering to large enterprises. It supports 70% of the Fortune 100 companies and services more than 36 million corporate employees and dependents. The company operates under long-term contracts (typically 3-5 years), utilising a fee-per-employee-per-month model. The robustness of its services is evidenced by high retention rates (98%) and an impressive 15-year average client tenure. Through its different business segments, Alight competes with ADP, Paychex, Fidelity, and a handful of other firms with longstanding through-the-cycle track records of stability and profitability.

Before its 2017 spin-off from large insurance broker Aon to private equity firm Blackstone, Alight’s business lacked focus, investment and strategic direction. Under Blackstone, new leadership revitalised the company by upgrading technology to the cloud, improving cost efficiency through rationalisation and expanding the product offering through strategic acquisitions. These transformative steps paved the way for Alight to go public in 2021. Alight distinguishes itself in the market by integrating healthcare, payroll and retirement offerings at scale, backed by significant improvements in technology. The combination of personalised service, advanced technology, and a diverse portfolio of bundled offerings serves as a formidable competitive advantage, as evidenced by recent contract wins.

Large enterprises typically offer numerous benefit programs to their workforce, but low engagement prevails due to disparate solutions. Alight’s software platform addresses this challenge by enhancing engagement, decision-making and outcomes for employees. Simultaneously, it proves cost-effective for employers and contributes to fostering a happier, healthier and more productive workforce.

The company targets 6-8% revenue growth over the medium term through cross-selling opportunities and new customer acquisitions. The potential negative revenue impact during times of increased unemployment is mitigated by increased revenues for administering COBRA healthcare, an insurance program available to employees who lose their jobs and job-related insurance. Operating margins are poised to expand with increased automation and operating leverage, while reduced restructuring expenses should further improve cash flows.

Aligned with minority shareholders, the board and management prioritise a strong balance sheet and robust free cash flow generation. They are committed to fostering organic growth, pursuing strategic acquisitions, and enhancing shareholder returns through a share buyback program. The company's share price is currently under pressure due to a temporary situation where private equity investors are gradually selling off their stake. We view this as an opportunity and the fund made an investment at 13x our estimate of this year’s after-tax earnings. We believe this is an attractive valuation considering Alight’s solid fundamentals and growth potential.

Update on the five largest positions of the fund:

Volution Group PLC (7.72%)

Volution, a leading supplier of ventilation products, has sustained robust operating performance, propelled by the growing awareness of indoor air quality and increasingly stringent regulations on energy efficiency. These structural tailwinds, coupled with strategic acquisitions, instil confidence that the company can make further progress in 2024. Results for the fiscal year ending July 2023 showed revenue growth of 6% at stable profit margins of 21%. The December trading update highlighted continued strong operating performance in the first four months of the new fiscal year.With a leverage ratio of 1x, Volution maintains ample flexibility to execute its acquisition strategy. The company’s share price increased by 18% last year, propelled by good operating results and positive market sentiment. Currently, the stock market values Volution at 16x estimated after-tax earnings for the current year.

Delfi Ltd (6.69%)

Delfi is the market leader in Indonesia’s chocolate industry with a robust portfolio of ‘own brands’ and an extensive distribution network. The first half of 2023 witnessed a surge in Delfi’s share price propelled by a 69% increase in 2022 after-tax profit and sustained strong operating performance in H1 2023. However, the third quarter saw a dip in profits due to increased investments in its proprietary brands. Despite the drop in share price following the Q3 results, Delfi finished the year up 44%. With a valuation at 11.5x last year’s net income we believe the valuation remains compelling.

Eurofins Scientific SE (6.56%)

Eurofins is a global leader in food, pharmaceutical and environmental testing. Over the past 12 years, Eurofins has grown aggressively from 100 to 1000 testing labs.  Significant investments have been made in IT and the implementation of a hub-and-spoke model to optimise the efficiency of labs.  These investments, combined with the end of COVID testing, have depressed earnings. The good news is that the company is approaching the end of a multi-year investment phase.  Adopting a long-term perspective, we anticipate that these strategic investments will not only strengthen the company’s competitive edge but also yield improvements in profit margins. The share price declined 12% during 2023 and closed the year near our average purchase price. The company’s 2027 targets reflect the positive impact of the strategic initiatives. Based on these targets, which we believe are realistic, we purchased the shares at a 10% free cash flow yield. This valuation is attractive for a very resilient business with the ability to re-invest capital at a high rate of return into organic growth initiatives and acquisitions.

Epsilon Net SA (6.34%)Epsilon Net is a Greek software company, dominant in the local market for HR/payroll and accounting software. It also has a fast-growing enterprise resource planning (ERP) business. The company is actively benefiting from the digital transformation of the Greek economy and a positive political environment. The share price rose by 48% in 2023, on the back of strong operating results. Management’s medium-term plan aims to grow sales to €150m by 2025 at +30% EBITDA margins. Given current business dynamics, we believe this target is achievable. Epsilon trades at 17x our estimate of 2025 after-tax earnings.

Marlowe PLC (5.63%)

MRL operates two divisions: Governance, Risk & Compliance (GRC) and Testing, Inspection & Certification (TIC). The TIC division focuses on ensuring compliance with fire safety and water & air hygiene regulations. Marlowe’s GRC division primarily revolves around clients’ employees, with advice and support on Employment Law/HR, Occupational Health and Health & Safety. This division also encompasses the rapidly growing compliance software business.  

In November 2023, Marlowe’s share price experienced a 23% decline following the release of H1 FY24 results. Several factors contributed to this downturn in sentiment, including higher one-off transaction and restructuring expenses from acquisitions, organic revenue growth at the lower end of guidance, and slightly lower margins in the TIC business. With no imminent transformative M&A in the pipeline, the company anticipates the gradual reduction of these expenses over the next 6 to 18 months. Significant M&A activity often clouds a company’s true earnings power, fostering uncertainty and volatility in its share price. Despite these challenges, we remain confident in our investment thesis.  At 16x this year’s normalised earnings we believe the risk-reward is attractive for a quality business with multiple drivers for earnings growth.

‍

Our next letter will be out in the first weeks of July 2024. Wishing you all a safe and healthy continuation.  

‍