Chong Ser Jing, Author at The Good Investors : Page 19 of 24

Why I Own DocuSign Shares

DocuSign has only been in my family’s portfolio for a short time, but it has done well for us. Here’s why we continue to own DocuSign.

DoucSign (NASDAQ: DOCU) is one of the 50-plus companies that’s in my family’s portfolio. I first bought DocuSign shares for the portfolio in December 2018 at a price of US$41 and I’ve not sold any of the shares I’ve bought.

The purchase has worked out very well for my family’s portfolio thus far, with DocuSign’s share price being around US$79 now. But we’ve not even owned the company’s shares for two years, and it is always important to think about how the company’s business will evolve going forward. What follows is my thesis for why I still continue to hold DocuSign shares.

Company description

DocuSign provides DocuSign eSignature, currently the world’s leading cloud-based e-signature solution. This software service enables users to sign a document securely using almost any device from virtually anywhere in the world. It is the core part of the broader DocuSign Agreement Cloud, which is a suite of software services – again all delivered over the cloud – that automates and connects the entire agreement process. DocuSign Agreement Cloud includes:

Automatic generation of an agreement from data in other systems;
Support of negotiation-workflow;
Collection of payment after signatures;
Use of artificial intelligence (AI) to analyse agreement-documents for risks and opportunities; and
Hundreds of integrations with other systems, so that the agreement process can be seamlessly combined with other business processes and data

At the end of its fiscal year ended 31 January 2020 (FY2020), DocuSign had over 585,000 paying customers and hundreds of millions of users. From its founding in 2003 through to FY2019, the company had processed over 1 billion successful transactions (around 300 million in FY2019 alone). DocuSign defines a successful transaction as the completion of all required actions (such as signing or approving documents) by all relevant parties in an Envelope; an Envelope is, in turn, a digital container used to send one or more documents for signature or approval to the relevant recipients.

DocuSign serves customers of all sizes, from sole proprietorships to the companies that are among the top 2,000 publicly-traded enterprises. The company’s customers also come from many different industries, as the chart below illustrates.

*Source: DocuSign* *investor presentation*

For a geographical perspective of DocuSign’s business, its users are in over 180 countries. But in FY2020, 82% of the company’s revenue came from the US.

Investment thesis

I had previously laid out my six-criteria investment framework in The Good Investors. I will use the same framework to describe my investment thesis for DocuSign.

1. Revenues that are small in relation to a large and/or growing market, or revenues that are large in a fast-growing market

Has it ever occured to you that the innocuous act of signing documents with pen-and-paper can actually be a significantly wasteful activity for companies? The thought struck me when I was doing research on DocuSign before I bought its shares. Think about it. Signing a paper document requires you to fax, scan, email, snail-mail, courier, and file. DocuSign’s solution can save us both time and money.

There are many use-cases for DocuSign’s software services, ranging from sales contracts to employment contracts, non-disclosure agreements, and more. In fact, DocuSign has a customer that has implemented over 300 use-cases. DocuSign documents are legally accepted and protected with cryptographic technology from tampering. The documents also have a full audit trail, including party names, email addresses, public IP addresses, and a time-stamped record of each individual’s interaction with a document.

DocuSign estimated that it had a total addressable market of US$25 billion in 2017, using (1) the number of companies in its core markets, and (2) its internal estimate of an annual contract value based on each respective company’s size, industry, and location. This estimate remains unchanged (it was mentioned in the company’s FY2020 annual report), though recent business moves may have significantly expanded its addressable market. More on this later. At just US$974.0 million, DocuSign’s revenue in FY2020 is merely a fraction of its estimated market opportunity.

I believe that DocuSign’s addressable market will likely grow over time. There are clear benefits to e-signatures. A 2015 third-party study by Intellicap (commissioned by DocuSign) found that the company’s enterprise customers derived an average incremental value of US$36 per transaction (with a range of US$5 to US$100) when using the company’s software as compared to traditional paper-processes. In FY2020, 82% of all the successful transactions that flowed through DocuSign’s platform were completed in less than 24 hours, while 50% were completed within just 15 minutes. DocuSign’s services help companies save money and time.

2. A strong balance sheet with minimal or a reasonable amount of debt

As of 31 January 2020, DocuSign held US$895.9 million in cash, short-term investments, and long-term investments. This is nearly twice the company’s total debt of US$465.3 million (all of which are convertible notes). For the sake of conservatism, I also note that DocuSign had US$183.2 million in operating lease liabilities. But the company’s cash, short-term investments and long-term investments still comfortably outweigh the sum of the company’s debt and operating lease liabilities (US$648.5 million).

3. A management team with integrity, capability, and an innovative mindset

On integrity

Leading DocuSign as CEO is Daniel Springer, 57, who joined the company in January 2017. Among other key leaders in DocuSign are:

Scott Olrich, Chief Operating Officer, 48
Michael Sheridan, Chief Financial Officer, 55
Loren Alhadeff, Chief Revenue Officer, 41
Kirsten Wolberg, Chief Technology and Operations Officer, 52

Most of them have relatively short tenure with DocuSign, but have collectively clocked decades in senior leadership roles in other technology companies.

DocuSign has opted not to share details about its compensation structure for senior management because of its status as an “emerging growth company.” And Springer’s total compensation for FY2019 was a princely sum of US$13.4 million. But I take heart in this: 94% of Springer’s total compensation in FY2019 came from stock awards, and around 70% of the stock awards vest over a period of four years. The multi-year vesting of the stock awards means that Springer’s compensation is tied to the long run performance of DocuSign’s stock price, which is in turn governed by its business performance. So I think Springer’s interests are aligned with mine as a shareholder of the company.

Notably, Springer also controlled 2.3 million shares of DocuSign as of 31 March 2019, a stake that’s worth a sizable US$211 million at the current share price.

On capability

From FY2013 to FY2020, DocuSign has seen its number of customers increase more than 10-fold (41% per year) from 54,000 to 585,000. So the first thing I note is that DocuSign’s management has a terrific track record of growing its customer count.

*Source: DocuSign June 2018 investor presentation and annual report*

To win customers, DocuSign’s software service offers over 300 pre-built integrations with widely used business applications from other tech giants such as salesforce.com, Oracle, SAP, Google, and more. These third-party applications are mostly in the areas of CRM (customer relationship management), ERP (enterprise resource planning), and HCM (human capital management). DocuSign also has APIs (application programming interfaces) that allow its software to be easily integrated with its customers’ own apps.

I also credit DocuSign’s management with the success that the company has found with its land-and-expand strategy. The strategy starts with the company landing a customer with an initial use case, and then expanding its relationship with the customer through other use cases. The success can be illustrated through DocuSign’s strong dollar-based net retention rates (DBNRRs). The metric is a very important gauge for the health of a SaaS (software-as-a-service) company’s business. It measures the change in revenue from all of DocuSign’s customers a year ago compared to today; it includes positive effects from upsells as well as negative effects from customers who leave or downgrade. Anything more than 100% indicates that the company’s customers, as a group, are spending more – DocuSign’s DBNRRs have been in the low-teens to mid-teens range in the past few years.

*Source: DocuSign IPO prospectus and earnings call transcripts*

On innovation

I think DocuSign’s management scores well on the innovation front, since the company has been busy with using blockchain technology and AI to improve its services.

Blockchain technology is the backbone of cryptocurrencies and DocuSign has been experimenting with blockchain-based smart contracts since 2015. In June 2018, DocuSign joined the Enterprise Ethereum Alliance and showed how a DocuSign agreement can be automatically written onto the Ethereum blockchain. Here’s an example of a smart contract described by DocuSign:

“A smart contract turns a contract into something like a computer program. The Internet-connected program monitors data and triggers actions relevant to the contract’s terms. For example, a crop-insurance smart contract might use a trusted Internet feed of weather data. If the temperature goes above 85 degrees Fahrenheit in April, the smart contract will automatically trigger a crop-insurance payout, again via the Internet. This total automation eliminates ambiguity and promises large savings in time and effort for all parties involved.”

It’s early days for DocuSign’s use of blockchain, but I’m watching its moves here. DocuSign’s management acknowledges that many of the company’s customers don’t yet see the value of blockchain technology in the agreement process. But the company still believes in blockchain’s potential.

DocuSign has been working with AI since at least 2017 when it acquired machine-learning firm Appuri during the year. In February 2020, DocuSign inked an agreement to acquire Seal Software for US$188 million. The acquisition is expected to close in the first half of DocuSign’s FY2021. Seal Software was founded in 2010 and uses AI to analyse contracts. For example, Seal Software can search for legal concepts (and not just keywords) in large collections of documents, and automatically extract and compare critical clauses and terms. Prior to the acquisition, DocuSign was already tacking Seal Software’s services onto DocuSign Agreement Cloud. The combination of Seal Software and DocuSign’s technologies have helped a “large international information-services company” reduce legal-review time by 75%. Ultimately, DocuSign thinks that Seal Software will be able to strengthen DocuSign Agreement Cloud’s AI foundation.

Speaking of DocuSign Agreement Cloud, it was released in March 2019. As mentioned earlier, it includes multiple software services. DocuSign sees DocuSign Agreement Cloud as a new category of cloud software that connects existing cloud services in the realms of marketing, sales, human resources, enterprise resource planning, and more, into agreement processes.

I see two huge positives that come with the introduction of multi-product sales. Firstly, it will likely lead to each DocuSign customer using more of the company’s products. This means that DocuSign could be plugged into an increasing number of its customers’ business processes, resulting in stickier customers. Secondly, DocuSign thinks that covering a wider scope of the entire agreement process could roughly double its market opportunity from the current size of US$25 billion to around US$50 billion.

4. Revenue streams that are recurring in nature, either through contracts or customer-behaviour

DocuSign’s business is built nearly entirely on subscriptions, which generate recurring revenue for the company. Customers of DocuSign gain access to the company’s software platform through a subscription, which typically ranges from one to three years. In FY2020, FY2019, and FY2018, more than 93% of DocuSign’s revenue in each fiscal year came from subscriptions to its cloud-based software platform; the rest of the revenue came from services such as helping the company’s customers deploy its software efficiently.

It’s worth noting too that there is no customer-concentration with DocuSign. There was no customer that accounted for more than 10% of the company’s revenue in FY2020.

5. A proven ability to grow

There isn’t much historical financial data to study for DocuSign, since the company was only listed in April 2018. But I do like what I see:

*Source: DocuSign annual reports and IPO prospectus*

A few notable points from DocuSign’s financials:

DocuSign has compounded its revenue at an impressive annual rate of 40.4% from FY2016 to FY2020. The rate of growth has not slowed much, coming in at a still-impressive 38.9% in FY2020.
DocuSign is still making losses, but the good thing is that it started to generate positive operating cash flow and free cash flow in FY2018.
Annual growth in operating cash flow from FY2018 to FY2020 was strong, at 45.1%. Free cash flow has increased at a much slower pace, but the company is investing for growth.
The company’s balance sheet remained robust throughout the timeframe under study, with significantly more cash and investments than debt.
At first glance, DocuSign’s diluted share count appeared to increase sharply by 30.7% from FY2019 to FY2020. (I only started counting from FY2019 since DocuSign was listed in April 2018, which is in the first quarter of FY2019.) But the number I’m using is the weighted average diluted share count. Right after DocuSign got listed, it had a share count of around 152 million. Moreover, DocuSign’s weighted average diluted share count showed acceptable year-on-year growth rates (acceptable in the context of the company’s rapid revenue growth) in the first, second, and third quarters of FY2020.

*Source: DocuSign quarterly earnings updates*

6. A high likelihood of generating a strong and growing stream of free cash flow in the future

DocuSign has already started to generate free cash flow. Right now, the company has a poor trailing free cash flow margin (free cash flow as a percentage of revenue) of just 4.5%.

But over the long run, I think it’s likely that there is plenty of room for DocuSign’s free cash flow margin to expand. I showed in my recently published investment thesis for Alteryx (NYSE: AYX) that there are other larger SaaS companies such as Adobe, salesforce.com, and Veeva Systems that have much fatter free cash flow margins. Here’s the table I showed in my article on Alteryx:

*Source: Companies’ annual reports and earnings updates (data as of 23 March 2020)*

Valuation

Right now, DocuSign has a market capitalisation of US$14.34 billion against trailing revenue of US$974.0 million. These numbers give rise to a price-to-sales (P/S) ratio of 14.7, which makes the company look pretty darn expensive. For perspective, if I assume that DocuSign has a 30% free cash flow margin today, then the company would have a price-to-free cash flow ratio of 49 based on the current P/S ratio (14.7 divided by 30%).

But DocuSign also has a few strong positives going for it. The company has: (1) revenue that is low compared to a fast-growing addressable market; (2) a business that solves important pain points for customers; (3) a large and rapidly expanding customer base; and (4) sticky customers who have been willing to significantly increase their spending with the company over time. I believe that with these traits, there’s a high chance that DocuSign will continue posting excellent revenue growth – and in turn, excellent free cash flow growth – in the years ahead.

The current high valuation for DocuSign does mean that its share price is likely going to be more volatile than the stock market as a whole. I’m also keeping in mind that stocks have been very volatile of late because of COVID-19 fears. But the potential volatility is something I’m very comfortable with.

The risks involved

DocuSign has a short history in the stock market, given that its IPO was just two years ago in April 2018. I typically stay away from young IPOs. But I’m making an exception for DocuSign because I think its business holds promise for fast-growth for a long period of time. But the company’s young age as a publicly-listed company is still a risk I’m watching.

Adobe is a much larger SaaS company with trailing revenue of US$11.7 billion. Through its Adobe Sign product, Adobe is the primary competitor of DocuSign. So far, DocuSign has defended its turf admirably. This is shown in DocuSign’s strong revenue and customer growth rates. But Adobe’s larger financial might compared to DocuSign means competition is a risk.

Another important risk for DocuSign relates to data breaches. DocuSign handles sensitive information about its customers due to the nature of its business. If there are any serious data breaches in DocuSign’s software services, the company could lose the confidence of customers and the public, leading to growth difficulties. The signing of documents may be highly time-sensitive events. So if there is any significant downtime in DocuSign’s services, it could also lead to an erosion of trust among existing as well as prospective customers. So far, DocuSign has done a great job by providing 99.99% availability in FY2020.

Valuation is another risk to consider. DocuSign’s high P/S ratio means that the market expects rapid growth from the company. So if the business performance disappoints subsequently, market sentiment could turn quickly on DocuSign, leading to a cratering stock price.

Earlier, I discussed the advantages that the launch of DocuSign Agreement Cloud brought to the company. But there are downsides too. For instance, multi-product sales involves higher complexity and a longer sales cycle; these factors negatively affected DocuSign’s billings growth and net dollar-based retention rate in the first quarter of FY2020. The ongoing COVID-19 pandemic has caused business activity around the world to slow tremendously, with many countries being in various states of lockdown. A lengthy sales cycle could hamper DocuSign’s business in the current environment. For now, DocuSign’s business does not seem to have been impacted by COVID-19. Here’s CEO Dan Springer’s comment on the matter in DocuSign’s FY2020 fourth-quarter earnings call:

“[T]he vast majority of our implementations are done remote. And of course, if you think about the perfect example of that it’s our web and mobile customers, where they never actually have to speak. Not only do they don’t have to have us in person they don’t need to speak to us to onboard. … We do find with some of our larger enterprise customers that they get more value when some of the installation is done on their premises. But we have not had the opportunity in the past to consider doing that completely remotely. And it may be in the new way of business over the next X period of time here then we’ll do more of it.”

And when DocuSign’s management was asked in the same earnings call if its growth would be affected by a recession, Springer answered:

“Yes, I don’t. Because, I think, for most of our customers, at least half of the focus is around efficiency. And people see the incredibly high ROI. And I can’t speak for all-digital transformation programs, of course, but as I think about the ones that are DocuSign-centric people are laser-focused on the ROI they get from getting rid of those manual processes, the wasted labor, getting rid of things like the transportation cost, the shipping, et cetera.

That’s a big focus. So I don’t think in a recession you would see people pull back on that. I would say that any time if you had a significant recession, you expect people to kind of shoot first ask questions later and that could lead to some delays. But, in general, we think the business case just gets stronger when people need to find those efficiencies.”

Lastly, the following are all yellow-to-red flags for me regarding DocuSign: (1) The company’s DBNRR comes in at less than 100% for an extended period of time; (2) it fails to increase its number of customers; and (3) it’s unable to convert revenue into free cash flow at a healthy clip in the future.

The Good Investors’ conclusion

Summing up DocuSign, it has:

Valuable cloud-based software services in the agreements space that solves customers’ pain-points;
high levels of recurring revenue;
outstanding revenue growth rates;
positive operating cash flow and free cash flow, with the potential for much higher free cash flow margins in the future;
a large, growing, and mostly untapped addressable market;
an impressive track record of winning customers and increasing their spending; and
capable leaders who are in the same boat as the company’s other shareholders

The company does have a premium valuation, so I’m taking on valuation risk. There are also other risks to note, such as strong competition and a longer sales cycle that may not be conducive for a business environment that’s struggling with COVID-19. But after weighing the pros and cons, I have to agree with the idea of having DocuSign continue to stay in my family’s investment portfolio.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

“Why Are You Confident That Booking Holdings Will Survive The COVID-19 Crisis?”

Booking Holdings is suffering because of the coronavirus, COVID-19. Can the company survive the crisis? I think it can. Here’s why.

A few days ago, I received a text from a friend asking the question that is the title of this article. He knew that Booking Holdings (NASDAQ: BKNG), an online travel agent, is one of the 50-plus companies that’s in my family’s investment portfolio.

Stalled growth

On 18 February 2020, I published my investment thesis on Booking. In it, I wrote that “The world – particularly China – is currently battling COVID-19. If the situation worsens, Booking’s business could be hurt.” Little did I know how badly Booking would suffer. International travel activities have essentially grounded to a halt since the publication of my thesis for Booking, with many countries closing their borders to control the spread of COVID-19.

In particular, the businesses of hotels and airlines across the globe have been crushed. A few days ago, Arne Sorenson, CEO of hotel operator Marriott International, said that the company’s seeing revenue declines of more than 75% in the US. At home, Singapore Airlines cut 96% of its flight capacity last week. Booking, as an online travel agent focusing on accommodations, is also facing a brutal operating environment.

Confidence

What gives me the confidence that Booking can survive? The company is the largest online travel agent in the world. The entire travel industry is awash in pain at the moment. But this also gives Booking the opportunity to win even more market share if some of its smaller/weaker competitors falter.

I believe that the COVID-19 crisis will blow over eventually (hopefully sooner rather than later, so that the incredible human suffering that’s currently happening can end as soon as possible). This will allow the travel industry to return to strength. When this happens, Booking will be in an even stronger position compared to before.

But Booking has to survive from now till then. I think the chances are very good that the company will. At the end of 2019, Booking held US$8.5 billion in cash, short-term investments, and long-term investments (this sum excludes US$3.3 billion in strategic investments) against total debt of US$8.6 billion.

I would prefer Booking to have significantly more cash than debt. But Booking’s debt is mostly long-term in nature (88.5% comes due on or after 31 December 2020). Moreover, the company’s debt has well-staggered maturities as shown in the table below. The earliest due-date for Booking’s long-term debt is September 2021 and it involves a manageable sum of US$1 billion. So there’s plenty of time for Booking to maneuver, and to wait for the travel industry’s health to improve.

No guarantee

But there’s no guarantee that Booking will survive. It could eventually crumble should the travel market undergo a long winter if COVID-19 proves to be a particularly tricky disease to combat. This is where diversification is important.

I mentioned earlier that Booking is one of the 50-plus companies in my family’s investment portfolio. Even if Booking fails to survive, my family’s portfolio will. Diversification is how I guard the portfolio against specific-company risks. With diversification, my family and I are able to stay invested in Booking and participate in its potential recovery without having to worry about a significant hit to the portfolio.

3 Lessons From My Biggest Stock Market Losers

Here are 3 lessons I’ve picked up from my biggest investing mistakes, so that you can benefit from my experience without going through the same pain.

It’s great to learn from our own mistakes. But it’s even better to learn from those of others. COVID-19 has brought extreme market volatility and economic distress to the world. In a time like this, it’s easier for us to make investment mistakes.

I’m here to share the eggs I’ve had on my face in the stock market and what I’ve learnt from them, so that you can benefit from my errors.

The backdrop

I started investing for my immediate family on 26 October 2010. The portfolio I help manage consists of stocks listed in the US market. There are currently over 50 stocks in it.

Some of the biggest losers in the portfolio include Atwood Oceanics, Ford (NYSE: F), Gilead Sciences (NASDAQ: GILD), GoPro (NASDAQ: GPRO), National Oilwell Varco (NYSE: NOV), Tapestry (NYSE: TPR), Under Armour (NYSE: UAA), and Zoe’s Kitchen.

*Source: Yahoo Finance for current prices*

Atwood Oceanics and Zoe’s Kitchen were privatised in October 2017 and November 2018, respectively, and I sold their shares on September 2016 and November 2018. I sold National Oilwell Varco in June 2017. I still own the other stocks mentioned.

Lesson 1: It’s okay to fail if you have the right investment framework

My family’s investment portfolio has clearly had many epic losers. But from 26 October 2010 (the inception of the portfolio) to 29 March 2020, the portfolio has still grown in value by 16.0% annually, without including dividends. This is significantly higher than the S&P 500’s return of 10.7% per year over the same period, with dividends.

*Source: S&P Global Market Intelligence; Google Finance; author’s calculations (from 26 October 2010 to 29 March 2020)*

It’s okay to have multiple failures in your portfolio. There’s an investment framework that I’ve been using for my family’s portfolio for years. It has guided me towards massive winners, such as Netflix (NASDAQ: NFLX), Amazon (NASDAQ: AMZN), and MercadoLibre (NASDAQ: MELI). The winners in the portfolio have more than made up for the losers.

If you’re investing with a sound investment framework, then don’t beat yourself up too hard if some of your stocks are down big. Look at your performance from a portfolio-perspective, and not harp on how each position is doing.

Lesson 2: Diversify smartly, and stay away from commodity-related companies

Atwood Oceanics and National Oilwell Varco are companies in the oil & gas industry. When I invested in them, Atwood was an owner of oil rigs while National Oilwell Varco was supplying the parts and equipment that kept oil rigs running.

They were among my first-ever investments, back when I was a greenhorn in the stock market. I invested in them because I wanted to be diversified according to sectors. I also thought that oil & gas was a sector that is worth investing in since demand for the commodities would likely remain strong for a long time. My views were right, but only to a small extent. I was wrong on two important areas.

First, it is important to be diversified according to sectors (and geography too!). But there are some sectors that are just not worth investing in for the long run because their economic characteristics are poor. For instance, the energy, materials, and transport sectors have historically produced poor returns on invested capital. This is illustrated in the chart below from a 2006 McKinsey report which mapped out the average return on invested capital for various sectors from 1963 to 2004. Charlie Munger, Warren Buffett’s long-time lieutenant, once said:

“Over the long term, it’s hard for a stock to earn a much better return that the business which underlies it earns. If the business earns six percent on capital over forty years and you hold it for that forty years, you’re not going to make much different than a six percent return – even if you originally buy it at a huge discount.”

Second, demand for oil did indeed grow from 2010 to 2016. But oil prices fell significantly over the same period. The trends in oil consumption and oil prices for that period are depicted in the chart below.

The sharp fall in oil prices despite the rising demand illustrates the difficulty in predicting oil prices. In fact, it’s practically impossible. I recently learnt about a presentation that Peter Davies gave in 2007 titled What’s the Value of an Energy Economist? In it, he said that “we cannot forecast oil prices with any degree of accuracy over any period whether short or long.” Back then, Davies was the chief economist of British Petroleum, one of the largest oil & gas companies in the world.

With lower oil prices, the business results and share prices of Atwood Oceanics and National Oilwell Varco plummeted. The chart below shows National Oilwell Varco’s share price and earnings per share from 2010 to 2016 (data for Atwood Oceanics is not available since it’s now a private company). I think the predicament of Atwood Oceanics and National Oilwell Varco can be extrapolated to other commodity-related companies. It’s tough to predict the price movements of commodities; this in turn makes it difficult to have a good grasp on the business results of a commodity-related company over a multi-year period.

Lesson 3: Not selling the losers is as important as not selling the winners

You’ll notice that my family’s portfolio is still holding onto many of the big losers. The sales of Atwood Oceanics and National Oilwell Varco happened because of something that Motley Fool co-founder David Gardner shared a few years ago:

“Make your portfolio reflect your best vision for our future.”

Part of the vision I have for the world is that our energy-needs are entirely provided by renewable sources that do not harm the precious environment we live in. For this reason, I made the rare decision to voluntarily part ways with stocks in my family’s portfolio (referring to Atwood Oceanics and National Oilwell Varco).

I sell stocks very rarely and very slowly. This aversion to selling is by design – because it strengthens my discipline in holding onto the winners in my family’s portfolio. Many investors tend to cut their winners and hold onto their losers. Even in my earliest days as an investor, I recognised the importance of holding onto the winners in driving my family portfolio’s return. Being very slow to sell stocks – even the big losers – has helped me hone the discipline of holding onto the winners. And this discipline has been a very important contributor to the long run performance of my family’s portfolio.

Making Financial Sense Of Singapore Airlines’s Massive Fundraising

Recently, Singapore Airlines announced a complex rights issue and mandatory convertible bonds offering. I’m breaking down the factual numbers.

Singapore Airlines (SGX: C6L) recently announced a massive round of fundraising. In all, Singapore’s national carrier is looking to raise S$15 billion. The first slice of the fundraising involves a S$5.3 billion rights shares issue, and a S$3.5 billion tranche of mandatory convertible bonds (MCBs).

Temasek Holdings is one of the Singapore government’s investment arms and the current major shareholder of Singapore Airlines (SIA) with a 55% stake. It has committed to mop up all the rights shares issue and MCBs that other SIA shareholders do not want.

My blogging partner Jeremy Chia published a wonderful article yesterday. He shared his thoughts on why he’s not interested in investing in SIA despite Temasek’s promise to provide up to S$15 billion in capital. I’m not here to share my thoughts on investing in SIA. Instead, I’m here to provide you with a factual breakdown of the numbers behind SIA’s rights shares issue and MCBs.

I recognise that SIA’s latest fundraising activity is complex, and there’s a lot of confusion about it. I want to help clear the air, to the best of my abilities. The Good Investors exists to demystify investing for you – so here I am!

Details of the rights shares issue of Singapore Airlines

Here are the important numbers concerning SIA’s rights shares issue:

Total sum: S$5.3 billion.
Number of rights shares to be issued: Up to 1.778 billion rights shares to be issued, on the basis of 3 rights shares for every 2 shares of SIA that currently exist. There are 1.185 billion SIA shares that exist right now.
Price per rights share: S$3.00.
Renounceable? Yes, this rights shares issue is renounceable, so you will get to trade the rights.
Changes in SIA’s book value per share (BVPS) and earnings per share (EPS) because of the rights issue: As of 31 December 2019, SIA’s BVPS and trailing-12-months EPS were S$10.25 and S$0.67, respectively. After the rights shares issue, the BVPS will fall to around S$5.89 while the EPS will decline to S$0.27, assuming everything else stays constant.
What you have to effectively pay for SIA’s shares: At the time of writing (11:20 am, 30 March 2020), SIA’s share price is S$5.82. If you subscribe for your full allotment of rights shares, you’re effectively paying a price of S$4.13 per share for SIA’s shares. The math works this way: Effective price per share = [S$5.82 + (S$3.00 x 1.5)] / 2.5.
The effective valuations you’re getting: At an effective share price of S$4.13, SIA will have a price-to-book ratio of 0.7 and a price-to-earnings ratio of 15.

Details of the MCBs of Singapore Airlines

For the MCBs, do note that the total sum SIA is looking for is S$9.7 billion. But the current tranche involves just S$3.5 billion. The key financial numbers for the current tranche of MCBs are as follows:

Total sum: S$3.5 billion.
Number of rights MCBs to be issued: Up to S$3.5 billion, in the denomination of S$1.00 per rights MCB, on the basis of 295 rights MCBs for every 100 shares of SIA that currently exist. As mentioned earlier, there are 1.185 billion SIA shares that exist right now.
Issue price per rights MCB: S$1.00, meaning you’ll pay S$1.00 to purchase each rights MCB.
Renounceable? Yes, this rights MCB issue is renounceable, so you will get to trade the rights.
Maturity date of MCB: 10 years from the date of issue of the rights MCBs.
Conversion terms of MCB: SIA is obliged to convert the rights MCBs into SIA shares when the MCBs mature. The conversion price is S$4.84 per SIA share. When the MCBs are converted at the maturity date (10 years from the date of issue), every S$1,000 worth of the MCBs will “grow” to S$1,806.11. This S$1,806.11 will then be converted into SIA shares at a price of S$4.84 each, giving us 373 SIA shares. The math works this way: Number of shares obtained upon conversion = S$1,806.11 / S$4.84
Redemption terms of the MCB: SIA has the right – but not the obligation – to redeem the MCBs every six months from the date of issue at a certain price, giving you a certain yield. If the MCBs have yet to be redeemed when we hit the 10-year mark from the date of issue, SIA is obliged to convert the MCBs into SIA shares, as mentioned earlier. The redemption prices and yields are given in the table below. Note that you cannot ask for the redemption – it is entirely up to SIA to decide.

What you’re effectively paying for SIA’s shares under the MCB, assuming it is converted: As mentioned earlier, if the MCBs are converted, every S$1,000 in MCBs will be converted into 373 shares. This gives rise to an effective price of S$2.68 per SIA share under the MCB. The math works this way: Effective price paid = S$1,000 / 373 shares.
What you’re effectively paying for SIA’s shares, in all, under the MCB, assuming it is converted: But to get hold of the MCBs, you’ll have to own SIA shares. Every 100 shares has a full allotment of 295 rights MCBs. At the time of writing, SIA’s share price is S$5.82. This works out to an overall effective price of S$3.47 per share. Here’s the math: Overall effective price paid = ([100 x S$5.82) + (295 x S$2.68)] / (100 +295).
Circumstances where you’ll make money on the MCBs alone (ignoring what happens to your SIA stake): There are a few scenarios where you’ll make a profit: (1) SIA redeems the MCBs before they are converted; (2) SIA allows the MCBs to convert into shares 10 years later and SIA’s share price is significantly higher than S$2.68 at that point in time. To be clear, the price of S$2.68 is the price you’re effectively paying for SIA’s shares in the event of the MCBs’ conversion. If SIA’s share price is around S$2.68 at the point of conversion, it’s very likely you’ll be losing money on the MCBs; if SIA’s share price is lower than S$2.68 at the point of conversion, you’ll be losing money on the MCBs.
When is it beneficial for SIA to redeem the MCBs? Redemption of the MCBs will require SIA to fork out cash, which negatively impacts SIA’s financial health. On the other hand, the conversion of the MCBs does not require SIA to dole out any cash. So from this perspective, it’s beneficial for SIA to not redeem the MCBs at all. This is important to note for the MCB holders for cash-flow-planning purposes, since SIA could very well choose not to redeem the MCBs.

Other important points to note

Shareholders of Singapore Airlines can choose to participate in the company’s fundraising activity in one of the following ways:

Subscribe for both the rights issue and rights MCBs
Subscribe for just the rights issue but not the rights MCBs
Subscribe for the rights MCBs but not the rights issue
Do not subscribe for both the rights issue and rights MCBs

If you’re a Singapore Airlines shareholder and you choose the fourth option, you can still recover some capital by selling the rights issues and rights MCBs (both are renounceable, so the rights can be actively traded). But you will face massive dilution, since the airline’s share count will increase significantly.

I hope laying out all these numbers will help you – if you’re a Singapore Airlines shareholder or are interested in its shares and/or MCBs – to make a better-informed decision.

Endowus’s Fight To Give A Better Retirement For Singaporeans

We recently spoke to Singapore-based roboadvisor Endowus and learnt about its desire to solve Singapore’s retirement problem and so much more.

On 13 March 2020, Jeremy and I met Samuel Rhee and Chiam Sheng Shi from Endowus for a long, lovely chat. Sam is Endowus’s Chief Investment Officer, while Sheng Shi is the company’s Personal Finance Lead.

(From left to right in the photo above: Jeremy, myself, Sam, and Sheng Shi)

Endowus is one of the roboadvisors participating in Singapore’s burgeoning fintech landscape. I first came across Endowus about a year ago and was interested to learn more. That’s because the roboadvisor was (and still is) partnering Dimensional Fund Advisors, a fund management company I have long admired for its investing discipline and overall conduct.

Sheng Shi came across The Good Investors recently and reached out to Jeremy and I to find out more. This led to the in-person meeting on 13 March 2020.

Jeremy, Sam, Sheng Shi, and I covered a lot of ground during our conversation. We talked about Endowus’s founding, its investment philosophy, the company’s strong desire to solve the retirement problem for Singaporean investors, the obstacles it had to overcome to build low-cost investment solutions for investors, and more.

I came away from the meeting impressed by Endowus’s team as well as their passion and actions to help investors in Singapore. Jeremy did too. We are all fighting the same good fight. Below is a transcript of our conversation (edited for length and clarity). This is NOT a sponsored post by Endowus. Jeremy and I hope you will enjoy Sam and Sheng Shi’s wisdom and candid sharing as much as we did.

Introduction of Sam and Endowus

Ser Jing:
Could you please give an introduction about yourself?

Samuel:
Okay. I’m Sam. I’ve been working 25 years in the finance industry on the institutional side. I was at Morgan Stanley for 17 years. And the last job I had was at Morgan Stanley Investment Management Asia where I was CEO and CIO and I was there for 13 years. I worked in London and then Hong Kong for about seven years and I’ve now been in Singapore for 15+ years. When I was on the buyside, I did macro, asset allocation, portfolio construction in public equities and mostly Asia and emerging markets. I became the Chief Investment Officer and ran the money in Singapore. Singapore is the headquarters so we ran about 45 billion total. The portfolio that I personally managed was about US$10 billion to US$15 billion, depending on how markets were and I became the CEO for the last four years I was there.

I am the Chief Investment Officer in Endowus. We have this fancy title called Chairman that was bestowed upon me that I don’t really use but it’s there just because I’m the oldest by far.

Ser Jing:
You look really young actually.

Samuel:
Yeah, I’m turning 48. So the next youngest guy is 11 years younger than me in the office.

Ser Jing: You look 40, at most!

Samuel:
I have a babyface (laughs)! I call it the gift of immaturity. I started in ‘94. So I’ve seen many crises. ‘94 was a bad year. ‘97 was the Asian financial crisis. In ‘99 I saw the tech bubble bursting. 2008 was the financial crisis. Then the 2011 Euro crisis. Now we’ve come here and in the midst of another bear market, and we are experiencing 30% falls, which is unprecedented in nature.

Ser Jing:
In terms of the speed, right?

Samuel:
Yeah, we’re at the very early stages of the unfolding of this bear market but it’s unprecedented in speed and that’s because of the nature of the external shock we are facing. We don’t really know how this goes.

Anyway, back to the introduction! I am in charge of the investment office. I strategize the overall investment framework, the investment philosophy, how we execute on that through the best products. So we’re completely product agnostic – we use whatever product is most suitable and cost efficient for our clients, whether it’s unit trusts or ETFs. We are an independent fee-only financial advisor. That’s the constraint that we have put upon ourselves because we don’t want to be paid by anybody else other than the client.

When you define yourself as a fee-only independent financial advisor, the products that are available to you are tremendous. We went with the best passive or passive-plus product, which was Vanguard and Dimensional Fund Advisors. Vanguard was a strategic partner. We were supposed to do work together, but they pulled out of Singapore a few months before we launched. So that was the story. We were excited to launch with Dimensional as it can only be made available through the IFA (independent financial advisory) channel. On the fixed income side we did not like any existing solutions and there were no decent passive products because of the small SGD fixed income market here so we chose the best manager which was PIMCO, which is very well known by institutional clients but not readily available to retail investors.

Ser Jing:
Not even Dimensional for the bonds portion? Because I think MoneyOwl uses them.

Samuel:
They have a short duration and short fixed income product, which is not globally diversified. We want a globally diversified core fixed income product. Dimensional products are suited for what they’re supposed to do, which is short term or short duration and they have other great products that we are trying to bring in.

Ser Jing:
Close to a money market fund?

Samuel:
I think it’s exactly what it is. Short duration and ultra high quality, you know, AA, AAA, treasuries, and sovereigns. And so I think there’s not much credit, not much high yield or emerging markets. I don’t think there’s any, and the term is just really short duration, so short fixed income products. Not global or through the duration spectrum.

We talked to Dimensional about requirements for a core fixed income product and they introduced a fund for us – a global quality bond fund. Unfortunately, their track record is really short. They just launched it last year with a Singapore dollar share class and we are looking to bring that into our portfolio so we are excited about that.

To be honest, in fixed income, active management is not as sinful as equities. Even in equities, I’ve been an active manager so I know that if you do it well you can do well. It’s just that for the average Singaporean investor, can you do it well? If you are a really long term investor, especially with your CPF money, can you do it well and with the transaction costs and limitations involved?

That’s the elephant in the room: Are there enough guys that are delivering consistent returns over the long run net of fees, for CPF and SRS/cash investment? I have outperformed for eight consecutive years as an active manager. I know it can be done. I’ve seen many people around me do it.

We talk about Warren Buffett, Soros, Julian Robertson, and all these guys. They’ll say it’s possible but net of fees, it is difficult. And most retail investors don’t have access. Last year the top five hedge fund managers in the world got paid over a billion. Four of them underperformed the index I think. This doesn’t make sense, this kind of concept. Warren Buffett is actually supportive of the strategy of just buying an index fund. Passive low cost works over the long term. So why fix something that’s not broken?

Endowus’s investment philosophy and how Endowus is different from the rest

Ser Jing:
All good! So next question: What is your investment philosophy like and has it evolved across the years?

Samuel:
Let’s talk about the Endowus investment philosophy. We are trying to build an investment product that is suitable for 90%-plus of Singapore’s population and suitable for investors’ CPF money, long term, for their retirement goals. That’s the primary raison d’etre. The reason for our existence is to solve this generational problem, the retirement pension shortfall. And if you try to do that in Singapore, you can’t do that without CPF cause it’s such a big piece. It’s 37% of your gross monthly income. We can invest that better for Singaporeans. What we want to do is find and build an investment that is suitable for that particular problem.

We want to build a core investment product suitable to everyone, where they can invest 90-100% of their wealth conveniently, securely and in a low cost manner. When I say core, I mean the product that will build upon your long term sustainable returns based on equities and bonds, equities being the riskier growth asset class, which gives you the long term returns. And bonds being your diversifier and stable returns over time.

People compare us with other robo advisors/online platforms and they say we’re active managers and they criticize us for it. I would say that asset allocation (across different asset classes) take precedence over fund choices. The asset allocation has to be strategic and passive. That’s our philosophy. The problem with a lot of robo guys here is that they’re active asset allocators. As an institutional investor, I know that asset allocation represents 80% to 90% of your returns historically depending on the period. You need a strategic long term passive asset allocation and these guys are doing active management based on their whitepapers with backtested numbers which are not real track records. Fundamentally our asset allocation investment philosophy diverges.

The second thing is that we are really focused on the advice piece. We’re not building a product ourselves like the other Robos. We have lots of product guys (fund managers) like Dimensional or Vanguard and so many thousands of managers out there building great products and they have scale. They have expertise and they can build up much better than us.

So for us, we don’t want to focus on the product. We’re not building a product, we’re not competing with any fund managers. So later on, if those (active allocation) guys do fantastically well, they can be on the Endowus platform and they can build it into a portfolio or offer it as a DIY solution.

It has to be strategic asset allocation. And in the execution of that asset allocation, we find the best product and we are agnostic to the structure. It can be an ETF or mutual fund. It doesn’t matter. It’s still the same funds that Vanguard has, say the S&P 500 fund, and Irish domiciled so it is tax efficient. It is the same product. The ETF and the fund are largely the same and we choose the more cost efficient and provide SGD funds as investors should match their assets and liabilities to SGD which is the home currency without taking unnecessary FX risk.

So basically ETFs are just listed and mutual funds are not but they have the same open-ended structure, same fund and cost structure. So this misunderstanding in the market that ETFs are the only way to be low cost, passive, and indexed is wrong. You can be none of those things for ETFs.

An ETF can be actively managed, high cost, and not indexed. So it doesn’t matter that it’s an ETF. You have to look at the underlying fund, what you’re investing in, right? Is it indexed? Is it passive, is it low cost? That’s what we apply. And sometimes ETFs are more expensive than accessing the mutual fund and mutual funds at institutional rates.

As an institutional investor, I know there’s access to funds at a lower cost. If you are an institution you don’t pay all the fees that people talk about. So what Endowus is doing is saying that as an institution we can group-buy for you.

How Endowus chooses the best investment products for investors

Ser Jing:
Why do you choose the funds that you do and not some of the ETFs in the US?

Samuel:
Now one of the problems with the US ETF fund is US dollars. That’s a problem for Singapore investors. Finance 101 is you need to match your assets with liabilities, including your FOREX liability. You should not be taking needless FX transactions when you invest, especially if the FX transaction cost is high like it is in Singapore for a retail investor.

When you convert SGD to USD, taking a hit there in terms of cost and then investing in USD, being exposed to that, and then later on having to bring it back at whatever exchange rate you don’t know. Then you go to the US and you have withholding tax and other things like inheritance tax issues. Bid-ask spreads on certain ETFs, you know, are another 5-10 basis points, which means you lose some when you hit the offer to buy and then again when you hit the bid to sell. This compares to mutual funds that will always be bought and sold on the same NAV [net asset value] and so no spread and no transaction cost, whereas ETFs have brokerage and transaction costs.

So we looked at all these things and concluded that US ETFs are really expensive and are not competitive for non-US investors. SGX-listed ones are in USD too and have huge bid-ask spreads. So for me after assessing the situation and products, we decided to go with Dimensional and PIMCO for our cash products. And for CPF products, we got the first passive Vanguard funds in there. Two of them exclusive to Endowus clients. Being agnostic to products is really important for us to change products if we find better, more efficient products.

We sourced for the best products most suitable for Singaporeans that are tax-efficient. It’s in SGD or in the case of fixed income, it is hedged to the SGD. For example, we are the ones that actually brought in the Dimensional World Equity product into Singapore. They didn’t have a World Equity Fund here, they didn’t have an SGD fund. We seeded and funded it. Before, it wasn’t available.

We also went to PIMCO and said, “Look, you have a global emerging market fund, but there’s no institutional share class and it is not SGD-hedged. Launch it for us and we’ll seed it and we’ll bring it our platform. We want to give it to Singaporean investors” They gave us some conditions and we know we want to do whatever it takes to bring the best product that we ourselves want to invest in. Within three, four weeks it was done. We seeded the SGD-hedged, institutional share class ourselves, and made it available to our clients on our advised portfolios.

So those are the kinds of solutions that we bring to the table, which is very different from everybody else. This is very different from trying to copy the US Robo model, which is to just buy US ETFs, pick off the list, try to get a tax refund later. In our view, this model is very, very fin-light. We pride ourselves in not only being Deep Tech, but also Deep Fin.

Endowus’s bootstrapping and employee-ownership mindset

Ser Jing:
How did Endowus gain the necessary initial capital to work with PIMCO and Dimensional Fund Advisors to seed the funds?

Samuel:
Okay. So the company is partner-funded and employee-owned. So everybody who’s an employee has the opportunity to invest in the company and they do. All of the employees are shareholders and we don’t have any external shareholders now. No VCs or PEs. The partners put up the money to begin the company. Employees put money in too. And the last round that we did, we didn’t even have room for all advisors who want to invest because employees take precedence. That’s how we structured the company. Its called bootstrapping and we’re bootstrapping not only in reality but in terms of our culture as well. That’s how we like it.

Endowus’s partnership with fund managers to bring the best products for investors to investors

Samuel:
And when we go to fund management companies, there is a language most people don’t know how to speak but I do. Fund managers actually are in a tough spot today because passive is taking over active. It’s a hugely competitive space as well. Think about the number of fund managers out there. They’re not future-proofed or prepared for the future. But if you go to them and make a proposition of what Endowus is about, why our values are aligned. We tell them that we’re going to gather assets and then we’re going to put it into the best products like theirs. Their response is immediately “Great. We’d love to work with you. What do you need?” Because for them, we are a digital asset gatherer and we’re free.

But we’re not a Fundsupermart. We’re not just going to put it on the platform. We’re actually gonna screen and go and get the best funds and provide the best-in-class funds at the lowest cost achievable by working with the fund managers directly.

Protecting investors’ interests, and Endowus’s unique cost-rebates to investors

Ser Jing:
You also direct the money into specific funds and don’t charge a trailer fee.

Samuel:
Yes. I mean the trailer fee, the fund manager doesn’t get, we don’t get it, so in our business model everyone’s interest is completely aligned. It’s the distribution guys like the traditional banks and brokers and platforms like iFast who take all of that. It should go to the client but these distribution and platform guys are taking it and lining their pocket. And the fund managers have to pitch and sell to the banks and platforms and brokers – the traditional distribution channels. It’s precisely why Vanguard gave up and left Singapore as they don’t pay trailer fees and it was impossible to get distributed.

The worst problem though is that it is in the end, the investors who get screwed because the best-in-class funds are often under the radar or not available. Vanguard’s best low cost passive funds are not available to retail investors! So the best funds are funds who are not willing to pay high or any trailer fees. Dimensional and Vanguard by philosophy would never pay trailer fees. And we as a philosophy would never take any. Unlike the iFast, Dollardex, DBSs of the world.

Ser Jing:
And I think Dimensional recently struck a deal with Finexis Advisory.

Samuel:
Actually they supply to a bunch of FAs [financial advisors] offline. They have no problem. They just distribute through financial advisors and not directly to retail or through traditional channels. So they have their own model, which is unique.

Vanguard doesn’t do the FA model. Dimensional started and really grew through FAs in the US. It works here as well although it’s not a huge pool but it’s still decent. So Dimensional is slightly different from Vanguard and that’s why they didn’t pull out.

But good fund managers, in general, are very happy to work with us. They don’t want to pay trailer fees anyway. Especially if you are the best quality or best performing. And so it’s perfectly aligned. So we go to them, we speak their language, we tell them why and we tell them there’s nothing in it for us and they just give us the best funds. We partner strategically with all the major fund managers. We have a great relationship with everybody.

We don’t carry everybody’s product. We don’t carry Aberdeen, Standard Life. You know, we don’t carry Wellington, GMO, Pinebridge. All these guys reach out to me and we keep a good relationship because we are always searching for best-in-class products, the most suitable product for Singapore. We will also provide more funds in the future through new services that we have in plan. It will really help investors with better choice, better advice and better price too!

If someone can come up with a better product, we’ll work with them. Amundi for example. We’re doing some work, looking for products – even on the ETF side as they are a leader in ETF cost. That’s the Endowus investment philosophy. Fund due-diligence, fund manager due-diligence, that’s like a lot of the work. We have to screen for the best funds. We have to creatively think about what product is best suited to represent. So if you do an asset allocation and you allocate to a different market, geographically, Global, DM [developed markets], EM [emerging markets], then you try to find the best fit and we don’t want to do specific things like China and Malaysia funds, but more like big blocks that make sense. And you bring it up to an asset allocation that is passive and strategic.

Endowus’s efforts to lower costs for investors

Jeremy:
Is there a criteria that you use to select funds? For instance do the funds you select have a maximum management fee?

Samuel:
So we target all-in fees of 1% or less including our own advice access fee. Our fees are fixed. So for cash, it is 60 basis points [0.60%] going down to 0.25% depending on how much you invest with us. For the CPF and SRS it’s 0.4%. We said from the get-go, “Look, this is retirement, this is helping people’s future and therefore let’s try to start at the lowest possible.” And also it was influenced by the fact that CPF had already announced that their wrap fees are going to go down to 40 basis points by October 2020 and it was at 70 basis points at the moment and 1% before. So we moved way ahead of the curve last year. They delayed that announcement, but we still went with 0.4%. You don’t know if they’re going to execute, but hopefully, they will. But even if they don’t, that’s fine. Then everybody can invest through Endowus!

So 40 basis points. We started with a flat 40 basic fee and we target only an additional 60 basis points total expense ratio for the portfolio. But we couldn’t get them for CPF. There weren’t enough products because CPF has to include the funds and you have to go through a consultant, Mercer, in the process. It takes at least like six, nine months to go through that. And strict definitions of three-year track record, first quartile performance, et cetera, and bonds, even more onerous. And so there are only like 80 funds left on the CPF list and we couldn’t build a very high quality globally diversified low-cost portfolio. So we fixed the low-cost part by thinking creatively again.

Would you believe CPF doesn’t have a single passive fund or global ETF you can access?

Ser Jing:
I did not realise that.

Samuel:
You can only access the Singapore local ETF. And so it’s STI [Straits Times Index] and ABF Singapore Bond ETF and that’s it. So you can’t build a globally diverse portfolio. How do we fix this?

So we went to Vanguard and met with the CEO Charles Lin at the time, and Gerard Lee the CEO of Lion Global. I asked them to help solve the retirement problem here in Singapore together. We gotta fix the CPF issues of high cost, lack of passive product, and we can do it together. So they already have a product. Vanguard supplies and manages the Infinity Series S&P500 and global equities and so we worked together to get it into the CPF-IS included fund list.

The problem though was that the cost of that fund was too high. The headline expense ratio was like 80 basis points and which included a trailer fee and the distribution was charging a sales charge on top of like 1% or more. We felt that that was ridiculous. We wanted to get it cheaper. They initially offered a standard rebate but we needed to get lower to achieve the lowest cost for CPF members and long term investors. So we pushed them until they agreed to get to a really low number. So in the end Vanguard gave us access at 10bps [basis points] and Lion Global’s wrap went down to just 20bps. We are so grateful for their support. They’ve been very value-aligned and tried really hard to get there with us. So total all-in management and wrap were 30 basis points and including expense ratio, gets to closer to 40bps. Compared to the 80bps and 1% sales charge, it’s a meaningful difference to give people a better chance of succeeding in investing. They denominated it in SGD, locally registered, and also put into CPF-IS. And you can’t get that with even cash ETF access, you know? If you look at it from a total all-in cost angle, it’s certainly so much cheaper than US ETFs.

Ser Jing:
This is off the track but I am actually a little bit confused. Why would Lion Global’s wrap services be needed? There seems to be a more elegant solution where Vanguard could just supply it directly?

Samuel:
Well, first of all they pulled out of Singapore. So the plan was for them to do that. In order to do that they have to be qualified for two things. One is they have to be a locally registered licensed retail fund manager, RLFMC, right? So they have to be a registered licensed fund manager. Secondly, they have to be an approved fund manager on the CPF Investment Scheme. So that’s the second step and the third step is you have to get your fund onto the CPF approved list. So there’s three steps and the moment Vanguard pulls out, they can’t do that.

So Lion Global is locally registered as a retail licensed fund manager. They’re approved by CPF as a CPF Investment Scheme fund manager. And the only thing that was left was for them to put it (the Vanguard S&P 500 fund) onto the CPF system. Because they were no longer there, so we needed to put it back and then fix the cost issue. Also, the underlying Vanguard funds do not have an SGD fund. This is the only SGD fund available.

So there was a new guideline that was introduced by CPF Board just as the first passive fund went in that there will be a cap of 50 basis points. That’s the total expense ratio. We are hoping that the total expense ratio will be a single digit fee expense ratio, so our total expense ratio (including the fund management fee) will be 40 or below 50, all in.

So now it’s in, but it’s only allowed and falls below the 50bps guideline because Endowus introduced the industry-first of giving back 100% rebate of trailer fees. So technically the product is still 57.5, but we give 27.5 rebate to get to that 30 basis point management and 40 TER. So it’s well below 50 and a second passive fund that we just put in is the Global Equities fund. So the Vanguard Global Equities. Similarly 18 basis points that Vanguard takes, 20 for Lion Global, and expense ratio of single digit, so all in its less than 48bps TER. So again below 50. So we’re the only ones who can distribute these as the official TER is higher and no one else rebates 100% of the trailer. So that’s the elegant solution. We looked into getting the institutional ones in but we couldn’t. So we tried to still solve it intelligently by putting another product in at low cost.

So those are the things that we could do to improve the product. So those two funds are passive. They are the first two passive funds in CPF and it is part of our portfolio. The only way to access it (for your CPF) is through Endowus. It (the two index funds) makes up the bulk of the equities allocation, which brings down cost dramatically from what we had before and it’s also available for Cash and SRS if you want to at that lower cost too.

Jeremy:
So for the two indexed funds, your clients are paying a 0.9% total expense ratio?

Samuel:
No, the total expense ratio is a concept that exists at the fund level. So that TER is 0.4% and 0.48% for the two funds – below 0.5%. So we’ve included both funds into our globally diversified portfolio. The whole list of funds will be allocated based on your risk appetite. Whether its 100% equity or 60% equity and 40% bonds, or whatever, we will build our globally diversified portfolio. The portfolio fund level fees (the TERs I mention above) vary depending on the risk level you choose, but effectively your all in total cost of investing in Endowus is less than 1%. For CPF and SRS it’s 0.4% to Endowus for all of our advice and access. Then the fund level underlying fee is 50~60bps. Yeah. So especially if you consider the fact that if you try to build that yourself, like right now through iFAST, everything, it’s probably closer to 2%-3% because you have the platform fee and the trailer fee that they take.

Sheng Shi:
We are definitely the lowest cost platform. Even if you get through Fund Supermart, they charge a platform fee. I looked up the cost of buying the same Infinity fund on iFast and they charge 35bps of platform fees on top of the trailer fees they receive which should be at least 27.5bps. So they are getting 62.5bps of fees for just selling a Vanguard passive fund.

Endowus’s founding and how the founders built the team

Ser Jing:
So the next question is how did you and the rest of Endowus’s founding team meet? Tell us more about the conversations that led to Endowus.

Samuel:
It was a pretty simple story. Basically I left Morgan Stanley. I retired from the firm on the condition that I don’t join a competitor, completely retired. And then I took a year out. So it was a sabbatical for me and I worked 23 years straight without a break and Morgan Stanley was 17 years of that. Within Morgan Stanley, I moved a couple of times.

So I’m very unique in the sense that I moved within the same company and any large financial institution is about joining the same department and doing it for the rest of your life. Like investment banking, research, or whatever. I was lucky that Morgan Stanley gave me the opportunity to move around. Anyway after 17 years I left and took the sabbatical. I needed to restore relationships with my wife, my kids, friends, cause I was so busy doing CEO and CIO.

It’s a role that in asset management very rarely is taken together. And it was forced upon me because of circumstances. It was supposed to be a temporary gig, but in reality it ended up being four years. I enjoyed it as it was a new challenge and made me learn a lot more about being a CEO and running a business more holistically. I think it was fun at times but very challenging at the same time as there were a lot of changes from a regulatory perspective, and we had to beef up governance and oversight and risk management. We had to revamp the whole trading team and other changes that were needed. But it was too much and I finally was able to negotiate a very amicable exit.

During my sabbatical, I went to a theological seminary to study theology, especially workplace ministry and things like the biblical interpretation of money. I find these things fascinating and that was really, really fun. And then I took a Stanford NUS International Management course to learn cutting edge management and other skills and during this time I had set up a vehicle to invest in fintech companies, so I had multiple fintech investments across the region. I stopped doing that once I joined Endowus full-time. But my idea was that I wanted to disrupt the pieces of the financial services landscape through the application of technology and innovative new services. The focus was on the biggest pools of financial assets and potential business opportunities that were not being disrupted.

One was, well it was Wealth Tech. The other one is pieces of the investment banking business. So those two verticals are by definition very relationship driven and very old school. There’s not much innovation, there’s nothing new really happening. There’s no technology being applied. And so those two were the space. I thought wealth was like true to my heart. I have a passion for solving retirement issues. The pension problem is the single biggest generational challenge. It’s like a major problem, not only in Singapore but Korea and other major aging countries.

So I was driven by this mission and I looked at all the robo guys, including the ones in Singapore at the time. There were also four guys in Korea. Hong Kong, Taiwanese, Australia, etc. I actually didn’t want to invest in any of them. And the reason is simple: They’re all product guys. They all have fund management licenses and were building product but just using ETFs instead of underlying securities so you have double layer of fees and inefficient structures. And I wanted to focus more on the value added piece, which I felt was going to be the advice piece and especially retirement related.

That is the more value-added piece and I believe long-term, advice wins. So we need to build an advice company and there are a few guys in the US that were doing robo retirement – like Bloom and some of these guys. So I wanted to do something in that space, retirement and advice. And I was thinking about starting my own company. The biggest one in Korea actually offered me to build that in Asia Pacific. They wanted to back me and give me the freedom to own it and build it. But the values and the ways you were looking at their investments just were not aligned. They will try to build algorithms to outperform. Right? So it’s product again. That was when a friend who runs a VC fund introduced me to You Ning and he said, “Oh Sam, you’re doing fintech. I have a guy who is doing fintech, you guys should meet.” That was it.

So I met You Ning first and we have common connections. So we hit it off from the get go. We were excited that we were so similar in the way we were thinking about things and how it should be different from the simple roboadvisors out there. He had incorporated the company with Greg and started Endowus and had focused on the CPF piece which was the catch for me as CPF is about retirement – or should be.

You Ning’s background was at Goldman Sachs investment banking. He did private equity, was at a hedge fund for a little bit, and then he ran the family office of Mr. Kuok, the founder of Wilmar. But a lot of it was private investments, so he thought my public market background would be a great fit. And then Greg did fund structuring and distribution at UBS, for private equity and venture cap. He also began the payment service at Grab when it was Grabtaxi and only cash!

So they didn’t have that public market expertise, which was what they needed. They wanted to get a CIO, they wanted to get my advice or mentorship kind of thing. And it kind of all came together. So my thing was, “Do I just become an investor or become an entrepreneur and join full time?” And that’s when I thought this group makes a good fit for me to be the older balance and the investment person for the team. Greg, who’s done Grab and payments and who’s actually built product was focused on the COO role. So he’s the product guy. And then You Ning brings the type of market expertise and private markets knowledge but is also meticulous, so You Ning has the CFO role. And then I was a CIO. So functionally those were the three divisions and it was a great fit to build out the company in a robust way. And I really build the investment side of the business. Whether it’s partnerships with FMCs [fund management companies], due diligence on the funds themselves, and building out portfolios to express the strategic asset allocation. So we all had like very defined contributions, very defined roles. And it was a perfect fit and personality wise and we work really well together. So that’s how we came together.

Ser Jing:
Thanks for sharing that. Because when I was looking through the founding team, I was just thinking you have these two seemingly very experienced investors, so how do you decide who gets to do what?

Samuel:
The fourth important piece of the founding team was Sin Ting. So I met them at the end of ‘17 beginning of ‘18. And I officially joined in February of ‘18. Sin Ting joined just before me in November of ‘17. Sin Ting is the other partner – I guess, cofounder as well. We came together as a team and we were licensed in January of 2018 and we started managing money from April and launched our platform in August of 2018 and our retail launch was April 2019.

She has a private banking background. So she was at Morgan Stanley in private banking and then she worked in Nomura private banking. So the other piece is the wealth piece, right? So I’m institutional, we’re all institutional. COO, CIO, so Sin Ting is the Chief Client Officer with private banking experience. Sin Ting fits that bill. Client Facing, client interaction, what clients want, how they should be served. The client experience is very important.

Ser Jing:
So she has a lot of input on how the product should be for the client.

Samuel:
Yeah, she’s the client advocate. So she faces the client and runs the client team where we have 6 registered reps and then she gives feedback to the investment product and tech product and feeds into how the product should be structured.

Obviously, it’s a group thing. You get everybody’s contributions and now Sheng Shi is also on board. He is a rep and he is client-facing, but he also reaches out to the community and videos and blogs and he’s our personal finance lead. He does a lot of wonderful grassroots work in the community and interfaces and partners with CPF Board for example.

Sin Ting leads the more high net worth kind of private banking. We have another person, Lean Sing who was from Citi Gold, so more mass-wealth kind of expertise. And he is great with our clients at the mass wealth all the way up to high net worth clients and really provides value-added advice to clients. He worked in finance and also went for a few years to study Theology and served at a church and came back to finance with us at Endowus as he believed in our values and vision. So we have really been very purposeful in building out the team and filling the gaps.

When you’re building a tech product, you can’t just build a financial services tech product. You’ve got to have deep financial services expertise. So the domain knowledge is very deep. You have to know the trade flows, you know exactly how things are executed, what investment products actually do, how they should be. How to find the best products. Think about tax, FX, and costs and things that others don’t know or don’t think about. So you need to rely on people who’ve had experience and are capable of doing that.We all have a wealth of knowledge and experience in the field that we are in and the clients that we are serving.

So our tech team is actually, it’s like the Avengers, it’s like guys who know finance, guys who know tech, and can build products. We don’t need superfluous stuff or a humongous team. We just need a dedicated team that has the expertise, like 10 people that can do it. Execute. That’s it. We built all the technology in-house and our team has really deep expertise and experience in building out our tech team. Our CTO Joo was at Goldman Sachs Asset Management and UBS and a few other financial firms building trading systems and complex tech platforms. He also built the backend of Stashaway. He has grown into an amazing CTO now leading the team for us. John and Jay, the front and back end leads, are amazing as is our Dev Ops CY. We brought in our Chief Product Officer from Silicon Valley – Jx Lye – amazing guy with great experience and will help take our product to the next level. So we are excited about our tech and product too.

Ser Jing:
So you have your own in-house software development.

Samuel:
Completely. Yeah. That’s why they are called the A team, the Avengers team and we are the B team, the business team. We are confident we have built the most cutting edge and flexible WealthTech platform in not just Singapore but all of Asia. It’s an amazing product.

Endowus’s greatest challenge

Ser Jing:
I’m mindful of time, I’m sorry. So maybe I’ll just ask two or three more questions. I think this one can be very important for individual investors in Singapore. What do you think is Endowus’s greatest challenge in trying to become a lasting investing institute for investors?

Samuel:
There’s a purpose for why we wanted to go in specifically with the goal of trying to to help solve retirement. Helping people secure their financial future, helping people to save and invest, to prepare for their life better. All those things, right? Grand phrases and captions but hollow words unless we can really help people’s lives in a meaningful way.

The most important thing is that I think clients need to buy into the idea of investing their CPF. And that’s a tough challenge. And the reason is that historically people have been told, your CPF is for this and this and it’s not just a retirement solution. It’s really a total social security system. And OA is always for housing, right? That’s what people instinctively think. OA is for housing. You have a retirement piece (retirement account). You have SA [Special Account], MediSave (medical cover) so it solves everything.

But the problem is that housing, I mean really as an investor, and I don’t know if you agree, but housing is probably a poor asset allocation to me at this point in time in this cycle. And equities have corrected 30% but housing has not even begun. So if you look at the opportunity for capital gains, if you look at the fact that it’s a low yielding asset class, and if you look at the fact that if you use your OA, especially for an HDB 99-year lease, it is not an efficient investment.

What you should do with your OA, because your SA is giving 4% to 5%, you should think of this piece as your bond allocation. And use your OA which is giving you just 2.5% (which by the way is not really guaranteed long term) and barely above inflation. Rather than using that for a house, you should really try to invest as much of it as your long term equities allocation. Build returns over the long run and build that for retirement. And it’s perfect for that purpose as it’s locked away and you cannot touch it for 20, 30, 40 years and you save regularly into it as a regular savings plan and it’s a meaningful enough chunk of it. The recent market correction is the right time to start thinking and using this. The problem has been that the costs have been too high and so outcomes have been poor or you get suckered into terrible ILP products. But now with Endowus you can get a globally diversified portfolio for the long term at really low cost which raises your chances of success.

The other reason is that your retirement adequacy is not enough. Even the enhanced retirement sum under CPF is not enough. It’s probably gonna be around $1,500 to $2,000 a month. So it’s just basically not enough to live in Singapore with the inflation rate that exists. So you need to do more and if your retirement account is not enough, your OA (ordinary account) is basically your backup plan, right? And so you need to build it up in a meaningful way. My friend Loo Cheng Chuan talks about 1M65 alot but together with his wife, he thinks if he uses Endowus and invests his OA then he can get to 4M65, that’s 4 million by the time he is 65, which is amazing. That’s the power of investing your CPF.

But the problem is no one knows of this fact and it takes time to change long-held beliefs. That’s the education piece and that’s the biggest challenge that we face. We do a lot of financial literacy and education, and hold events and webinars, but it takes time. And the incumbent banks and platforms are not helping much. Even if we fail, if we can change the way these guys run their business so they lower fees and improve access to individual investors and provide better advice because of the competition we bring then we would have done our job. We are David and they are Goliath in this fight.

But we know it is the right thing. We’re up for the challenge and we’ll do it, but it’s a long haul and it’s going to be a tough ask and it’s going to take a long time. But we’re fine. Time is on our side and we’re patient entrepreneurs, so we’ll keep at it because we know we’re doing the right thing.

Ser Jing:
Fantastic! I guess this is a really good point to end the conversation. Thank you for your time.

Why I Own Alteryx Shares

Alteryx has only been in my family’s portfolio for a short time, but it has not done well for us. Here’s why we continue to own Alteryx.

Alteryx (NYSE: AYX) is one of the 50-plus companies that’s in my family’s portfolio. I first bought Alteryx shares for the portfolio in September 2019 at a price of US$118 and I’ve not sold any of the shares I’ve bought.

The purchase has not worked out well for my family’s portfolio thus far, with Alteryx’s share price being around US$98 now. But we’ve not even owned the company’s shares for a year, and it is always important to think about how the company’s business will evolve going forward. What follows is my thesis for why I still continue to hold Alteryx shares.

Company description

Alteryx provides a self-service subscription-based software platform that allows organisations to easily scrub and blend data from multiple sources and perform sophisticated analysis to obtain actionable insights.

The company’s platform can interact with nearly all data sources. These include traditional databases offered by the likes of IBM, Oracle, and SAP, as well as newer offerings such as those from MongoDB, Amazon Web Services, Google Analytics, and even social media.

Once data from different sources are fed into Alteryx’s platform, it cleans and blends the data. Users can easily build configurable and sophisticated analytical workflows on the platform through drag-and-drop tools. The workflows can be easily automated and shared within the users’ organisation, and the results can be displayed through Alteryx’s integrations with data-visualisation software from companies such as Tableau Software and Qlik. Here’s a chart showing the various use cases for Alteryx’s data analytics platform:

*Source: Alteryx June 2019 investor presentation*

At the end of 2019, Alteryx had around 6,100 customers, of all sizes, in more than 90 countries. These customers come from a wide variety of industries and include more than 700 of the Global 2000 companies. The Global 2000 is compiled by Forbes and it’s a list of the top 2,000 public-listed companies in the world ranked according to a combination of their revenue, profits, assets, and market value. With thousands of customers, it’s no surprise that Alteryx does not have any customer concentration – no single customer accounted for more than 10% of the company’s revenue in the three years through 2019. The graphic below illustrates the diversity of Alteryx’s customer base:

*Source: Alteryx 2019 fourth-quarter earnings presentation*

Despite having customers in over 90 countries, Alteryx is currently still a US-centric company. In 2019, 71% of its revenue came from the US. The UK is the only other country that accounted for more than 10% of Alteryx’s revenue in 2019 (10.7%).

Investment thesis

I had previously laid out my six-criteria investment framework in The Good Investors. I will use the same framework to describe my investment thesis for Alteryx.

1. Revenues that are small in relation to a large and/or growing market, or revenues that are large in a fast-growing market

Alteryx earned US$417.9 million in revenue in 2019. This is significantly lower than the US$73 billion addressable market that the company is currently seeing. It comprises two parts:

US$49 billion in the global big data and analytics software market (according to a July 2017 IDC report) which includes the US$28 billion global analytics and business intelligence market (according to a January 2019 Gartner report)
A US$24 billion slice, based on Alteryx’s estimate of the spend associated with 47 million spreadsheet users worldwide who worked on advanced data preparation and analytics in 2018 (according to an April 2019 IDC report)

I believe that better days are ahead for Alteryx for a few reasons:

I mentioned earlier that the company’s data analytics platform can interact with nearly all data sources. This interactivity is important. A 2015 Harvard Business Review study sponsored by Alteryx found that 64% of organizations use five or more sources of data for analytics.
Market researcher IDC predicted in late 2018 that the quantity of data in the world (generated, captured, and replicated) would compound at an astounding rate of 61% per year, from 33 zettabytes then to 175 zettabytes in 2025. That’s staggering. 1 zettabyte equals to 10¹² gigabytes.
A 2013 survey on more than 400 companies by business consultancy group Bain found that only 4% of them had the appropriate human and technological assets to derive meaningful insights from their data. In fact, Alteryx’s primary competitors are manual processes performed on spreadsheets, or custom-built approaches. These traditional methods for data analysis involve multiple steps, require the support of technical teams, and are slow (see chart below).
Crucially, Alteryx’s self-service data analytics platform is scalable, efficient, and can be mastered and used by analysts with no coding skill or experience. I think this leads to a few good things for Alteryx. First, it democratises access to sophisticated data analytics for companies, and hence opens up Alteryx’s market opportunity. Second, it places Alteryx’s platform in a sweet spot of riding on a growing trend (the explosion in data generated) as well as addressing a pain-point for many organisations (the lack of resources to analyse data, and the laborious way that data analysis is traditionally done).

(Traditional way to perform data analysis)

2. A strong balance sheet with minimal or a reasonable amount of debt

As of 31 December 2019, Alteryx held US$974.9 million in cash, short-term investments, and long-term investments. This is comfortably higher than the company’s total debt of US$698.5 million (all of which are convertible notes).

3. A management team with integrity, capability, and an innovative mindset

On integrity

Alteryx was listed in March 2017, so there’s only a short history to study when it comes to management. But I do like what I see.

The company was founded in 1997. One of its co-founders, Dean Stoecker, 63, has held the roles of CEO and chairman since its establishment. Another of Alteryx’s co-founders is 57-year-old Olivia Duane Adams, the company’s current chief customer officer. The third co-founder, Ned Harding, 52, was a key technology leader in the company and left in July 2018; he remains an advisor to Alteryx’s software engineering teams. The company’s chief technology officer role is currently filled by Derek Knudsen, 46. He stepped into the position in August 2018 after Harding’s departure. Knudsen had accumulated over 20 years of experience working with technology in companies in senior leadership positions before joining Alteryx.

Stoecker and Duane Adams collectively controlled nearly 10 million Alteryx shares as of 31 March 2019. These shares are worth around US$980 million at the company’s current share price of US$98. That’s a large stake and it likely aligns the interests of Stoecker and Duane Adams’ with Alteryx’s other shareholders.

Alteryx has two share classes: (1) The publicly-traded Class A shares with 1 voting right per share; and (2) the non-traded Class B shares with 10 voting rights each. Stoecker and Duane Adams’ Alteryx shares were mostly of the Class B variety. So, they controlled 47.9% of the voting power in the company despite holding only 16% of the total shares. Collectively, Alteryx’s key leaders controlled 54.1% of the company’s voting rights as of 31 March 2019.

Having clear control over Alteryx means that management can easily implement compensation plans that fatten themselves at the expense of shareholders. The good thing is that the compensation structure for Alteryx’s management looks sensible to me.

In 2018, 70% to 79.7% of the compensation of Alteryx’s management team came from long-term incentives. These incentives include restricted stock units (RSUs) and stock options that vest over multi-year periods. There is room for some misalignment to creep in though – as far as I can tell, there is no clear description given by Alteryx on the performance metrics that management must meet in order to earn their compensation. But I don’t see this as a dealbreaker. Because of the multi-year vesting period for the RSUs and stock options, Alteryx’s management will do well over time only if the share price does well – and the share price will do well only if the business does well. From this perspective, the interests of management and shareholders are still well-aligned.

On capability and innovation

Alteryx’s business has changed dramatically over time since its founding. In its early days, the company was selling software for analysing demographics. Alteryx’s current core data analytics software platform was launched only in 2010, and a subscription model was introduced relatively recently in 2013. I see Alteryx’s long and winding journey to success as a sign of the founders’ ability to adapt and innovate.

I also credit Alteryx’s management with the success that the company has found in the land-and-expand strategy. The strategy starts with the company landing a customer with an initial use case, and then expanding its relationship with the customer through other use cases. The success can be illustrated through Alteryx’s impressive dollar-based net expansion rates (DBNERs). The metric is a very important gauge for the health of a SaaS (software-as-a-service) company’s business. It measures the change in revenue from all the company’s customers a year ago compared to today; it includes positive effects from upsells as well as negative effects from customers who leave or downgrade. Anything more than 100% indicates that the company’s customers, as a group, are spending more.

Alteryx’s DBNER has been more than 120% in each of the last 20 quarters – that’s five years! The chart below illustrates Alteryx’s DBNER going back to 2017’s first quarter.

Alteryx’s management has also led impressive customer-growth at the company. The company’s customer count has more than quadrupled from 1,398 at the end of 2015 to 6,087 at the end of 2019.

But there is a key area where Alteryx’s management falls short: The company’s culture. Alteryx has a 3.5-star rating on Glassdoor, and only 65% of reviewers will recommend Alteryx to friends. Stoecker only has an 85% approval rating as CEO. SAP, a competitor of Alteryx, has 4.5 stars on Glassdoor, and recommendation and CEO-approval ratings of 93% and 97%, respectively. Alteryx has managed to post impressive business-results despite its relatively poor culture, but I’m keeping an eye on things here.

4. Revenue streams that are recurring in nature, either through contracts or customer-behaviour

Alteryx’s business is built nearly entirely on subscriptions, which generate recurring revenue for the company. The company sells access to its data analytics platform through subscriptions, which typically range from one to three years. In 2019, 2018, 2017, and 2016, more than 95% of Alteryx’s revenue in each year came from subscriptions to its platform; the rest of the revenue came from training and consulting services, among others.

5. A proven ability to grow

There isn’t much historical financial data to study for Alteryx, since the company was listed only in March 2017. But I do like what I see.

*Source: Alteryx IPO prospectus and annual reports*

A few key points to note:

Alteryx has compounded its revenue at an impressive annual rate of 61.6% from 2014 to 2019. The astounding revenue growth of 92.7% in 2018 was partly the result of Alteryx adopting new accounting rules in the year. Alteryx’s revenue for 2018 would have been US$204.3 million after adjusting for the impact of the accounting rule, representing slower-but-still-impressive top-line growth of 55.2% for the year. 2019 saw the company maintain breakneck growth, with its revenue up by 64.8%.
Alteryx started making a profit in 2018, and also generated positive operating cash flow and free cash flow in 2017, 2018, and 2019.
Annual growth in operating cash flow and free cash flow from 2017 to 2019 was strong at 33.8% and 21.4%, respectively.
The company’s balance sheet remained robust throughout the timeframe under study, with significantly more cash and investments than debt.
At first glance, Alteryx’s diluted share count appeared to increase sharply by 22.1% from 2017 to 2018. But the number I’m using is the weighted average diluted share count. Right after Alteryx got listed in March 2017, it had a share count of around 57 million. This means that the increase in 2018 was milder (in the mid-teens range) though still higher than I would like it to be. The good news is that the diluted share count inched up by only 6% in 2019, which is acceptable, given the company’s rapid growth. I will be keeping an eye on Alteryx’s dilution.

6. A high likelihood of generating a strong and growing stream of free cash flow in the future

Alteryx has already started to generate free cash flow. Right now, the company has a poor trailing free cash flow margin (free cash flow as a percentage of revenue) of just 5.4%.

But over the long run, Alteryx expects to generate a strong free cash flow margin of 30% to 35%. I think this is a realistic and achievable target. There are other larger SaaS companies such as Adobe, salesforce.com, and Veeva Systems (my family’s portfolio owns shares in all three companies too) with a free cash flow margin around that range or higher.

*Source: Companies’ annual reports and earnings updates*

Valuation

You should get some tissue ready… because Alteryx’s shares have a nosebleed valuation. At a share price of US$98, Alteryx carries a trailing price-to-sales (P/S) ratio of 16.1. This P/S ratio is in the middle-range of where it has been since Alteryx’s IPO in March 2017 (see chart below). But the P/S ratio of 16.1 is still considered high. For perspective, if I assume that Alteryx has a 30% free cash flow margin today, then the company would have a price-to-free cash flow ratio of 54 based on the current P/S ratio (16.1 divided by 30%).

But Alteryx also has a few strong positives going for it. The company has: (1) a huge addressable market in relation to its revenue; (2) a large and rapidly expanding customer base; and (3) very sticky customers who have been willing to significantly increase their spending with the company over time. I believe that with these traits, there’s a high chance that Alteryx will continue posting excellent revenue growth – and in turn, excellent free cash flow growth – in the years ahead.

The current high valuation for Alteryx does mean that its share price is likely going to be more volatile than the stock market as a whole (I’m also keeping in mind that stocks have been very volatile of late because of COVID-19 fears). But the potential volatility is something I’m very comfortable with.

The risks involved

I see a few key risks in Alteryx, with the high valuation being one. Besides introducing volatility (which I don’t see as a risk), Alteryx’s high valuation means that the market has high expectations for the company’s future growth. If Alteryx stumbles along the way, its share price will be punished. With COVID-19 causing widespread slowdowns in business activity across the world, there may be a global recession in the works. Should it happen, Alteryx may find it tough to grow its business.

Competition is another important risk. I mentioned earlier that Alteryx’s primary competitors are spreadsheets, or custom-built approaches. But the company’s data analytics platform is also competing against services from other technology heavyweights with much stronger financial resources, such as International Business Machines, Microsoft, Oracle, and SAP. Providers of data visualisation software, such as Tableau, could also decide to move upstream and budge into Alteryx’s space. To date, Alteryx has dealt with competition admirably – its quarterly DBNERs and growth in customer numbers are impressive. I’m watching these two metrics to observe how the company is faring against competitors.

Two other key risks deal with hacking and downtime in Alteryx’s services. The company’s platform is important for users, since it is used to crunch data to derive actionable insights; it is also likely that Alteryx’s platform is constantly fed with sensitive information of its users. Should there be a data breach on the platform, and/or if the platform stops working for extended periods of time, Alteryx could lose the confidence of its customers.

Then there’s also succession risk with Alteryx. Dean Stoecker, the company’s co-founder and CEO, is already 63. Should he step down in the future, I will keep an eye on the leadership transition.

Lastly, the following are all yellow-to-red flags for me regarding Alteryx: (1) The company’s DBNER comes in at less than 100% for an extended period of time; (2) it fails to increase its number of customers; and (3) it’s unable to convert revenue into free cash flow at a healthy clip in the future.

The Good Investors’ conclusion

Summing up Alteryx, it has:

A valuable self-service data analytics platform that addresses customers’ pain-points and is superior to legacy methods for data analysis;
high levels of recurring revenue;
outstanding revenue growth rates;
positive profit and free cash flow, with the potential for much higher free cash flow margins in the future;
a large and mostly untapped addressable market;
an impressive track record of winning customers and increasing their spending; and
capable leaders who are in the same boat as the company’s other shareholders

The company does have a premium valuation, so I’m taking on valuation risk. There are also other risks to note, such as tough competition and succession. But after analysing all the data on Alteryx’s pros and cons, I’m happy for my family’s portfolio to continue owning the company’s shares.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

Freediving & Investing

I’m extending a helping hand to those who are panicking or feeling stressed over the recent market volatility because of fears over COVID-19.

Freediving is the sport of diving underwater that relies on holding our breath without any breathing apparatus. Professional freedivers have been known to descend to depths of 100 metres or more on one single breath. It’s truly a sight to behold on what the human body can achieve.

I went to a freediving trial a few years ago in a deep swimming pool in Singapore. During the session, I was taught that when we hold our breath, a long gap actually exists between the time when our urge to breathe kicks in and the time when we actually do need to breathe. The information was interesting to me, so I’ve remembered it till now.

A few days ago, I went for a swim in the morning. While swimming, I tried extending the number of breast-stroke repetitions I could do while underwater. But try as I might, I couldn’t. I knew, logically, that my body would not be physically harmed even if I continued holding my breath for an extended period of time after the urge to breathe kicks in. But the urge was too strong. Each time it appeared, I gave in to it after a few short seconds. I couldn’t fight the visceral urge. After I stopped my swim, a light bulb went on in my head. I saw a link between investing and freediving.

Freediving requires us to fight the visceral urge to breathe when holding our breath. But it is difficult to do so, even if we have all the right analysis and understand the logic. I knew I would be fine and that my body did not have to breathe at that instant. But my body was screaming at me to surface from the water and take in some air.

Investing requires us to fight the visceral urge to capitulate when bear markets inevitably occur. But it is difficult to do so even if we have all the right analysis and understand the logic. Our brains will be screaming at us to sell when stocks are falling, even if we understand that we are going to be fine over the long run just leaving our portfolios as they are (assuming they were well-constructed from the start).

So what can we do?

We can train our bodies to hold our breath for long periods of time – there are well-documented methods.

I don’t know what the solution is for investing. But I’m hopeful that those of us who are susceptible to panic during bear markets can find some relief if someone can provide an empathetic listening ear and useful context when they occur. The current volatility in stocks – because of fears over the coronavirus, COVID-19 – means that many of us are likely enduring our brains screaming at us to sell. I want to help.

I have a long article sharing the useful context. The Singapore-based roboadvisor Endowus also put out a wonderful video recently sharing even more context. You can contact me at thegoodinvestors@gmail.com too. I cannot give financial advice, but I can perhaps help you deal with your investing-related emotions in a more constructive manner. You’re not in this alone.

9 Key Reminders For The Recent Market Turmoil

Amidst the market volatility and societal turmoil from the coronavirus, COVID-19, here are some important reminders for us as investors.

Stocks around the world have been incredibly volatile in recent weeks because of the new coronavirus, COVID-19. All over the world, business activity has slowed, large-scale gatherings of people have been cancelled, planes are grounded, hotels are empty, people are quarantined, and healthcare systems are pushed to their limits. Recessionary fears are also rampant.

Amidst the market and societal turmoil, I want to share some important investing-related reminders for all of us to provide context, soothe fraying nerves, and be a voice of calm, reason, and peace.

But before I get there, I want to stress this: COVID-19 or no COVID-19, recession or no recession, I am not changing the way I am investing. Regardless of how COVID-19 or the global economy develops, the stock market is still a place to buy and sell pieces of a business. This also means that a stock will do well eventually if its business does well. So I will continue looking for companies that excel according to my investing framework, and investing in their shares for the long run.

On to the update…!

1. Recessions are normal

The chart below shows all the recessions (the dark grey bars) in the US since 1871. You can see that recessions in the country – from whatever causes – have been regular occurrences even in relatively modern times. They are par for the course, even for a mighty economy like the US.

*Source:* *National Bureau of Economic Research*

The following logarithmic chart shows the performance of the S&P 500 (including dividends) from January 1871 to February 2020. It turns out that US stocks have done exceedingly well over the past 149 years (up 46,459,412% in total including dividends, or 9.2% per year) despite the US economy encountering numerous recessions. If you’re investing for the long run, recessions can hurt over the short-term, but they’re nothing to fear.

*Source: Robert Shiller* *data; National Bureau of Economic Research*

2. The stock market has regularly seen serious short-term losses while on its way to earning great long-term returns

Between 1928 and 2013, the S&P 500 had, on average, fallen by 10% once every 11 months; 20% every two years; 30% every decade; and 50% two to three times per century. So stocks have declined regularly. But over the same period, the S&P 500 also climbed by 283,282% in all (including dividends), or 9.8% per year. Volatility in stocks is a feature, not a bug.

In fact, stocks have also experienced brutal one-day drops that – with the proper perspective – turn out to be blips.

Some market commentators have labelled 9 March 2020 as Black Monday because the S&P 500 fell by 7.6% that day. But that is nothing compared to the historical Black Monday – on 19 October 1987, the S&P 500 plunged by 20.5%. To make matters worse, the index was already down by 10.1% in the three days preceding 19 October 1987. So in four trading days – from the close on 13 October 1987 to 19 October 1987 – US stocks were down by 28.5% in all.

Black Monday (the historical one) was a harrowing experience for those who lived through it. But here’s the thing: From 13 October 1987 (before Black Monday happened) to 9 March 2020, the S&P 500 was up by 773% in total, or 6.9% per year. With dividends, the S&P 500 was up by around 2,100%, or 10.0% annually.

From an individual stock perspective, we can also look at the US e-commerce giant Amazon (NASDAQ: AMZN). The company (which is in my family’s investment portfolio) was a massive long-term winner from 1997 to 2018, with its share price rising by more than 76,000% from US$1.96 to US$1,501.97. But in the same timeframe, Amazon’s share price also experienced a double-digit top-to-bottom fall in every single year (the declines ranged from 13% to 83%).

*Source: S&P Global Market Intelligence*

One of my favourite finance writers is Morgan Housel. In an April 2019 blog post, he brilliantly articulated a concept that I’ve held in my mind for a long time: Instead of seeing short-term volatility in the stock market as a fine, think of it as a fee for something worthwhile. The stock market has produced good to great returns over the long-term. But it demands an admission fee. And the admission fee is what we’re currently experiencing.

3. Recessions and market crashes are inevitable

The late Hyman Minsky was an obscure economist when he was alive. But his ideas flourished after the Great Financial Crisis of 2007-09.

That’s because he had a framework for understanding why markets and economies go through inevitable boom-bust cycles. According to Minsky’s then radical view, stability itself is destabilising. When an economy is stable and growing, people feel safe. And when people feel safe, they take on more risk, such as borrowing more. This leads to the system becoming fragile.

The same goes for stocks. Let’s assume that stocks are guaranteed to grow by 9% per year. The only logical result would be that people would keep paying up for stocks, till the point that stocks become way too expensive to return 9% a year. Or people will take on too much risk, such as taking on debt to buy stocks.

But bad things happen in the real world and they happen often. And when stocks are priced for perfection, bad news will lead to lower stock prices.

4. There is always something to worry about

Peter Lynch, the legendary manager of the Fidelity Magellan Fund from 1977 to 1990, once said that “there is always something to worry about.” How true. The table below, constructed partially from Morgan Housel’s data, shows that the world had experienced multiple crises in every single year from 1990 to 2019.

But over the same period, US stocks were still up by nearly 800% after factoring in dividends and inflation.

COVID-19 is not the first deadly disease outbreak the world has faced. But global stocks have registered solid long-term gains despite multiple occurrences of epidemics/pandemics in the past. The chart below shows the performance of the MSCI World Index (a benchmark for global stocks) from 1970 to January 2020 against the backdrop of the various epidemics/pandemics we’ve experienced in the past 50 years.

5. Don’t invest in stocks with money that you will need within five years, at least; also, don’t use leverage

When I was helping to run the Motley Fool Singapore’s investment newsletters, my ex-colleagues and I repeated the same message over and over again: You should not invest with money that you need within the next five years.

The message is meant to prepare for days like we’ve seen over the past few weeks. The worst thing that can happen to us as investors is to be placed in a position where we’re forced to sell stocks. It doesn’t matter if we’re forced to sell when stock prices are high. But it can be disastrous to be forced to sell when stock prices are low.

To reap the rewards of long-term investing, we need to give ourselves holding power. And a very simple but effective thing we can do to gain holding power is to invest with money that we would very likely not need to touch for a good number of years.

Another simple but effective way we can have holding power in the financial markets is to not use leverage. Investing with leverage is to invest with borrowed capital. If we invest with leverage, we could very easily become forced-sellers when stocks fall. This becomes a severe headache during occasions when stocks fall sharply, such as over the past few weeks.

6. Volatility clusters

As mentioned earlier, the S&P 500 fell by 7.6% on 9 March 2020. The decline was so severe it triggered a circuit breaker in the process. On 10 March 2020, the prominent US market benchmark jumped 4.9%. A great day in the market followed a bad day.

This clustering of volatility is actually common. Investor Ben Carlson produced the table below recently (before March 2020) which illustrates the phenomenon.

The clustering means that it’s practically impossible to side-step the bad days in stocks and capture only the good days. This is important information for us, because missing just a handful of the market’s best days will destroy our returns.

Dimensional Fund Advisors, which manages more than US$600 billion, shared the following stats in a recent article:

$1,000 invested in US stocks in 1970 would become $138,908 by August 2019
Miss just the 25 best days in the market, and the $1,000 would grow to just $32,763

So it is important that we stay invested. But this does not mean we should stay invested blindly. Companies that currently are heavily in debt, and/or have shaky cash flows and weak revenue streams are likely to run into severe problems if there’s an economic downturn. If a global recession really happens this time (it looks increasingly likely that it will) and our portfolios are full of such companies, we may never recover. It’s good practice to constantly evaluate the companies in our portfolios, but I think there’s even more urgency to do so now.

7. Stick with high-quality businesses – don’t be attracted to a stock just because it has a low valuation

It’s easy for us to be lured by stocks that have low valuations after sharp declines in their prices. But it’s crucial that we also pay attention to the quality of the underlying businesses of the stocks we’re looking at. Low-quality businesses can’t compound in value. If we invest in them, our investments can’t grow over time. We may even lose money.

My friend Chin Hui Leong is a whip-smart investor and the co-founder of The Smart Investor, an investment education website. On 5 May 2009, he invested in American Oriental Bioengineering (AOB), a China-based pharmaceuticals company that was listed in the US. Chin was attracted to its low valuation – back then, AOB’s price-to-earnings ratio was only 7.

The S&P 500 reached a bottom during the Great Financial Crisis in March 2009 (it hit 677 points) and has nearly quadrupled since. So the timing of Chin’s investment in AOB was great. But he went on to effectively lose his entire investment in the company over a few short years because of its poor business performance subsequently. From 2009 to 2013, AOB’s revenue shrank from US$296 million to US$122 million while its US$41 million in profit became a loss of US$91 million. A cheap stock can easily become a big loser if its business does poorly.

Chin also has a fantastic and inspiring example of what can happen if we stick with high-quality businesses. He invested in Netflix (NASDAQ: NFLX) (my family also owns shares of Netflix) on 12 January 2007 at a share price of around US$3.20. On this occasion, his timing was poor. The S&P 500 closed at 1,431 on the day of his Netflix investment and reached a peak of 1,565 on 9 October 2007 before the Great Financial Crisis hit. But today, Netflix’s share price is around US$330, about 100 times higher than when he first invested.

8. Oil prices are low now, but we still shouldn’t buy oil & gas stocks indiscriminately

There are two widely-tracked prices for oil: West Texas Intermediate (WTI) crude and the international benchmark. Brent crude. Both shockingly fell by more than 30% each on 9 March 2020 at their respective low points.

WTI eventually closed the day with a 24.6% decline to US$31.13 per barrel while Brent crude settled with a 24.1% slide to US$34.36 per barrel. These prices were the lowest seen since February 2016. Some market observers have linked this sharp fall in oil prices to the recent turmoil in financial markets that we are seeing.

The lower oil prices have also caused the share prices of oil & gas stocks around the world to plummet. In the US market, Exxon Mobil (NYSE: XOM) plunged by 12.2% on 9 March 2020. Meanwhile, at our home in Singapore, Keppel Corporation (SGX: BN4) fell by 9.6% while Sembcorp Marine (SGX: S51) was down by 11.4%.

Oil prices are near multi-year lows now – they were around US$100 in 2014 and around US$32 at the moment. It could thus be tempting to pick up oil & gas stocks with the view that their share prices will tag along when oil prices rise. There are two problems here.

First, it’s practically impossible to forecast future oil prices. In 2007, Peter Davies gave a presentation titled What’s the Value of an Energy Economist? In it, he said that “we cannot forecast oil prices with any degree of accuracy over any period whether short or long.” Back then, Davies was the chief economist of British Petroleum, one of the largest oil & gas companies in the world.

Second, oil prices and oil & gas stocks can move in opposite directions. In mid-2014, oil prices started their rapid descent from around US$100. WTI reached a low of US$26.61 in February 2016. 10 months later (on 21 December 2016), WTI had doubled to US$53.53. But over the same period, 34 out of a group of 50 Singapore-listed oil & gas stocks saw their share prices fall. The average decline for the 50 companies was 11.9%.

There can be many obstacles that stand between a positive macrotrend and higher stock prices. In the case of oil & gas stocks, these include a weak balance sheet and deteriorating business fundamentals as a result of poor operational capabilities.

9. We will get through this

There are 7.8 billion individuals in our globe today, and the vast majority of us will wake up every morning wanting to improve the world and our own lot in life – COVID-19 or no COVID-19. This motivation is ultimately what fuels the global economy and financial markets.

Miscreants and Mother Nature will occasionally wreak havoc. But we should have faith in the collective positivity of humankind. We should have faith in us. We can clean up the mess. To me, investing in stocks is the same as having faith in the long-term positivity of mankind. I continue and will continue to have this faith, so I continue and will continue to invest in stocks.

I want to leave the last words in this article to Morgan Housel. A few days ago he published a blog post with the most apt of titles: We’ll Get Through This. In it, he wrote:

“Remember that when progress is measured generationally, results and performance should not be measured quarterly.

It looks bad today.

It might look bad tomorrow.

But hang in there.

We’ll get through this.”

Investing Through The Coronavirus Crisis; Portfolio Management; Evaluating A Company’s Leaders; And More

I did a video chat with Reshveen Rajendran recently and talked about the coronavirus (COVID-19) situation, portfolio management, and so much more.

On Tuesday (10 March 2020), I recorded a video chat with Reshveen Rajendran who runs an investing education service (link goes to Resh’s Youtube channel). I first got to know Resh in 2013 or 2014 through a mutual friend.

Last week, Resh reached out to see if I would be interested to record a video with him to discuss a wide variety of investing topics. I love talking about such things so I readily agreed.

You can check out the video below. I had a wonderful time talking to Resh. He asked really good questions and we covered a lot of ground. Some of the topics include:

The importance of having a long-term perspective when investing
What’s going to happen next with the coronavirus (COVID-19) situation
What can you do when your stocks fall?
How should we approach investing in oil & gas stocks?
My investing mistakes
How I manage my portfolio allocations
Companies’ competitive advantages
How we can evaluate a company’s leaders
A company that still has bright long-term prospects despite being heavily affected in the short run by the COVID-19 situation (find out more about this company here)
The 3 stocks I will buy if I can only invest in 3 stocks
What Jeremy Chia and I are working on at the moment

I hope you will enjoy my conversation with Resh. All credit goes to him. Resh, thank you my friend!

What It Was Like To Live Through The Greatest 1-Day Market Crash In History

An investor’s first-hand account of what it was like to live through Black Monday, the worst 1-day crash in stocks in the US market.

Yesterday, I published Staying Calm Through The Recent Big Fall In Stocks. In the article, I shared how US stocks fell by a stunning 20.5% in one day on 19 October 1987. This event is now infamously known as Black Monday.

I used Black Monday as an example to show that incredibly sharp short-term declines have happened in the past. Yet, US businesses and the stock market as a whole have continued growing significantly. I thought Black Monday was an apt example, given the current climate – on Monday night (9 March 2020), US stocks declined by 7.6%.

In Staying Calm Through The Recent Big Fall In Stocks, I wrote that “when Black Monday occurred, it was likely an extremely stressful time for investors.” I could not find any data or anecdotes to illustrate how investors must have felt back then. As the market gods would have it, I just found one.

Ben Carlson once received a message from a reader who experienced Black Monday. Carlson is the Director of Institutional Asset Management at Ritholtz Wealth Management who blogs at A Wealth of Common Sense. This is what the reader wrote to him (italics are mine):

“As one who was actually invested in 1987 (and since 1973), I still have vivid memories of that market crash. It is oh-so-easy to look today at a long-term chart having a tiny blip and say “So what! . . . of course the market recovered . . . those who sold were fools.”

In 1987, market news was nothing like it is today. We had no Internet. We had the next day’s WSJ [Wall Street Journal] and Friday’s 30-minute Lou Rukeyser’s Wall Street Week; we subscribed to a few stock newsletters (delivered by snail mail) and Kiplinger and Money magazines . . . that’s about it.

Therefore, though I heard about the crash on the radio as I drove home from work on Black Monday, I was not prepared to find my wife in tears . . . her first words were “You’ve lost our retirement!” (Reading it does not convey the impact of hearing it.)

In real time, the crash was a VERY big event. Fear for a changed future was the natural response. Talking heads were saying “This worldwide event could last for years; our children will have a lower standard of living than we have.”

Long story short— she insisted we sell everything the next day (which was also a significant down day); we eventually re-entered the market.”

I can’t prove it, but I guarantee that many investors are today having similar thoughts as what I highlighted in the quote above. It was fortunate that Carlson’s reader eventually re-entered the market. Black Monday turned out to only be a painful blip in the short run (see chart below). From 13 October 1987 (before Black Monday happened, meaning stocks were at a higher price than after the 19 October 1987 crash) to 9 March 2020, the S&P 500 increased by 773% in total, or 6.9% per year. With dividends, the S&P 500 was up by around 2,100%, or 10.0% annually, according to data from Robert Shiller.

Black Monday was monumental for those who lived through it. But if those investors had the courage to stay invested, they would have been amply rewarded.

What we experienced on Monday night and for the past few weeks, feels similar to what Carlson’s reader described. But I also think the chances are very high that in five, 10, and 20 years from now, we will look back on our experiences in the past few weeks and think “What a time it was to live through. But I’m glad I stuck with stocks for the long haul!”