Good Investing Talks - Fred Liu, how do you pick the best stocks for Hayden Capital?

Episode Date: August 2, 2021

In the second part of your 2021 conversation, Fred Liu and I discussed the investment process of Hayden Capital. We also take a look at his investment in Sea Limited.

Fred, it's great to have you back for the second part of our yearly interview. In the first part, you were telling me something about the frustration and the fire that lead to some learning or some educational parts in your letters, where you want to help people get a better understanding of the investing world you are looking at. How did you observe the impact of your letters? change things and to what extent did they change things? I mean, maybe it would be helpful to give a little bit history with the letters, right? And why first started and how it's kind of impacted the way that we do things at Hayden. I mean, when I first started Hayden, we really just started with a couple families around us.

You know, Hayden didn't have a brand. No one knew who the heck I was. I was really just writing for myself at first and really trying to put my thoughts onto paper, right? And also, I recognize that, you know, in terms of building an investment management firm, right? You know, in the last interview, I talked about how we really try to find partners that are very well aligned with us. And most partners, you know, out of a pool of 100 potential people out there, probably, you know, 95% of them are not going to be rightful. us, right? And so in terms of building an investment firm as well and getting what we're doing out into the world, I thought that writing our letters and just making it public and making us

very easy to find would be, is something surprisingly that most investment firms don't do, but I think it's one of the best tools that an emerging manager has nowadays. And really a lot of my inspiration from back in the early days was reading other people's investments. letters, right? The reason why it's named Hayden Capital is because I spent a lot of my freshman year inside of Hayden dorm at NYU reading other investors letters. The internet was just starting to come about. People were starting to put their ideas onto the internet. You were starting to get presentations from Iris Song or different types of conferences. I mean, I got a lot of value out of that. And so I always said, I'm going to write for myself. I'm going to put my ideas

on the paper. But at the same time, they're going to be kind of plant the flag in the ground and have allow other people to also learn about what we're doing and those who resonate can come find me and we're easy and you know there were a couple other investors who were starting to do that I mean I'm sure you know like John Hoover I remember reading his stuff even before I started Hayden hi John you're a big inspiration to me um and so yeah we just really started publishing it was probably about like two years after we published our first letter you know started putting on Twitter started putting on the internet before we started getting real traction right um And then as I had more of these, more people reading them, a lot of people would reach out.

I would travel and, you know, I would put in our letters, hey, I'm visiting X, Y, and Z City. Let me know if you want to grab coffee. Let me know if you want to go meet. We have really interesting conversations through there. I met a lot of my current network that way. You get differentiated insights. You kind of aggregate all this information together.

And then you kind of redistribute it back out into the community through the letters, right? and it creates this kind of virtuous cycle. And that's really what has happened. And so what is also interesting is that because our materials kind of get sent around a bit more widely nowadays, it helps us curate our partner base, number one, because it reaches the hands in various corners of the world, of the people who think like us, and they naturally want to engage and they reach out. But also among companies, too, right? a lot of, you know, companies that we are interested in or competitors of the companies that we own have started reading our reports and, you know, we get feedback that way as well. So it just created this kind of virtuous cycle, which is pretty amazing, which I honestly

don't think you could have done as an investment firm 30 years ago or even 20 years ago, right, when the internet was just starting to come about. I think, well, 30, 20 years ago, if you tried to run a hedge fund in New York, you were probably collecting capital from the same pool of partners. right, probably 50 people, 100 people that sit within the same circle group, right? And you're having dinners with them and meeting them periodically. But out of those 100 people, probably most of them don't align with you. And so you, but because their pool is smaller, you are kind of forced to accept capital that isn't

probably right for you. And so you need to be a little bit more on guard and a little less transparent and a little bit more cautious of how you protect that pool of capital. capital, right? And to make sure that your ideas don't disseminate out and then make sure that the turn within your client base is low. But today, because we're able to pick our spots and kind of skim the cream off the top from a global investor base, we don't have those problems. So we are able to be more transparent. We're able to be more open with our ideas. And that creates that virtual cycle, which I think is just amazing. And I, you know, I said last interview, I'm still surprised how many investment firms out there are still operating. under a model that worked 30 years ago, but probably not today. But there's also a certain surplus to what you're sharing are secrets and insights as others don't have and sometimes you profit from keeping the inside secret. How are you dealing about this tension of being like that, no, I think ideas.

Look, there's a couple sources to edge, right? Informational, analytical, and behavioral, right? Let's call it that. Um, informational. The internet is free information, right? Most data out there that you have access today as an investor probably wasn't available 20 years ago, right? We operate in businesses that live online. You can literally track GMV. You can track weekly sales. You can track the breakdown of that GMB. You can track like, you know, the customer breakdown in geographic concentration. How are you going to do this like 20, 30 years ago, right? All of this information is readily available to most investors today. day, that is no longer an edge. Your edge is by collecting all of this, there's too much information, by collecting all of this information and filtering it in a way for you to then go have some sort of analytical edge, for you to see some sort of insight that other people don't through this pool of data, right? So I have no problem disseminating our information out,

even if we're giving a little bit of our secret sauce, like, who cares? We've already built our position, right? The more people that know about out how great this company is and the better quality of the shareholder base, if we can upgrade that shareholder base in our own little way, that benefits everyone, right? It benefits the company. It benefits us. It brings more attention to the stock. And maybe it pulls forward some of that, you know, valuation, right? So I honestly think it's beneficial for everyone here. At now, do one thing that isn't really a secret. Please subscribe to this channel or leave a like or a comment. And if you hear the podcast, you can also go to the portal you're hearing it and

leave a review. This really helps me. Thank you very much. That's interesting. Maybe let's take a step back to boil down to the point what are great businesses for you. But maybe let's start with your edge. How do you define your edge as an investor, the field you're operating in with love and passion. I think, you know, I think last interview, I talked a little bit about how we've been narrowing our circle of competence, right, for the majority of the life of Hayden, and we've only slowly started expanding it out again. I think our edge is just kind of understanding internet-facing, internet-based consumer-facing

businesses in U.S. and in Asia, right? It's just where we've spent a lot of time, where we've dug and looked at a lot of companies, it's not necessarily something, you know, I was born with, right? It just I spent a lot of time in this area and we've developed this kind of competency. That's really the edge, right? All investing is pattern recognition. You need to look at enough data points. You need to look at enough patterns to formulate your own idea of what works and what doesn't

and how businesses develop and how ecosystems develop. And yeah, that just takes a lot of time, right? Our edge isn't some naturally secret sauce. it just, we've spent a lot of time in that area. So, yeah, that's really the basis of it. Even if you have spent a lot of time in the area of your edge, what are businesses that fall into your too hard bucket? Where you say, even in my edge, it's too hard to grab them?

Sure. I would say something that is kind of on the, it's not necessarily on the peripheral. but a little bit more removed from the periphery of our circle is probably like B2B companies, right? Enterprise, whether you want to talk about software or anything selling to businesses is very, very tough. Because on the B2B side, you're typically concentrated in terms of the number of customers that you have. So let's say you're a soft SaaS type of business, right? You have 100 customers. How many people inside of each corporation really use your piece of software and are extremely knowledgeable about it?

Maybe like 5 to 10, right? So call it a couple hundred customers in this entire world who probably have the information and data insights that you're looking for when you're trying to do research. And then we have to go find, you know, a representative sample of these customers, right? That's really, really tough versus something like e-commerce or something like a consumer marketplace. There's probably hundreds of thousands or millions of users, right? It's a lot easier to go find the customers who have, you know, some sort of, sort of insight in how they use the product and can get feedback on it, and then you can build a representative sample a lot easier.

So I would say that, you know, anything that's B2B is a bit more outside of our circle, right? It's also hard to kind of collect this information online, whether you're talking like, you know, web scraping or alt data or what have you. Just because, you know, a lot of these habits and how they interact with the product, just doesn't live online in the beginning, right? So it's hard to track. Is there another example for the to heart bucket in your edge? I mean, the obvious ones would be like healthcare or biotech or, yeah, really anything that

kind of lives outside of where we're spending time, right? Like I said, even, you know, I used to cover industrials, right? In a previous life in a different role, I haven't done it in eight years, right? And so I would say that even that I've, my skill set and my patterns are probably outdated by this point. So if I try to go back to it, it's probably outside of my edge as well. If you look back to the last 12 months, how much time have you spent on existing portfolio positions and how much time have you spent on new ideas? Yeah. I would say 60, 40, I would say.

Yeah, 60% because our businesses are constant. evolving and they're launching new products and services and features and all of that. Yeah, so of the whole research time spent about 60% on maintenance work and just keeping on top of these because sometimes, you know, every these, some of these businesses evolve so rapidly that they're launching completely new business lines or completely new geographies and, you know, a couple of years down the line, they may be completely different businesses than when you first invest it, right? So you have to stay on top of it. And then the other 40% is, you know, turning over rocks and um adding more data points to kind of your your pattern recognition framework

right what makes you decide to to say i want to invest more time in a new name and grab the hook that i find there yeah i would say there's four main criteria that we're looking for although it can be flexible depending on the company but really what we're looking for is number one a strong industry tailwind, right? We want a large tailwind propelling this company based on some sort of consumer behavior trend because of some new habit that's being formed. Or just, you know, because of the internet or technology or whatever, it's just a completely brand new business model is able to exist that wasn't previously able to exist, but is serving the same need or service that has always been in demand for decades or hundreds of years.

So that's number one. Number two is that once you spot this kind of tailwind or what my friend kind of describes as like finding a wave, right, you're looking for big waves. You also want to find the companies that are going to be leading the pack, right? Because certain companies have certain advantages. And in the industries where we operate, they tend to be, you know, they're tend to be benefits to scale. and they tend to be winner-take-most type of markets.

So you want to find the companies that have a certain sort of advantage or certain culture, certain secret sauce to them that allows them to be at the forefront. And as they pull away from the pack, right, even more advantages accrue to them. Whether it's, you know, more data, for instance, right? You do more transactions. You see more transactions across different geographies. You can kind of tailor your inventory. You can kind of tailor your business model around that.

that smaller competitors wouldn't be able to. And also, they may have better access to capital, right? Because they are able to list first, because they have a much stronger shareholder base, their cost of capital is lower. So they're able to experiment and try out more experiments, right, with that lower cost of capital. And some of those experiments are going to work, and that's going to propel them even further ahead of their competitors. So we're looking for some aspect of that. So that's criteria number two.

Number three is you're looking for a great management team that is capable of kind of navigating this, right? In our industries, they're evolving so rapidly. You don't need someone to just maintain the status quo and make sure that, you know, the business doesn't die. Rather, you need someone to innovate and propel the business constantly forward. So in this case, it's kind of like, you know, being a surfer on this wave, right? You see this big wave, but you also need to have the skills to really surf that wave, right? And hopefully when that wave kind of peters out to hop on to a new one that is equally as large of a tailwind or as large of a wave. And then lastly is really around valuation, right?

We're looking for some sort of disconnect in the markets. When we typically initiate a position, they're very, they're not very well known in the market. There's controversy. There's uncertainty in terms of the trajectory of a business, right? How steep that future earnings power slope is going to look in the future. And we feel like based upon our, you know, data points based upon our pattern recognition, what have you, that we feel we have a differentiated opinion on that. And so if we are right, we're actually going to get multiple expansion over the course of that business, right? So we think that earnings are going to keager higher than what the street expects over the next three, five, ten years.

And on top of that, as the business gets more certain in the business model kind of becomes more evident to people and that it becomes evident that it's going to actually be able to be profitable sustainably, you'll see that multiple also expand on top of that earnings power kicker. So really, you know, very loosely, those are the four things that we're looking for here. On the lead of pack indicators, you mentioned the cost of capital. What are other indicators that you say this might be leader of the pack? I would actually say that cost of capital is a output, right, rather than an input. So it's not necessarily what we're looking for. It depends on the industry, right? Every single business is different in terms of what criteria allows us to predict that. They will be the leader of the

pack. But for instance, consumer marketplaces, right? The number one thing you should look for is addiction. We're looking for consumers and suppliers to be addicted to this platform in some form, right? And I think I understand the basis of the question of where you're going. So maybe I'll preempt it is that if you think about like consumer marketplaces, the best analogy that I have for it, and I've talked about a little bit, is they're like self-regulated ecosystems, right? And as the company, as the management, you're almost like God. You are almost like the government in a sense. You are dictating the rules and setting the laws for what happens inside of this ecosystem that you

create, but you don't really control the businesses that move to this ecosystem. Let's say it's like a new city, right? You don't really control the businesses that come to this new city. You don't control the population that decides to immigrate from elsewhere, right, to your new city. But you're setting the rules and making things attractive enough for these businesses and these consumers to then interact with each other, right? So whether it's in form of taxes, right, zero taxes, that's always great for attracting new people to your new city. And then hopefully they start interacting with each other, you know, people love living there, get a lot more value. living there than the cities where they came from, and they aren't going to move.

And so you can charge them a 2% tax. You can charge them a 5% tax. But say they get 10% more value or 20% more value than the old city where they came from. They still aren't going to move, and they're going to be happily willing to pay that tax. And you're going to spend that tax revenue, you know, then creating even a better environment in your city, right? Whether it's building, upgrading your subway system or, you know, building new roads,

making the roads wider or, you know, attracting even better talent to your city somehow so that these businesses have great employees to go work for them. You know, those are typically the early signs that we're looking for, right? Even when a city isn't charging any sort of tax or, you know, in the case of a business, any sort of revenue. But you can see that the businesses that move there love it. You can see that the inhabitants that move there, love it. And they're interacting with each other.

and a lot of transactions are flowing, that's the basis of an early sign, I would say, for a consumer marketplace that you should really look for because that taxation is inevitable, right? Because you're going to have the ability to tax them and you will, and you will recycle those tax revenue into create an even better city,

which then kind of creates that virtual cycle effect, right? But is it really addiction or is it love of the offer give to the customers? Oh, yeah. So I didn't really touch upon the addiction part, but the addiction part in a consumer marketplace would be like transaction frequency, right? So for most marketplaces, we're looking for people to log onto the app, you know, several times a day. Maybe some of our companies, people are spending, like, close to an hour per day inside of the app, right? They're ordering, actually transacting four to five times a month. That's addiction, especially when you compare it versus other ecosystems.

commerce sites where you may get like one order every three months or one order every six months. You have to re-remind people, right, that your business even exists right when they are searching for a product that your business might be able to serve. So I think that's the real difference, right? But for other business models outside of consumer marketplaces, that form of addiction may be different. You mentioned the great management team. What is a great management team or what are indicators for a great management team? There's no one-size-fits-all, right? Because each business is different.

Each business model is different. It requires different skill sets from your management team. I would say the commonality is that you want to put yourself in management shoes. So when we look at a stock, we think past, present, future. Each stock is a story, right? You want to start with a founding. Why the heck was this business founded in the first place? What problem were they trying to solve?

What value were they trying to create? Right. and from the time that they were founded to today, what are the key questions or key friction points that they really had to solve and that they got right to propel them to where they are today. And the only reason we would be interested is because they have something special, right, today.

So how did they create that special sauce in the preceding five years and 10 years or whatever? And hopefully, and most of our companies are founder-led, so it's the same people who started on day one today, what decisions did they make? and looking in hindsight with the data that you have now, did they make the correct decisions? And even if they made a mistake

and they made incorrect decisions, given the data that they had at that point in time, say five years ago, did they make the correct decisions with that set of data, right? That's what we're looking for. You want to put yourself, you want to, number one, know the company well enough for yourself to have an objective opinion

of what was the correct decision and what you have done as an investor. And so, you know, Yeah, and then you want to go back and then see if management kind of thought similarly to how you would have acted. And then, yeah, going forward over the next five years, there are generally, say, one to three different questions or friction points that they need to solve to really create a lot of value for this business. And you want to see how they are thinking about those questions. And as an investor, you probably have an objective opinion of what you would do as a management team. And so you want to see if the management team aligns and has.

as publicly said, this is the direction that we're moving and whether you agree or disagree with them. And sometimes maybe you disagree, right? But we want to ask then what information does the management team have that we don't have access to? That if we had access to that data, maybe we would change our opinion, right? And so we want to also have that debate. And so, yeah, it's just literally a conversation and making an opinion or a judgment on whether this management team has kind of navigated. navigated the corners well over the past five to 10 years. What's your strategy when you have decided to invest time in a new name?

Are you going all in or do you have Fred's new ideas Fridays or is Philip doing all the work? What are your strategies there? Yeah. Well, it's a little bit different with kind of Philip on board over the last couple of months. But I would say the process is generally pretty similar, right? Like I said, each stock is a story. We want to understand the past first.

Generally, that is going to take a couple weeks to about a month on and off, right, to kind of get your head around. And a lot of that is qualitative, right? Going back, reading old transcripts, going through different earnings reports, understanding really the founding story of this business and the history behind it, right? once you kind of understand that, then you should have a firm enough grasp of what are the key questions going forward over the next three to five years. And so at that point in time is when we'll write like an initial memo, right? A couple pages and heck, Philip has been producing like 10 page initial memo, so it could be up to 10 pages.

But we really want to understand the history, the present, how the business is. advantage today and why we think it's going to continue to be advantaged in the future, and what are the one to three key things that they have to get right for the stock to work? We're not trying to answer those questions at that point in time, right? We're just trying to lay out the thesis, and if this happens, if this happens, the stock is going to be a home run. And then we are also trying to answer in order to answer these questions, what pieces of data or who do we need to talk to or, you know, what data sets do we need to buy?

What alternative data providers do we need to be able to answer this, right? And so that's the initial memo. If we decide to move forward on it, we're going to build a model at that point in time. A model is really a scratch sheet of paper for you to quantitatively put your thoughts on the paper, right? You're never going to outmodel someone and be able to get, you know, get any edge. But it's good to be able to put hard numbers onto a scratch sheet of paper while you're doing the future analysis. And then over the next couple months, it's really around answering those key questions, right? And that's where the fun work starts.

That's where the primary research takes place, whether that's having conversations with people within our network, you know, using certain expert networks, you know, piecing together, like what competitors are doing and what competitors are saying. and kind of just understanding how this whole industry is going to evolve over next five to ten years. And hopefully by the end of that process, we'll have a pretty good thesis or understanding of how those couple questions are going to be answered and if it's beneficial for the company. And if it is, and we think this company has a right to win, at that point, we're going to take an initial position in the company, right? but our positions are also sized smaller, call it, you know, 5% or so when we initially invest, because those questions are really execution-based, right? They're based upon how consumer behavior is going to shift, how a certain entire country, for instance, disposable income may go up, and a certain portion of that, disposable income

goes to a certain type of company, whether it's e-commerce or what have you. So those are, you just have to wait and see and see if your thesis around that, is correct. So as we start to see these KPIs or data points that kind of prove out our thesis, that's when we increase our position over time. And while that's occurring, you obviously have to stay on top of your names. You have to or probably do like as much, if not like, double the amount of work as our initial work during that kind of maintenance phase, right? Because we need to monitor our companies very closely and see if that form of addiction actually is taking place. And so that process can take, you know, a couple months up to a couple years, right?

And as these different KPIs hit, you're basically flexing up your portfolio, your position, right? You're increasing the amount that you're contributing capital to this position because the business model has derrised because some of that uncertainty has dissipated. So number one, that position probably deserves to be a larger portion of the portfolio because it's less, it's more certain, right? and also your thesis is proven out so your future trajectory of this company is probably steeper right the earnings power curve is probably steeper than what the rest of the street expects and so it deserves to gain more capital as well and so that process takes you know like I said a couple months to a couple years so yeah generally we will stop building the position when they hit right before that kind of break even sustainable type of level right that happens usually within the first three years on investments. And hopefully by that point in time, we will have built a position to about our limit, which is 15%. And then once they hit that sustainable type level,

hopefully we are very confident in that industry tailwind. We're confident in this management team. We're confident that this company is the leader of the PAC and will continue to lead the PAC going forward. And so because of that, we're very comfortable with such a large position size, right? It's kind of inevitable by that point in time. And then we are just going to allow our capital to compound alongside of this business as they create more value for their ecosystem, their stakeholders, for hopefully over the next 10 years plus, right?

And then we just kind of let it live on within our portfolio and produce returns for our partners at that point. How much of this work is quantitative and how much is qualitative? If you said you don't outnumber people in your model. So how are you thinking about this mix? I think you have a high degree of qualitative work. That's a lot of. Interview, understanding. Yeah.

It can be quantitative too, right? Let's say you have a conversation with someone. And heck, we just had a conversation with a company where we're not really interested in, but it was an interesting insight. The person was talking about how much trouble that business is having with monetizing their payments method, right? And this is probably something that most investors don't quite understand, right? They don't quite understand the degree to which it's tough to monetize this certain business. And so because of that, when we build our models, we may have lower expectations for this certain business segment than most

of the rest of the street, right? So that is a qualitative conversation leading to a quantitative insight, right? So, yeah, I think it's a combination of both there. You mentioned the street quite often. How much role does the street play for your assessment and how much do you give about the opinion of the street? I would say not very much per se.

Well, I'll caveat that. In the very short term, most people are trying to predict, you know, on a quarterly basis or over the next year, we honestly don't care, okay? That's not what we're trying to look for. We're trying to see what do most people expect for the trajectory of a company, right? Whether that's earnings power or, you know, market share or whatever. We're trying to figure out what is the general expectation among most investors out there. And that general expectation is probably priced into the stock somehow. We're hoping to have a differing due to insight that this, maybe the tailwind is going to be larger, in our opinion, than most other investors expect.

Maybe this is a number two player within their industry. We think they have a right to win and become number one within their industry, but most other investors don't, right? And so that's probably priced into stock as well. So we're trying to look for, you know, differentiation in that sense. And in that sense, we're trying to compare it to, you know, what other investors are expecting because it's probably priced into stock. And we do want that kind of multiple expansion as our thesis is proven right. But yeah, on a shorter term basis, it really doesn't matter for us. You want to reach top one of the expertise on the company you're invested in.

When do you feel you have reached this top one percent? I mean, there's no way to quantitate. prove that, right? I just think if you're having conversations with other investors who own the stock and through those conversations, you just naturally feel like you have more information or that you have some sort of insight that the other investors haven't thought about, I would say that would place you in probably, you know, among the top of the pack, right? And just given our concentrated nature, we probably spend a lot more time than most other

funds on each name, right? I know several funds that my friends work at, you know, they may spend a couple weeks on a name, right? And honestly, in this industry, that might be a lot. But for us, we're spending months in the initial phase, right, just to establish that initial 5% position. And then after that, we're doing, you know, multiples of the maintenance work over the next several years. So just through that nature of time spent, you're probably going to have more information than other people out there. You're looking for great businesses. Maybe let's take a general look.

I don't know. It's hard to answer this question, I know, but how many business do you think that exist globally that are great businesses that are publicly investable? Out of the entire universe of companies out there, small percentage, one, two, three percent is my guess. You know, there's no way to quantitatively prove that, right? Everyone's view of quality is kind of subjective. Heck, I recently read Josh Terraceoff's recent essay, right?

Where he talks about that exact aspect when you see, you recognize quality when you see it, right? It's hard to quantify. Yeah, I would say probably a couple percent. If I were to randomly pick companies out of, you know, the indices, yeah, I would probably find two or three out of 100. And where do you see the main difference in your edge between a good business and a great business? In terms of identifying between the two? Yeah. I would say that's actually relatively hard.

I would say the easier way to identify that. Well, number one, you want them to be the best within their industry, right? So that's a comparative analysis. And then the other question is the leader within. a certain industry versus the leader in another industry, where do you want to allocate your capital, right? That's also a bit harder, but the best way to do it is just instead of trying to find the absolute best, just try to upgrade the quality of your portfolio consistently. So try to find the best within the number of rocks that you have turned over, right?

That's really what we're trying to do. When we come across a new idea and we think like there's something special about this company, we compare it versus the worst name in our current portfolio, right? Is it better than this? Do the risk-reward dynamics actually favor this new company? Is there enough, you know, substantially more return potential in this new idea than our existing portfolio company for us to justify that upgrade in that swap, right? That's what we're trying to do. I think if you spent all your time searching for like the absolute best 10 companies in this world, that would be a really,

really tough process. And you would probably be sitting in cash the entire time, right? Because it would take a long time for you to go find those 10 companies. So, yeah, all we're trying to do is just constantly upgrade the quality of our portfolio. And heck, you know, we're seven years in. And so I think we're at a pretty good place in time. Originally, our bar that we needed to beat was cash. We started with over 60% cash.

We took a number of years to get down to like low single digits. And now our competition is really the worst. position in our portfolio right um i think that's an easier way to think about upgrading and you know good versus great uh than then trying to find the absolute great companies in the world how do you create this ranking of your portfolio companies how do you get clear what's the worst and what's what are the better ones i think that's subjective right um number one some of our companies they just can't absorb that much of our capital or they don't deserve that much of a capital because they're still early stage, right? There are still

hypotheses. We still need to see like consumer behavior hit. We still need to see certain industry dynamics hit. And they haven't yet. And so contributing more capital to this positions is not a very prudent thing to do. Right. And so, you know, it's not necessarily the companies with the highest return potential are going to be our largest companies because our highest potential. Because our highest potential, return potential companies may also have the most risk associated with them. So you have to constantly balance all of these factors. You also have to think about, you know, what is the likelihood of a certain company, you know, hitting upon these thesis points that you're looking for versus, say, your top position may be

a more mature company. Things are already proven. The management team has already battle tested. They've already proven their executional capabilities. You've already done hundreds of hours or heck, maybe even 1,000 hours of work on the name and got to know every single person. So you're extremely confident in it, right, versus your smaller and lesser in position. So it's constantly ranking between those. It's not a hard science, right?

A lot of this is subjective. But yeah, that's the role of a good portfolio manager, right? This isn't an exact science to this industry. how much companies did you say they have to go out of the portfolio after the seven years you're investing i think one example is so plus amazon did you did so we had a lot more churn in the early years of hayden um if you look at all the positions that we've invested in since inception it's well over 30 right um we gave that analysis about a year and a half ago and i think in our Q419 letter, just about the attribution and hit rate versus slugging rate within our portfolio

rate. And it was always the top 20% of our positions that drove the majority of our alpha. And heck, today that has gotten even more skewed, right? And so yeah, we've had a lot of names that we've basically had to kick out, right? We own seven today. Over the course of our history, we've owned 30 plus. So yeah, you can kind of do the math in terms of how many have exited. If you're in your framework and also talking about addiction, one important part to get people addicted is the consumer acquisition. And what do you think is a great strategy for consumer acquisition and the companies you're looking at? And how much of a role does the consumer acquisition strategies play for you in your analysis to find a great company? I mean, how each company acquires customers is going to be.

different right let's say let's just use e-commerce right it's kind of our sweet spot so if you are a lower frequency type of e-commerce platform that's totally okay you may be selling very expensive products that people purchase very infrequently whether that's like white label appliances right or like electronics or what have you you can make decent money off of that but the problem is people are not looking for that every single day they're looking for it every six months once a year so you you probably have to do performance-based marketing or advertising, right? You have to do Google AdWords and whatnot to capture them, right, when the consumer has intent to go purchase a new refrigerator or a new laptop.

That's fine, but that consumer, that customer acquisition cost is variable, right? Every time you sell something, you're probably spending something to acquire that customer. Versus a generalized marketplace that has high addiction that, you know, people buy four to five times a month that lives, the app button lives on the home screen of their phone, right? And number one, how many times do you open your phone a day? 10, 20 times a day, right? It's like real estate. It's like prime real estate, right?

You're looking at that app every single day, every single time you open the phone, and maybe a certain percent of the time you're opening it, you browse through it. It's a fun experience. It's kind of like walking into a mall, right? I think about it like walking into a mall. You walk into it five times a day. Maybe you don't find something 90% of the time, but, you know, maybe you come across a shop that seems interesting, has some cool item that you didn't know

you need it, you go explore it, and you end up buying, you know, once a week, right? Buying something once a week. Those consumer acquisition costs get then get amortized, right, over the life of that customer and over the life of those purchases. And if you're buying five times a month, that means you're buying 60 times a year, right? It's amortized over 60 times. And because of that and because of competition, consumer acquisition costs have steadily gone up in the last, heck, not even last couple years.

I'd say even 10 years, right? So it's got more and more expensive to acquire customers. Heck in China right now, it costs about $20 to $30 U.S.D to go acquire a customer, right? And that's why you have this kind of consolidation of these large platforms that are then trying to sell many, many items because they need to amortize that high cack, right? And so it really depends, to answer your question, it really depends on the business in terms of what makes a good consumer acquisition. type of strategy. But I would say the better model is probably the ones that have very high addiction and very high repeat type of customer base because you can amortize that cack over a

very long period of time, right? And when you break it down on a per transaction basis, that means it's probably in, I don't know, a dollar, 50 cents sometimes, which means that you can also lower your basket sizes, right? The amount of items that consumers need to purchase every single time. When you lower your basket sizes, you increase immediate gratification, right? That kind of dopamine effect of immediately being able to buy something and having arrive to your door and, you know, same day sometimes.

And then you do it more and more and creates that virtuous cycle. So it depends on the company, but I would say, yeah, the addiction, high repeat rate type of businesses are definitely more attractive. Are there any good example you can see about great customer acquisition strategies? like you did this where you had a network acquisition strategy with your letters you created it was very cheap and good are there any great examples for this customer acquisition strategies not that i can think of really i don't i i don't think there's anything brand new out there that companies are are doing right um i mean word of mouth is obviously the cheapest by far right um heck

Yeah, some companies give like referral codes, for instance, right? When you're family and when you're trying to build trust in terms of a new way of buying something, hearing it from people that you already trust, family and friends, is one of the best ways to go acquire a customer, right? I already trust my friend. My friend says this platform is great and it's the cheapest products and high quality products. I'm probably going to have a much higher, you know, chance of using that service. that business um so i think that's probably the best but no i i don't think there's really really anything brand new out there in terms of that i've seen that companies are are acquiring customers

how do you make sure that the capital allocation of the company you're investing in is great well you know i've given this chart in my uh materials for the last couple years in terms of how just everyone is allocating capital in some sense, right? If you think about our partners, our LPs, they're really choosing between manager A, B, C, D, what have you. Why are they choosing Hayden? And how do they build trust that Hayden has the best capital allocation opportunities, right? They're diving into our portfolio.

Why did you choose stock A versus stock B versus stock C? And, you know, given, first they need to underwrite kind of the pool in which we're operating in, right? does this pool of ideas, whether it's like, say, consumer tech and U.S. and Asia, does that even have attractive returns in the first place? And then among that, we are the fishermen fishing in this pool. Are you able to fish the highest return companies, right, A versus B versus C? That process is a judgment of our investment process, right? And so you dive into specific names and whatnot. When we're looking at companies, these managers are also allocating capital themselves, right? They're allocating into project A, B, and C, right? Maybe they're building a new

factory. Maybe they're choosing to spend a couple hundred million bucks on acquiring new customers. Maybe they are, I don't know, launching a completely brand new product that has no relation to their current core business, right? Which one is management choosing and why, right? As an investor, you need to have enough data yourself and enough of opinion yourself to then go say, I think they should have chosen project A. I think it's the highest return type of project, right? Based upon my unit economic analysis, based on my conversations, based upon my understanding of where this industry is going into strategy, they should have chose A, but management chose B. So why did they choose B? Right? Then you have that conversation. Then you have that dialogue. You try to understand

like why they went in that direction. And this goes back to what I was saying earlier. Maybe they have other data or something else that they're seeing that you as an investor am not. So maybe we are wrong, right? We want to understand that decision-making process and the why behind it. And so at that point, it's kind of like you're trying to determine if you are right or if management is right, right? And you make a judgment on that.

And if sometimes maybe management makes the decision that you thought they should have made, So I guess that's easier. And you could both be wrong at the end of the day. But maybe that's how you determine if they're a good capital allocator, right? You just kind of need to understand the why behind it and kind of make that subjective opinion based upon, you know, the quantity and the bulk of work that you have done up front to reach that conclusion. What makes a great company culture for you? That depends. Again, it's all, I mean, there's no one-size-fits.

all, right? If you are a company that is based upon, let's say, efficiency, right? For instance, JD has always been known to have kind of like a top-down military-esque type of culture, right? Decisions are made at the top, and then everyone else at the bottom kind of executes the orders and follows them, but just at a really rapid pace and at a very efficient pace. And so, you know, their mode has always been like logistics, for instance. That doesn't require necessarily innovation from, you know, very low-level employees. That just means getting it to the customer's door in two hours and doing it in a very efficient manner and cheat manner, right? So, you know, that may be their edge and that may be the culture, a military-esque style

execution. Or it may be more based upon innovation, right? You need your middle-level employees, you need your junior level employees to constantly be generating new ideas and innovative ways to kind of execute this new business line or this new strategy and you need a very open-minded management who enables their lower-level employees to go run with those ideas and test if they work in experiment right that's a completely different set of culture different type of culture um it really depends on the type of company that you're investing it right so just The quintessence of the great businesses, you have always said to analyze them in relation to other businesses in the space they are operating in, or in the industry they are operating

in. I would say you have to figure out and determine what is their competitive advantage, what is their edge, why is, let's say you have a certain industry, why is a company going to be the leader in this industry? What do they need to do to be the leader? What do customers really care about? What do their suppliers really care about? And how do you go execute upon that, right?

And once you know how to answer that question, then the next question is, does the culture of this company then enable and maximize their ability to do that, right? And again, each company is different. Each industry is different. So, yeah, it depends. I had some questions coming up on the S curve. and inflection points related to it. What are examples of inflection points you observed in some of your early bets

that convinced you to average up like the early phase of the S curve? Yeah. I mean, the best example is, let's say, C, right? Because we were just talking about consumer ecosystems. And we were looking for addiction, right? Before we even invested, we knew that Shopify, the platform, had higher addiction because people were transacting on the platform

45 times a month, right? People were visiting the app more frequently. People were spending more time inside of the app. And heck, anyone who's interested can go back and look at our 2018 presentation, right, that we laid out these KPIs. And at the point of which I gave that presentation, by the way, our position was still very small. It was lower than 5%.

So we knew there was addiction. We knew that they had basically built the infrastructure for this brand new city that they were creating. They were inviting businesses to come live in this new city by offering zero taxes, basically zero commissions. And heck, they were inviting inhabitants to come live in the city, the demand side, right, by basically giving away free money. They were saying zero shipping costs, zero commissions, you know, we'll even give you promo codes, 30% off, 20% off, what have you, if you make one purchase. So they were basically paying people to come live in the city. But what we were seeing was that once they moved there, they were transacting four to five times a month. They were spending a lot of time inside of these shops.

They were providing more reviews for each individual shop owner than where they were getting elsewhere, where they were listed elsewhere, right? So that means from a shop owner perspective, you're probably not going to move to a different platform, right? Because this is where the bulk of your orders are coming from. There's a very labor-intensive process because if you understand e-commerce in Southeast Asia or just Asia in general, a lot of it is chat-based. right? People ask a lot of questions, so you have to spend a lot of time answering questions. And so this is where most of the time was spent. But there was no monetization. There was no revenues. There was no tax revenue coming in, right? But you knew that the company's game plan, their strategy, was that once you get people addicted, we are then going to charge a tax. They made that extremely

clear. And we also knew through some of the sales materials that we were able to get a hold of that they were communicating to their merchants like, hey, we're going to raise our taxes on you very, very soon. Get your products on. So we have this already addictive kind of foundation to this ecosystem, very, very sticky. And we knew that they were going to charge, say, you know, a 1% tax, right? A 1% tax really isn't very much if you are providing your sellers, you know, 90% of their business. You're going to happily be willing to pay for it. And they're selling products where their margins are close to 50%. They will happily pay for that 1%. Um, So we invested kind of right before that monetization phase, and that was what gave us an early indication, like, hey, something might work.

Soon as they raised the monetization over the next six months, we basically saw, number one, none of the sellers left, none of the customers left, right? In fact, this platform continued to grow above their competitors that were still kind of giving away free money, right? And actually, what we even saw was some of their competitors follow suit in terms of raising prices and raising their taxes as well. So, you know, that kind of proved to us that, hey, there's something actually going on here. There's a very vibrant, sticky ecosystem going on here. And so over the following six months, we, again, we had a very small position up front, but we increased our capital committed to that idea because our thesis started to prove itself out, right? And over the following year, they continue to raise their prices.

They continue to diversify kind of their base of seller. and the type of products that they sell, they started moving up market into more branded items as opposed to unbranded items. And you started seeing people buying very expensive and very, I mean, for instance, like Dyson vacuums, right?

Shoppy sells Dyson vacuums now. It's not something that they would have done several years ago. But because they had built so much trust, they were able to do so. So every step along the journey as they kind of moved up market, as they built their logistics,

as their shipping times decreased, as they built more trust with consumers and as consumers spent more and more time inside of the app, we continue to increase our position over that period. So yeah, maybe that's a relatively newer

investment for us, you know, I call it like three years or so, less than three years. But yeah, I think it's a good example of our process for building these positions. You started your position with a two to three percent tracking position. Am I right with this? Yeah, it was a couple

By the time I gave that presentation, if I remember right, it was about a 4% position there. And then by the following spring, we increased it to about 8, 9% and the stock had also moved as well. It went from call it like 10 bucks to 20 bucks or so. And we also contributed more capital. How much are you willing to pay up over time if you get more confidence for your investment? It depends on how confident we are. and the difference between the slope of that earnings curve that we expect versus what's already priced into the stock, right? So if we are extremely confident, for instance, that this company is going to realize, say, I don't know, 50% IRAs over the next three years, right?

But the stock is pricing in, you know, say 20% type of expectations. Obviously, we're going to be able to pay up for it, right? because we're extremely confident and, you know, we have some sort of differentiation versus what's being priced into the name. So I wouldn't necessarily say that's paying up in that case. It's just we have a different view of what the future earnings trajectory looks like versus everyone else. And we think we're paying a pretty fair price, not an expensive price, right?

Or even a cheap price. So, yeah, I wouldn't say that we really pay up for our names. but if the multiple goes up aren't you paying up then or how do you see this yeah you mean as as we hold a name and the multiple goes up and we continue to hold it right is that what you're saying no when you when you bought like you did i think you did three times you did buy a c as you just described that and i think the multiple might have gone up in this time, or didn't it go up? It has. I mean, it's gotten from extremely cheap, almost like a deep value type of situation

that was not pricing in the shoppy e-commerce business at all to a point where it's being priced, but not at anything that's very taxing on the stock, right? We're looking for a close to $10 billion in revenues this year, right? If we count gaming revenues as booking, it's not reported revenues, but they're going to do about 10 billion. And on that, you know, gaming, they realize, heck, let's say a blend of e-commerce and gaming, they're going to realize close to like 50% type of margins, right? Gaming, they're doing about 60, e-commerce is about 40 structurally. So we're looking for, you know, call it $4,5 billion in profits for a company growing 80, 90%, right? And it's trading at 140-ish, right? 14 times, right?

that's not extremely taxing for how dominant this business is, how many free options are embedded into this business, and just on the core business that we have extremely high confidence in, we still expected to grow, call it 60 to 80% over the next year or so, and that's not going to very slowly decline to a more normalized rate, right? So for something like that, that's why we have such a large position and why we're extremely confident. And I don't think that valuation is very taxing at all, right? we're actually not expecting multiple compression in this case from here until maturity.

But if we had a name that's, you know, say, trading at 30x and we think that at maturity, because of whatever, you know, factor that it should be trading closer to 10 at maturity, we better be very, very confident in that earnings trajectory, right? Because it's always your headwind is going to be that multiple compression. Your tailwind is going to be that earnings growth. The net of that is your stock's return, right? Right. So you just better be very, very confident on that earnings trajectory. And that's going to be a very volatile situation, right? Because it's constantly going to be a tug of war between that earnings growth and that multiple fluctuation. Right. We try to generally avoid those situations. If the net of those starts getting close to, say, between 10 and 15%, that's generally when we're going to start trimming. And if it falls below 10%, which is generally where I view kind of the markets or or just call it the S&P type of opportunity cost,

we're probably going to sell out at that position and just follow it and wait for a better entry price to re-go into it. So yeah, so it's really about the net of those two, right? The headwind and the tailwind, but usually when we enter a name, we expect multiple expansion and we also expect that earnings keager

to continue to compound at very attractive rates. What are these three options, you mentioned. Within C. Yeah. Yeah. I mean, payments, number one, C money, their e-wallet, right? In Indonesia, they're expanding into Malaysia.

They have shopping food, for instance. They are starting to compete with Gojack and Grab on the food side, really, to kind of funnel into their payments business. They're going into Latam, for instance, which we've talked about previously. Yeah, and they have a couple games kind of in the pipeline. you don't really know if they're going to work until actually launches and see what the reaction is from the gamer base. But yeah, there's a couple options that really aren't being priced into the stock, right? How are you tracking the increasing competition that more capital goes to grab, go to, or that other local champions like Kupang and JD are also going into SIA?

how do you keep in track of these developments and evaluate them for C? Hey, Tillman here. I'm sure you're curious about the answer to this question. But this answer is exclusive to the members of my community Good Investing Plus. Good Investing Plus is a place where we help each other to get better as investor day by day. If you are an ambitious, long-term-oriented investor that likes to share, please apply for good investing plus just go to good minus investing dot net slash plus you can also find this link into show notes i'm waiting for your application and without further ado let's go back to the conversation

in all this talking about c we haven't covered one important aspect the regulator because you have different regulations and regimes in which he's operating And also we see it with China at the moment and also local data, sovereignty requirements on topic. So how do you factor in the regulator in all these markets? I'm never going to have that edge, right? The only thing that we can really do, you know, that's kind of like uncertainty in the stock, right? But in Southeast Asia, for instance, a lot of these countries recognize that tech companies and technology is basically going to be a source of their growth in GDP, right? It's serving their consumers in a way in terms of allowing access to products that maybe are not available to them locally.

Maybe it provides a more frictionless experience that allows them to upgrade their consumption. upgrade their lifestyles and whatnot. So that is great. In terms of the employee base or labor market, all these countries want to create, you know, higher quality workers, right? They want to create tech employees and whatnot to upgrade, you know, the amount of incomes that they can command as a country. And tech companies allow them to do that. And when you look at kind of the top companies in Indonesia, a lot of these guys have very close government connections. Some of, you know, government officials may sit on the board, you know, they may be former government officials, what have you. And so there are different, you know, connections that are kind of smooth the process.

I mean, at sea, for instance, Forrest always kind of credits the EDB program for kind of like jump starting and providing some capital to Garina back in the early days. You know, they hosted kind of the former meetings inside of like shoppy headquarters and whatnot. So you can, can tell that there's very close ties with Singapore government. You can go on LinkedIn. You'll see like, you know, see posting all the time. We just hosted X, Y, and Z foreign minister of whatever country, whatnot. So you can tell that they're pushing in that direction. You know, I'm never going to have an edge in terms of that and have any sort of like, you know, secret info that's going to give us some sort of extra alpha. That's, you know, that's not something that I do. But it's,

you want to know that at least the company is thinking in that direction, right? And is making a conscious effort towards cultivating these regulators. Are you factoring regulation or the political risk somehow in your valuation of companies? For instance, if you're still invested in JD or no, if you're still invested in them, does this play a role for you? It depends where the company sits relative to what regulators ultimately want, right? I would say China in general, I mean, you've seen the news in the last six months or so. you know it's definitely become a bit tougher there's more uncertainty there are some companies

that have gotten unfairly punished that um really have no effect uh from all this regulation because they are actually acting in the interest of the government and where the direction that the government wants to push society to go um but you know as investors especially for a lot of these companies that are listed in the west you know western investors don't necessarily understand that or don't see it so they kind of punish all the stocks uh you know indiscriminately um In Southeast Asia, it's a little bit different because, again, these companies are very large. They are acting in, they are on the side of the government and pushing these countries and societies and populations in the direction that the governments want them to go. They are not kind of budding heads and creating conflict.

And so because of that, there's a lot less regulatory uncertainty, I would say, in Southeast Asia than elsewhere. in addition to because each individual country is relatively smaller compared to say i'm heck china right each individual market is less important to a company like c than say china is to ali baba right you lose china you kind of lose all of ali baba's business um but for c you lose say the philippines it's not a huge part of their business right so you cut off one leg you still have you know a bunch of other lakes that you can kind of stand upon um and so because of that the companies that operate in Southeast Asia, have a bit more leverage, especially the larger ones and the world-class ones, over the government regulators than in other larger markets.

Is there anything you want to add about the understanding? We need to have as Western investors about Southeast Asia that we still get wrong? I would just say open-mindedness, right? understand that there are very interesting things that are happening outside of the world and the U.S. is not the leader in every single aspect of business model development or strategy. There are very interesting new innovations that are happening elsewhere, usually tailored for local markets but are probably applicable to larger markets or western markets like the U.S. And that you can learn from them.

And often by tailoring to local taste or local consumer behavior, that can provide a bigger edge than any amount of capital can. And you can kind of look at, you know, the debate several years ago between Lazzata and C, right? Lazzata had a lot more capital behind it, but C1. That was because they kind of tailored to the local markets versus Lazzata was a very Chinese company in imposing their culture upon the rest of the region. So, yeah, I would just say open-mindedness in general, right, and realize that because the world is becoming more and more global, great ideas and innovative ideas can come from a lot of places, and sometimes most innovative businesses don't sit in the U.S.

That's interesting. Let me close our conversation with a question on Hayden that came in different forms to me. it's a bit going about your great performance from the last year which was super and it often comes close with if you have a great performance in one year underperformance will follow in one of the following years how do you think about this risk and also how do you think about this risk that there's a rotation going on that is going away from sectors you're mostly investing in and your edge because a lot of money was pouring in the space. How do you see this risk? Do they play a role for you? In terms of performance, I've always told all their partners and have, you know, talk about this multiple times.

Number one, volatility is kind of the pricey pay for a strategy like this. If you don't understand that, you're probably not right for, you know, a strategy like Hayden's. And returns are always lumpy, right? Sometimes you'll have very large returns in a certain year and sometimes you'll underperform, right? But our goal is that over a 10-year period that we will outperform our relevant benchmarks and, you know, any other potential investment that our partners could have made. I would say, yeah, sorry, can you repeat that second question? Do you have fear that the sector rotation makes you look stupid with your, you feel? strategy? Yeah. So I would say that, look, our previous interview, I described myself as a pill

manufacturer, right? We do one thing and we do it well, but we're not right for everyone. Because of that, you know, if that disease that we're trying to solve for is no longer invoked, right? Maybe we won't have as much of an opportunity set or, you know, potential to perform. But I would also say that in any macro environment, there are always pockets of opportunity. Maybe it'll be tougher, right, in the next 10 years than our previous seven. But as a good investor, your job is to really keep as wide of a funnel as possible and go find those pockets. And when you're concentrated like we are, you don't really need that many pockets to go find, right, to generate some sort of return for your partners. So I would just, heck, I would give this example.

I mean, people would point to call it the mid-2000s as kind of the heyday of value, right? Like deep value and what you traditionally think of as a value strategy. Have you seen Tencent's returns from 2004 until, you know, heck now or even the late 2000s, right? No, but they must look very good. Yes. We're talking, you know, call it like 20X-ish over those 10 years. You can always find pockets of opportunity and new ideas, especially if you are open-minded and willing to look in other geographies as well, right?

So, Tencent definitely was not, say, a value stock back in the day, but they still had great performance, even though it was kind of the heyday of value and that strategy was most invoked. You just need to find businesses where the earnings are growing so rapidly that even if the multiple never expands or you face multiple compression, your net IRA is still extremely, extremely attractive. And you can find that. The earnings kegert of a company does not care, like, you know, whether value or growth or whatever is in vogue, right?

It doesn't matter. What these companies' earnings trajectories are based upon is consumer demand. And most consumers don't even own stocks, right? They don't know what's going on. They just know this is a product that appeals to me. This is what I want. I'm going to spend more my wallet share on it. And the company is going to benefit from that.

That's what you should be looking for. Dig into like the actual real economy, not necessarily what other investors are doing and, you know, how multiples are going to fluctuate, especially if you have a longer term price. Do you have anything to add for the end of our interview? Not that I can think of, to be honest. Yeah. I think you have pretty good questions. then thank you very much for your time and for the interview and we still haven't sent any greetings to philip for the end of the interview that's the part hi philip hope you good thank you very much fred thank you

bye bye bye as in every video also here is the disclaimer you can find a link to the disclaimer below in the show notes the disclaimer says always do your own work what we're doing here is no recommendation and no advice So please always do your own work. Thank you very much.