Good Investing Talks - Why are you invested in Sea Limited and Carvana? A Q&A with Fred Liu (Hayden Capital)

Episode Date: January 25, 2021

Fred Liu of Hayden Capital is a Value Investor with a focus on quality investments. He is investing concentrated and looking for opportunities in the Asian internet space.

Let's have a start for our conversation. Before we start, I want to show the disclaimer. And give you some information that is, this is no investment advice. You can look up the disclaimer in the details of the video that you can find below. Do your own research and yeah, don't take this as an investment advice, take this as an opinion, in-depth talk and some information, but no investment advice. And always do your own work. And then let's go back to our talk and interview. Fred, in your last letter you said you had some plans during your time in quarantine to improve

your cooking skills. So what new receipts you've tried? and what you've learned in this time this is the first question before we start with it was after I read your letter I was so curious to ask it you know I have a lot of cooking references in my letters right like I referenced Tom Colicchio's book a couple years back um so this time for the first time I made fresh pasta so that's the first thing that's different um the second thing probably stuffed cabbage cabbage uh put some rice ground beef uh different spices, whatnot, did that. And then I also made a Chinese dish from Xi'an,

where my family's from, called them delicious. It's kind of like little chunks of dough with carrots, you know, green beans, potatoes, what have you, into a kind of stew. So that's probably the third thing that's new that I made. So sounds very tasty. No, I'm hungry. No, for sure, I've been eating well.

That's good. Let's go switch to the topic of investing. You had a, as an investor, you always have an evolution from the way you go into investing and you become a different kind of invested during the good days and also the bad days. Like what was your evolution in investing? How would you describe your way in that field and what were the best fails that contributed to this way of evolving or growing? in investing. Yeah, sure. So I think, yeah, so when you okay? Yeah. Okay, yeah. Yeah, so I think it helps to kind of start a little bit earlier in my investing journey. So, you know, I first started, you know, I got my first shares of stock when I was 11 years old. It was 15 shares of Walmart. I've talked a little bit about this in the past, but basically, you know, my,

My dad gave it to me for Christmas one year. And when we would walk into Walmart, he'd be like, hey, you know you own that door or that shelf, right? And that kind of sense of ownership really originally got to me. I distinctly remember sitting on the school bus once and, like, bragging to my friends that I own a piece of Walmart. And so I've always been hooked. I've always been loved money, I guess, because I'm greedy in that way. And so all throughout middle school, high school, I started day trading, bit in middle school as I can I could open a minor custodian account with my

parents approval I basically lost everything over the course of the summer I was day trading I started going in penny stocks it was not a good experience lost everything that I had saved up to that point so that's what originally turned me on to value investing because when I went to a library to think you know there must be a better way to do this you know the book Warren Buffett way was one of the first books that I read. So the approach made complete sense to me. And so I started reading as much as I could

about the value-investing philosophy. By the time I got to high school, I basically knew that I wanted to be an investor. I had done like a banking internship in high school. I had done classes at Columbia University, what have you. And so I think like everyone, you know, I started off more on the net net deep value type of spectrum. I think when you start off as an investor, that quantitative approach, it seems simplest

to you and makes the most sense. And you know, during my freshman year of college, it was the start of the financial crisis as well. So there still were plenty of net nets. You know, the first stuff I ever bought was SL Green, kind of back at the bottom of the crisis. I have to do, I'm sorry, I might have done a mistake because the first time I'm doing this setting I think we've now the live stream should have just started yeah I'm sorry I have to

start from I'm sorry but I might have done a mistake because oh sorry I have to let us restart again and sorry for messing up the beginning but now we can restart and hello everyone and Hello to our audience. It's nice to have Fred Leo of Hayden Capital here today. Hi Fred. How are you doing? I'm doing well. Thanks, Tillman. That's good. I had a little bloop there, but quite all right. Sorry for messing up to start, but before we start, we have to do some regulatory things, and I have to show you our disclaimer. Let's do that quickly. The key message is,

this is no investment advice you have always to do your own research and we are giving your opinions and qualified remarks but it's no investment advice and please do your own research fred for the beginning maybe let's start with a question that's from the non-investing space in your last letter you said that you're preparing you're working on your cooking skills in quarantine so So what came out of this? Yeah, so a couple things. I've never baked or, you know, made fresh pasta before.

So that was my first achievement. I can say by the second time, it came out pretty well. The next dish made some stuffed cabbage. So ground beef, rice, tomatoes. That was a experience because usually I cook Asian cuisine. And so it was good to venture outside of that. And then the third thing is probably a Chinese dish from where I'm where my family is from Si Yan. It's called Mahshutze.

So basically little chunks of dough, carrots, potatoes, green beans, all in a stew. And very tasty. It was a dish that I had all the time growing up. And it's hard to find in New York or in the U.S. And so you're kind of forced to make it yourself. That sounds very tasty. And you should send me to receive. that i get some idea how to do it but maybe yeah should find a good chinese restaurant to cook

it for the first time um let's switch to investing and maybe let's start with the question how you involved as an investor and um what were the best fails that contributed to your growth as an investor yeah so um you know as i was i was saying earlier it really starts at the beginning um I got my first shares of stock from my father when I was 11 years old, 15 shares of Walmart, right? And like I was saying, I distinctly remember bragging to my friends on school bus about how I owned a chunk of Walmart. I think I've always loved that sense of ownership. You know, whenever we walk into Walmart, my father would say, like, hey, you know, you own that door or that brick or that shelf. And I thought that was so cool.

And then I took the wrong turn initially. By the time I could open a minor custodian account when I believe I was 12 or 13 years old, I started day trading. I started listening to CNBC, you know, watching Jim Kramer, trying to get the half-hour earnings spots. Needless to say, over the course of summer, I basically lost everything that I had. It was a couple thousand bucks that had saved up until then. Painful for, you know, 12, 13 years old. And I started going to penny stocks really taught me around like level two quotes, bid ask spreads, all of that, right? So that was a good lesson.

After that experience, I basically, I went to the library and basically said there must be a better way to pursue investing. And so the first book that kind of always stares at you is Warren Buffett, right? He's kind of the most famous investor. And so I picked up the book, The Warren Buffett Way, it was one of the first books. And then, you know, I read a lot about value investing throughout that period throughout middle school and high school. And by the time I got to high school, I knew I wanted to be an investor. Had done banking internships, had the classes at Columbia University by that point. And I really fell in love with kind of discipline.

My dad wanted me to be an engineer. You know, he sent me to like summer camp to try to like force me to be an engineer. I knew I didn't want to do it. He's a mechanical engineer. What did you build at this summer camps? Paper airplanes to see, like, who could fly at the furthest, like bridges to see, you know, like which ones can hold the most weight. Yeah. So, yeah, that experience wasn't for me.

So I decided to go to NYU, specifically because I didn't want that liberal arts background. I knew I was an investing there by then. I wanted to learn how to build models, you know, run BCC, what have you. And so, give me a second, just close. Yeah. Yeah, so after NYU, you know, I went to J.P. Morgan asset, and I worked on their small cap equity team at the moment. You know, I had already developed a similar philosophy to how I think about investing today. You know, when I first started off in college, definitely like everyone, I kind of gravitated towards the net, that's the deep value.

type of names, like I was saying, I think most investors that I know kind of start off in that space, either because it's simpler to understand. It's like a quantitative exercise rather than qualitative. I think as an investor, you don't really appreciate the qualitative aspects of business until you get more sophisticated as you progress in your career. So, you know, like, you know, my first stock was during that time was SL Green during the middle financial crisis. You can still find names like that. I was evaluating what is the net asset value of all the office space that they owned within Manhattan and trying to run calculations based on that and being able to buy

that like half their bulk, right, of what I calculated as their book. And then I eventually, like I said, made my way to J.P. Morgan. They had a much more quality kind of focus within small cap space looking for names under $2 billion. dollars. We were five analysts, you know, one PM. And so that really helped home my philosophy a lot. The problem with working at kind of a larger asset management firm, a more institutional firm, is that there's a big push towards not only forced diversification, but also, for instance, we were closed at the time, but JP Morgan would like force us to open new products and

and I could just feel our time getting stretched. If we were evaluating a new name, you know, I talked to other friends at other firms, so it's not just firms like JPMorgan, but other firms as well. You only have so much time to go deep into each individual name. I felt like that wasn't the right way to pursue true investing. And so it was around that time that I started thinking about, like, what does a great investment firm look like,

from a client standpoint, you know, how do you structure the firm so that everything is aligned in the client's best interest? And then also how can basically the frustration I also had and started realizing at that time, just talking to a lot of people in the industry is I realized a lot of people sit behind their computer screens and think that they can have an edge on the market by doing that. They feel more comfortable because there's a lot more information on the internet nowadays. But, you know, I think the underappreciative part is really understanding the incremental unit economics behind selling these businesses and you're never going to find that on the internet right by

the time it's in a 10k or in a public filing it's already relatively well-known so I think a lot of the edge in the market today is just doing your good old fashion channel checks talking to as many people as possible so I wanted to build a eventually build a firm like that after JP I went to a firm called a New Street, a boutique, TMP research shop, they do really good work around the new economic type analysis that I was talking about. And they also do really good work around building their networks and, you know, trying to get information from people that just through industry sources or through relationships that they already have. And so after New

Street, I decided to launch Hayden. And we've kind of been pursuing that strategy ever since. definitely gotten honed over the last couple years, but the basic core principles are the same. So how many people do you need a year if you do your research? Sure, I think it's actually increased. I remember looking a couple months ago, and actually we did 300 plus meetings or calls last year. For me personally, I was looking at my calendar. It's about five meetings a week, so one a day. And then when I'm traveling, I generally try to pack about three to four meetings per day during my travels. And so that gets you into that 300-ish range.

With this quantity, how do you get the documentation on the quality of the meetings because it needs some time to work after them and prepare them as well? Or how is normal meeting looking like? Yeah, I mean, we, I personally love meeting everyone. So whether it's company executives, you know, former employees of a firm, whether it's like VC investors who may be investing in earlier stage companies that we would look at to understand like what's going on in that segment of market and potential threats to the companies that we own. Or it's just other investors as well, right? I think there's something to learn from everyone. And even if, you know, let's say both of you have disagreeing views on a certain stock, there's always, those are the best conversations, right?

So I try to meet everyone that I can to get like a holistic view of a certain topic that I'm trying to have a better grasp of fun. And so meetings, I mean, yeah, the meetings take a little bit of prep time, maybe like 30 minutes, 45 minutes beforehand, just writing down a couple questions. But other than that, you know, the conversations flow pretty naturally. Interesting. I already see that there are some questions coming in, so we will walk you to these questions. But maybe let's go to the next question. How would you describe your edge as an investor? Like I said, I think a lot of people sit behind their computer screens these days and they

feel comfortable with that. I think as an investor your best edge is, you know, let's say you have a deep understanding of a certain industry. Maybe you work in that industry. Talking to all of your colleagues, you know, all of your clients, I think that's the best edge because a lot of people on Wall Street are sitting in New York and they may not use these products or have ever seen anyone use these products. And if you're sitting, I don't know, in an emerging market and actually have firsthand experience with it, I think that's a real edge against a lot of the investors, the more professional investors. And so I try to do the same thing. Even though, for instance, we have some investments in Southeast Asia, I can't really use the product, but talking to as many customers

as possible, I think helps me get closer to that first-hand experience. Interesting. You have a certain focus on aging companies. Can you maybe help me and other viewers with things that desk-based investors and others investors usually get wrong about Asia and what is what are interested in this space? I think number one I think people still have a strong at least in the West people still have a strong biased against Asian companies Asian Asian Asian Asian management teams whatnot I think what's what needs to be said and I think what people need to understand is that call it 20 years ago um you know the the

people who got rich in China especially call it 20 years ago they were the ones who basically grew the quickest they weren't the ones who were necessarily the smartest the best that allocating capital they just basically threw money into as many products as possible and because the company was growing so rapidly or the country was going so rapidly they kind of got carried away with that pill one, right? And they benefited from it. You know, if you look at, for instance, average incomes in China in the early 2000s up until, you know, 2010, 2012, it was growing at a high teens keager. Imagine your personal salary growing 20% every year, right? That instills a different type of mindset. Like, I can't lose type of mindset. But as China has slowed, I think, and, you know,

just anecdotally, I've noticed this as well, a lot of management teams are becoming more rational. A lot of management teams have experience with Western companies or have worked inside of Western companies. They have a much better sophistication around capital allocation, return on investment capital, what have you. And so these companies are changing. It's just a natural dynamic that you see when a country starts maturing, and the pie doesn't grow so rapidly that you can just toss money against the wall, and it's going to bring you back 100 bucks for each dollar that you throw. And so you're starting to see that in China today. And I think Asia changes so rapidly that if you have a bias from even five years ago, 10 years ago, that bias is probably outdated.

So I think that that's probably something that not a lot of people quite appreciate just yet. And I would just suggest anyone just go visit Asia if you haven't already and then start talking to people. I think you would be pretty impressed with the business environment there. What are your reason takeaways from your trips to Asia? I mean, you know, I know we've talked about this before, one of our life's positions to see, right? The biggest takeaway in Southeast Asia is that it's starting to hit, you know, what's widely called as like the golden zone, right?

That $2,000 to $4,000 USD GDP per capita, you basically reached a level where families can kind of feed themselves, they can take care of its necessities. And so the play is really, as each family gets an incremental dollar of discretionary income, you know, your discretionary spending literally gets multiplied by three or four X as compared to the four. I think that's the biggest opportunity here. You're starting to see a lot more startups come up as well. There aren't quite that many listed companies, you know, is a great example but they're listed in New York in terms of local companies

they're just the quality isn't quite there yet but if you look at the earlier stages the series A B C there's quite a few called like mature tech firms in the region I think over the next five years you're gonna see these firms succeed and they're gonna start being listed and I think part of the opportunity is just understanding that market getting ahead of it so that in five years when these companies start being listed, you have an advantage there. Interesting. We already have some questions.

I think the questions on Kavana, I will put to the later part of the interview. But we have a question here from Frank. How do you think Shoppy is competing with Lasada today? Where are they each in terms of positioning today? Yeah. So, yeah, so I think Lazzata has recognized the error of its weight. so to speak. Basically, they started off as a predominantly one-p retailer focused on high-value categories like electronics. And the problem with these types of categories is that it's a low-frequency

purchase, right? You don't really buy a new computer every month. You don't buy a new cell phone every month. In logistics, it's very expensive. Versus where shop B started out is that it was predominantly fashion and beauty focused. If you think about like a dress, it's very easy to ship. If you look at surveys in the region, a lot of people are willing to wait in terms of delivery time for a piece of apparel versus maybe a brand new cell phone, right? A cell phone you may want tomorrow because you have some urgent need for it. And so that's where they started off. And they started off in the C to C marketplace focusing on kind of long tail inventory. Lazzata has basically started moving in the direction of Shopify as well.

And Shopify, likewise, has started selling electronics, home goods, you know, normal household appliances and whatnot. So I think you're starting to see them converge a bit. But the difference is really in the culture of Shopify. They're really good fast followers. If they see a new innovation or product feature from Lazada, they're very quick to basically implement the same thing. And they do it about three times better, basically. So I think at this point in time, because the market has matured somewhat that, you know, people have formed their own habits, their own shopping habits.

You know, for Shopify, your average number of orders per month is somewhere like four or five times a month, right? If you're ordering that frequently, that brand stays in your head. So next time you do want to order something, your first go-to is Shoppy, and you probably already have the app download it on your phone. And your phone is probably a low-spec phone, doesn't have that much space, so you don't want to download too many apps. So these apps become almost like real estate on your mobile phone. And, you know, if you, the average number of times a person visits these stores is multiple times a day, right? And so it's

similar to going inside of a mall, you know, call it five times a day. You may not buy something the first four times, but the fifth time you walk past something and it seems attractive so you make that purchase. It's the same thing that Shopify is trying to invoke right now, get people using the app, get people spending as much time as possible on the app, and eventually they're going to find something that they like. So, you know, they just do a much better job of that than Lazada. And they, in Indonesia, they're, you know, basically a number one player, Lazada, I believe, like number four last I saw. In other countries, they're a little bit more neck-to-neck, but Shoppy seems to be growing quicker. So I think by this point, you know, two years ago,

the market controversy was how is Shoppy going to be able to compete against the capital canon of Alibaba and SoftBin? I think that question's been kind of proven out already, which is why you see where shares are today. But I think it's only just the beginning. shopping is just starting to prove that they are the winner in the market and typically you see e-commerce as a winner-take-most type of market and where you see the profitability come through is when the marketplace is two or three times larger than the next largest marketplace so you can look at shopping and taiwan for instance right they have the dominant portion of of market share called like 78 percent right um and that's where they're most profitable so if you watch how market share trends

versus relative to other players, that's a good proxy for their eventual probability as well. Maybe let's go level higher or to the basics for our German views because I have to admit that I'm not the best expert in the Asian, Southeast Asian shopping market. Can you maybe describe some of the basics of the name you just mentioned? And also the background of Alabama, there was also one question coming up yeah um so i'm in the sea really operates two core main businesses they have the third emerging business one of them is gaming uh the gaming started off as a republisher of uh it sent a lot of tensen games um and so that's a beautiful business it requires very little capital uh if they already know what games are successful in china they have the right of first refusal to basically

cherry pick the best games localize it uh you know change the language integrated with the local payment methods, what have you. So that's a beautiful business. And then they have basically taken the cash flow from there. They're going to generate about call at 1.2, 1.4 billion USD EBITA this year. And they've taken all of that cash flow to reinvest into Shoppy, in addition to some debt as well. And Shoppy is an e-commerce marketplace and how it differs from, you know, something like Amazon or like I was saying, is that they started more on the social networks.

A lot of sellers at the time were selling on platforms like Facebook, Instagram, what have you. And so they created a system that was very easy to take these seller shops off of Instagram and import it onto the shopping platform. You know, on Instagram, basically, people would load these posts, right, of items that they have. And then you would DM them and negotiate, you know, the pricing, payment, where to send the payment, where to send the item. And it was a very clunky experience, and they noticed that a lot of people were doing that through the talk app.

And so they launched Shop B, which is a more formalized, the lower friction type of marketplace, predominantly C to C, so consumers to consumers where they started off. And so that business has grown, you know, from 2015 to today. we think they're going to do about over 30 billion in GMV on a overall level they're still not profitable but you have to look at it on a country basis like I said Taiwan's already profitable Indonesians probably break even and then the other countries were sure that they're going to break even within the next two years or so so that's their that's their second business and that's kind of what's driven the stock over the last year or so and then their third business is called

see money. It's basically their e-wallet platform in addition to they offer seller loans. And so this really is synergistic with the shoppy business because a big issue in the region is kind of these sellers are like mom and pops. And so they may store their extra inventory and they're called second bedroom. And so they have a bunch of these holiday sales. You have like 10, 10, 11, 11, 9, 12, 12. And you get these huge spikes in these high. holiday sales. And so as a seller, the biggest problem is that you often run out of inventory during these sales. And so these sellers need working capital in order to kind of meet those spikes in demand. And so that will help. It will help with retention. And then also as a e-wallet

platform, they're starting to go offline as well. And so we can see kind of, you know, what AliPay has done in China to get a good idea of, what the roadmap looks like for shopping pay. So, yeah, those are the three core businesses upseat at the moment. Do you have any idea where you see this company in five or ten years? I know Forrest thinks that this is going to be a $100 billion business. You know, it's in a, I think it hit 40 billion today. It still has a ways to go.

The thing with these types of companies, you know, we invest in relatively earlier, stage companies when you have market penetration of you know a couple percent um it's really hard to gauge where the market is going to mature in 10 years and 20 years right how much is the internet penetration or in this country's so so e-commerce penetration i mean it's like 3 percent right there's some way to go right you have a long ways to go you see china is probably the most penetrated and the high teams close to 20%. But, you know, they're still growing very quickly. You have Amazon in the U.S. still putting up 20% cagers, despite being, you know, e-com penetration four to five times higher than the region. And the thing is that generally, e-commerce penetration

tends to follow, like, density in a city or density in a geography. You know, if you're in the U.S., like right now I'm currently in Cincinnati in the suburbs, you can drive to a Walmart or the mall or whatever pretty easily, right? But if you're in a city of 20 million people in China, going to the store is a really big pain. And so you tend to use these e-commerce services a little bit more. It's why you see like food delivery taking off in China as well. So I would think that Southeast Asia, because it is more dense than places like the U.S. will be able to exceed where the U.S. kind of peters out in terms of mature penetration in the market. But it's too early to tell these businesses change over time. Consumer habits change over time. There may be, I don't know,

instant teleportation of goods that you order and maybe someone will come out with that in 20 years or something. So it's really hard to gauge where the top of that S curve is. So I would just say look maybe three to five years ahead. You can probably get more confidence there. to where these firms hit that top of the S-curb, you should keep in a close eye on it. But, you know, it's anyone's guess. Yeah, it's about the future, and the future is uncertain. But you can make some predictions based on the patterns you've observed somewhere else

and the chances you have and the user patterns. But maybe let's go back to the nearer past in the year 2020. What a year until now. How have you found value in this crisis? and how have you positioned yourself from the beginning of the year on? You had some Asian insider information that I've read in your letter? I don't know if it's inside info. I mean, if you were paying attention to the news and reading Asian news,

you could kind of tell what was happening with coronavirus and the impact that was having on businesses. And how did your earwold during the last months and where have you found value in this last month? Yeah, so our portfolio was relatively insulated. You know, we had some hedges on, and they added a couple percent to our portfolio, but it wasn't significant. Our portfolio was relatively protected because we do operate in, or we're invested in

a lot of these internet retailers, right? And so when all of your brick and mortar shops are closed, especially in emerging markets. Customers that may not have used a service like that before, they have no other choice but to use, say, e-commerce for their daily means. And so it actually attracted a lot of customers to these platforms, and it was effectively free customer acquisition, right? And so a lot of these companies benefited from this, you know, Shoppy reported, I believe, 140% year-over-year GMV growth back in April. I think the opportunity was that when coronavirus was really starting to hit the West, a lot of people thought that people would just cut back on spending in general. So you saw

some of these names take a hit in the early part of March late, or part of March. And then people quickly realize that these are actually beneficiaries of this trend and that a lot of these customers who may not have to use these platforms before, if you have a great mousetrap, they're going to stick inside of that mousetrap, and they're going to refer more of their friends, right, even after coronavirus ends. And so I think that's why you've seen such a rapid rebound in this space. I think that one thing that that's interesting is that a lot of people, and I talked about this in my last letter as well, that a lot of people are trying to look at the traditional brick and mortar space and gauge when is the U.S. going to open up when are certain countries going to open back up when is traffic going to normalize right and I think that's a really hard game to play at least from my standpoint I think a lot of people won't make a lot of money doing that but in my view I think that's I just don't have an edge there and so I think the best opportunity is actually think about who is a beneficiary during periods like this if you think about a lot of

these tech companies, these internet companies, you've seen the news about, like, work from home and whatnot. These are very resilient type of businesses, right? If you can have your entire workforce, basically working from home and not be in a physical office, not have to have a physical presence, that's a really resilient type of business, right? So I think the opportunity is really even in the emerging space where things like Shopify have 3% market share. There's other companies out there we were looking at, like, buy, now, pay later type of companies. These are a small portion of the market. Businesses that have a superior mousetrap, that you know that once people learn about this business model,

that they will use it, that they think it's a superior way to buy something. And so these types of businesses, because they're so nascent and the biggest friction point is educating consumers, they benefit the most during something like this where consumers are naturally looking for a way to buy things online so I think a lot of investors should kind of focus their time there in my opinion and there was also one question on how you remain patient in this rally we are currently in that's I think for myself it's a paradox market but how you do you remain discipline in this surprising rally was

Well, I personally still think our names are cheap. And so I think that helps with the patients, right? You know, things like C, one of our largest position, even at $40 billion, I still think it's probably one of the easiest buys in my portfolio today, just given the level of risk that they've proven their dominance in the market and kind of the massive macro tailwind behind them whether it's an industry tailwind or a even gdp type of tailwind in these countries so uh yeah even even though names like that have um been very successful for us this year um i would recommend to new clients you know to continue buying them as well and maybe adding on onto this observation

when you use the parts of the markets that are overvalued for your guess yeah well i focus on a my core competency is a in a very small sliver of the market right as you can probably tell and so in my space i think the place to look for shorts is probably um you know a lot of these names have basically been driven by this whole trend towards work from home people are talking about you should buy all of these tech stocks these internet stocks what have you. The question is that if you don't have a great mousetrap, but people are forced to enter that mousetrap because they have no other options, they're going to leave as soon as the country opens up and people are allowed to, you know, go into stores again. And so the question is which companies actually do have a superior mousetrap as a business model, as a product, serve their customers the best. as opposed to their customers just being forced to use the product during this period of time, and they're going to leave as soon as they have a chance.

Those are probably the most overvalued segments of the market right now, because I think we're in a period, at least within the last month or two, everything is just kind of trading together, and everyone thinks that these Internet companies will all benefit, and that's not true. Some of these will go back to kind of the levels that they were at in terms of consumer demand and whatnot. How do you get confidence about the chance that people will leave the mouse trap soon? That's qualitative, right?

So it's either you can talk to as many consumers as possible, you can do surveys, you can use, for instance, case studies, you can use alt data to kind of track it on a weekly basis. It really depends on the individual name. Um, but I think you need to make a judgment, right? Do you think that this company's value proposition to its customers is superior to the brick and mortar alternatives? Um, yeah, it's gonna depend.

Just that I hope I get it right that C is still cheap in your eyes. Yes. What must or what could happen that it might be reevaluate and getting some valuation or evaluation that makes it not that cheap anymore. I think driving forces of, or let's put it as a question in general, when is this especially interesting to invest

in such online retailers and when you can profit from your revaluation? We already talked about this. Right, right. So I think there's this idea of, you have to think about how quickly the intrinsic value of a company is growing, which you can use as a proxy call it like their current earnings power, right?

If earnings are cagering at, say, a 50% annual basis, right? That's pretty impressive. If you're able to buy a company like that at a multiple or valuation, that doesn't imply any future growth, that's basically the type of situations that we look at. You know, when we bought C, it was about a $4.5 billion company. We thought the gaming business alone, would make up the significant majority of that, plus they had a good chunk of cash on their

balance sheet. And so the market wasn't valuing the shopee business at all. And so those are the situations where you have shopee that grew, you know, over 100% for a couple of years. And their earnings power kind of grew in line with that. And on top of that, as they kind of prove to the market that this business is stable, this business is capable of generating cash flow. and that they will be the winner in the market, you get a valuation re-rating, right? You literally started that basically a multiple of zero, and now I'm sure the market is valuing at, you know, close to 10x or whatever. And so I think with these earlier stage companies where you are, it's a new business model, maybe it only started existing a couple years ago,

you need to have confidence that even if they aren't profitable yet, that they do have a pathway to profitability and that it like again it all derives from what is their relative market share versus competitors and what is the customer value proposition right the problem is that a lot of public investors aren't comfortable making those type of judgment calls a lot of public investors may not do the necessary channel checks that actually understand what's going on behind the scenes what makes one marketplace sticky versus another what makes say, you know, the average customer of one marketplace use the product for an hour a day and the other one maybe five minutes a day, right? And they may be valued similarly. So I think

for these companies, you need to be able to have those kind of data points to understand what are the early signs of a marketplace that's going to grow quicker than its competitors and then be willing to take that bet. I think, that you know for certain names they do get overvalued so you want to think like if your earnings are catering at a 50% but it's pricing in say the next four years of growth already and so actually let me see if I can draw something for you real quick it would be good then I take the chance for in the short break to ask for more questions so I'm happy to see for more questions from the audience we're still

have around 25 minutes to go and we will also do something on Kavana but let's continue with your drawing. I'm happy to see it. Sure. So it's done. So basically if you think about an S curve, right, this is this is the S curve, this break even. If you're operating in this area, right? Your intrinsic value may be called Kering at 60%, but let's say the price is here, right? So as an investor, the return that you're going to realize maybe like a 20% it's the slope of this curve, say this is five years out or three years out or what have you. If you're able to buy it at valuation of here, you're going to realize the same Kager as that earnings power, right? But if it is a higher than, you know, multiple that's justified with where

the business is today, you're probably paying a higher price. And so you need to evaluate what is the slope of this curve. If this slope, um, calls it falls below, you know, we use a rough estimate of call like 10% over the next three years even though it might be a great company i i think it it would be in times like that where you should consider starting to trim the position um but you know everything that we hold today i think we'll be able to meet that uh bar pretty pretty easily the first stock i came into touch with you was uh jd because we had a very lively discussion in germany about jd as an investment two years ago or something like that and what is JD an example for this kind

of revaluation and you sold it to that reason or did you sell it because there was other reason so yeah so I think in the case of JD anyone who's interested can read our letter during that period I talked about it last year I will link them below so you can find letters of but yeah I think by the time we've bought it, J.D. was pretty well known in the market anyways. It wasn't a case of, you know, shopping. J.D. was started, I mean, at the time, it was even started 15 years before we bought it, right? And so, in that case, the issue with the name was that the product itself had a similar issue to what Lazzata has today. It's very electronics focused, very mail focused, and honestly,

male consumers don't leave very detailed reviews. They don't refer products to their friends. They don't refer companies to their friends. So that segment of the market is an issue as well. And the real problem is just the low order frequency of that platform. And so we found better opportunities in cases like Shopify where, like I said, customers order multiple times a month. The basket size are very sticky. It's a fun product to use. J.D. is more of like an Amazon-type model where it's about efficiency, right? You saw them benefit during this coronavirus period because they have their own internal logistics systems. They're able to get your items to you basically on the same day. The problem is that

your average customer may only use the platform two or three times a year. And so you constantly have to reacquire that customer as well. And so I think that just added a lot of friction. I'm I'm sure JD will continue to do just fine. We just saw better opportunities. Interesting. Was there also a reason to also get one question from the chat with the internet space in China and how do you see the movement there?

I would say China is getting very competitive. And so I don't think you're going to see the same opportunities in China as obviously 10 years ago, 15 years ago, when a lot of these behemoth companies were founded. You do have new companies such as bite dance that do have a much more international approach from the get-go. So that keeps it interesting. But the cost to acquire customers everywhere is going up.

And so that's why you see a big pivot in China. In my opinion, I talked about this in a prior letter as well, the whole trend of super apps, right? able to offer multiple services multiple products on the same app because once you acquire a customer once you can then kind of diversify that cost across all these different product lines and some products may be run at cost in order to just retain the customer and then other products may be low frequency but high margin type of type of lines such as you know hotel bookings or whatnot and and that's what really kind of provides profitability to the business but in general I'll

say that, yeah, China is just becoming much more competitive nowadays. I think a lot of Chinese companies are actually out-executing the Western Internet companies. You're seeing a lot of, you know, one of our themes is the cross-pollination of these business models, right? Because you have a lot of Silicon Valley type of companies that are keeping a close eye on what the Chinese companies are doing. Like if you launch a new feature, like let's say live streaming, right, and it increases is the average retention of your users. As Amazon, I'm definitely going to take a close look at that and see if it's applicable to the U.S. consumer as well

because you kind of have a roadmap already, right? That's already been trialed in China. And you may have slight differences on the margins, but consumers are generally the same globally. So, yeah, I think that a lot of these companies are becoming more mature, more sophisticated, and it's become a little bit tougher to find good values there. Interesting to hear that.

I will now go to the questions on Kavana. And we'll start with the first from William. His questions is about what you think about Kavana's partner inventory program from the unit economics perspective compared to the normal retail sales. Yeah, I think it's a little too early to know for sure. I mean, they've never talked about it publicly. They just started trialing the program. the program. I think it's really too early to know for sure what the what the

unit economics are going to look like. But if you think about the benefits of the program, right, you think about the benefits that Carvana provides, it's really around, you know, your your Honda Accord that Carvana offers isn't going to be that much different than CarMax's Honda Accord or, you know, your local brick-and-mort dealers, right? The benefit that they provide is the convenience the trusted brand, the logistics network, the reconditioning centers. And so they're basically following the Amazon playbook, right? Prove to the market, educate the market.

And then once the market is basically primed with your own product, then start opening it up to third party partners. And then charge them for the most valuable parts of your business, which is, you know, basically shipping, shipping the car or the book. or the product to the end customer and then leveraging your brand a quiet you know they've spent a ton of money on marketing they have great brand awareness in the market imagine you're a local brick and mortar player there's no chance that you can have that same level of brand awareness even within your local market um so you can kind of charge for that and then eventually most likely they're going to move

into kind of like a sponsored placement type of model uh perhaps but i think as it as in terms of specific numbers. I think it's too early to really know for sure. To learn more about Kavana, I will also link the interview ahead with Cliff Sosson, who is heavily invested in Kavana up here so you can have a look at this also. There's another question on Kavana. You said in your letter like the question says that you said in your letter that Kavana is a bet in the management team the ability to execute a business. What your current thought about on management? I think they've done everything right.

Like I said, I wasn't expecting them to kind of launch a marketplace model this quickly or to even trial it. And the fact that they're doing it, I think, is something. So when you're evaluating management, right, I always wanted to think that as a investor, you should put yourself in the shoes of management, say, what, if I were running this business, what would the roadmap for it look like? And I think marketplace, if I were running it, marketplace and the whole Amazon Fulfilled by Amazon Playbook is something that I would definitely try.

And you can tell management is thinking in a similar way, right? So that, I think, gives credit towards the quality of Ernie and the entire team at Carvana. So, yeah, my opinions haven't changed at all. And you see during periods like, you know, the last couple months, they raised money, even though they honestly didn't really need the money. They're using it to get more aggressive during this period to take share at a above trend level than they were going to do before. And so I think when your competitors are hurting, yeah,

and you aren't as much, that's when you should be getting aggressive. And they have access to capital that your local brick and mortar guy isn't going to have. And so why not use that to your advantage? So I still think highly at home. Is there also some reflection in numbers of the way they are getting more aggressive? I think they'll probably release some details, but a lot of it is going to be around building out their inventory, I call it like their marketing channels, building out their vending machines, reconditioning centers, what not.

I mean, you know, like I said, I'm sitting here in the suburbs of Cincinnati at the moment, and 15 minutes away, Carbona just announced that they're going to build a 40,000 square foot reconditioning center hiring. 400 or 500 people. They just announced that. Which I don't even know if they've announced it, but it's in the local news. So you can see them doing things like that. There's one question from Frank. Couldn't Carmix go straight to customers? I believe they're doing that already.

Yeah, they are. I think what's interesting is that with these industries, these nascent kind of business models of selling use cars online, When you're at, you know, this entire industry is, you know, one, two percent penetration of the market, depending on how you want to cut it. At that level, the biggest friction point is around consumer education, right? CarMax absolutely can do this. I don't think that it's going to be a winner take all type of market.

But when you're at one to two percent penetration, the biggest problem is just getting people to know, like, hey, you can buy a car online, site, unseen, and yes, you can trust it. And the more players that you see kind of piggybacking on each other's marketing spend, the more beneficial it is for everyone. And especially in a case like a used car, right, you're going to spend at least 10 hours evaluating what model you want, what dealer you want to buy it from. And during those 10 hours, if you came because of a CarMax commercial,

you're probably going to make your way towards Carvana because you're obviously going to price shop, right? And then if Carvana offers a better experience, if they offer a cheaper price, you'll probably use them, even though it was CarMax that paid for that marketing. You see this across other industries as well. You know, for instance, shoppy pay, right, or C money in the case of C, they let competitors basically burn billions of dollars on this e-wallet initiative in Indonesia to basically educate the market and then nowadays you know as of a couple months ago they

start getting aggressive because the market is now educated and so they can come in with the biggest use case which is e-commerce and automatically you know they reported 40% of their orders in Indonesia where through that through their own e-wallet this this past quarter I think when market when the total industry market share as a percent of the addressable market is that single low digits, you don't really need to worry about competition as much. You just need to focus on executing yourself. It's when you start getting to that high single digit, call a 9, 10% penetration. That's when you start budding heads against your competitors. And that's when you

start, the pie stops growing as rapidly, right? Because now you need to basically take a piece from someone else in order to continue growing. That's when you start seeing the problems around the competition. But at a very, very early stage, I think actually the more marketing dollars that go into it, the more benefits everyone. Maybe we could go back to your drawing. And where do you see Kavana on the S-curve currently? Well, they haven't broken even just yet. So they're probably below this line, like right there. And where do you see it in five or 10 years? to take the long-term view. Sure.

Ten years, again, that's, we don't know where it's going to be. We have to, you know, part of our process is re-evaluating these businesses every two years, every three years, what have you. So I don't know where it's going to be. That's too far at the call. We have to reevaluate as we go. But, you know, within a couple years, I think they're going to break even. I think we're in our model, we have them doing like $15 billion in sales within,

call about four years or so and at those types of levels at a normalized margin they're going to be doing like a billion plus so the question is you know what do you think that a business like that should be valued I don't know at the moment because I'm not a specialist sure how flexible are you in your thesis if you say you really evaluating your thesis every two years like um i think you have to constantly re-evaluate i mean um i also talked about this in a letter about like in a concentrated portfolio like this and especially investing in companies that are a bit earlier on the s curve uh it almost follows that preto principle that 80 20 rule um and it's

almost similar to like a venture fund right there's going to be a handful of winners that really drive the majority of your returns. And so you have to be cognizant that a lot of your names may break even. They may not work out. And your thesis is probably going to be wrong a lot of the time. So to answer your question, you have to be very flexible because that's just part of this model, this strategy. So how much time does it take for you to change your thesis and also to admit that you're wrong? probably longer than it should take. But generally, you know, it depends how wrong I am, like the degree to which I'm wrong, right?

If it's a fixable problem or not. And then, you know, in certain cases I may, if I think that management has a plan to kind of fix that problem, I may give them some time to see if they're able to. I think it depends on a case-by-case basis. You know, I like those questions where I ask you, where would be something in five or ten years? And Dennis, hi, Dennis. I have you here as well.

Ask a question, where do you see Hayden Capital in five or ten years? I would hope that we are still in business, number one. I'm very confident of that. I think there's a certain chance for that. Number two, I want, you know, I think our core process is there. I think that, you know, like everything that we do, we have the tools in place. As we grow larger, I hope to basically add depth to that process. So in terms of whether adding more analysts, you know, I always talk about, like,

thinking about analysts like hunters, that's who I'm looking for. I'm looking for autonomous idea generators rather than, you know, I can build a model myself. That's no problem. So I hope to be able to add to that. I hope to be able to add people perhaps on the data side in order to kind of prove out these features, these D.C.s quantitatively. But other than that, you know, I think Hayden will always be concentrated.

I think we will always be investing in these types of companies. Hopefully my circle of competence will have expanded by that point to encompass adjacent industries as well. But at its core, I don't think Hayden will change that much. You'll still recognize the firm strategy and what we're doing. Do you already look for applications? Sorry? Do you already look for applications for Hayden? For the right people, I'll definitely keep them in mind. Okay, they can contact you on Twitter. I hope your message is open. Otherwise, you have to help them. interview and we are coming to the end of our interview and for the end I want to

give you the room if you want to add something we haven't discussed or shed item on an aspect you want to go deeper into so the floor is used yeah I think the biggest takeaway for me and again it goes back to what I was saying at the beginning of the interview I think investors are too welded to their desks nowadays, they rely on second-hand research too much. I think we need to go back to where the industry was maybe 50, 60 years ago, actually picking up their phone and talking to people, actually grabbing coffee and going to meet people. You know, one of my former bosses used to say there's someone in this world who has the information that you want, and it's your job as an

analyst to go find that person. And I think that's something that I've definitely taken to heart. And I think a lot of investors will benefit from that. Because there's so much information that's just in people's heads, and you're not going to be able to get that unless you build a relationship with them and meet them face to face. So that's my last piece of advice there. And for me, it's also the message to add.

You need also social distance as well in these times. The virus isn't over, and I hope we don't have a second wave. Sure. Wear a mask. Yeah. Yeah. Yeah. Yeah.

But social distancing and mask are important. So thank you very much for the interview. And thank you very much also for our audience that you asked this good questions and helped me asking Fred good questions. Thank you very much for joining us and subscribe. That would be great that I get more. i get more subscribers and the channel gets bigger and more people see the content thank you very much thank you thanks so much