September may prove to be a meaningful inflection point for the fund as we had material positive performance (+6.55%) in a month when the markets were broadly higher.
Typically, in the recent past, the fund has been negatively correlated with the board indexes. It would then follow that September would have been a down month for the fund. However, there have been a number of important undercurrents positively affecting our positions recently.
It has been our belief for the last six months or so, that Software-as-a-Service (SaaS) Companies have been materially overvalued. Investors have been all too willing to pay exorbitant prices for mediocre companies in this sector. Some of these companies have doubled or even tripled year-to-date which in our view is an opportunity on the short side in select cases. The companies in our sights tend to be those at the margin; those benefiting from association without the strong fundamentals to justify their out-performance. These companies are typically cash-burning entities with high revenue (sales) growth.
In the current environment, growing revenue is not well differentiated from growing profits. We often think of growing revenue without regard to profits as giving away $1 for $0.90. It’s not particularly difficult. To reference WeWork again, as discussed in last month’s commentary, WeWork has provided beautiful and reasonably priced co-working spaces for small businesses and freelancers. Unfortunately, the model has worked so “successfully” because WeWork has essentially subsidized the overhead and lease expense by running multi-billion-dollar losses. This headline encapsulates the absurdity that is WeWork’s “business” model:
How Can a Company with $1.8 Billion in Revenue Lose $1.9 Billion?
This company however, as discussed previously, briefly obtained a $47-billion-dollar valuation despite terrible fundamentals and a business model that does not seem to have a hope of operating in the black.
As noted last month, investors appear to have adopted more discretion in capital allocation. A number of failed or poorly performing IPOs show the market’s waning appetite for these money-losing businesses. As such, one subset of our shorts is starting to produce gains month after month as valuations begin, emphasis on begin, to normalize.
On another front, one of our most prominent shorts, a company we believe to be misleading investors (to put it mildly), has been questioned by the SEC using what appears to be our material. The company then responded asking for more time (presumably to “produce” sufficient answers!). This is certainly encouraging as it shows that the SEC has taken our findings seriously.