Disney’s corporate blunders and why BP could be next

In the latest episode of Stocks Neat, I'm joined by Senior Analyst Chloe Stokes as we delve into the topic of market short-termism. We discuss notable examples of corporate blunders, including the struggles of Walt Disney and the potential threat of ChatGPT (an AI-driven natural language processing tool that has grown in popularity recently) to Google. Co-Portfolio manager of the Forager International Fund, Harvey Migotti, also brings to the table a past corporate blunder that he analysed several years ago.

To wrap up the episode, Chloe reflects on her five years at Forager, sharing her greatest investment success, biggest mistake, and most valuable lesson.

“We are going through a market environment where investors are pressuring companies to show them profitability regardless of what that’s going to do to their long-term futures.”

You can listen on: SpotifyAppleBuzzsproutYouTube



Just a quick reminder, this podcast may contain general advice, but it doesn’t take into account your personal circumstances, needs, or objectives. The scenarios and stocks mentioned in this podcast are for illustrative purposes only, and do not constitute a recommendation to buy, hold, or sell any financial products. Read the relevant PDS, assess whether that information is appropriate for you, and consider speaking to a financial advisor before making investment decisions. Past performance is no indicator of future performance.

[00:00:39] SJ: Hi, everyone, and welcome to Stocks Neat, a Forager Funds podcast where we talk about things happening on the stock market and try a few whiskeys, other drinks, or alcohol-free beers, or whatever’s going on in our lives as we go along. I hope you’ve been enjoying it. And thanks for tuning in today.

I’m going to try. Not we’re going to try. I’m going to try another Irish whiskey today on special down at the local bottle shop. Comes nice and cheap. And I’m joined, in Gareth Brown’s hot seat, by Chloe Stokes, filling in for Gareth, who’s off with his family in the Cook Islands. Hi, Chloe.

[00:01:14] CS: Hi, Steve.

[00:01:15] SJ: Very much looking forward to having you on the podcast today. I think you are our most popular ever podcast when you were on last time. And we got a visceral reaction out of you in trying the whiskey. But we’re not going to get that today.

[00:01:26] CS: No. I thought maybe just insulting the whiskey lovers once was enough.

[00:01:32] SJ: All right. We’re going to talk today about market short-termism, which we know a lot about. We try and take advantage of as investors, but which also causes some fairly serious implications in the real world. And we’re going to talk about some of the corporate blunders that have happened as a result.

Delve into what’s going on at Disney, which I think we both think should be one of the world’s great companies, but it’s going through a rough trot at the moment. And finally, touch on your five-year anniversary at Forager and what you’ve learned. Let’s jump into it.

Harvey is going to join us a bit later. We were talking about some of these topics in the office and he couldn’t keep his nose out of it. I said, “Why don’t you come on?” And I guess he can sub in for you and try the whiskey and tell us what he thinks as well.

I read a very, very good book over the Christmas break called Chip Wars. And it’s a fascinating history of computer chips way back from the 1960s where there were four transistors per chip, to today where there are about 180 million transistors on a chip. And the technology that’s gone into that but also some of the corporate war stories along the way.

And one of the most fascinating parts of it for me was Intel’s dominant moat that it had in this sector from the 1980s through to the mid-2000s. And Apple rocked up on their doors. Steve Jobs rocked up in their door and said, “We need you to make a chip for the Apple iPhone.” And Intel decided it was going to cost them too much money. It was going to hurt their profit margins, which Wall Street were very focused on remaining high. And that they weren’t sure whether the Apple iPhone was going to sell.

In the subsequent eight years, Apple’s been one of the world’s best businesses to own. And Intel’s share price has gone backwards because it is stuck making chips for PCs. And that is not the growing part of the market out there.

It’s a fascinating book, full stop, but a really interesting insight I think into a decision that was made around a corporate boardroom because investors were putting a lot of pressure on that company to meet its quarterly profit targets that has cost a lot of money since.

I wanted to delve into that topic a little bit particularly in the environment that we’re in at the moment where there’s a huge amount of pressure from investors to return some companies to profitability.

[00:03:44] CS: Yes, it’s very topical at the moment. And we are going through a market environment where investors are pressuring companies to kind of show them profitability regardless of what that’s going to do to their long-term futures. But there are a number of companies I think that we’ve been talking about who aren’t playing along with this change in investor expectations. And they’re definitely being punished for it.

Two of the ones that come to mind are Spotify and Meta. First, I guess I’ll touch on Spotify. Their share price is currently at around $90. Down 75% from its high. Despite a business that’s actually going quite well, they’re growing at a much faster rate than competitors like Apple Music and Amazon. And it’s quite clear that they’re the winners in this space. And we’ve been talking about it a lot, it’s a space where you typically only have one music subscription unlike streaming, where you might have multiple. But earnings are still negative and they look like they will be for some time.

Spotify generates I think 25% gross margins. But they spend all of that on sales and marketing and research and development. They’re still investing in growing their user base and they’re making sure that the platform is industry-leading. One of the recent things that they’ve been investing in is podcasts, which has been going pretty well for them, I think.

[00:05:13] SJ: We owned this stock, what? $130 or $140 dollars I think was the investment way back pre-Covid, I think? Or during Covid perhaps when the meltdown happened. And, yeah, we had a model there that that business was going to grow its revenue line, which it has done. Grow its number of customers, which it’s done, have pretty low churn rates, which has happened.

But we did also have those margins marching up that it would be a very nicely profitable business by now. And it’s probably a bit of a poster child I guess for a business where people have gone, “Well, you’re not showing us any signs here that we’re eventually going to build a really profitable business.” The share price is now below that $140 level. What is the management team here saying that they’re trying to do?

[00:06:00] CS: Well, management thinks that they can more than double subscribers to one billion over the next four to five years. It makes sense that that’s going to cost money. And it’s money that they won’t need to continue spending once the user base reaches maturity. And the CEO and co-founder, Daniel Ek, have been really clear about investing for the long-term despite the investors wanting him to show them profitability now. He is unapologetic about it. And that’s easy to do because him and his co-founder combined have control of the voting power of the company.

When customer acquisition cost declined at the beginning of the pandemic due to softening advertising spends, Spotify used that opportunity to keep spending and take market share. And Ek has been very clear even recently after those investor pressures have been going on for some time now that they will do this again should the opportunity arise.

But what he has also done is being pretty clear around the economic rationale of this investment. They’re really focused on the long-term value of each customer and improving that over-time while growing user base. I think they’re very specific around their investments, which is reassuring. But again, we also don’t own the stock.

[00:07:16] SJ: Yeah, he’s done a few interviews on Invest Like the Best, another podcast which I’d recommend people go and listen to, because he’s a very, very – he’s quite clearly a very smart person. And I think he is definitely extremely focused on building a very valuable company here. He has different views than the market at the moment about what that value looks like or how it is created. And there’s a lot of question marks about whether he’s going to achieve what he’s going to achieve. But I do give him some credit for laying it out really clearly and say, “This is what we’re trying to build.”

Now, another stock that we do own that’s going through something similar but where maybe the founder hasn’t really laid out what they’re trying to achieve with all of their spend is Meta. Another company under an enormous amount of investor pressure, where the founder, controlling shareholder is sort of saying, “Stuff you. I’m going to do what I think is right.”

[00:08:03] CS: Yeah, Meta, they’re also investing in growth, which they’ve always done. And at the moment, we’re seeing it in a couple of ways on their income statement. We’re seeing it in kind of lower revenues because they’re focusing on the new short-form video format, reels, which is on Instagram and Facebook, which generates less revenue than, say, a photo post or a story, which is similar to the traction that we saw when other formats were rolled out, like stories as an example. They’re also investing in CapEx to improve their AI engines to compete with TikTok. You might have noticed your Instagram feed is showing more people that you don’t follow. And this is similar to TikTok. It’s great for keeping people engaged and for time spent on the app.

[00:08:49] SJ: You might be over-estimating or underestimating the age of our listener base here, Chloe. But some people may have noticed.

[00:08:55] CS: Well, yeah, some people might have noticed. And I think these first two factors are pretty reasonable and I think probably money well spent. The third factor is kind of the increase in operating expenses, which is largely investing in the Metaverse, which Zuckerberg thinks is the future. The jury’s still out on this one. But he has made some pretty good business decisions historically. But either way, the company is currently forecasting that they’ll spend more than $130 billion on operating and capital expenses this year, which is a huge number. And I think around 12% above what the company is spending in 2022.

And I guess another thing to note is that I think those results came out in October, where they announced the operating expenses and capital expenditures for 2023. And just weeks later, they came out and lowered that guidance slightly, which the market reacted quite positively, to. But there’s no doubt that, I mean, Zuckerberg wants to invest in what he thinks is required for the long-term of the business. And investors don’t necessarily agree with that at the moment.

[00:10:04] SJ: Yeah, and I have always been of this view, but particularly having just finished this book, I really do think shareholders need to give some leeway to people. Even if the money ends up being wasted, I think some defensive, protective spend on potential new ideas – on potential things that compete with your own business is a really, really important part of staying competitive and staying at the forefront. There are so many examples of businesses that have just focused on profit margins and run themselves into the ground over-time and put their prices up too much for their customers. And ultimately, what you’re doing is creating an opportunity here for someone else to come and compete with your business.

Google is going through a really interesting exercise at the moment. That ChatGPT came out before Christmas. Everyone’s playing around with it. And it’s a pretty obvious threat to Google’s business. And we don’t own the shares. But I would fully expect that everyone around that boardroom table at Google is saying, “This is an area that we need to make sure we’re spending a lot of money on. And even if we don’t know whether that’s going to or if that’s going to generate revenues, it is a threat to our business, and we need to be competing.”

And not everyone has controlling shareholders. There are good and bad elements to it. We’ve had our frustrations with some of this spend at Meta. But we’ve also come from an environment where companies could spend whatever they wanted and investors reward it. And the pendulum has fully swung in the other direction. What’s the right balance here? I mean, how do you think about, as an investor, where do you want to pull the pin and say, “Well, this is just too uncertain for me to invest in.” Versus, “I need the company to be spending something on protecting its future profitability?”

[00:11:42] CS: That’s a hard question, I would say. Because especially when you’re forward-thinking industries, like technology and social media, that are constantly changing, you definitely want them to be spending. I think if that R&D spend or that capital expenditure goes down, you need to be worried because it’s almost a sign of arrogance that they’re happy with where their product is and they’re not thinking about innovating further.

In an ideal situation, you want a company to be able to keep increasing their profit while investing in new ideas. Using their incremental profits to invest and innovate their business. But that’s not always possible when you’re going through a market downturn. And at the same time, do we then turn around to Meta and say, “Well, because advertising spend is being hit at the moment. You should rest in terms of the Metaverse, which is where you think the future of the company is.” It’s a really hard question to answer.

And I think, also, there needs to be a little bit of trust in some of these founders as well. I mean, everybody was questioning him when it was a switch to digital. He’s been questioned about the switch to stories. And he has come out on top each and every time so far. Not saying that the same thing will happen again. But like you said, I think a lot of these founders do deserve a bit of grace when it comes to choosing how to invest the funds of their company.

[00:13:03] SJ: Yeah. And this one’s cultural rather than controlling shareholder-driven. But on the ASX Cochlear I think is a really good example of a business that has almost worked backwards and said we are going to spend a certain percentage of our revenue every single year on R&D. And as the business has grown, that R&D spend has grown alongside it to the point where I think it’s so big now at the revenue line and the R&D line, that as long as they keep doing that it’s going to be very, very difficult for someone to come along and out-compete them in terms of coming up with new stuff. Unless it is something you tend to spend all of your R&D sort of doing the same thing you’re already doing. If there’s something that disrupts it, it’s going to come from left field rather than a better version of what they’re doing.

All right. I’m going to get Harvey in quickly because this is the topic he was very interested in. And he’s got a stock that he wants to have a rant about right now that he thinks he’s making a strategic blunder. All of these historical cases are very easy to look back on, Intel, and say they should have done things very differently 10 years ago. It’s never so easy at the time. Harvey’s got one that he’s talking about now.

I’m joined now by Harvey Migotti, Portfolio Manager on our international fund. Thanks for jumping in, Harvey. Chloe and I have been talking about topics for today’s podcast in the office and you kept jumping in on the topic so I thought I’d get you in for your thoughts on these corporate blunder topics in particular.

But first, you’re going to help me try the whiskey because Chloe had a bad experience last time around and wouldn’t help me out today. You’re subbing in on two fronts here. We’re drinking The Sextons, which is an Irish whiskey. Comes in a pretty cool hexagonal bottle. You were just telling me you’ve had this before.

[00:14:38] HM: I have actually. Last time I went to the US, I was – I wanted to pick up a whiskey for my family over there. And the lady said this is great value for money. The one at the duty-free shop. So, this is the one I actually ended up buying. And it was really good. Very tasty. It’s hard to find in stores here, I think. But I’ve seen it online.

[00:14:58] SJ: Yeah, it was on special down here, which is normally a pretty expensive bottle shop at 65 bucks. And I think you can get it online for even less than that. Let’s give it a taste.

[00:15:09] HM: Delicious.

[00:15:11] SJ: It’s a sherry cask whiskey. And you can taste the effects of that. Very, very – yeah, very nice.

[00:15:16] SJ: Yeah, my sherry casks are always my favorite generally. And finding one that’s not 150 plus, it’s always welcome if you want to – everyday or every weekend, just regular whiskey, and you don’t want to break the bank, I think you can’t go wrong with this one.

[00:15:30] SJ: Good advice. Something that did break the bank though was Rolls-Royce for investors.

[00:15:35] HM: Yeah, that’s right.

[00:15:35] SJ: We’re going to do the easy bit first because I think these corporate blunders are always easy in hindsight. And talk us through one of your favorite missteps when it comes to a company that you were quite close to at the time.

[00:15:46] HM: When I first looked at the aerospace sector back in 2012, I was at a hedge fund. And one of the big pair trades that I ended up doing was going long Safran and shorting Rolls Royce. There were several reasons, but accounting fraud was one of them. They never generated any cashflow. There was always something dripping out even though their profits kept improving. There’s something definitely going on there and they how they booked profits relative to the spend they needed to do to repair these engines that they’re selling.

But the big mistake I think that they made is exiting the narrow-body market, which is for people that are unaware, there are two kinds of engines. Ones that are large. And you find them on Boeing 747s and 787s, and Airbus A380s and so forth. They generally have two isles and travel long-distances for long-haul flights.

And then you have the narrow bodies, the smaller engines. You sell a ton more units because there’s just a ton more narrow-body planes out there. And you burn them hard and you get money in the spare parts. They actually exited the narrow-body market. They sold part of their stake in IEEE, which is a very good company. Owned by three aerospace businesses that they owned a part of it.

They exited that and decided to focus solely on the large body market. They had a decent marketshare there. And I think they felt at that time that that was the right move. We didn’t feel like it was. And it’s a less profitable market because you just produce much less units because it’s just less engines to sell out there.

And on top of that, these guys, when they were selling their engines, they sell them at losses. And they had something called Total Care. Total Care Packages. Customer pays them X-amount per year. And you are, as the engine manufacturer, responsible for all the maintenance, and parts and everything.

On the other, Safran, at the same time, when they were selling with engines, the customer needed a repair, they come in and you’d sell them parts at 80% margins instead. So two totally different models. Rolls-Royce loved that because they booked profits up front. But then, lo and behold, every eight years you need to repair the engines. Oof! Cash flow drain comes out. And you can model that out in the waves and everything.

Another big strategic blunder from them, mis-pricing the total care packages. Promising you pay us X-amount per year and we’ll put endless repairs down on your engine through its life cycle.

[00:18:00] SJ: Needed a lot more repairs than they’d originally anticipated.

[00:18:02] HM: Correct. They needed a lot more repairs. They broke down more regularly than expected. And obviously, manufacturing costs and prices of the parts went up and they had to bare the burden. While on the other end, you had other companies that offloaded the burden to the airlines.

Lo and behold, over the last eight years, Safran has outperformed Rolls-Royce by 10x. I think that there were many reasons for that. But certainly, exiting a very nice profitable – one of the best businesses in the world in the narrow-body market. And then kind of trying to book profits upfront and focused on near-term profitability rather than thinking about the long-term. And properly modeling their costs of maintenance. Just two really stupid blunders. And you went from darling, right?

[00:18:42] HM: Yeah. This is a real darling stock out there. And then it became a value investor favorite on the way down as well. And then became a value trap. And now, I mean, people – is it in restructuring yet or what?

[00:18:53] HM: No. They just got a new CEO.

[00:18:54] SJ: I mean, it’s close enough to bankrupt, right? They’re struggling.

[00:18:57] HM: They have a tough time. Their engines business for maritime and ships and so forth. People are transitioning to cleaner technology. So do they start spending a bunch of CapEx and transition themselves or sell it? They obviously have tonnes of profit. Put problems in their aerospace division. Like I said, these contracts were priced inappropriately. They’re 25-year, 30-year contracts.

[00:19:17] SJ: Especially now with inflation.

[00:19:19] HM: Exactly. Right? Although, I do believe that they have some sort of inflation escalators. Many of these companies do. At the end of the day, they’re suffering and profitability is just not there. These businesses are such long cycle businesses. When you’re buying engine and it runs for 25 years, you sell an airplane, it runs for 25 years.

[00:19:35] SJ: Yeah, you get the decision wrong on that.

[00:19:37] HM: You get it wrong and you’re paying it back for 15 plus years. And that’s the tough part, but that’s also the beauty of the space. If you nail it, you see companies like Safran who’s just out-performed the broader indices for the better part of the last decade.

[00:20:33] SJ: All right. Hindsight’s one thing. Let’s talk about the current. What’s a company that you think is currently making a strategic blunder that everyone’s going to look back on and say, “Well, that was a really stupid thing to be doing.”

[00:20:43] HM: Well, I’m going to be fighting the ESG crowd here. And I wouldn’t even say that it’s so much of a strategic blunder as much as maybe misallocation of capital. And that’s the company in question is BP.

40% of their spending budget, CapEx, in 2025 is going to go to sustainable and energy transition projects. BP has decided that they want to significantly lower their oil and gas production. In fact, they’re going to lower it by 40% by 2030. And they want to fill this gap with clean and renewable technologies and so forth. Nothing wrong with that. That’s maybe great in a 100-year view. And what not if they get it right?

But the problem I have here is that you’ve got a business that’s generating a ton of operating cashflow at the moment. It’s trading at two or three times EBITDA multiple. They can buyback significant amount of their shares at the moment. And if they want to run down their own gas production, that’s fine. But you can then milk the business. Give a ton of dividends, and a ton of share buybacks, you know, capital returns to investors. And instead, they’re going down this path of, “I’m going to spend half of my CapEx to transition.” And that is not necessarily a bad thing if they’re able to do it efficiently.

But just recently, I think in October of last year, they bought a company called Archaea Energy in the US. They paid a 200 times EBITDA multiple – 11-time sales.

[00:22:03] SJ: And this was big, right? How many billions of dollars?

[00:22:05] HM: It was reasonable. Three and a half billion. I mean, BP is 100 billion market cap. It’s not huge in the context of things. But you just start to wonder. This is a public company already. If you as an investor wanted to go down this path and buy this clean energy company, you could have done that. Instead, these guys come in, they pay a 40% premium and actually it was more like 70% from the lows. I think maybe there’s some rumors calculating prior to this and so forth.

They pay a huge premium at the cost of existing investors in BP stock, which could have come back to the investors themselves. And then they could have gone out and bought this company. And the question is, obviously, maybe there are synergies and whatnot. But I just feel like that is a big, tough transition and it’s not very clear that it’s actually going to create the return on equity that one would want or come to expect. They will probably succeed. They will succeed. It’s a big enough company. They’re in a decent position. They can generate a lot of money on their oil and gas business. The question is, is that the best use of capital for a company that’s trading at such dirt-cheap valuations? Or is it to buyback their own shares?

[00:23:04] SJ: And look, I think the whole sector is – this is where you get dramatic strategic stuff ups, right? We’ve talked about the chip industry going through multiple cycles where there are opportunities to deploy enormous amounts of capital or choose not to. And those decisions can be huge. And the whole mining sector at the moment, we’ve talked on previous podcasts about BHP selling that coal mine in Colombia for 500 million dollars that generated two billion dollars of free cash flow last year. And that mine is still operating and the coal is still being burned. It hasn’t changed the carbon output of the world one iota. And yet, the BHP shareholders are suffering because of that.

And you touched on this. But for me, it’s also a failure to analyse what you are actually good at. BP has hundreds of – probably 100-year history here, right? In extracting hydrocarbons out of the ground running really, really complicated offshore oil and gas projects. That is difficult. They have unique expertise in it. They don’t know the first thing about buying renewable energy projects in different parts of the world. And to your point, they can pay the money out to shareholders and the shareholders can go and do that job better than they can do it. Because that is our skill set, is allocating capital. And their skill set is extracting hydrocarbons out of the ground. And they’ve got this idea that they need to be the ones that transform their own business into something different. And I fundamentally don’t agree with that. And it’s where these huge strategic missteps come from.

[00:24:25] SJ: Yeah. And just to touch upon that again. 40% drop in oil and gas production, that’s a big gap you’re going to have to fill with other sources of profitability and revenues, right? Huge gap over 10 years. And they can get there. The question is how much they pay for that gap as you mentioned. It is a big question. And there you go. But ESG pressure from investors and certain shareholders has kind of forced a hand of some of these management teams. Let’s see how it all turns out. But I know I’d rather be getting dividends if I own a stock.

[00:24:54] SJ: All right. Thanks for joining us, Harv. Appreciate it.

[00:24:55] HM: Thank you.

[00:24:56] SJ: I wanted to touch on one more strategic juncture that our business is at that I think is a very interesting one. Company is Walt Disney, which if you said to me before I started reading about this company, “How’s it going?” I would have said, “Well, this is the age of content. And there is probably no better content owner in the world than this business.” They own Marvel. They own Star Wars, Lucasfilms. And they own of course all of the Disney properties as well. And yet, they now have an active shareholder on their register trying to get a seat at the board.

The former CEO has ousted the current CEO and put himself back in as CEO. Long newspaper articles about the infighting at the company and the problems. And probably most importantly, I think in a very strong eight year period for the share market and for similar companies, Walt Disney Company share price is below where it was eight years ago. What’s causing the strategic problem here?

[00:25:51] CS: Well, revenue has actually been going okay. They’ve grown their sales 40% since 2018. But there’s a lot of stuff going on here. They’ve done what the market deems an expensive Fox acquisition. And they loaded up on debt to do that. They’ve also suspended the dividend for a couple of years. And prior to that, it was known as a high-dividend paying stock that increased the dividend every year.

But I don’t think those are the major issues. The big issue here is high costs. And in particular, in the streaming segment since its launch in 2019. Despite making almost 20 billion in revenue from streaming in 2022, which is I would say pretty impressive over a couple of years, Disney’s operating margin is still negative 20%.

[00:26:43] SJ: And that’s just in streaming.

[00:26:44] CS: Just in streaming. Yes. Just for some context, Netflix generated just over 20 billion in revenue in 2019 from streaming. And its operating margin at the time was about 13%. That’s a dramatic difference.

And given Disney’s intellectual property and iconic franchises, you would think that the company could generate similar or even better economics than Netflix. But it’s just not what we’re seeing. And it’s hard to say whether there’s something else going on here or if the company is just too big and horrible at cost control.

[00:27:19] SJ: Yeah, the activist investor there, Nelson Pelts, is trying to get on the board, he’s calling it a cost problem across the business, including the CEO’s salary. I’m not sure that’ll go down too well. But I actually feel like this wanting to own the distribution is something of a strategic blunder. They own content. And I think that’s the asset that you want to own in this era. The distribution platforms are dime a dozen. They’re competing like crazy. There are very, very low switching costs. I turn them off and on all the time when I want to watch a particular show and I move across to a different one. And I don’t see that changing. Whereas if you’re the one who owns the content and you can trade those platforms off against each other, they could have had an incredibly high margin profitable business just from continuing to do that. I think it has been a mistake personally to want to own the distribution themselves. But we’ll see how that one unfolds.

Chloe, I just wanted to finish, you’ve just passed your five-year anniversary with Forager, believe it or not. It has been a wild, wild five years. Probably the craziest five years of my investing career. It’s been a very interesting time to start. And I wanted to ask you three quick questions to finish this podcast. First, your biggest investment success in these five years?

[00:28:34] CS: It would have to be Farfetch. We bought that stock back in June 2020 and it increased threefold in the space of about six months. We moved pretty quickly to get into that one. And it was definitely worth it in the end. But it’s an interesting story because the current share price is actually a lot lower than what we paid back in 2020. But we don’t own the business now.

[00:28:57] SJ: Some similarities there with Spotify, right? I think the revenue has been wonderful. But the margins haven’t yet delivered. But one we are watching very, very closely. Your biggest mistake?

[00:29:07] CS: Definitely Boohooo. When we bought Boohoo, its share price was heavily impacted. Well, we thought it was already heavily impacted by ESG concerns. And it had been a really fast-growing and highly profitable business for almost a decade. Our thesis there was that they’re in a good place to correct the ESG issues that they were facing. And that the business would continue growing profitably as it had done in the past.

And the first part of the thesis about ESG has played out pretty well. I think they’ve done a decent job of addressing those issues and taking them really seriously. And this is probably the part that I was the most concerned about when we were researching the business. But it’s actually the sales, and especially International sales, and margins that have let the thesis down. They’ve been heavily impacted by the supply chain issues, and delivery delays and increased costs. And initially, we thought this might be a short-term issue. But it’s now dragged on for quite some time. We’re concerned that, especially the international sales, the issues might continue even after all the other problems are resolved.

[00:30:14] SJ: It’s so interesting that whole online retailing space. Because this company had a really consistent long-term track record of profitability and margins. And in some ways, Covid was a massive boom to them and then has become a massive problem for two reasons. I think, one, you’ve just touched on some of the operational issues. But it’s also created a much more competitive, I think, online environment. Not just online companies that purely do that. But most offline companies got their acts together online as well through the Covid lockdown. We’ve had a similar experience with Adore Beauty here in Australia that had that space to themselves and now has some pretty profitable competitors that are also doing well online.

[00:30:53] CS: Well, I think that’s also part of the reason why we haven’t jumped right back into Farfetch, right? We came out of that Covid period with a lot more questions about online retail as a whole space than what we went in. It’s a bit of a theme there.

[00:31:05] SJ: Yep. Biggest lesson then out of the five years that you think will help you as an investor in the future?

[00:31:12] CS: I think being prepared and being patient at the same time, which can be hard. I think winners in this game are usually the ones that turn over the most rocks. So, you need to always be looking at new businesses and doing the work, so you’re prepared in case of a share price fold. Because as we’ve seen, opportunities can be fleeting. But then once you’re prepared, you have to be careful not to get caught up in fear of missing out or FOMO.

We went through a period in 2020 and 2021 when every time we would look at a stock the price would rise really dramatically and what we would say is we would miss it. And it turns out now we’re getting a lot of opportunities to buy those businesses at even cheaper prices than what we were looking at in 2020 and 2021.

I think the lesson is to have all that work done. Think about what you think is a reasonable price. And don’t let that fear of missing get you to leap in before it’s hit that price. Don’t think you’ve missed out on a business because it’s above what you think it’s worth right now.

I think a good example of that, that we’ve taken advantage of even before Covid was with ULTA. ULTA Beauty. We looked at that a number of times. It’s quite a large high-quality business. And we always thought it was a little bit too expensive but we’ve done some work on it. And then in late 2019, they had a negative set of quarterly results. And it was what we thought was a short-term kind of blip in their performance. And we had the opportunity to buy the stock at a really cheap price. And I think this happens on most stocks at some point in time.

[00:32:47] SJ: Yeah. And it certainly happens on the ones that you’re going to make lots of money out of. That’s my view, is that if you prepare yourself enough and you’re patient enough, it doesn’t matter if you’d never buy eight in ten of the ones that you were looking at. It matters that the one or two in ten that you do end up buying were at attractive enough prices that you make lots of money out of them.

And if you’re doing your research well, you don’t want those businesses to do badly, right? You researched it. You thought it’s worth a certain value. And if you’re right regularly enough, it’s going to end up being worth that value. And a lot of them might never trade at a level that says to you this is meeting our return thresholds. But as long as one or two do out of a large sample set, then you’re going to end up with excellent returns out of it.

And to be fair, it has been particularly volatile times. You might go through the next 10 years and not get that same degree of volatility and constantly having to be adjusting that threshold about where you pull the trigger and where you don’t. But it is a great lesson and one that the past five years I think has taught all of us, not just you.

Thanks for joining us today, Chloe, filling in for Gareth. It’s much appreciated. It’s been a great podcast. And we’ll get you back on later in the year.

[00:33:52] CS: My pleasure. Thanks for having me.

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Steve Johnson
Founder & Chief Investment Officer

Steve began Forager Funds in 2009, and now manages approximately $350m across two funds. Offering a listed Australian Shares Fund (FOR) and an unlisted International Shares Fund, Steve focuses on long-term investing in undervalued companies.

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