Recently I’ve had a few of those occurrences where you pick up some new learning, then begin to see it crop up everywhere. The latest arrived this month, after beginning to read ‘The Missing Billionaires’ by Victor Haghani and James White, which (amongst many other things) describes why what you buy isn’t as important as how you size it.

In its first few chapters, it introduces the Kelly Criterion (a formula for optimising bet size) but makes the distinction that the formula doesn’t include an explicit notion of risk aversion. It simply maximises the rate of growth of wealth.

Within a couple of days of taking this in, Matt Levine, Bloomberg’s brilliant columnist (if you’ve not heard of ‘Money Stuff,’ it’s free to sign-up and frequently fascinating), published a piece highlighting some excerpts of ‘Going Infinite’, the new book on Sam Bankman-Fried (SBF), the infamous ‘crypto king’ facing decades in jail for defrauding investors in FTX.

In it, Levine quotes an anecdote from Bankman-Fried’s early days in Jane Street - the trading firm he joined before founding FTX - in which SBF takes on a bet with a colleague before humiliating him by manufacturing favourable odds. Perhaps a petty move but on the trading side, pretty smart… Levine makes an interesting point though: in SBF’s attempts to humiliate his colleague, his last two coin flips actually had negative expected value; there was a higher probability of him losing money from the trade than from profiting.

In this story:

  1. Bankman-Fried found a perfect trade, for him: It was risky but it had a lot of edge, it made him look smart, and it made his counterparty look dumb.
  2. He did it, it paid off, he looked smart, his counterparty looked dumb, all was right with the world.
  3. It was so intoxicating to be right that he kept doing the trade.
  4. He never noticed that the trade stopped being good: The glow of being right persisted long after he became wrong.
  5. Eventually he lost the bet and everyone was mad at him.

Everything about Sam Bankman-Fried’s life was perfectly optimized for becoming a famous billionaire and an infamous criminal defendant, in that order.

FTX’s sudden collapse may be seen as the defining moment when over a decade of low rates and cheap capital came to an end. Spectacular implosions of greed always make for a good narrative. Maybe though, the story is more appropriately framed as a lesson in risk management: that it’s more important to stay in the game than it is to win it.

Business Updates

Crowdstrike

Yet another solid Crowdstrike quarter! The main takeaways of note for earnings reported at the end of August: revenue guidance was raised for the full year ($20M on the bottom-end, $10M on the top) to a range of $3.03 - $3.04 billion (which would represent 35% growth at the high-end); a second successive quarter of GAAP profitability - $0.03 net income per share; long-term operating margins were met in the quarter, ahead of schedule:

We are accelerating our timeline to reach the target model. As implied in our guidance, we now expect to exit Q4 within our target non-GAAP operating margin model and to remain within our target model on an annual basis starting in FY ‘25. - Burt Podbere, CFO, Q2 2023 - Prepared Remarks

There were several queries about ARR growth in the second half of the year:

With the business momentum we see and competitive market dynamics, we believe our second half performance will yield double-digit net new ARR growth. - George Kurtz, CEO, - Prepared Remarks

Plus the usual smattering of competitor trash-talk:

Smaller, narrower point product companies are being left behind. These companies are quickly going the way of legacy AV, already in the hands or looking for the safe hands of strategic or private equity buyers. Point product, single-feature cloud security companies are learning the hard way that platforms built by design win at scale. Today’s competitive landscape solidifies CrowdStrike’s leadership position and turns what were once competitors into immediate shared donors. - Kurtz, Prepared Remarks

Crowdstrike’s war-chest has been steadily building up over the past couple of years, and reached $3.18 billion in cash and cash equivalents during the quarter. It was put to use in September, with the announcement of the acquisition of Bionic (to further secure cloud workloads), a deal said to be paid for predominantly with cash and to close in the current quarter.

Team17

This was the month in which Team17 were placed into the ‘too hard’ bucket for me. What on the surface was a relatively solid update, with 31% YoY growth in revenues (albeit with a pre-tax profit drop from £11M to £8M), plus affirmation of expected full year results in line with market expectations.

Unfortunately the start of October brought less welcome news in the form of layoffs and business restructuring. It was announced that the CEO of the games label division (Team17 digital), Michael Pattison, has also left the business.

This in combination with the mismanagement of Hell Let Loose, an IP acquired for £46 million (almost 6 times the just reported profit before tax) early last year and the inherent hit-driven nature of the sector lead to cutting my losses on my small position. The group are clearly adept at identifying winning formula but it’s not clear to me how much of that insight is reliant on outgoing Group CEO, Debbie Bestwick’s extensive industry knowledge. My inkling is: a lot. Either way, I feel there are simpler decisions out there, even if it comes in the form of topping up an index fund.

Alphawave

When viewed in comparison to the last major update in April when shares were suspended shortly before the CFO was fired, Alphawave’s H1 2023 results were a welcome return to ‘mostly normal’ operations. Though that’s a relative positive, the results themselves were a bit of a mixed bag. Royalties and Silicon Orders came in flat at $84 million, licence revenues were down 40% sequentially to $48 million and the Group swung from a profit of $16 million this time last year to a net loss of $15 million, which was put down to continuing digestion of the 3 businesses acquired in 2022.

Despite this, full-year guidance of $340-360 million was re-affirmed and implies a similar performance in the second half of the year to the first. There were also some bullish comments on the earnings call about the revenue ramp in 2024 as hyperscaler business starts coming through:

Look, I can’t provide all of the specifics because these deals are always covered by NDAs, but I can repeat what I’ve said in the past, which is we expect revenue to come in, in 2024. Silicon has already been deployed.

So what – with revenue, that means parts – production parts are shipping. And it’s typically a 1- to 2-year ramp of revenue until you get to high volume. And look, high volume with hyperscalers with the combination of PAM4 and coherent products, look, it can scale to hundreds of millions of dollars per year of revenue.

That’s our plan, that’s factored into our guidance and that’s what everyone should be modelling in for Alphawave. - Tony Pialis, CEO, H1 2023, Q&A

As seems to often be the case with Alphawave, however, there was something to leave an uneasy feeling:

During the second quarter of 2023, the group’s fixed charges coverage ratio was below the minimum allowed ratio of 1.25x. This is mainly due to 3 items: first, a higher working capital requirement as a result of the significant reduction in deferred revenue I highlighted on the previous slide; second, a higher proportion of lower-margin silicon revenue at the beginning of the year; and third, the increased investments in research and development activities as the company invested in its own product business.

We have established a long-term waiver for the covenant with our lenders covering the period to 30th of June 2024. At that point, the covenant will be reset to 1.1x until 30th September 2025 when it reverts to 1.25x.

The group’s net leverage ratio remains unchanged, and there is also a new minimum liquidity requirement that the group needs to maintain until 30th of September 2025. - Christian Bowsher, Interim CFO, H1 2023, Prepared Statements

With cash and cash equivalents of $122.8 million only just covering current net debt of $100 million, this is something to keep an eye on. Alphawave shares remain suited to those with a preference for risk…

YTD return vs benchmarks

(Index source: Koyfin)

Portfolio Nasdaq S&P 500 FTSE 100
32.7% 37.55% 12.92% 4.80%

Portfolio

Holding Ticker(s) Weighting (%)
Cash - 26.0
iShares Core UK Gilts UCITS ETF GBP (Dist) IGLT.L 10.8
Xtrackers NASDAQ 100 UCITS ETF XNAQ.L 9.1
Alphawave IP Group plc AWE.L 8.8
Adyen N.V. ADYEN.AS 6.3
iShares VII PLC - iShares MSCI EM Asia UCITS ETF USD (Acc) CEA1.L 5.3
Twilio Inc. TWLO 5.1
ASOS Plc ASC.L 4.3
Invesco Bloomberg Commodity UCITS ETF CMOD.L 4.0
iShares Core MSCI Europe UCITS ETF EUR (Acc) SMEA.L 3.8
Datadog, Inc. DDOG 3.7
Howden Joinery Group Plc HWDN.L 3.6
CrowdStrike Holdings, Inc. CRWD 3.5
Amazon.com, Inc. AMZN 2.9
Advanced Micro Devices, Inc. AMD 2.8

Adjustments

Adyen

Adyen’s shares fell in dramatic fashion following their H1 2023 report in the face of increased competition and ongoing hiring costs. Gross margins fell to an all-time low of 43% and sequential volume growth of processed transactions grew just 1%. This follows the payment processor’s expansion into the US market, where it faces competition from the likes of Braintree - owned by PayPal, and effectively used as a loss leader in order to advance PayPal’s higher margin checkout business - as well as Stripe, Global Payments, and Fiserv.

[the-payments-ecosystem.webp] Just a little competition… Source: Insider Intelligence

Despite the alarming appearance of the chart above, Adyen have succeeded in growing sales at 35% annually over the past 5 years, growing faster than the overall payments market. The key to their success? A strategic focus solely on the payments sector (organic growth only, no acquisitions), combined with a strict focus on controlling operational costs (Europeans don’t do galling levels of stock-based compensation apparently!) and a disciplined vision for growth that has seen the business continue to hire whilst the majority of their peers have been laying staff off.

While some of the recent decrease in share price can likely be attributed to multiple re-rating for a stock that was previously a market darling and could do no wrong, in my view a business of this quality deserves a premium in spite of the decline in North American revenue growth (it’s worth noting that the region made up 25% of net revenue in H1, vs 58% for EMEA).

Snowflake & TM17 disposals

September (or more accurately, the beginning of October) finally saw the disposal of my Snowflake position. Last month I queried why I own the stock if my own sentiment about it is so negative. I chewed this over during the past few weeks and have concluded that, in large part, it rested upon the reputation of management. While I still feel that can form a valid part of an investment thesis, it was causing me discount my own criticisms of the business. Ultimately, the valuation, levels of stock-based compensation, ludicrous 10-year-out revenue targets, and the uncertainty around competition add up to paint a pretty unclear picture of future returns. I may come to regret betting against Slootman et al. further down the line, but right now I feel slightly crazy for ever having owned the stock…

The TM17 scenario is discussed above.

Next month:

  • Recapping ASOS’ H2
  • An update on Howden’s
  • Amazon’s Q3