Global Equity: Shareholder Update

EPIC Global Equity Fund
March 2023

Shareholder Update

I would like to begin by thanking all Shareholders for your continued trust and investment in the EPIC Global Equity Fund. 2022 was a challenging period for the market, and in particular for a quality growth strategy.  We appreciate the confidence you have placed in us to manage your investment.

As at 24 March 2023, I am pleased to report that year to date the EPIC Global Equity Fund Class B GBP is up 12.95%, ahead of the MSCI World return of 2.34% (all figures quoted in GBP). While happy with this turnaround, we remain focused on the underlying company results, which have demonstrated resilience and growth.

For this update, we will be focusing on the companies within the technology and communications sector. Further updates will follow shortly.

Salesforce

We were particularly encouraged by Salesforce’s results; this proved to be a defining quarter. Management and market expectations were comprehensively surpassed. Revenue grew 17% year-on-year in constant currency. MuleSoft and Tableau licence deals were particularly buoyant in the quarter. Management highlighted that eight of the company’s 13 cloud products had annual recurring revenue growth of at least 50%. Sales cloud grew 16%, service cloud grew 15%, platform grew 18% (includes Slack), marketing and commerce cloud grew 16%, and data grew 20%. The rate of customer attrition has remained historically low, below 7.5%. The company’s non-GAAP operating margins impressively grew to 29.2% from 15% in the previous year.

We invested in Salesforce because we believed that the company was under-earning and attached weight to management narrative of improved profitability. The accelerated margin expansion, slowdown in stock-based compensation, the disbanding of the M&A committee and continued stressing of profitability on the earnings call, all increased our conviction in this position.

We believe that, despite the 40% year to date share price return, the shares remain attractive for the company which pioneered the software as a service model and the market leader in CRM.

Meta Platforms

Meta Platforms (Facebook) rallied strongly as the firm reported better-than-expected results. Like many others, we have been deeply concerned about the capex spent on the Metaverse. However, unlike those who sold the shares, we remained invested in Meta because we concluded that the discounted value of future cash flows is likely to be far greater than implied by the market valuation.

We note that last year the shares fell to 2015 price levels. In 2015, Meta generated $7.5 billion in free cash flow. At the end of 2021, the firm produced over $38 billion in free cash flow. At a market cap of approximately $240 billion in October 2022, Meta was trading at a free cash flow yield of just under 16%. According to "Wall Street's Dean of Valuation", NYU Stern Professor Aswath Damodaran, the market price implies that Meta will survive for just a further twenty years. Professor Damodaran calculated that the market believes that Meta's trailing 12-month operating income, which has been temporarily impacted by the economic slowdown, will never recover. Additionally, there would be no growth in advertising income, R&D expenses would continue to be elevated at $32 billion, and Meta would lose $10 billion annually in Reality Labs (its Metaverse initiatives). In his analysis, he treated the entire Metaverse investment as wasted expenditure, which reduced his valuation of Meta value by approximately $71 billion.

Meta is by no means out of the woods, but its competitive advantages remain intact, and there are encouraging signs. Meta is improving its ad conversion and measurability, which increases demand from advertisers and lessens the impact of Apple's well-documented changes. It is within this context that we need to view the year-to-date 66% share price return.

Alphabet

Alphabet's fourth quarter and full-year results were a mixed bag. The company experienced 7% revenue growth in the final quarter of the year at constant currency. However, operating income during the quarter was down 17% from last year, resulting in 24% margin compared to last year's 29%. The advertising segment continued to struggle with economic headwinds, while YouTube missed expectations despite strong subscriber growth for its premium, TV, and music services. On a positive note, Google's search business held up better, and the Google Cloud revenue increased by 32%, with Google Cloud Platform outpacing other cloud offerings.

While it is too early to determine whether OpenAI and Microsoft pose a significant threat to Google's search and ad business, we note that Alphabet's DeepMind is at the cutting edge of AI. DeepMind’s Alphafold famously solved the 50-year-old problem of protein folding, considered to be one of the most important medical breakthroughs in recent decades. Management quickly pointed out that the firm has the technology to launch AI-based features not only in search, but also within its ad technology stack and cloud offerings. We closely monitor developments within this space.

Adobe

Adobe, the creative software 800-pound gorilla, reported fiscal first-quarter results which exceeded management and market expectations on both the top and bottom line. First-quarter revenue grew 13% year-on-year in constant currency terms (9% as reported) to $4.66 billion. Management noted strength in all customer sizes and all products.  Digital media revenue grew 14% year-on-year while digital experience grew 16% year on year. Adobe added $410 million in net new annual recurring revenue compared with guidance of $375 million. Non-GAAP operating margin was 45.8%, compared with 46.8% a year ago and 44.7% last quarter. Forward indicators continue to paint an encouraging picture: performance obligations grew 13% year on year while current deferred revenue grew 9% year-on-year.

Intuit

Intuit, the financial software specialist, reported very strong second quarter results which comfortably beat market expectations. Top line grew 14%, driven by the small business and self-employed group where revenue increased 20% year-on-year. The consumer division grew 26% year-on-year. Such strong performances easily compensated for Credit Karma’s weakness (-16% year-on-year) which had been previously brought to the market’s attention. Intuit also announced that CFO Michelle Clatterbuck will be retiring in August with Singh Aujla, a long-term company stalwart, taking over.

Mastercard

Mastercard reported a robust end to 2022. Revenue was up 17%, excluding currency movements, as gross dollar volumes and transactions both increased 8%. Cross border transactions grew 38%, and the reopening of China is expected to serve as a boost. Adjusted operating margins grew to 55%, from 54.2% last year. Mastercard said that inflation has not weighed on customers’ overall spend yet spending has shifted towards lower cost and generic brands. Spending on travel and eating out remain a tailwind. In the coming year, Mastercard is expecting net revenue growth in the low teens and operating expenses are likely to rise in the mid-single digits.       

Visa    

Visa reported a similarly solid set of figures which beat analyst expectations. Revenues grew 15%, excluding currency movements, led by solid volume growth of 7% despite economic headwinds. For the full year operating income grew 24.5%. Operating margins contracted slightly to 68.4% from 69.8% predominantly due to personnel costs and investments for growth. Since 2020, Visa has grown its revenue 34%, operating income by 40% and reduced its share count by nearly 4%, yet the shares remain rangebound.

Roper Technology

Roper Technology reported fourth-quarter results, which beat analyst expectations, both on the top and bottom line. Operationally, the company performed very well, with network software and technology-enabled products reporting double digit organic growth.  2022 full year revenue increased 11% and diluted earnings per share increased 15%. The company also deployed $4.8 billion towards acquisitions of high-quality vertical software businesses.

The departure of long term highly regarded CFO Rob Crisci is disappointing, but we note that his replacement, Jason Conley, also has a strong reputation and has been involved in the company’s capital allocation decisions for some time as chief accounting officer.

Overall, we remain impressed with Roper’s execution.

The business continues to show improvement. Since 2016, organic growth has increased from 1% to 9% in 2022. Cyclical revenue has decreased from 44% in 2016 to practically zero in 2022. During the same period, EBITDA margins have grown by 500 basis points, and net working capital has improved from 3% to a negative 17%. Gross margins are now over 70%, and the free cash flow margin exceeds 30%. Recurring and reoccurring revenue now account over 70% of the total revenue.

Despite its improved quality, the company's shares are currently trading at lower-than-average valuation levels. We see plenty of upside potential in this truly worldclass compounder.

Microsoft

Microsoft reported solid fiscal second-quarter 2023 results, with revenue growth of 7% in constant currency, and GAAP operating margin of 38.7%. Azure growth was 38% year-on-year in constant currency, slightly better than management's guidance, while Dynamics 365 grew 29%. However, there were decelerating growth trends across several product lines, including commercial bookings, and weaker-than-expected performance in areas such as Bing, Windows, devices, and gaming. Management expects weakness in consumer-related revenue to continue, with most of the recently announced headcount reductions centred in these areas. The outlook for the March quarter was shy of consensus estimates, with revenue growth of 3% year-on-year on an as-reported basis, including a currency headwind of 300 bps.

Management noted Microsoft’s recent investment in OpenAI, in which it owns a 49% stake. The company believes that artificial intelligence will be the platform of the future and plans to integrate AI throughout its entire portfolio.

Amadeus

Satellite holding Amadeus reported 2022 results which were ahead of expectations. Optically, the results were always going to look good following the pandemic-induced downturn in travel, yet the recovery was better than anticipated. Revenues grew 68% whilst incremental incentive cloud costs kept margins towards the higher end of guidance.

Nvidia

Nvidia reported results in line with expectations. Gaming was slightly ahead of projections whilst data centres were marginally weaker where the slowdown in cloud spending growth is having an impact. Nvidia held its annual GTC developer conference, where the company rolled out several best-in-class hardware and software products which are presented as crucial for the AI revolution. Nvidia’s AI advantage is called “insurmountable” by analysts as, due to a slowdown in Moore's Law, both the hardware and software environments needed to drive the data-centre cost and power efficiencies are increasingly becoming unobtainable using only CPUs. As a result, Nvidia’s sustainable competitive advantage, or moat, continues to widen. The company has formed a new partnership with Alphabet’s Google Cloud Platform, with Google selecting Nvidia's L4 inference chips over its own TPU5 custom silicon. Separately, Google recently launched a new AI product, Bard, one of the many new generative AI products that are seeking to expand after the recent prominence of OpenAI's ChatGPT.

In addition, portfolio holding Adobe announced at its own event an AI product named Firefly, a "co-pilot" technology aimed at helping create content within its own products (also highlighted by Nvidia). Nvidia founder and Chief Executive Jensen Huang said that he expects the “tiny, tiny, tiny” amount of revenue the company currently gets from generative AI to become "quite large" over the next 12 months. The firm’s latest H100 data centre graphics processing unit (GPU) is the best in class being nine times faster than its predecessor in artificial intelligence training and up to 30 times faster in AI inferencing for transformer-based large language models like OpenAI’s ChatGPT. AI models like ChatGPT require thousands of GPUs.

Conclusion

In summary, we believe that the results showcased in this report are highly promising and we remain optimistic about the prospects of the underlying businesses held by the Fund.

We would note that whilst we do not have direct exposure to recent banking woes we are mindful that cloud revenue may be impacted due to reduced funding available to tech startups. However, we do not think this is likely to result in a significant impact on underlying revenues. 

We will provide a further update on the results of other holdings within the EPIC Global Equity Fund shortly. We note that we have recently covered Adyen and ASML in previous updates.

Malcolm Schembri
Fund Manager, EPIC Global Equity Fund