Feb 2020 Update:
For the year this portfolio is up 12%. For the month, it is down 7% versus the end of January. I am going to focus in this write up on the strategic powers each company is developing currently. I posted on the 7 powers about a year ago and continue to use it as a filter in my selection of stocks from this board and the MF universe in general.
This month I have 20 holdings in this portfolio across 16 companies (some call options account for the difference.)
This looks like a big position, and it is. It has grown from my initial investment in 2017 at $34/share and I have not cut it back because I believe this company has the largest strategic advantage of any company in my portfolio, and they continue to execute at a level higher than the growth of their industry, which itself is large and growing quickly.
I know many are reluctant to embrace a company growing in the 35% range annually, and I understand that perspective. However, I think TTD’s position has the greatest long term upside due to the large TAM and secular tailwinds. With programmatic growing at 25% annually, 35% growth means that they are a dominant force that continues to take share. The comprise around 20% of the market already, and so should be able to continue to grow faster than the market for quite a while. This is a little different than other cloud stocks because the advertising for conventional linear TV is a burning platform. People are moving to streaming much faster than the ad dollars are, and that won’t last forever, and is likely to experience something of a tipping point at some time in the near future.
Powers this company is acquiring:
• Network effects:
At its core, TTD is a marketplace business which takes a percentage of the total volume transacted. Marketplaces benefit from the mutual attraction of buyers and sellers. In this case I expect ad buyers (brands, agencies) to congregate where the ad sellers (TV networks, Amazon, Hulu, etc.) are. Other, smaller marketplaces that may disrupt have to overcome this preference by growing to a sufficient scale to being to attract niches. However, TTD has an additional advantage that makes this difficult in their ability to allow brands to harness and use their own data in placement of ad buys across different kinds of media (CTV, display, audio, etc.). Accordingly, the only competitive edge I can see for a challenger would be cost- using a lower take rate to try to compete on price. But TTD at this point has said that they will be flexible in use of rebates on their take rate to ensure they continue to dominate, and their operating leverage is strong enough that they can do this and still remain profitable.
• Counter Positioning:
Vs. Walled Gardens (FB, GOOG, etc.). The incumbents in this space are pretty opaque about the effectiveness of ads. At small scale, my wife has invested in FB and GOOG ads for her small business and is only told how many times her ad was seen and how many people clicked on it. From what Jeff Green says, brands don’t want to use (and may not be able to use) their own data to target ads with these players. If they do, they run the risk of that proprietary data being cooped by the platform and used/sold to others.
If these player are going to try to match the transparency of TTD, they will have to give up some portion of their business that is ineffective for the advertiser, who will want to better target those ads somehow. They will not do this unless they have to, or unless they think they can on aggregate charge more for the ads in the new state. By the time this happens, TTD’s scale will probably be large enough that the ease of use and designing campaigns will have generated a switching cost advantage.
Vs. Roku/other platform owners: Sell side platforms are more limited in their attractiveness for the buyers. I have some concerns about ROKU taking DatXu and walling off TTD from working on their platform to capture a larger percentage of revenue spend. This may happen in time, but for now TTD placed ads are still revenue for Roku, and some brands/agencies will not migrate to a new platform, and by cutting off TTD they would cut their own growth. As they are focused on building out their platform at this point, I think this is unlikely in the foreseeable future, as long as cord cutting is accelerating.
• Why I don’t own Roku:
I actually do, just not in this account. But it is less than 2% of my overall holdings. I view it as a less powerful company because of their intermediate position. Their customer is the consumer, but they make their revenue from streaming services (who are going to actively cut them out whenever they can do so, will try to negotiate down their ad slot counts, etc), and their much smaller ad platform, that is not diversified across media types to the same degree as TTD. They will gain higher revenue % from a smaller number of ad slots, and others are going to try to force their ad counts down to maximize their own. Thus, their interests are opposed to their revenue source unlike TTD, who is aligned with their revenue source (brands and ad agencies). TTD will collect 15-20% of the revenue from a much larger number of ad slots. There is a role for both, but I feel TTD is likely to be more resistant to disruption going forward.
Moving $4.4B worth of ads is not trivial. From this they should be able to better fund development of new tools and technologies and have a large store of data useful to brands in designing their campaigns. This should improve quality, hopefully at a pace greater that other platform operators can match, further driving the Network Effect and the switching cost power.
• Switching cost:
This is probably the weakest power as an agency would not have to bear tremendous expense or risk their entire operation for a client by trying out a different platform for a portion of their spend. But, there is a dimension of quality that exists here. For their customers (ad agencies and brands), moving away from TTD to something else would have costs, some financial, and some in effectiveness. To the degree that TTD can build a superior toolkit (AI designed campaigns, broad reach across multiple channels, geographies, and services, ability to identify who an ad has been served to and in what form), brands are going to be locked in, to some degree.
Powers this company is growing:
• Scale: Being the dominant player in their space has allowed AYX to build a large lead in the market which has generated scale in the following ways:
? Integrations with data sources- AYX has plugins that allow you to pull data out of defined locations relatively easily. When we were shopping it, they did not have a tool for our ERP system yet. (It is a smaller niche product). Given that so many of their customers are pulling from 6+ data sources, the ability to reach into other systems for the data without having to set up manual reports is a strong advantage to the user, and they are building out this ability. As this matures, the bar for a challenger will go up.
? Analytical capability- Their large lead in terms of time and share affords them the scale to build up a suit of tools for users to derive insights. Currently they are apparently not able to match some advanced programs, but this will only improve via acquisitions and internal development. Their customers are fanatical about the program, and they listen to their users and develop based on their needs. The gap for any new challenger is already large, and growing.
• Switching cost: Users have spent months to year developing reports using AYX. Changing to a new platform would result in the need to replace and re build those reports, re-form those data links to the sources, as well as training the large base of users on the new system. This generate pricing power for AYX.
• Network effects:
? Trained users- This is a bit of a mix- it might also be considered a scale effect, but I am placing it here because it results in broad use rather than a cost or quality advantage.
I attended an AYX marketing event in 2019 and encountered many people who were ecstatic with the product and could not imagine doing their work another way. AYX requires a different thought process to design reports versus Excel, but it is easy enough to learn that many advanced Excel users have already converted. These people are missionaries and as they move in their careers they will carry AYX with them, planting it in new departments and organizations. Consider the scale advantage here like that Microsoft enjoys with Word. Are there other similar products? Yes. But few people consider them because they know Word, everyone they know uses it, and it has become the standard. In 10 years I expect that for most heavy lifting in analytics, AYX will be like Word and able to meet the needs of 90% of users.
GH: Guardant Health: 9.7 %
Powers this company is growing:
• Cornered Resource-
A patent search for Guardand Health reveals about 1300 hits for various combinations of methods and systems for the detection of cancer and genetic variation. This is a new field of study and there are surely many ways to skin the cat of blood based cancer detection, from genetic to proteomics, and I am not an expert in these areas. However, I know that GH has successfully achieved Medicare reimbursement for initial tests for NSC lung cancer and is beginning to displace surgical biopsy because of the interest risks. Their Feb 2020 conference call indicates they are well on their way to a pan cancer typing approval across all solid tumors, and they are getting initial partnerships with biologics manufacturers to identify candidates for clinical trials, and will ultimately have test volume from any treatments that get approved. I would say that due to the multiple of approaches and competitors in the space like Grail, Exact Sciences, Invitae, and others, they will not be an exclusive provider of these kinds of tests. However, their IP (if it is strong) and head start along the regulatory pathway should be advantageous and help them control a significant piece of the market. Additionally, by being first to regulatory approval (likely per Feb CC), they are getting to establish the process and expectations that others will have to follow. Perhaps they will be able to seed some land mines making it difficult for others to follow up?
Others here know this business better than me. My view on DDOG is the simple adoption process should allow them to grow quickly, and as they are embedded I am hoping that they will enjoy switching cost power, where the insights they are providing are valuable enough and hard enough to duplicate that they will have pricing power over time. My worry with them is that they were able to make the magical tool, but what stops others from making systems that are just as magical? With a head start on competitors I expect them to be able to gain some scale advantage, and hope this will enable them to be a great company over time.
Monitoring, logs and security are rife with 2nd tier has beens. I am keeping this one at a modest level because I don’t see how they are uniquely positioned to dominate the market over a decade or two.
Again, others know this one better than I do. I don’t own any other security focused companies because it makes sense to me that this is an area where it is hard to stay on top due to technical debt. Once a company has developed a technology and a concept it is hard to rip it all up and replace it with the next better technology, and in security this is probably ultimately necessary several times in a company’s lifecycle.
I see some scale economy power for CRWD due to the way they leverage data across customers using AI. Because the quality of AI models doubles for every 10x increase in training data, their scale ought to give them some advantage in the quality of their predictions… until someone comes along with a disruptive technology that learns better or works by a better mechanism or addresses a threat that doesn’t exist yet. But security is hard. I have this as a relatively low conviction pick.
Abiomed makes the Impella series of heart pumps. Growth has been tepid the past year after some confusing data releases by the FDA (debunked) and at a conference (also debunked) due to improper selection of sample populations. Basically, the devices are used on the sickest patients, so if you don’t control for initial health condition it can look like the device creates complications and reduces survivability. That has driven a reduction in sales due to confusion in the market.
However, the device competes with intra aortic balloon pumps, which are reimbursed at a lower rate by payers, creating every incentive for providers to use Impella if they believe it is safe and more effective. ABMD is currently running a clinical trial to evaluate Impella as a front line treatment for heart attack. Currently, as I understand it, (and some physicians here may be able to correct this if wrong), immediately on arrival at a hospital for a heart attack, physicians focus on trying to restore blood flow to the heart to prevent disuse death. Due to the compromised circulation, the heart is working hard in this condition and that effort causes demand for more oxygen which it cannot get due to blocked arteries. There is a theory that ABMD is evaluating that if they heart is assisted with an Impella on arrival and allowed to “rest” for 20-30 minutes, it can stop working so hard and less tissue may die due to the reduced workload, and the procedures can begin after the recovery. If this is effective, it could mark a sea change in the treatment of heart attacks that is better for patients and would be a major boon to ABMD.
Powers they are developing:
Cornered Resource: The balloon pump incumbents use a very mature technology that is not able to do what the Impella can due to its placement in the anatomy. The Impella is patent protected. The regulatory burden is also a significant barrier to entry for others. These are not easy devices to make, and having to make one while avoiding patents from ABMD ought to be quite challenging.
Other holdings/Try Out positions:
Shockwave Medical- 3%
Exact Sciences- 3%
Vertex Pharmaceuticals 2.5%
Telemedicine, Meet, Luvago <1% each