Model Portfolio Updates

It’s time to update our IPO Candy Model Portfolio. Our first pass is to add some new names and also eliminate a couple that no longer meet our investment criteria.

Adding: SDGR, FVRR, ARLO, WORK, LVGO, CHWY, SWAV, FREQ

Removing: GSKY, SPOT, PS, FNKO

Here is more about the additions:

Schrodinger (SDGR) – This is one of the most interesting companies we’ve seen coming public in years. Part of it is their unique technology, another is their multi-faceted business model to monetize innovations in new drugs and new materials. We expect some parts of the business will be hard to model on a quarterly basis which will create more than usual volatility. This will be a classic buy-the-dip name. You can read our full post here: Schrodinger has a powerful new platform for drug and material development.

Fiverr (FVRR) – This is a play on the “gig economy” which has come up with a way to organize freelance work into more comprehensible service offerings. It’s a better experience than what you get from other providers like Upwork (UPWK). Upwork is over 2x the their size but Fiverr is growing twice as fast and looks poised to become the leader in this space.

Arlo (ARLO) – Here is a piece of “broken candy” that hit a major speed bump in their growth path post-IPO. We’ll get a full note together on this one soon but here is the skinny. Arlo makes the best wireless cameras out there. There is lots of competition including Google Nest, Logitech, and Amazon Ring but Arlo is consistently ranked above them for most applications. But hardware isn’t a great business and tends to have low multiples. Arlo cloud software has lagged but is catching up which can translate into much higher growth in their SaaS business over the next few quarters. Not only will this boost margins but it will help the company get a better valuation since investors much prefer that model.

Recently they did a major deal to accelerate their penetration in Europe that is a much more efficient method to address that market – again leading to higher growth and greater ROIC. Finally the valuation of the company is now very low. The $250M market value is equal to what they have in cash. They will burn cash this year but revenues are $370M and beginning to grow again. It’s too cheap but at least half and if they are successful on the cloud side of the business this can be a 4-5x.

Slack (WORK) – There are quite a few things we still don’t like about Slack. The first is the size of the market considering that most large enterprises will simply use Microsoft Teams and be done with it. However there are a number of use cases where Slack is a much better fit. And some organizations (IBM and Uber) recently have been willing to standardize on Slack for internal use.

Our thinking in adding Slack has to do with their increasingly valuable market position and signals from major players like Google that they are going to make another run at the “office productivity” space and not conceding it to Microsoft. If Slack continues to build more functionality into their platform and steadily increase their user base it will be hard to ignore them. There are definitely vertical segments where they could offer unique features and expand their market opportunity which would be another path for them into the enterprise.

Livongo (LVGO) – We see the future opportunities in healthcare more in early detection and management. Although Livongo would be considered a healthcare technology company they have figured out that the solution lies in effectively combining technology with behavioral aspects to produce results for chronic diseases like diabetes.

Chewy (CHWY) – People love their pets and Chewy has carved out a niche for themselves as the “Amazon of pet products” which is a big enough market to be excited about but no so big that other major retailers like Amazon are really going to make it a top competitive priority.

Shockwave Medical (SWAV) – This is a new approach to treating cardiovascular disease using the proven technology that has been used to treat kidney stones but tailored to the specific needs of vascular procedures. They company is still small ($43M in revenue for 2019) but it’s growing revenue at over 200%. With an aging population and a superior treatment this company should continue to grow and attract the attention of larger medical device companies who will want to offer this treatment.

Frequency Therapeutics (FREQ) – We don’t like to own companies that have drugs in clinical trials. Frequency Therapeutics is worth making an exception for because they are trying to harness the power of dormant progenitor cells in the body by reactivating them to create new functional tissue. Their first application is for hearing loss which is routine and supports a large hearing aid industry. It would be a breakthrough for hearing loss but would also prove that this approach could be effective for other applications.

And a little more color on the removals:

GreenSky (GSKY) – Managing new consumer credit products has proven to be a tough challenge for many companies, including GreenSky. Not only have they faced operational problems but many new competitors have jumped into the market making this kind of “installment payment on demand” a common option.

Spotify (SPOT) – As a regular user we still love Spotify. But it’s still unclear how these types of platforms can make money without content ownership. Disney has made this so clear in their strategy of buying up the best content before launching Disney+. This goes in our “great product, unclear investment” category.

PluralSight (PS) – This should be a great company doing great things in corporate education. Education in general is over-ripe for major disruption but this company has not inspired confidence in execution. Everyone rates it a buy despite this. It’s also the case that they “education” market can be a tougher place to see high returns on invested capital outside of the “institutions of higher learning” – at least for now.

Funko (FNKO) -If only Funko would have expanded their product line before the market for their signature “Pop” figures got saturated. They could have done it and leveraged their execution advantages. The shares may yet recover but at this point we can’t justify keeping it in the Model Portfolio.