Global markets had a volatile start to the year, with steep losses and a rally all the way back to finish the quarter at a small net gain.  The financial media had a field day with constant breaking news. Focus was on the direction of oil prices and a slowdown of the Chinese economy. Do not expect views on any of these topics in our letters; we are the first to admit we simply don’t know. Instead, we focus on the things we do know; keeping our head down and looking for high quality businesses or assets that we conservatively value at much higher intrinsic values than implied by the share price. In doing so, we were able to add three excellent businesses to our investment portfolio in the first quarter. Coincidentally, two are in the TIC-Industry (Testing - Inspection - Certification).

TIC - Industry

We have been monitoring this industry for a while and were attracted by the growth, high operating margins and high returns on capital. However, due to its high valuations, we had not invested in the TIC industry in the past. This industry contains a fascinating set of businesses with good tailwinds from growing public and regulatory requirements on health, safety and environmental issues. The increasing global reach from the TIC customers, combined with demanding specialisation in material knowledge, has over the years led to an externalisation of these mission critical, but on an individual basis, low cost tests. These tests are generally handled in TIC labs for the customers. A TIC lab primarily consists of real-estate and engineers (basically high fixed costs). To command high operating margins and high returns on invested capital, the labs need volume. The key is that it can take years to develop the expertise, reputation and customer base in order to achieve the volume that allows for these attractive economics. This also explains why companies in this industry focus on growth through acquisitions, rather than starting new labs that would be loss-making, potentially for several years.

Because these new portfolio companies are not within our top-5 holdings, we will briefly describe both:

Exova Group PLC:

Within the TIC industry, London-listed Exova is mainly active in Destructive Testing services, Energy and in some niche sectors of Health Sciences. The company used to be part of a much larger listed company (Bodycote PLC) in the beginning of this century. Fast-forward to an untimely private equity ownership (CD&R) it found its way back to the public markets in the summer of 2014. Subsequently, the market value of the company halved following disappointing earnings releases; unjustified in our opinion considering the high quality of the underlying cash flow generating businesses. But what makes Exova particularly attractive is that because it’s considerably smaller than its global industry peers, it is able to make opportunistic acquisitions at lower multiples, which still make a real difference to Exova’s bottom-line. We used this quarter’s volatility to buy into Exova at very attractive levels versus our intrinsic value calculation. We purchased the company using adjusted margins for acquisitions and restructurings at a price/earnings multiple of 12x 2015 earnings, whereas the global peers trade between 18x-22x 2015 earnings.

ALS Ltd:  

ALS Ltd is based in Brisbane, Australia. Most local (retail) shareholders still regard this company as the premier minerals testing business it used to be known for. Minerals testing is an oligopoly of three with SGS and Bureau Veritas (BV) competing with ALS. Historically, SGS and BV had a less cyclical business mix and more fixed costs. But ALS started as a minerals tester and developed a unique hub and spoke model. The hub being the centralised lab with highly specialised engineers and the spokes accounting for basic sample extraction and tagging.  During a down cycle, it allows the company to keep the volumes of testing in the hub at a sufficient level, while reducing the cost structure of the spokes. This key difference explains why ALS can still generate a 20% operating margin in a down cycle, when its 2 competitors are break-even or even loss-making in their minerals divisions.  We therefore like ALS' position despite this business being cyclical. Additionally, the company recently made an untimely acquisition in the Oil & Gas industry at the top of the cycle. With the commodity recession hitting both the Minerals and newly acquired Oil & Gas divisions, the share price got decimated by more than 70% from the peak. What investors missed was that the company had been expanding in other TIC areas and their global Life Sciences’ division now accounts for 63% of current EBIT. ALS has an attractive market position in Life Sciences, a non-cyclical business with attractive growth prospects. We invested in the company just after a retail equity capital raise at 8x EBITDA or 10x our estimate of normalized after-tax earnings.

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For the quarter ended March 31, 2016 the fund had 17 listed equity positions. The 5 largest positions in the fund represented 33.54% of assets under management.

Summary of the 5 largest positions of the fund:

Boustead Singapore Ltd:

This Singapore-based company is a conglomerate of 3 quality businesses, which are fundamentally different. The underlying divisions simultaneously went through headwinds, which allowed us to invest at an attractive valuation. The businesses consist of 1) a 48.8% participation in recently spun-off Boustead Projects Ltd; a design, build & lease real estate business that owns a portfolio of new and recently build high-end fully let industrial buildings. It counts IBM, Airbus, Bombardier, Rolls-Royce, SD Schenker and SDV amongst its tenants. 2) an asset light global engineering business active in the niche market of direct-fired process heater systems, mainly for oil & gas refineries. 3) a distribution business of Esri geospatial software, which has a 60% market share in geographic information systems (best explained as a professional Google Maps, mainly for governmental use). These 3 businesses have high operating margins and generate a high return on invested capital. They are led by a chairman who focuses his entrepreneurship on shareholder value creation. We were able to purchase this conglomerate for respectively 5x and 12x the normalised earnings of the energy and geospatial business, and paid 55% of intrinsic value for the real estate assets. A potential catalyst exists in moving the real-estate assets into a REIT structure and the conservative balance sheet also allows for opportunistic acquisitions.

Compugroup Medical AG:

This is the second time we were able to invest in this Koblenz-based medical software vendor. It was one of the first investments of the fund, which we successfully entered and exited between 2012 and 2014 for a 105% return. We think this medical software business is of very high quality with high barriers to entry and a dominant position in virtually all the markets it operates in. It has very sticky customers (mostly doctors) with extremely low churn rates, no cyclicality and high free cash flow generation due to the low capital requirements to run the business. The business model is also helped by the continuous pressure from governments to cut public health spending by increasing connectivity. As we kept in touch with this company after our exit, we got more comfortable with a German initiative that was recently turned into Law. It will connect all the public health stakeholders with compatible software. Compugroup, being a leader in this field, was part of the government development program and once implemented, we believe the company will secure years of sustainable growth. We re-entered the equity at 12.5x cash earnings.

EM Systems Co Ltd:

This Osaka-based medical software business is the leader in pharmacy software in Japan.  The company sells soft- and hardware to 23% of the pharmacies in Japan. The country is not as advanced yet in its implementation of medical software to control and cut public health spending as compared to Western countries. However, our experience in this industry gives us confidence in the future recurring revenue stream. The company is led by an owner-operator with a good track-record as both an operator and a capital allocator. When the company recently moved over to a cloud based subscription model, the market punished the share price, ignoring years of stable future cash flows once the transition was complete. In addition, the company owns a prime office building in central Osaka. We purchased the shares at roughly the value of the real estate, covering our margin of safety. If the company makes good on its promise to sell the real estate, then we will have received this great company almost for free.

Keck Seng Inv (HK) Ltd:

This Hong Kong listed company originally started accumulating and developing real estate in 1977 in the Portuguese enclave of Macau. Over the years the founding family moved from ‘build to sell’ to ‘build to hold’. Today it is a diversified real estate investment holding company, majority owned by its founding owner-operator chairman. Its real estate assets are spread over the globe, primarily in the U.S., Vietnam, Macau, China, Canada, Japan and Singapore. Keck Seng’s main assets are the W-hotel in San Francisco, the Sofitel hotel in New York, the Sheraton hotel and casino in Ho Chi Minh City and residential real estate in Macau. The company also has a very conservative balance sheet. Using market values, the company compounded at 17% p.a. between 2003/2013. We made our investment at a discount of 85% to Net Asset Value, excluding the excess cash.

STI Education Systems Holdings Inc.:

This company is based in the Philippines and is a provider of Tertiary (Higher) Education. STI is the largest vocational college in the Philippines, offering practical education that opens doors to attractive employment opportunities. This is not the top ranked college, but it is one of the best-run for-profit colleges, where prestigious companies like Starbucks Inc. recruit from. Today, the education system in the Philippines is going through a major change to set itself on par with global education standards by adding what was missing: Kindergarten and the final 2 years (grade 11&12) of the Secondary Education. This vacuum created by the absence of a normal yearly intake (students now need to finish grade 11&12 rather than immediately going in Tertiary Education) caused the company’s value to collapse. In the meantime it became clear that the government is also not capable to supply all the logistics for these newly introduced grades to be taught in the public education, and colleges like STI are filling their empty classrooms with students they later hope to attract for Tertiary Education. The company has a strong balance sheet and we were able to make our purchase at an undemanding valuation of 3.9x 2015 after-tax earnings. Alternatively, if we look at the company’s assets as opposed to its earnings, we bought this company at a 46% discount to the cost of the college’s real estate portfolio.