In our first letter of 2017 we mentioned a quiet period in terms of portfolio activity. During the second quarter, we saw a continuation of a similar pattern. The fund started the quarter with 39.15% in cash, and this further increased to 44.73% when one of our portfolio companies, Exova Plc, was successfully delisted and again taken into private ownership after just three years as a public company. Our search for value often steers us to companies which are under-followed and under-researched. When we choose to invest in a hidden champion, we know we run the risk of an acquisition or merger at a price below our estimate of intrinsic value. In the case of Exova, we do regret having been forced to part with a great business in an industry with attractive characteristics. In this particular case however, we are satisfied that the take private was executed at a level which closely matched our target exit price. During our 18 month holding period, Exova returned 1.8x the initial investment. This quarter, we also decided to reduce our position in EM Systems, the Japanese software developer for pharmacies, which we profiled in our 2015 Q4 letter. When we initially became shareholders of this company, there was a tremendous margin of safety due to an overlooked high quality real-estate asset on the company’s balance sheet. At the time of purchase, we paid what we considered to be roughly the value of the real-estate and received the operating company for free.  Our investment thesis was built on the revenue drop being of a temporary nature and that the company was investing to make the transition to a more robust business model. When the company completed the switch from a software licensing to a subscription based model, we started to see an increase in revenue and profitability. In essence, we witnessed its transition from a safe asset play to a cash flow compounder with good visibility on its future recurring revenues. In our earlier letters we elaborated on our view of the perfect portfolio having a diversified set of no more than 20 companies, each of 5% weighting and not exceeding 7% for our high conviction ideas (both at cost). In the case of EM Systems, it returned 2.7x our initial investment and had grown to 9.65% of our AUM in June, when we took the decision to reduce our investment by half.

As we entered the summer we continued to diligently look around global equity markets to seek out the type of companies we like to own. To broaden our investment horizon and due diligence capabilities, we have engaged with two external investment analysts to work locally on Japanese and Chinese companies on a project basis. We’ve also been reading through stacks of old letters from fellow investors to further our insights into the business models that attract our attention. Our watchlist now has in excess of 200 of such companies which we believe to be true champions in their field. But today it’s merely that; a list to watch. Patiently.

We are agnostic to the macro-environment and would only need to glance over our watchlist to determine that valuations of our favoured companies are currently too elevated for consideration. Whenever prices of any of the watchlist constituents drops considerably, we get into action, refresh our models and check our original thinking against today’s reality. We like to own good companies, but for a good company to turn into a good investment we need to adhere to a disciplined price setting. At the time of writing we just finished building up a new addition to our portfolio with an investment in a Taiwanese company. We look forward to profiling the company in our next quarterly letter. In summary, we will only invest in a disciplined manner whenever and wherever we find the opportunity, in the meantime we remain focussed and cash-rich.

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For the quarter ended June 30, 2017, the fund had 13 listed equity positions. The five largest positions in the fund represented 29.08% of assets under management.

Summary of the five largest positions of the fund:

Boustead Singapore Ltd:

This Singapore-based company is a conglomerate of three quality businesses, which are fundamentally different from each other. The underlying divisions simultaneously went through headwinds, which allowed us to invest at an attractive valuation. Boustead Singapore consists of the following three businesses: 1/ a 51.2% 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 three businesses have high operating margins and generate high returns 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 businesses, 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:

We purchased this Koblenz-based medical software vendor at approx. 8x cash earnings. It was one of the first investments of the fund. 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 interconnectivity. Despite a strong increase of the share price we maintained a substantial position because we got more comfortable with a German initiative that was turned into Law at the end of 2015, and will be fully operational by mid-2018. It will further connect all the public health stakeholders with compatible software. Compugroup, being a leader in this field, was part of the government development initiative and once implemented, we believe the company will secure years of sustainable growth.

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 33% of 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 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 on top the company makes good on its promise to sell the real estate, then we will have received this great company almost for free.

Judges Scientific plc:

Judges Scientific (JDG) is listed on AIM, a sub-market of the London Stock Exchange and home to smaller companies with less regulatory burden than the main market. JDG specialises in the acquisition and development of a portfolio of scientific instrument businesses. JDG designs, assembles and sells high quality scientific instruments with a focus on material sciences and vacuum environments. JDG generates sales of approx. £56m; 60% from universities, 10% from testing firms and the rest from a diverse group of researchers with pharma, biotech, commercial and industrial backgrounds. More than 80% of sales are exported. Whilst most of the company's products have a long lifecycle, many of these products are sold into diverse markets and into different countries. The businesses share the following characteristics: sustainable profits and cash flows, high operating margins, high returns on capital, high and stable market shares in small niches, high fixed costs (mostly specialised personnel, many PhD’s), low capital requirements and asset light. Since its IPO in 2005 it generated a total return to shareholders of approx. 28% per annum over the 12-year period. When the company came with two negative trading updates to announce poor operating results for reasons we believe to be of temporary nature, the share price declined to a level we found attractive.

C.Uyemura & Co Ltd.:

The company is active in a niche market of the Electroplating Chemicals Industry and is not particularly small (market capitalisation = ¥53b~US$484m) but does a great job of hiding itself. The company is listed on the Second Section of the Tokyo Stock Exchange, usually reserved for small caps with extreme low transaction volumes. Although the company has a 20-year history of growth and profitability, they never made an effort to get onto the First Section of the Tokyo Stock Exchange, unlike their two main Japanese competitors (JCU & MEC). Whilst the industry is consolidating and at best growing in the single digits, it has very high barriers to entry. The industry has seen no new players for several decades due to product complexity, know-how, customer service capabilities and reputation. There are only a small dozen companies active in this space. The three largest making out 60% of the global market and Uyemura, together with three Japanese players have about 20% market share. Electroplating Chemicals are an attractive niche in the surface treatment industry and an important component in the production of printed circuit boards. Whilst the process is critical in the production of mainly mobile phones, PC’s and car electronics, the expense to the client is small in comparison to its overall manufacturing cost. This is a balance we like to see because rational customers don’t act penny wise and pound foolish on the small but critical components of their end-products. Uyemura is either a supplier or sub-supplier to most smartphones including iPhones and also for example for Toyota Motors in the car industry. Even in an environment of slowing demand for mobile phones does Uyemura manage to keep margins high because of the higher specification requirements in the latest smartphones like the iPhone 8, X and future iterations. This business has a very high customer retention rate, is asset-light, operates with high margins and has limited need of extra capital and thus is generating lots of cash. At our purchase price, the company’s market capitalisation is 2/3 covered by cash and 4/5 covered by cash + owned real estate. These excess assets give us good downside protection. The Uyemura family still owns 25% of the company. If we back out net cash & real estate, then we are paying 1.3x EV/EBITDA. We believe this is a very cheap valuation for a good company with a long history of profitability, a stable market share in an industry with very high barriers to entry and the other characteristics we described above.