For the third time in as many letters, we are communicating on Premier Technical Services Group Plc (PTSG). While this will be the last time as an active portfolio company, no doubt will we refer to this period of events in our future letters. On June 20th, we received notification from the stock exchange that PTSG’s management had been working with a private equity division of Macquarie Group Australia to take the company private at 210p. We had initially invested at 140p towards the end of 2018 and increased the investment throughout the first half of 2019 buying our last shares when the price had  dropped to 70p. Our average cost was 122p. We sold out of PTSG in June 2019 for a +70% return to the fund over a mere six-month period. The fund still has a large cash position and is building new stakes by taking advantage of depressed stock prices of quality businesses suffering from temporary problems. We look forward to report on this progress in the next quarterly letter.

Before we move on, we would like to share our final thoughts on PTSG. First, many investors will look at these last 12 months and conclude that PTSG was a very risky adventure based on the volatility of the share price combined with the negative rumours on blogs and in the press. We beg to differ. An accumulation of unrelated circumstances like for example the absence of basic cash-flow generation, results that were substantially boosted by a consultancy fee paid by a company it then acquired and lastly the related party transactions, were in our opinion the main reasons why investors lost confidence in PTSG’s management. Our research resulted in a much more positive outcome. It included several meetings with the CEO and the CFO. We received detailed explanations on the above issues and it led us to conclude that the negative sentiment was caused by poor communication and not by fundamental problems with the business. Management’s poor communication skills were not a reason for us to change our view on the company; a high-margin, high return-on-capital, recession-proof business with a long runway for growth ahead, run by a team of seasoned managers with a great track-record as operators and capital allocators. This investment is an example of how our capacity to research as contrarians allowed us to determine that PTSG was an opportunity with very favourable risk/reward characteristics. Value investing is best practised without emotional attachment. This is however not easy if the share price drops substantially and the market is telling you that you’re wrong. We won’t always get it right, but as mentioned above, in the future we will look back on our approach and learn from the processes we applied that made PTSG a successful investment. Secondly, the return we achieved in such a short period of time is obviously welcomed, but a part of us is saddened to let the company go. PTSG’s business quality, growth potential and valuation made it a gem that doesn’t present itself often in our continuous search for great companies. We analyse many companies for the portfolio, but rarely are the stars so aligned as was the case for PTSG. When the new owners paid 210p for a company that was trading at 70p, it may have looked like we were offered a great deal, yet our own estimate of intrinsic value was 300p. If PTSG continues to execute well on their growth opportunities, both organic and through acquisitions, then it will create a lot of value for its new shareholders.

This quarter we also sold our last CompuGroup Medical SE (CGM) shares. Koblenz-based Compugroup Medical is the leading European software and service provider in the eHealth market. CGM was interesting to us, as strong social drivers create demand for its products. Indeed, an ageing global population combined with increased wealth creation makes the health sector a great beneficiary of investment. CGM’s eHealth business sits at the centre of this powerful movement. Governments in developed markets are focused on making healthcare more efficient and CGM produces tools that help achieve this. The founding family still controls 45% of the shares, provides the CEO and Chair of CGM. Through focussed acquisitions, CGM outgrew its German roots to become the dominant provider of eHealth services in Europe. It is active in four segments of the eHealth market, but derives most its revenue (69%) from software for doctors (Ambulatory Information Systems, AIS). The other three segments are Pharmacy Information Systems (24%), Hospital Information Systems (15%) and Health Connectivity Services (6%). We consider the AIS division as the jewel in the crown. It is characterised by the stickiness of its customer base with a churn rate below 5%. eHealth software is also an a-cyclical business, which meant CGM was able to continue with price increases, even during the recent recessions. Software is also an interesting industry; software development comes with high upfront costs but low reproduction costs leading to high gross margins. This makes the business highly cash generative once scale is achieved, as the capex spent is effectively a ‘one time development expenditure’ followed by ‘multiple sales’ of the same software.

This was in fact the second time our fund owned shares of CGM. We had more than doubled our money during our first 20-month of ownership in 2013, after it had reached our calculation of intrinsic value. Yet, less than a year later towards the end of 2014, we entered into the equity again at approximately the same level as we had exited and made it the second-largest position of the fund. The reason: a government initiative, dating back many years, was finally looking to become reality in the German eHealth sector. Due to the timing uncertainty, we had purposely not considered this as part of the intrinsic value calculation the first time around. Could this be a ‘gift that keeps on giving’? We got very encouraged by our findings; for starters, CGM continued to benefit from all the quality characteristics which originally attracted us to this business. In addition, the company stood to benefit from taking on a key role in the government-led consortium called Gematik. This initiative was tasked with connecting all stakeholders of the German healthcare system in a secure and cost-effective manner. Not only was CGM chosen as a development-partner for its proven expertise in the field, it also had a head start over the competition with regards to its advanced progress and implementation capabilities into their existing eHealth client base. In short, an investment in CGM would give us all the business quality assurances we liked the first time around, combined with a clearly visible path of growth in Germany, when the initiative started to roll out and interconnect the medical sector. Usually, we are reluctant to pay for high growth potential but CGM’s dominant market position, its leading role in the government project and the high certitude of law that would encourage (read: force) general practitioners to increase IT spending, convinced us that the risk-reward was attractive again, despite having to pay a higher multiple on historical earnings.  Over the next four years, our re-investment in CGM would more than double again in value. We believe the upside of the Gematik initiative is now priced into the stock and therefore decided to exit one of the fund’s earliest holdings. The volatility of the share price, which stands in stark contrast to the underlying business performance, encourages us that one day we will be able to own this great business again at an attractive valuation for the fund.

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Summary of the five largest positions of the fund:

Boustead Projects Ltd & Boustead Singapore Ltd (BP 6.02% and BS 3.79%):

We own both the holding company, Boustead Singapore, and its 51% owned real-estate entity, Boustead Projects (together Boustead). During the year, we increased the position to make it the fund’s largest holding with a combined weighting of approx. 10%. The key value driver is a portfolio of industrial properties in Singapore and an asset-light design & build business in the construction industry. After a few years of price declines, the property market in Singapore has been stabilising and Boustead recently announced a record order book including design & build as well as design & build-to-lease projects. This bodes well for future profits for Boustead and ensures that the portfolio of investment properties will soon reach the critical size required for Boustead to launch its own REIT. Today, Singapore REITs trade close to Net Asset Value thereby valuing the underlying properties at the appraised market value. Based on our analysis the share prices of Boustead Projects and Boustead Singapore imply a discount of more than 50% on the appraised market value of their property portfolio thereby offering both downside protection and substantial upside if management can execute its strategy and launch a REIT. Recent developments and a tripling of the order book increased our confidence in a successful outcome.

Sporton International Inc. (7.39%):

Sporton holds the global market leader position for international certification and testing of smartphone and wireless communication devices. Testing and certification includes compulsory and compliant testing services for electronic devices. Sporton is one of the few companies that can provide both.  The main types of products tested are smartphones (44%), products such as keyboards, monitors and peripherals (34%) and Internet of Things (22%). Most sales are generated in Taiwan and China, which is also where most products are developed and manufactured for the global market. Sporton also has the largest market share of US FCC filings for personal communication systems and is the only firm focused on this type of testing and certification. Its main competitors are smaller subsidiaries of much larger established companies such as Bureau Veritas, SGS, UL and Intertek. These smaller competitors generally test the lower-end smartphone and Wi-Fi equipment. New entrants face substantial barriers to entry; the testing industry is a capital and technology intensive industry that heavily relies on its engineers and high-tech labs. No new meaningful competitors have entered this industry for over a decade. The smartphone industry is currently in a period of transition between maturing 4G technology and a nascent race to adopt 5G technology. The last waves of technological advances (3G & 4G) allowed Sporton to increase revenue and profit margins and the company expects the same to happen this time around. Other than the expected growth of 5G over the recent 4G, mostly due to the complexity in the new technology (and testing), Sporton expects to see a further driver of revenue growth with Internet of Things (IoT) devices and smart cars. Management expects revenue growth of 8-10% p.a. over the medium term. The capacity increase that came online in H2 2018 should further boost revenue growth to over 10% in 2019 and 2020. The current operating margin is 27% and Sporton believes it can increase this to 35% when 5G testing takes off. The company’s CEO & Chairman still owns 27.1% of the business and takes no salary. Additionally, the risk of bad capital allocation is reduced as the company makes no acquisitions and sets a policy of paying out most of the profits through dividends. The dividend pay-out ratio is 79%. Sporton’s share price had been suffering from poor market sentiment. We see this partly due to the still relatively small quantity of 5G smartphones being certified, combined with a concern of a slowing Chinese economy and an unfriendly trade tariffs environment. We purchased shares at 15.2x trailing earnings or at 12.8x net of the excess cash on the balance sheet. The dividend yield is also attractive at 5.3%. At this valuation, we do not need the company to reach management’s targets to achieve an attractive return. Over the last five- and ten-year periods, revenue grew at approx. 10% p.a. with average operating margins of 29% versus 27% today.

Hamilton Thorne Ltd (5.02%):

U.S.-based Hamilton Thorne Ltd (HTL) is a C$100ml company that supplies equipment, software and disposables to In Vitro Fertilisation Labs (IVF), a $1bn niche market segment inside the $15bn global fertility industry. The fertility market is interesting because it exhibits characteristics of a high-quality industry, combined with long-term demographic growth potential, as the maternal age has increased over the last decennia and couples are increasingly relying on assisted reproductive technology (ART) to fulfil their wish for children. HTL is facing more regulation and increased demands on the medical standards of their product offerings and the industry consolidation has led to rising barriers to entry. This has worked well as a deterrent to potential competitors from entering this niche market. In September 2016, HTL made the first of two transforming acquisitions by buying US-based Embryotech Labs, a provider of medical device toxicology testing services for less than 5x EBITDA. This business has low capital requirements and very sticky customers. In 2017, they made a second acquisition by purchasing Gynemed GmbH, a German company that manufactures and distributes consumables for IVF labs, most importantly the cell culture media. Gynemed is known in the industry for producing the best cell culture with a shelf life double that of the competition. Gynemed supplies 98,5% of all fertility labs in Germany, Switzerland and Austria. It is a low capex, high margin business (+75% gross) business and has very loyal customers. IVF labs that use cell culture media in their certified processes rarely switch suppliers because this requires the whole process to be re-certified. HTL’s market is expected to grow at 5-10% annually. The introduction of new products, cross-selling opportunities from the acquired businesses and gaining market-share from smaller and less competitive companies, should allow HTL to grow organically at 10% or more for many years to come. We estimate that we bought into the new HTL at 12x forward EBITDA. HTL’s only listed peer is (the much larger) Vitrolife AB, trading for 32x EBITDA.

Sberbank Rossi POA (4.85%):

The fund invested through the London-listed ADR’s in the equity of the largest bank in Russia. The opportunity presented itself following President Putin’s 2014 forays into Ukraine and the subsequent international pressure on the Russian Federation. For the record, we are not particularly big fans of financials, mainly for two reasons; we avoid leverage and we find bank balance sheets typically too opaque for our fundamental analysis. But the strength of Sberbank’s balance sheet, its exceptional historical profitability, its durable competitive advantages, it’s very strong management, its long runway for growth and finally a depressed valuation, all contributed to our conviction of investing in a very controversial situation. For the 10-year period to December 2015, Sberbank’s book value per share in Euro terms compounded at 14.3% p.a., despite the financial crisis in 2008 and the Ukraine crisis. The Ruble also lost about 58% of its value against the Euro over that period. Sberbank dominates the Russian banking sector with >40% of all deposits and a retail branch network over 10x the size of its nearest competitor, resulting in a significant funding cost advantage. On the lending side, the bank focuses on the higher quality borrowers. Viewed in a global context Russia remains substantially underbanked, based on the low percentage of GDP for banking products such as deposits, lending, insurance products and credit cards. We believe Sberbank is very well positioned to benefit from this long-term growth potential. We made our first investment in Q1 2014 at 4x trailing earnings and 80% of book value. We subsequently made further investments as the share price declined when the economic situation deteriorated. Griffin Fund’s current country limit for Russia is 4% of AUM at cost.

Volution Group PLC (4.66%):

Volution is a leading supplier of ventilation products to the residential and commercial construction industries in the UK, the Nordics, Central Europe and Australasia. The ‘friendly middleman’ concept applies to this business as the end-customer is typically not choosing the brand of his ventilation products. These ‘friendly middlemen’ generally pass the cost through to the end customer and prioritize easy-to-install, reliable and familiar products that can be delivered quickly. Volution has a portfolio of long-established brands and guarantees fast delivery of thousands of different products through its distribution networks. The company benefits from scale advantages and can organise this at a low cost. The ventilation market in Europe is typically fragmented and consists of many companies of varying size and scope. The demand for their products is a function of activity in construction markets, both new-build and refurbishment. Regulation and consumer trends have been a tailwind for the demand of Volution’s products. Stricter building regulations have resulted in a shift towards air-tight buildings, resulting in increased use of Volution’s higher margin value-added systems and other more environmentally friendly solutions. CEO Ronnie George owns 2.8% of the company and approx. 50% of his compensation is performance linked. At 9x our estimate of current-year after-tax earnings, the valuation is attractive for a well-managed company with a strong market position in a niche with regulatory tailwind; a consistently strong cash flow generator with good prospects for both organic and inorganic growth. Management is focused on continuing its strategy of growth through acquisitions and it has the financial means to take advantage of the large opportunity-set in a fragmented ventilation market. Operating margins have the potential to improve as the company keeps growing and higher margin products become a larger part of the business mix. Cost overruns on establishing a new assembly facility in Reading (UK) also had a negative impact on profit margins for 2018. This is now completed, which should eliminate a major drag from the 2018 performance. We made Volution a 5% position for the fund.