Current Investment Environment

Recent years have seen global equity markets dominated by the strong performance of a small number of very large U.S. companies as well as the rise of passive investing. The performance of equity markets varies significantly by segment, as demonstrated by the year-to-date (YTD) performance of the following indices: MSCI World USD +11.75%, S&P 500 +15.05%, and Russell 2000 +1.73%.

The "Magnificent 7 had a disproportionate impact on the performance of both the MSCI World and the S&P 500 indices. These seven stocks now constitute more than one-fifth of the weight of the former and over one-third of the weight of the latter. In sharp contrast, the Russell 2000 Index, being only slightly up for the year, highlights the differing performance of small-cap U.S. stocks compared to these large companies.

In January 2024, the Financial Times reported that, for the first time, passively managed U.S. mutual funds and exchange-traded funds (ETFs) had amassed more capital than actively managed funds. The rise of passive strategies is also a global phenomenon which has been building for years, based on the premise that stock pickers do not outperform the market in the long term. The combined success of passive investing and the "Magnificent 7", has contributed to the current high valuation of the S&P 500 relative to its historical mean on several valuation metrics.

It will be interesting to observe the impact of substantial capital being invested in indices by investors who do not consider what they are buying or the price they are paying.

Griffin Value Fund's Approach

Our fund focuses on investing in high-quality companies we believe are undervalued, typically at earnings multiples below historical averages. Currently, the weighted average P/E of the fund is under 13 times next-twelve-months earnings (S&P 500: 24.3x). Investors concerned about the current market environment can be reassured that we have not changed our investment criteria. We believe valuation is crucial in investing and we focus on out-of-favour segments of global equity markets to identify investment opportunities with an attractive risk-reward profile. Our investment choices result in a unique portfolio that differs from stock market indices, allowing us to focus on performance without concern for short-term index comparisons. Historically, the fund has generated a high return on invested capital, and we are confident that this will continue in the future.

The fund experienced a very eventful first half of the year, marked by two acquisition offers (Tyman and Epsilon Net), two short reports (Fairfax Holdings and Eurofins), and Marlowe’s divestment of a significant part of its business. The top five positions are detailed below, including comments on current valuations.

Marlowe PLC

In our 2023 H1 letter, we mentioned that Marlowe operates two divisions: Governance, Risk & Compliance (GRC) and Testing, Inspection & Certification (TIC). In February, the company announced a divestment of GRC (excluding the Occupational Health business) for GBP 430 million. This divestment, which accounted for approximately 20% of the group's revenues and 40% of the group's adjusted EBITDA, represented 121% (!) of Marlowe's market capitalisation at the time of the announcement.

The divestment was driven by the company’s frustration with the low valuation it received in the public equity market. After years of aggressive growth through more than 80 acquisitions, with high restructuring and integration expenses that depressed cash earnings, investors became sceptical about the true earnings power of the business. The group's ongoing focus following the divestment will be on driving organic growth across its TIC and Occupational Health businesses while delivering margin expansion and strong cash generation. Having spent considerable time with management throughout this period, we believe Marlowe can double its earnings over the next four years through a combination of organic revenue growth, bolt-on acquisitions, and some margin improvement.

We previously described our optimism about the quality of Marlowe’s businesses: “Firstly, their revenue streams are non-discretionary and recurring, providing stability and predictability. Additionally, they are capital-light, minimising the need for heavy investments in physical assets. This, coupled with their durable competitive advantage, gives them an enviable position in the market. Furthermore, the company benefits from a long runway for growth, driven by structural trends in the industry.”

Post-divestment, we can now also add a solid balance sheet and short-term upside from capital allocation to the list of positives. Marlowe used the sale proceeds to fully retire its debt obligations and recently returned GBP 150 million to shareholders through a special dividend. In June, the company also announced a GBP 75 million share buy-back, approximately 18% of the current market capitalisation.

Without accounting for any margin improvement, the shares are valued at 15 times our estimate of this year’s after-tax earnings or an EV/EBITDA of 8 times. This valuation is very attractive for a business with the characteristics we described and the potential to double earnings in the next four years. The lower risk profile post-divestment and the attractive valuation motivated us to increase the fund’s investment to approximately 10%.

Tyman plc

Tyman is a UK-listed leading international supplier of engineered components for the door and window industry, generating approximately 75% of its profits in the US, where it holds a market-leading position.

In April, Quanex Building Product Corporation announced an agreement to acquire Tyman through a cash and share offer. The fund began investing in Tyman five years ago at an average cost of GBP 2.43 per share. We sold the shares a few days ago at GBP 3.63. We initially invested in Tyman after a significant share price decline due to operational issues following an aggressive expansion in the US (see our 2019 Q3 investor letter). We believed these operational problems were temporary and Tyman's strong market position, combined with the undersupply of housing since the Great Financial Crisis, offered an attractive long-term outlook. Despite management's successful resolution of operational issues, several factors continued to depress the valuation. These included a lack of growth initiatives, a sub-optimal business mix (high-quality US business combined with lower-quality international operations), and a UK listing for a company generating most of its revenue and profit in the US. More recently, higher interest rates negatively impacted market sentiment for the construction industry. Including dividends, we realised an IRR of 13.8% on our investment in Tyman, close to our target return of 15%.

Epsilon Net SA

Epsilon Net is a Greek software company, dominant in the local market for HR/payroll and accounting software. It also has a fast-growing enterprise resource planning (ERP) business. The fund began investing in Epsilon Net three years ago, establishing a position at an average cost of EUR 3.29 per share. This April, General Atlantic, a large global asset manager, offered EUR 12 for all shares listed on the exchange.

We believe the offer price is opportunistic and below our estimate of fair value. In a few days, we will know if the offeror has been successful in achieving the 90% threshold needed to squeeze out the remaining investors. The fund has not yet sold its shares and is holding out for a higher offer price.

Eurofins Scientific

Eurofins is a global leader in food, pharmaceutical, and environmental testing. Our 2022 H2 investor letter provides a detailed summary of our investment thesis.

In June, the US hedge fund Muddy Waters (MW) published a report claiming that Eurofins was – in their words – “optimised for malfeasance”. MW alleged weaknesses in the company's governance and internal controls, questionable related party transactions and oddities in its accounting. All of which they believe could indicate possible fraud. This is not the first time Eurofins has been targeted by short sellers who try to profit from a decline in the share price. Eurofins's strong founder/CEO influence and complex structure make it an attractive target for such actions.

However, the short report did not raise any significant elements that we had not already considered in our investment thesis. Crucially, MW did not provide any hard evidence of errors in Eurofins’ financial statements or any wrongdoing against minority shareholders. The short thesis is entirely based on ‘opinion journalism’. We raised our concerns directly with the company’s management and received detailed clarifications that many of MW's claims were blatantly wrong. Despite the poor quality of MW's analysis, the share price initially dropped more than 20% before recovering some of the losses after Eurofins published its responses. We remain convinced that Eurofins possesses very attractive characteristics that far outweigh the negatives. We took advantage of the lower share price to increase the fund’s investment.

Fairfax Financial Holdings

Fairfax is a global insurance company we discussed in our 2022 H2 Investor Letter. In February, the hedge fund Muddy Waters (which also targeted Eurofins), published a short report accusing Fairfax of using aggressive accounting practices to inflate its book value and earnings power. However, the markets swiftly concluded that the report lacked substance. As a result, the share price quickly recovered and ended 27% higher in the first six months of 2024.

Higher underwriting profits and investment results, bolstered by increased interest rates, all contributed to a rise in the share price. Currently, the shares are trading at 1.23 times book value and 9.2 times earnings, based on the company’s sustainable EPS estimates of USD125 for the next four years. This estimation does not take into account potential gains on equity positions and bonds, which are expected to be significant over the long term.

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Update on the five largest positions of the fund:

Marlowe PLC (8.07%)

As of June 30th, Marlowe accounted for 8.07% of the fund’s Net Assets. This weighting was affected by the payment of a large special dividend. In July, part of the proceeds from this special dividend was re-invested, increasing Marlowe's position in the fund to 10%.

Eurofins Scientific SE (6.83% [2])

Eurofins is a global leader in food, pharmaceutical and environmental testing. Over the past 12 years, Eurofins has grown aggressively from 100 to 1000 testing labs.  Significant investments have been made in IT and the implementation of a hub-and-spoke model to optimise the efficiency of labs.  These investments, combined with the end of COVID testing, have also depressed earnings.  Adopting a long-term perspective, we anticipate that these strategic investments will not only strengthen the company’s competitive edge but also yield improvements in profit margins. The company’s 2027 targets reflect the positive impact of the strategic initiatives. Based on these targets, which we believe are realistic, the shares are currently valued at a 12% free cash flow yield. This valuation is attractive for a very resilient business with the ability to re-invest capital at a high rate of return into organic growth initiatives and acquisitions. The share price declined 21% during the first half of 2024, partly due to a short report by Muddy Waters, and the fund took advantage of the price weakness to increase its investment.

Epsilon Net SA (6.34%)

See above.

Fairfax Financial Holdings (5.96%)

See above.

Kaspi.kz (5.36%)

Kaspi is the market leader in Kazakhstan for consumer finance, online shopping and payments. In January 2024, the company moved its main listing from London to New York, further improving its access to investors and capital. In addition to excellent operating performance, the share price propelled 40% higher in the first half of 2024. Despite trimming our position, Kaspi still remains a top-five holding. The company continues on its stellar growth trajectory and forecasts a 25% increase in EPS compared to last year, implying a current valuation of 11.8 times this year's profit.

Our next letter will be out in January 2025.  Wishing you all a safe and healthy continuation.