Plural Investing Q2 2024 Quarterly Letter

To our Partners:

Plural Partners Fund L.P. delivered a gross return of -1.0% and net return of -1.3% in Q2. Our goal is to deliver returns over a five-year period significantly above that of global markets.

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We are value investors. We invest in businesses that we believe are worth substantially more than the price they are trading at. We think of risk primarily as the chance of a loss over a five year horizon and not the temporary drawdowns in stock prices that occur from time to time. We manage this risk by only investing in businesses trading at a substantial discount to a conservatively calculated intrinsic value and that we would be happy to own if the market shut for five years. We welcome stock price volatility as it often presents opportunities to invest further at even better prices. When such opportunities cannot be found we hold cash instead.

The majority of our capital is typically allocated to our six to eight best investments. We look for qualities such as attractive business economics and management teams who possess and foster a culture of high integrity, customer focus, and prudent capital allocation. Our businesses may be ‘hidden gems’ because they are small, receive little coverage, listed on under-researched exchanges, operating in unpopular industries, or offer terrific opportunities beyond short term concerns. We develop a research edge over other investors by doing extensive primary research and utilizing quantitative tools. This edge can be significant when we are competing mostly against retail investors or the small positions of larger institutions, which is why we deliberately fish in those waters.

A one-page appendix entitled “Principles of Our Partnership” is attached to this letter. This should give you an idea of what you can and cannot expect from our partnership.

We estimate that our businesses trade for 7.7x their FCF in three years’ time and will still be growing at double digit rates then. These businesses generally have strong balance sheets with little or no debt, earn an average post-tax return on tangible capital of 19%, and are run by well-aligned management teams with an average insider ownership of 13%.

Small cap, value, and international markets continue to underperform large cap US growth indices, but there were some signs after the quarter that this long period of underperformance may be reversing, including in the UK where we have several investments. Regardless of whether the environment becomes more favorable we are increasingly finding reasonable businesses trading at a single digit or low double digit multiple of FCF.

Below, we profile Watches of Switzerland (OTCPK:WOSGF) and Endor (OTC:ENDRF). Watches of Switzerland is a new investment that trades at 10x this year’s FCF despite a strong balance sheet, competent and aligned management, and a long runway to deploy capital at 20% returns. Endor is an investment we exited.

Portfolio Allocation

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Watches of Switzerland (WOSG.LN)

We published a 35-page writeup on Watches of Switzerland in July, which you can view here.

Watches of Switzerland is a retailer and partner to Rolex and other luxury watch brands. It trades on 10x this year’s FCF despite double digit growth and we think can return 32% p.a. for three years for a 130% total return.

We believe most of the company’s value lies in its relationship with Rolex, which only sells through authorized retailers like WOSG who act as gatekeepers to the Rolex universe. That relationship gives WOSG far superior economics to a typical retailer, and makes it closer to a subsidiary of Rolex. Almost every Rolex is sold off a customer waitlist and prices only go up over time, while stores strictly adhere to Rolex’s recommended retail prices. That means no price competition and no inventory risk. There is no online competition either, as that would prevent customers from being vetted and having the ‘Rolex experience’ in a store. Many sources told us that being selected as a Rolex retailer is like being given a license to print money.

WOSG’s management are competent, experienced, and well incentivized, with CEO Brian Duffy owning £32mm of stock. Duffy joined in 2014 and his strategy of investing in stores to elevate customer experiences has successfully grown WOSG’s share of Rolex sales in the UK from around 35% to 50%. This encouraged Rolex to entrust WOSG with replicating its strategy in the US, where WOSG is now the number one player with 10% share and has grown at 30% p.a. for the last five years.

The stock has fallen 75% since 2022 after Rolex acquired another retailer and the luxury watch bubble burst. Investors are concerned that WOSG’s relationship with Rolex is in danger, but our work suggests it is more likely getting stronger. The company’s scale is an advantage that allows it to invest significantly more in flagship stores than competitors can, particularly in a US market that is dominated by mom & pops. As Rolex continues to shrink its store base, we expect WOSG will continue to gain share as weaker competitors shutter.

WOSG is likely to grow at 10-15% p.a. for years given the large opportunity for growth in the US. It trades for just 10x our estimate of this year’s FCF despite its qualities and historically traded for 20x. We expect the stock will re-rate as short term concerns ease and the company continues to deploy capital at 20% returns.

Endor AG (E2N.MUN)

Endor makes racing wheels, pedals, and other hardware for gamers playing motorsport games like Gran Turismo. The company was run by industry pioneer Thomas Jackermeier and has the leading market share, brand and technology in the premium segment of the market. Despite these advantages, we sold out of our position throughout the first half of the year after realizing that we had misjudged management’s competence and character. While we always haircut our expectations to reflect the risk of management misexecution and understood that meant there was a small chance of substantial downside, the company’s position at the forefront of a rapidly growing industry meant we saw a very bright future, multi-bagger upside, and on balance a favorable risk/reward. Yet as management continued to misexecute we believed the risk of our downside scenario had increased greatly and so the investment was no longer attractive. We therefore sold our position.

When we discussed our position in last year’s Q2 letter, Endor was suffering from a global chip shortage. Management had exacerbated this problem by substantially overordering new chips in response. This caused a cash outflow just as it ran out of products in stock and therefore cash inflows. Funding the resulting shortfall required the company to tap into credit facilities that were intended to finance temporary seasonal cash fluctuations.

This and other mistakes had caused the stock to decline heavily, but we believed that Endor was now trading at a distressed price for a premium brand in an attractive industry that would be worth a multiple if conditions normalized. Our analysis of the company’s cash flow suggested there was limited room for further mistakes, and so we were pleased to see normalization appearing to begin in Q4 as we expected. Endor had recruited a new COO and CFO, inventory was coming back in stock, and a series of major product launches that had been delayed were debuting in time for Black Friday and Christmas. Management announced at the end of November that Black Friday sales were up 240% y/y, full year profit guidance would be met, and investors should expect significant growth in 2024 with new products and the first ever listings on Amazon (AMZN).

That recovery did not continue. We were surprised when just a few weeks after announcing strong Black Friday results that management reversed course by stating Endor had actually made a substantial loss. This was partly due to further mistakes: major shipping issues meant many customers were not receiving their orders, and incredibly the company had sold a product it had not yet received a license for. Our work suggested that meant the company had seen a further cash outflow during what should have been the most profitable period of the year. Given Endor’s already overdue credit, we judged that our downside scenario was playing out. When our follow-up conversations with management and other sources left us dissatisfied, we concluded that the risks had increased significantly and the company was no longer an attractive investment. We therefore sold out of our position.

The dial-in details for our quarterly call are attached on the next page.

Please do not hesitate to contact us at [email protected].

Best Regards,

Chris Waller, Portfolio Manager