Investor letter for Kapitalforeningen Blue Strait Capital Year 2021
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Investor letter for Kapitalforeningen Blue Strait Capital
Year 2021
Dear Fellow Investor.
The net asset value per unit increased by 13.99% after fees in 2021. The MSCI World Index
which represents a wide segment of companies across the world, had a return of 30.96%.
The compounded average annual rate of return for Blue Strait since its inception in October
2017 is 10.21% against the MSCI World Index at 14.53%, while the accumulated return for
the entire period is 50.96% for Blue Strait and 77.74% for the MSCI World Index.
The objective is to deliver a satisfactory actual return after fees over the long term while also
generating a return above that of the MSCI World Index. At my meetings with you in con-
nection with the establishment of Blue Strait, I described “long-term” as being between 5
and 10 years. We are now about halfway through this period, and the fund's return is below
that of the MSCI World Index, which may seem insufficient.
Though it may appear as somewhat unsatisfactory at this time, the whole “book” is not yet
written. Blue Strait has a very concentrated portfolio of companies, which is why large pos-
itive and negative fluctuations in individual years affect the entire portfolio return – also
relative to the MSCI World Index. A too short period is not necessarily indicative of the un-
derlying intrinsic value development of the individual companies. In the long term, the com-
panies’ price developments will follow their intrinsic business value developments.
We have some catching up to do, which I am determined to pursue. It is a matter of keeping
focus while recalling the words of Warren Buffet:
”Games are won by players who focus on the playing field –
not by those whose eyes are glued to the scoreboard.”
Blue Strait is not marketed and therefore only attains the interest of new investors by word
of mouth. Again in 2021, I have welcomed new investors and would like to thank all of you
for the confidence you show in me. Together, my wife and I are the largest investor in Blue
Strait and we have increased our investment during 2021.
Blue Strait still has seven companies in the portfolio, but Zooplus has been divested and a
new investment made in Trupanion Inc. The risk of such a concentration is higher, which is
a deliberate choice as mentioned in previous investor letters. The two largest positions at the
end of 2021, JD.com and Danske Bank, made up a total of 49.9%, while the smallest position,
1Heico, made up 3.6%. In the face of rapidly increasing equity markets in 2021, the share
price of JD.com declined, which reduced its percentage share of the portfolio from 37.5% to
28.2% at the end of the year though we added slightly to the position. Fannie Mae’s position
size declined from 18,1% to 7.1%. I will go into more detail about JD.com and Fannie Mae
later. Danske Bank’s share of the portfolio increased from 9,2% to 21.7%. While a modest
increase in the share price in 2021 is responsible for a minor part of this substantial increase
in the sposition size, I also added considerably to the position in the autumn, as listed below.
JD.com 28.2%
Danske Bank 21.7%
Ringkjoebing Landbobank 11.9%
Admiral Group 11.7%
Trupanion 9.7%
Fannie Mae, pref. 7.1%
Heico 3.6%
Liquidity and other 6.1%
Total 100.0%
As a long-term investor of non-geared assets I do not consider large price fluctuations to
express a material risk. The time between my initial investment and the day of selling the
position can be full of ups and downs. Price fluctuations are not important. What is im-
portant is for us to arrive at the time of selling with a satisfactory average annual return.
Rather, the risks relate to three issues:
1. Whether I correctly analyse a company’s return on invested capital, free cash flows
and long-term competitive advantage and its ability to expand it;
2. Whether I pay too much for the individual company; and
3. Whether I misjudge the time it takes for ordinary companies to eliminate the differ-
ence between market value and intrinsic business value.
As these three parameters can only be measured over a number of years, this type of invest-
ment is not suitable for short-term investors. By way of example, Fannie Mae decreased by
64% and Zooplus increased by 183%.
The movements in the market values of Fannie Mae, pref., JD.com and Zooplus had the
greatest impact on the year’s overall return.
Fannie Mae was by far the position that detracted the most from Blue Strait’s return, with a
negative return of -8.8 percentage points. Following steep share price increases in the 2019
2financial year, this position had grown to 23.2%, after which the position then eroded during
2020 and even more in 2021.
This is what I wrote about the company in 2019:
Fannie Mae is the largest mortgage lender in the US and currently has the highest profit
per employee. Like other financial companies, this company faced critical challenges at the
onset of the financial crisis in 2008. A number of financial companies were placed under
conservatorship during the financial crisis to stabilise their finances and relaunch them as
well-consolidated undertakings. The AIG insurance company was one of them, and Fannie
Mae was also placed under conservatorship. Under the scheme, Fannie Mae was granted
an overdraft facility with the US Department of the Treasury against annual instalments
of 10% until the loan was repaid.
When Fannie Mae had written off all bad debts in the summer of 2012 and faced years of
high profitability, President Obama’s then administration changed the law to enable the
government to appropriate the company’s entire annual profits in the future rather than
10% a year. 11,000 documents on this subject remain classified and under seal. A number
of plaintiffs have succeeded in bringing a few documents to light, exposing that the Obama
administration was aware that Fannie Mae would be profitable once again and directly
stating that the legislative change would enable the government to take shareholders’
profit in the future. In God’s own country and the cradle of capitalism, this amounted to
highway robbery. Government expropriation of private property without compensation!
The shareholders’ litigations are currently working their way through the court system
and reaching their conclusion. Fannie Mae continues to be trapped in conservatorship, but
the current administration under President Trump is working to change the situation. In
March 2019, Trump issued a formal memo about ending the conservatorship of Fannie
Mae which was officially articulated and planned throughout the year. A number of court
orders have found in favour of the plaintiffs, which is positive. And there are formal and
clear indications that the Trump administration is working to release Fannie Mae from its
conservatorship. Both the price increase and positioning have brought the share of this
position up to 23.2%. I want to make it perfectly clear, though, that these matters and the
final realisation of the administration’s plans will be crucial to the final success of this in-
vestment!
Fast forward:
1. Due to the pandemic, the Trump administration did not see the plans through before
stepping down in January 2021, and
2. In a majority ruling in June, the US Supreme Court decided against the shareholders
in one of the litigations that had just reached the Supreme Court.
3As mentioned, time ran out for the Trump administration, but it did manage to implement
a few changes that are still in effect, including that the Treasury no longer appropriates the
profits from Fannie Mae. Rather, the profit is added to the equity as retained earnings. While
this is positive, the Treasury’s senior preferred capital is concurrently being revalued, which
is negative. If it were not for the revaluation of the Treasury’s senior preferred capital, we
owners of preference shares would have received our annual dividend. This dividend corre-
sponds to 54% of the current share price!
Without going into too much legal detail, the Supreme Court in part ruled against the plain-
tiffs in the Collins case which was brought by a number of shareholders. On the other hand,
the Supreme Court stated that the potential argument that the government had taken money
from shareholders could be tried in the lower Fifth District Court where the Collins case now
continues.
Our ”work-out” investment follows two tracks:
• The future actions of the Biden administration in terms of recapitalisation and pri-
vatisation.
• The outcomes of the individual cases that are slowly working their way through the
legal system.
In a historical perspective, US politicians have mainly exercised responsibility and pragma-
tism whenever this would benefit the country’s economy. The Biden administration has not
returned to the previous practice of sweeping Fannie Mae’s profit to the government. At the
same time, we await a plan for the minimum solvency requirement imposed on Fannie Mae,
which will probably be lower than at present due to the very low risk inherent in Fannie
Mae’s current business model. Finally, a recapitalisation and privatisation could generate a
large revenue for the government from options sold by the government during this process.
It remains a “Work-out” situation with a high risk, but also a very substantial potential. Suc-
cessful outcomes of the coming judgments in the legal system could accelerate the process.
The other company whose shares deviated significantly in 2021 was JD.com with a decline
of 14%, measured in DKK. Due to the large position, this detracted -5.7 percentage points
from Blue Strait’s return. As JD.com continues its steep growth in customers, turnover and
cash flow, the negative price impact could solely be attributed to political events and macro-
economic expectations.
The current Chinese regime exhibits an increased political tendency towards controlling and
regulatory interventions in the private sector than previous political regimes, which received
quite a bit of press mention last summer when the private education sector was impacted,
resulting in significant share price declines. The technology sector has also felt the winds of
change. The equity markets loathe uncertainty, and the prices of technology shares, includ-
ing JD.com, have consequently tumbled.
4This, combined with trade disagreements between China and the rest of the world, property
developers on the brink of collapse and lower growth, which is to be expected as a result of
the many regulatory interventions in the private sector, has left many of these companies
with very low price tags. The pricing of a number of technology companies in China, includ-
ing JD.com, currently seems to incorporate many potential negative events.
As mentioned above, JD.com continues its growth in intrinsic business value. So in spite of
the decreased market value, I estimate that JD.com’s intrinsic business value increased in
2021 and that the difference between the two has expanded.
I sold our position in Zooplus in 2021. However, as a “buy and hold” investor, it was a posi-
tion that I expected to maintain in the portfolio for many years to come. A very capital-light
business model with a large probability of a high return on invested capital as they scale up
the business in the long term.
Zooplus is Europe’s largest online pet food retailer, typically dog and cat food and other pet
accessories, with a market share of almost 50% of the online market and approximately 7%
of the total market. The total food and accessories market for pets is worth about EUR 25
billion and grows relatively independently from the economic cycles, at 3-4% a year. Zooplus
has an operating margin of 6-7% on existing customers. A profitability that Zooplus uses to
fund new customer acquisition in the form of marketing costs that attract new customers to
the platform. Zooplus prospered in particular from the onset of the pandemic in early 2020.
Turnover has grown at an annual rate of 19% over the past five years, and Zooplus has the
largest customer base of dedicated pet owners in Europe.
A company that has a dominant online platform such as Zooplus must reinvest all profita-
bility in the company. The underlying return on invested capital is high, the total accessible
market is large and investing in growing the company to increase its market share will con-
sequently also increase its competitiveness. Ultimately, this may result in an even higher
return on invested capital, which is the driving force for a company’s intrinsic business value.
On 13 August, a company under the private equity firm Hellman & Friedman (H&F)
launched a takeover bid for Zooplus based on obtaining an ownership share of at least 50%.
I had been in contact with H&F and made an agreement on selling half our position. I had
some considerations as I believed the price to be very low. In return, our agreement, together
with those of other shareholders, could “entice” H&F to actually present a takeover bid. After
the public announcement of the takeover bid, other buyers could enter the field with higher
purchase bids which we could participate in with the entire position. I also pondered the
management's actions throughout the process which convinced me that I wanted to sell, af-
ter careful consideration.
At the same time, the management made a business agreement with H&F about the com-
pany’s strategic and financial future. The CEO and founder would stay on as managing di-
rector in an agreed process in which the management as a co-owner, though selling their
shares, would presumably be incentivised with new options.
5I do not believe that the management and the board of directors adequately catered to share-
holder interests by means of this procedure.
However, the private equity firms EQT and KKR quickly moved in, with KKR rapidly pulling
out again. EQT presented a higher bid, which H&F followed up. Finally, H&F and EQT to-
gether made an agreement with a marginally higher purchase bid. After H&F and EQT
joined forces, I could no longer expect takeover bids from other stakeholders. H&F and EQT
would now be able to gather a very large share and subsequently seek to take the company
private.
I started investing in Zooplus in February 2018 and have regularly reinvested at lower prices
until May 2019. Selling the entire position last autumn resulted in an accumulated return of
217% over the holding period and a compounded average annual rate of return of 54% in the
period. The contribution to Blue Strait’s return in the 2021 financial year proper was 22.6%.
Though we sold at a total value which, on the face of it, was at the low end of my intrinsic
business value estimate, the return on this investment in the short term is highly satisfac-
tory. It is also an excellent example of value-based investing where the intrinsic business
value is much higher than the original market value.
Being a value investor is investing in a company at a price below the intrinsic business value.
Quality companies with a high return on invested capital are rarely traded at a conspicuously
low price in relation to equity and earnings. This means that even an objectively high value
can be a low value relative to the intrinsic business value.
Exploiting the compounding of interest which materialises when a company with a high re-
turn on invested capital is able to scale the business and thereby reinvest is enhanced over
the long term. This is the reason for “buy and hold,” which is why this type of company in
the portfolio is welcome, though my anchoring in the old value investing mindset continues
to nurture investment ideas in ordinary companies.
Dividends
Under current tax law, realised capital gains and dividends received in Blue Strait in the
preceding financial year, less costs and realised capital losses, must be distributed as divi-
dends on the day after Blue Strait’s general meeting. When a portfolio is concentrated, the
realised capital gains may be comparatively large. For private individuals with free assets,
there may be a time lag in tax payments that pension or company investors do not experi-
ence. In this context, I recommend that private investors consult their accountants.
As at the end of 2021, there are unrealised capital gains of DKK 102.9 million or DKK 34.2
per unit. The expected dividend for the 2021 financial year, based on realised capital gains,
is currently calculated at DKK 18.9 per unit.
6Objective
My objective is to maximise the investor’s long-term average annual net asset value per unit
and to outperform the MSCI World Index while minimising the risk of permanent loss of
capital. I pursue this objective by primarily investing in quality companies, but also in ordi-
nary companies when these companies are estimated to be significantly undervalued. I am
not concerned about the quarterly or annual price fluctuations but will rather focus on the
actions taken presently that will maximise the long-term value. If I succeed in implementing
this strategy, remain disciplined and focus on the long haul, it is highly probable that I will
achieve our objective.
Again, thank you very much for trusting me with your investments in Blue Strait. I will do
my best to live up to this confidence, both in terms of your investments as well as mine, and
I will live by the words of Colin Powell:
“There are no secrets to success. It is the result of preparation, hard
work and learning from failure.”
The art is to learn from your mistakes, maintain your passion and continuously attempt to
get better at what you do.
Best regards
Ole Nielsen
January 2022
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