top of page

Our Letters

The Year so Far

Dear Investor,

 

The year so far

The year is off to a strong start for Somar. We are encouraged by our performance both on the long and short sides. After years of macro-driven capital markets, we have found 2024 to be more discriminatory in company performance. This dispersion of returns bodes well for active management going forward.

The last few weeks have been busy with multiple earnings releases. We have seen an unusual, but welcome, symmetry in outcomes. Companies doing well both on reported earnings and strategic investments are being rewarded, while companies falling behind on either earnings or strategic investments are being punished. This has benefitted fundamental investors. At Somar we have benefited both from our long and short investments and are having a strong February so far.

It is also confirmation of the emergence of the age of Artificial Intelligence (AI). Most large companies are investing billions of USD in building both the infrastructure and capabilities to take advantage of this emerging technology. It is still unclear how consequential it will be. Most pessimists equate it to a nice add-on feature with some micro-impact on a few industries, while optimists expect strong macro-economic impact with acceleration of productivity and economic growth for the next couple of decades. At Somar we will be driven by the data we see in real time and currently are somewhere in the middle of those two positions. There are industries where the impact is already large and expanding: cloud infrastructure, semi-conductors, software coding productivity. While others are still in testing mode: customer service, media production, education among others.

Discontinuous change is good for active investors that can anticipate opportunities early and position their portfolios to take advantage of them. We have already benefitted from this in both our long and short investments. We expect much more in the future.

In the next few months, we will write to you about recent investments we harvested to illustrate the opportunities we see.

Somar team

I would like to take this opportunity to thank the Somar team for the wonderful work they do on behalf of the Somar investors. We have a deep bench of talent, and I don’t anticipate adding to our team even if we were to double our current assets.

The investment team is composed of João Delgado, Carlos Silva, and Tiago Rodrigues. One is focused exclusively on shorts. The other two are tasked with deeply researching new clusters adjacent to our historical focus area where we believe there are attractive opportunities. Both these efforts have produced quality ideas that have already produced attractive returns. However, we believe most of the return is still ahead.

Will Bruce and Dhwani Vahia lead our operations and we have no hiccups, problems, or surprises. Issues are quickly flagged and addressed, and our external interlocutors frequently praise the professionalism of our operations team.

Dhwani also leads our client service area, and I will let you tell me where we can improve. So far, I haven’t yet received any complaints. That said, suggestions are always welcome as we want to continue to grow and improve over time.

* * *

 

The team always enjoys hearing from you and updating you on our progress. Don’t hesitate to contact us to learn more about our approach.

 

Sincerely,

Pedro Ramos

Short Illustration: EBIX

Dear Investor,

 

Short Illustration: EBIX

The policy of low interest rates has spawned several poor capital allocation decisions. It has also enabled many fraudulent ventures to emerge. Steadily, these frauds are being uncovered. Debt maturity often provides a good catalyst for separating real cash generating ventures from narrative and obfuscation-driven frauds. Somar diligently looks for this. EBIX represents an instructive recent illustration.

Around the 2010s, EBIX was a highly profitable, mature software and services provider to the insurance industry. Led by CEO Robin Raina, it then embarked on a debt-financed acquisition expansion that boosted its revenue fivefold from about $200mn in 2012 to about $1,000mn in 2022. This expansion, however, added mostly a highly competitive unrelated business (prepaid gift cards), involved fraudulent clients and financial statements, yielded its CEO some nice compensation and led to the company’s bankruptcy 18 months later. Somar identified multiple early signs of EBIX’s demise: management character (or lack thereof), financial statement fraud, lies about customers, strategic mismatches, and upcoming debt maturities.

The character of CEO Robin Raina was the first thing that caught our attention. In 1998, after Raina was promoted to VP of Sales, EBIX overstated its revenues by 18%, later leading to a regulatory investigation and to the sanction of the auditor who allowed such manipulation. In the 2010s, as CEO of a mature business, Raina decided to embark on a debt-fueled M&A expansion into the low margin, highly competitive business of prepaid gift cards. This delivered growth, hid the ex-growth nature of the base business, and allowed the company to temporarily maintain a higher multiple. It also, however, steadily destroyed shareholder value. To underline its disregard for shareholders, in 2023, months before EBIX declared bankruptcy, Raina took an annual bonus equal to 3% of EBIX market capitalization.

A close analysis of EBIX’s financial controls also raised red flags. Between 2004 and 2022, EBIX was audited by 7 different firms. In 2021, one month before the 10-K filing, RSM resigned due to “unusual transactions related to EBIX’s gift card business in India”. After asking several times for additional audit evidence regarding suspect transactions, RSM didn’t receive them. EBIX replaced it with KG Somani, an Indian auditing firm with no experience auditing US-listed corporations.

EBIX also misrepresented its customer relationships. For example, it reported partnerships with Reliance Industries and Apollo Tires. When questioned, these two companies denied even knowing EBIX. Additionally, EBIX’s India regulatory filings reveal that two other enterprises alone accounted for more than 20% of its prepaid gift card revenue. One of these only reported $151 thousand total revenues and its corporate headquarters stood in an empty flat on a rundown building. The other, a purported e-commerce company, had a malfunctioning website, no employees on LinkedIn and no activity at all on social media. EBIX also reported more than 650k retail outlets in India, with more than 900 distributors in the country. However, an investigation contacted all distributors, and only 7% reported selling EBIX’s prepaid gift cards. Additionally, Google Maps’ Street view did not match the EBIX reported photos of these customers.

Even taking the financials and customer relationships at face value, it was clear the acquisitions were value destructive. Its gross margin declined from 80.9% in 2012 to 31.3% in 2022, and its operating margin declined from 38.6% in 2012 to 11.5% in 2022. Its ROCE declined from 18% in 2013 to 10.1% in 2022. It appears that to mask the maturity of a great business, EBIX management decided to acquire its way into an unrelated and inferior new core business. No longer a vertical software company, EBIX was now a commodity prepaid gift card provider. By 2022 this new segment represented 76% of total revenue. Clearly a financial engineering project rather than a sensible strategic long-term move.

All this value destruction piled up in the balance sheet in the form of debt. It reached $650mn maturing in February 2023, while EBIX had access to only $90mn of cash. With tightening credit conditions, the refinancing would either be extremely expensive or not possible at all. Equity issuance and sharp shareholder dilution was the only other option. EBIX’s chosen solution was to IPO its EBIX Cash business in India. However, this had been announced in August of 2019, and it was repeatedly delayed for unclear regulatory issues. In March of 2022 it was reported that the IPO was imminent. It never happened. EBIX defaulted in February 2023, but got successive extensions from its debtors until December 2023, when it finally filed for bankruptcy.

* * *

 

The team always enjoys hearing from you and updating you on our progress. We are finding excellent opportunities both on the long and short sides. Don’t hesitate to contact us to learn more about our approach.

Sincerely,

Pedro Ramos

Uncertainty and Scenario Planning

Dear Investor,

Uncertainty and Scenario Planning

The recent past has brought very large challenges: Covid pandemic, flare-up of inflation, sharp rise in interest rates, two large on-going wars, real estate / financial crisis in China, and simmering tensions in the South China Sea. Each of these has different implications for different industries and different geographies. Most of these came suddenly and mostly unexpectedly. How to position a portfolio of assets to not only survive but also thrive in this environment?

First, at the underwriting of any long or short investment we analyze its outcome under multiple scenarios. This ensures that we are aware of any scenario that could materially impair our returns and think through its probability and how we would manage if that risk were to manifest itself. Very rarely do we move forward with an investment where a low-probability scenario would lead to a very large impairment. Any potential impairment, even if small, is always weighed against the probability and magnitude of upside at the time of underwriting.

Second, after the investment is made, we constantly monitor the incoming data to reassess the probabilities of the scenarios contemplated and identify early signs that an adverse shock may be occurring. We proactively do additional field work / primary research to confirm the incoming adverse data.

Third, position sizing considers potential risks across positions. For example, if we found extremely attractive investments in different industries in Southeast Asia, we would be cognizant of their aggregate exposure to the region and cap it to limit the fund’s exposure to a regional geopolitical or macro-economic shock.

Fourth, we take advantage of both the liquidity of the markets and the large body of research on multiple industries and geographies we have done over the past seven years to quickly adjust our portfolio to any large, unexpected shock that occurs. Liquidity is an advantage that not only helps protect the downside but also enables us to position the portfolio to thrive in the new environment. Covid in 2020 was a good example of this.

Fifth, as a team we discuss weekly what we are hearing and learning from incoming data and challenge each other to think through the impact of potential future shocks on each of our positions. We push each other to consider the unthinkable and how we would thrive in that scenario. This increases the team preparedness for discontinuities in the macro and geopolitical scenario.

For each discontinuity we think of the range of outcomes and how they would impact each of our positions. For example, on the ongoing war in Gaza / Israel we consider the probability and impact from the most benevolent outcome to the most destructive. Although we assign low probabilities to each, they help us think through the evolution of risks and their impact as we move from one end of the continuum to the other. Based on this, we have a game plan of the ideal portfolio to protect and grow our investor’s capital.

This is a time where our work allows us to make a big difference. As opposed to an environment where all assets go up powered by low and declining interest rates, the years ahead should be volatile and impact industries and geographies differently. We are ready to use all our work to make sure your dollars are always allocated to the most attractive opportunities we can find.

* * *

 

We hope you and your families are healthy and safe. Don’t hesitate to contact us to learn more about our approach and thoughts during these more volatile times. We look forward to continuing to hear from you in the weeks and months ahead.

 

Sincerely,

Pedro Ramos

Short Case Study: Enviva

Dear Investor,

Short Case Study: Enviva

Enviva is a case of a wolf in sheep’s clothing. The company attracted investors by covering itself in ESG credentials. Our due diligence uncovered lies, environmentally damaging practices, an unprofitable business model, excessive financial leverage, and an unsustainable dividend. Our short yielded a higher than 50% ROI on the position.

Founded in 2004, Enviva (EVA) is one of the world’s largest producers of wood pellets, an important raw material to produce biomass and electricity from the burning of biomass. It has 10 operating plants in the US and exports to the UK, EU, and Japan.

Starting in 2020, the company took advantage of investors’ enthusiasm for ESG-friendly investments to label itself as an environmentally-friendly company. The company stressed that biomass-burning was a renewable source of energy. This led to a more than 60% growth of its share price.

This claim amounts to “greenwashing” as biomass burning is a step backwards for the global environment for three reasons: 1) the burning of biomass leads to high emissions of CO2; 2) Biomass burning is the most inefficient and dirty source of energy with higher emissions per unit of energy generated than other sources, including coal; 3) while in the long-run biomass is renewable, the aggressive logging of forests to produce biomass leads to deforestation a more serious problem for global warming and eco-system stability.

To prevent deforestation, regulators limit logging to 45% of a given area. Enviva claimed to follow this rule. However, based on GPS coordinates of their activities (according to their own websites) as well as comparative photographs from Google Earth and Google Maps, we estimated that Enviva was logging at clear-cut rates of between 65% to 90%, more than double of what Enviva reported their clear-cut rate to be (30%). This was confirmed by interviews with some former Enviva employees, which added that higher clear-cut rates lowered unit production costs. Unsurprisingly, Enviva lost its Chief Sustainability Officer, Dr. Jennifer Jenkins (a Nobel prize recipient) in 2021 and never replaced her. The company also lost its director of sustainability and climate initiatives after just 18 months on the job.

Additionally, Enviva has an unprofitable and cash-burning business model. In the last decade, Enviva turned a cumulative $6.2bn in revenue over a decade into just $218m of cashflow from operations and burned more than $1.1bn in free cashflow. Our forensic accounting analysis revealed some accounting shenanigans hid an additional half a billion dollars of cash burn during the period.

To further entice investors, Enviva offered a generous dividend. Given the absence of cash generation, the dividend was funded through debt, taking advantage of the low interest rates and lax debt underwriting standards during the period. Unsurprisingly, the leverage ratio (net debt / Adj. EBITDA) soared from 2.7x in 2015 to 10.5x in 2022. Correcting the accounting shenanigans, Somar estimates the leverage ratio was actually 22.6x in 2022, a clear case of financial distress. The sudden rise in interest rates put additional pressure on the company.

 

All of this came to roost during 2023. One month after its investor day when Enviva presented a cost-cutting and productivity improvement project, the company badly missed its earnings with a negative operating margin of more than 19%. More importantly, the company admitted it wouldn’t be able to meet its costcutting targets, cut guidance and suspended its dividend. The stock fell more than 50% and we covered our position.

Over the following months, the stock gradually retraced some of its losses, re-opening the opportunity for Somar to short again. During Q3 2023 the CFO was replaced. When the company reported its Q3 earnings the guidance was pulled, the company announced the CEOs resignation and that it was breaching its debt covenants. Our second short trade also yielded well over 50% of profit on our position.

 

In the age of index investing and thematic exposure, the opportunity for people with less scruples to tap into investors following the theme of the day (SPAC, ESG, Crypto, …) is high. These “entrepreneurs” cash in before the economic reality catches up with the story sold to investors. In addition, a lot of investors are getting exposure through ETFs and most of these perform very limited diligence on their portfolio components. This opens opportunities for investors that do in-depth due diligence to find great short opportunities like Enviva. Somar will continue working on it and will report back to you on additional cases in future letters.

 

* * *

We hope you and your families are healthy and safe. We wish you a happy Thanksgiving and Holiday period. Don’t hesitate to contact us to learn more about our approach and thoughts during these more volatile times. We look forward to continuing to hear from you in the weeks and months ahead.

Sincerely,

Pedro Ramos

A year of several cross-winds

Dear Investor,

2024: A year of several cross-winds

Since 2020, financial markets have been mainly driven by large macro-economic and geopolitical events: Covid in 2020, re-opening in 2021, inflation and interest rate hikes in 2022 and end of interest-rate hikes coupled with accelerated investment in AI infrastructure in 2023.

We can never preclude a major geo-political event being the major driver of financial markets during 2024. But assuming no major news on this front, several intriguing trends and imbalances pervade each industry that should color investment opportunities in the new year.

It takes no foresight to believe that high investment to train new AI models will continue during 2024. However, we will see the beginning of the second wave in the sector: the development of customized applications with significant value for either businesses or consumers. It is likely a new generation-defining company will come out of this emerging sector. Including, hopefully, one or two attractive opportunities for Somar.

On media we are already witnessing a new focus on cash generation rather than investment in stand-alone streaming ventures and large libraries of new content. This will lead to lower content spend, consolidation, stronger cash-flow generation, and margin accretion.

Social media should continue to outperform, especially the larger companies that have been better able to use AI to measure conversion in a post Apple privacy (ATT) initiative. They continue to show discipline in cost control and better capital allocation priorities.

Assuming no major consumer recession, consumer businesses should perform well with a return to channel shift from brick-and-mortar to online commerce. After explosive growth during the pandemic, online consumer retailers over-invested and faced new competition from a slew of richly venture-funded start-ups. New competitors have either closed or sold, costs have been cut over the last few quarters and the consumer spending that migrated to experiences and brick-and-mortar is showing signs of returning. We expect in 2024 these businesses will return to their more attractive pre-pandemic growth rates while delivering operating leverage and cash-flow generation. The best management teams here have a great opportunity to deliver high shareholder returns in 2024.

A similar trend of return to pre-pandemic growth with operating leverage should also be observed in the software and cloud-computing sectors. After being impacted by declining demand driven by cost-cutting / headcount reduction in its customers and lower startup job creation, the last couple of quarters have shown early green shoots of stabilization of demand.

The reduction in mortgage rates and strong investments spurred by both the CHIPs Act and the Inflation Reduction Act will lead to acceleration of construction activity and higher demand for related industrial suppliers. It could also put pressure on commodity prices, but these will ultimately be driven by Chinese demand which has been soft over the past year. That said, low inventories, brittle supply chains and low spare capacity could, in a positive macro scenario, lead to temporary spikes in commodity prices that would impact headline inflation rates and the interest rate trajectory.

The proliferation of wars and conflicts will lead to increased investment in defense around the world. That will be good for the companies that supply the armies but bad for the governments that need to fund them. We are particularly interested in seeing the choices made in the EU. Given slowing economies, high debt levels, high taxation, but low investment in defense, can they step up at this moment without creating credit fears in some countries by bond market vigilantes? In addition, higher interest rates are being passed onto consumers and businesses, which may pressure their ability to repay their loans. After the tailwind of higher interest margins in 2023, the financial sector faces the potential of higher credit losses.

* * *

While these cross-winds create exciting opportunities for active investors, what most excites us is finding the gems that will prosper no matter what. The entrepreneurs whose life mission it is to create a much better solution for their customers and the passion to bring their solution to as many customers as possible. The “square pegs in round holes”. Our team studies the innovators closely and monitors their progress continuously. We find many good entrepreneurs that provide incremental improvements. Once in a while, we find odd thinkers that upend assumptions and offer unique value propositions. If customers start to flock to their company with enthusiasm, we know we have a gem on our hands. At a sensible price we are buying.

 

Human nature doesn’t change. We see this in the multiple cases of fraud, stock-promotions, and serial offenders we research on the short side. We have resources 100% dedicated to this and will continue to update you throughout the year of our investments there. I hope you find these insightful. Some of the stories seem eerily similar even though they come from different geographies and industries. The one thing we can bank on for 2024 is that more frauds and stock promotions will present themselves. Human nature will continue to tempt too many down that path.

* * *

We wish you a prosperous 2024. We are energized for the new year and grateful for your trust in us on this journey. Don’t hesitate to contact us to learn more.

Sincerely,

Pedro Ramos

Cyxtera Technologies

Dear Investor,

 

We hope you are enjoying a good summer with time for rest, recovery and connection with family and friends. Despite the rally in the market this year, the Somar team has found good short opportunities. This month we bring you one example.

Cyxtera Technologies

Cyxtera Technologies operated as a global data center operator providing colocation and interconnectivity services to more than 2 800 companies worldwide across 61 different data centers in 28 countries. The company was acquired by private equity in 2017 and went public via reverse merger with the SPAC Starboard Value Acquisition Corp on July 21, 2021. We came across Cyxtera a year after it hit the public markets and found several red flags in its financials and its business model. We judged its excessive leverage put it at risk of bankruptcy. Somar covered the position after Cyxtera filed for bankruptcy.

Cyxtera business consisted of renting space in data centers and subleasing it to its customers. Additionally, the company offered interconnection services for its customers to establish fast, convenient, affordable, and highly reliable connections to their preferred network service providers.

The company was strategically trapped with no profitability nor growth at a sub-scale position. Its sales of $700mn paled in comparison to its peers’ $4bn and $6bn. To make matters worse, Cyxtera was losing market share: its sales stagnated between 2018 and 2021 in a sector growing high-single digit to mid-single digit. Cyxtera’s operations were subpar, and it consistently reported operating losses, vs. 20% margins for its peers. Naturally, the company struggled to generate cash to sustain such high debt levels.

Cyxtera was also vulnerable to its high customer concentration. Lumen, its top customer, represented 11% of revenue. The top 20 and 50 customers represented 42% and 55% of the company’s recurring revenue. Lumen had already indicated that it was not going to renew its contract in 2025. Comments gathered from customers and employees suggested Cyxtera was providing a deteriorating quality of service.

Rising energy costs pressured its margins as Cyxtera was only able to pass 90% of the extra expenditure to customers. Starting from a low level of cash generation, this hurt its finances. With most of its debt at variable interest rates, Cyxtera faced growing interest expenses which put further strain on liquidity.

The company’s high leverage limited management options. Interest paid consumed 80% to 85% of cashflow from operations. With debt to adjusted EBITDA at 14.6x, Cyxtera’s only source of extra funds would have to be dilutive equity issues.

Management’s resort to using creative metrics was a concerning sign. Cyxtera reported “transaction-adjusted EBITDA”, a made-up metric that excluded several cash expenses (for example around $75m excluded in 2021).

 

One of Cyxtera’s private equity owners, Medina Ventures, was involved in a similar underperforming deal in the sector. Manuel Medina, Medina Ventures General Partner, was the CEO of Terremark, another data center operator. Its stock price was flat from 2005 to 2010, and in 2010 generated negative free cashflow of $95M. In 2011, the company was sold to Verizon, which divested Terremark in 2016.

 

Our scenario analysis suggested the company had to accelerate its revenue growth (despite losing its largest client) over the next 10 years, ramp its operating margins to best-in-class for Cyxtera to even have a positive equity value. To reach the $6 dollar stock price that the market was attributing to Cyxtera, the company would need a revenue CAGR of 11% for the next decade, with unprecedented operating margins of about 40%.

We will spare you the details of the last few months which included desperate measures such as sale-and leasebacks of the last-owned assets, attempts to convert to REIT and to raise dilutive rounds of capital. Eventually, the creative destruction gale of capitalism took its path and Cyxtera was forced to close doors and let their more efficient and better managed competitors take their customers.

 

This case study illustrates a current source of good short ideas: zombie highly-levered companies that have been able to muddle along due to the prolonged period of zero-interest rates. As these debts come due and need to be refinanced at higher rates, creditors and shareholders are thinking hard of whether to double down or throw in the towel and close operations. While it is Somar’s practice to cover once most of the profit has been made, sometimes the deterioration is so fast that affords us the opportunity to hold the position until the filing.

* * *

We hope you are having a restful break. We look forward to continuing to hear from you in the weeks and months ahead.

Sincerely,

Pedro Ramos

On Holding

Dear Investor,

On Holding

Hopefully by the time you read this letter you will either be on vacation or have one or more weeks penciled in for the near future. Let me suggest you add On shoes to your luggage. Please let me know your thoughts.

Started by professional athletes, some of them Olympic athletes, and with a differentiated shoe focused on performance, On is the fastest growing large sports shoe company in the world. It has two innovative patents that significantly improve their performance versus competitors: air pockets that reduce the impact while running and an inner metal plate that facilitates forward motion at the take-off phase of your running stride. Starting in track, On has expanded into hiking and tennis, after adding Roger Federer as an investor, consultant, and ambassador (amazingly Roger called them first).

Most businesses have demand as the bottleneck to growth. Not On. The company sells all the shoes it can manufacture and has been growing at more than 50% per year for the last 7 years. Mass consumer products like this are rare (Tesla and iPhone in the early days for example).

While not an athlete myself, I’ve participated in a few runs and triathlons over the years. With age and weight gain, I have come to appreciate the importance of a good shoe to prevent injuries and long recoveries. I found some improvements with quality running shoes, but nothing in the ballpark of the improvement I got after I tried my first On. I’m embarrassed to admit that I only tried them as part of Due Diligence on the company IPO. But that experience surprised me. It was the largest step up in performance compared to anything I had tried before. Additional calls to other consumers provided confirmation of my experience. Finally, a few friends of mine who had family members go through orthopedic procedures told me the surgeons suggested using On shoes during the recovery period. So Somar decided to do a deep diligence on the company

We found it was an early challenger in the $300 Bn Global Sports shoe market. This market is growing fast, in the high single digit range. With a little less than 1% market share, On has plenty of opportunity to grow.

On is an authentic performance brand. Designed and built by athletes for athletes. Nike challenged Adidas in its earlier days with the same strategy. However, both Nike and Adidas, along with Puma, Hoka, Veja and others are currently more focused in marketing to streetwear junkies and cultural influencers (for example, the Adidas collaboration with Kanye West) than to focus on improving product performance. This leaves a fantastic opportunity for On. They have extended from track into tennis through its investor and partner Roger Federer and recently by signing world number 1 female player: Iga Swiatek.

Other adjacent opportunities will follow as the company builds its capacity to serve them. Their patents have also provided them with a differentiated product since day one.

Modelling the company with similar margins to its peers and conservative expansion assumptions provided with an inherent value of multiples of what On was trading in the market for. It is worth noting that the company has been profitable almost from day one, despite its strong growth and expansion investments.

Our adverse scenario that led to less than 20% downside on the investment, involved a strong deceleration of growth and weaker margins than the competitor. A situation in which the current enthusiasm for the product would die off immediately and the company’s current premium pricing would not be sustainable.

Balancing the risk-reward, the investment was quite attractive, and we bought a medium position and added to it on weakness. Our on-going due diligence suggests the thesis is well on track with almost no shoes ever going on sale (and if they do, only very limited quantities and in odd sizes) and a noticeable expansion in the number of people wearing the shoes in NYC.

This year, the market started to recognize the value of the company and the stock has about doubled. We still see significant upside ahead and believe that if management continues to execute, On could be a powerful compounder of wealth for Somar investors for at least the next decade. We will keep updating you on it.

I hope you find the time to rest, recharge and enjoy the company of friends, family, and nature in the summer months. If you get bored, please give me a call. It’s always wonderful to talk to our investors about the opportunities we see.

Sincerely,

Pedro Ramos

Somar Anniversary

Dear Investor,

Somar Anniversary

Somar’s anniversary is a good time to take stock of what has been accomplished and what remains to accomplish in the years ahead. When I think back to our first day, I realize how much we have improved: we have a better team, a wider and more attractive opportunity set, a crisis-tested operational team, and more investors than when we started. Our alpha generation is improving, well-illustrated by last month’s production of alpha and positive returns in both our long and short books

As a Portfolio Manager I have grown a lot over the past few years. Having faced scenarios unanticipated by many, such as Brexit, Covid, Trade de-coupling and sharp interest rate increases, I have been able to keep our risk under control and in many cases add significant alpha with the dislocations available. I look to the future with open-eyes and confidence in turning so-called “unprecedented” scenarios into prosperity opportunities for Somar investors.

Over the past few years, I have trained our analyst team comprised of hungry, talent-heavy, and opportunity-starved rising stars from the elite universities of my native Portugal. They have proved very focused, hard-working, and insightful analysts. One specializes in short investments. Others specialize in focus industries for Somar.

The institutional setup of public equity investing has made the market more inefficient in the emerging entrepreneurial public companies. The rise of passive investment has drained active investment dollars into large cap stocks by design of market capitalization-weighed indexes. Most large active managers launched cross-over funds to invest in private fundraising rounds ahead of potential IPOs. We welcome the reduced competition on our opportunity set and believe will serve us well in the next few years.

Institutional investors love fresh-thinking, performance-focused and nimble emerging managers. But they worry about their firm’s risk and operational failure. The team at Somar has answered those concerns conclusively. We faced wide market swings, a pandemic and sharp interest rate swings without missing a beat. For an external observer, our operations could even be classified as “boring”. The trains run on time, the trades clear, the cash matches. Every day. Every year. Our risk controls identified all types of attacks: phishing, impersonation, over-charging. I couldn’t be prouder of our operation team.

There is not a single day of my work that I don’t think of our investors. I’m incredibly grateful for their trust and I will be forever loyal to them. We have the investors we need to get Somar to where we dream. We will continue to grow organically by compounding capital. While we are still accepting additional capital, we will stop accepting it far before the level we feel could in any way be detrimental to Somar’s returns. Our investors have been loyal throughout the years. I will not forget this.

A final confession I make with some hesitation. I like to under-promise and over-deliver. But I feel our performance so far doesn’t reflect the quality of our work and the opportunities we have. Some of you are familiar with the way public markets work and understand this. Last Christmas, I mentioned to some of you how Meta was selling for mid to high-single digit multiple of its earnings. A clear example of how low valuations can get in public markets. Since then, Meta’s stock has more than doubled. As a member of the socalled FANG group of stocks, Meta is widely followed by analysts. Our long portfolio includes names that we believe will be the Meta of 5 to 10 years from today. They have less coverage. They can be ignored and discounted even more than Meta. I see well more than 10 companies today in this situation. This gives me confidence that our returns will improve in the years ahead.

It has been a good journey so far. But I am confident the future will be even better. Nothing will make me happier than sharing those fruits with you

Sincerely,

Pedro Ramos

Year in Review

Dear Investor,

Year in Review

With a few days left in the year, and a decent December so far, we feel comfortable to say that Somar had a good 2023 in both process and performance. Our team worked well to uncover attractive long and short opportunities, and we were able to offer double digit returns to our investors.

2023 was especially prolific in short idea generation. We were short a few banks that declared bankruptcy in the year. We also found a few new stock promotions and some stock frauds that allowed us to have a good year on the short side.

On the long side we came into the year with an attractive portfolio that performed well. Some beaten down names like On shoes, JTC, and DoorDash started to rally strongly off the lows. But we believe these companies’ potential is way above what they have so far achieved. We found a few additional new ideas that we may write to you about in 2024. Overall, this makes us pleased about 2023 but even more encouraged for 2024

I would like to thank the Somar team who worked tirelessly all year. We originated top ideas both long and short, managed risk well, served our partners promptly and kept our operations at the level of firms several times our size. We are in a good position, and we look forward to continuing this trajectory in 2024 and beyond.

2023: main trends by industry

In the financial markets, the year was marked by the so-called “Magnificent 7”. As of this writing, these 7 firms (Apple, Microsoft, Microsoft, Tesla, Meta, Alphabet and Nvidia) were up close to 50% for the year while the remaining 493 companies of the S&P 500 returned high-single digits. The Magnificent 7 rally was spurred by enthusiasm around AI, and the efforts of some to reduce costs and become more efficient. Surprisingly, the largest gain in market capitalization in the group (more than $1 trillion for Apple) was for the only company that neither announced AI projects nor reduced costs (and had declining sales). So thematic investing is still alive and well in financial markets.

Other industries also experienced major changes throughout 2023. We will give a one or two sentence description of most, to keep this letter short, but please reach out if you want to discuss further.

The banking sector was under pressure at the beginning of the year due to the impact of rising rates on their fixed rate, mostly public debt securities. A few banks went bust, most notably Silicon Valley Bank and Signature Bank. Credit growth slowed as mortgage demand collapsed with the sharp rise in rates. While non-performing loans steadily increased, no sharp increase in write-offs materialized as the US economy was able to avoid a recession. European banks fared better on the security side due to slightly lower rate raises and less exposure to fixed rate assets, and a little worse on non-performing loans due to the stagnation in Germany and other core EU economies.

The energy market went sideways. While demand grew at the top end of forecasts, supply also surprised on the upside as US production, augmented by growth in Brazil and Guyana, kept markets well supplied. Despite the geopolitical instability and China’s exit from Zero-Covid, we had relatively stable energy prices which helped keep a lid on inflation and consumer confidence in the western world.

Travel and other consumer services continued their post-Covid recovery. Retailers continued to benefit from the re-opening, while online retailers experienced better growth as secular trends reassert themselves.

Highly promotional and over-funded VC consumer companies either folded or significantly reduced their operations. This has allowed the leaders and incumbents to restore their margins and restore sales growth. This trend seems sustainable in the medium term, as fundraising from VCs and exits through IPOs hit multiyear lows.

The passage of the CHIPs Act, Inflation Reduction Act and the commitments to energy transition imply an investment in infrastructure that does not seem to be priced in, in the financial markets. Renewable forms of energy have lower density than fossil fuels and will require strong investments in grid and production infrastructure. This, together with the different bill of materials needed for electric vehicles, will require the usage of certain materials such as copper and lithium to grow by multiples. In addition, the strong investment in the training and development of new AI models will lead to a strong growth of the energy needs of data centers that some estimate will be equivalent in the US to the current annual consumption a middle-sized European country like the Netherlands. This is an ambitious, capital-intensive project. Not many of these are likely to yield attractive returns, and they are likely to be inflationary. That said, one of the privileges of being an investor is finding and partnering with those entrepreneurs that invent ways to do more with less, solve complex problems and deliver on societal aspirations with high returning private enterprises.

Ozempic and similar weight-loss GLP-1 drugs took the world by storm and crowned Novo Nordisk as the most valuable European company. While this is a sector we don’t invest in, we are inspired by the innovation and hope further advances in AI, CRISPR, and other biotechnologies will continue to improve the health and life quality of the world.

Great investment returns compounded over several decades create hard to fathom results. That is the mission of Somar. And while we devote wholeheartedly to the multi-decade return, the lifespan of all of us is beyond our control. So, we root that 2024 brings all of us health, and more novel cures and advances to extend the span of quality lives for all of us.

* * *

We wish Happy Holidays and a healthy, happy, and prosperous 2024. Don’t hesitate to contact us to learn more about our approach.

 

Sincerely,

Pedro Ramos

Short Illustration: Fisker

Dear Investor,

 

Short Illustration: Fisker

Fisker was another electric car startup led by dishonest promoters, with the wrong strategy and limited execution capabilities challenging a highly competitive market. The company went bankrupt in 2024. Somar shorted the stock several times with the latest trade in 2024 when we delivered an almost 50% return to our investors.

 

Henrik Fisker is a car designer who made a name for himself while at BMW and later at Aston Martin. He later had a short stint at Tesla and left due to disagreements with CEO Elon Musk. He then decided to launch a competing company and this first venture offered a view into his character.

Fisker Automotive, Fisker’s first electric vehicle (EV) venture, was founded in 2007 and went bankrupt in 2013. During its life it produced only 2,400 cars. During this process, the company lied to the US government to get a half a billion dollar loan, outsourced its battery production to a failing Chinese company and failed to live up to Henrik Fisker’s commitments leading to multiple lawsuits, a judge claiming Mrs. Fisker was not a credible witness due to conflicting testimonies, Mr. Fisker claiming 10,000 firm orders when only 750 had been received, promising the state of Delaware to hire 2.5k employes and only hiring 2 among other shenanigans. Henrik Fisker blamed his investors for the venture’s failure.

In 2016, Henrik launched a new company: Fisker Inc. This time he brought on-board both his wife (CFO) and daughter (Chief Marketing Officer). Unfortunately, this second try would end the same. It had an uncoherent and shifting strategy, poor operational execution, accounting shenanigans and an extremely well-funded and aggressive group of competitors.

From the outside it was hard to determine what the company’s strategy (if any) was. It started out promising to develop a hybrid luxurious sedan, but then pivoted to an all-electric SUV. It also announced it would target the lower-income consumers with prices lower than $50k. The company would only design the car with sales done directly to the customer on its website.

 

However, when the company finally presented its prototypes and started taking orders, it priced its models at: $37k, $50k and $70k. These competed directly with models from Volkswagen, Chevy, Hyundai, Audi, BMW, among many others. More concerningly their price/performance ratio compared poorly with models already in production by Tesla.

Other worrying signs of the leadership ethics (other than their past) were their easily disproven claims:

  • Fisker would use solid-state batteries: the technology is still not yet in prototype let alone production;

  • Management would take minimal wage to reduce cash burn: after selling $20mn of stock to buy an LA mansion;

  • Saying car was ready to launch while reports from insiders that the software was not working.

Given the strategy, woeful execution, high competition, and management lies, Somar was counting on Fisker running out of cash as being the catalyst for our short investment. Due to the SPAC listing, Fisker started its life as a public company with almost $1Bn in cash. Our analysis suggested this cash would bleed fast as production ramped up unless management was able to keep the stock price high to issue additional shares. It would depend on the commercial success of the vehicle and Somar collected data before building a position.

There were several early signs that our thesis was correct:

  • Fisker increased deposits asked from customers from $250 to $5,000, a clear sign of liquidity issues;

  • A widely followed car reviewer deemed Fisker the worst car he had ever reviewed;

  • Reports of software problems in the vehicle leading to limits in top speed and sudden car stops;

  • Multiple customers returning their cars for refund.

At the start of 2023 Management guided for 42.4k cars produced and 8% to 12% gross margin. If true, this would significantly reduce the company’s cash burn. Our analysis indicated this was not even close to reality. We started shorting the company.

What happened:

  • Fisker produced only 10k cars and sold only 4.9k cars;

  • Gross Margin was significantly negative: -35%;

  • The company lied initially reporting positive 7.5% gross margin and later had to restate this after going through 3 different Chief Accounting Officers in one month;

  • The company quietly raised more than $300mn of equity to repay a convertible bond offering.

Meanwhile their competitors, most notably Tesla, continued to report strong growth and cash generation in the same segment and increased our confidence that there was no place in the market for the Fisker offering. We shorted several times during the period. Our return in 2024 was almost 50% as we covered a few days before the company declared bankruptcy.

* * *

The team always enjoys hearing from you and updating you on our progress. We are finding excellent opportunities both on the long and short sides. Don’t hesitate to contact us to learn more about our approach.

Sincerely,

Pedro Ramos

bottom of page