Precursor | January 2025 Update
"Any contrarian knows that just as a grim present is usually precursor to a better future, a rosy present may be precursor to a bleaker tomorrow." - Seth Klarman
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THE MONTH | The Fund’s NAV was led down 3.18% in January by the best two performers of the prior month, IMB and IXU. There was no negative news flow, just the ebb and flow of trading in stocks that are not deeply liquid. The stocks that did advance did so with positive quarterly cash flow reports released during the month.
The last five months have been disappointing. The Fund’s NAV progressively advanced to be +17.5% at the end of August 2024 from its low point of June 30, 2023, while the market environment remained difficult (the S&P/ASX Emerging Companies Index was +5.4%). But the Fund is now only 4% above that low (Emerging Companies Index +12.6%). The greatest drag was Spacetalk (SPA; share price -49% in that period), which has subsequently rebounded +66% in February after announcing loan refinancing and its financial results. Behind that came MedAdvisor (MDR; share price -58% in that period), which disappointed the market with its guidance for lower year-on-year revenue in the December half but in our view remains a valuable company with a near-monopoly in Australia and a material opportunity in the US.
SMALL TALK | We profiled IMB on the back of its refinancing news.
OUTLOOK | We have witnessed generally positive profit reporting for periods ending December 31, 2024. There have been huge swings on the back of results announcements by large and mid cap companies on high valuation multiples - but less volatility among smaller stocks. The most immediate risk for the Fund is its investment in Scout Security (SCT), which has faced a funding dilemma since the ASX intervened in its recapitalisation plan in 2024.
MONTHLY PORTFOLIO REVIEW
Water treatment technology company De.Mem (DEM) reported $533k operating cash flow for the December quarter - its second consecutive positive quarter, resulting in cash flow positivity over the full calendar 2024. DEM said it had a “strong outlook for CY 2025”, with 90% of cash receipts being recurring in nature.
Online pet services business MadPaws (MPA) achieved positive cash EBITDA and operating cash flow in the December quarter. Operating cash flow was $1.73m, including a working capital gain from pet sitter liabilities (excluding that gain, MPA said the result would have been +$0.3m). MPA held $3.99m cash at balance date, with a $2m facility drawn. “As we enter the second half of FY25, we are well-positioned with strong momentum across our core businesses and $1.9 million remaining in SWM [Seven West Media] media contract to further accelerate our growth,” MPA said.
Security monitoring company Intelligent Monitoring (IMB) banked $9.76m EBITDA in the December quarter on $42m revenue. Operating cash flow was $6.55m pre-one-offs or $0.49m after those expenses. IMB reaffirmed its FY25 earnings guidance of >$38.0m adjusted EBITDA, before the impact of any acquisitions. IMB said it “has a significant acquisition pipeline that continues to grow”. It held $26m cash and $81.7m in drawn debt, with “debt refinancing proceeding according to plan” - and subsequently executed its refinancing in February.
RegTech gambling company Ixup (IXU) said net cash outflow from operations for the December quarter, when adjusted for non-recurring one-off cash outflows was $0.8m, consisting of the $2.3m outflow recorded in the quarterly report prior to normalisations and then +$1.5m for one-off non-recurring items related to investments in cost base reductions and a re-balancing of working capital. IXU said its current cash position ($2.74m at quarter end) is expected to be sufficient to fund this transition to positive cashflow, subject to current expected contract delivery.
Last month we wrote about Scout Security (SCT - Equitable’s Martin Pretty is a non-executive director) and the very real funding risk it faced. There has been some investor support despite the ASX having handicapped its 2024 recapitalisation by suspending it without setting out what needed to be done to come out of suspension for many months. It is continuing to work to execute on the synergistic acquisition of fellow DIY security tech business Roo Inc that was announced late in CY2024 and raising capital.
MONTHLY PORTFOLIO CHANGES
The Fund picked up shares in cybersecurity business Senetas (SEN) in January. SEN has since announced a transaction that we think has not been fully appreciated by the market. In addition to its 100%-owned core encryption business, SEN owns a diluted 55.7% of Votiro Cybersec Global, which has agreed to sell its business to a privately-owned US group for $US37.5m (~$A60m). As we understand it, the Votiro vehicle has $13.7m of debt in it to repay, so the net equity value to SEN would be $A26 - plus the $A9m loan SEN made to Votiro as part of the $13.7m total debt. SEN’s market cap is ~$38m currently - and the $3m gap is probably covered by its cash position (which is obscured in its accounts by consolidation of Votiro’s financials). On our numbers, that leaves SEN’s operating business - which achieved $1.3m EBITDA and $1.9m net profit in 1H25 - essentially for free (although there is a deferred component and an equity component in the Votiro sale that one might discount).
WHAT’S ON OUR MINDS
M&A
So far in the current quarter there has been $US14 billion worth of transactions in Australasia, compared with $US16.8b for the full March quarter of 2024.This follows a 34% increase in Australasian M&A spend in CY2024, in USD, according to dealogic. There has been a regular flow of transactions involving small-to-mid cap ASX-listed companies.
Liquidity
Trading in the S&P/ASX Emerging Companies Index remains well below the peak dollar values of 2022 (34% below the peak 12 month period, which ended April 2022) but up 21% year-on-year, using the 12 month trailing trade value in the Emerging Companies Index as a proxy for micro and small caps.
Private market valuations
Private markets continue to slowly adjust to changes in the cost of capital that have occurred over the past few years. Despite marketeers labelling private assets as low volatility, there is underlying volatility in the pricing of private assets AND correlation with public markets.
Companies valued at >$US500m experienced “down rounds” when IPOing (Reddit and ServiceTitan), noted PitchBook,
Discounts in secondary market fund trading ranged between 60% and 70% of NAV in early-stage and late-stage venture funds in CY 2024, according to Lazard. For private credit the pricing was 76% to 86% of NAV.
But in US secondary markets for VC-backed companies, on average, the ZX Index Values for January 2025 were in-line with the last round price per share, the narrowest margin in the last 24 months; with an average bid-ask spread of 11%.
Our private Investments
A key lesson for us when investing in unlisted entities has been the importance of having adequate influence with the investee. When problems arise, exiting private investments is often not an option. But if we can influence the actions taken in response, we can push for the best possible outcome.
“Recap” risk and opportunity
Australasian equity capital raising activity has continued to gain momentum - up 44% in CY2024 (as measured in USD by Dealogic) and up 90% year-on-year in early CY2025, thanks largely to the Goodman Group capital raising. IPOs remain scarce.
We analysed quarterly cash flow reports for the June quarter of 2024 and found over 262 companies with no more than four quarters of cash funding at hand based on their most recent burn rates - and also 95 companies in net debt positions that reported negative operating cash flow. With these companies competing for new capital, there is a funding risk for existing investments that are not self-funding at this stage. The situation is also an opportunity for investors to apply bottom-up, fundamental research and engage constructively with companies to provide them with capital on attractive terms.
Interest rates & inflation
Interest rates remain low by historical standards (see 700 years of declining rates charted here). Increasing signs of softness in the economy has led the Federal Reserve to begin cutting rates in the US in September 2024. The Reserve bank of Australia (RBA) has followed suit in February 2025 but uncertainty remains regarding central bank policy. Shifting market sentiment regarding the extent to which interest rates could decline will influence the market in the short term.
Energy
The world is going to need all forms of energy to sustain or further advance standards of living. “Electricity demands from AI data centres are outstripping the available power supply in many parts of the world” already, reported Bloomberg. Dragonfly Fund does not invest in the resources sector directly but we do seek opportunities to participate in the energy economy.
Applications to invest in Equitable Investors Dragonfly Fund can be made online with Olivia123.
10k Words | February 2025
The AI theme is taking up greater share of S&P 500 market cap than previous growth “bubbles” while fund managers’ cash holdings are at 15-year lows. US valuations have left Europe in the dust but sustainable high growth is scarce; and there is healthy debate over whether US valuations stack up (and on Morningstar’s numbers Australian stocks are more overvalued than US peers). It is reporting season in Australia and the final week of February will be big. Be careful what you take away from it though - it seems CEO sentiment is not a reliable indicator. Meanwhile, US consumers are showing some distress in the form of credit cards 90+ days in arrears. There has been an uptick in non-performing personal loans and home mortgages as a % of bank assets in Australia too. With coffee bean prices surging, meanwhile, it is good to know the bean is only ~11.5% of the price of a cup of coffee.
Dragonfly Fund has the capability to "swap" shares in a company or companies for Dragonfly Fund units where Equitable Investors finds them attractive and suitable investments. If you have a stock in your bottom drawer that we might be able to do something with, please reach out. NOTE to date we have used this capability sparingly, rejecting all but a very small number of proposals, but we continue to seek favourable opportunities.
Want to catch up?
If you are interested in learning more, please get in touch via mpretty@equitableinvestors.com.au and we will be pleased to arrange a meeting.